Business Context and Reporting Period
The Sherwin-Williams Company develops, manufactures, distributes and sells paints, coatings and related products primarily in North and South America, with additional operations in the Caribbean, Europe and Asia. The filing is an unaudited Form 10-Q for the quarter and six months ended June 30, 2013, compared with the corresponding 2012 periods.
The company reports four operating segments: Paint Stores Group, Consumer Group, Global Finishes Group and Latin America Coatings Group.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2013 | Three Months Ended June 30, 2012 | Six Months Ended June 30, 2013 | Six Months Ended June 30, 2012 |
|---|---|---|---|---|
| Net sales | $2.714 billion | $2.573 billion | $4.881 billion | $4.709 billion |
| Gross profit | $1.234 billion | $1.151 billion | $2.196 billion | $2.060 billion |
| Gross margin | 45.5% | 44.7% | 45.0% | 43.8% |
| Income before taxes | $380.9 million | $327.8 million | $549.3 million | $470.1 million |
| Net income | $257.3 million | $227.8 million | $373.5 million | $328.0 million |
| Diluted EPS | $2.46 | $2.17 | $3.57 | $3.13 |
| EBITDA | $441.8 million | $382.0 million | $672.1 million | $579.2 million |
Second-quarter sales increased 5.5%, pretax income increased 16.2%, net income increased 13.0% and diluted EPS increased 13.4%. For the first six months, sales increased 3.6%, pretax income increased 16.8%, net income increased 13.9% and diluted EPS increased 14.1%.
SG&A was $837.1 million in the second quarter and $1.616 billion for the first six months. SG&A declined to 30.8% of sales in the quarter from 31.5% and to 33.1% for the six months from 33.3%.
The effective tax rate increased to 32.5% in the quarter and 32.0% for the six months, compared with 30.5% and 30.2%, respectively, in 2012.
Cash Flow, Liquidity and Capital Structure
- Operating cash flow was $302.1 million for the first six months, up from $202.1 million in 2012.
- Investing activities used $127.4 million, including $72.1 million of capital expenditures and $5.0 million for acquisitions.
- Financing activities used $296.8 million, including $103.3 million of dividends and $232.5 million of treasury stock purchases.
- Cash and cash equivalents were $741.1 million at June 30, 2013, down from $862.6 million at December 31, 2012 but up substantially from $46.6 million at June 30, 2012.
- Total debt was approximately $1.685 billion, including $50.7 million of short-term borrowings and $1.635 billion of long-term debt. Debt was $1.245 billion at June 30, 2012.
- The current ratio was 1.70, compared with 1.04 at June 30, 2012 and 1.68 at December 31, 2012.
- Remaining borrowing capacity was $2.277 billion, including $1.050 billion of unused capacity under the commercial paper program.
- The company was in compliance with its leverage covenant, which generally limits leverage to 3.00-to-1.00, or 3.25-to-1.00 under the newer credit facility.
Material Changes Versus the Prior Comparable Period
- The Paint Stores Group drove consolidated growth, with second-quarter sales up 8.0% and segment profit up 24.7%. Comparable-store sales increased 7.0%, and paint sales volume increased more than 10%.
- Global Finishes Group sales increased 3.0% in the quarter and segment profit increased 13.4%, supported by pricing, acquisitions and operating efficiencies.
- Consumer Group sales declined 1.0% in the quarter and 2.2% for the six months, primarily because of lower retail customer volumes and the elimination of part of a large customer paint program.
- Latin America Coatings Group segment profit declined 90.8% in the quarter and 25.6% for the six months, primarily due to an $11.8 million Brazilian import duty assessment and unfavorable currency translation.
- Interest expense increased $4.8 million in the quarter and $9.8 million for the six months because of higher long-term debt balances.
- The company increased its quarterly common dividend from $0.39 to $0.50 per share, implying a stated 2013 annual dividend of $2.00 per share.
- The company repurchased 1.30 million shares during the first six months and had authorization remaining for 15.15 million shares at June 30, 2013.
Outlook, Unusual Items and Risks
Management described financial condition, liquidity and cash flow as strong, supported by improving domestic architectural paint demand, higher Paint Stores Group volume, operating efficiencies and pricing. The filing does not provide a specific full-year revenue or earnings guidance range.
- The company recorded an $11.8 million pretax, $8.4 million after-tax Brazilian import duty assessment in the second quarter. Management stated that post-2008 years remain open to audit, although no additional accruals were recorded.
- The company paid $80.0 million to its ESOP in the first quarter under a Department of Labor settlement; the related $49.2 million after-tax charge was recorded in the fourth quarter of 2012.
- The proposed approximately $2.34 billion acquisition of Comex remained subject to conditions and regulatory approvals. On July 17, 2013, after the quarter end, Mexico’s Federal Competition Commission did not authorize the transaction by a 3-2 vote. Sherwin-Williams was preparing a response to the commission’s concerns.
- Environmental liabilities accrued were $110.9 million. The unaccrued maximum of the estimated range of possible environmental outcomes was $85.6 million above the minimum accrued amount. Management could not estimate the ultimate liability or resolution timetable.
- The company had not accrued amounts for lead pigment and lead-based paint litigation, including a Santa Clara County, California public nuisance trial that commenced July 15, 2013. A significant adverse outcome could materially affect earnings, liquidity or financial condition.
- Other key risks include raw material and energy costs, foreign currency, commodity prices, economic conditions, competition, acquisitions and integration, regulatory changes, environmental matters, litigation and unusual weather.
Important Facts for Investors to Verify
- Whether the Comex transaction was ultimately approved, abandoned or renegotiated following the Mexican regulatory decision.
- The sustainability of Paint Stores Group volume growth and the improvement in consolidated gross margin.
- The impact of the Brazilian import duty matter and any further audits or assessments.
- Future cash uses for debt service, dividends, share repurchases and potential acquisitions relative to operating cash flow.
- Changes in environmental accruals, lead-paint litigation exposure and the outcome of the Santa Clara County proceeding.
- Whether higher interest expense and the increased debt balance affect future earnings, leverage covenant headroom or acquisition capacity.
- The effect of the higher effective tax rate and the availability of tax credits on subsequent periods.