The Sherwin-Williams Company
Q3 2014 Earnings Call Transcript

Published: 28 Oct 2014

[Operator:]

Good morning. Thank you for joining The Sherwin-Williams Company's review of the Third Quarter 2014 Financial Results and Expectations for the Fourth Quarter and Full Year. 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 2 hours after this conference call concludes and will be available until Monday, November 17, 2014, 5

[Robert J. Wells:]

Thanks, Jesse. Good morning, everyone. Thanks for joining us. We're going to begin the call this morning with some prepared remarks by John Morikis, President and Chief Operating Officer; and Chris Connor, Chairman and CEO. Following their remarks, we will open the call to questions, and Sean Hennessy, our Chief Financial Officer; and Al Mistysyn, Vice President, Corporate Controller, are with us on the call to participate in the Q&A session. Before I pass the microphone to John, let me remind you that 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 statements whether as a result of new information, future events or otherwise. A full declaration regarding forward-looking statements is provided in our earnings release transmitted earlier this morning. In the interest of time, we have also provided some balance sheet items and other selected financial information on our website at www.sherwin.com under Investor Relations third quarter press release. With that, let me turn the call over to John to review our performance for the quarter.

[John G. Morikis:]

Thanks, Bob. Third quarter 2014 was another strong quarter for the company. But before we go through our results in more detail, I'd like to take a few minutes to highlight some key organizational changes we made during the past 3 months. Let me begin by saying that none of these changes will affect the composition of our reportable segments for the third quarter or in future reporting periods. For the past 4 years, Jay Davisson has provided outstanding leadership to our North American Paint Stores organization, overseeing a period of impressive growth and expansion. In August of this year, we broadened Jay's responsibilities to include the distribution of our products through Latin America. In this new capacity, Jay and his team will be charged with growing our business across North and South America, providing integrated resources to support our sales and marketing efforts. To support this effort, the R&D teams and labs located in Latin America region will become part of the global supply chain R&D organization. This will result in faster technology transfer and new product development across multiple product portfolios. Pablo Garcia Casas, Formally President and General Manager of Sherwin-Williams Mexico, has been promoted to President and General Manager, Latin America division, reporting to Jay. Again, none of these organizational changes affect our reportable segments for our third quarter or in future periods, nor do they affect our leadership or organizational structure of the Paint Stores Group in North America. Our goal is to promote collaboration in the sharing of resources between our North American and Latin American business units to accelerate growth across both regions. In the third quarter, we continued to see strong momentum in both of our domestic businesses -- in both our domestic businesses and mixed results from our nondomestic operations. I'll begin by highlighting overall company performance for our third quarter 2014 compared to third quarter 2013, then comment on each reportable segment. Consolidated net sales increased 10.6% to $3.15 billion, driven primarily by strong performance in our stores group and acquisitions. The Comex acquisition added 3.3% to net sales in the quarter, while unfavorable currency translation decreased consolidated net sales 0.7%. Consolidated gross profit dollars increased $175 million year-over-year to $1.47 billion, and gross margin increased 120 basis points to 46.7% of sales from 45% in the third quarter last year. This was -- margin improvement was primarily the result of better operating leverage from higher production and distribution volume, which more than offset the anticipated gross margin drag from the stores acquired from Comex. Selling, general and administrative expenses for the quarter increased $94.7 million to $984.4 million. As a percent of sales, third quarter SG&A was flat year-over-year at 31.2%, reflecting a decline in core SG&A as a percent of sales, plus the incremental SG&A from acquisitions. Interest expense for the quarter was $16 million, an increase of $631,000 over third quarter last year. Consolidated profit before taxes in the quarter increased $86.6 million or 22.3% to $474 million. Our effective tax rate in the third quarter of this year was 31.2%, compared to 32.1% in the third quarter of 2013. For the full year 2014, we expect our effective tax rate to be in the low-30s compared to last year's rate of 30.7%. Consolidated net income increased $63.3 million or 24.1% to $326.2 million. Net income as a percent of sales increased to 10.4% compared to 9.2% in the third quarter last year. Diluted net income per common share for the quarter increased 31.4% to $3.35 per share, compared to $2.55 per share in the third quarter 2013. The combination of acquisitions and currency decreased earnings per share $0.04 in the quarter. Now looking at our results by operating segment. Paint Stores Group turned in another strong performance in the third quarter. Segment sales increased 15% to $2.03 billion. And comparable store sales, sales by stores open more than 12 calendar months, grew 9.6%. This comp store revenue growth includes almost no effective pricing and no contribution from the Comex stores. So core store volume growth was solidly in the high-single digits. Acquisitions added $80.4 million or 4.6% to sales in the quarter. Regionally, in the third quarter, our Southwestern division led all divisions, followed by Southeastern division, Midwestern division and Eastern Division. Paint Stores Group's segment profit for the quarter increased $72.5 million or 20.2% to $431.8 million. Segment profit as a percent of sales increased to 21.3% from 20.4% last year, as higher paint sales volumes were more than enough to overcome a $5.4 million loss on the acquired stores. During the quarter, we added 18 net new stores, bringing our year-to-date total to 51 new locations. At quarter end, our total store count in the U.S., Canada and Caribbean was 3,959, compared to 3,868 locations at the end of the third quarter 2013. Our Paint Stores Group plans to add approximately 80 to 90 net new store locations during calendar year 2014. The integration of the stores we acquired from Comex a year ago is proceeding according to plan with some consolidation costs coming in below what we originally expected. For our Consumer Group, organic sales growth slowed somewhat in the third quarter, but segment operating margins held up well. Sales increased 5% to $385.2 million from $366.8 million last year with acquisitions adding 3.9% to net sales in the quarter. Segment profit for the Consumer Group increased $5.9 million or 8.1% to $79 million from $73.1 million last year. Acquisitions decreased segment profit $1.9 million in the quarter, as a result of strong seasonality in some of the acquired businesses. Segment profit as a percent of external sales increased to 20.5% from 19.9% in the same period last year. For the second consecutive quarter, Global Finishes Group generated revenue growth in the mid-single digits and made progress on operating margin. Third quarter sales in U.S. dollars increased 5.7% to $536.3 million, driven by higher paint sales volumes and selling price increases. Unfavorable currency translation decreased sales 0.4% in the quarter compared to last year. Global Finishes group's domestic business continued to show strength in the third quarter, but this improvement was partially offset by weakness outside of the U.S., particularly in Latin America. Segment profit, in U.S. dollars, increased 36.4% in the quarter to $60.8 million from $44.5 million last year, due primarily to higher paint sales volumes and price increases. These results also include a $6.3 million gain on the early termination of a customer agreement in the quarter. Unfavorable currency translation rate changes reduced segment profit $900,000. As a percent to net external sales, Global Finishes Group's segment profit was 11.3% in the quarter compared to 8.8% last year. Our Latin America Coatings Group continues to operate in a very challenging economic environment. Third quarter net sales for the group stated in U.S. dollars, decreased 4% to $200.4 million. Volumes in the quarter were negative and unfavorable currency translation decreased net sales by 7.8%, both of which were offset to some degree by selling price increases. Segment profit in the third quarter, stated in U.S. dollars, increased to $11.8 million from a loss of $1 million in the same period last year. In the third quarter 2013, we incurred a charge of $19.8 million related to a Brazil tax assessment. This year, lower sales volumes, currency-related raw material cost inflation and unfavorable currency translation were only partially offset by selling price increases. Currency translation decreased segment profit $4 million in the quarter. As a percent of net sales, segment operating profit was 5.9% in the quarter, compared to negative 0.5% in the third quarter 2013. This concludes our review of results for the quarter. So I'll turn the call over to Chris Connor, who will make some general comments and highlight our expectations for fourth quarter and full year. Chris?

