Valspar Earnings Call Nuggets: Earnings Per Share Expectations and Australia Outlook
Valspar Corporation (NYSE:VAL) recently reported its third quarter earnings and discussed the following topics in its earnings conference call.
Earnings Per Share Expectations
Dmitry Silversteyn – Longbow Research: A couple of questions. I’m just trying to understand sort of a shortfall in revenue that you expect versus your expectations and the impact that’s having on the bottom line. A $0.20 reduction in mean – midpoint of the guidance which basically means all of its going to happen in the fourth quarter implies that there’s some margin issues added and that go beyond the top line. So, can you go through sort of the genesis about sequentially lower EPS that you expect in the fourth quarter, at least, judging from your guidance and then how are the issues that you’re facing now go into the results as you head into 2014 and what confidence should we have in your performance returning to the old Valspar standards?
Gary E. Hendrickson – Chairman and CEO: Sure, Dmitry. It’s Gary. Your first question – so I’ll take your number of $0.20 and we will work with that for a minute; $0.05 of it is tax. As Jim mentioned, we’re going to have a higher tax rate in the quarter than we expected and you probably modeled. So, that’s part of it. The rest of it is entirely sales driven. When we adjusted our guidance after the first quarter, we expected that in Q3, Q4 we were going to see some recovery in international markets and in our GI business. I think Jim covered this in his prepared remarks. We didn’t see that. We didn’t see China strengthen to the extent that we expected. Our industrial business in China is still weak and frankly, although Huarun had a good quarter this quarter, it’s not up to the expectations that we had for Q3 and we don’t think Q4 will be there either. Australia, we expected some recovery in the residential housing market in Australia. That has not happened. In fact, it is possible that that market has gotten worse as the year has progressed. And both in my remarks and in Jim’s remarks we talked about the GI business and some of the segments that are weak there. So, as you know, from following the Company for a while that we’ve done a lot of work on our cost structure to develop operating leverage in the business and so it doesn’t take a lot – a huge sales mix in order to have an impact disproportionate possibly as you might look at it, a disproportionate earnings mix. So that’s it. It’s all about that. It’s all about sales in the fourth quarter that will not be where we expected them to be when we adjusted our guidance after Q1. With respect to your question about next year, I think both Jim and I made some comments about next year in our opening remarks, and we’re not here on this call to talk about guidance for next year. We’ll do that in our fourth quarter. But I will say that that I believe that we’re set up for a good year in 2014. So I’ll just reiterate some of the things that I said in my introductory comments and Jim said as well. First is our U.S. business has been very strong this year. The housing market is recovering, construction spending is up, and we have secured significant new business wins. Jim mentioned in the quarter that our volumes in the U.S. were up 10%, and for the year, they were up mid-single-digits. So, we’ve got a lot of momentum in our U.S. business going into 2014. Second, our new business, the long-range businesses that we’ve talked about publicly, particularly in our paint segment, are on track. 2014 is the year that we go from investment to accretion in those businesses. We’ve invested significantly in those initiatives this year prior to having the gross margin to support that full investment. Next year that trend reverses itself and we start to see accretion from those investments. And as I mentioned, our net new business – we achieved our net new business targets in both our coatings and our paint segment in the quarter and have year-to-date, and so that’s momentum going into next year as well. We started with the restructuring that we announced in the second quarter and that will provide some tailwind to us going into next year. Inver, as Jim said, will provide about $0.10 of earnings accretion. And then just like in the – the opposite of the phenomenon that we’re experiencing this year with delevering because our sales are not as strong as we expected, when these international markets and GI markets start to recover, we are going to get significant leverage out of that. So, I think we’re set up for a good year in 2014…
Dmitry Silversteyn – Longbow Research: That’s helpful, Gary. I just want to clarify the shortfall in revenue versus expectations. I’m not sure what you were expecting. But looking at what I was expecting, which is basically high-single-digit growth year-over-year in revenues for the fourth quarter, your guidance does not seem to be that significantly below it. So, is the matter here that you’re going to be selling more out of inventory (indiscernible) production, so there is going to be a disproportionate margin impact on that stuff, slightly lower revenue as you sort of right-size towards the end of the year, is that what’s going on?
