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Executives

Robert J. Wells - Vice President - Corporate Communications & Public Affairs

Christopher M. Connor - Chairman of the Board, Chief Executive Officer

Sean P. Hennessy - Chief Financial Officer, Senior Vice President - Finance

John L. Ault - Vice President, Corporate Controller

Analysts

Saul Ludwig - Keybanc Capital

Jeff Zekauskas - J.P. Morgan

Robert Felice - Gabelli & Company

John Roberts - Buckingham Research

Jonathan Grassi - Longbow Research

Prashant Juvekar - Citigroup

Amy Zhang - Goldman Sachs

Gregg Goodnight - UBS

Analyst for Ivy Zelman - Zelman & Associates

Eric Bosshard - Cleveland Research Company

Stephen O’Neill - Hilliard Lyons

Matt McGinley - Morgan Stanley

Donald Carson - Merrill Lynch

John Emerich - Ironworks Capital

Analyst for Chuck Cerankosky - FTN Midwest

Sherwin-Williams Company (SHW) Q2 2008 Earnings Call July 17, 2008 11:00 AM ET

Operator

Good morning. Thank you for joining the Sherwin-Williams Company’s review of the second quarter 2008 financial results and expectations for the third quarter and full year. With us on today’s call are Chris Connor, Chairman CEO; Sean Hennessy, Senior Vice President of Finance and CFO; John Ault, Vice President, Corporate Controller; and Bob Wells, Vice President, Corporate Communications.

This conference call is being webcast simultaneously in listen-only mode by VCall via the Internet at www.sherwin.com. An archived replay of this webcast will be available at www.sherwin.com beginning approximately two hours after this conference call concludes and will be available until Wednesday, August 6, 2008 at 5:00 p.m. Eastern Time.

This conference call will include certain forward-looking statements as defined under U.S. Federal securities laws with respect to sales, earnings, and other matters. Any forward-looking statements speaks only as of the date on which such statement is made, and the company undertakes no obligation to update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise.

A full declaration regarding forward-looking statements is provided in the company’s earnings release, transmitted earlier this morning.

After the review of second quarter results, we will open the session to questions.

I will now turn the call over to Bob Wells.

Robert J. Wells

Thanks, Claudia. In order to allow more time for questions, we’ve provided balance sheet items and other selected information on our website, www.sherwin.com, under investor relations second quarter press release.

Summarizing overall company performance for second quarter 2008 versus second quarter 2007, consolidated net sales increased $31.4 million, or 1.4%, to $2.23 billion, due to strong sales by our global group and acquisitions that were partially offset by sales declines in the paint stores group and consumer group.

Acquisitions completed since June 30, 2007 increased net sales in the quarter by 2.4%. Favorable currency translation rate added another 1.1% to second quarter sales.

Consolidated gross profit dollars decreased $13.7 million for the quarter to $972.9 million. Gross margin decreased 130 basis points to 43.6% of sales from 44.9% in the second quarter last year. Selling, general and administrative expenses increased to 30.4% of sales in the second quarter this year from 30.3% last year.

An impairment charge of $23.9 million in the second quarter resulted primarily from trademark impairments related to soft sales in some acquired trademarks tied closely to the new residential market.

Interest expense net of interest and investment income increased $4.2 million compared to second quarter last year. Consolidated profit before taxes in the quarter decreased $47 million, or 15.5%, compared to the second quarter ’07, to $256.2 million.

Our tax rate in the second quarter was 33%, compared to 33.2% in the second quarter of ’07. For full year 2008, we expect our effective tax rate to be comparable to last year’s rate of 33%.

Consolidated net income decreased by $30.9 million to $171.7 million, from $202.6 million in the second quarter of 2007. Net income as a percent of sales was 7.7%, down from 9.2% in the second quarter last year. Diluted net income per common share for the quarter decreased $0.07, or 4.6% to $1.45 per share.

Looking at our results by operating segment, sales for our paint stores group in second quarter 2008 were down eight-tenths of a percent to $1.36 billion. Comparable store sales, sales by stores open more than 12 calendar months, declined 4.5%. The decrease in paint stores group sales was the result of weak demand for architectural paint and non-paint items in most end-user segments, which were partially offset by improved industrial maintenance coding sales and acquisitions completed during 2007. The acquisitions increased group net sales for the quarter by 2.6%.

Regionally in the second quarter 2008, our Midwest division led the sales performance, followed by Eastern division, Southwestern division, and Southeastern division. Three of the four divisions achieved positive sales results in the quarter.

Segment profit for the group decreased $27.7 million, or 11.6%, to $210.4 million in the second quarter 2008, due primarily to second quarter impairment charges of $20.4 million related to certain acquired trademarks. Also, lower net sales and margin pressure from higher input and freight costs.

Acquisitions reduced segment profit by three-tenths of a percent in the quarter. Segment margin declined to 15.5% in the quarter from 17.4% in the second quarter last year. In the consumer group for the second quarter 2008, sales decreased 3.2% to $383.9 million. The decline was due primarily to soft DIY demand at most of the segment’s retail customers. Segment profit for the consumer group decreased 28.8% in the quarter to $58.8 million.

Segment profit as a percent of external sales decreased to 15.3% from 20.8% in the same period last year, due primarily to dramatic increases in raw material costs, lower volume throughput in our manufacturing and distribution operations, and a $2.7 million second quarter impairment charge related to an acquired trademark.

Turning to our global group for the second quarter 2008, sales in U.S. dollars increased $54.6 million, or 12.6% to $488.9 million, due primarily to increased sales volume, selling price increases, favorable currency translation, and acquisitions.

Sales in local currencies increased 6.8% in the quarter and acquisitions increased the group’s net sales by 3.8%. This sales increase reflects growth across most product lines and geographies outside the United States.