[Christopher M. Connor:]

Thanks, John. Good morning, everybody. Thanks for joining us today. There is not much I need to add to John's comments on our third quarter results other than we remain convinced this positive momentum is sustainable. Regardless of the financial market's ongoing concerns over the resilience of the domestic housing recovery, if and when the nonres rebound will materialize or whether the job market can sustain all this, we see an increasingly positive picture developing for our company. Home prices are still rising at a healthy yet manageable pace and mortgage availability has improved. At the same time, rates are dropping. Remodeling activity has picked up in terms of both current projects and contractor sentiment. New square footage growth is positive year-to-date in both the residential and nonresidential markets. In cities across America, occupancy rates in multifamily housing, office space, hospitality, manufacturing and warehouses have reached very healthy levels, a really good bellwether of future demand for new commercial space. And many of the industrial coatings markets have turned the corner and are showing increasing strength. This positive momentum has been evident in our sales and earnings performance going back to the second quarter last year. The results we released this morning set new all-time records for consolidated sales, operating margins, net income and earnings per share for any quarter in our company's history. It was also a record quarter in terms of net operating cash generation. Working capital management continues to be a source of operating cash for the company, particularly as we integrate the operations of the Comex business we acquired 1 year ago. These efforts have driven our working capital ratio down 170 basis points year-over-year to 10.8% of sales, compared to 12.5% on September 30 last year. 9-month net operating cash increased more than $100 million compared to the same period last year and stands at just over 10% of sales. In the third quarter alone, we generated $550 million in net operating cash, bringing our 9 month total to $881.3 million. Free cash flow, which to us is net operating cash, less CapEx and dividends, was $583 million. We continue to invest a portion of the company's cash back into the business in the form of capital expenditures. For the first 9 months of 2014, we spent $136 million on CapEx, depreciation expense was $125.7 million and amortization expense was $22.6 million. For the full year 2014, we anticipate CapEx spending will be in the range of $170 million to $180 million. Depreciation will be about $170 million, and amortization will be about $30 million. In the third quarter, we bought back 2 million shares of our common stock in the open market, bringing our year-to-date total purchases to 5.33 million shares at an average price of $2.05, I'm sorry, $205.46. On September 30, we have remaining authorization to acquire 6.8 million shares. Last week, our Board of Directors approved a quarterly dividend of $0.55 per share, up from $0.50 last year. Before I turn to our expectations for the balance of the year, I want to comment briefly on the organization changes John highlighted at the beginning of the call. Needless to say, for the past 2 years, we've faced very difficult market conditions in Latin America. Our management team and all of our people throughout the region responded with intelligence, hard work and determination. I'm pleased with their response, and confident in their future. The actions we've taken to promote closer collaboration between our North American and Latin American businesses is not a reaction to the current economic environment, rather it's an important step towards our long-term goal to be the market leader in architectural and protective coatings throughout the Americas. For the fourth quarter, we anticipate our consolidated net sales will increase 6% to 8% compared to last year's fourth quarter. With revenues at that level, we estimate diluted net income per common share in the fourth quarter to be in the range of $1.30 to $1.40 per share, compared to $1.14 per share in the fourth quarter of 2013. This guidance includes our expectation that the Comex acquisition will reduce diluted net income per common share by approximately $0.10 in the fourth quarter. For the full year 2014, we expect consolidated net sales to increase 9% to 11% compared to full year 2013. With annual sales at that level, we have raised our expectation for full year diluted net income per common share to a range of $8.70 to $8.80 per share, compared to $7.26 per share earned in 2013. This annual guidance includes $0.28 per share EPS dilution, which is lower than both our original full year expectation of $0.50 dilution and a revised second quarter expectation of $0.35 per share dilution from the Comex acquisition. Again, thanks to all of you for joining us this morning. And now, we'd be happy to take your questions.

