Business Context and Reporting Period
The Sherwin-Williams Company develops, manufactures, distributes and sells paints, coatings and related products to professional, industrial, commercial and retail customers. This unaudited Form 10-Q covers the three and nine months ended September 30, 2011, compared with the corresponding 2010 periods.
Reportable segments are Paint Stores Group, Consumer Group and Global Finishes Group. Effective July 1, 2011, the Company acquired a controlling interest in Leighs Paints, a U.K.-based industrial fire-protection coatings manufacturer.
Financial Performance and Position
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Net sales | $2.485 billion | $2.172 billion | $6.695 billion | $5.881 billion |
| Gross profit | $1.038 billion | $972 million | $2.858 billion | $2.635 billion |
| Gross margin | 41.8% | 44.7% | 42.7% | 44.8% |
| Income before taxes | $260.3 million | $255.4 million | $612.0 million | $574.1 million |
| Net income | $179.9 million | $175.3 million | $427.3 million | $389.6 million |
| Diluted EPS | $1.71 | $1.60 | $3.98 | $3.53 |
| EBITDA | $318.9 million | $309.7 million | $780.9 million | $745.8 million |
SG&A was $760.2 million, or 30.6% of sales, in the third quarter and $2.207 billion, or 33.0% of sales, in the first nine months. Interest expense was $10.5 million in the quarter and $32.9 million year to date. Effective tax rates were 30.9% and 30.2%, respectively.
At September 30, 2011, cash and cash equivalents were $46.0 million, total current assets were $2.509 billion and total current liabilities were $2.355 billion, producing a current ratio of 1.07. Total debt was approximately $1.169 billion, consisting principally of $517.5 million of short-term borrowings and $651.3 million of long-term debt. Remaining borrowing ability was $1.318 billion.
Operating cash flow for the first nine months was $446.0 million, compared with $477.6 million in 2010. Investing cash flow was negative $180.9 million, including $96.9 million of capital expenditures and $29.8 million for acquisitions. Financing cash flow was negative $269.5 million, including $328.7 million of treasury-stock purchases and $115.7 million of dividends. Cash declined $12.6 million to $46.0 million.
Material Changes Versus the Prior Comparable Period
- Sales increased 14.4% in the third quarter and 13.8% for the first nine months, driven by price increases, acquisitions and strong Global Finishes performance.
- Gross margin declined 290 basis points in the quarter and 210 basis points year to date, primarily because of higher raw-material costs and acquisition effects, partially offset by pricing.
- SG&A improved as a percentage of sales because of expense control and higher revenue.
- Paint Stores Group sales increased 10.2% in the quarter and 7.8% year to date; income before taxes increased 5.2% and 5.7%, respectively.
- Consumer Group sales declined 2.0% year to date and pretax income declined 19.3%, reflecting lower volume and the elimination of part of a large retail customer program.
- Global Finishes Group sales increased 31.2% in the quarter and 39.3% year to date, while pretax income increased 36.3% and 33.2%, respectively, aided by acquisitions, pricing, volume and favorable currency translation.
- Short-term borrowings increased $162.9 million from September 30, 2010, while total debt increased $102.5 million. The Company entered into a new five-year $1.050 billion credit agreement in July 2011.
- The Company repurchased 4.24 million shares for $328.7 million during the first nine months and had authorization to repurchase 1.51 million additional shares at September 30. The board subsequently authorized an additional 20 million shares.
- Effective March 31, 2011, the Company retired 125.4 million treasury shares, reducing treasury stock, common stock and retained earnings by approximately $4.5 billion, $0.1 billion and $4.4 billion, respectively.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide specific quantitative earnings or sales guidance. Management described financial condition and liquidity as stable but cited soft domestic demand, rising global raw-material costs and tight credit markets. The Company expects continued exposure to economic conditions, pricing pressure, raw-material and energy costs, foreign currency movements, acquisition integration, regulation, weather and competitive factors.
In October 2011, after the reporting date, the Company settled the IRS audit of its leveraged ESOP transactions. The settlement is expected to produce an approximately $75.0 million after-tax charge, or $0.72 per diluted share, and reduce shareholders’ equity by approximately $51.2 million in the fourth quarter. The Department of Labor investigation remains open.
Environmental accruals totaled $142.3 million at September 30, 2011. The unaccrued maximum of estimated environmental outcomes exceeded the recorded minimum by $101.6 million, although management does not expect environmental matters to have a material adverse effect on financial condition, liquidity or cash flow over time.
The Company has not accrued amounts for lead-pigment and lead-based-paint litigation because management does not believe a loss is probable and cannot reasonably estimate potential exposure. A significant adverse resolution could materially affect future results, liquidity or financial condition. The Company also paid a $570,000 civil penalty under an EPA consent agreement relating to alleged hazardous-waste violations at its Baltimore facility.
The Company was in compliance with its 3.25-to-1.00 leverage covenant at September 30, 2011. Product warranty accruals increased to $26.8 million from $22.9 million a year earlier.
Important Facts for Investors to Verify
- Assess whether pricing actions can offset continued raw-material inflation and restore gross margins.
- Evaluate the sustainability and integration benefits of Leighs Paints and prior Global Finishes acquisitions.
- Review the fourth-quarter impact of the $75.0 million ESOP tax settlement and the unresolved Department of Labor investigation.
- Monitor leverage, commercial-paper reliance, covenant headroom and available borrowing capacity.
- Track working-capital growth, particularly receivables and inventories, and its effect on operating cash flow.
- Evaluate potential environmental exposure above the $142.3 million accrual and the unaccrued $101.6 million range differential.
- Follow lead-paint litigation, the Santa Clara County proceeding and related insurance-coverage issues, for which the filing provides no reliable loss estimate.
- Confirm the effect of share repurchases and the new 20 million-share authorization on future share count, liquidity and capital allocation.