Business Context and Reporting Period
Company: The Sherwin-Williams Company
Filing Type: Form 10-K (Annual Report)
Reporting Period: Fiscal year ended December 31, 2006
Business Overview: Founded in 1866, the Company manufactures, distributes, and sells paint, coatings, and related products to professional, industrial, commercial, and retail customers primarily in North and South America. Effective January 1, 2006, the Company reorganized its reportable operating segments into three groups: Paint Stores Group, Consumer Group, and Global Group.
Key Financial Metrics
| Metric | 2006 | 2005 |
|---|---|---|
| Net Sales | $7,810 million | $7,191 million |
| Net Income | $576 million | $463 million |
| Income Before Cumulative Effect | $576 million | $463 million |
| Diluted EPS | $4.19 | $3.28 |
| Total Assets | $4,995 million | $4,369 million |
| Long-Term Debt | $292 million | $487 million |
| Cash Dividends Per Share | $1.00 | $0.82 |
| Ratio of Earnings to Fixed Charges | 7.0x | 6.7x |
Operational Highlights:
- Employees: 30,767 as of December 31, 2006.
- Store Count: The Paint Stores Group operated 3,046 company-operated specialty paint stores, opening 117 net new stores in 2006.
- Foreign Sales: Net external sales of consolidated foreign subsidiaries totaled approximately $831 million (10.6% of total consolidated net sales).
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased by approximately 8.6% ($619 million) compared to 2005.
- Profitability: Net income increased by approximately 24.4% ($113 million) compared to 2005.
- Debt Reduction: Long-term debt decreased significantly from $487 million in 2005 to $292 million in 2006.
- Segment Restructuring: The Company changed its reportable operating segments effective January 1, 2006, consolidating previous segments (Paint Stores, Consumer, Automotive Finishes, and International Coatings) into Paint Stores, Consumer, and Global Groups.
- Acquisitions: The acquisition of Susannah Dobbs Company LLC in 2006 was included in the Consumer Group.
Guidance, Risks, and Contingencies
Management Commentary & Outlook:
- Management anticipates sufficient productive capacity to meet needs through 2007.
- Raw materials and fuel supplies are generally available, though the Company experienced significant cost increases in energy and raw materials (particularly titanium dioxide) during 2006.
- Seasonality remains a factor, with the majority of sales for the Paint Stores, Consumer, and Global Groups traditionally occurring in the second and third quarters.
Key Risks and Contingencies:
- Lead Pigment Litigation: The Company is a defendant in numerous legal proceedings regarding lead pigments and lead-based paints. A jury in Rhode Island found the cumulative presence of lead pigment constitutes a public nuisance and ordered abatement. The Company intends to appeal. Management states that the potential liability cannot be reasonably estimated and no amounts have been accrued.
- Raw Material Costs: Increases in the cost of raw materials and energy may adversely affect earnings if not offset by cost reductions or price increases.
- Foreign Operations: Risks include foreign currency exchange rate fluctuations (exposure to British pound, Argentine peso, Brazilian real, etc.), political instability, and regulatory constraints in international markets.
- Environmental Compliance: Increasingly stringent environmental laws may increase compliance costs. The Company is involved in remediation activities at current and former sites, where ultimate liability may exceed current accruals.
- Life Shield Investment: The Company owns a 25% interest in Life Shield Engineered Systems, LLC, which involves higher product liability risks than standard coatings.
Investor Verification Checklist
- Lead Litigation Exposure: Verify the status of the Rhode Island abatement order and the potential financial impact of the appeal, given the Company's statement that liability is unquantifiable.
- Margin Pressure: Assess the Company's ability to pass on raw material cost increases (specifically titanium dioxide) to customers without losing market share.
- Debt Strategy: Confirm the sustainability of the reduced long-term debt position ($292 million) and the Company's liquidity management via commercial paper and lines of credit.
- Segment Performance: Review the specific financial contribution of the newly defined Global Group versus the domestic Paint Stores and Consumer Groups.
- Foreign Currency Impact: Evaluate the sensitivity of earnings to fluctuations in the Brazilian real, Argentine peso, and other key foreign currencies.