Segment profit for the global group in U.S. dollars decreased 1.7%, or $800,000 to $48 million for the quarter. Profit stated in local currency declined 7.5% due primarily to the negative impact of the domestic economy on portions of global group’s business that could not be fully offset by profit improvements from operations outside the United States. Acquisitions added 3.1% to global group profit in the quarter.

I’d now like to comment briefly on some of our balance sheet items. Our total debt on June 30, 2008, was $1.23 billion, including total short-term borrowing of $933.6 million. Total debt on June 30, 2007, was $757 million.

Our cash balance at the end of the quarter was $45.6 million, compared to $57.5 million at the end of the second quarter 2007. Total borrowings to capitalization were 42.7% at the end of the quarter versus 27.3% at the end of the second quarter 2007. Long-term debt to capitalization was 15.5% at the end of the second quarter this year compared to 13% last year.

In the second quarter 2008, the company purchased 2.1 million shares of its common stock in the open market. At June 30, 2008, the company had remaining authorization to purchase 20.8 million shares of stock. In second quarter 2008, we spent $31.1 million on capital expenditures, depreciation expense was $35.3 million, and amortization expense was $5.4 million.

For full year 2008, capital expenditures will be between $140 million and $150 million. Depreciation will be about $150 million versus $139 million in 2007, and amortization will be $21.4 million versus $24.5 million in 2007.

I will now conclude by giving a brief update on the status of our lead pigment litigation. In our appeal of the Rhode Island lawsuit to the State Supreme Court, on July 1st the court released its decision, reversing the trial court’s finding that the defendants created or significantly contributed to a public nuisance in that state. A unanimous court held that the State could not show interference with a public right nor that the defendants were in control of the alleged nuisance at the time harm was caused to Rhode Island children. This marks the end of the Rhode Island case. The abatement proceedings in the Superior Court have been halted and the appointment of co-examiners -- and the appointed co-examiners discontinued their interview process and will not be preparing a report for the court.

In Ohio, the City of Columbus has dismissed its public nuisance action with prejudice, bringing to an end the last of the municipal suits in Ohio. The Ohio Attorney General suit has been removed to federal court by the defendants. A federal judge will determine whether this lawsuit will be heard in federal court or returned to state court. Oral argument on that issue has been set for August 25th.

In Wisconsin, the Thomas case, a personal injury suit tried successfully to a jury last fall has been appealed by the plaintiffs. Another individual plaintiff case has been accepted on appeal by the Supreme Court on the question of whether lead pigment is an inherently defective product.

In California, the defendant companies have petitioned the California Supreme Court to consider the question of whether cities and counties could retain contingent fee counsel to aid them in their suit against the former manufacturers of lead pigment. The court’s decision on whether to hear this issue should be made by August 15th.

In Mississippi, the trail in the Gaines case has been delayed until June 17, 2009. The case involves a single plaintiff adolescent. There are currently a number of procedural and dispositive motions pending before the court. It is not expected they will be decided upon soon.

That concludes my review of our results for second quarter ’08, so I’ll turn the call over to Chris Connor, who will make some general comments and highlight our expectations for third quarter and full year. Chris.

Christopher M. Connor

Thanks, Bob and good morning, everyone. Thanks for joining us today. You know, at the beginning of 2008, we knew that our plans for sales growth and earnings improvement would face some very significant challenges -- the likelihood of continuing turmoil in the domestic housing market, raw material cost inflation driven by rising petroleum prices, slowing commercial construction activity, a weakening domestic economy, and declining consumer confidence, to name just a few. And in fact, these were the realities we faced during the second quarter and first half of this year.

Consequently, the demand for coatings products across North America continued to deteriorate and the cost of producing, transporting, and selling these products continued to rise.

The good news is that every dark cloud has a silver lining. The actions we’ve taken in response to the difficult market conditions we faced this year we believe will make the company stronger, more competitive, and more profitable in the years ahead. They will unlock new sources of cash, further streamline our operations, and position the company to better capitalize on the eventual recovery that we expect in this market.

Despite the lower sales volume in the quarter, our working capital ratio, defined as accounts receivable plus inventories minus payables to sales, was flat compared to last year at 14.1%. The combination of responsive production planning that held inventories in line with sales volume and prudent management of receivables and payables contributed to improvement of $44.3 million to net operating cash in the first half.

Operating cash decreased by only $8 million to $262.8 million, despite a drop of almost $65 million in net income in the first six months. The contribution from working capital offset most of the shortfall from earnings.

Free cash flow, operating cash minus CapEx and dividends, was flat year over year at $105 million due to a reduction in capital expenditures in the first half.

On our first quarter call, I spoke briefly about our internal efforts to trim fat and build muscle across the organization. These efforts continued in the second quarter and helped to offset inflationary pressure on our operations. SG&A expense, as an example, increased only $10 million, or 10 basis points as a percent of sales, compared to the second quarter of ’07. And we think this is particularly noteworthy considering we supported seven acquisitions and almost 100 net new stores compared to the second quarter of last year.

During the quarter, we continued our plans to close redundant store locations. So far this year we’ve opened 39 new locations and closed 62, for a net reduction of 23 stores. Our store count in the U.S. and Canada now stands at 3,302.

During 2008, we expect our paint stores group to open approximately 100 new store locations and close about 80, finishing the year with a net store increase in the range of 20 locations. Our global group added three new branches in the second quarter, bringing their total to 12 new locations for the year.

I think it probably goes without saying that raw material costs continue to rise much faster than we can offset them with expense reductions. For that reason, we have announced additional price increases across many of our businesses, effective in the July/August timeframe. These price increases in the high-single-digit range, including an unprecedented third price increase announced for our paint stores group, are necessary to help offset some of the raw material cost increases we experienced in the second quarter. We believe the significant challenges we faced in the first half of 2008 will certainly continue into the second half. Demand is likely to continue to deteriorate and raw material cost pressures will increase as the full impact of recent prices increases have yet to be realized.

