The Sherwin-Williams Company (SHW) Q2 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to The Valspar Fiscal 2013 Second Quarter Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Tyler Treat. Please go ahead.

Good morning. My name is Tyler Treat, and I'm Valspar's Treasurer and Vice President of Investor Relations. Thank you for joining us on our fiscal 2013 second quarter earnings conference call. We have 2 speakers today to provide you with insights on the results we announced this morning: Gary Hendrickson, our Chairman and Chief Executive Officer; and Jim Muehlbauer, who recently joined Valspar as Executive Vice President, Chief Financial and Administrative Officer. After our prepared remarks, we'll be happy to take your questions. Let me also remind you that comments made by me or by others representing Valspar may contain forward-looking statements, which are subject to risks and uncertainties. Our SEC filings contain additional information about factors that could cause actual results to differ from management's expectations. These filings can be found in the Investor Relations section of our corporate website at valsparglobal.com. And finally, please note that our reported results this morning included non-GAAP financial measures. This result should not be confused with the GAAP numbers we reported this morning in our earnings release or with the GAAP numbers we will report on our Form 10-Q. For GAAP to non-GAAP reconciliations about reported to adjusted results and guidance, please refer to the supplemental schedules in this morning's news release. With that, let me introduce Valspar's Chairman and CEO, Gary Hendrickson.

Thank you, Tyler, and good morning, everyone. We delivered strong volume performance in the quarter, and our overall results were in line with our expectations and reflective of the environment I discussed with you on last quarter's call. We were particularly pleased to report total volume growth of 7% and to see volume growth in both our Paints and Coatings segments. These gains came despite continued uneven global demand and market weakness in some product lines in international markets. Driving much of the volume growth in the quarter was new business we won from our ongoing efforts to grow in product lines that would deliver profitable growth for the long term. Several quarters ago, we discussed our exit from some unprofitable product lines and customers, which cumulatively represented 2% of our volume. Now that we have begun to anniversary these initiatives, the new business growth we have been talking about is much more apparent. In North America, consumer paints, excluding the new Ace business, volume grew low-teens, driven by the deployment of new retail programs designed to grow market share as the U.S. housing market continues to recover. The Love Your Color Guarantee marketing initiative is just now entering its second year, and we introduced new advertising and marketing support during the quarter to further differentiate the Valspar brand among consumers. In late March, we launched our expanded professional program at Lowe's, which we alluded to in our last call. This program significantly enhances our ability to serve the large and growing professional paint market. And while it's early, we're encouraged by the momentum we've achieved thus far. We're making good progress in integrating our acquisition of Ace's manufacturing assets. At this early stage, sales volume to Ace consists of private label products that carry a lower selling price than our existing business. This had a dilutive impact on average selling prices for the total Paint segment during the quarter, which we expected to happen during the integration period. Our cost synergy targets for this business are on track, and we expect further volume growth as we enter the painting season and as we launch Valspar branded paint in Ace stores later in the year. We believe that the new initiatives with our existing Paint business, Pro Paint and Ace, position us well to capture additional sales going into the painting season. In the Coatings segment, we grew volume in packaging, wood and coil products. Packaging volumes increased high-single digits, and sales were up low-single digits. Growth was driven by significant new business wins with key customers in all geographic regions. These gains were partially offset by continued end market weakness in the general industrial product line. Similar to the trends we described in the first quarter, demand for coatings used for off-road equipment, pipelines and shipping containers remain weak. This environment is consistent with what some of our industrial customers have recently reported. So we were pleased with total company volume growth in the quarter and the progress we've made in bringing in profitable new business. You will notice that the company's gross margin rate did decline modestly compared to last year due to our mix of sales, and Jim will speak to the factors that caused this decline in his comments. You may recall, on our last call, I mentioned we will be taking actions to restructure our North American paint manufacturing footprint following the Ace paint acquisitions, as well as steps to continue improving profitability in our Australia business. These actions were announced today on our press release, and Jim will provide more color on the impact of these initiatives in a moment. I do want to note that these steps are consistent with the cost synergy plans for Ace and ongoing profit improvements in the Wattyl business we have previously discussed. As we stand at the midpoint of the year, the business is performing as expected given the demand environment of key customers and markets we serve. When we developed this year's plan for double-digit earnings growth, we assumed uneven global demand but with no significant market declines, stable raw material costs and significant new business growth across our product lines. Most of these factors have largely played out with the notable exception of worse-than-expected decline in some general industrial product lines and markets. However, it is important to note that our long-term view of these markets remains bullish. We're making prudent investments today to grow our capabilities and capture profitable growth in some of the world's largest industrial markets like China, Latin America and Europe and will continue to do so in the future. Looking ahead to the balance of the year, we are planning for more growth, mainly driven by new business. The solid growth in our consumer, packaging, coil and wood product lines that we have seen to-date is expected to accelerate in the back half. And based on this view, we are maintaining our adjusted EPS guidance of $3.60 to $3.80 for the full year. And now, I would like to introduce Jim Muehlbauer, the company's new Chief Financial and Administrative Officer. I'm very pleased to add Jim's experience and perspectives to our leadership team as we continue to build the business for the future and deliver returns for our shareholders.

