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Sherwin-Williams Co. (NYSE:SHW)

Q3 2007 Earnings Call

October 23, 2007 11:00 am ET

Executives

Chris Connor - Chairman and Chief Executive Officer

Shaun Hennessy - Senior Vice President of Finance and ChiefFinancial Officer

John Ault - Vice President and Corporate Controller

Bob Wells - Vice President Corporate Communications

Analysts

Armando Lopez - Morgan Stanley

Anthony Petaneri - CitiGroup

Eric Bosshard - Cleveland Research Company

Peter Thompson - Coho Partners

Chuck Cerankosky - FTN Midwest

Jeff Zekauskas - JPMorgan

Saul Ludwig - KeyBanc

Greg Goodney - UBS

Tim Isaac - Bear Stearns

Robert Follis - Gabelli & Company

Operator

Good morning. Thank you for joining the Sherwin-WilliamsCompany's review of the Third Quarter 2007 Financial Results and expectationsfor the Fourth Quarter and Full Year.

With us on today's call are Chris Connor, Chairman and CEO.Shaun Hennessy, Senior VP, Finance and CFO. John Ault, Vice President andCorporate Controller and Bob Wells, Vice President Corporate Communications.

The company has provided information regarding the thirdquarter and first nine months financial results. Business segments sales andprofits, balance sheet items and selected statistical data an their website,www.sherwin.com, under Investor Relations third quarter press release. Pleaseaccess this to supplement comments made on this call.

This conference call will include certain forward-lookingstatement as defined under U.S. Federal Security Laws with respect to sales,earnings and other matters. Any forward-looking statement speaks only as of thedate on which such statement is made and the company takes no obligation toupdate or revise any forward-looking statements, whether as a result of newinformation, future events or otherwise.

A further declaration regarding forward-looking statementsis provided in the company's release transmitted earlier this morning. Thiscall is being webcast simultaneously in listen-only mode via the Internet at www.sherwin.com.

An archive replay of this webcast will be availableapproximately two hours after this conference call concludes. It can beaccessed at www.sherwin.com and will be available until Friday November 9th,2007 at 5:00 p.m. Eastern Time. After the company's opening remarks we willopen this session to questions.

I will now turn the call over to Bob Wells.

Bob Wells

Thank you, Joe. I'll begin by summarizing overall companyperformance for 2007 versus third quarter 2006. Consolidated net salesincreased 3.8%, $2.2 billion. Primarily due to acquisitions, strong domesticpaint sales to commercial and industrial maintenance markets and stronginternational paint sales.

During the third quarter, we completed four acquisitions,which combined with M.A. Bruder & Sons and Nitco Paints acquired earlierincreased third quarter consolidated sales by 2%.

Consolidated gross profit increased by $52.6 million for thequarter to $988.4 million and gross margin increased 80 basis points to 45% ofsales. Selling, general, and administrative expenses decreased slightly to30.5% of sales in the quarter to 30.7% last year, due primarily to tightspending controls.

For the quarter, interest expense, net of interest andinvestment income was $15.2 million compared to $10.3 million last year dueprimarily to an increase in debt during the quarter.

Consolidated profit before taxes for the third quarterincreased $17.6 million or 6.4% to $294.3 million. This improvement wasachieved despite a net increase of $13 million in net interest expense andother general and other expense net from higher environmental provisions andcurrency-related losses that were partially offset by increased gains on thesale of assets during the quarter.

Our tax rate for the quarter was 31.9% compared to 35.3% inthe third quarter of '06. We expect our effective tax rate for the full year tobe slightly higher than our year-to-date 2007 rate of 32.4%.

Consolidated net income for the quarter increased by $21.2million or 11.9% to $200.4 million. Net income as a percent of sales improvedto 9.1% in the third quarter this year from 8.5% last year due primarily toimproved operations.

Diluted net income per common share for the quarterincreased 19.2% to $1.55 per share compared to $1.30 per share in the thirdquarter 2006. Acquisitions reduced diluted net income per common share for thequarter by $0.02 cents per share.

Looking at our results by operating segment. Sales for ourpaint stores group increased 3.9% to $1.4 billion in third quarter 2007.Comparable store sales, that is sales by stores opened more than 12 calendarmonths were essentially flat in the quarter, compared to third quarter lastyear.

During the quarter Paint Stores segment completed the acquisitionof Columbia Paint & Coatings, a 41-store chain of specialty Paint Stores inSpokane and Washington. The acquisition combined with M. A. Bruder acquiredearlier in the year, increased Paint Stores Group sales by 2.7% in the quarter.

In addition to the growth from acquisitions, we saw someimprovement in domestic architectural Paint sales to do it yourself customersand residential repaint contractors and continued strong commercial andindustrial maintenance product sales. Regionally in the third quarter, our MidWestern Division lead the sales performance followed by Eastern, Southwesternand Southeastern. All four divisions achieved stronger sales results in thequarter compared to a year ago.

