The Sherwin-Williams (SHW) John G. Morikis on Q2 2016 Results - Earnings Call Transcript

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The Sherwin-Williams Co. (NYSE:SHW) Q2 2016 Earnings Call July 21, 2016 11:00 AM ET

Executives

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

John G. Morikis - President, Chief Executive Officer & Director

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

Analysts

Christopher S. Parkinson - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Ghansham Panjabi - Robert W. Baird & Co., Inc. (Broker)

Jeffrey J. Zekauskas - JPMorgan Securities LLC

Duffy Fischer - Barclays Capital, Inc.

Arun Viswanathan - RBC Capital Markets LLC

Scott A. Mushkin - Wolfe Research LLC

Vincent Stephen Andrews - Morgan Stanley & Co. LLC

Don Carson - Susquehanna Financial Group LLLP

Michael Joseph Harrison - Seaport Global Securities LLC

Greg Melich - Evercore ISI

Nils-Bertil Wallin - CLSA Americas LLC

Ivan M. Marcuse - KeyBanc Capital Markets, Inc.

Charles Cerankosky - Northcoast Research Partners LLC

Scott Rednor - Zelman & Associates

Rosemarie Jeanne Morbelli - Gabelli & Company

John Roberts - UBS Securities LLC

Christopher Evans - Goldman Sachs & Co.

Eric Bosshard - Cleveland Research Co. LLC

David Wang - Morningstar, Inc. (Research)

Brian J. Lalli - Barclays Capital, Inc.

Richard O'Reilly - Revere Associates

Matthew Stephen Skowronski - Longbow Research LLC

Operator

Good afternoon. Thank you for joining The Sherwin-Williams Company's review of the Second Quarter Results for 2016. With us on today's call are John Morikis, President and CEO; Sean Hennessy, CFO; Al Mistysyn, Senior Vice President and Corporate Controller; and Bob Wells, Senior Vice President, Corporate Communications.

This conference call is being webcast simultaneously in listen-only mode by Issuer Direct via the Internet, at www.sherwin.com. An archived replay of this webcast will be available at sherwin.com, beginning approximately two hours after this conference call concludes and will be available until Wednesday, August 10, at 5:00 PM, 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 speak only as of the day 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 company's prepared remarks, we will open the session to questions.

I will now turn the call over to Bob Wells.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks, Jesse. Good morning, everyone, and thanks for joining us. In the interest of time, we've provided some balance sheet items and other selected financial information on our website, sherwin.com, under Investor Relations, July 21 Press Release. I'll begin by highlighting overall company performance for the second quarter 2016 compared to the second quarter 2015, then comment on each reportable segment.

Consolidated net sales increased 2.8% to a record $3.22 billion, driven by higher paint sales volume in our Paint Stores Group. Unfavorable currency translation decreased consolidated net sales 1.5% in the quarter. Consolidated gross profit dollars increased $105.8 million in the quarter to $1.64 billion.

Our consolidated gross margin increased 200 basis points in the quarter to 50.8% of sales from 48.8% in the second quarter last year. More than half of the gross margin improvement in the quarter resulted from the positive mix effect of Paint Stores Group, our highest gross margin segment, outpacing the growth of the other segments, coupled with increased operating leverage from higher production and distribution volume.

Selling, general and administrative expenses increased $54.7 million over second quarter last year to $1.1 billion. As a percent of sales, SG&A increased to 32.7% in the second quarter this year, from 31.9% last year. A relatively small portion of this increase was acquisition-related expenses.

Interest expense increased $28 million compared to second quarter last year to $40.9 million. This increase includes $20.7 million in acquisition-related interest expense with the balance resulting from a shift to long-term debt from short-term that occurred mid-year 2015.

Consolidated profit before taxes in the quarter increased $31.4 million to $539.2 million, due primarily to improved operating results from our Paint Stores Group. Unfavorable currency translation reduced profit before tax in the quarter by $3.3 million compared to second quarter last year.

Our effective tax rate in the second quarter was 32.1%, excluding the impact of the change in accounting standard. For the full-year 2016, we expect our effective tax rate will remain in the low 30%s, excluding the impact of the change in accounting standard.

Consolidated net income increased $28.1 million to $378.1 million. Net income as a percent of sales was 11.7% compared to 11.2% in the second quarter last year. Diluted net income per common share for the quarter increased 7.8% to $3.99 per share from $3.70 per share in 2015. The $3.99 includes $0.09 accretion from the accounting change and $0.16 dilution from acquisition-related expenses.

Looking at our results by operating segment. Sales for our Paint Stores Group in the second quarter 2016 increased 6.2% to $2.11 billion from $1.98 billion last year. Comparable store sales, that is, sales by stores opened more than 12 calendar months, increased 5.2%. All of the Paint Stores Group sales increase was due to higher organic architectural paint and equipment sales volumes across all end markets. Price mix had a negligible impact on sales in the quarter and Protective & Marine coating sales were a modest drag on revenue growth.

Regionally in the second quarter, our Southeastern division led all divisions, followed by Midwestern division, Southwestern division, Canada and Eastern division. Sales and volumes were positive in every geographic division.

Segment profit for the group increased $75.6 million, or 17.4% to $509 million in the quarter, as higher architectural paint and equipment sales volumes were partially offset by higher SG&A spending. Segment operating margin increased to 24.1% of sales from 21.8% in the second quarter last year.

For our Latin America Coatings Group, second quarter net sales stated in U.S. dollars decreased 11.2% to $133.3 million, due to unfavorable currency translation and negative volumes that were partially offset by selling price increases. Currency translation rate changes decreased sales in U.S. dollars by 16.4% in the quarter.

Segment profit in U.S. dollars decreased to a loss of $9.6 million in the quarter from a profit of $4 million last year. Segment profit was negatively impacted by higher raw material costs and unfavorable currency translation that were partially offset by selling price increases.

Currency translation decreased Latin America segment profit $1.3 million in the quarter. As a percent of net sales, segment operating profit was negative 7.2% in the quarter compared to a profit of 2.7% in the second quarter 2015.

Turning to the Consumer Group, second quarter sales decreased 2.6% to $477.5 million. As a reminder, in April, we annualized the completion of the load-in of the HGTV HOME by Sherwin-Williams paint program in Lowe's stores, which was completed by May 1 last year.

Segment profit for the Consumer Group decreased $6 million to $108.3 million in the quarter from $114.2 million in the second quarter last year, due primarily to lower sales and increased SG&A spending, partially offset by improved operating efficiencies. Segment profit as a percent of external sales decreased to 22.7% from 23.3% in the same period last year.

For our Global Finishes Group, sales in U.S. dollars decreased 1.3% to $499.2 million in the quarter, as unfavorable currency translation was partially offset by positive price mix. Unfavorable currency translation decreased net sales for the segment 2.6% in the quarter.

Second quarter segment profit stated in U.S. dollars increased $8 million, or 13.9% to $65.2 million, due primarily to decreasing raw material costs and good cost control, partially offset by unfavorable currency translation, which decreased segment profit $1.5 million in the quarter. As a percent of sales, segment profit increased to 13.1% from 11.3% in the same period last year.

That concludes my recap of our results for the quarter. So, I will now turn the call over to John Morikis, who will make some general comments and highlight our expectations for third quarter and full-year. John?

John G. Morikis - President, Chief Executive Officer & Director

Thank you, Bob. Good morning, everyone, and thank you for joining us. I think it's fair to say our results for the second quarter were mixed. Architectural paint volumes through our Paint Stores Group held up well in the quarter, resulting in solid revenue growth and continued strong earnings leverage and flow-through.

