Valspar Corp. Q2 2008 Earnings Call

May.13.08 | About: The Valspar (VAL)

Valspar Corp. (NYSE:VAL)

Q2 FY08 Earnings Call

May 12, 2008, 11:00 AM ET

Executives

Lori A. Walker - Sr. VP and CFO

William L. Mansfield - Chairman and CEO

Analysts

David Begleiter - Deutsche Bank Securities

Robert Koort - Goldman Sachs

Jeffrey Zekauskas - J P Morgan

Donald Carson - Merrill Lynch

D. Silversteyn - Longbow Research

Steven Schwartz - First Analysis

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Valspar Second Quarter Conference Call. Further conference only participant lines will be in a listen-only mode; however, there will be an opportunity for your questions and instructions will be given at that time. [Operator Instructions]. As a reminder, today's call is being recorded.

With that being said, I would like to turn the conference to Ms. Lori Walker, Senior Vice President and Chief Financial Officer. Ms. Walker, please go ahead.

Lori A. Walker - Senior Vice President and Chief Financial Officer

Good morning everyone and welcome to our second-quarter earnings conference call. Bill Mansfield, Chairman and CEO is with me on our call this morning. A couple of brief comments before we begin. First, I would direct your attention to the press release we issued this morning, which contains much of the information that we'll be covering in the call. Also a reminder that in our comments this morning, we will make statements that reflect our current views and estimates about our future performance and financial results. These comments are based on certain assumptions and expectations that are subject to risk and uncertainties. Our Form 10-K filing lists, some of the most important risk factors that could cause actual results to differ from our predictions.

This morning, I will cover our second quarter results. Bill will make a few comments about our outlook for the rest of the year and then we will get to your questions.

I'll start with the review of the quarter. We turned in a good performance for the quarter; essentially our results were right in the line with our expectations. Second quarter sales totaled $836.4 million, up 3.5% from last year, primarily result of increased sales from acquisitions and currency. Adjusting for these two items sales were down 2.6%. Our packaging, coil and general industrial product lines all performed well. However, we continue to see weak demand for architectural and wood coating these products due to the decline in the U.S housing market.

Net income for the second quarter was $40.8 million. Second quarter adjusted net income per share was $0.41 in 2008 and $0.40 in 2007. Excluding non-cash adjustments of $0.03 and $0.05 per share respectively, for Huarun minority interest shares. In 2007, second quarter net income was $41.5 million; second quarter reported earnings per share was $0.38 in 2008 and $0.35 in 2007. Our gross margin was 29.2% down 1.3 percentage points from the second quarter of 2007. The decrease is due to higher raw material cost, partially offset by pricing. Operating expenses were 20% of sales, down 0.9% from 20.9% in 2007 due to tight control of expenses. The tax rate for the second quarter was 34%. We now expect the effective tax rate for the full year to be 34% to 34.5%, due to the geographic mix of earnings outside of the U.S. We do expect some volatility in our effective tax rate from quarter-to-quarter due to the adoption of 1048.

During the quarter we repurchased 1.1 million shares, average shares outstanding were down $3.2 million from a year ago, with the decline related to the 1.85 million shares we repurchased during the first half of 2008, and 2.596 million shares that we repurchased last year. Average shares outstanding were a 100.2 million for the second quarter and are projected to be approximately the same for the third quarter. Recapping our sales performance, we reported 3.5% growth in the quarter. Our core growth defined as volume price mix was down 2.6%, primarily reflecting negative volume, currency added 3.7% and acquisitions added another 2.4%.

Looking at our segment result, coating segment sales increased 9% and were basically flat when adjusted for currency and acquisitions. Sales performance in both our packaging and industrial product lines was good, with packaging in particular showing excellent strength. Paint segment sales declined 4.4% and we are down mid-single digit when adjusted for currency and acquisition.

Our other category which includes resins, colorants, gelcoats and our furniture repair business was down about 1% and declined about for same when adjusted for currency and acquisitions.