[Operator:]

[Operator Instructions] Our first question is coming from the line of Ghansham Panjabi with Robert W. Baird.

[Ghansham Panjabi:]

Just first off on the customer termination you referenced for Global Finishes. Does that impact the top line at all going forward? And is the gain just specific to the third quarter or is there any sort of residual flow-through into 4Q as well?

[Sean P. Hennessy:]

Well, the fourth quarter, no. There's no residual into the fourth quarter. I would say there's going to be a small amount of residual sales decrease in the future, but not enough to be material.

[Ghansham Panjabi:]

Okay. And then just in terms of the comp store sales for Paint Stores going forward. I mean, obviously, you're starting to cycle through some very, very tough comparisons as you did in 3Q. Can you just, sort of, give us an early glimpse into what a realistic growth rate is for you versus the industry in 2015? I know it's a little bit early, but I thought I'd ask anyway.

[Christopher M. Connor:]

Yes, Ghansham. So we'll give you a lot more color on that, obviously, when we have our year end call and give your our guidance for next year. I think we've been commenting for some time now to the investment community that our expectations is that stores group can perform at 1.5x to 2x the market based on the rebounding contractor segments that we've talked about. So if we think that the market will continue to be a little bit ahead of GDP growth next year, let's say, the 3% to 4%, we would expect our volumes in that stores group to outperform.

[Operator:]

Our next question is coming from the line of Vincent Andrews with Morgan Stanley.

[Vincent Andrews:]

Could you -- it sounds like Comex continues to come in better than you expected. Do you have an update on when you expect the stores in total to become completely accretive rather than dilutive?

[Sean P. Hennessy:]

Yes, we sure do. This is Sean Hennessy. And again, we're giving you guidance of $0.28 loss this year. And we've been consistent in the last few quarters saying that we're going to actually earn $0.08 to $0.13 next year. So we believe that next year, we're going to have $0.36 to $0.41 accretion. And we've given you EPS guidance there. So we think next year, we're going to have positive operating profits.

[Vincent Andrews:]

But you're not pulling that forward to slightly better performance in the last couple of quarters.

[Sean P. Hennessy:]

No. And here's why. When you take a look at the difference between the $0.35 and the $0.28, this is really driven by -- it's really driven by closing costs. Closing costs have come in less than we thought. So operationally, we think we're pretty much in the same situation we were. The $0.06 that we did take this quarter, we did anticipate it in our full year guidance of $0.35. We did anticipate it in the fourth quarter, not the third quarter. But for the full year, we did anticipate that $0.06. So the difference between $0.35 and $0.28 is really closing costs.

[Operator:]

Our next question is coming from the line of Aram Rubinson with Wolfe Research.

[Aram Rubinson:]

A question on Comex about -- I know they're not in the same-store sales. But can you tell us about how those stores are performing on a year-over-year basis? I ask because seasonally it looks like your sales in Comex went down 22% from the second quarter, whereas your regular Sherwin stores went up 9%. And I just don't know why they behave so different on a seasonal basis.

[John G. Morikis:]

Yes. So if you look at that performance over the past 12 months, we've had revenues through those stores of $425 million. And that is down slightly year-over-year. As we took that business over, those stores were under pressure, and they had sales that were going backwards. We've since stabilized that business, and we're feeling good about where that business is going, and we expect that those stores will perform much better going forward. We do expect that they'll lag our comp Sherwin stores in performance, but they'll continue to get better in their performance.