Segment profit for the group increased 9.6% to $248.4million for the quarter. Operating margin increased to 17.7% from 16.8% lastyear due primarily to tight expense control and gross margins recovering to amore normalized rate. In the consumer group for the third quarter 2007, salesdeclined $5.5 million a reduction of 1.6% to $349.4 million.

This was due primarily to continued soft DIY demand at mostof the group's retail customers. During the quarter, Consumer Group completedthe acquisition of VHT, a line of high temperature coatings and premium aerosolproducts.

This acquisition had no affect on segment sales or profitsin the quarter. Consumer segment profit increased $3.9 million or 6.4% to $64.1million in the quarter. Segment profit as a percent of net external salesincreased to 18.4% from 17% in the quarter last year primarily due to tightspending control and improved manufacturing direct conversion cost.

Turning to our global group for the third quarter '07, netsales in U.S. dollars increased $32.9 million or 8% to $444.9 million. Statedin local currency, sales grew by 4.5% in the quarter due primarily toarchitectural and automotive paint volume gains in South America and improvedproduct finishes sales in most markets.

The second quarter acquisition of Nitco Paints and the thirdquarter acquisitions of Napco, a protective coatings company based in Mexicoand Panturist Industrially (ph) a paint company in Europe, increased globalsegment net sales in U.S. dollar by 1.6% in the quarter.

Segment profit for the global group increased $5.3 millionor 12.4% to $48 million in the quarter. Segment profit as a percent of netsales improved to 10.8% from 10.4% last year. This improvement was mostlyattributable to increased sales, improving operating efficiencies related toadditional manufacturing volume, and expense control.

I'd now like to comment briefly on some of our balance sheetitems. Our total debt on September 30th, 2007, was $960.7 million. Short-termborrowing increased $380.6 million to $656.4 million compared to third quarterlast year.

Total borrowings to capitalization were 34.2% at the end ofthe quarter versus 27.5% at the end of third quarter 2006. Long-term debt tocapitalization was 14.2% at the end of the third quarter this year compared to19.7% last year.

Our cash balance at September 30, 2007, was $21.2 millioncompared to $400.4 million in 2006. Over the past year we have used this cashand the increase in short-term borrowings to retire $200 million in long-termdebt, fund acquisitions, purchase treasury stock and provide seasonal workingcapital. During the third quarter the company acquired 5.55 million shares ofits common stock on the open market.

In the third quarter 2007, we spent $33.9 million on capitalexpenditures; depreciation expense was $35.5 million and amortization expensewas $6 million. For the full year 2007, capital expenditures will beapproximately $160 million below our earlier estimate of approximately $180million.

A significant share of these capital expenditures will gotoward investing in new stores, additional plant capacity and continuedspending to upgrade our manufacturing facilities and replace plant and storeequipment as necessary.

Depreciation will be about $130 million for the year versus$123 million in 2006. An amortization will be $24 million versus $23 million in2006. I'll conclude this review with a brief update on the status of our ledlitigation. In Rhode Island, the defendants appeal to the Rhode Islands SupremeCourt is progressing slowly.

The transcript of the lower court trial was delivered to theSupreme Court and a scheduling conference should take place in the near futureto determine when briefs will be filed and when oral arguments will be heard.

In the abatement proceeding, the lower court judge haselected to interview potential candidates for the position of special master.We expect these interviews to occur in the coming weeks. In Ohio, all of theremaining lawsuits are now active and motions to dismiss have been filed.

You might recall from our second quarter comments that threeof the eight remaining Ohio municipal suits had been stayed along with theattorney general's suit pending the state's Supreme Courts ruling on senatebill 117, a bill designed to clarify Ohio's product liability law.

The Supreme Court upheld the validity of senate bill 117,but gave opponents of the bill until November 1st to gather the signaturesneeded to put a recall referendum on the 2008 ballot. The stay in the city ofColumbus attorney general suit has been lifted, and that case will begin movingforward. A motion to dismiss will be the first issue to face the court.

In Wisconsin, the Thomas case, a single plaintiff suitbrought on behalf of a minor child is in trial the plaintiff has concluded itscase and the defendants have just begun putting theirs on. The trial isexpected to re-conclude in early November.

That concludes my review of the quarter so I'll turn thecall over to Chris Connor who will make some general comments and highlight ourexpectations for the balance of the year. Chris?

Chris Connor

Thanks, Bob and good morning everybody. Thanks for joiningus today. The third quarter of ‘07 was a solid quarter for the Sherwin-WilliamsCompany in many ways. We generated record sales, earnings and cash flow for thequarter. We completed four important acquisitions as Bob mentioned. Wecontinued to expand our controlled distribution platform domestically as wellas abroad, and we purchased 5.5 million shares of our stock.