Thanks, Gary, and good morning, everyone. I'm excited to be with you today on my first Valspar earnings call. Since joining the company in March, I have been getting up to speed on the business and spending time listening to perspectives on the industry and Valspar from several customers, investors and analysts. I sincerely look forward to connecting with you in the future to hear your perspectives as I work with Gary and the leadership team to continue the company's strong track record of profitable growth and building shareholder value. Turning now to our results for the second quarter. I know you have read today's release and can follow up with Tyler on some of the detailed financial questions. I plan on focusing my comments this morning on the bigger takeaways from the quarter, providing supporting information for key performance items and commenting on our outlook for the second half. As Gary said, volume growth from both the Paints and Coatings segments was one of the quarter's key highlights. The 7% volume increase was led by a very strong performance in the Paints segment, especially in North America. Volumes in the Coatings segment also increased and improved sequentially, despite continued softness with general industrial customers. Volumes in our North American paint product line increased strong double digits, led by growth with core customers and the addition of new business with Ace, which is comprised of private label SKUs at this early stage of the partnership. Excluding the new Ace business, volumes in North America paint increased low-teens in the quarter and were partially constrained by the abnormally cool spring experienced in certain regions of the U.S. compared to last year. We also saw volumes improved in most of the product lines in the Coatings segment, including packaging, wood and coil, as we continued to win new business in the marketplace. Volumes in the general industrial product line declined in all of our markets due to reduced customer demand and macroeconomic conditions. As you may recall, we are lapping a very strong period last year in our general industrial product line. In fact, our 2-year volume growth in general industrial is up mid-single digits despite the decline this year. Overall, we were pleased with the continuing new business wins and volume growth given the uneven market conditions, which Gary outlined on last quarter's call. Total sales in the second quarter were flat, which was a slight improvement from the 1% decline experienced in the first quarter. Sales growth was impacted by 7% volume improvement, a sales mix shift as the result of the new business and a slight improvement in pricing. Let me provide you with a little context on why sales were flat in a period when volumes increased 7%. First, we had a couple of product lines that drove large volume increases, but provided smaller improvements to sales dollars, given their overall lower average selling price. This was especially true with the addition of the Ace private label volume. The sales dollars growth from new business was essentially offset by volume declines experienced in some general industrial product lines such us off-road, shipping container and pipe coatings that have relatively higher average selling prices. This change in sales mix was also the primary driver behind the decline in our gross margin rates versus last year. The gross margin rate in the second quarter was 33.5%, a decline of 110 basis points. The lower gross margin rate can simply be attributed to 2 main drivers: First, we grew significant new business volume from lower-margin products like the Ace private label business; and second, part of the decline was just a change in P&L classification. Some of our vendor support programs in the Paints segment changed this year, resulting in these payments being reflected as reductions in net sales and gross margin. Historically, these expenses would have been included as selling, general and administrative expenses. This change had no overall impact on EBIT, but lowered the gross profit rate and improved the operating expense rate by approximately 50 basis points in the quarter. We expect this impact to continue into the second half of the year and subside when we anniversary this change in early fiscal 2014. Together, the sales mix change from new business and the reclassification of vendor support expenses in the P&L drove a majority of the gross margin rate decline in the quarter. Moving to operating expenses. We have continued our focus on supporting investments to grow our core business and new businesses for the future, like the Professional Paint program, opportunities in packaging and in general industrial, Ace, B&Q and in the expansion of our R&D capabilities. Excluding the impact from the vendor support reclassification, operating expense as a percent of sales improved approximately 100 basis points in the second quarter. The reduction in expenses was primarily the result of lower incentive compensation and benefits from productivity initiatives. Bringing it altogether, total second quarter EBIT grew 4%, and EBIT margins improved 60 basis points versus last year. From a segment perspective, EBIT margins in Paints improved 100 basis points to 13.5%, driven primarily by higher sales volume. In the Coatings segment, lower sales in some of our general industrial product lines reduced EBIT margins to 15.5%, a decrease of approximately 110 basis points. As you saw in the release, today, we also announced several restructuring actions, primarily focused on manufacturing savings initiatives in the North American paint business as a result of acquiring the Ace Paints assets and our ongoing profitability improvement initiatives in our Australian business. These initiatives include consolidations in our manufacturing operations to improve efficiency and effectiveness, as well as actions to lower expenses in several businesses. In total, we expect to incur approximately $18 million to $23 million in non-recurring charges, after tax, for these initiatives in fiscal 2013 and '14. Together with approximately $30 million in capital to support these initiatives, we expect that these actions will improve annual EPS by approximately $0.10 when fully realized in fiscal 2015. Looking at the back half of the year, we expect growth from new business actions in consumer paints, packaging, coil and wood coatings to improve. Accordingly, our outlook reflects higher gross rates in sales and EBIT margins in the second half than we have experienced year-to-date. To assist you with your modeling, we expect that sales growth in the related operating leverage benefits will be the largest in the fourth quarter due to the expected timing of adding new business in our packaging product lines, private label paint volumes and the launch of Valspar branded paint at Ace, as well as growth in our Professional Paint program. We continue to expect annual adjusted EPS in the range of $3.60 to $3.80 and GAAP EPS of $3.45 to $3.65, including the anticipated restructuring costs in fiscal 2013. With that, we would like to open up the call and take your questions.