[Sean P. Hennessy:]

We also believe that because as the integration continues to be completed, breaking the sales out and then going forward, really it's going to be a difficult, if that's possible. So this would probably be the last quarter that we're able to give you Comex sales. Because as the integration occurs, the sales go from one store to another.

[Aram Rubinson:]

But suffice to say that if your normal business drops off in Q3 to Q4, I assume we should expect that the Comex sales would also seasonally drop? And then I'll leave that one alone.

[Sean P. Hennessy:]

Sure, of course.

[John G. Morikis:]

Yes.

[Christopher M. Connor:]

One point to add to the Comex story Aram, is that we've closed 7 Comex stores this year as well. Or the other side of the business, obviously, we continue to add stores.

[Aram Rubinson:]

Okay. And then I'm sure the question will be asked. But oil prices have obviously gone through the floor and that must have had some change on your input price outlook. I'm just hoping you can update us and remind us again kind of what percent of your inputs are oil-based and how we should think about that for 2015?

[Robert J. Wells:]

Yes, Aram this is Bob. It is certainly true that a portion of our raw material basket is sensitive to crude oil pricing. About 10 years ago, we did an analysis that told us that a 10% move in crude oil would result in just under a 1% move in the raw material basket. Since that time, we haven't updated that analysis. But since that time, our raw material basket has become less oil sensitive, primarily in the solvent category and resin category. So a 10% move in crude oil today would result in something less than 0.9% move into raw material basket. There will be some benefit, but it won't really be material.

[Operator:]

Our next question is coming from the line of P.J. Juvekar with Citigroup.

[P. J. Juvekar:]

Several companies that have reported so far have talked about signs of commercial growth. You have a pretty good exposure to that through your stores business. So what kind of opportunity do you see in 2015 from commercial construction?

[Robert J. Wells:]

P.J., this is Bob again. We feel very good about the direction and kind of the momentum in the nonresidential market. And our optimism is fueled by 2 sources of information. One is the same published data sources that everyone else is looking at. And that shows contracts for new addition and major alterations up very significantly in a lot of the categories that Chris mentioned in his opening remarks. Office and bank buildings up more than 25%. Hotels and motels up almost 50% year-over-year. Manufacturing and schools and colleges in the mid-teens. And those categories, all told, represent almost 40% of the nonresidential space. There are some negative categories, retail and health care and managed care being kind of standing out amongst the negatives. But overall, square footage contracted year-to-date is up 5%. We also get timely robust feedback from our contractor customers. Many of them who specialize in this commercial space. And clearly, they are busier and more optimistic today than they were a year ago.

[P. J. Juvekar:]

And just quickly on M&A pipeline. Chris, you talked about in the past, making strategic acquisitions in Asia and Europe. And I know, at some point, you'd said that valuations were high in Asia. So what do you see there now?

[Christopher M. Connor:]

Yes, I think we've been consistent, P.J. Our interest in Asia and Europe would be to continuing the support our industrial coatings businesses, which we would embed in that global group. I don't think these evaluations particularly are out of line for us. Ours is just a much more thoughtful process at looking for the right technologies in the right end customer segments. Coupled with that will be our continued focus on architectural opportunities throughout the Americas. And obviously, in Latin America, plenty of opportunities. So we continue to stay diligent in those 2 areas and keep The Street posted whenever we have something to share with you.

[Operator:]

Our next question is coming from the line of John McNulty with Crédit Suisse.

[John P. McNulty:]

With regard to cash flow, you pushed the working capital levels to some pretty aggressively really kind of squeezing a lot or wringing a lot out of rag. I guess, I'm wondering how much, now that we're kind of anniversary a lot of the Comex moves or initial moves, I guess, how should we think about the ability to wring more out of the working capital rag going forward?

[Sean P. Hennessy:]

One of the things that we always are conscious of as we go through these inventory analysis, as we're looking at that service. And what's interesting is that service is actually higher today than it was when we were at 15%, 18% working capital. What we've said is we used just to talk about 11% of sales would be normal. I think our goal now is 10%. We think that will continue to work, especially some of the changes we've made in Latin America and so forth, we think that we can run this company at 10% working capital to sales and still have higher service to our customers.

[Christopher M. Connor:]

Yes. We don't like your word squeeze, John. It's basically [ph] running -- 15% is better.

[John G. Morikis:]

I would say that the commercial teams are thrilled with the service levels and we're operating at a very good place right now.

[John P. McNulty:]

And then one last question. With regard to, I guess, the administrative line or the corporate line, there was a tick up on the provision for environmental. It jumped up $11 million. And so can you just remind us of what that is and how we should be thinking about that expense maybe going forward?