The EBIT margin for our coating segment was 10% for the quarter, basically flat with the second quarter of 2007. As a reminder, coating accounts were approximately 60% of the company. Paint segment EBIT was 9%, down from 11.1% in 2007. The EBIT margin for our other category which includes corporate expenses was 3.5%, compared with 3.3% last year. Total company EBIT margin was 9.1% for the quarter down from 9.7% in 2007.

Moving to the balance sheet, total debt at the end of the second quarter was $1.113 million, up $96 million from the end of last fiscal year. The increase is primarily due to acquisition and share repurchases. We are now estimating that year end debt for fiscal year 2008 will be in the range of $950 million to $975 million. This is up from the year end estimates we gave during our first quarter call reflecting our share repurchases during the second quarter. Our total debt-to-capital ratio at the end of the second quarter was 43.9%, with net debt-to-capital at 42.1%.

Capital spending in the second quarter was $9.2 million, down from $19.8 million in the second quarter of 2007. Our forecast for capital spending for the full year is now approximately $45 million, down $15 million from the estimate we gave during our first quarter call. Depreciation and amortization for the quarter totaled $19.9 million, up from $17.8 million in the second quarter of 2007. Our full year forecast for depreciation and amortization is approximately $80 million.

So, with these comments on the numbers, I will now turn the call over to Bill.

William L. Mansfield - Chairman and Chief Executive Officer

Thanks Lori and good morning everyone. Thank you for joining us on the second quarter call. As you read in our press release this morning, we had lowered our guidance and now expect earnings for the year to be in $1.55 to $1.65 per share range.

Let me give you some context on what has changed. We have seen an increase in raw material cost that has accelerated beyond our prior expectations. Quite frankly none of us anticipated that oil would be trading in excess of $125 a barrel, driving feedstock and energy cost significantly higher. We are now anticipating a 5% to 8% increase in our raw materiel cost for the year, and that's up from the 3% to 5%, we previously had been forecasting.

We started our pricing actions last November and given the recent acceleration in material cost, we have initiated additional pricing actions. The majority of the $0.10 drop in our full year guidance will occur in the third quarter. We expect our third quarter performance to be below last year. This is because of the lag between the latest increase in material cost and the impact of our additional pricing actions. Our fourth quarter is expected to be slightly above last year's reported results.

Now, let me turn to some of the actions we have taken in addition to pricing, to improve our operations. We continue to prudently control costs. Today, our headcount in the U.S is 6.5% less than it was six months ago and our discretionary spending on items other than employment cost is down 10% year-over-year. As Lorie mentioned earlier, our operating expense for the second quarter was 20% of sales, and we expect expenses at 20% of sales for the reminder of the year based on our actions. We are using Lean Six Sigma to drive productivity in the corporation. These projects will help to offset the financial impact of lower volumes on our manufacturing cost structure, particularly in the U.S.

Our capital spending was down more than $10 million for the quarter, and will be down 40% year- over-year. Our spending is targeted on maintenance and productivity improvements, and even in those end markets where we are seeing some weakness, we are generating new business both at existing customers and new costumers.

Before we get to your questions, let me give you give me an overview of what we are seeing in our business segments. In our coating segments, the performance of our global packaging business is quite good with sales for the quarter up mid teens following a similar performance in the first quarter.

We are growing in all geographic regions and market segments and when adjusted for currency the business is up mid single digits. Our core product line is showing remarkable strength. The business in the U.S is holding up quite well. We are gaining new business in both the U.S and international markets and we are benefiting from the synergies and growth provided by our acquisitions. We do anticipate that end market demand for coal coatings to the U.S may moderate over the next year and that dynamic is built into our guidance.

In our general industrial coatings product line, we've gained new business in the U.S that has offset weak demand and we are seeing good growth in markets outside the U.S. As we have said in previous calls, our wood product line in the U.S has been weak for sometime. However, continuing weakness in U.S housing has further negatively impacted our export business in China. I want to be perfectly clear on this point. I am not talking currently about our Huarun business in China. Our Huarun business is doing very well. What I am talking about, however, is the historic Valspar business where we supply furniture coatings for furniture that is exported back to the U.S. That business has been further negatively impacted by continued weakness in U.S housing.