Our outlook for the third quarter 2008 is for consolidated net sales to be down slightly compared to last year’s third quarter. With sales at this level, we expect diluted net income per common share to be in the range of $1.20 to $1.45 per share, compared to $1.55 per share for the third quarter last year.

For the full year 2008, we are reaffirming our guidance that we expect sales to be slightly lower than 2007. With annual sales at that level, we are reaffirming our guidance that our diluted net income per common share for the year will be in the range of $3.60 to $4.10 per share, compared to $4.70 per share last year.

Yesterday, our board of directors declared a regular quarterly dividend of $0.35 per share, continuing our longstanding record of paying out 30% of prior year’s earnings per share.

Finally, I think it’s appropriate for me to briefly comment on the developments in lead pigment litigation that have occurred during the last three months. Just as I did back in the first quarter of 2006 when a Rhode Island jury found that our company caused or substantially contributed to the creation of a public nuisance in their state. At that time, we commented that we continued to believe these suits are without merit and that the facts and the law are on our side. We pledged to vigorously defend these suits in all jurisdictions wherever they may arise.

It took nine years, two juries, and a State Supreme Court hearing, but today the public nuisance law in Rhode Island is squarely in line with the overwhelming majority of jurisdictions in the United States.

Again, thanks to all of you for joining us this morning and now we’d be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is coming from Saul Ludwig with Keybanc Capital. Please state your question.

Saul Ludwig - Keybanc Capital

Good morning, guys. Impressive results considering the impairment charges. When you provided the guidance the last time, did you have embedded in that guidance the knowledge of the $23 million impairment charges? And in thinking about the guidance you’ve given for the rest of the year, does that include any known additional impairment or special items?

Sean P. Hennessy

At that time when we put our forecast out of $1.40 to $1.50, it did have an impairment. As you know, when you take a look at -- when you look at the -- hang on one second. Let me pull this out here, Saul. You know, impairments are taken when the sales volume of a trademark does not support the asset value on the balance sheet at that time, so as acquisitions are integrated, trademarks are phased out and the decline in the value flows through our P&L. When you take a look at the process that we’ve taken this first six months and the integration of some of the acquisitions, and you can see on the segment table that $20 million of this actually went through the stores group, it refers to a lot of the acquisitions that we -- more recent acquisitions. So as we’ve integrated and increased the velocity of that integration, we had a feeling that the sales of those branded products were going to decrease and so we had it in there for the second quarter.

For the full year, we’ll watch to see what happens with the sales but it’s hard to -- we don’t have a specific forecast for the impairment for the second half.

Saul Ludwig - Keybanc Capital

So there’s no impairment charge in your second half outlook, so to speak?

Sean P. Hennessy

That’s true.

Saul Ludwig - Keybanc Capital

Okay, good. Second question, I noticed that in the quarter, your environmental expense fell sharply from $7 million to $1 million, or from $8 million to $1 million this year, which certainly helped earnings. I see last year in the third quarter, environmental expense was like $14 million. How do you -- and then $6 million in the fourth quarter, so you had $20 million in environmental costs in the back end of the year last year. It seems to be running much, much less this year. How do you think about that? Granted, it’s hard to estimate precisely but in your guidance, how are you thinking about environmental costs?

Sean P. Hennessy

Right now, and as you’ve said, a year ago environmental costs in the second, third quarter were a little higher than the prior year. This year, a little lower. We do look at this. We have a team of environmental attorneys that are working on environmental problems that we have inside the company. As we look at those, we feel that we will have some environmental expense in the second half of the year but we really don’t forecast that line by line. But we do have some environmental in there for the second half of the year.

Saul Ludwig - Keybanc Capital

-- last year, maybe?

Sean P. Hennessy

Probably less than last year.

Saul Ludwig - Keybanc Capital

And then just finally, what was your raw material -- let’s say unit raw material cost increase second quarter versus second quarter this year?

Sean P. Hennessy

Hang on, Saul. I’ll have to pull that out. We’ll give you that answer in a second.

Saul Ludwig - Keybanc Capital

Thank you. You can go on to the next question then.

Operator

Our next question is from Jeff Zekauskas with J.P. Morgan. Please state your question.

Jeff Zekauskas - J.P. Morgan

Good morning. Was your volume decrease on a consolidated basis in the second quarter greater or less than your volume decrease in the first quarter, in gallon terms, I guess? Maybe that’s the way to put it.

Christopher M. Connor

The units, the movement in our units were slightly below the first quarter but not dramatically different.

Jeff Zekauskas - J.P. Morgan

So is it fair to say that in rough terms, maybe your volumes were down 4% and your prices up 2%? Is that the right -- is that an order of magnitude that seems correct to you?

Christopher M. Connor

Directionally, that’s correct, Jeff.

Jeff Zekauskas - J.P. Morgan

And I assume that what you would expect is the pricing to accelerate as you issue these new increases -- do you see the volumes in the second half as being comparable to the volume decrease in the first half? Are you more worried or less worried or can’t you tell?

Christopher M. Connor

I think it’s a little early to make that call. I think the guidance that we’ve given, that we expect sales to be slightly lower in the second half would indicate that it’s possible they could go down further.

Jeff Zekauskas - J.P. Morgan

And all things being equal, will you expect your raw materials to really step up in the third quarter versus the second quarter?

Christopher M. Connor

Yes.

Jeff Zekauskas - J.P. Morgan

I don’t know if you noticed, but there’s some possible consolidation among your acrylic suppliers.

Christopher M. Connor

Wow, we hadn’t heard.

Jeff Zekauskas - J.P. Morgan

What do you make of that? And do you think that that -- you know, is that neutral for Sherwin or negative or positive?

Christopher M. Connor

Well, time will tell. I guess I would comment on Dow and Roman Haus that both of these companies have had longstanding relationships with Sherwin-Williams. They are important suppliers to us. They’ve been very good companies to deal with and we expect that that relationship will continue and time will tell whether this is a positive, neutral, or negative -- too early to make that call.