Our Global Finishes Group also did a commendable job of managing both gross margins and SG&A, resulting in a respectable 180 basis point operating margin improvement on modest volume growth.

We continue to see positive demand momentum in some of our industrial coatings businesses, primarily in Europe and the U.S., and currency headwinds in Latin America are starting to ease. Those were the positives in the quarter.

On the other hand, while we expected difficult comparisons in the HGTV HOME paint program due to heavy stocking orders in the second quarter last year, some of the retail programs we thought would generate growth in the quarter fell short. We are supporting many of these programs with incremental SG&A investment and we have high return expectations on these investments. Finally, while currency comparisons have improved in many Latin American countries, demand trends remain difficult and our outlook for this segment for the full-year continues to deteriorate.

Our earnings per share results in the quarter include expenses related to the Valspar acquisition as well as a tax benefit related to the adoption of a new accounting standard. If you back out these items, diluted net income per common share increased 9.7% on sales growth of less than 3%. As a percent of sales, gross profit increased 200 basis points year-over-year and operating profit and profit before tax, both expanded a little more than 50 basis points.

Excluding the acquisition expense, our incremental margin on consolidated profit before tax was 36%. SG&A was the only line on the P&L that went the wrong way as a percent of sales. The result of higher SG&A spending by Paint Stores Group, channel investment by Consumer Group and expenses related to the Valspar acquisition.

Paint Stores Group delivered another strong sales performance in the residential segments, which includes residential repaint contractors, new residential construction and DIY. Combined, sales to these three segments grew by more than 10%. Sales to commercial, healthcare and property management customers also generated solid year-over-year growth. The outlook for continued growth in these segments over the balance of the year remains positive, supported by very healthy order book trends reported by most of our contractor segments, extending into 2017.

During the first half of the year, Paint Stores Group opened 45 new stores and closed 14 redundant locations. This completes our consolidation of redundant store locations acquired from Comex. Our plan for the full-year still calls for store openings in the range of 90 to 100 net new locations. Today, our total store count in the U.S., Canada and the Caribbean stands at 4,117 compared to 4,025 a year ago.

We anticipated a modest sales decline from Consumer Group coming into the second quarter. This, combined with the elevated SG&A investment tempered our second quarter outlook which is reflected in our guidance. We remain confident that the great work our Consumer Group teams are doing in strengthening our brand positioning across all retail channels and the investment we are making in many of these channels will pay handsome returns in the years ahead. Consumer Group's commercial, industrial and MRO business continue to show good progress on both sales and margin in the quarter.

Unfavorable currency translation continues to weigh on sales and profit performance in our Global Finishes Group and Latin America Coatings Group. Both segments reported positive sales in local currency in the quarter and Global Finishes Group volumes were positive, thanks in large part to improving market conditions in North America and Europe.

Volume sales in most Latin American countries continue to decline with Brazil standing out as the most notable exception. Although Brazil's volume momentum improved in the quarter, margin pressure from raw materials continue to challenge profitability in Brazil and throughout the region. In the first six months of 2016, we generated $510 million in net operating cash, an increase of $161 million compared to the first half of 2015, driven by higher six-month net income and good working capital discipline.

Working capital was a use of cash in the quarter, increasing by about $3.8 million year-over-year. Working capital as a percent of sales decreased to 11.6% from 11.8% at the end of the second quarter last year. Our capital expenditures in the quarter totaled $62.1 million. Depreciation was $43.8 million and amortization was $6.2 million.

In 2016, we anticipate capital expenditures of approximately $240 million, depreciation of $170 million to $180 million and amortization of about $30 million. Capital spending will run higher than normal in 2016 as we complete some facility renovation projects.

During the quarter, we made no open market purchases of our common stock for treasury. On June 30, we had remaining board authorization to acquire 11.65 million shares. As indicated when we announced the Valspar acquisition, we intend to build cash on our balance sheet over the course of the year to reduce total borrowings required to close the deal, which will eliminate our share repurchase activity in 2016.

At the close of the second quarter 2016, our cash balance was $402.7 million compared to $75.1 million on June 30, 2015. Yesterday, our board of directors approved a quarterly dividend of $0.84 per share, up 25% from $0.67 last year.

The outlook for Paint Stores Group over the next six months remains very positive, and we should see steady improvement from Consumer Group and Global Finishes Group. These positives will be offset, to some degree, by continued weakness in Latin America. As we've commented over the past few quarters, the gross margin tailwind we have enjoyed in recent years from raw material cost deflation will diminish, as we go through the back-half of 2016.

Our outlook for third quarter 2016 is for consolidated net sales to increase low to mid-single digits percent compared to last year's third quarter. With sales at that level, we expect diluted net income per common share for the second quarter to be in the range of $4.10 to $4.30 per share compared to last year's record $3.97 per share.

The full-year 2016 earnings per share guidance we provided at the end of the first quarter did not include expenses related to the acquisition of Valspar or the tax benefit from the adoption of the new accounting standard. Today, we are revising our guidance for full-year consolidated net income per common share to reflect these two impacts.

For the full-year, we expect consolidated net sales to increase over 2015 by a low-single-digit percentage. With annual sales at that level, we are revising our expectations for full-year diluted net income per common share to be in the range of $11.65 to $11.85 per share compared to $11.16 per share earned in 2015.

Again, I'd like to thank you for joining us this morning. And, now, we'd be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. At this time, we would be conducting a question-and-answer session. Our first question is coming from the line of Christopher Parkinson with Credit Suisse. Please proceed with your question.

Christopher S. Parkinson - Credit Suisse Securities (USA) LLC (Broker)

Perfect. Thank you very much. Could you just comment on your performance in the DIY channel specifically at the home centers? And how HGTV trended versus Infinity inventories? And then also whether or not you believe there is a large inventory – or excuse me, a pull forward from March as well? Thank you.

John G. Morikis - President, Chief Executive Officer & Director

I don't think that there was a large pull forward in the first quarter. I'd say that our performance in the second quarter, we feel as though inside our largest customer with Lowe's that we're continuing to gain momentum as far as the performance in the market, I think we're going to let them comment on how their performance rated against the market.

Christopher S. Parkinson - Credit Suisse Securities (USA) LLC (Broker)

Perfect. And just a quick follow-up. You outlined a few trends in LatAm and indicated you still expect some continued weakness. But can you offer a little more color on what you're seeing here and whether or not you believe you've reached an inflection point in terms of the magnitude of operating losses? Thank you.

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

Yes, I think that last year we earned positive profit in each one of the quarters last year. And for the year, we think that this year is going to be the exact opposite. But I do think when you look at the investments we're making, we think we're doing the right long-term and we think that the markets are troughing.

I think that when you look at specifically at Mexico and Brazil, we're closer to the end. What we said last year, we felt that Brazil, you wouldn't see an improvement during 2016, maybe mid-2017. I don't think we've seen much difference there with political and so forth.

In Mexico, we think Mexico is doing better. We think that's doing fine, but Argentina, Chile, Ecuador, we're still having some headwinds there and so we do believe that for the year we're going to lose money in Latin America.

John G. Morikis - President, Chief Executive Officer & Director

But as we've spoken in the past, we feel this is an opportunity for us. We see rather than just waiting for the market to correct, and we do think that the market will improve, that there are some steps that we can be taking and we're taking those steps, and ensuring that we've got the right products, the right channels and the right people in those markets and we're making very good progress in the improvements down there. So, as the market does improve, we expect to outperform the market.