[Operator Instructions] And our first question comes from the line of Ivan Marcuse with KeyBanc Capital Markets.

And the first, for a lot of companies, March was pretty slow because of weather, at least in the paint industry. Did you see an acceleration going into April? And is there any trends in the paint industry, at least in North America, with the new businesses that you've gathered over the past year or 2 that will make you more or less optimistic looking out the next couple of years?

Hey, Ivan, it's Gary. Thanks. Obviously, our first quarter was great -- our second quarter was a great quarter in terms of volume growth in North America -- particularly in North America. Our paint volumes in North America were up almost 30% in the quarter. Part of that was Ace. But excluding Ace, our volumes were up in the low-teens. And obviously with the new Professional program that we launched at Lowe's, we had some load-end. But even excluding the load-end, the business in North America, volumes were up mid-single digits. And to your first question about whether we saw any trends developing in the quarter, I would say that we did. The second half of the quarter was much stronger -- materially stronger for us at sell-through -- at retail sell-through than the first half of the quarter. So it looks like that, clearly, there was -- there's a late start to the painting season, but I think the season will develop into a pretty strong one relative to those that we've seen in the past. I think that speaks to the improving trends in the housing market, and also -- but for us, we're -- we've got to focus also on growing our market share. And I think some of the good results that we saw in the quarter are a result of the marketing programs that we've been working on with our retail partners over the last couple of years. I've mentioned Love Your Color Guarantee in my opening remarks, and we feel like we're really well positioned in our North American business to continue to capture growth, both through market share gains as a consequence of great marketing and great retail partners and as the housing market continues to recover.

Great. And then, just as a quick follow-up. How much of the contribution to EBIT was from new business? And if -- and then, going over to the B&Q business, where do you stand on the rollout in the business there? We understand that I think you should be somewhere in like 30 stores or something at this point. Is that where you're at? And what's your expectations as you go through the year?

Yes. I don't know the exact answer on how much of the contribution to EBIT was new business. And we talked about Ace as being dilutive in the first few quarters of the year. And the load-end involved a lift. So you're going to have to get back with Tyler on that. I mean, as Jim pointed out, the increase in our EBIT in our Paints segment was volume-related, but I can't break it out for you. With respect to B&Q, that program is right on track. We've got the Valspar program set in 14 B&Q stores. I was with the their executives in London last week, and they couldn't be more pleased with the performance of the Valspar program in their stores. We'll start the mass store rollout in about 4 to 6 weeks' time, and we expect to have all 350 stores set in early '14. So all systems go on the B&Q launch, and we're all really excited, both at Valspar and at B&Q.

Great. And just a last question, on your -- in your general industrial, I was a little surprised to see piping was -- pipe was down. Is that associated with just more macro demand, or is there something specific in the quarter? And do you expect that business to sort of get back on the growth rate trajectory that's been on?

Yes. That -- so, that's a relatively new business for us, Ivan. And I think, as we've talked about in the past, we're very pleased with the progress that we've made as a relatively new entrant into the market. The business has been growing at a compound rate over the last 3 years of 25%, even including the decline that we experienced in this quarter. Pipe coating is a project business. Pipe projects are not being done, and the pipe is not being coated because it would just be put into inventory if it were. So what we think happened in the quarter is that the -- particularly in North America, where the majority of our business still is, the very long cold winter delayed some projects from getting started. And you can't -- in some cases, you can't put pipe -- pipelines up if the ground is frozen and covered with snow. So we do expect to see some recovery in the second half for the business. Great -- I mean, the great news for that -- for us is that the macro trends in energy transmission and water transmission and the need to move those BTUs around the world is a great long-term trend, and we're well positioned for the -- to keep growing in the future.

And our next question will go to the line of P.J. Juvekar with Citi.

You're restructuring in Australia again. It seems like Dulux is gaining share there based on their comments. So can you provide some color on -- is it lost of Bunnings? Is it slow rollout of Masters' expansion plans? Can you just talk about that?