[Sean P. Hennessy:]

Good question. If you look at our footnote that we've continued to put in our Q and the K, these are historical sites, manufacturing sites. And the ongoing expenses are booked when specific remediation plans are approved. And really trying to predict the timing that -- of the approvals with the government agencies is very difficult even while we're working with those agencies. So in the quarter, we have a little more agreement that what we're going to do in a site. And if you look at -- we talked about the Gibbsboro site in our footnote, and I think that's where we're at, and which is why the -- but this -- the work that we've done this quarter, that's why the expense was higher. And that was higher than we expected. That was probably $8 million to $10 million higher than expected. That was not in our guidance for the quarter. So we were surprised of the timing also John.

[John P. McNulty:]

And that goes back down to normal now that we're -- now that it's been announced and it's kind of run through your channel, is that the right way to think about it?

[Sean P. Hennessy:]

Yes. And if you look at it, our admin expense was negatively affected by $11 million in the quarter, $9 million year-to-date. So it's really that timing. It's definitely what some timing now.

[Operator:]

Our next question is coming from the line of Jeff Zekauskas with JP Morgan.

[Jeffrey J. Zekauskas:]

There's a new chloride-based large TiO2 plant being built in China or coming onstream in China from Henan Billions. Are you familiar with the technology in that plant? And is it feasible for Sherwin-Williams to import TiO2 from China that's chloride-based for its global operations?

[Robert J. Wells:]

Jeff, this is Bob. We are familiar with that technology. We understand it to be not as productive a technology as some out there, but it's going to produce high-quality chloride TiO2. To the extent that, that chloride TiO2 comes on to the global market, we would certainly be in a position to negotiate.

[Operator:]

Our next question is coming from the line of Dennis McGill of Zelman & Associates.

[Dennis McGill:]

Chris, I'm so surprised your letting Bob get away with a 10-year old analysis. Maybe just ask that question a little differently. If you put the whole basket together as you guys have done in the past, and everything holds where it is today, what would be your outlook over the next year, let's say, for raw material cost?

[Christopher M. Connor:]

So Bob may be using 10-year-old analysis, but Hennessy uses a 148-year-old analysis. What we do here is based on history. It's a little bit early for us, Dennis, to give you comment on the basket of raws for 2015. Again, that will be a first quarter call. We hold ourselves to that discipline to advise you of that. Having said that, and with the earlier question from Aram about oil, we don't see a lot of pressure right now, but we'll give you much more definitive answer on that here in the next call.

[Dennis McGill:]

Okay, fair enough. And then, John, just to clarify the accretion from Comex next year, the $0.08 to $0.13, are there any onetime items? Or is there [indiscernible] that will be included in that?

[Sean P. Hennessy:]

No. I think that when we acquired this asset, we had 8 manufacturing sites. We've announced 5 have closed. And so we've taken the closing costs on those 5, I don't see any major changes in the next -- or hit in that analysis of $0.08 to $0.13.

[Dennis McGill:]

Okay. And then last question on the balance sheet. If you were not to find another acquisition over the next year, let's say that meets your criteria and the cash flow is going to remain strong, would you ever consider borrowing and levering up a little bit to accelerate share repurchases?

[Sean P. Hennessy:]

I think we've been pretty consistent on this for greater than 10 years, David, at all 148. But we still believe that if we generate this cash, we're going to pay out dividends, invest in the business in CapEx and void of acquisitions, we think our debt's going to be in very good shape in that 1

[Operator:]

Our next question is coming from the line of Ivan Marcuse with KeyBanc Capital Markets.

[Ivan M. Marcuse:]

Sean, can you give me the changes in gross profit for the segments?

[Sean P. Hennessy:]

Yes, I can. Paint Stores Group was an increase of $137.8 million. Consumer was an increase of $14.6 million. Global Finishes Group was $14.5 million. And Latin America was up $9.8 million. And just remember now, Latin America, that's where the hit from the raw material -- issue in Brazil last year hit. That's why it's up.

[Ivan M. Marcuse:]

Got you. And then if you look at your Latin America arm [ph] division and I know you're changing, you're making some leadership changes there. Is your strategy in that region going to change? Or is it going to -- what sort of, I guess, Jay is supposed to -- what is he deemed to do besides improve it? How is he going to go about getting that sort of the margins reversing out or gaining more share than what's been gained over the past couple of years?

[John G. Morikis:]

Yes. I think it's fair to say that we built a pretty strong franchise here in North America and then we believe that these skills and expertise can and should be leveraged throughout the Americas. And so our long-term thoughts and commitments in the region haven't changed, we do believe that we can drive those margins into that 12% range. And it's going to be up to that team to really get into those markets with the local leadership, understand what's the best route to markets and leverage all the resources that we have to reach that type of a good return.

[Ivan M. Marcuse:]

Okay, great. And then last question. Was there any price mix of any consequence that was impacting the top line for the stores group?

[Sean P. Hennessy:]

No.

[Christopher M. Connor:]

No, mostly volume.

[Operator:]

Our next question is coming from the line of Chris Perrella with Bloomberg.

[Christopher Perrella:]

Just a follow-up on the Latin American strategy there. When the downturn came in North American Paint Stores, you continued to invest. I see the LatAm stores are flattish for a while now. Is the impetus now to start to build up the stores await the recovery?