Jeff Zekauskas - J.P. Morgan

Would you have any interest in integrating into acrylics?

Christopher M. Connor

Again, too early to make that call.

Jeff Zekauskas - J.P. Morgan

Too early to make that call -- okay, thank you very much.

Operator

Our next question is coming from Robert Felice with Gabelli & Company. Please state your question.

Robert Felice - Gabelli & Company

Congrats on a nice quarter, a little better than I think everyone had expected. I guess first question, with the threat of the potential liability from lead paint now gone, could you discuss your existing capital structure, whether you feel it’s optimal? And what actions, if any, around a more aggressive buy-back, perhaps an ASR we should expect?

Sean P. Hennessy

I think we’ve certainly managed our balance sheet and liquidity sources differently since February ’06, the date of the Rhode Island trial verdict. Our philosophy continues to be the same -- we’ll use our cash and balance sheet to increase shareholder value. If you haven’t noticed, we already eliminated the $500 million accounts receivable securitization line of credit, which will lower our liquidity costs. On the balance sheet, this verdict does give us tremendously more options, which we are evaluating.

Our current forecast calls for year-end debt to be in the range of that 950 to 975. We haven’t change that yet. When you look at the verdict we received the first week of July, we haven’t really stepped that up, except for the accounts receivable securitization. And that’s also without any additional acquisitions. We do have one acquisition of the [Incam] in Southeast Asia but the acquisitions and buy-back opportunities, we’re going to be watching the stock price and we do have 20 million shares authorization from our board, so I would say that we’ll watch the stock price and we’ll be careful to see what’s happening on the acquisition front, and then we’ll make that decision.

Robert Felice - Gabelli & Company

But at this point, no plans for any more aggressive or accelerated buy-back?

Sean P. Hennessy

No.

Robert Felice - Gabelli & Company

Okay. And then, if I look at your first and second quarter earnings, and then your guidance for the full year and for the third quarter, it implied that you expect to have your worst year-over-year earnings comparison in the fourth quarter of the year, something north of 30% decline in EPS. Yet at that point, you’ll have -- you should have the bulk of your pricing in place to offset cost inflation, so I was hoping you could just help me understand that a bit.

Sean P. Hennessy

I think when you take a look at the forecast, we have our second half gross margin lower in the second half than in the first half of the year. The first half of the year came in at 43.7; the second quarter came in at 43.6. We have the lowest gross margin in the fourth quarter for one reason -- it’s really that’s when we’re going to take the bulk of the LIFO expense. We’ll see what event we have forecasted right now in the fourth quarter, the -- we’ll see as raw materials continue to roll in, so our gross margin is lower in the third quarter and then lower again in the fourth quarter, but it has to do with LIFO, not the selling prices.

Robert Felice - Gabelli & Company

Okay, that’s helpful. And then I guess lastly, you had mentioned, Chris, the high-single-digit price increase. I was hoping maybe you could provide greater clarity around the magnitude of the price increase specifically in the paint stores group?

Christopher M. Connor

I think as we commented in the past, the January and May price increases were both kind of in the mid-single-digit range, and this one that we are going out with right now, it’s going to be in the high-single-digit range. These are being discussed with customers as we speak right now and implemented in the middle of the paint selling season, and we’ll see how well they go.

Robert Felice - Gabelli & Company

Okay, and how much of the cumulative pricing has stuck so far? I guess I’m wondering what run-rate you’re at in terms of --

Christopher M. Connor

Yeah, the effect of implementation.

Sean P. Hennessy

I would tell you for the company wide, when you look at the company in total, what we’ve said is it usually takes us 12 to 18 months, and between the first -- right now, the first price increases that we implemented in the first of January, we’re running about 50%, 55%, which is normal at this time. The second price increase that we mentioned in stores group were below that, were a little below that because we’re implementing it today. But if you take a look at it, it’s right on pace with prior years and we think eventually we’ll recover this in the marketplace.

Robert Felice - Gabelli & Company

So just cuffing the numbers and remembering what they were, it sounds like you are probably running at about a 3%, 3.5% pricing run-rate at this point, is that fair?

Sean P. Hennessy

Yes, in the month of June.

Robert Felice - Gabelli & Company

Great. Thanks so much for taking my questions.

Operator

Our next question comes from John Roberts with Buckingham Research. Please state your question.

John Roberts - Buckingham Research

Good morning, guys. A couple of things; why didn’t the range on the guidance narrow as we -- you know, we had $0.50 of range with nine months, and now you have certainty in the quarter just reported. We still have $0.50 of range.

Sean P. Hennessy

Well, when you take a look at it, when we did put out the $0.50, that was the first week of June, so it’s only four or five weeks ago, and we had a pretty good view of where we were in the second quarter at that time, and that’s why we came in right in the middle of the range, the $1.45. So I think that the volatility of the gross margin, we’re going to wait to see what happens with the gross margin. Jeff asked us about some volume questions and we’ll have more of a view of it here in the third quarter. Third quarter is a very large quarter for us, so I understand what you are saying. You’ve seen the second quarter but we had a pretty good idea of where we were going to come in in the second quarter when we gave that range.

John Roberts - Buckingham Research

And then in the back half of the year, you are going to open more stores than you will close? During the first half, you’ve closed more than you open and now that reverses. Is that going to impact productivity? Productivity has been a pretty good offset for you to help out offset some of the volume weakness.

Christopher M. Connor

That kind of opening schedule is very traditional and historic for us. We’ve always had -- third and fourth quarter have been higher openings for these stores, and I think it speaks to the aggressive nature of the closing, so you are right, that’s going to reverse a little bit.

From a productivity standpoint, you know, we’re talking about 20 stores on a basis of over 3,000, so it’s not going to have a material impact.

John Roberts - Buckingham Research

Okay, and then lastly, sometimes the averages -- average volume declines in margins kind of belie the range that you are seeing. Could you maybe give us a sense of where are the worst areas, and are they -- do you have some areas that are down well over double-digit percentages? And what are the strongest areas of the company? Do you have any areas showing double-digit percent kind of volume trends?