We’re pleased by to the improvements and consolidated netincome and earnings per share performance that we’ve reported for the quarter,up 12% and 19% respectfully. This morning, however, I want to take a fewminutes to highlight the profit performance of our operating segments duringthe quarter. Because I think, this clearly demonstrates the underlying strengthof our business model and the earnings power of our company.

Combined segment profit for our three reportable segmentsincreased by almost $31 million more than 9%, and the sales improvement of 3.8%.Sales from acquisitions, which were slightly diluted earnings contributed 2% ofour total 3.8% increase in consolidated sales.

Clearly our operating segments are hitting their stride interms of managing expenses and maximizing our profit flow through. All threesegments posted strong operating margin increases for the quarter and werecovered an additional 80 basis points of consolidated gross margin. We stillanticipate our consolidated gross margin for the year will be up more than 100basis points over last year.

Importantly, the hard work our operating segments have doneto improve our profitability has come at the same time that we've continued toinvest in strengthening our capacity for future growth.

During the third quarter, our paint store segment opened 29net new stores and added 41 new stores through the acquisition of Columbiapaint and coatings. During the first nine months of 2007, paint stores groupopened 59 net new stores and acquired 172 for a total increase in store countof 231 stores.

Our commitment to control distribution extends beyond NorthAmerica. Our global group also opened seven new stores and branches during thequarter. And that brings our total year-to-date 26 new facilities.

We continue to make progress in our management of workingcapital as well from the third quarter, although our working capital ratio,accounts receivable, plus inventories, less payable, for 12 month sales,increased to 14.4% for the quarter compared to 13.1% for the third quarter of2006.

The acquisitions of M.A. Bruder, Columbia paints, Nitcopaints, Natco in to us account for this increase. Year-to-date we've generated$563.6 million in cash from operations compared to $537 million for the sameperiod last year, an increase of more than $26 million in that operating cash.

As I mentioned at the beginning of my remarks, one of theways we've been using our cash is to purchase our stock on the open market.Year-to-date we've purchased over $10 million shares.

On September 30, 2007, we had remaining authorization topurchase approximately $2.6 million shares of the company stock. On FridayOctober 19th, our Board of Directors cancelled this remaining authorization andapproved a new share repurchase authorization for 30 million shares.

This action by the Board prepares management to maintain ourconsistent, long-standing practice of being an opportunistic buyer of our stockon the open market in the years to come.

Also at this meeting, our Board declared a regularlyquarterly dividend of $0.315 per share compared to $0.25 last year continuingonce again our long-standing record of paying out 30% of prior year's earningsper share and marking our 29th consecutive year of increased dividends.

Looking ahead we expect our consolidated net sales for thefourth quarter to increase 5 to 6% over the fourth quarter of 2006. For thefull year 2007, we expect sales to increase in the low single-digits over 2006.

Based on that level of annual sales growth, we have raisedour expectations for diluted net income for common share for the year to arange of $4.70 to $4.75 per share compared to $4.19 per share last year.

This change in our outlook for the year is a reflex in bothof strength of our results in the first nine months and our confidence that weare well positioned to manage through the challenges that lie ahead in thefourth quarter and beyond.

Planning for 2008 is currently in progress and we will beprepared to provide you with sales and earnings expectations for next yearduring our year-end 2007 conference call.

Again, I'd like to thank all of you for joining us thismorning, and now we'd be happy to open the lines for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from ArmandoLopez with Morgan Stanley. Please go ahead with your question.

Armando Lopez - Morgan Stanley

Hi, good morning everyone.

Chris Connor

Good morning Armando.

Armando Lopez - Morgan Stanley

Just a couple of quick questions, I guess first on the CapExcoming in lower than expected, could you maybe just talk a little bit moreabout what the variance around that is?

And then second, in terms of the full year guidance of $4.70to $4.75 that seems like it would imply $0.80 to $0.85 fourth quarter, whichwould suggest a slowdown in the margin acceleration from the second and thirdquarter, if you could just talk a little bit about that?

Chris Connor

Why don't I ask, Sean Hennessy to comment on our Cap Exnumber. Sean.

Sean Hennessy

When you take a look at Cap Ex, Armando. We had a fewprojects that we were planning in land purchases that we've pushed out and oncapacity and that's really the main reason why our Cap Ex is going to be alittle lower this year.

Armando Lopez - Morgan Stanley

Okay. So will that show up, then, next year? Or is it justlike postponing it a year?

Chris Connor

Yeah, I think, that is as we watch the volume as we take alook at those things. Eventually they will spend that money, but we don'tthink, we didn't want to spend the money before we really needed to.

Armando Lopez - Morgan Stanley

Okay.