[John G. Morikis:]

Well, we are committed to that region, but we're -- and we're also committed to the right strategy in region. And so, as you look by country, we'll be deciding what the best channel would be. And in some cases, it will be our stores. In others, it'll be through other channels of distribution. And the team is working very aggressively right now with the teams on the ground to assess those and we'll be going full throttle once they've defined the strategy by micromarket.

[Christopher Perrella:]

All right. And a question, the price of oil and, I guess, gas on your distribution network, is there a benefit? Or how should we think about lower gas prices for the Consumer Group and I guess, the distribution network?

[Sean P. Hennessy:]

Yes. I think that -- we do buy a lot of gas and when we have a lot of shipping and so forth, we'll see what that effect is. I don't really have a metric that I can give you at this time.

[Christopher M. Connor:]

Here's one to think about, Chris. We talked about what it costs to get a gallon of paint delivered to shelf, 85% of that cost is raw material. You've got the variable, manufacturing cost. Fuel and transportation is a small percentage of what's left. So fuel savings on the fleet will be de minimis in the impact in earnings for us.

[Operator:]

We'll move on to our next question, which is coming from the line of Bob Koort with Goldman Sachs.

[Robert A. Koort:]

Chris, I'm wondering if you guys have ever looked at econometric models around oil price and is there expected to be any elasticity of demand for your products as consumers get a little more fat in their wallets?

[Christopher M. Connor:]

Yes. I think the other metrics that we've been talking about, Bob,that are driving demand for our products are a lot more powerful than that. The occupancy rates that Bob referred to in the various end segments, our consumer confidence. Does oil impact that a little bit, perhaps slightly. But we would not put a lot of weight on oil prices changing the curve or demand for paint in the United States.

[Robert A. Koort:]

And given -- it sounds there is about that the relatively limited influence of oil prices on your costs. Does it have any influence on your efforts on pricing? Or do you view those as relatively independent?

[Christopher M. Connor:]

Yes. Well, it'd be just one of the many raw material input costs that go into the entire basket. We've been very clear that we price based on raw material input costs. So we've yet to make the call for next year on what the remainder of those items might be. But for right now, it seems that oil will not be a pressure point for us.

[Operator:]

Our next question is coming from the line of Greg Melich with ISI Group.

[Gregory S. Melich:]

I've got a couple of questions. Maybe a follow-up on the last one. Could you remind us, looking at history, how that price mix plays out when oil prices or raw material costs are coming down? And then I have a follow-up.

[Sean P. Hennessy:]

Well, I think if you take a look at that chart that we showed you, the long-term chart of our gross margin, I believe 2006, oil went up to $140. It came back down into the $75 range. I could be wrong on that. But our gross margin the following year, even though the market was decreasing, we held that price and we hit an all-time high at that point, 46% gross margin.

[Gregory S. Melich:]

Right, the gross margin went up, but what happened with the price mix per gallon? Will that come in? Or is there a lag or, how do we think of that?

[Sean P. Hennessy:]

I would tell you that the oil going down did not have effect on the price mix.

[Christopher M. Connor:]

Again, Greg, we've talked about the price mix ratio here for us has been to continue to see a demand for better quality products as labor costs continue to escalate, and that's a biggest part of this particular job. So I'm not trying to be obtuse here. That just isn't much impact on the oil price just dramatically on the way our customers act or the operating margins you're going to see for the company.

[Gregory S. Melich:]

Got it. And then the second question was on -- I think in the second quarter, you called out sprayer sales, that sort of stepped up to a new good level. Do you have any update on that? Has it stayed there or...

[John G. Morikis:]

Yes. I think, be safe to say that they've continued at a pretty good pace.

[Gregory S. Melich:]

Great. And then housekeeping one, the admin expenses, I see popped up to $109 million, up around $20 million. Was that a onetime step up, Sean? Or do we expect this level going forward or how should we think about that?

[Sean P. Hennessy:]

Yes. When you look at the third quarter, I think and you're right, it was up $20.8 million. And that's where the $11 million from that environmental -- that hit that was not in our guidance. So secondly was just a -- the other piece of it was higher compensation, including stock-based comp, which was up about 10. And again, that's just timing. We knew about that, but it was really that environmental that drove half of that increase in the quarter.

[Gregory S. Melich:]

So fair to say $100 million would have been like the normal.

[Sean P. Hennessy:]

More normal.

[Gregory S. Melich:]

More normal?

[Sean P. Hennessy:]

Yes, right.

[Operator:]

Our next question is coming from the line of John Roberts with UBS.

[John Roberts:]

I know there's no changes to the Latin American reporting, but it sounds like it paves the way for potentially collapsing the Latin American segment and the Paint Store segments into a sort of a Pan regional segment, much like you have in the global segment. Would that make sense and provide some cost savings or why doesn't it make sense?

[Sean P. Hennessy:]

Yes.