Christopher M. Connor

I think in Bob’s comments, we gave some indication geographically about where we are struggling, and I think we made the comment that the Southeastern part of the United States was our poorest performing, and with the exception of that one division, the other three actually had sales gains, including pricing and acquisition support for them, but definitely the Southeastern part of the United States, which for us is the Virginias, the Carolinas, Georgia, Florida, and the Caribbean, where the vast majority of the new residential housing market has impacted them, and continues to do so, by the way.

We don’t think we have seen the bottom and we don’t think we’ll see the bottom in ’08. We think it deteriorates in ’09, particularly in Florida from the latest data points that we are looking at. So that’s the part of the United States that we are getting hit with the hardest. When we look at it by more of a customer segment, again the new residential component of this business, not only in Southeastern but where there’s new residential -- the West Coast as well continuing to struggle.

Sean P. Hennessy

John, through June, new residential construction square footage was down more than 40% nationally, and certainly above that in the pockets that Chris mentioned.

John Roberts - Buckingham Research

Thank you.

Operator

Our next question is coming from Dmitry Silverstein with Longbow Research. Please state your question.

Jonathan Grassi - Longbow Research

This is Jonathan [Grassi] for Dmitry. Can you first give us your performance in the paint store group and the consumer group versus the overall market? It basically looked like it did better than one of your -- a lot better than one of your competitors who reported this morning. What would you attribute that to?

Christopher M. Connor

Well, first of all, we’re just seeing some of those other numbers come out and we rely on the federal government’s data points, which usually come out several quarters in arrears, so I’m not sure we’re prepared to claim victory just yet on this quarter.

Our strategy has been to focus on, primarily through the stores group, on the professional painting contract, and we are bullish on that segment long-term, to the extent that those -- that customer continues to grow and play an important role, we’ll benefit from that. We definitely are taking on the chin on the new residential. We marginally believe that we are gaining share against all of the segments that we are involved in and time will tell whether that continues.

Sean P. Hennessy

There are a few segments, Jonathan, that we mentioned are doing -- are still holding up okay. Industrial maintenance coatings is holding up okay. Commercial repaint, which is property management sales, in terms of the industry are holding up pretty well.

One of the advantages of our stores network is that we can focus the attention of our selling organization on those segments that are holding up, so that’s where they’ve been concentrating their efforts and it may bear out in perhaps a little less negative growth rate than the industry.

Jonathan Grassi - Longbow Research

Okay. Are you seeing a big difference between professional contractors and DIY customers?

Christopher M. Connor

No, both are down.

Jonathan Grassi - Longbow Research

Similarly?

Christopher M. Connor

You know, within reasonable ranges. They are not dramatically different.

Jonathan Grassi - Longbow Research

Okay, and then I guess just one last question regarding Latin America -- have you started to see any deterioration in that market, or is that holding up pretty well still?

Christopher M. Connor

Holding up well for us -- the predominant portion of our business in Latin America is in Brazil. That’s the largest country for us. That economy continues to do well. We have a good presence in that country with architectural, industrial, automotive finishes, as well as some specialty products as well, and no end in site right now.

Jonathan Grassi - Longbow Research

Okay. Thank you.

Operator

Our next question is coming from Prashant Juvekar with Citigroup. Please state your question.

Prashant Juvekar - Citigroup

Good morning. Bob, can you give us some price volume breakdowns in all your three major segments? I mean, that would be helpful if you give that on an ongoing basis.

Robert J. Wells

We’ve never done that, other than to say in somewhat general terms that certainly volumes are down more than sales, which implies that pricing was positive and I think Jeff kind of spit out some numbers earlier in the call, and they are certainly in the range.

Prashant Juvekar - Citigroup

Okay, I’ll follow-up with you on that. You mentioned that you announced the third price increase in paint stores group. The big boxes are not raising prices fast enough, so is their risk that you lose the marginal customer to big boxes?

Christopher M. Connor

You know, that’s always a risk. We pay close attention to that. We’re aided by the fact that Sherwin-Williams products are only available in our own stores, so the apples-to-apples comparison is not something we were concerned about. The quality of the products, the innovation, the continued focus on bringing new products to market also has created a gap anyway in that environment, and of course we’re paying attention. We’re blessed with great competition in this space. The price elasticity demand is important to us; however, we are behaving in our typical traditional fashion, rationally and raising prices to offset raw materials and we’ll continue to do that going forward.

Prashant Juvekar - Citigroup

Thank you.

Operator

Our next question comes from Amy Zhang with Goldman Sachs. Please state your question.

Amy Zhang - Goldman Sachs

Good morning. Two quick questions; the first one is what’s your year-over-year raw materials cost increase assumption behind your second half ’08 earnings guidance?

Sean P. Hennessy

Amy, when we talk about raw material costs, we typically comment on the industry, and as you know, at our financial community presentation, we said that we expect year-over-year for the full year raw material costs to be up in the 9% to 14% range. They were certainly less than that in the first half, which implies that they are going to be on the high side of that range in the second.

Amy Zhang - Goldman Sachs

Okay, and then I guess you’ll prepare for another price hike in the second half of ’08 if we see the raw material costs peak over the next six months?

Christopher M. Connor

That would be the historical way that we’ve dealt with this and you should expect us to continue to do that.

Amy Zhang - Goldman Sachs

And then a second question is non-residential construction market -- obviously people have started to worry about that market in the second half ’08, not only the commercial side but also the industrial and institution factors. Can you just remind us how much is Sherwin-Williams exposure to that market? And also, if overall non-residential construction market demand declines by 10% or 20% in the second half ’08, on a year-over-year basis how big of an impact it would be on Sherwin-Williams?

Robert J. Wells

Well, in answer to the first part of the question, we have pretty broad exposure across all new construction segments in the U.S., so we are certainly in those arenas and have substantial share in all of those arenas.