Chris Connor

And on the margin compression, I guess, $80 to $85, we'reseeing at $4.70 to $4.75. I think when you take a look at a lot of differentthings that are moving around in that quarter, I think our segments will be alittle compressed in one or two of the segments. But I think, for the full yearwe're going to show nice margin improvement in the three segments.

Armando Lopez - Morgan Stanley

Okay. And thenjust one last one, in terms of the 30 million authorization for the buyback.

Chris Connor

Yes.

Armando Lopez - Morgan Stanley

Is there a timeframe that you're expecting to work through?

Chris Connor

No, I don't think so. As we’ve said, this is consistent withour practice. Two years ago we received 20 million authorization from theboard, two years before that 20 million authorization. So this is just part ofour normal policy using excess cash to be opportunistic in the market.

Armando Lopez - Morgan Stanley

Okay. Thanks a lot. Nice quarter, guys.

Chris Connor

Thanks Armando.

Operator

Thank you. The next question is from P.J. Juvekar withCitiGroup. Please state your question.

Anthony Petaneri - CitiGroup

Hi, this is Anthony standing in for P. J.

Chris Connor

Good morning, Anthony.

Anthony Petaneri - CitiGroup

Good morning. After looking at results from value spar andPPGX, so we've had a lot about residential weakness creeping into commercialconstruction and industrial order books. Could you comment on any deteriorationor softness you're seeing on industrial end markets?

Chris Connor

Sure, we’ll be happy to. Our commercial and industrialactivity held up well in the third quarter. Fairly consistent with the samebuying levels that we've seen throughout the calendar year 2007. Kind of salesand earnings guidance that we've given for the fourth quarter assumes that samekind of market performance going into the fourth quarter.

We would comment that for the industry, in calendar year2006, these commercial industrial markets were growing more robustly perhaps inthe double-digit range. And they have slowed down in '07. You know, theindustry forecasting, perhaps, even a little slower in '08.

But we continue to believe this will be a positive segmentfor our company and we expect to make progress here.

Anthony Petaneri - CitiGroup

Great. Great. And just following up, I mean, when you lookat the industrial end markets, if you look at auto or marine are theresub-segments where you're seeing particular strength or particular weakness? Oris it…?

Chris Connor

Yeah. Anthony, I think that probably the strongest segmentthat we’re seeing is in industrial maintenance coatings. Not any particular enduser segment, but in general the protective finishes for Steel And Concretehave been very strong.

Anthony Petaneri - CitiGroup

Okay. Great. Thanks, guys.

Operator

Thank you. The next question is from Eric Bosshard withCleveland Research Company. Please state your question.

Eric Bosshard - Cleveland ResearchCompany

Good morning.

Chris Connor

Good morning, Eric.

Eric Bosshard - Cleveland ResearchCompany

Two questions. First of all, from a bigger pictureperspective, because when you came into the year you talked, I guess relativeto the beginning of the year you're going to end up earning $0.10 or $0.15 moreon sales there probably 4 or 5 points lower than what you had planned cominginto the year. Can you just explain, how you're making more money with weakersales?

Chris Connor

Yeah. Eric, I think, part of the processes that we gothrough here with our management teams are to react to the markets environmentthat we face. And if you look at our SG&A expense.

Particularly, we're really proud of the job our team hasdone to get that in line to see a lot of this slowing come ahead of time andpulled in. And the margin performance has also been strong for the company.

Eric Bosshard - Cleveland ResearchCompany

Within the gross margin performance, which you've done agood job on all year, is there anything you highlight that you've been able toaccomplish within that year during the year to create that upside?

Chris Connor

Well, the two inputs to gross margin, both played a rolehere. First, pricing, and our ability through our controlled distributionplatform to get the necessary pricing over time has been indicated over thelast several years I think our team did a nice job, did well this year. And inthe raw materials input cost while we think for the industry is going to be upagain this year, year-over-year.

We would comment on our team's job in managing through thatas best as possible. So, on both sides of that, we've been able to make someprogress this year.

Eric Bosshard - Cleveland ResearchCompany

And second question on the raw material issue. Clearly those(inaudible) in the last 30 or 60 days, the world is changing. Can you commentabout what your expectation is in terms of the industry's raw material costgrowth this year and sort of how you're thinking about positioning the businessin light of that as we move towards 2008?

Chris Connor

Yeah. I think the raw material input for calendar '07 andthe third quarter, we saw continued to go up probably another 1 to 2% for theindustry. And I think we're moving our guidance up a little bit. We had talkedabout it being in the low single digits, maybe flat to up to 3%.

It's our opinion now that the industry would see around 2 to4% raw material cost increase for this calendar year '08, it's a little earlyfor us Eric, yet to give guidance or pulling all those numbers together andwe'll be happy to comment on that on our first quarter call

Eric Bosshard - Cleveland ResearchCompany

And then just last, you commented earlier about commercial,but can you talk about the momentum of the business, September, October,indicated a commercial may be a little slower. But are you seeing things getbetter, get worse, stay the same? Can you give us a little sense on it?