Christopher S. Parkinson - Credit Suisse Securities (USA) LLC (Broker)

That's great detail. Thank you very much.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thank you, Chris.

Operator

Thank you. The next question is coming from the line of Ghansham Panjabi with Robert W. Baird. Please proceed with your question.

Ghansham Panjabi - Robert W. Baird & Co., Inc. (Broker)

Hey, guys. Good morning. First off on the 5.2% same store sales increase that you reported during the quarter, did that come in basically where you thought it would come – where you thought it would heading into the quarter? And in terms of the outlook, do you sense any change in industry fundamentals either in residential or commercial construction, or any particular region within the U.S.? Thanks.

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

This is Sean Hennessy. And the 5.2% is fairly close to where we were. We have said that in the first quarter that was tremendously strong. We're almost double digits in the comp store, so we did feel that it was going to be lower than that first quarter, but the 5.2% in that materially different than what we had in the guidance.

John G. Morikis - President, Chief Executive Officer & Director

And regarding the market, Ghansham, I'd say it's been great deal of my time with our customers and with our people in this segment, and there's a strong sense of bullishness in this area. There's continued growth in the residential repaint area. This is yet another quarter for us with double-digit gains in residential repaint. Our commercial customers are really speaking of a very solid book that currently exists, as well as a number of bids in the pipeline. So, on the architectural side, we're really excited about this market.

Ghansham Panjabi - Robert W. Baird & Co., Inc. (Broker)

Okay. And just my second question, in terms of the – maybe you can share the raw material costs including titanium dioxide and inflation more broadly including labor inflation from the back half of 2016 and heading into 2017. I guess I'm asking because the industry has not seen a paint price increase since 2013, it seems like the case is increasing for one in 2017, would you sort of agree with that?

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Yes, Ghansham, this is Bob. On the raw material outlook, we still see low mid-single-digit deflation for the full-year 2016. Although, you asked specifically about TiO2. The majors in TiO2 we think are probably gaining some traction on the second quarter price increase that they announced, that is off to December 2015 lows.

The implementation at this point as near as we can tell from an industry standpoint is probably in the mid-single-digit cents per pound, so not a significant increase in percentage terms. As expected, they've been out with a third quarter announcement. We think that it's likely they may get some traction, but how much they get really depends on customer size, on location geographically.

So, we're likely to see some year-over-year inflation in TiO2 as far as the rest as the basket. The feed stocks for the latex and acrylic monomer market have been very stable. Chemical grade propylene has been steady at around $0.31 a pound. So we don't necessarily see inflation in that side of the basket.

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

And on the labor side, we're putting our game plans together for 2017. We've done a lot of work on 2017. But we don't see – in our guidance, we still see productivity gains, especially in the Stores Group. So, when you look at that labor expense – and we're evaluating 2017, as we go.

And as always, before we announce in the market what we're going to do with pricing, we would talk to our customers first. So, those plans are being developed right now. And if we do go, after we've talked to the customers, we'll be pretty transparent and let you know.

Ghansham Panjabi - Robert W. Baird & Co., Inc. (Broker)

Okay. Perfect. Thanks so much.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks, Ghansham.

Operator

Thank you. The next question is coming from the line of Jeff Zekauskas with JPMorgan. Please proceed with your question.

Jeffrey J. Zekauskas - JPMorgan Securities LLC

Hi. Good morning. When you look across the paint industry in United States and you compare the performance of company-owned stores, whether it's yours or those of other companies, to the amount of paint that's going through the big box retailers or through channels that are non-company-owned stores, do you see differences in volume growth or are they comparable?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

I think, when you look at the results, I think, it's showing up, Jeff, that the painting contractor is the faster growing – that the painting contractor is growing faster than DIY. I think that's our perception, and I think the facts bear that out.

Jeffrey J. Zekauskas - JPMorgan Securities LLC

And is there a different conduct of the big box retailers toward inventories; that is, are they taking steps to meaningfully push down their inventories either temporarily or permanently?

John G. Morikis - President, Chief Executive Officer & Director

No, I think that our customers have always done a very good job in managing their working capital, and we're constantly working with them. We want to have the right inventory on the shelf, Jeff. And there are times when that means that they're little lighter in some areas and a little more in others.

And so I'd say it's just an ongoing discussion that we have with our customers. We want to help drive their key metrics cumulatively or any others that they have. And so, as they are reviewing what it is that's working for them, we want to be a part of that.

Jeffrey J. Zekauskas - JPMorgan Securities LLC

Okay. Great. Thank you so much.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks, Jeff.

Operator

Thank you. The next question is coming from the line of Duffy Fischer with Barclays. Please proceed with your question.

Duffy Fischer - Barclays Capital, Inc.

Hey. Good morning, fellas. Question just on the raw materials again. For Global Finishes, you called out that raw materials was down and a benefit for LatAm that was up and a headwind, what's the dichotomy going on there?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

I think that Latin America 100% of the raw materials are based on U.S. dollar and it's fully affected by the currency changes. In the Global Finishes, we do have a portion of that business that's in the United States that doesn't have that same effect and I think that's what – that's really the dramatic difference there.

Duffy Fischer - Barclays Capital, Inc.

Okay. Great. In the 2016 since you called out on the acquisition cost, what was that pre-tax and where did that roll through the P&L?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

Sure. 100% of it went through the admin section. It was $25.2 million pre-tax which we broke down to $15.4 million after-tax, which gave $0.16. $4.5 million approximately went through SG&A, the other $21 million went through the interest expense. And again, that was 100% in the administrative segment.

Duffy Fischer - Barclays Capital, Inc.

Okay. Great. Thanks a lot, fellas.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks, Duffy.

Operator

Thank you. The next question is coming from the line of Arun Viswanathan with RBC Capital Markets. Please proceed with your question.

Arun Viswanathan - RBC Capital Markets LLC

Morning, thanks. Just a question on the same stores, I think you do both Protective & Marine in there, so is that a fair assumption that your architectural sales were above that 5.2% and maybe you can just gauge what kind of range your Protective & Marine was tracking in the quarter?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

Yeah. Your first part of the question and sort of your implication is exactly right. Architectural was the fastest growing and the Protective & Marine was dampened. Really don't have a metric that I think we can share with you that we'd be comfortable with.

John G. Morikis - President, Chief Executive Officer & Director

But I would say this, Arun, is that, all along as we've been going through this, just as we just talked about Latin America, there are a number of segments within the Protective & Marine opportunities for our company. And so while we've been experiencing some pressure in oil and gas, the teams are pivoting and really focused on other segments that offer opportunities in both sales and margin.

Arun Viswanathan - RBC Capital Markets LLC

Okay. Thanks. And just similarly on those points, though, would you say that both in Latin America and in Protective & Marine you're nearing kind of a bottom in those comps and is your guidance kind of embed and using in those comps through the year?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

I think so. Yeah, I think as we move forward, the comps – we're going to lap those comps. And at the same time, some of the good work our teams – what they're putting in place right now will continue to, I think positively benefit us going forward.

John G. Morikis - President, Chief Executive Officer & Director

And I think that even though the comps are getting easier, we're basically saying I think that we're in a trough now. I don't think we're ready to say that we're going to see some major growth in either the Latin America or the Protective & Marine, but I think we're in a trough.

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

In the oil and gas.

John G. Morikis - President, Chief Executive Officer & Director

Yeah.