Basically what we’ve seen so far is that some of the non-residential markets have already been declining pretty rapidly. The commercial and manufacturing segments are down sharply through the first half. Through June, total non-residential is down about 19% but there is kind of a dichotomy there because at least according to the data we’re looking at, a lot of those institutional components or categories are still holding up well. Educational buildings, public buildings, et cetera are still pretty sharply positive. So we have not seen weakness in those sectors yet. It’s not to say it can’t come but it certainly could.

If you look at the breakdown of the industry when you are talking about new construction, you are still only talking about a relatively small piece of the business. You are talking about primarily the architectural coatings market, which is roughly half of the industry in the U.S., so you are excluding all of the industrial segments that are growing pretty well.

And then within the architectural segment, new construction only accounts for about 20% of unit volume. So we are going to see pressure in residential and non-residential new construction but it’s pressure we’ve been seeing and it’s a small portion of the overall market.

Amy Zhang - Goldman Sachs

So that means in the second half, your second half ’08 EPS guidance, you don’t assume much more pressure from the non-residential construction market, is that right?

Christopher M. Connor

We assume it will continue to diminish but to Bob’s point, the scale of it is relatively small and it’s baked in the forecast we’re giving you.

Amy Zhang - Goldman Sachs

Okay, understood. Thank you.

Operator

Our next question is from Jeff Zekauskas with J.P. Morgan. Please state your question.

Jeff Zekauskas - J.P. Morgan

Thanks very much. How are prices going in your consumer business? Do you have any plans to increase prices in the third quarter?

Christopher M. Connor

Yes, Jeff, we have, as we’ve indicated earlier, taken pricing out in our consumer group in the beginning of the year and the comments that I made in my opening remarks were that across all segments, we’re instituting pricing in the July/August time period. That includes our consumer group and that includes the comment that these are in the high-single-digit range.

Jeff Zekauskas - J.P. Morgan

Your global business didn’t grow as much as it normally does. Can you talk about some of the weak factors that softened the results this quarter?

Christopher M. Connor

As you know, Jeff, in our global business we have really three different businesses that we include in that. We have our automotive refinish business on a global basis. We have our product finishes or what we call our chemical coatings business on a global basis and then we have our international architectural business, primarily in Latin America.

The Latin America and architectural businesses have continued to do very well and trend at the same kind of high performance that we’ve seen in the last several quarters. The softness for global in this particular quarter mainly is coming in the domestic automotive businesses. Refinish business is down as miles are declining with higher oil prices, and some softness in our product finishes business is also domestically.

Jeff Zekauskas - J.P. Morgan

In the second quarter, were the volume trends very different month to month, or could you perceive any trend through the quarter, Chris?

Sean P. Hennessy

The second quarter, you have to remember, April we didn’t have Easter versus the last year but when you adjust it for April, if you look at April, May, and June, there really was no distinguishable difference. It was relatively -- strength or weakness was across the board.

Jeff Zekauskas - J.P. Morgan

And lastly, one of the raw materials that really hasn’t touched the paint industry very much over the past couple of years has been TI02, but there’s been a lot of raw material increase for the TI02 suppliers, or for some of them, notwithstanding the very weak demand environment. Are they having any more luck in pushing through price increases?

Christopher M. Connor

I think the revised guidance that we’ve given now on the industry’s [around] costs likely to be in the 9% to 14% range does include the recent raw material price increases announced in titanium and it would be premature for me to comment on how those are going for them.

Jeff Zekauskas - J.P. Morgan

Okay. Thank you very much.

Operator

Our next question is from Gregg Goodnight with UBS. Please state your question.

Gregg Goodnight - UBS

Good morning, all. I’m looking at the interest expense and in light of some of Sean’s comments, what is your guidance for the full year? Do you expect the interest run-rate to sustain or to go down? Can you help us out on that one?

Robert J. Wells

I think that what we mentioned is that the net interest expense, which is interest expense minus the interest income, we believe will be in the low $60 million range, so between $61 million and $63 million for the year.

Gregg Goodnight - UBS

Okay, excellent. Good. The second question is you mentioned, if I recall, that there were 39 new stores opened year-to-date and you expect 100 by the end of the year. Will the bulk of these new openings come in the third quarter, or are they going to be spread out fairly evenly over the rest of the year?

Christopher M. Connor

You know, Gregg, we start every year with the discipline and mindset that we are going to get these open, 25 every quarter on a straight line and despite our best efforts, they always tend to lag toward the back half of the year. A lot of this is driven by a municipality -- building inspectors, et cetera -- that are creating delay in the process. There always seems to be a push to get them in before the year is over. That’s important to developers and landlords, et cetera. So despite our best forecasting, this thing always tends to push towards the back half.

My guess is as we sit here right now, we’re thinking we’re probably going to have a pretty equal third and fourth quarter, but the reality and the history would tell you some of the third quarters will lag and the fourth quarter has always been our largest opening quarter.

Gregg Goodnight - UBS

Excellent. Okay, thanks for the help.

Operator

Our next question is from Ivy Zelman with Zelman & Associates. Please state your question.

Analyst for Ivy Zelman - Zelman & Associates

This is actually Dennis on for Ivy. My first question just kind of relates to the paint store segment; if you look at the 40 basis point deterioration in margin year over year, can you maybe break down the delta on the growth line versus the SG&A line within that segment?

Sean P. Hennessy

Well, what we’ve always continually said is we need around a 3% growth rate to just start to see some leverage. So when you see that our external sales for the first six months are about negative 1.2, the sales are probably 30% of the deterioration and 70% of the gross margins.

Analyst for Ivy Zelman - Zelman & Associates

Well, I guess looking at it a different way, would SG&A within that segment be lower year over year?

