Business Context and Reporting Period
The Sherwin-Williams Company develops, manufactures, distributes and sells paint, coatings and related products through its Paint Stores, Consumer and Global Finishes segments. This unaudited Form 10-Q covers the three and nine months ended September 30, 2009, filed October 27, 2009.
Key Financial Metrics
| Metric | Q3 2009 | Q3 2008 | 9M 2009 | 9M 2008 |
|---|---|---|---|---|
| Net sales | $1.997 billion | $2.269 billion | $5.495 billion | $6.280 billion |
| Gross profit | $929.0 million | $960.5 million | $2.505 billion | $2.714 billion |
| Gross margin | 46.5% | 42.3% | 45.6% | 43.2% |
| Net income | $175.2 million | $177.1 million | $370.5 million | $426.7 million |
| Diluted EPS | $1.51 | $1.50 | $3.17 | $3.57 |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $615.6 million | $592.6 million |
| EBITDA | $310.2 million | $323.7 million | $701.1 million | $810.6 million |
At September 30, 2009, cash and cash equivalents were $32.8 million. Total debt was approximately $711.0 million, consisting primarily of $411.0 million of short-term borrowings and $300.0 million of long-term debt including the current portion. Remaining borrowing capacity was $1.215 billion, and the current ratio was 1.02.
Shareholders’ equity was $1.703 billion. The company paid $124.6 million of dividends and repurchased $276.2 million of treasury stock during the first nine months. Capital expenditures were $63.6 million and acquisitions used $14.1 million.
Material Changes Versus the Prior Comparable Period
- Net sales declined 12.0% in the third quarter and 12.5% for the first nine months, reflecting weak paint volume, depressed housing and commercial markets, and unfavorable foreign-currency translation.
- Paint Stores Group sales declined 13.5% in the quarter and 13.4% year to date; comparable-store sales declined 13.5% and 13.3%, respectively.
- Consumer Group sales declined 7.1% in the quarter and 4.0% year to date, while Global Finishes Group sales declined 11.3% and 16.2%, respectively.
- Gross margin improved substantially because of pricing, cost controls, favorable mix and lower freight and distribution costs, partly offset by lower manufacturing volumes and site-closing costs.
- SG&A expense declined $27.1 million in the quarter and $93.9 million year to date, but increased as a percentage of sales to 32.8% and 34.9% from 30.0% and 32.0%.
- Net income declined 1.1% in the quarter and 13.2% year to date. Diluted EPS increased slightly in the quarter because of lower share count and a lower tax rate, but declined 11.2% year to date.
- Operating cash flow increased $23.1 million year to date, while total debt declined $315.8 million from September 30, 2008. Debt as a percentage of total capitalization fell to 29.5% from 37.1%.
- Segment profit increased 115% for the Consumer Group in the quarter and 19% year to date, but declined 4% and 10% for Paint Stores and 35% and 52% for Global Finishes.
Outlook, Risks, Contingencies and Unusual Items
Management described demand as depressed and global economic conditions as challenging. The filing does not provide a clear formal earnings or sales guidance range. Management stated that liquidity and cash flow remained strong and that sufficient borrowing capacity was available to fund current operating needs.
- The company closed 28 Paint Stores, three Consumer manufacturing facilities, and one Global Finishes manufacturing facility plus 19 branches during the first nine months. Qualified exit-cost provisions and adjustments totaled approximately $15.3 million.
- Environmental-related accruals were $174.4 million at September 30, 2009. The unaccrued maximum of the estimated range of possible outcomes was $108.3 million above the recorded minimum accrual. Management cannot estimate the ultimate liability but does not expect environmental matters to materially affect financial condition, liquidity or cash flow because resolution is expected over an extended period.
- Lead pigment and lead-based paint litigation remains a significant unquantified contingency. No amounts were accrued because potential losses cannot reasonably be estimated; a significant adverse outcome could materially affect earnings, liquidity or financial condition.
- Other risks include weak end-market demand, raw-material and energy prices, foreign-currency movements, interest rates, competitive pricing, acquisition integration, environmental regulation, tax examinations, litigation and unusual weather.
- The company remained in compliance with its consolidated leverage covenant. Currency and commodity hedges were used for risk management and were not material at September 30, 2009.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether weak housing, commercial and industrial demand persists and how quickly comparable-store sales recover.
- Whether improved gross margins are sustainable if raw-material costs, manufacturing utilization or freight costs change.
- The scale and timing of additional environmental remediation costs, including the $108.3 million unaccrued exposure above recorded accruals.
- The potential financial impact of lead-paint litigation and the availability of related insurance coverage.
- Future debt reduction, share repurchases, dividend payments and the maintenance of available borrowing capacity.
- The final year-end LIFO inventory valuation and other estimates that may differ from interim amounts.