We have actions underway that will be completed by the end of May and result in a 15% reduction in our cost structure for our export furniture coatings wood business in China. The cost and the benefits of this reduction are contemplated in our guidance. Our coatings segment which accounts for approximately 60% of the company is doing well, with the one exception being our wood product line, where we are aggressively reducing our cost structure. With regard to our paint segment, you may recall from our first quarter teleconference, that we expected the architectural paint market in the U.S to be down about 8% in 2008, similar to the markets 2007 performance. The market for architectural paint is tracking as expected. However, we believe we are outperforming the market. This is because of our branding initiative, and a growing strength of our Valspar, Cabot and Huarunbrands. We continue to invest in our brands to build long-term shareholder value. This investment has made us a stronger company.

Finally, we expect a free cash flow, which we defined as operating cash less CapEx and less dividends, so we expect free cash flow to be approximately $100 millions better in our '08 than last year which was our '07.

So, with those comments, I will open the call up for your questions.

Question And Answer

Operator

[Operator Instructions]. And our first with the line of David Begleiter with Deutsche. Please go ahead.

David Begleiter - Deutsche Bank Securities

Thanks, good morning.

William L. Mansfield - Chairman and Chief Executive Officer

Good morning. David.

David Begleiter - Deutsche Bank Securities

Bill, could you detail the gaps between prices and raw materials either in Q2 and Q3 or what you expect for full the year?

William L. Mansfield - Chairman and Chief Executive Officer

We would expect David if you take in the comments where we expected to rate to revenue on expenses to stay pretty much what it is for the balance or what it was in the second quarter approximately 20% for the balance of the year. What that implies is our gross margin will be under some pressure in the third quarter, but we would expect to see recovery during our fourth quarter.

David Begleiter - Deutsche Bank Securities

And when do you think that gap could close in your favor?

William L. Mansfield - Chairman and Chief Executive Officer

Probably in the... not probably for the full fourth quarter, but certainly for the perhaps in the October period, and then we see it moving in our favor starting in beginning of '09.

David Begleiter - Deutsche Bank Securities

And last thing some of the new business gains you discussed in general industrial, where they're occurring exactly and how large are they?

William L. Mansfield - Chairman and Chief Executive Officer

Well, David what I would tell you is that in the U.S, the U.S economy clearly has shown signs of slowing down. Our folks have been able to offset a core shrink or a reduction in the core business with gains in new business. And I'm quite pleased with their performance. Outside the U.S, however, our business is growing organically both in response to more quickly growing economies and the fact that we are able to bring our technology to bear to grow share outside the U.S.

David Begleiter - Deutsche Bank Securities

Thank you.

William L. Mansfield - Chairman and Chief Executive Officer

You are welcome.

Operator

And next question from the line of Robert Koort with Goldman Sachs.

Robert Koort - Goldman Sachs

Thanks very much. Good morning.

William L. Mansfield - Chairman and Chief Executive Officer

Good morning Rob.

Robert Koort - Goldman Sachs

Well do you... is this becoming any easier with this constant threat of inflation to raise prices from a process standpoint. I don't mean in terms of your customers being anymore less agreeable, but if you have been able to change the way you introduce price hikes to make little easier or no?

William L. Mansfield - Chairman and Chief Executive Officer

Ithink I would answer that question in a contrast. If I look back to 2005, when we went through significant raw material inflation; our process is much quicker. It's a more rapid process that is responding quicker. Now having said that you are right in terms of the customers still have their opinions. I would also tell you that this is double edged sword. Number one, there is a clear understanding that particularly in the U.S, we are importing inflation and our customers are seeing their trucking cost as an example to go up, they are seeing their energy cost go up, and so there may be a little more understanding not to be confused with agreement, but that's the positive side of the sword. The negative side of the sword in my opinion is it starts down the path to institutionalizing inflationary expectations and expectations. But for the general economy that's a worry.

Robert Koort - Goldman Sachs

And then if could ask you, you mentioned the paint markets, there are texture markets weak this year, they were weak last year, I think over the last two years that erosion in demand has set us back may be a decade in terms of total gallons sold in the U.S? Assuming there is a light at the end of this tunnel, what kind of response will you expect back to trend line? Can we see a rapid recovery or are we going to be just be plugging away a sort of the historical 3% to 4% type rates?