Arun Viswanathan - RBC Capital Markets LLC

And then, just last question, you had put out earlier that your belief is that you can potentially get to 820 million gallons in the next peak, is that still your belief and when do you think you can get there in that cycle? Thanks.

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

It is, Arun. And we base that belief on the fact that the install base of square footage that requires maintenance has grown pretty dramatically since we considered mid-700 million gallons to be normalized. So this peak should be well above the last peak just at normal build rates and we're not back to normal build rates yet. We consider normal to be closer to 1.4 million, 1.5 million residential starts and a little stronger non-res activity than we're seeing right now.

So, once we get build rates back there and once the maintenance cycles have returned to kind of normalized repaint activity, we think we're going to see normalized volume in the 780 million to 810 million gallons and very likely that this cycle should peak above that 810 million gallons. Whether that takes three years or five years to get back to, time will tell, as the rate of recovery in the residential market right now, I think, that is probably going to take at least three years to get back there.

Arun Viswanathan - RBC Capital Markets LLC

All right. Thanks.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thank you.

Operator

Thank you. The next question is coming from the line of Scott Mushkin with Wolfe Research. Please proceed with your question.

Scott A. Mushkin - Wolfe Research LLC

Hey, guys. Thanks for taking my questions.

John G. Morikis - President, Chief Executive Officer & Director

Good morning, Scott.

Scott A. Mushkin - Wolfe Research LLC

Good morning. So, I just wanted to – a little longer-term oriented question, just trying to understand, your gross margin obviously up nice in the quarter and gross margins been coming up quite a bit. Obviously, raw material cost has something to do with that. But as you guys look at kind of like your normalized gross margins, what are your thoughts about that? Can we still see things come up here and – I just wanted to get your thoughts on that?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

Yeah. I think that the way we run the business, we believe that in the long-term, we're going to continue to raise the ROS. I think that the gross margin, we've had great expansion. And basically because of three things – really nice gallon growth especially in the Stores Group, an integration that is complete now from the Comex North America, and raw materials have been a tailwind but those things have occurred.

I think that in all cases, we're always looking long-term. I like your term – really looking in the long-term. And again this year, we're taking a balanced approach to where we're going. We're investing. There is times when the gross margin will lead our ROS improvements. And there is times that SG&A – and in fact that gallon growth that we've had in the Stores Group is because of innovation. I think that we continue to do a lot of innovation, and innovation has helped us in all the different segments.

So when you look at where we're going this year, our mid-point of our range is $12.60; last year was $11.13 – a 13% increase – and then when you take a look at a challenging global environment and no share buybacks. Our original guidance had approximately $0.25 worth of buybacks in there.

So, we're generating net operating cash at record levels, and we're continuing to make prudent investments in the business. So, you're going to see SG&A probably this year isn't going to be in the improvement in the ROS, it has to be in gross margin. And we had the tailwind. We've clearly said there wasn't going to be a tailwind. We had the innovation. We had Stores Group going away. But we're pretty confident that those investments will earn solid returns in the future, and that's how we do this balanced approach for the long-term that you asked.

Scott A. Mushkin - Wolfe Research LLC

That's perfect. I appreciate all the color. And just maybe switching gears just a little bit to capacity levels that you guys are seeing right now, one of these – where are they and what will they look like if you successfully close the Valspar acquisition?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

We always have said that we were – 88% to 92% is the sweet spot for us. And 2008 and 2009, when the market did go down 25%, 30% in that one year, we managed it. We did not take all the capacity out to get down to that level. And that's where the earlier question about the 820 million gallons, we were shooting for that 750 million gallons, 770 million gallons. So that capacity – we live with the capacity in the low 70%. We're now much closer to that 88% to 92%, and that's why our margins are doing very well.

Since then, that North America acquisition of Comex – I think those gallons going into our footprint, but we've hung onto a couple of the assets they have and when we look at the Valspar, we think that they have some great assets to give us for capacity. We think that gives us another leg in the stool that give us the ability to have that capacity utilization go down in the short-term, but then gives us the ability to grow without a great deal of CapEx.

Scott A. Mushkin - Wolfe Research LLC

All right, awesome. Thanks guys. Appreciate it.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks, Scott.

Operator

Thank you. Our next question is coming from the line of Vincent Andrews of Morgan Stanley. Please proceed with your question.

Vincent Stephen Andrews - Morgan Stanley & Co. LLC

Thank you very much. Just to dig in a little bit more in Consumer Group, you mentioned a couple of programs you were running at retail that didn't get the traction that you were looking for and you obviously have some increased spending against that. So, what is just sort broadly or specifically, what's the course correction that you're looking to do and is it something that you can do this year or is it something that we have to wait until next paint season to see the results of?

John G. Morikis - President, Chief Executive Officer & Director

Well, I think what's important here is that there is some investment here and we see as the clear opportunity. We do go into this with our eyes wide open. We know that there are investments made that may not come back in the first quarter that we make those investments, maybe not the second. But if you look at our market share in this segment, there's terrific opportunities, we believe a disciplined approach and aggressive approach here can help us to grow our market share and manage our margins for our shareholders. So, we're moving in this direction with a very disciplined look. We're making the investments and we think that there are opportunities out there for us to grow.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

And...

Vincent Stephen Andrews - Morgan Stanley & Co. LLC

And just as a – go ahead, sorry, Bob.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Yeah and as far as the timing as you mentioned, we're patient. We think – but we don't see it snapping back in the next quarter or so.

Vincent Stephen Andrews - Morgan Stanley & Co. LLC

Okay and just as a follow-up, you mentioned Consumer Group should improve sequentially through the balance of the year; but, I mean, should we be modeling 3Q still flat to down, or how should we be thinking about that on the top-line?

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

You know on the top-line, I think, as we settle sequentially, we'll improve I think that; but, you know, with some of the situations we just talked about, we think it's going to be flat to up slightly.

Vincent Stephen Andrews - Morgan Stanley & Co. LLC

Okay. Thanks very much.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks, Vincent.

Operator

Thank you. The next question is coming from the line of Don Carson with Susquehanna Financial. Please proceed with your question.

Don Carson - Susquehanna Financial Group LLLP

Yes, thank you. Question first just on your overall impression in the architectural market, you know, last year was obviously – I know, you don't like to talk about weather, but it was weather depressed and growth was 2% to 3%, are you seeing the snapback you expected this year or has that been moderated again by weather? Bob, what's kind of your outlook for the U.S. architectural market growth this year?

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Yeah, Don. For starters, we don't think there was much of a weather effect in the numbers this year. We think that build rates are holding up very well, but they're not on fire. Residential construction is up about 10% year-over-year in square footage terms.

In the commercial markets, starts are down but completions are up pretty significantly year-over-year. So we're seeing solid demand growth in the new construction market. In the repaint market, while the pro-residential repaint business has been really solid, what's hard to determine at this stage, because we just don't have the data is how the DIY channels held up in the second quarter. So, I hesitate to say, that there's just not enough data to call market growth in the second quarter yet, but I think that's the truth. The contractor market seems to have grown nicely, but it's hard to tell on the other piece.

Don Carson - Susquehanna Financial Group LLLP

Okay. And, John, a question, maybe you can update us on Valspar synergy outlook, to the extent you've been able to talk to your counterparts over there and have meetings about combining the two companies. What's your updated outlook for synergy potential or as – what's your updated confidence level in the original target you set out?

John G. Morikis - President, Chief Executive Officer & Director

Right. I don't think we're going to move the original target and – but I think that as time goes on, we continue to feel very confident that we're going to hit those numbers.