Chris Connor

No. Guidance were given for the quarter for sales in the midsingle digit range, which will be slightly better than what we've been able todo this year. It's been built pretty much the way that our years come togetherwith the Stars Group performing in the mid single digits and our global alittle bit higher and our consumer segment flattish.

And the role that the commercial, industrial accounts areplaying in that store's business particularly, have been consistent. So, Iwould say there's really no significant change in the direction of what we'reseeing from our revenue.

Eric Bosshard - Cleveland ResearchCompany

Okay. That's great. Thank you.

Operator

The next question is from Chuck Cerankosky with FTN MidwestSecurities. Please state your question. I'm sorry; the question is from PeterThompson with Coho Partners. Please state your questions

Peter Thompson - Coho Partners

I’m sorry. I just had a one quick one for you if it ispossible. Can you say how much you spent on the 5.5 million shares you bought?

Chris Connor

Sure, Sean -- but in the …

Sean Hennessy

Yes, the average price was $67, spent approximately $360million.

Peter Thompson - Coho Partners

Okay. Can I just ask you one strategic question just on your-- on the Global Group? Could you just comment on kind of where you guys,you’re thinking that's going over the like three to five years?

Chris Connor

Yeah, I think the Global Group will continue to be a strongdriver for us. We have given guidance that we expect it to grow at a highsingle digit, low double digit over the foreseeable timeframe that you'rereferencing.

As you know, our strongest presence is in Latin America, andwe've continued to add to that position with some of these smaller acquisitionswe've commented on. And the company has shown an appetite to perhaps expand insome more of the growth markets with recent activities in China and India.

Peter Thompson - Coho Partners

Is auto still being a gain market?

Chris Connor

Our automotive business continues to focus on theafter-market. And they are a significant part of that Global Group. Theyrepresent about a third of those segments, revenue and profits.

Peter Thompson - Coho Partners

Great. Thanks so much.

Operator

The next question is from Chuck Cerankosky with FTN Midwest.Please state your question.

Chuck Cerankosky - FTN Midwest

Good afternoon or good morning, everyone.

Chris Connor

Hi Chuck!

Chuck Cerankosky - FTN Midwest

Hey, Chris! One for you, before I’m going for Sean, andlooking at the DIY demand trends. They seem to be better the stores in thequarter than in the consumer group, any particular reason for that?

Chris Connor

Not particularly. Our retailing partners from our consumergroup pretty much across the Board were feeling some weakness out the door. Ithink that's been borne out by their comments and their calls and releases. Ourstore's business continues to really focus on the high-end DIY customer andable to make some marginal improvements there.

Chuck Cerankosky - FTN Midwest

So, it sounds like it might be consumer segmentation here,quality versus price.

Chris Connor

Yeah. I don't know that I'd go that far. These areparticularly from our store standpoint; it's not a big segment of what happensthere? Was just we had a good quarter.

Chuck Cerankosky - FTN Midwest

Okay. Sean, if we're looking at the $0.02 that acquisitionscost earnings in the quarter. How would you break that down that operatinglosses or financing costs offsetting out and profits from the acquiredcompanies?

Sean Hennessy

I would say 100% operating. As, we have come through, wehaven't completed our synergies and some of the expenses, we've had during theintegration sales, but I would say it's 100 operations.

Chuck Cerankosky - FTN Midwest

When do you think that will flip into the positive?

Chris Connor

I think, second quarter, probably around second quarter ofnext year.

Chuck Cerankosky - FTN Midwest

So that will be more or less a slight drag until then?

Chris Connor

Yes.

Chuck Cerankosky - FTN Midwest

All right. Thank you. Great quarter.

Chris Connor

Thanks, Chuck.

Operator

Thank you. The next question is from Jeff Zekauskas withJPMorgan. Please state your question.

Jeff Zekauskas - JPMorgan

Hi, good morning.

Chris Connor

Good morning, Jeff.

Jeff Zekauskas - JPMorgan

This quarter our year sales grew about 30.8% and you'retalking about 5 to 6% sales growth in the fourth quarter. Where is theacceleration coming? Where is the extra two percentage points of growth comingfrom and why?

Chris Connor

Well, I think, as we commented at the beginning of the year,Jeff. We knew, if the year went on, we have a little bit easier comparables sothat’s playing somewhat of a role here given the fourth quarter then we hadlast year.

Beyond that, I think that, the strength that we've seen inparticularly the paint stores group and global group continues to give usconfidence that we're going to get these numbers.

Jeff Zekauskas - JPMorgan

How much was your gallon went up this quarter or for theyear, excluding acquisitions?