Sure. We are -- P.J., we are right on our plan in the Australia business. The only thing that we didn't anticipate when we acquired the business in 2010 and made our commitment that we would get the business to the company's average margins in 5 years' time is the weak housing market. But despite the weak housing market, we are on our plan to get that business to the company average margins. EBIT margins were up about 200 basis points in the first year that we owned it. It will be up about 200 basis points this year. And integral to that plan was the closing of an additional factory, which is the one that we announced this morning. So we couldn't do it all at once. We had to phase in the improvements that we were making over time. We did a lot early. We took a little pause. And now, we're going into what is substantially the last phase of the restructuring. But as I said in my opening comments, this was our plan right from the beginning. So with respect to the comment that our competitor made -- I didn't read them in detail. I -- but I'll respond to what you just said. Somebody took share from us in the Australia market, and that was planned. When we bought the business, we had way too many stores and we were doing business with way too many independent paint stores. And we've been pretty clear that we've been restructuring our distribution footprint in our stores business over the last 2 years. And as part of that, we closed -- we walked away from unprofitable stores that we're doing business, and someone got that business. So I will agree 100% that somebody is taking share from us in the -- was taking share from us in the Australia market. Again, that was planned. We felt that we needed to pretty fundamentally restructure the business to get it back on the -- to get it into a model and be at the cost structure to the point where we could be profitable as we grow it. Now I will say this: we are in growth mode again. Masters is continuing to build out their stores, and we've ended up with 75% or more of the shelf space in the Masters stores with our Wattyl brands. And so we'll grow with that. We are -- we will be anniversary-ing most of the restructuring action that we took in our store footprint in Q3, and it will be all anniversary-ed in Q4. And in fact, in --- even in this quarter, we saw an improving negative trend. The numbers are still negative, but it was an improvement over the first quarter. The third quarter gets substantially better. And in the fourth quarter, we'll finish with the anniversary of those stores. And so, we're almost at the inflection point now where we expect to see that the negative volumes that we've experienced over the last year or so turn positive. That will happen in Q4 and into Q1 of next year. So that's kind of a long-winded answer to your question, but I thought some context was important.

Great. And then, second question is on Ace. Are you shutting down all Ace paint plants? And then on the store side, how many stores are you rolling out your program in?

No. We acquired 2 of the Ace plants, P.J. We will not be closing both of them. We have an opportunity to restructure our manufacturing footprint in North America. That -- we have our plans, but we're not ready to say publicly what the specifics of the plans are. And with respect to rolling out into the Ace stores, we won't be launching the Valspar program until late in the year, and we are in the process now of working with individual Ace store owners and the Ace corporate office to sign up dealers for that launch. And we're not prepared at this point to say exactly how many we'll have at launch.

And next, we'll go to the line of Bob Koort with Goldman Sachs.

This is actually Neal Sangani on for Bob. Has there been any change in the $400 million target that you set for new business wins for next year? Any upside there?

No change in that number, Nielsen (sic) [Neal]. It really rolls through next year and into '15 before we get to that run rate. And that's the 3 programs at -- the third one has now been announced. That's B&Q, it's the Professional program at Lowe's and it's the Ace acquisition.

And just to circle the globe on the prior line of questions, what are you seeing in China coming out of the new year, and what does the year look like on demand trends there?

Yes. For consumer paint?

Yes.

Yes. It's -- I think it's going to be a weak-ish year. I think the market will grow a little bit, but at not what we've seen in past years in terms of the growth rate. For our business, we -- this quarter wasn't a great quarter in absolute terms. But in the context of a comparison to 2012, it was a pretty good quarter. In 2012, in this quarter, our volumes were up 33% in our consumer business in China, mainly as a consequence of pipeline fill for our product for the new affordable housing market. So in a relative sense, we were down on that number in China this year, but we expect that in the third and fourth quarters, we'll get back onto a -- into a better trend line. But the market overall is not -- I would not say that the property market in China is robust.

And next, we'll go to the line of Jeff Zekauskas with JPMorgan. Silke Kueck-Valdes - JP Morgan Chase & Co, Research Division: It's Silke Kueck-Valdes. Were raw materials a benefit to you in the quarter?

Very slightly. Silke Kueck-Valdes - JP Morgan Chase & Co, Research Division: Very slightly. And why is it only very slightly because it seems that material costs really haven't moved up very much or in fact they're probably a low on a year-over-year basis?

Some things up, and some things are down. When we talk about our raw material costs, we think about the total basket. And while you're correct that some things were down, other materials were up due to mainly -- due to supply and demand. And the price of oil is still pretty high. Our raw material basket today is still at more or less the historical high. Silke Kueck-Valdes - JP Morgan Chase & Co, Research Division: And for the remainder of the year, now given that you have this reclassification of how you're booking your sales and gross profit, did you expect any gross margin expansion this year, or that's just impossible?

We focus on EBIT margin, Silke, and we do expect some EBIT margin expansion for this year versus last. Silke Kueck-Valdes - JP Morgan Chase & Co, Research Division: Okay. Regarding the Paints business, what [indiscernible] North American business grew 30%. And if you strip out Ace, you grew, you said in, like, low teens. And then, if you -- you said if you exclude the load-ends, you'd grew mid-single digits in Paints. So load-ends means that's the new volume that was put on the shelf at Lowe's in the Pro Paint business?

Correct. That's correct. Silke Kueck-Valdes - JP Morgan Chase & Co, Research Division: Okay. I have one more follow-up, if I may. The general industrial business seems like so broad in categories. Is the general weakness more related to your contractors like Deere and Caterpillar? Is that, like, the largest source of the weakness?