Don Carson - Susquehanna Financial Group LLLP

Okay. Thank you.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks, Don.

Operator

Thank you. The next question is coming from the line of Mike Harrison with Seaport Global Securities. Please proceed with your question.

Michael Joseph Harrison - Seaport Global Securities LLC

Hi, good morning.

John G. Morikis - President, Chief Executive Officer & Director

Hi, Mike.

Michael Joseph Harrison - Seaport Global Securities LLC

I was wondering if you could give a little more detail on the solid margin performance you had in the Global Finishes Group? I know you mentioned the price and mix was improving. What exactly was driving that and how sustainable could a number like 13% margin be as we get into the second half in that segment?

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

I think that when we take a look at that group I think that the improvement stems from really four focused driving that product technology I mentioned earlier into the market, improving SG&A, capturing pricing in the – where to offset currency and then capturing reductions in the raw materials that they occur in the United States.

So, these combination of four things I don't think are going to change. You'll see the slide. For the longest time, we used to talk about 12% and I think that this has given us great confidence that we can say 13%. And with some market share gains, I think, we can actually beat that number. So, I think the game plan has worked very, very well.

Michael Joseph Harrison - Seaport Global Securities LLC

All right. Great. And then a question on Latin America. You'd sounded like you mentioned that you expect to be below breakeven for the rest of the year. But just wondering, as we get into the heavier paint season there in Q4, is there a chance that we get north of breakeven? And also wondering if there was some unusual costs in Q2 that help explain a pretty significant sequential weakening in terms of the earnings in Latin America? Thank you.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

The answer to the last question is, no, there really was no one-time thing that I would point out. I just think it was the operation as it is. I think we come closer to breakeven and maybe there is a chance that if we have a little stronger sales – the fourth quarter definitely is the closest to breakeven for the remainder of the year. But right now, I would not come out here and say we're definitely going to make money in the fourth quarter.

Michael Joseph Harrison - Seaport Global Securities LLC

Thank you very much.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks, Mike.

Operator

Thank you. Our next question is coming from the line of Greg Melich with Evercore ISI. Please proceed with your question.

Greg Melich - Evercore ISI

Thanks. Two questions. One was accounting and charge clarification and then second on the business. Sean, the income tax benefit – could you explain what that actually is? And is it just simply as straight as $0.09, $8 million is coming into taxes?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

Yes. And what that is, is when we've expensed – when starting the new rules many, many years ago, expensing stock option, RSO grant and so forth, you charge the P&L for the Black Scholes amount. So, whatever the Black Scholes value was on the day of the issuance, basically, you straight line to a three-year or a five-year option vesting period.

Then what would occur is, if the stock – the differential between when the day of vesting, a differential between the Black Scholes value and the actual value was actually that difference would use to go to retained earnings. We always took it on our tax return, and that was one of the differentials between book and cash taxes.

So this change, this accounting change for us has nothing to do with and won't change our cash performance; but instead of having that differential for us as you said in the second quarter, $8 million go to retained earnings and now goes directly through the P&L. So that's why it was $0.09 in the second quarter. Year-to-date, it was $0.28 and the reason why it was $0.19 in the first quarter is because of the – in the first quarter when the vesting occurred of our long-term RSOs, so that many people around that, so that's why it hit in the first quarter, second quarter was really driven by stock options that were exercised. So, that's what it is. It does have a cash differential that's why we pointed it out. We adopted it this quarter, so we can do it the accounting this way. I think as time goes on, I think January everyone has to go on it, so I think what we took the opportunity to do it now just to get this noise out of our P&L next year.

Greg Melich - Evercore ISI

And so we should see something else in the next two quarters?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

Yes.

Greg Melich - Evercore ISI

More like the second quarter not the first quarter?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

Right. And just so you know when we try to say, we guesstimated that number will be $0.45 for the year. So, when we were talking about when we show that schedule in the back, that's where that $0.45 comes from. So 2017, we're seeing 2017 in the next two quarters, so $0.085 a quarter or something in that range.

Greg Melich - Evercore ISI

Thank you. That's a great catch up. So, then back to the more fun stuff, John, I guess, what will be helpful is understanding through the quarter I think there were a couple questions that sort of tease it out, if I remember last year we had a wet June and that may have had some impact, would you say that the business was quite steady in Paint Stores Group through the quarter or was there strengthening or weakening or how would you put that together?

John G. Morikis - President, Chief Executive Officer & Director

I'd say, it was pretty steady if you compare apples-to-apples, Greg, the performance inside stores still go in the right direction but consistent throughout the quarter.

Greg Melich - Evercore ISI

Okay. Got it. And I think in the prepared comments you mentioned that in Consumer, what was weaker than expected was other retail programs. I think I got – I hope I wrote that down right. Explain to us what that is, is that other architectural paint programs or is it some of the spray paints or sealants or give us a little more color on that would be helpful?

John G. Morikis - President, Chief Executive Officer & Director

Yeah. Those are few things that we're working on, Greg and quite frankly, we prefer that our customers start talking about that when the timing is right. We're leaning forward in that area. And as I mentioned and it is important in a very disciplined fashion. We didn't feel as though that the return would come back in the first quarter.

Sales-wise, we have high expectations for ourselves and we're going to continue to push to grow our sales. We have a high regard for our team there and they're pursuing some opportunities with customers in a number of different channels and in a number of different segments and spaces. So, it's not one but a number of areas that we are investing in and believe that we can grow.

Greg Melich - Evercore ISI

But it specifically wasn't the HGTV that cycling the sale in last year, that was on plan?

John G. Morikis - President, Chief Executive Officer & Director

That's correct.

Greg Melich - Evercore ISI

All right. Thanks. Good luck.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thank you, Greg.

Operator

Thank you. The next question is coming from the line of Nils Wallin with CLSA. Please proceed with your question.

Nils-Bertil Wallin - CLSA Americas LLC

Yeah. Good morning. And thanks for taking my question. First is on non-res starts, as Bob, I think you said completions have been good this year so that's obviously helping your business. But starts themselves have been down meaningfully in the first part of this year. Does that mean that there's going to be a fairly significant headwind next year and what you do to sort of get ahead of that?

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Yeah, Nils, on average, as we typically point out, the time between starts and completion runs about 20 months to 22 months in the non-residential space, which means that next year we're primarily going to be completing 2015 starts. 2015 was a pretty strong year. Not as strong as 2014. 2014 was the strongest year since the recession.

2015 was the second strongest and today so far year-to-date we're running down about 9% in square footage of starts. So, we will see the non-residential market trend downward in terms of completions over the next couple of years. As a reminder, the non-res market you're talking about, a-third of the new construction piece of the market, which new construction totals less than 20%. So it will be a headwind in out years just not a real significant one.

Nils-Bertil Wallin - CLSA Americas LLC

Got it. And then, at your recent Investor Day, you guys highlighted quite a bit of the innovation particularly Paint Shield, wondering how that's tracking and obviously there's back – tying into the non-res starts, there has been some quite a bit of strength in healthcare. So, wondering if you've been able to get in on the ground, so to speak.

John G. Morikis - President, Chief Executive Officer & Director

Yeah. I'd say, with the new technology like this, as expected in this area that there will be a little bit of a ramp-up. We're working with a number of different decision makers and influencers in this area. Trend-wise, it's going in the right direction. And we're going to continue to focus on it. But the comparisons, as we go forward here, while we expect to continue to improve.

Nils-Bertil Wallin - CLSA Americas LLC

Understood. I'll pass it on.

John G. Morikis - President, Chief Executive Officer & Director

Thanks.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks, Nils.