William L. Mansfield - Chairman and Chief Executive Officer

This is my opinion. I will not certainly say this is opinion of our customers. It might be, but I am unsure. I would tell you that I don't expect a rapid recovery. I think what we are going through now is the deflation of an asset bubble [ph] and I think that in early '09 we will get back to the long term trend line.

Robert Koort - Goldman Sachs

Thank you so much.

William L. Mansfield - Chairman and Chief Executive Officer

You are welcome.

Operator

Our next question is from the line of Jeffrey Zekauskas with J P Morgan. Please go ahead.

Jeffrey Zekauskas - J P Morgan

Hi, good morning.

William L. Mansfield - Chairman and Chief Executive Officer

Good morning Jeff.

Jeffrey Zekauskas - J P Morgan

A few questions, what was cash flow from operations for the first half?

William L. Mansfield - Chairman and Chief Executive Officer

Cash flow from operations for the first half, we haven't calculated it exactly so it's an estimate it's about plus $65 million.

Jeffrey Zekauskas - J P Morgan

Plus 65?

William L. Mansfield - Chairman and Chief Executive Officer

From last year.

Jeffrey Zekauskas - J P Morgan

Second in your coatings operation, I think in the first quarter you were up about 14%? And so, there was a deceleration in the second quarter. What really decelerated from the first quarter to the second quarter? Was that consolidated, was that coatings volumes?

William L. Mansfield - Chairman and Chief Executive Officer

In our coatings segments, segment, Jeff, we have a number of product lines including the wood coatings product line. And so, I would tell you that most of what we saw in the second quarter in deceleration had to do with what I mentioned before about a further deterioration in the Asia furniture coatings business.

Jeffrey Zekauskas - J P Morgan

Right. And forgive me if you said this already. Did coatings volumes or, did coatings volumes grow in the quarter?

William L. Mansfield - Chairman and Chief Executive Officer

Give me a second, Jeff.

Jeffrey Zekauskas - J P Morgan

Thank you.

Lori A. Walker - Senior Vice President and Chief Financial Officer

Jeff, they grew a little bit in the second quarter.

Jeffrey Zekauskas - J P Morgan

Little bit in the second quarter, okay. And in the, in paints a lot of your competitors are kind enough to give same-store sales growth. I know that you know, Lori's [ph] always expanding its stores and there is a little bit of Huarun in there. But can you give an idea of what same-store sales growth is like in that area?

William L. Mansfield - Chairman and Chief Executive Officer

I really cant, I hesitate, we don't own paint stores. I think the people that you are referring to own certainly, one in particular owns an awful lot of paint stores and I think others do also. I hesitate to comment on what our customer stores performance are.

Jeffrey Zekauskas - J P Morgan

Is the raw material price inflation going up faster in coatings or in paints?

William L. Mansfield - Chairman and Chief Executive Officer

I would tell you it's pretty much across the board. I wouldn't differentiate one segment, versus another.

Jeffrey Zekauskas - J P Morgan

Okay. And then lastly in terms of when you go to the big box retailers to get price relief, can you do that, you know, in the course of the next few months or you have to wait until this time next year. How does the timing of price increase work there?

William L. Mansfield - Chairman and Chief Executive Officer

I can you tell you in this environment it is a continuing discussion item and it's not a process that has a specific point in time. These discussions have been ongoing for long time.

Jeffrey Zekauskas - J P Morgan

Okay. Well, good luck.

William L. Mansfield - Chairman and Chief Executive Officer

Thank you, Jeff.

Operator

Our next question is from line of Don Carson with Merrill Lynch. Please go ahead.

Donald Carson - Merrill Lynch

Yes, thank you. Bill you mentioned that you have a same outlook for the U.S architectural market down 8%, but are you seeing mix shifts there either shift away from contractor to DIY, which would help the big box, or within the big box are you seeing any shift down in price points? And then finally, I'm just wondering what impacted inventory reductions by your customers have versus actual end market demand?

