Sherwin-Williams Company — Form 10-Q Summary
Business context and reporting period
Quarterly report for the three and nine months ended September 30, 2017. Sherwin-Williams develops, manufactures, distributes and sells paints, coatings and related products through The Americas Group, Consumer Brands Group and Performance Coatings Group, with an Administrative segment.
The period reflects the June 1, 2017 acquisition of Valspar, which materially changed the company’s scale, segment structure, asset base, debt profile and reported expenses. The Valspar acquisition contributed $1.075 billion of third-quarter sales and $1.456 billion of nine-month sales.
Financial performance and liquidity
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $4.507 billion | $3.279 billion | $11.004 billion | $9.073 billion |
| Gross profit | $1.902 billion | $1.636 billion | $4.982 billion | $4.534 billion |
| Gross margin | 42.2% | 49.9% | 45.3% | 50.0% |
| Income from continuing operations | $316.6 million | $386.7 million | $916.4 million | $929.7 million |
| Net income | $316.6 million | $386.7 million | $874.9 million | $929.7 million |
| Diluted EPS | $3.33 | $4.08 | $9.23 | $9.85 |
| Operating cash flow | Not separately provided | Not separately provided | $1.259 billion | $966.5 million |
- Third-quarter sales increased 37.4%; nine-month sales increased 21.3%.
- Income before taxes declined 20.1% in the quarter to $427.7 million and 3.7% for the nine months to $1.243 billion.
- SG&A increased in dollars but declined as a percentage of sales to 29.0% from 32.0% in the quarter and to 31.5% from 34.1% for the nine months.
- EBITDA from continuing operations was $670.3 million in the quarter and $1.698 billion for the nine months, compared with $629.5 million and $1.550 billion, respectively, in the prior-year periods.
- Cash and cash equivalents were $207.9 million at September 30, 2017, versus $889.8 million at December 31, 2016.
- Total debt was approximately $10.949 billion, representing 80.0% of total capitalization, compared with $1.962 billion and 55.1% at September 30, 2016. Remaining short-term borrowing capacity was $1.950 billion.
- The current ratio was 1.07 at September 30, 2017, versus 1.28 at December 31, 2016 and 1.47 a year earlier.
- Capital expenditures were $143.4 million and cash dividends paid were $239.0 million during the first nine months.
Material changes versus the prior comparable period
- Valspar acquisition: The $8.9 billion all-cash acquisition added substantial sales and assets, including $5.753 billion of preliminary goodwill and $6.319 billion of acquired intangible assets. The company also recorded $114.8 million of inventory step-up amortization and $118.8 million of intangible amortization during the first nine months.
- Margin pressure: Gross margin fell 770 basis points in the quarter and 470 basis points for the nine months, primarily because of purchase-accounting adjustments, higher raw-material costs and hurricane-related effects.
- Higher financing costs: Interest expense increased $47.5 million in the quarter and $63.3 million for the nine months due primarily to acquisition-related debt.
- Higher acquisition costs: Acquisition-related costs, inventory purchase-accounting adjustments and incremental intangible amortization reduced diluted EPS by approximately $1.42 in the quarter and $2.22 for the nine months, compared with acquisition-related charges of $0.24 and $0.64 in the prior-year periods.
- Segment trends: The Americas Group sales increased 6.5% in the quarter and 8.8% for the nine months, while segment profit increased 1.2% and 7.3%, respectively. Consumer Brands and Performance Coatings sales benefited from Valspar, but segment profit declined 19.2% and 12.4% in the quarter.
- Cash flow and financing: Operating cash flow improved by $292.3 million, but investing cash usage increased to $8.911 billion because of the acquisition. Financing cash flow was $6.990 billion, primarily from new long-term debt.
Guidance, outlook, risks and unusual items
The filing does not provide a clear quantitative earnings or sales guidance range. Management states that operating results, liquidity and cash flow remained strong, supported primarily by The Americas Group, and that sufficient borrowing capacity was available for current operating needs.
- Hurricanes affecting Texas, Florida and the Caribbean reduced sales and margins during the quarter.
- Management identified risks from Valspar integration, achievement and timing of synergies, competitive pricing, raw-material and energy costs, foreign currency, economic conditions, environmental regulation and unusual weather.
- The company was in compliance with its 5.25-to-1.00 consolidated leverage covenant at September 30, 2017. Debt agreements contain default and cross-default provisions that could accelerate borrowings upon an event of default.
- Environmental accruals totaled approximately $195.5 million, with an unaccrued maximum estimated range $84.8 million above the accrued minimum. Management cannot estimate the ultimate liability, although it does not expect environmental matters to materially affect financial condition, liquidity or cash flow.
- The company faces lead-pigment and lead-based-paint litigation, including a $1.15 billion Santa Clara County judgment under appeal. No amounts have been accrued because management does not believe a loss is probable and cannot estimate a loss range.
- Warranty accruals increased to $128.1 million, including $107.3 million acquired with Valspar.
- Valspar was excluded from the company’s assessment of internal control over financial reporting because it was acquired during 2017. Valspar represented approximately $1.1 billion of third-quarter sales and $11.3 billion of assets at September 30, 2017.
- The company expects the new lease accounting standard to have a material impact on the consolidated balance sheet, primarily through recognition of lease assets and liabilities for retail operations.
Most important facts for investors to verify
- Progress toward Valspar integration, expected synergies and finalization of preliminary purchase-accounting allocations.
- Whether gross-margin pressure from inventory step-up amortization, raw-material inflation and integration costs moderates after the acquisition accounting effects subside.
- Debt reduction, leverage covenant headroom, refinancing requirements and the effect of higher interest expense on earnings and cash flow.
- Underlying organic sales and profit trends by segment, particularly Consumer Brands and Performance Coatings after separating Valspar contributions.
- Ultimate exposure from the Santa Clara lead-paint litigation, environmental contingencies and acquired warranty obligations.
- Impact of hurricanes and other weather events on demand, distribution and operating costs.