Operator

Thank you. The next question is coming from the line of Ivan Marcuse with KeyBanc Capital Markets. Please proceed with your questions.

Ivan M. Marcuse - KeyBanc Capital Markets, Inc.

Great. Thanks for taking my questions. First one, can you give me the gross profit changes on the Paint Stores, Consumer and Global and Latin America? Give a chance.

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

Sure. Paint Stores Group was an increase of $116 million. Consumer was flat. Global Finishes was up $2.5 million, and Latin America was down $13 million.

Ivan M. Marcuse - KeyBanc Capital Markets, Inc.

Great. And then in terms of the Paint Stores, the significant contribution margin has been pretty largely probably due to the volume leverage and outflow of raw materials. Does raw material sort of level out? Do you look for that contribution margin to sort of go back to the traditional 25%, 30% type of flow through to the bottom line, as you go through the back-half?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

Yeah. I think the 60%, 70% flow through are nice. But you're right. Not just that raw materials grew, we're fully integrated now with Comex. And those things have really helped us over the last two years, three years. So, yeah, we see as time goes on, we still have great flow through. But probably you're going to see it closer to maybe a little higher than what we've done in the past. But yes, it will.

Ivan M. Marcuse - KeyBanc Capital Markets, Inc.

And then the last question. In terms of the acquisition-related costs, how much of – what are the big buckets that these costs are going into and how much of them are cash? And are they big enough where you're sort of getting ahead of what cost may be when the deal finally closes in the first quarter?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

Sure. In the first quarter, the acquisition cost – I'm going to just speak to PBT. I won't talk about it unless you want me to. But if you take a look at the big buckets, there were advisor fees there. And then another big piece of that niche, that's the cash-out in the third quarter because of the timing and so forth, but that plus the bridge and turmoil fees, we're amortizing those bridge and turmoil fees today, that's cash.

Then we have some legal fees that are cash, but the big hit will be Valspar's advisor and legal fees, which will occur at the close. So, when we look at that $0.72 that we show in the fourth quarter to finalize the 132, the majority of that is going to be a cash hit that's why a lot of times we look at the cash needed to close this $11.3 billion, we look at it closer to $11.5 billion because we have these $200 million worth of pre-tax closing costs in total. The majority of which will be paid back at that time.

Ivan M. Marcuse - KeyBanc Capital Markets, Inc.

Great. Thanks for taking my questions.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thank you, Ivan.

Operator

Thank you. The next question is coming from the line of Chuck Cerankosky with Northcoast Research. Please proceed with your question.

Charles Cerankosky - Northcoast Research Partners LLC

Good morning, everyone.

John G. Morikis - President, Chief Executive Officer & Director

Good morning.

Charles Cerankosky - Northcoast Research Partners LLC

Most of my stuff has been covered already, but I want to go back to the Consumer segment. Just focusing on the segment rather than the customer, John, Sean and Bob, how would the sales change year-over-year look if you could take out the load in sales of a year ago?

John G. Morikis - President, Chief Executive Officer & Director

It would be up slightly.

Charles Cerankosky - Northcoast Research Partners LLC

So, 2%, 3% is that a good way to put it slightly?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

Yes.

Charles Cerankosky - Northcoast Research Partners LLC

All right. Thank you.

John G. Morikis - President, Chief Executive Officer & Director

Thank you.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks, Chuck.

Operator

Thank you. Our next question is coming from the line of Scott Rednor with Zelman & Associates. Please proceed with your question.

Scott Rednor - Zelman & Associates

Hi. Good morning. Question for Sean, when you're referring to SG&A been elevated for the balance of the year, the 70 basis points of deleverage that we saw in 2Q, is that the run rate we should consider for the back half of the year?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

I think you're not going to be far off, it's not going to be exactly that, but that's probably not a bad number.

Scott Rednor - Zelman & Associates

And then when we think about the 70 basis points in 2Q, is that all Consumer or are there investments elsewhere that cause deleverage?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

I think the majority of which was in Consumer, but LACG – but we're still investing in stores. I think that the stores investments have not changed. We think this is a continued driver. So, the SG&A increase as a percent of sales was not in stores, but we still are investing in the stores as heavy as we ever have been.

Scott Rednor - Zelman & Associates

Right. So just a tailored question, maybe the consumer – given that you had heavy investment last year and then you have heavy investment this year that might be related to other programs. Do you think this is needed to sustain that flat to low single-digit growth you guys have guided to longer-term? Or should we expect the growth rate to be better than that once you get a return on these investments?

John G. Morikis - President, Chief Executive Officer & Director

We're going to be trying to drive that higher, Scott. Investments that we're making here we believe can help us.

Scott Rednor - Zelman & Associates

Okay. Fair enough. Thank you.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks, Scott.

Operator

Thank you. Our next question is coming from the line of Rosemarie Morbelli with Gabelli & Company. Please proceed with your question.

Rosemarie Jeanne Morbelli - Gabelli & Company

Hello and good morning, everyone.

John G. Morikis - President, Chief Executive Officer & Director

Good morning.

Rosemarie Jeanne Morbelli - Gabelli & Company

I guess it is still morning. I was just wondering if on the Global Finishes Group you could talk a little bit about the areas where you are seeing some improvement outside of oil and gas, which markets or which industries are actually growing?

John G. Morikis - President, Chief Executive Officer & Director

Inside our Protective & Marine we're focused on a number of them. Rosemarie, I prefer not to highlight those for obvious reasons, but our teams are really pivoting into some areas where we've had some presence in the past, but we feel as though we could be more meaningful in the marketplace. And so we're investing in sales rep time and specification effort as well as some product development to help us.

So, as we're pursuing these segments we're – sometimes adversity brings out the best. We're finding that we have technologies that will help customers in adjacent segments. We have people that are knowledgeable and we can pursue better. So, we're after them. I'd rather not highlight them right now, but rest assured that we're out there and pursuing them.

Rosemarie Jeanne Morbelli - Gabelli & Company

So when we look at the industrial world or the industrial market what you are seeing is, I am just making sure I understand, is that you don't want to talk about those particular areas which are actually doing better than what we read in the paper, for example?

John G. Morikis - President, Chief Executive Officer & Director

That's correct. And in some of the areas that we just have a lower share in the very profitable segments that we can increase our share in.

Rosemarie Jeanne Morbelli - Gabelli & Company

Okay. And for Sean, if I look at that – the impact on the interest expense from the acquisition expenses. So, I am actually calculating that your regular interest expense is $20.2 million more or less. Is that the right number to look at for the balance of the year, until you are actually borrowing the full boat for the Valspar acquisition?

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

Yes it is. We did borrow last year in July. And so, we've now fully anniversaried those bonds that we issued. So, we're 100% fixed right now because we're not in any variable interest. That's a very good rate. That $20 million is a very good number.

Rosemarie Jeanne Morbelli - Gabelli & Company

Okay. And then lastly, if I may, and you may not want to respond to it, but anything new on the regulatory front regarding the Valspar acquisition.

John G. Morikis - President, Chief Executive Officer & Director

Well, I wouldn't say that there is anything new. We disclosed that we've received a second request, and we're working with the FTC to provide all the information that they need to complete their review. So, we're trying to be as responsive as we can to provide them with the information that they're asking for.

Rosemarie Jeanne Morbelli - Gabelli & Company

And with that in mind, do you still expect to close at the end of the first quarter?

John G. Morikis - President, Chief Executive Officer & Director

We still are anticipating closing in the first quarter, yes.