We -- the 3 segments of our general industrial business that we called out, Silke, represent about 70% to 80% of the weakness that we saw in that product line. So those 3 that we mentioned, off-road, pipe coatings and container coatings represent 80% -- almost 80% of the decline that we saw on volumes in our general industrial business. Silke Kueck-Valdes - JP Morgan Chase & Co, Research Division: Maybe if I can ask a final question, what would be the cash charges related to the restructuring that you're taking this -- in 2013?

Yes, Silke, it's Jim Muehlbauer. Roughly, of the charges that we spoke about, I'd say about 60% of them are going to be cash-related, and that will happen both this year and next year. Majority of the cash will actually go out the door this year.

And next, we'll go to the line of Chris Nocella with RBC Capital Markets.

Just as you look into your portfolio, how do you see the opportunities for, maybe, further cost reductions in some other businesses? And also, can you just rank your thoughts on acquisitions or share repurchases or maybe some other uses of cash?

Sure, I would be happy to. I think the restructuring announcement that we made today speaks to some of the opportunities we continue to see in streamlining the back end of the business as we grow a more global footprint for Paints and Coatings overall. And certainly, as I'm early into the role, I see a number of encouraging opportunities of things that we can continue to leverage on the back end of the business, whether it's our manufacturing footprint, our indirect spending, I think there's a lot of opportunity over time that we can get after in those spaces. So that's going to be important because, as Gary mentioned in his comments, we have a number of investment properties around growing the Valspar brand and investing in markets where we see future growth, whether it's in China, Latin America, even some parts of Europe, at the end of the day, that are going to require investment funding. So we're scouring all parts of the business model and P&L to look for ways to, a, fund that growth but also continue to enhance returns on the bottom line. So I'm encouraged by the opportunity we see in that space. And I think from a -- your second question essentially around capital allocation. Once again, I'm new to the role. But certainly, looking what the company has done historically, I think, very successfully, is, number one, it's invested in growing its core business, which provides the best returns for shareholders. It's done so by acquiring companies that were both accretive from a technology and from an infrastructure support perspective. One of the things, Chris, that I've come to appreciate much more now that I'm inside the company is just the level of support that Valspar provides its customers, whether it's in the consumer paint business or in the Coatings business and the relationships that we have with those customers and what you have to do to invest in those relationships. So I think growing that business, continuing to invest in that space is what really keeps our growth profile and our cash flow healthy going forward. After that, certainly there's opportunity to continue enhancing shareholder returns by returning funds to shareholders. And I think the company has been on a very predictable and important part of enhancing overall returns by buying back shares in the marketplace. So that, coupled with the long history of paying dividends, I think, is providing a nice yield profile for investors who are looking at this space.

Great. I appreciate the insights. And just to switch gears on the Coatings, it seems that the container business was a pretty big help for margins last year. It's coming off a little bit this year. Is this the new normal level for the containers business specifically, or do you think maybe we're a little bit of a low this year and it'll kind of rebound as we're looking out?

No -- Yes. Chris, the container business is terrible in terms of the numbers of containers that are being built. I mean, we are probably at 10% or 20% of what the peak would be. And so, it's a very cyclical business. It's part of a -- it's a relatively small part of a pretty stable company, but it's cyclical. And right now, it's at the bottom of the cycle. I mean, global trade is what drives -- and the numbers of containers that are shipped out of China and around the world is what drives the need for containers. And right now, those metrics are not in favor of the container industry.

We'll move to the line of John McNulty with Crédit Suisse.

This is actually Ernie Ortiz filling in for John. With regards to the recently expanded Valspar Pro program, the DIY stores have been working on penetrating the contractor market for a while now. Where's the strategy different this time that gives you the confidence in the potential for growth for this program?

Ernie, so the Pro market is not a new market for Valspar. We actually introduced a Pro product into our retail distribution about 4 years ago, and it's done very well. Further growth for us in -- particularly in home improvement channel was constrained somewhat by the fact that the full product offering was not offered to Pros in that channel. So our new program is a comprehensive program of Valspar products for the Pros, a full line of good, better, best. We have invested in salespeople in the field, who are calling on professional painters and driving them to our retail partners. We've solicited a lot of input from professionals and to how this program certainly should be managed, and we have a fantastic partner that wants to grow in the Pro market as much as we do. And the good news is a lot of professionals shop in the home improvement channel, but aren't buying their paint yet in the home improvement channel. And so the opportunity to capture those professionals as they shop with our retail partner is, we think, a very exciting opportunity.

Okay. That's helpful. And then, I think you also spoke about opportunities in packaging. Can you just provide an update on how customers are moving towards BPA-free coatings? It seems some of the headlines have dissipated somewhat. But have customers been progressing towards that goal?