William L. Mansfield - Chairman and Chief Executive Officer

Okay, let me deal with the first question. We seen no trend if you will, not even data points would indicate any shift between contractor and DIY, one way or the other. In terms of trading down in price points, no, nothing... in fact last year we saw exactly the opposite and at least in terms of our mix, we continue to see that. We look to our branding initiative and the marketing behind our brand is contributing and helping with respect to the potential trading down. I'm sorry, what was your third point, I forgot.

Donald Carson - Merrill Lynch

I was just wondering about...

William L. Mansfield - Chairman and Chief Executive Officer

Inventory?

Donald Carson - Merrill Lynch

Yes, inventory versus end market weakness, what... how much inventory reductions by customers would have contributed to your volume weakness above and beyond just general soft end markets?

William L. Mansfield - Chairman and Chief Executive Officer

I would tell you that number 1, our customers inventories appear to be in reasonably good shape as we view them today. What we did experience in our second quarter however, is during the month of April last year in '07, we had an extraordinary month. We'll leave it at that. And our sales were quite strong. Subsequent to April of '07, our customers blood down inventory. We have not seen that phenomenon this year. Our April sales were right inline with what we would say was prudent and correct for end market demand. But, they were below last April, because we saw a substantial increase in sales as a result of our customers loading in inventory; that did not happen this year.

Donald Carson - Merrill Lynch

Okay. And then one question on Ross [ph], the leading acrylics supplier has been trying to move to indexing their prices to raw material changes; is that something you think the trade in Valspar in particular would be willing to accept?

William L. Mansfield - Chairman and Chief Executive Officer

That's the question that I cannot answer for obvious reasons suffices to say that, that should be really interesting discussions with that unnamed supplier going forward.

Donald Carson - Merrill Lynch

Okay, thank you.

William L. Mansfield - Chairman and Chief Executive Officer

You are welcomed Don.

Operator

And next from the line of Dmitry Silversteyn with Longbow. Please go ahead.

D. Silversteyn - Longbow Research

Good morning.

William L. Mansfield - Chairman and Chief Executive Officer

Good morning.

D. Silversteyn - Longbow Research

I have two questions; number one, can you give us an idea of when we can begin to see the cost saving initiatives and cost reduction initiatives in wood coatings start flowing from the P&L line?

William L. Mansfield - Chairman and Chief Executive Officer

That's probably a fourth quarter issue. We will have a number of the actions completed by the... if not all of them completed by the end of May, but we will have some bleed through of our cost associated with that during the third quarter. So, full impact will be felt to our fourth quarter.

D. Silversteyn - Longbow Research

Okay, I am assuming that's part of your guidance of expecting fourth quarter to be up year-over-year in terms of earnings.

William L. Mansfield - Chairman and Chief Executive Officer

Correct.

D. Silversteyn - Longbow Research

Okay. Secondly in pricing, obviously you can go into lot of details, but can you give us an idea of... I understand it's difficult pricing everywhere; but where is it easier to get prices versus markets, where you basically are running up against a brick wall in terms of packaging general industrial, coil, wood, architectural. Could you just give us some flavor for how the pricing power across your portfolio spends currently?

William L. Mansfield - Chairman and Chief Executive Officer

That is a very difficult question to answer for about 15 different reasons. I can tell you it's not easy anywhere.

D. Silversteyn - Longbow Research

Right.

William L. Mansfield - Chairman and Chief Executive Officer

But if I go back to the per-answer I gave to a question, I think our customer have some understandings of the pressure we are under, and I think I need to leave at that. It's fair to question, but very difficult to me answer.

D. Silversteyn - Longbow Research

Let me narrow this down then. Is it... are you still having pretty robust, relatively speaking pricing power in packaging and there is pockets of pricing power in industrial and can you give us an idea what's going on in architectural, obviously not with your big box retailers, but maybe with some of your small private stores.

William L. Mansfield - Chairman and Chief Executive Officer

I probably would give you answer and draw your attention to the relative operating margin for performance of the two segments, and I think that would give you really good indication.

D. Silversteyn - Longbow Research

Fair enough. Okay.

William L. Mansfield - Chairman and Chief Executive Officer

Thank you Dmitry.

D. Silversteyn - Longbow Research

No problem. Just a final question if I can on purchases.

William L. Mansfield - Chairman and Chief Executive Officer

Sure.