Sean P. Hennessy

Not lower year over year but it was well-controlled, and the reason why it’s not probably in the core, what I’ll call core was lower but with the acquisition last year of MAB in June 1st, we had three months versus one month; Columbia had three months versus zero months, so without acquisitions, I’d say it was lower but with the acquisition, it was higher.

Analyst for Ivy Zelman - Zelman & Associates

So the percentage of sales SG&A would have been slightly lower within that segment on a comparable basis and the deterioration would largely be driven by leverage loss and the raw material pressure?

Sean P. Hennessy

Yes.

Analyst for Ivy Zelman - Zelman & Associates

Okay. And just remembering back to the investor conference, I don’t think the 9% to 14% increase included the most recent Dow announcement. Is there a reason why that didn’t put some upward pressure on that?

Christopher M. Connor

I think we’re waiting to see how that price increase goes in. I mean, the reason we give a range, Dennis, is because there’s a lot of moving parts and the range was up dramatically from our previous range, so it anticipated some future pricing actions.

Analyst for Ivy Zelman - Zelman & Associates

Okay, that’s helpful. And then just lastly, Sean, I missed your comment earlier about the 4Q08 LIFO adjustment. Can you just run through what you were getting at there?

Sean P. Hennessy

What I’m getting at is that we are a LIFO company. What we do is we have -- we run our company on FIFO and then put in the LIFO reserve. As the raws are increasing this year, as it goes from the lowest raw material increase we are going to experience is the first quarter through the fourth quarter, so the last raw materials are the first ones we’re going to expense through our P&L. So what we do is we put in a forecast and we try to put in what we think are LIFO expenses and we try to straight-line it quarter by quarter but when we look at it, invariably when we have years like this, the fourth quarter, the LIFO expense tends to be higher than any other quarter, as more information comes in, as more and more of the raws change. So we just have more LIFO expense in our forecast in the fourth quarter than any other quarter.

Analyst for Ivy Zelman - Zelman & Associates

Okay, so I guess one way to think about it, if you had perfect forecasting, the current gross margin would be slightly lower and the fourth quarter would be slightly higher than what you will probably ultimately impact on the fourth?

Sean P. Hennessy

Yes, and what ends up happening because of our sales curve, that higher expense creates a higher impact because of the fourth quarter, because of the -- well, sales. And then -- I’m sorry, go ahead.

Analyst for Ivy Zelman - Zelman & Associates

No, that’s okay. Continue on.

Sean P. Hennessy

I was just going to mention, I wanted to mention the [SOL]. The sheet that I have here just shows the raw materials versus the forecast and the raw material variance for the second quarter was immaterial, so it was right on our forecast. I just don’t have that forecast number.

Analyst for Ivy Zelman - Zelman & Associates

And Sean, did [Incam] close?

Sean P. Hennessy

No, it did not close in the first or second quarter. We believe it will close in the third quarter.

Analyst for Ivy Zelman - Zelman & Associates

Thanks a lot, guys.

Operator

Our next question is from Eric Bosshard with Cleveland Research Company. Please state your question.

Eric Bosshard - Cleveland Research Company

Good morning. Two things; first of all, the LIFO effect, Sean, that you just talked about in 4Q, do we continue with a difficult year-over-year LIFO comparison when we get into 1Q and 2Q of ’09 as well?

Sean P. Hennessy

No, because usually we’ll reset the standards and then it won’t get -- it will go right into our standards. But you are absolutely right; we believe the first and second quarter will be our -- right now, the way the run-rate is, the raw material hurdle we’ll have will be the highest in the first and second quarter of ’09.

Eric Bosshard - Cleveland Research Company

Okay, and then secondly, the price increase, the third price increase in eight months I think is unprecedented in your history. I know you’ve had three in 15 months, or something like that, but how is it going, if you could give us your perspective on the feedback from your customers and also from a competitive standpoint, how you feel like that’s going?

Christopher M. Connor

I’ll comment on that, Eric. Two days ago, we had all of our store leadership in from around the United States to go through a first half review with them and this was a topic of great discussion, as you would imagine.

I would say that as we’ve commented frequently on these calls, as well as on individual meetings with investors, we are operating in a rational industry. We are seeing pricing activity occurring from all of our competitors, and we are working our way through this. No customer is happy to receive a price increase, let alone three of them in one year, and specifically in the middle of the paint season. So these are difficult discussions, they are well supported with facts in terms of why the company needs them. Our customers, to the best of their ability, are passing them on. We are blessed, particularly with the professional painting contractors, you know, we’ve also shared the fact that a typical painting job is approximately 80% labor, 20% material, so that does mitigate the impact somewhat for these folks, and our guys are out there doing a good job of making progress on this.

The price increases that we are talking about in the July/August time period are being announced as we speak. They are not set to take effect until later in the month, so it’s a little early for us to comment on how well they are going to go in and we will certainly be prepared to comment on that on the next quarter call.

Eric Bosshard - Cleveland Research Company

Thank you.

Operator

Our next question is coming from Stephen O’Neill with Hilliard Lyons. Please state your question.

Stephen O’Neill - Hilliard Lyons

Good morning. I think you answered this as part of Jeff’s question, but could you elaborate on the impact of the domestic economy on the global group? I think the tail end of his question, you answered that and I’m afraid I missed it.

Christopher M. Connor

We didn’t give any specific number, Steve, on what that was. We just directionally commented that while the architectural businesses in Latin America and the other coatings business in Latin America were doing terrific for us, that some of the softness in the segment relative to previous quarters was related to the domestic automotive refinish and some of the domestic product finishes businesses, which are feeling the effects of the economy in North America, like so many other businesses.

Stephen O’Neill - Hilliard Lyons

And then I think this was asked and I’m afraid I didn’t understand it -- did you say earlier that your guidance of $1.40 to $1.50 for March did include the impairment charge?

Christopher M. Connor

Yes, we had figured that we would have some impairment in the quarter in that number.

Stephen O’Neill - Hilliard Lyons

Thank you.

