Business Context and Reporting Period
Company: The Sherwin-Williams Company
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2003
Business Overview: The Company manufactures and sells paints, coatings, and related products through four primary segments: Paint Stores, Consumer, Automotive Finishes, and International Coatings.
Key Financial Metrics
| Metric (in thousands) | Q2 2003 | Q2 2002 | 6 Months 2003 | 6 Months 2002 |
|---|---|---|---|---|
| Net Sales | $1,471,678 | $1,453,198 | $2,620,139 | $2,602,376 |
| Gross Profit | $665,752 | $651,810 | $1,167,515 | $1,143,914 |
| Gross Margin % | 45.2% | 44.9% | 44.6% | 44.0% |
| Operating Profit | $173,432 | $173,429 | $221,937 | $229,533 |
| Net Income (Loss) | $110,130 | $107,526 | $140,930 | $(40,826) |
| Diluted EPS | $0.75 | $0.70 | $0.95 | $(0.27) |
| Cash & Equivalents | $20,016 | $11,503 | $20,016 | $11,503 |
| Short-term Borrowings | $51,996 | $0 | $51,996 | $0 |
| Long-term Debt | $505,515 | $507,244 | $505,515 | $507,244 |
Liquidity: The current ratio was 1.36 at June 30, 2003, down from 1.39 at year-end 2002. The Company had $718.0 million in unused borrowing availability under its commercial paper program.
Material Changes vs. Prior Period
- Revenue Growth: Consolidated net sales increased 1.3% in Q2 and 0.7% for the six months ended June 30, 2003, compared to 2002. Excluding currency fluctuations, sales increased 1.8%.
- Profitability: Gross profit margins improved to 45.2% in Q2 2003 from 44.9% in Q2 2002. Operating profit remained flat in Q2 but decreased 3.3% for the six-month period.
- Segment Performance:
- Paint Stores: Sales increased 2.4% (Q2) driven by architectural paint sales, though comparable store sales were only up 1.7% due to harsh weather.
- Consumer: Sales decreased 1.4% (Q2) due to retailer store count adjustments and weather impacts.
- Automotive Finishes: Sales decreased 1.9% (Q2) due to a reduction in repairable vehicles and a slow automotive market recovery.
- International Coatings: Sales increased 5.2% (Q2) in reported dollars, but underlying growth was 15.0% excluding currency impacts. Weakness in South America offset strength in the U.K.
- Cash Flow: Net operating cash for the six months was $71.5 million, a decrease from $136.3 million in the prior year period. Cash and cash equivalents decreased $144.0 million primarily due to $96.0 million in treasury stock purchases and $45.6 million in dividends.
Guidance, Outlook, Risks, and Unusual Items
Accounting Changes: The six-month 2002 net loss of $(40.8) million included a one-time cumulative effect of a change in accounting principle (SFAS No. 142) of $(183.1) million related to goodwill and intangible asset impairments. This non-cash charge is not present in 2003 results.
Management Commentary:
- Domestic architectural paint sales remain strong, partially offset by sluggish industrial and automotive sales.
- Weak foreign currency exchange rates, particularly in Argentina and Brazil, negatively impacted international results in U.S. dollars.
- Capital expenditures of $62.0 million for the first six months were primarily for new store openings and a new distribution center.
Risks and Contingencies:
- Lead Paint Litigation: The Company is a defendant in numerous lawsuits regarding lead pigments and lead-based paints. Management believes the litigation is without merit and has not accrued any amounts, though potential liabilities cannot be reasonably estimated.
- Environmental Remediation: The Company faces potential liabilities for environmental cleanup at current and former sites. Accruals are based on currently available facts, but ultimate costs could be significantly higher.
- Variable Interest Entities: The Company is analyzing whether to consolidate certain real estate partnerships under FASB Interpretation No. 46. Maximum loss exposure is estimated at $8.4 million in equity plus $19.6 million in tax credit recapture risk.
Investor Verification Checklist
- Excluding Currency Impact: Verify the 15% underlying growth in International Coatings sales to assess true market performance versus currency translation effects.
- One-Time Charges: Confirm that the 2002 comparison period includes the $183 million goodwill impairment charge, which distorts year-over-year net income comparisons.
- Liquidity Position: Review the $52 million in short-term borrowings and the $144 million decrease in cash to understand the impact of aggressive share buybacks ($96 million) on working capital.
- Legal Exposure: Monitor developments in lead paint litigation and environmental remediation costs, as management has stated these liabilities are currently unquantifiable.
- Segment Mix: Analyze the divergence between strong Paint Stores performance and declining Consumer/Automotive segments to gauge exposure to housing vs. industrial cycles.