D. Silversteyn - Longbow Research

Is it possible that you will be accelerating share repurchases going forward. I know you have expanding order sort of speak and secondly would you prefer to do share repurchases versus acquisitions or do you expect to continue to be active in the acquisition front?

William L. Mansfield - Chairman and Chief Executive Officer

Let me start with the third point, first. Acquisitions have been a key part of our strategic for a long time and they continue to be. Color and this kind of economic environment as you might expect were being very, very prudent; there are opportunities. We look at them and if we find the rate strategic fit, we would move forward. Having said that, also in today's environment, where our share price has been in our opinion significantly under pressures and perhaps undervalued, we felt that our shares were better use of cash for a situational period of time than acquisitions. We have a 4 million share authorization; Lori mentioned we have got some. So, we have an open authorization 2.1 million shares for the balance of the year and we will just have to see how the year unfolds and what the situations are with respect to any further use of the authorization.

D. Silversteyn - Longbow Research

Okay, all right. Thank you.

William L. Mansfield - Chairman and Chief Executive Officer

You are welcome, Dmitry.

Operator

[Operator Instructions]. And we got the Steven Schwartz with First Analysis. Please go ahead.

Steven Schwartz - First Analysis

Good morning all.

William L. Mansfield - Chairman and Chief Executive Officer

Good morning, Steve.

Steven Schwartz - First Analysis

Bill, just some small ones here; what was the... last year you had a tough comp or this year you had tough comp because of paint. Last year an auto refinish, right? I think in the first and second quarters?

William L. Mansfield - Chairman and Chief Executive Officer

Yes.

Steven Schwartz - First Analysis

You had higher volumes. Could you estimate how many basis point impact that may be had this year by not having that?

William L. Mansfield - Chairman and Chief Executive Officer

I can't, but I can give you a little color and you are right, we did have a strong automotive refinish two quarters last year because of this transition from water to solvent and customers stocking up if you will on the solvent product. That transition from through water based automotive coatings is a very difficult transition for the market. We are not the only ones, who are experiencing difficulties. I would tell you it's a pretty much of a market observation and consequently that has some further impact on the business.

Steven Schwartz - First Analysis

Okay, and then in all other your EBIT margin improved slightly; what is different about that part of the business and albeit a small. But what's different there that allows you to improve your margin whereas obviously you weren't able to do that in the other areas?

William L. Mansfield - Chairman and Chief Executive Officer

I'll let Lori answer that one, Steve.

Lori A. Walker - Senior Vice President and Chief Financial Officer

Yes, Steve, in all other you end up with those smaller businesses that's all the corporate expenses set in all other. And so you are going to think see swings quarter-to-quarter based on the seasonality of the smaller businesses that are in there and lets the cost reduction on our corporate expense levels that type of things. So, you are going to see it fluctuate typically in the first quarter, it's negative and then it's slightly positive to slightly negative than the second, third, fourth quarters.

Steven Schwartz - First Analysis

Okay, great. Thank you.

William L. Mansfield - Chairman and Chief Executive Officer

You are welcome, Steve.

Operator

And with no further questions in queue, Mr. Mansfield, I'll turn it back to you for any closing comments.

William L. Mansfield - Chairman and Chief Executive Officer

Okay, thank you. Just to summarize, we are implementing additional pricing actions as I've said before. We expect the weakness in the U.S. markets to continue, but expect the markets outside the U.S. to continue reasonably strong. Our international sales currently account for 40% of the company's total. We are managing the company for very difficult economic conditions keeping tight control on all costs and driving productivity improvements. We continue to take costs of our wood business particularly in Asia. We are gaining new business to offset weak end market conditions in the U.S. particularly in our general industrial business.

Our packaging business continues to do well as does our acquisitions. And in architectural paints, we believe we are outperforming the market, and the strength of our Valspar, Cabot, and Huarun brands are growing. And then finally; as I mentioned, we expect free cash flow as we defined it to be approximately $100 million better than last year.

And with those closing comments, I thank you for your interest in Valspar, and we look forward to speaking with you again in mid-August at our third quarter conference call. Thank you all, and have a good day.

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.

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