[Christopher M. Connor:]

Well, how we report the segments in this particular case is historical. And I think there's very difference to those markets, so we want to continue to give that visibility to that. John made the comment about a lot of the learning and skill base programming we operate in North America, which will be moving into Latin America, that's just for those markets. So we're going to continue to run the company as efficiently as we can with an eye towards driving the most growth and share gains. And we think this is the structure that's best going to serve that. No change intended to the reporting segments for now or the short-term future.

[Operator:]

Our next question is coming from the line of Kevin McCarthy with Bank of America Merrill Lynch.

[Kevin W. McCarthy:]

Do you care to provide an update on how U.S. architectural gallonage is trending for this year? I think, back at your Investor Day in May, you put forth a new normal level of 760 million gallons. Just trying to get a sense of how far below that we're tracking in 2014.

[Christopher M. Connor:]

Yes, we don't have good data anymore. Kevin, as you know, on that. Our expectation or sense is that through the first half of the year, we thought the market was moving at about a 3% to 4% range. Just listening to some of our other competitor's results, it may be slowing a little bit to that. Last year's gallons were 700 million with a 3% pop. If you look at 721 million gallons, so you still have 40 million below that 760 million. Hopefully, we'll have a little better data to share with you on the first quarter call what the year came in now in gallons.

[Kevin W. McCarthy:]

That's helpful, I appreciate it. And then, as a follow-up, could you comment on how your auto refinish coating sales trended relative to the Global Finishes segment as a whole?

[John G. Morikis:]

In the Global Finishes Group, the strongest performing markets there were Product Finishes and Protective Marine. Automotive would have been in third position there. Domestically, they were stronger than they were internationally.

[Operator:]

Our next question is coming from the line of Arun Viswanathan with RBC Capital Markets.

[Arun S. Viswanathan:]

Most of my questions have been answered. I guess, just a little bit on the Paint Stores Group. I mean, you guys have been trending up in the high-single digits now for several quarters. Maybe you can just help me understand why you think that should continue at that 1.5x to 2x the industry level.

[Allen J. Mistysyn:]

The strategy that we have in our stores with this direct model is to get very close to these customers, build the products and services that they need. We're very aggressive in understanding the customers' need individually. And since we compete on a local basis, we have these local teams that are getting closer and closer to these customers. We're not waiting for the market to come to us, we're going to the market. And we feel as though we've got the products and services that are helping us to grow share at a faster rate than the market.

[Arun S. Viswanathan:]

And I guess, just as the way to put that in context, I mean, relative to that 740 to 760 peak gallonage number, you're only at 700 maybe in the industry. So that is it fair to assume that your share has grown by significant measures since then?

[Allen J. Mistysyn:]

Yes.

[Arun S. Viswanathan:]

And that's just because of the -- largely because of the customer base, I guess, is what you're saying?

[Allen J. Mistysyn:]

Yes, I believe so. I think we're aiming at the right targets with the compelling offer and service to provide them.

[Christopher M. Connor:]

One of the charts we've used in our deck frequently, talks about where these gallons will come from as the industry moves from 700 back up to a normalized run rate. And it's going to come in the areas that are depressed and not quite there yet. New home construction, commercial construction, each tend to be very heavily skewed towards the painting contractors as opposed to any DIY participation in the rebound. And to John's point, that's where we really built the model through the Stores Group to support that customer segment. So we would expect to outperform on the rebounding portion of the gallons, just given our share position against our contractor today.

[Arun S. Viswanathan:]

Okay. And I'm sorry, just to fully understand this. So yes, I've seen those charts of the new home sales coming back, and we did have a pretty good number earlier this week or last week on new home sales for September. Existing was good. So you think you can still deliver this kind of high-single digit range even with new home sales? I guess, kind of still only in a recovery stage or...

[Christopher M. Connor:]

We will give you guidance on the first quarter call. But to your point, we've sustained this now for multiple quarters over a couple of years. And we're still kind of -- to use -- since we're in the World Series time, a baseball vernacular, this recovery feels like it's the bottom of the third or fourth inning to us right now. So there's a little bit of a runway yet here. And we think we're in good position to capitalize on it.

[Operator:]

The next question is coming from the line of Dmitry Silversteyn with Longbow Research.

[Dmitry Silversteyn:]

Most of my questions have been answered, but I'd like to follow-up on a couple of things. First of all, back in your Investor Day, you've given the presentation on the Consumer Group, there were some hints that you guys are working on some programs. Perhaps, to get into various distribution channels. Is there any updates there? Should we be expecting something from the Consumer Group besides the programs that you already have and the products that you already supplied to various distribution channels?

[Christopher M. Connor:]

Yes, here again, Dmitry, we've been very consistent on this messaging point with the investment community. We've been working on expanding our Consumer Group business forever. And we've always been clear that we are willing to sell into these channels with the great platform of brands we have. The real opportunity would be on our architectural paint program in one of the big box players. And we just have been clear about our unwillingness to put the Sherwin-Williams contractor program brands into those platforms. But fairly now we've always believe we have an awful lot to offer. So those efforts continue as they have for some period of time. And if anything ever changes, you'll be among the first to know.