Chris Connor

For the store's group, which is the best place for us tocomment on gallons, we were negative low-single digits in the quarter ongallons. And that's been fairly consistent for the year.

Consumer with negative sales would have been a little bitmore backwards in gallon performance in global group had a probably mid-singledigit gallon volume improvement.

Jeff Zekauskas - JPMorgan

As first Rhode Island goes, so if it turns out that RhodeIsland determines Sherwin-Williams share of abatement cost is I don't know,$800 million? Are we going to see an $800 million cash outflow at a point intime? Or is that not the way to look at it?

Chris Connor

That's way too early to make an assumption regarding, whatthis abatement, if it ever comes to that settlement will look like.

Jeff Zekauskas - JPMorgan

I mean, assuming that that were the number. Is that the wayit would affect Sherwin-Williams funds flow statement that way or would it not?

Chris Connor

Well, the other issue that's unknown to us, at this time,Jeff, is what is the timing mechanism of what an abatement order might looklike in the future. So, if that were spread over a ten-year period or afive-year period, if other parties were brought into it. I just think, it'svery too speculative at this point to comment on that.

Jeff Zekauskas - JPMorgan

Lastly, in terms of raw materials, you spoke about theindustry being up 2 to 4%. I don’t know, it looked like TiO2 prices were downabout 10% and even acrylics were probably down in the first half as well.

Do you think, raw materials are not really moving up thatfast? Or how do you get 2 to 4% increase?

Chris Connor

Jeff, maybe you would like to accept the position as ourChief raw materials procurement agent, if you see a price like that.

Jeff Zekauskas - JPMorgan

That's terrific.

Chris Connor

There is a lot of different components that go into thebasket of raw’s. And certainly, we've seen a pressure this year on the oilderivatives products, their packaging costs, demand for natural gas and energycomponents wherever that factors through has created some input.

So all in, this is the trend that we've been seeing allyear. And as we've gone in the fourth quarter with oil up over into the mid andhigh 80s and even bumping against 90, this is what, we think is going tohappen.

Jeff Zekauskas - JPMorgan

Okay. Thank you very much.

Operator

Thank you. The next question is from Saul Ludwig withKeyBanc. Please state your question.

Saul Ludwig - KeyBanc

All right. Good morning, guys.

Chris Connor

Good morning, Saul.

Saul Ludwig - KeyBanc

A lot of companies are complaining about distribution costand high fuel costs. How bigger deal is that as you ship this heavy materialall over the country?

Chris Connor

Well, Saul. A couple of things. It has negatively affectedus and it has increased our cost of goods sold. We've put it through and youcan see, what happened to our margin. But, also the last couple of years we'vehedged our gasoline purchases for our fleet.

And those hedges have really helped us in the last -- in thefirst three quarters of this year.

Saul Ludwig - KeyBanc

Is this going to be a problem going forward as your hedgesroll over?

Chris Connor

No, because we've layered them. We have layers and we havesome that go out timing wise very well for us.

Saul Ludwig - KeyBanc

Okay. Great. How much did you spend for acquisitions in thethird quarter?

Sean Hennessy

We spent $99 million in the third quarter and make us year-to-date $248 millionyear-to-date.

Saul Ludwig - KeyBanc

How do these businesses lose money? When you don't have toamortize any goodwill, you must to have paid some enormous multiple of EBITDAfor them to be diluted. I'm just trying to figure out how you’re actually havedilution on an acquisition these days?

Sean Hennessy

Well, I think, Saul, when you sit there and take a look attaking care of the customer first, I think that both -- one of this -- onemajor acquisition we did this year was, I'd say, tight on SG&A at the storelevel and taking care of it. Just with timing, putting in some SG&A and soforth. But in the long run, it will be creative in the first full year we haveit.

Saul Ludwig - KeyBanc

Okay. Sean, I can't help but ask about the administrativecost line. We'd be disappointed if you didn't.

Sean Hennessy

Saul, I'll tell you right now, if you will take a look atit, if you take a look at the line for the quarter we're at $66 million versus$53, which is up about $53 million. Really, let me tell you three factors thatcaused that to be a little higher than last year.

We had a $12.5 million environmental provision we took inthe quarter. So, that was in that. Our interest expense was up about $4.7million. That's a little over $17 million. We also sold an asset. We sold thethird jet that we have, and we had a $6 million gain. So, when you put thosethree together between the interest and the environmental and the jet, it'sabout $11 million hit.

Saul Ludwig - KeyBanc

You had another $5million gain. Did you have an $11 milliongain on asset of that?

Sean Hennessy

Right, $5million was in the store's operating segment ofthere was a piece of property from one of the acquisitions we've done a fewyears ago and so that other gain was in the store's operating segment.

Saul Ludwig - KeyBanc

Oh, that wasn't down in other income?