There have been some customers that have converted from BPA-containing products to non-BPA-containing products. And I'm have to say that, as that's happened, we've maintained our market share and many times -- in many cases, we've replaced ourselves. And in other cases, we've taken market share from the market. I would not say it's a wholesale movement at this time, mainly because the food regulatory agencies around the world have said that the BPA molecule is a safe molecule repeatedly, including our FDA and European Food Safety Administration. But there are some brand owners that believe that their consumers would like to see a package that did not contain BPA, and they've made some moves. And as I said, we've participated in that.

Next we'll go to the line of Kevin Hocevar with Northcoast Research.

I was wondering if you could quantify the amount of sales for the -- those new consumer paint business opportunities with Ace and Lowe's? And I don't think there's anything for B&Q yet besides the kind of the early 30 stores or so. But could you quantify the amount of sales from those business opportunities?

Yes. Kevin, it's Jim Muehlbauer. It's certainly early days in what we're doing in loading the business with the Professional Paint that Gary spoke about and just ramping up the private label SKUs. What we've tried to do is provide a little color on the volume that goes along with those businesses. As you might understand, we're not particularly interested in providing sales level detail by product line and by individual customers. I think the key is in, really, Gary's comments around the $400 million opportunity that we see over the next year or so in growing our paint business, certainly of which B&Q, Ace and our professional program at Ace and our core business on top of the $400 million provides a lot of tailwind for us, as the housing market continues to recover domestically.

Okay. And then, in terms of kind of longer term looking at your margin profile -- I mean, there's a lot of moving parts. It seems like there's a lot of -- there's restructuring going on. You have a -- some new business opportunities that might be lower price points. So just kind of wondering, what can these margins get to? I mean, last year, I think Paints was around 11% and Coatings maybe 16.5% or so. So can these get -- Paints maybe get to mid-teens and maybe high-teens for Coatings? Just kind of curious about the longer-term outlook for margins there.

Hey, Kevin, why don't I start with that, and I'll let Gary certainly provide his perspective since he has a lot more context than me. But I think you hit on a really important point. When we think about the long-term margin structure of the business, the diversification that Valspar has in the product lines that it's in, Paints and Coatings and the markets we play in, I think provides a very interesting and compelling story to look at where margins can grow because today, just looking at the questions we received about, "What's the market look like in China today? What's it look like in Australia?" We haven't talked at all about Latin America long term. These are very high-growth markets for coatings companies and certainly Valspar. And the amount of investment that we have in those markets today, supplying volume is not leveraged appropriately. We've got a lot more scale opportunities in those markets. And as Gary mentioned as well, adding that volume to our business and that scale to our business allows us to increase EBIT margin significantly in those spaces. So we're very bullish on where the long-term EBIT margins can go in the business, and we're very happy to invest in the near term to access those opportunities. I think as you look at the next 12 months out, certainly in the Paints business, the leverage we're going to get from increased volumes and continued housing recovery is going to be beneficial to the business. And certainly as the coatings markets, as the decline starts to come down a little further over the next 12 to 18 months, those EBIT margins should come up as well. One of the things I was amazed at, just looking a little bit of the history, that even in our Coatings business, on a 2-year basis, our EBIT margins are up over 300 basis points despite the decline we're seeing in the current year. So I think that the team has done a nice job over the last couple of years building that Coatings business certainly. And even though we've got some temporary softness in some of our markets, there certainly is a longer-term opportunity to continue that growth profile.

And we'll go to the line of Charles Dan with Morgan Stanley.

Just wanted to clarify. A couple of quarters ago, we've talked about some of the investment spending and marketing spend for some of your new business as being concentrated in the first half of the year. But your SG&A, even adjusting for some of the movement of accounting treatment for some of your expenses, seems like it was lower than we would have expected. So are we going to see that ramp up in the third quarter, or do we think that most of that is behind us? And as it translates to Paints EBIT margins, should we see some sequential EBIT margin decline because of some of that investment spending?

Yes. Charlie, it's Jim. I think as you look at the Paints business for the back half of the year, in total, my expectation would be you would see EBIT margin increasing, primarily given the volume expectations we have for the business. Gary talked in his comments about the increased investment we've had in marketing spending around the brand. So we will launch some new advertising in that space. It started to hit the business in Q2. We'd expect to see more of that in Q3. So we're looking for less margin expansion in the Paints segment in Q3. It will be higher, actually, in Q4 with the additional volumes we're putting in the business.

Okay. Great. And just a follow-up on the -- on reconciling volumes versus mix shifts. It seems like even if your -- the new business came in at a much slower ASP that there would still be, it looks like, some mix leakage in the legacy or core business aside from the new Ace and Lowe's contracts. So can you confirm whether that was the case as well?

Yes, that was absolutely the case. And we talked about what's been going on in the Coatings business the last several quarters...

Sorry. I meant -- just to clarify, I meant the -- just the Paints business x Lowe's and Ace.

Yes -- no, I don't think we've seen any leakage in the business x Lowe's and Ace. We've been adding profitable sales volume to that business overall. We've not seen material change in our EBIT margins related to our core business.

And next, we'll go to the line of Nils Wallin with CLSA.

