Sherwin-Williams Company — Q3 2013 Form 10-Q Summary
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 covers the three and nine months ended September 30, 2013, compared with the corresponding 2012 periods. Reportable segments are Paint Stores, Consumer, Global Finishes and Latin America Coatings.
Key financial metrics
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Net sales | $2.847 billion | $2.603 billion | $7.728 billion | $7.313 billion |
| Income before taxes | $387.5 million | $343.0 million | $936.7 million | $813.1 million |
| Net income | $263.0 million | $235.0 million | $636.4 million | $563.0 million |
| Diluted EPS | $2.55 | $2.24 | $6.11 | $5.37 |
| Gross margin | 45.5% | 44.2% | 45.2% | 43.9% |
| Net margin | Approximately 9.2% | Approximately 9.0% | Approximately 8.2% | Approximately 7.7% |
| EBITDA | $449.6 million | $398.3 million | $1.122 billion | $977.5 million |
| Net operating cash flow | Not separately provided | Not separately provided | $777.9 million | $569.3 million |
SG&A was $889.7 million in the quarter and $2.505 billion for the first nine months. SG&A represented 31.2% of sales in the quarter and 32.4% year to date. Interest expense was $15.4 million in the quarter and $45.8 million year to date, up from the prior-year periods due primarily to higher long-term debt.
At September 30, 2013, cash and cash equivalents were $1.036 billion, total current assets were $3.771 billion and current liabilities were $2.406 billion, producing a current ratio of 1.57. Total debt was approximately $1.930 billion, comprising $295.3 million of short-term borrowings, $2.4 million of current long-term debt and $1.632 billion of long-term debt. Remaining borrowing ability was $2.083 billion, including $850 million of unused commercial-paper capacity. Shareholders’ equity was $1.870 billion.
Year-to-date investing cash usage was $253.9 million, including $108.5 million of capital expenditures and $92.8 million for acquisitions. Financing cash usage was $347.5 million, including $154.4 million of dividends and $492.0 million of treasury-stock purchases. Cash increased by $173.1 million during the first nine months.
Material changes versus the prior comparable period
- Third-quarter sales increased 9.4%; nine-month sales increased 5.7%. Growth was driven primarily by higher Paint Stores sales volume.
- Paint Stores sales increased 13.5% in the quarter and 9.0% year to date; comparable-store sales increased 10.9% and 7.4%, respectively.
- Consumer sales increased 5.4% in the quarter but only 0.3% year to date. Global Finishes sales increased 3.1% and 2.3%, respectively. Latin America Coatings sales were essentially flat.
- Income before taxes increased 13.0% in the quarter and 15.2% year to date. Net income increased 11.9% in the quarter and 13.0% year to date.
- Gross margin improved by 1.3 percentage points in the quarter and 1.3 percentage points year to date, primarily from higher volume, price increases and operating efficiency.
- Latin America Coatings profit declined materially, including a third-quarter loss before taxes of $1.0 million versus profit of $21.9 million in the prior-year quarter. The segment was affected by Brazilian import-duty assessments and unfavorable currency translation.
- Net income benefited from share repurchases; average diluted shares declined to 102.6 million from 104.0 million in the quarter.
- Net operating cash flow increased $208.6 million year to date, despite the $80.0 million payment to the ESOP related to the Department of Labor settlement.
Guidance, outlook, unusual items and risks
The filing does not provide a specific numerical earnings or sales forecast. Management described financial condition, liquidity and cash flow as strong and cited improving domestic architectural paint demand and better results in the Paint Stores, Consumer and Global Finishes groups. Management stated that sufficient cash and borrowing capacity were available for current operating needs.
- Comex acquisition: Sherwin-Williams completed the acquisition of Comex’s U.S./Canada business on September 16, 2013. The proposed approximately $2.25 billion acquisition of the Mexico business remained unauthorized after the Mexican competition authority denied the Company’s appeal on October 29, 2013. The Company was evaluating its options, including refiling.
- Brazil tax assessments: The Company recorded $16.9 million in third-quarter cost of goods sold and $2.9 million in SG&A, with after-tax charges of $13.5 million for the quarter. Year-to-date after-tax charges were $21.9 million, reducing diluted EPS by approximately $0.13 in the quarter and $0.21 year to date.
- Environmental liabilities: Environmental accruals were $111.9 million. The unaccrued maximum of the estimated range of possible outcomes was $81.9 million above the accrued amount. Management expects matters to be resolved over an extended and uncertain period.
- Lead-paint litigation: The Company had not accrued amounts for lead pigment and lead-based paint litigation and could not estimate potential losses. The Santa Clara County public-nuisance trial concluded in September 2013, with a decision expected by December 31, 2013.
- Debt covenant: The Company was in compliance with its consolidated leverage covenant at September 30, 2013. Default and cross-default provisions could accelerate borrowings if triggered.
- Other principal risks include raw-material and energy costs, pricing pressure, foreign exchange, economic conditions, regulatory changes, environmental matters, litigation, acquisitions and unusual weather.
Most important facts for investors to verify
- Whether the Comex Mexico transaction proceeds, is refiled or terminates, and the resulting purchase price, financing and regulatory effects.
- The sustainability of Paint Stores volume growth and gross-margin expansion after the unusually strong quarter.
- The effect of Brazilian tax settlements, foreign-exchange movements and operating performance in Latin America.
- Debt repayment capacity, leverage-covenant headroom and the impact of share repurchases and dividends on liquidity.
- Developments in Santa Clara County and other lead-paint litigation, including potential liability and insurance coverage.
- Changes in environmental remediation estimates, particularly the $81.9 million unaccrued maximum exposure.
- Year-end LIFO inventory valuation, physical inventory results and any resulting fourth-quarter adjustment, since interim LIFO amounts are estimated.