Sean Hennessy

No, it wasn't?

Saul Ludwig - KeyBanc

Within the in the stores so that side of margin of thestores to some degree.

Sean Hennessy

Yes. That helped the margin in the stores, yes.

Saul Ludwig - KeyBanc

Okay. And as we look to the fourth quarter, do we seeadministrative flattening out?

Sean Hennessy

Yes. I think you're going to see flattening outyear-to-date, when you take a look at the $31 million, I know last year-to-dateI talked about benefits costing $14 million and environmental and interestexpense. But For the full year we do see that flattening out (inaudible) Forthe fourth quarter, not the full year? Yes, the fourth quarter…

Saul Ludwig - KeyBanc

All Right. Then also last year in the fourth quarter you hadonly a 22% tax rate. You also had a $16 million legal expense settlement, whichI assume won't reappear. But the tax rate, is this part of the reason in thisyear looking for 33% tax rate, last year a 22% tax rate. Is that an issue inthe lower rate of earnings per share growth?

Sean Hennessy

Yes. If you take a look at it for the full year and thisquarter, as Bob mentioned, our tax rate was in the 31 versus 35. In the firstquarter it flipped the other way. For the full year we feel it will bemarginally higher than last year. You're right, in the fourth quarter we'regoing to have to go over that 22% tax rate.

Saul Ludwig - KeyBanc

Was the $16 million legal expense that you had last year,was that fully taxed? I mean, you got a tax benefit on that?

Sean Hennessy

Not fully, but on the majority of it, yes.

Saul Ludwig - KeyBanc

Okay. And I guess, Chris, you say in the stores relative tothe down 6% of comp store sales, it was write down 2 5% in volume, which wouldapply up 1.9% in price, something like that?

Sean Hennessy

Directly in that's close

Saul Ludwig - KeyBanc

Okay. Great. Thank you, guys.

Sean Hennessy

Thanks, Tom.

Operator

Your next is from Greg Goodney (ph) with UBS. Please stateyour question.

Greg Goodney - UBS

High, guys.

Chris Connor

Hi Greg.

Greg Goodney - UBS

The revenue for store on your acquisition is that part ofthe issue that the stores were slightly dilutive to earnings? Do you expect toget the revenues up to your average, which is, what about a 1.5 million bucks astore? And when would do you that?

Chris Connor

Yes. I don't think the revenue impact at the acquisitionswas part of the operating losses Sean, was commenting on. Our expectations arethat these stores will start to perform closer to our levels in every way. Andit probably takes you around two to three years to get to that run rate.

Greg Goodney - UBS

Okay. How much of a GAAP is there now?

Chris Connor

We wouldn't comment on that.

Greg Goodney - UBS

Okay. Next question. What's next on the M&A front? Isthat going to be it for a while or do you have more things planned?

Chris Connor

Of course we have more things planned. Time will tellwhether we're successful with any of them.

Greg Goodney - UBS

So I shouldn't necessarily assume that M&A is going tominimal and that cash would be used exclusively for share buyback, then.

Chris Connor

I think you can expect us for the remainder of the year aswell as into '08 and beyond we continue to use cash consistent with the way wehave been and we can find a creative acquisitions kind of in the size rangethat we're doing, we're going to make them.

Greg Goodney - UBS

Okay. Thanks, guys.

Chris Connor

Thanks.

Operator

The next question is from Tim Isaac with Bear Stearns.Please state your question.

Tim Isaac - Bear Stearns

Yes. Hi, good afternoon. Thanks for the call.

Chris Connor

Hi, Tim.

Tim Isaac - Bear Stearns

Hi. I was wondering on the lawsuit or the trial and withWisconsin (ph) that you mentioned its will probably be finished by November, isthat can you just give us a little bit more background on what the potentialoutcomes – outcome for that could be in sort of the down sides now?

In other words, I guess if you lost, is that a punitivedamage situation? Or is it a class action status?

You know and what would you need to appeal? Thank you.

Chris Connor

Well Tim, I can't comment prospectively on what the damagesmight be. The suit is a personal injury lawsuit and it is a minor child whoallegedly was affected by ingesting led paint when he was a young child.

And Wisconsin has a somewhat unique interpretation by theirSupreme Court pertaining to risk contribution theory of liability, which is whythis suit is being was brought in Wisconsin but, it is not a class action suit.It is a loan (inaudible) and the pretty straightforward suit in terms ofpersonal injury complaint.

Tim Isaac - Bear Stearns

Okay great and are they alleging a certain amount or is itkind of just is there like a dollar amount they are putting on at this point?

Chris Connor

I don't believe there is. The plaintiff already made arecovery against the property owner.

Tim Isaac - Bear Stearns

Okay.

Chris Connor

Okay so it is time to go after somewhat you're saying?

Chris Connor

Yes.