Just on the heavy machinery market, I mean, last quarter, I think it was down 20%. And hearing some of the big producers don't have a very positive outlook for volume growth for the rest of the year, so I'm just wondering what your view is in terms of the cadence of top line declines in that business through 2013 and into 2014?

Yes. I don't expect it to get any worse. I think we're probably at the bottom. The good news for us is that this pause in activity has given us the opportunity, particularly in developing markets and in Europe. So in Latin America, in China, in India and in Europe, our customers are much more willing now because their lines are not running at capacity to give us the opportunity to deploy our technology a bit more globally. So our book of business in China is much healthier today than it was a year ago, meaning that we're doing business with more customers with Valspar technology in China today than we were a year ago. I don't think we would have gotten that opportunity had the market remained at the breakneck pace that it was running at 12 to 18 months ago. So while the -- while it's a little bit painful in this quarter and probably will be a little bit painful for the rest of the year. In the long run, this has been a fantastic time for us.

That much healthier book of business that you're talking about, is that existing customers or are you actually perhaps taking share in new business?

The latter, and a pretty significant number of new customers. Now this is a big market. This is a -- we think the total paint demand for the off-road market globally is $2 billion to $3 billion. And we are a very, very small player in that $2 billion to $3 billion market. So we've got a -- this is part of our core strategy. We've got a global team of very talented people who are equipped with the right technology, the right know-how to do business with virtually any off-road or agricultural equipment manufacturer in the world, and they're deployed and they're out there winning business.

Got it. Just on your kind of longer-term organic versus acquisition growth. I mean, it seems like there's a fair amount of organic opportunities that you're investing in. Does this mean that the acquisition pipeline is kind of relatively moderate, or is there anything else out there that looks attractive to you?

There are things -- there are a number of opportunities that are attractive and would fit our portfolio very nicely. The issue is getting those -- is when those assets come up for sale when the owners decide to do a transaction, and then agreeing a price. The latter 2 are much more complicated than the former. It's easy to find companies that would fit very nicely with Valspar in terms of business fit and culture. But getting to the right price and at the right time is the challenge. We're very active in this area, though.

Understood. And just sort of a follow-up to that. I mean, certainly you've made it clear that the Wattyl acquisition, everything that -- your plans for that acquisition are on track, but who can forecast the market? Has that -- has the experience -- or what you learned from Wattyl changed at all your price sensitivity or the price risk that you're willing to take with an acquisition?

I'll tell you what. The sell side of the investment community is a lot more worried about Wattyl than I am. I've said this before in private meetings, I'll say it here publicly. I am not concerned about Wattyl. Wattyl is going to be a fantastic deal for Valspar in the long run. All of the things that needed to be done to turn that business around are in the process of being done. The business is improving. The volume declines that we've experienced were expected. They are part of our plan. Wattyl is going to be a fantastic deal for us. If anything, it makes me more confident to do deals because that one is a long way away, and we used a local team for most of the actions that we took, perfectly aligned with our global team and they are doing an absolutely great job. It's proven that we can do complicated deals in virtually any geography to me.

We do have a follow-up from P.J. Juvekar with Citi.

Quickly -- just a quick question on wood coatings. You've been experiencing good performance there for the last couple of quarters. Where is that strength coming from? Is it mostly in the U.S., or is China improving? And is this business now mostly driven by existing home sales?

Yes, you're right, P.J. We've had a couple of good -- I think about 3 -- probably 3, maybe 4 improving quarters, and the business is in good shape in North America. I'll take the 2 pieces you asked about the 2, and the dynamics are different between North America and China. North America, the improvement is being driven by about 50% new business wins and 50% market growth. And this is the business in Valspar, this business in our consumer paint business, so the 2 that are very highly correlated to the U.S. housing market. So -- and in the case of wood coatings, we have a correlation to both the new construction and the building products segment and kitchen cabinetry segments of that business as well as existing home sales. So the business is in good shape. It's performing well, and it's growing. We were very pleased with what's happening in North America. In China, there are really 2 businesses. One is the one that we acquired with Huarun and it's a distribution business, and that's selling into the Chinese market through exclusive distributors. That's been a very good business for us year in and year out. The China market, notwithstanding the comments I've made earlier about the housing market not being particularly robust, that business will grow this year and they'll improve their profitability. And then the second part of the business in China is the legacy Valspar business, which were the OEMs -- which are the OEMs that are manufacturing furniture that's exported back to the U.S. market, and they're having a good year as well. They're growing and are more profitable than they were in the previous years. So all in all, the wood -- our wood coatings business is performing very, very acceptably.

Next we'll go to the line of Rosemarie Morbelli with Gabelli & Company. Rosemarie J. Morbelli - Gabelli & Company, Inc.: Gary, looking at Australia, I know you said you are going to anniversary your decision to close stores and walk away from certain pieces of business by the fourth quarter of this year. In order to grow, do you need some help from the Australian economy to turn around? Or is the number of increasing stores from Masters enough to offset whatever downturns there may still be?

