The Sherwin-Williams Company: 2011 First-Quarter Form 10-Q
Business context and reporting period
The filing covers the three months ended March 31, 2011. Sherwin-Williams develops, manufactures, distributes and sells paint, coatings and related products primarily in North and South America, with additional operations in Europe, Asia and the Caribbean. Reportable segments are Paint Stores Group, Consumer Group and Global Finishes Group.
Financial performance and liquidity
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Net sales | $1.856 billion | $1.565 billion | 18.5% increase |
| Gross profit | $797.4 million | $692.0 million | 15.2% increase |
| Gross margin | 43.0% | 44.2% | Down 120 basis points |
| Income before taxes | $94.7 million | $59.5 million | 59.3% increase |
| Net income | $68.3 million | $32.6 million | 109.5% increase |
| Diluted EPS | $0.63 | $0.30 | 110.0% increase |
| EBITDA | $149.1 million | $110.9 million | 34.5% increase |
| Net operating cash flow | $(153.2) million | $(115.8) million | Greater seasonal use |
SG&A increased to $691.1 million from $612.9 million but declined to 37.2% of sales from 39.1%, reflecting expense control and higher sales. Net margin was approximately 3.7%, compared with approximately 2.1% in the prior-year quarter.
- Cash and cash equivalents were $53.9 million at March 31, 2011, compared with $91.2 million a year earlier.
- Total debt was approximately $1.339 billion, including $678.4 million of short-term borrowings, $10.0 million of current long-term debt and $650.9 million of long-term debt.
- Total debt increased $298.6 million year over year and represented 45.4% of total capitalization, compared with 41.0% at March 31, 2010.
- The current ratio declined to 1.06 from 1.25 a year earlier. Remaining borrowing ability was $883.3 million; the company stated that available capacity was sufficient for current operating needs.
- First-quarter investing cash use was $29.0 million, including $27.0 million of capital expenditures. Financing cash flow was $181.3 million, primarily from increased short-term borrowings.
- Working capital absorbed substantial cash as accounts receivable and inventories increased with higher sales and acquisitions. Net operating cash generated during the twelve months ended March 31, 2011 was $669.2 million.
Material changes versus the prior comparable period
- Paint Stores Group sales increased 9.2% to $929.3 million and pretax income increased 44.2% to $68.9 million.
- Consumer Group sales increased 1.0% to $294.9 million and pretax income increased 9.7% to $41.1 million.
- Global Finishes Group sales increased 49.6% to $630.2 million and pretax income increased 60.0% to $36.8 million, driven primarily by 2010 acquisitions, higher volume, price increases and favorable currency translation.
- Foreign subsidiary sales increased 66.8% to $470.0 million, substantially reflecting the 2010 acquisitions of Sayerlack, Becker Acroma and Pinturas Condor.
- Gross margin contracted because of higher raw material costs and acquisition mix, partly offset by selling-price increases. Global Finishes Group gross margin declined 3.2 percentage points.
- The effective tax rate fell to 27.9% from 45.2%. The 2010 rate included an $11.4 million one-time tax charge related to health-care legislation, which reduced 2010 diluted EPS by $0.10.
- The company repurchased 1.1 million shares for $90.8 million during the quarter and had authorization remaining for 4.65 million shares. It retired all 125.4 million treasury shares effective March 31, 2011, reducing treasury stock, common stock and retained earnings by approximately $4.5 billion, $0.1 billion and $4.4 billion, respectively.
- The quarterly dividend was increased from $0.36 to $0.365 per common share effective with the April 20, 2011 board action.
Outlook, commentary, risks and unusual items
Management described the financial condition and liquidity as stable despite seasonally weak first-quarter demand, flat domestic demand, higher global raw-material costs and tight credit markets. The filing does not provide specific full-year sales or earnings guidance. Management reported improving global demand in architectural, OEM and automotive finishes, as well as improvement in domestic DIY and protective and marine products, but noted that first-quarter results are not necessarily indicative of the full year.
- Environmental accruals totaled $150.8 million at March 31, 2011. The unaccrued maximum of estimated environmental outcomes was $103.0 million above the accrued amount; ultimate costs remain uncertain.
- Lead-pigment and lead-based-paint litigation remains unresolved. No amounts were accrued because potential liabilities could not reasonably be estimated. A significant adverse determination could materially affect earnings, liquidity or financial condition.
- The company faces ongoing product liability, warranty, commercial, antitrust and other litigation. Product warranty accruals were $23.5 million at March 31, 2011.
- The IRS and Department of Labor were reviewing leveraged ESOP transactions. The IRS indicated that proposed adjustments could disallow some or all related deductions and assess interest and penalties; no accrual was recorded.
- The company was in compliance with its 3.00-to-1.00 consolidated leverage covenant at March 31, 2011.
- Principal operating risks include raw-material and energy inflation, competitive pricing pressure, economic and housing conditions, foreign-currency fluctuations, acquisition integration, environmental regulation, litigation, taxation and unusual weather.
Most important facts for investors to verify
- Whether price increases and acquisition contributions can offset raw-material inflation without further gross-margin erosion.
- The sustainability of operating cash flow as inventories, receivables and seasonal working-capital needs remain elevated.
- Short-term borrowing levels, available revolver and commercial-paper capacity, interest rates and compliance with leverage covenants.
- The integration and earnings contribution of the Sayerlack, Becker Acroma and Pinturas Condor acquisitions.
- Potential exposure from environmental matters, lead-paint litigation and the leveraged ESOP tax examination, none of which has a clearly estimable ultimate cost in the filing.
- The effect of ongoing share repurchases, treasury-share retirement and the higher quarterly dividend on leverage, liquidity and per-share results.