Operator

Our next question is from Gregory Melich with Morgan Stanley. Please state your question.

Matt McGinley - Morgan Stanley

This is Matt McGinley on behalf of Greg. Can you tell me how the mix has changed as your prices have increased? And have you seen any signs of a downtrade?

Sean P. Hennessy

Actually, we look again at that at the end of July and we looked at specifically some of the high-end exteriors and we’re not seeing a shift down at all, and we’re still -- and we’re seeing a slight positive shift for us.

Matt McGinley - Morgan Stanley

Okay. And in regard to promotional and advertising spending in this environment, are you increasing it due to the environment or are you decreasing it in line with the drop in demand?

Christopher M. Connor

Basically consistent with the process. Those dollars are managed on a percent to sales, so they may be slightly down this year but in terms of tone and types of discount and frequency, all those things are maintaining.

Matt McGinley - Morgan Stanley

Okay, great. Thanks a lot.

Operator

Our next question is from Don Carson with Merrill Lynch. Please state your question.

Donald Carson - Merrill Lynch

Thank you. Two questions; first, Chris, still a bit confused on your outlook for the paint market. Do you think -- I know that you talk about the Southeast getting worse next year, but if you look at the broad national architectural market, do you think that we’ve bottomed here at sort of an 8% year-over-year decline? Do you see it getting worse in the second half before it gets better?

Christopher M. Connor

We’re a little reluctant to give outlooks and forecasts. This has been a remarkable period to go through. We think that certainly there are pockets of the United States where the new residential market will continue to deteriorate even further from these historic low levels, and to the extent that that’s offset by the repaint markets, it’s just really early for us to make that call.

To your point with kind of 8% gallon declines for the industry, it would be difficult to see that worsening much from that level, but we are a little reluctant to say that it’s going to get any stronger from that level, certainly for the next several quarters.

Donald Carson - Merrill Lynch

Okay, and then a capital structure question -- you said you haven’t really changed your view yet post the successful resolution of the pigment litigation to lever up a bit more. Is that partly because you are trying to keep your powder dry for acquisitions? And what is the acquisition environment? Are some of the smaller companies still a little shell-shocked about the environment and not yet willing to consider selling?

Christopher M. Connor

On your first point, you are absolutely correct. We want to keep the powder dry. We do think -- we think we -- and it goes to your second point; we think that eventually there might be some real nice assets here. We’re continuing to look at it but I don’t think the owners of these businesses has really changed. I think that we’ll see how they feel over the next six months and year, but we continue to push.

Donald Carson - Merrill Lynch

Okay, and what’s the backlog like on international acquisitions? Is there anymore progress there?

Christopher M. Connor

There’s some interesting properties out there right now. To Sean’s point, a little bit more activity there than domestically, given a more robust market and willingness to sell more of the -- on an up trend. And we don’t comment much more beyond that in terms of what we are seeing or what we are doing.

Donald Carson - Merrill Lynch

Thank you.

Operator

Our next question is from John Emerich with Ironworks Capital. Please state your question.

John Emerich - Ironworks Capital

Thanks. Just a couple of unrelated questions, if I could ask them separately; first of all, I apologize. I missed the depreciation and amortization guidance for the year and if you gave CapEx ranges as well?

Sean P. Hennessy

We did. The CapEx range that we gave, John, was $140 million to $150 million, and for the year we said depreciation would be about $150 million and amortization would be about $21.4 million.

John Emerich - Ironworks Capital

Super. And second to last, what’s the right tax rate to use for this company, kind of on a go-forward basis?

Sean P. Hennessy

Well, we think that the -- right now we’ve been able to maintain it in the low 30s. We’ve commented that we think that’s where we’ll be. On an ongoing basis, our statutory rate is 38%. The low to mid 30s would probably be the right one to use.

John Emerich - Ironworks Capital

Okay, and then lastly, just some balance sheet metrics, specifically debt and cash, long- and short-term, if you have it.

Sean P. Hennessy

Yes, our total debt at the end of the second quarter was $1.5 billion, and $300 million of that is long-term, $1.2 billion of that was short-term.

Christopher M. Connor

And variable.

John Emerich - Ironworks Capital

And cash?

Sean P. Hennessy

In cash, we had $50 million, approximately.

John Emerich - Ironworks Capital

Super. Thank you very much.

Operator

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

Analyst for Chuck Cerankosky - FTN Midwest

Good morning. This is actually Alex sitting in for Chuck. I guess just one quick question -- what trademark was impaired in the quarter?

Christopher M. Connor

These trademarks were in our, as Sean said, of the $23 million, 20 of it was in our stores group. We don’t give specifically which ones but we’ve indicated they were the trademarks from recent acquisitions made in this segment, as we’ve begun to consolidate these brands and businesses a little bit quicker.

Analyst for Chuck Cerankosky - FTN Midwest

All right, that’s it. Thank you very much.

Operator

(Operator Instructions) Our next question is come from John Roberts with Buckingham Research. Please state your question.

John Roberts - Buckingham Research

This morning, PPG indicated there were significant differences regionally in raw materials, that the international raw material costs were significantly lower for them than domestically. Are you maxed out in terms of what you can do regionally to shift your sourcing?

Christopher M. Connor

I can’t really comment on Chuck’s comments on the PPG call in terms of what they were saying. These chemicals frequently are priced on a global basis. We are sourcing chemicals, both from the United States as well as markets around the world. I wouldn’t characterize us as being maxed out on any raw material strategy, and we’ll continue to aggressively manage these going forward.

Operator

Thank you. There are no further questions at this time. I would like to turn the floor back over to management for any closing comments.

Robert J. Wells

Thank you. I would like to close by expressing our appreciation for you taking time to join us this morning. As usual, I’ll be around this afternoon to answer any additional questions that arise and thank you for your continued interest in the Sherwin-Williams Company.

Operator

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

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Source: Sherwin-Williams Q2 2008 Earnings Call Transcript
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