That's a good question, Rosemarie. In the model that we have that gets the business to our company average margins -- at least, to our company average margins in 3 years' time, we have very modest growth from the base of the market that we have today, and I think it's 2% or 3%. So we're not expecting a dramatic recovery in the U.S. house -- or the Australian housing market to be the thing that saves the business. What will allow that business to be successful are the things that we've done in terms of the cost structure and the business model, and we think those 2 things are right now. And we will grow with the trade. 2/3 of our business is a professional business that goes through our store network. And we think we'll have some of the market share that we've lost as we -- that we talked about earlier on the previous question. We will recover, not all of it in the short term, but we will start to grow the trade business through better execution of an improved business model. And then, we will get growth with Masters. And they're still on their plan to open 150 stores. I think they've got 30 -- in the low-30s opened today. I think the stores are performing well. And the combination of growth in the trade business with an improved business model, improved product offering and a -- and some growth with Masters, those are the 2 -- the growth vehicles that we're looking at. I would say that, as the U.S -- as the Australian housing market recovers, that will be additive to our plan. Rosemarie J. Morbelli - Gabelli & Company, Inc.: Okay. And then, looking at the off-road business, I mean, there was quite a bit of inventory left in the OEM producers. So have you seen that inventory level come down to a level, for lack of finding a better word, that is now going to require some inventory buildup, or is that still more to go?

Yes. See, we don't have visibility to inventory that our customers have in the channel, Rosemarie, not like we would say in the retail business. So I can't -- really can't answer your question. Rosemarie J. Morbelli - Gabelli & Company, Inc.: Okay. And if I could have a couple of quick questions. Did you buy back stock during the quarter, and are you expecting to buy some more in the second half of the year? Or because your cash flow growth is really positive in the second half, this is when you'll start buying it back?

Rosemarie, it's Tyler. We bought back 1.9 million shares during the quarter at an average price of $62.65. And I'll just remind you that our stated goal on our share repurchase reduced our net share count by 2% a year. So we'll continue down that path. Rosemarie J. Morbelli - Gabelli & Company, Inc.: Okay. And what kind of a tax rate are we expecting for the balance of the year -- or for the year as a whole?

Yes. Rosemarie, it's Jim. We're still anticipating 31% to 32%. And if you look at our effective tax rate to the first half of the year, we're at 31%. Rosemarie J. Morbelli - Gabelli & Company, Inc.: Right. So it could go up a little bit based on, what, stronger income coming from the U.S. geographic kind of spread?

It's why we have a range. Rosemarie J. Morbelli - Gabelli & Company, Inc.: Okay. All right. And regarding the debt repayment, where do you expect to be by year end?

Our net debt should be a little bit over $1 billion at year end, Rosemarie.

And next, we'll go to the line of Steve Schwartz with First Analysis.

If you could just clarify on the timing of the Ace business for the remainder of the year, it sounds like it's going to continue to ramp through the year and be even stronger in -- by the time we get to the fourth quarter. But that goes counter to typical North American seasonal trends. So what's happening there?

We're manufacturing 100% of the private label business for Ace today. And, Steven -- so, we're going to -- we'll see a ramp-up as we go in -- from first quarter volumes and second quarter volumes, as we go into the painting season. That's what I meant. So I would expect that that -- the Ace paint private label business would react the way any other private label business would. And then what I mentioned was, in Q4, we will start selling the Valspar program at Ace.

I see. Okay. Are you drawing down a legacy inventory with Ace right now?

Yes. We bought inventory. We bought finished goods inventory that -- we acquired it, and we're selling it.

And next, we'll go to the line of Eugene Fedotoff with Longbow Research.

First, could you talk about packaging coatings, both how the business performed in the quarter and your expectations for the next couple of quarters? If I've heard you correctly, I think you mentioned that sales were up low-single digit, but volume was up high-single digit. Was the difference -- was it the negative mix impact, or was it pricing?

Yes, it was a negative mix impact. We -- Eugene, we grew pretty significantly with market share gains in our beverage product line, which has a lower selling price -- quite a bit lower selling price has been the average for the packaging mix, so yes. So volumes, we're very pleased with the business in the quarter, and we have high expectations for the business for the remainder of the year. They've won a lot of new business, and we're now in the process of commercializing that business.

Great. And just a question for Jim. What is D&A and CapEx in the quarter?

CapEx in the quarter was roughly $16 million and D&A was about $20 million, $22 million.

And the final question will come from a follow-up line of Kevin Hocevar with Northcoast Research.

One question that I was prompting Kevin here. Did you actually -- we understand about mix having the effect on the price/mix component, but were there actually any price reductions on product lines apples and apples year-over-year?

Not material, Saul. Not in a material way. There were -- the couple of our general industrial segments got a little bit more competitive in the quarter as volumes went down. But it's normal, and it's not material to our results.

Okay. That's the last question. Thank you, and thanks to our audience for participating in our second quarter earnings conference call. Follow-up questions from investors and analysts can be directed to me, Tyler Treat. Questions from the media can be directed to Mark Goldman. Contact information for both of us can be found in our press release. Thank you, and that concludes our call.

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