The Sherwin-Williams Company — 2011 Q2 Form 10-Q
Reporting period: Three and six months ended June 30, 2011, compared with the same periods in 2010. The unaudited filing covers the development, manufacture, distribution and sale of paints, coatings and related products through the Paint Stores, Consumer and Global Finishes Groups.
Key Financial Metrics
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Net sales | $2.355 billion, up 9.9% | $4.210 billion, up 13.5% |
| Gross profit | $1.023 billion; 43.4% margin | $1.820 billion; 43.2% margin |
| Income before taxes | $257.0 million, down 0.9% | $351.7 million, up 10.4% |
| Net income | $179.1 million, down 1.4% | $247.4 million, up 15.5% |
| Diluted EPS | $1.66, versus $1.64 | $2.29, versus $1.94 |
| Net operating cash flow | Not provided for the quarter | $108.2 million, versus $236.5 million |
- SG&A was $755.6 million, or 32.1% of sales, in the quarter and $1.447 billion, or 34.4% of sales, for six months, with margins improving from the prior-year periods.
- EBITDA, as defined by management, was $313.0 million for the quarter and $462.1 million for six months, compared with $325.2 million and $436.0 million, respectively.
- Cash and cash equivalents were $71.6 million at June 30, 2011. The current ratio was 1.10.
- Total debt was approximately $1.225 billion, or 41.2% of total capitalization, compared with $908.6 million and 37.2% at June 30, 2010. Remaining borrowing ability was $750.3 million.
- Short-term borrowings were $571.1 million, including $371.0 million of domestic commercial paper and $200.1 million under foreign programs. Long-term debt, including the current portion, was approximately $653.8 million.
- Six-month investing cash use was $85.4 million, including $68.9 million of capital expenditures. Financing cash flow was $1.4 million, after dividends of $77.8 million and treasury-stock purchases of $132.7 million.
Material Changes Versus Prior Comparable Period
- Sales growth was driven primarily by selling-price increases, acquisitions and strong organic growth in the Global Finishes Group. Foreign subsidiary sales rose 50.3% in the quarter and 57.8% for six months, largely from acquisitions and favorable currency translation.
- Paint Stores Group sales rose 4.3% in the quarter and 6.3% for six months, while Consumer Group sales declined 8.4% and 4.5%, respectively. Global Finishes Group sales increased 39.5% and 44.2%.
- Gross margin declined from 45.4% to 43.4% in the quarter and from 44.9% to 43.2% for six months, primarily because of higher raw-material costs and acquisition effects, partly offset by price increases.
- Segment profit declined in the quarter for Paint Stores by 2.5% and Consumer by 23.9%, while Global Finishes increased 15.3%. For six months, Paint Stores increased 6.1%, Consumer declined 13.3%, and Global Finishes increased 31.6%.
- Operating cash flow declined by $128.3 million year over year, primarily because of seasonal and acquisition-related working-capital needs and higher sales. Accounts receivable and inventories increased substantially.
- Interest expense decreased by $14.6 million in the quarter and $15.5 million for six months, mainly because the comparable 2010 periods included costs associated with repurchasing 7.45% debentures.
- The effective tax rate was 29.7% for six months versus 32.8% in 2010. The 2010 rate included an $11.4 million one-time charge related to U.S. health-care legislation.
- The company retired all 125.4 million treasury shares on March 31, 2011, reducing treasury stock, common stock and retained earnings by approximately $4.5 billion, $0.1 billion and $4.4 billion, respectively.
Outlook, Risks and Unusual Items
- The filing does not provide a clear quantitative earnings or sales guidance range. Management described soft domestic demand, rising global raw-material costs and tight credit markets, but stated that liquidity and operating conditions remained stable.
- On July 8, 2011, after quarter-end, the company entered into a new five-year $1.05 billion credit agreement, replacing a $500.0 million facility. The leverage covenant was increased from 3.00-to-1.00 to 3.25-to-1.00; the company was in compliance at June 30.
- Effective July 1, 2011, the company acquired Leighs Paints, a United Kingdom industrial fire-protection coatings manufacturer. The filing does not provide the purchase price.
- Environmental accruals totaled $147.5 million at June 30, 2011. The unaccrued maximum of estimated possible environmental outcomes was $100.5 million above the recorded minimum accrual. Management does not expect these 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 unaccrued because management does not believe a loss is probable and cannot estimate potential exposure. A material adverse effect remains possible if liability is ultimately imposed. Santa Clara County litigation remains pending; most other public-nuisance proceedings were resolved in the company’s favor.
- The IRS challenged tax deductions related to leveraged ESOP transactions. The challenged deductions totaled $418.7 million for audited years, representing stated federal tax savings of $146.5 million, with additional later-period deductions of $99.2 million and tax savings of $34.7 million. No accrual was recorded, and the ultimate outcome is uncertain.
- Other risks include raw-material and commodity prices, foreign-currency movements, acquisition integration, economic conditions, environmental regulation, litigation, customer concentration changes and unusual weather. The company uses derivatives for hedging and does not expect market-risk losses to be material.
Investor Verification Points
- Verify whether price increases can offset continuing raw-material inflation without further gross-margin erosion.
- Assess the sustainability and cash conversion of Global Finishes Group growth, including the contribution and integration costs of acquisitions.
- Monitor working-capital requirements, short-term borrowing levels, current-ratio trends and compliance with the revised leverage covenant.
- Review developments in the IRS leveraged-ESOP tax challenge and quantify potential tax, interest and penalty exposure as information becomes available.
- Track environmental accruals and the $100.5 million unaccrued range exposure, as well as developments in lead-paint litigation and related insurance coverage.
- Confirm the purchase price and subsequent financial contribution of the Leighs Paints acquisition, which closed after the reporting date.