Rosemarie Jeanne Morbelli - Gabelli & Company

Okay. Thank you.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks, Rosemarie. Thank you.

Operator

Thank you. Our next question is coming from the line of John Roberts with UBS. Please proceed with your question.

John Roberts - UBS Securities LLC

Yeah. Thanks, guys. Housing may not be at a peak again yet, but Cleveland certainly seems to be on a high right now.

John G. Morikis - President, Chief Executive Officer & Director

Wait till October and the Indians in the World Series.

John Roberts - UBS Securities LLC

There is a lot of questions on the call here about the sustainability of paint demand at these levels. On your pro customers, do you have insights into their backlogs? When you talk about them being bullish, do you think their backlogs or business are higher or just because there has been such a strong first half, they probably run off a fair amount of backlog that it would be hard for them to maintain the same level?

John G. Morikis - President, Chief Executive Officer & Director

Actually, John, the discussions I've had with many customers around the country would say that they've got a good book of business that they're dealing with right now. They've got a good book of business that they have in the pipeline either secured or believe that they're going to secure. But what gives us, perhaps, most excitement is the pipeline of bids that they're looking at down the road. They also feel – that's why I mentioned earlier that they are bullish about those as well.

John Roberts - UBS Securities LLC

All right. Are they buying spray equipment and ladders that would be supportive that they have a lot of confidence in their outlook?

John G. Morikis - President, Chief Executive Officer & Director

They are, yes. I'm going to say that we have strong equipment sales, as we pointed out in the first portion of our discussion.

John Roberts - UBS Securities LLC

Okay. Great. Thank you.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Yep. Thank you.

Operator

Thank you. The next question is coming from the line of Bob Koort with Goldman Sachs. Please proceed with your question.

Christopher Evans - Goldman Sachs & Co.

Hello, everyone. This is Chris Evans on for Bob. Just in your 2016 guidance I was hoping you could give me a little more directionality or specificity on your same store sales number that you're implying?

John G. Morikis - President, Chief Executive Officer & Director

I think that we've never broken out segment win inside our guidance but I think what we freely have said for probably 14 quarters in a row when you look at that guidance number, the Stores Group again will [lead our] sales in the third quarter and fourth quarter and for the full-year. So I think that the first half of the year is probably a pretty good indication of where you'd see, when you break out your sales in the model that Stores Group is going to be number one and those comp stores are going to be strong.

Christopher Evans - Goldman Sachs & Co.

Thanks, John. And then another year you're expecting 90 to 110 net new stores, you put out some pretty good targets out there on 6,000. Can you just talk about sort of what gives you guys the confidence to say that you're not hitting or you won't hit a saturation point or some diminishing returns with that level of continued growth?

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

I'd say we spend a lot of time on this metric. We've been watching to see how the new stores today are creating cash and the metrics versus the metrics we've done over the years. We compare it to the market. We compare it to how that market is in relative size to stores per household and the metrics have all been going in the right direction, which would tell you if your incremental stores continue to perform like that, you're probably – and the markets are performing that you're probably not at a saturation point.

John G. Morikis - President, Chief Executive Officer & Director

Chris, we often cite that we're blessed with a number of very good competitors and there's plenty of opportunity out there for us to continue to grow and new stores is one channel for them.

Christopher Evans - Goldman Sachs & Co.

Great. And then just one more really quick one with share repurchase side lines, decent amount of dilution in the quarter just kind of wondering, is that a reasonable run rate to expect as we go through the year or is that kind of unique to this quarter?

John G. Morikis - President, Chief Executive Officer & Director

No, I think it's pretty reasonable. I think when we look at what we think our share count will be in the fourth quarter because of that dilution it's slightly higher than in the second quarter. But I think your point is well taken, again, approximately $0.25 of our original guidance we came out of January with had share repurchase. So when you look at the share count if you go out to the fourth quarter and have a slightly higher number than the second quarter, I think you're in good shape.

Christopher Evans - Goldman Sachs & Co.

Thanks guys.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thank you, Chris.

Operator

Thank you. Our next question is coming from the line of Eric Bosshard with Cleveland Research Company. Please proceed with your question.

Eric Bosshard - Cleveland Research Co. LLC

John, I wanted to circle back, you had talked about steady sales kind of month-to-month in the quarter, and hearing pretty good things from the customers, the painters from the channel in terms of what's going on. Curious how we look at the comp of 9% in the first quarter and 5% in the second quarter and look at the guidance it implies, the 2Q comp is the right number through the rest of the year, something in that neighborhood, what's the difference between 1Q and 2Q?

John G. Morikis - President, Chief Executive Officer & Director

Well, the size of the number, obviously, when you look at the first quarter just the raw number versus the second has an impact on it, Eric and what I was speaking to as far as the comparisons month-to-month, we didn't see any significant highs and lows within the quarter that they were pretty consistent in our year-over-year comparisons.

Eric Bosshard - Cleveland Research Co. LLC

Okay. And so the – and I understand the scale and the magnitude of the quarters can make – can sort of hide the impact or overstate a little bit the impact of growth, were there pieces of the business that just grew faster in 1Q than they grew in 2Q?

John G. Morikis - President, Chief Executive Officer & Director

No, not that I can think of. We have, again not to be too repetitive here, but we had a terrific quarter and then in residential repaint, double-digit gains. As talked about in the first portion of our comments about the whole residential, new residential DIY, all performing well and I don't know that there was any significant swings from the first quarter to second quarter.

Eric Bosshard - Cleveland Research Co. LLC

Okay. I'll circle back to get more detail. All right. Thank you.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks, Eric.

Operator

Thank you. Our next question is coming from the line of David Wang with Morningstar. Please proceed with your question.

David Wang - Morningstar, Inc. (Research)

Hi. Thank you for taking my question. I just had two. First is, wanted to get a little bit more understanding on the margins. So overall incremental margins are around 36% with Paint Stores performing particularly well. Are we close to the sweet spot in your capacity utilization and if so, is there much operating leverage remaining as we ramp up to what your estimate for mid-cycle paint volumes would be, or is this going to be more of a headwind going forward where we wouldn't see as much incremental margin for new paint volumes?

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Yeah, I think that we're getting closer to the sweet spot. I think that there is still some room when it comes to looking at that incremental margin. I think, when we were in the low-70%s, we had a great deal of room, and so you saw a greater impact. But I do think the incremental margins will still be strong. They will be higher than our ROS today.

And I think that's the key for us. We are always trying to make sure that our incremental margin – our incremental flow-through, as we call it, is greater than our current ROS. So I still see that happening. I just don't see it happening at the 60%, 70% incremental margins.

John G. Morikis - President, Chief Executive Officer & Director

We've got a terrific operating team that's constantly working to improve and unlock capacity in our facilities. And so that process continues. And we've got a wonderful team there that's working diligently to do that on a regular basis.

David Wang - Morningstar, Inc. (Research)

So, currently we're not at the 80%, 90% or so utilization?

John G. Morikis - President, Chief Executive Officer & Director

That's true.

David Wang - Morningstar, Inc. (Research)

Okay. Great. And then a second question on normalized paint volumes. I think your new forecast for 780 million gallons to 110 million gallons is a bit higher than your prior forecast. I think what we discussed a few years ago was normalized volumes of around 760 million. That's probably closer to what we are at today.

And it looks like a large portion of the difference between your previous expectation and your new one is higher mid-cycle levels for res repaint and DIY. I know you guys discussed having a larger base of homes that would need repainting. But to the extent that the mid-cycle and new res forecast hasn't changed much, is it that we just expect the cycle to have a much bigger rally in the near-term before normalizing the mid-cycle or, I guess, what is driving the main difference?