[Dmitry Silversteyn:]

All right, fair enough. Just a follow-up on the Consumer Group. How much of the either percentage of sales, or if you can just sort of ballpark for us sort of the size of the business, how much of that business goes into the independent retail channel? In other words, the stores that are not owned by companies and not DIY, but independent paint stores.

[Christopher M. Connor:]

Yes. So all the sales in that segment are external sales, that doesn't go through any of our stores. There are some industrial coatings businesses in the aerosols, for example, that we would sell to the MRO industry. But I'm going to just guess that we're probably talking about a solid 80% of it is going into the traditional home improvement retailing channels.

[Dmitry Silversteyn:]

I understand that. But my question was specifically on the independent paint store channel.

[Christopher M. Connor:]

A very small portion of that.

[Dmitry Silversteyn:]

A small portion? Okay. And then, finally, can you provide any updates, if there are any, on the what's going on with the California lead decision and where you stand on appeals and sort of what you're doing right now?

[Robert J. Wells:]

Yes. Dmitry, as you know, the judgment was centered against 3 of the defendant companies in the first quarter of this year. We have filed an appeal, and we filed our appeal briefs on September 16. We are now awaiting the plaintiff's response to those briefs. And once filed, we will have an opportunity to prepare responses to their briefs. And the short story is that we expect briefing to go on until year end or maybe even into first quarter '15 following which the court will schedule oral arguments. And we believe the court is likely to take through 2015 or more likely into '16 to render a decision. At that point, we believe the loser will appeal to the California Supreme Court, which is likely to take another 2 years plus.

[Dmitry Silversteyn:]

Okay. So nothing to worry about as far as cash outlays in the major way until we get to the end of the decade at least?

[Robert J. Wells:]

We have years to resolve this, yes.

[Dmitry Silversteyn:]

And then just -- I'm sorry to keep revisiting this unpleasantness. But any updates on the cross suits that you and Comex owners have filed against each other?

[Robert J. Wells:]

Yes, our lawsuit in the State of New York has been stayed indefinitely, but the arbitration process is ongoing. And the timing of the arbitration is uncertain, but it is moving forward.

[Operator:]

Our next question is coming from the line of Richard O'Reilly with Revere Associates.

[Richard O'Reilly:]

A couple of quick questions. When I -- when we look at the Consumer Group, the absolute profit went up $6 million or so for the quarter. But I'm surprised it's the increase in Paint Sales Stores was $250 million and the inter-segment sales for the Consumer Group was $110 million, up $110 million. I just would have thought more of a flow-through to the bottom line for the Consumer Group than the $6 million. Am I missing something there?

[Sean P. Hennessy:]

Well, the only thing you're missing is that we also had a $1.9 million loss in the Consumer Group related to the Comex acquisition. And so -- with your number, when you take a look at it, the flow-through of -- on the internal sales will change from quarter-to-quarter due to sales mix, but I think that's the only thing you're missing, quite honestly.

[Richard O'Reilly:]

Okay. It's nothing out of the what should be -- or what would be normal for that size of the -- for the growth in retail sales?

[Sean P. Hennessy:]

Right.

[Richard O'Reilly:]

Right. Okay. Okay. Second question is, in Latin America, you talked about increasing raw material cost. What is -- what's increasing in Latin America that's not going up in North America?

[Sean P. Hennessy:]

Yes. Actually, nothing. But Latin America buys the majority of its raw materials in U.S. dollar denominations and sells the finished goods in local currency. So that devaluation is been a pretty good headwind for us in South America -- Latin America.

[Operator:]

We do have a follow-up question coming from the line of John McNulty with Crédit Suisse.

[John P. McNulty:]

So with regard to the Comex stores, I believe you'd indicated on prior calls that you were looking for margins to be kind of in the upper-single digits in 2015. Is that still the case? And if not, can you give us an update just to how to think about that?

[Sean P. Hennessy:]

Yes. And John what we tried to do because we were sort of mixing apples and oranges. And what happened there was we'd given EPS guidance for 2014. And that's why we switched the metric to the EPS for 2015, the $0.08 to $0.13 positive or $0.36 to $0.41 improvement. Operating margins are going to be positive. What happened was we originally gave a 60% of current stores, when our stores were in the 14% range. And then our stores jumped to 16%, and we're not going to be at 60% of that. And again, we're going to have margin improvement. And so that metric didn't work anymore. So we still feel pretty good about the operating margins. If you back out -- if you go up from $0.08 to $0.13, it's going to show you that we're going to have to be in the mid-single digits operating margins in the stores to hit that number.

[Operator:]

It appears there are no further questions at this time. I would now like to turn the floor back over to Mr. Wells for any additional or concluding comments.

[Robert J. Wells:]

Thanks, again, Jesse. As always, I'll be available for the balance of today, tomorrow and throughout the coming week to answer any follow-up questions you have. We want to thank you again for joining us this morning, and thanks for your continued interest in Sherwin-Williams.

[Operator:]

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