Sherwin-Williams Company — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2016. The filing covers the development, manufacture, distribution and sale of paint, coatings and related products across the Paint Stores, Consumer, Global Finishes and Latin America Coatings segments.
Financial Highlights
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net sales | $3.279 billion | $3.152 billion | $9.073 billion | $8.735 billion |
| Gross profit margin | 49.9% | 49.9% | 50.0% | 48.5% |
| Income before taxes | $535.6 million | $550.7 million | $1.291 billion | $1.252 billion |
| Net income | $386.7 million | $374.5 million | $929.7 million | $855.8 million |
| Diluted EPS | $4.08 | $3.97 | $9.85 | $9.03 |
| EBITDA | $629.5 million | $616.4 million | $1.550 billion | $1.441 billion |
| Operating cash flow | Not separately provided | Not separately provided | $966.5 million | $902.5 million |
Liquidity, Debt and Capital Allocation
- Cash and equivalents were $702.6 million at September 30, 2016, up from $205.7 million at December 31, 2015 and $91.0 million at September 30, 2015.
- Total debt was approximately $1.962 billion, consisting primarily of $1.907 billion of publicly traded debt and $50.3 million of short-term borrowings. Debt represented 55.1% of total capitalization, compared with 66.6% a year earlier.
- The current ratio was 1.47, compared with 1.27 at September 30, 2015 and 1.24 at December 31, 2015. Remaining short-term borrowing ability was $2.278 billion.
- Capital expenditures were $173.1 million, cash dividends paid were $233.9 million, and no open-market treasury stock purchases were made during the first nine months.
- The company had no borrowings under the $7.3 billion bridge facility or $2.0 billion term loan arranged for the proposed Valspar acquisition. It also had $1.328 billion of unused capacity under its $1.350 billion global credit agreement.
- The company was in compliance with its 3.50-to-1.00 consolidated leverage covenant at September 30, 2016.
Material Changes Versus Prior Comparable Period
- Sales increased 4.0% in the third quarter and 3.9% for the first nine months, driven primarily by higher Paint Stores volume and a prospective change that grossed up certain third-party service revenue and related costs. The classification change increased reported sales by 2.3% in the quarter and 0.8% year to date without affecting operating profit.
- Paint Stores sales rose 6.7% in the quarter and 7.5% year to date; Global Finishes sales declined 1.1% and 1.9%, respectively; Consumer sales declined 2.1% in the quarter but increased 0.4% year to date; and Latin America sales were essentially flat in the quarter but declined 12.1% year to date.
- Gross margin was unchanged in the quarter but expanded 150 basis points year to date, primarily from higher paint volume and improved operating efficiency.
- SG&A rose to 32.3% of sales in the quarter and 34.3% year to date, versus 31.5% and 33.5%, respectively, largely from new-store costs, higher support expenses and Valspar-related costs.
- Income before taxes declined 2.7% in the quarter but increased 3.2% year to date. Net income increased 3.3% in the quarter and 8.6% year to date.
- Interest expense increased $27.1 million in the quarter and $68.5 million year to date, primarily because of debt issued in July 2015 and amortization and servicing costs related to acquisition financing.
- The effective tax rate declined to 27.8% from 32.0% in the quarter and to 28.0% from 31.6% year to date, primarily because of the adoption of ASU 2016-09. The accounting change increased net income by $11.3 million in the quarter and $41.0 million year to date.
Outlook, Unusual Items and Risks
- The company agreed to acquire Valspar for $113 per share in cash, or approximately $9.5 billion plus assumed debt, subject to regulatory approvals and other closing conditions. Required divestitures above specified thresholds could reduce consideration to $105 per share or permit termination of the transaction.
- Valspar-related costs included $49.2 million of SG&A and $49.9 million of interest expense during the first nine months. Management reported a $0.24 per-share acquisition and financing cost impact in third-quarter diluted EPS and $0.64 per share year to date.
- The company entered into interest-rate locks on a $3.6 billion notional amount in anticipation of future debt issuance. A $157.3 million liability was recorded at September 30, 2016 in other accruals, with the pretax loss recorded in accumulated other comprehensive loss.
- Environmental accruals totaled approximately $166.4 million, including $143.9 million in long-term liabilities and $22.5 million in current accruals. The unaccrued maximum of the estimated possible environmental outcomes exceeded the minimum accrued amount by $81.5 million.
- The company has not accrued amounts for lead pigment and lead-based paint litigation, including a stayed $1.15 billion Santa Clara County abatement judgment under appeal. Management stated that a loss was not considered probable and the potential range could not be estimated.
- Other risks include raw-material and energy costs, foreign currency, economic conditions, regulatory requirements, litigation, environmental obligations, acquisition integration, financing needs and the ability to achieve expected Valspar synergies.
- No specific earnings or sales guidance was provided in the filing.
Investor Verification Priorities
- Verify the timing, regulatory conditions, financing and final consideration for the Valspar acquisition, including any required divestitures.
- Assess the recurring operating performance excluding Valspar acquisition costs, financing fees and the ASU 2016-09 tax benefit.
- Monitor leverage, future debt issuance, interest-rate-lock settlements and compliance with debt covenants.
- Review environmental accrual adequacy and developments in lead-paint and other litigation, particularly the Santa Clara County case.
- Confirm the effect of the third-party service revenue gross-up on reported sales and segment margins.
- Track foreign currency effects and Latin America performance, as well as raw-material cost trends and margin sustainability.