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Well, David, the question you're asking is why is what we consider normalized growing? And I think you answered the question. It's growing because the base is growing. And if you look at the overall U.S. architectural paint market, more than 80% of average annual volume goes toward repaint and it's applied to structures that already exist.

If you look at that 740 million to 760 million normalized range that dates all the way back to the late 1990s. And we've had three building cycles since the late 1990s that have put a lot more square footage in place. Our population has grown significantly since then. So, we think it's reasonable to adjust the normalized expectation up based on primarily repaint volume.

The other thing you see is, as the housing market continues to improve and get healthier and that health is oftentimes reflected in home values, you'll see the frequency of repaint activity increase. So at the peak of this cycle, people are painting more, just like they are remodeling more.

David Wang - Morningstar, Inc. (Research)

All right. So, there will be no change to your estimates for, say, housing starts for the peak or normalized?

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Well, no, for normalized that normalized band would assume housing starts in the range of 1.4 million to 1.5 million. We think that's sustainable given our current rate of household formation.

David Wang - Morningstar, Inc. (Research)

All right. Great. Thank you.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thank you.

Operator

Thank you. Our next question is coming from the line of Brian Lalli with Barclays. Please proceed with your question.

Brian J. Lalli - Barclays Capital, Inc.

Hey, thanks for the time here late in the call, guys. I appreciate it. Just a quick question from the debt size and I apologize if I missed any prepared remarks in this but if could – could we get an update on the plans for, I guess, the longer term debt financing around the Valspar acquisition?

And then, secondly, as a follow-up to that, Moody's specifically had comments on the ratings front being at risk for downgrade potentially even out of investment grade depending on the structure. So if you could maybe just comment on your commitment to IG rating and how that might guide your financing decisions as we get closer to closing, that would be helpful? Thanks a lot.

Sean P. Hennessy - Chief Financial Officer & Senior Vice President

First of all, what we said and I don't have this in front of me, but I think I'm going to be very close. Bob can tell us on the financial community presentation that's now in the Sherwin.com under IR, so we have a schedule and I actually show you what we think our debt to EBITDA would be all the way out to I believe 2020.

So, I'd ask you to do that but I think what we try to show there is that the day of close our leverage is going to go over 6% if we close, and based on closing first quarter 2017 our debt to EBITDA would be over 4%, approximately 4.25%, and so by 2019 we'll be at 3% and by 2020 at 1.9% which is under 2%. And I think that's a big goal by 2020 to be under 1.9%.

What we said is, and I want to answer this way because immediately after that financial community presentation, we were asked, does this mean that you're not going to buy any stocks through 2020 and I said no, we are going to buy stock when our debt to EBIT starts to approach 2.5% to 1%. So that will give you a little picture of what we're thinking.

And then on the Moody's front, I think that we read the same thing from Moody's. Every summer after the second quarter we've always had an individual meeting with Moody's and Fitch and S&P. We did have a meeting prior to the announcement of the Valspar acquisition, which is some – and I think that we're going to go see all three of the rating agencies during this quarter and it's been – we're optimistic that we keep the investment-grade.

Investment-grade is very important to us because in the first quarter of every year our cash flow is negative, because we're building inventory for the season so we're in the commercial paper, we want to be in the A1/P1. We don't want to have one of them not be an investment-grade. We take a look at the metrics and we feel pretty good about the metrics long-term. And so, the investment-grade is pretty important to us.

Brian J. Lalli - Barclays Capital, Inc.

Great. Thanks for the response. I appreciate it.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks, Brian.

Operator

Thank you. Our next question is coming from the line of Rich O'Reilly with Revere Associates. Please proceed with your question.

Richard O'Reilly - Revere Associates

Okay. Thank you. Good afternoon now gentlemen.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Hi, Rich.

Richard O'Reilly - Revere Associates

Hi. On the Protective & Marine business I thought in your opening comments you talked about that under the Paint Stores Group. Was I correct?

John G. Morikis - President, Chief Executive Officer & Director

Yes.

Richard O'Reilly - Revere Associates

Okay. Is there also – there is also a Protective & Marine in the Global Finishes segment?

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Yes. That's correct, Richard. The Protective & Marine cuts across three segments. There's also some Protective & Marine business in Latin America.

Richard O'Reilly - Revere Associates

Okay, fine. So is your comment that you made for under the Paint Stores Group a preferable to all three other segments, where the other segments, Protective & Marine being down?

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Yeah. In terms of the impact of the current oil and gas pricing and the depression in mining activity, yes.

Richard O'Reilly - Revere Associates

Okay, fine. Okay, thanks. Now, in the Paint Stores Group for Protective & Marine it's being sold by the local stores versus one of your major distributor centers is that the difference there?

John G. Morikis - President, Chief Executive Officer & Director

That's correct. We use the 4,000 plus stores as a point of distribution.

Richard O'Reilly - Revere Associates

Okay, great. Second question is, I don't want to sound stupid about this, but in the Consumer Group, when you talk about making investments I'm not sure exactly what that means? If it means, your people in the stores, training the stores people, shelf space, can you elaborate a little bit on that?

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

I think, number one, that's a partial list, but all three – all the things that you just mentioned plus different point of purchase materials, displays, maybe even thinning equipment, color matching equipment – all of that will go into that.

Richard O'Reilly - Revere Associates

Okay. So, that's what you mean by making the investments. Okay. Thank you, gentlemen.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks, Rich.

Operator

Thank you. Our next question is coming from the line of Matthew Skowronski with Longbow Research. Please proceed with your question.

Matthew Stephen Skowronski - Longbow Research LLC

Hey, guys. I'm Matt Skowronski on for Dmitry. Looking at Brazil and Latin America, Brazilian currency is kind of flat year-over-year. So, do you guys expect positive FX comps in the second half or are other currencies kind of going to weigh you down like the peso or the Argentinian peso?

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

No. Don't worry about the Argentinian peso. The four currencies that drive us – and I'm talking specifically Sherwin – are Brazilian reais, which is better than it was in the first quarter but still a headwind in the second quarter. We were still in the 3.11. We expect that possibly by the fourth quarter that's not going to be a headwind. That's going to be a tailwind.

The second is Canadian dollar. The Canadian dollar has continued to be weak. So, we expect that's going to be a headwind for the remainder of the year. The euro, which is relatively flat, and so we think – but we have a big presence in the UK. And with the Ronseal brand, the [Lee's] paint brand, the Geocel and the Great Britain pound is now a headwind – a significant headwind.

Matthew Stephen Skowronski - Longbow Research LLC

Okay. Perfect. That's all the questions we have. Thank you so much.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Okay. Thanks, Matt.

Operator

Thank you. It appears we have no additional questions at this time. So I'd like to turn the floor back over to Mr. Wells for any additional concluding comments.

Robert J. Wells - SVP-Communications & Public Affairs, IR Contact

Thanks again, Jesse. As always, I would be available over the next few days to handle any additional questions that arise out of this morning's call. If you'd like to be placed in the queue for a follow-up call, please call Christy Johnson at 216-566-3001, and she will add you to the callback schedule. That number again 216-566-3001.

I'd like to thank you again for joining us today, and thank you for your continued interest in Sherwin-Williams.

Operator

Ladies and gentlemen, this does conclude today's teleconference. Again, we thank you for your participation. And you may disconnect your lines at this time.

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