James L. Muehlbauer – EVP, Chief Financial and Administrative Officer: Dmitry, it’s Jim. I’d answer that from the perspective of – our expectations for the back half of the year, as we exited Q2, had significant increases in sales based on the new business wins that we’ve been talking about all year long, plus the recovery in the markets that Gary mentioned. So, from a sales expectations standpoint, we are expecting much higher sales. We also were expecting an appropriate margin rate that was going to go along with those sales. So, as I look at where Q3 landed and what we expect for Q4, our margin expectations versus our internal plans really haven’t changed that much in Q3 and Q4. Really our miss versus our expectations is primarily sales driven as Gary mentioned. So, we’re not seeing any big surprises on the margin line. It’s just that the businesses that we’re selling through based on their current margin profile are lower than what some of our historical businesses have been. Still very profitable, but we do not have a margin issues this year versus our plan, our issue was top line orientated.
Dmitry Silversteyn – Longbow Research: So, the top line – okay, so maybe the way it’s booked. This is the top line, the short fall that you are experiencing is in the higher margin product lines, so you are not getting the profit benefit of them, perhaps that’s the growth of the lower margin lines?
James L. Muehlbauer – EVP, Chief Financial and Administrative Officer: Correct. I think it’s more profit volume from the lower margin lines to make up for those gaps and once again we know those markets are going to turn around eventually, because structurally we have not lost business in those spaces and we are expecting certainly a long-term profile of growth in many of those markets, especially GI with good customers and good markets like China to recover…
Gary E. Hendrickson – Chairman and CEO: One other point on that Dmitry, I think we got a sales move – we had a sales mixed issue all year long. The private label business, we’ve talked about some of the wins in Packaging, Coatings staying at the lower selling prices. But if you look at our margin line in Coatings, you will see that that’s still a good business. As Jim said, it just takes more of it to make up for the gaps that we have seen in some of the higher priced, higher margin segments that are weak this year.
Kevin Hocevar – Northcoast Research: I was wondering if you could comment on kind of longer term outlook for Australia because, it looks like some of the data has been pointing to — interest rates have been cut over there, home prices increased the most in years in the second quarter, existing home financing seems to be improving. So, it doesn’t sound like that’s been reflected in your numbers. So, kind of what’s your outlook here over the next 18 months or so into 2014 for your Australia Paints business?
Gary E. Hendrickson – Chairman and CEO: Well, you are right. I think the interest rate in Australia now is 2.5% down from something like 7%. So, the government is doing everything they can to stimulate the housing market, but the housing market is still bad. Kevin, we get the Australian Paint Manufacturer Federation data, which is the actual volumes of paint that are sold by all the paint manufacturers in the Australian market and that data last quarter said that trade volumes, that’s professional painters, volumes down 8% to 9% on the previous year. So, hopefully, we’re at the bottom and some of the moves that the government is making to stimulate homeownership will take hold, but we can’t count on that. We’re going to run our business the way that we think is appropriate and for us that meant, a pretty dramatic and historic over the last couple of years, a pretty dramatic restructuring of the business to get the cost structure right. We lost some market share in that process. We’ve talked about that previously, that was the right thing to do for the long-term. Where we sit today is a business that has the appropriate cost structure, that is winning in the retail marketplace; that means with the big box masters and independent trade stores or independent paint stores and hardware stores, that’s our retail market there and that business is doing well; and the stores business that has the cost structure and when it grows, we’re going to get significant operating leverage out of that cost structure. Jim said and I said in my opening remarks that we saw some incremental improvement in our stores business in the quarter. That’s encouraging. As that continues and as the market recovers, we’re going to see a pretty significant earnings drive out of the actions that we’ve taken. But I can’t call the market. I mean I don’t know. I would only be speculating – to answer your question directly, I would only be speculating as to what’s going to happen in Australia…
Kevin Hocevar – Northcoast Research: And also, I was wondering if you could comment on the sell-out from your customers at the big box and distributor network here in the U.S. versus kind of your sell-in. Are you seeing any inventory management at your customers in that channel at all or is it pretty standard right now?
Gary E. Hendrickson – Chairman and CEO: Our customer – our big customer is managing their inventory extraordinarily well. They’ve got a great supply chain team and they’re getting productivity on their inventory. The impact for us meant that year-over-year inventory is down about 10% in that channel. We are seeing strong sell-through, as I mentioned, mid-single-digit sales of Valspar products in that channel, and I think inventory today is appropriate for where it should be going into the remainder of the paint season. But there is a change year-over-year for us.
Kevin Hocevar – Northcoast Research: Then finally I was just wondering if you could comment on how – what raw materials did during the quarter and kind of outlook going forward?
James L. Muehlbauer – EVP, Chief Financial and Administrative Officer: Yeah. Our outlook on that, Kevin, hasn’t changed at all. Raw materials in the quarter were down modestly. We’ve looked at the different parts of the raw material portfolio, and there’s always – there’s different moving pieces but our view on that for the year really hasn’t changed at all. We’ve pretty much been on our mark.