Tim Isaac - Bear Stearns

Okay. Thank you very much. Congratulations on your quarter.

Chris Connor

Yes.

Operator

(Operator Instructions) Next question is from Robert Follis,Gabelli & Company. Please state your question.

Robert Follis - Gabelli & Company

Hi, guys. Most of my questions have been answered just acouple of quick ones. I guess first if I look at the operating income marginsfor the first three quarters really the highest level you see and

probably the last five, six, seven years.

So, just a couple of questions around that I guess firstly,how much of the improvement

this year would you attribute to I guess operatingefficiencies, cost controls versus pricing above and beyond raw material costinflation?

Chris Connor

I would tell you the we were completed, I wanted to jump inthere to answer, but hopefully you completed your question. But when you sitthere and take a look at our P&L and if you go right down to P&L, ourmargin is up 45 versus 44 year-to-date.

The margin expansion that we've had compared to last year isreally first and foremost, that margin. Secondly as Chris mentioned earlierwhen Eric had that question, our SG&A is only up 4 times we've have beentwo straight quarters or SG&A as percent of sales went down.

When you think about the amount of new stores andacquisitions and so forth and so, that's really goes back to your efficiencies.And I think that for this year, margin is probably 60%, the efficiency is 40.If you look at the long-term and say, okay, now let's look over to five, six,seven years, our gross margin, that 45 year-to-date is back toward the high endof where we were four

years ago.

I'd say 90% of what the margin expansion has really beenefficiencies and sales increases.

Robert Follis - Gabelli & Company

So, would you say that despite what could potentially be anup tick in raw materials as heading to the fourth quarter into 2008, that you'dbe able to at least sustain current margins and then also, as you look as youlook out over the next three or five years. What do you see as the ceiling forthe margins?

Chris Connor

Yes, I think if you look at the short-term, and if we wereto have a raw material increase in calendar year '08, if we were able tomaintain margins, our history, Robert, would indicate that perhaps for aquarter or two or longer, depending on the severity of the increase, we seemargin pressure. But over a period of time we're able to get pricing in themarket and recover those margins.

And over a longer historical period, what we've done, aswe've gone through each of these cycles, as we've come out of it, we've gottenback to our previous high watermark and then actually been able to make alittle progress beyond that.

Kind of the way we think about running the company as we goforward is we would expect over time, with operating efficiencies and continuedhard work that we can keep driving these margins perhaps 10 to 20 basis pointsa year so. There is no upward limit that we've ever established on what we canaccomplish here.

Robert Follis - Gabelli & Company

Okay. So as I look to '08, perhaps some pressure, a littlebit of pressure if raw tick up further. Hopefully you'll make that up as you goalong.

Chris Connor

To you and all the listeners, when we next get together onthe fourth quarter and full year conference call, which will be in the firstquarter of '08, we'll give you all that thinking in terms of what we expect tohappen to raws and how we'll manage to get through that.

Robert Follis - Gabelli & Company

Okay. And then I guess lastly, you've done a great job inthe last three quarters controlling SG&A and bringing you down as a percentof sales. Is this sustainable? As we look forward, do you think you canmaintain this level?

Chris Connor

Yeah. I think it's one of the hallmarks of the company. Ifyou think about it, a significant portion of our SG&A resides in our storeorganization, with 3200 stores. So the ability to manage that, to flex it whennecessary, and, again historically if you look back over periods, this has justbeen something the company has developed a habit and discipline in doing.

So, our expectation going forward is that we will be in thatrange. It may go backwards 10 to 20 basis points, in a given period. But overtime and sustainable we would expect to be in that period or slightly better.

Robert Follis - Gabelli & Company

Okay. Thanks for the help.

Chris Connor

Thank you. The next question is from Saul Ludwig withKeyBanc. Please state your question.

Saul Ludwig - KeyBanc

Just a follow-up on this, the environmental costs which wereso much in the third quarter. As we look to fourth quarter, I don't know, eveninternally how you guys budget that number, but you've got to think about it, Iguess, and make a shot.

Last year you had $6 million in environmental cost in thefourth quarter, year before you had $12.5 million. How should we think aboutthe fourth quarter, recognizing that it may be a mushy number?

Chris Connor

I think it will be lower than last year. Okay. Thank youvery much.

Operator

I'm sorry, there are no questions in queue. I'd like to turnit back over to management for closing comments.

Chris Connor

Thank you, Joe. I will be available all afternoon to answerany follow-up questions you have. I look forward to taking your calls. And asalways, we appreciate you joining us in this morning's call and thank you foryour interest in Sherwin-Williams.

Operator

Ladies and gentlemen, this concludes today's teleconference.You may disconnect your lines at this time. Thank you for your participation.

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Source: Sherwin-Williams Q3 2007 Earnings Call Transcript
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