Business Context and Reporting Period
The Sherwin-Williams Company develops, manufactures, distributes and sells paints, coatings and related products primarily in North and South America, with additional international operations. This unaudited Form 10-Q covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016.
Reportable segments were Paint Stores, Consumer, Global Finishes and Latin America Coatings, plus Administrative.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $2.761 billion | $2.574 billion | 7.3% increase |
| Gross profit | $1.343 billion | $1.262 billion | 6.5% increase |
| Gross margin | 48.6% | 49.0% | Down 40 basis points |
| SG&A | $1.016 billion | $1.002 billion | 1.4% increase |
| SG&A as percentage of sales | 36.8% | 38.9% | Down 210 basis points |
| Income before taxes | $306.6 million | $216.4 million | 41.7% increase |
| Net income | $239.2 million | $164.9 million | 45.0% increase |
| Diluted EPS | $2.53 | $1.75 | 44.6% increase |
| EBITDA | $383.1 million | $290.8 million | 31.7% increase |
| Net operating cash flow | $231.8 million | $(62.1) million | $293.9 million improvement |
Net profit margin was approximately 8.7%, compared with approximately 6.4% in the prior-year quarter. The reported effective tax rate was 22.0%, compared with 23.8%; excluding the impact of ASU 2016-09, the rates were 32.8% and 32.0%, respectively.
At March 31, 2017, cash and cash equivalents were $1.018 billion. Total debt was approximately $1.954 billion, consisting primarily of $700.8 million of current long-term debt and $1.212 billion of long-term debt. Remaining short-term borrowing ability was $1.934 billion, including $1.334 billion of unused capacity under the global credit agreement. The current ratio was 1.32.
Capital expenditures were $41.5 million, cash dividends were $79.5 million, net investing cash usage was $29.9 million, and net financing cash usage was $60.1 million. The Company generated $1.602 billion of operating cash flow during the twelve months ended March 31, 2017.
Material Changes Versus the Prior Comparable Period
- Paint Stores sales increased 12.1% to $1.810 billion, and segment profit increased 19.9% to $304.1 million, driven primarily by higher architectural paint volume.
- Global Finishes sales increased 3.6% and segment profit increased 7.9%, supported by volume and price increases.
- Latin America Coatings sales increased 12.9% and segment profit improved to $1.2 million from a $0.9 million loss, aided by price increases and favorable currency translation, partly offset by lower volume.
- Consumer sales declined 10.7% to $337.5 million and segment profit declined 5.3% to $60.6 million, primarily because of lower volume.
- Gross margin declined because of higher raw-material costs and a change that grossed up third-party service revenue and related costs in reported sales. The classification change increased reported sales by approximately 2.2% but did not affect operating profit.
- SG&A benefited from lower Valspar acquisition costs of $5.0 million versus $31.1 million in Q1 2016. Management also reported lower Administrative expenses and higher operating results in the Paint Stores and Global Finishes groups.
- Net operating cash flow improved substantially because of higher net income, lower working-capital cash usage and the $87.6 million cash settlement of interest-rate locks.
- Debt as a percentage of total capitalization declined to 48.6% from 67.1% at March 31, 2016. The increase in current debt primarily reflected 1.35% senior notes becoming due in 2017.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide a specific full-year sales or earnings forecast. Management stated that liquidity and cash flow remained strong and that the Company had sufficient cash and borrowing capacity for current operating needs. The filing cautions that first-quarter results are not necessarily indicative of full-year results.
The proposed acquisition of Valspar remained a major strategic and financing item. The agreement was extended to June 21, 2017, and the transaction was expected to close at $113 per share after a planned approximately $420 million divestiture of Valspar’s North American industrial wood coatings business. Completion remained subject to customary conditions and antitrust approvals. The Company had committed $7.3 billion of bridge financing and a $2.0 billion term loan, with no amounts drawn at March 31, 2017.
The Company settled $3.6 billion of interest-rate locks in March 2017, recording an $87.6 million pretax gain in accumulated other comprehensive loss. It expected to amortize $6.9 million of the gain as a reduction of interest expense during the following twelve months.
Environmental liabilities included approximately $181.6 million of accrued costs at March 31, 2017, including $161.6 million in long-term liabilities. The unaccrued maximum of the estimated range of possible environmental outcomes exceeded the accrued minimum by $86.6 million. Management stated that the ultimate liability could materially affect results in a period when additional costs are accrued, although it did not expect environmental matters to materially impair financial condition, liquidity or cash flow over time.
The Company disclosed significant lead-pigment and lead-based-paint litigation, including a stayed appeal of a $1.15 billion Santa Clara County public-nuisance judgment. No amounts were accrued because management did not believe a loss was probable and could not estimate a range of potential losses. An adverse outcome could materially affect net income, liquidity or financial condition.
Other risks include raw-material and energy costs, pricing pressure, foreign-exchange and commodity fluctuations, economic conditions, regulatory approvals and integration of Valspar, environmental regulation, litigation, tax matters and unusual weather. The Company was in compliance with its consolidated leverage covenant at March 31, 2017.
Important Facts for Investors to Verify
- Confirm the final status, closing terms, financing and integration results of the Valspar acquisition, including required divestitures and antitrust approvals.
- Assess the sustainability of the earnings increase excluding the ASU 2016-09 tax benefit, which increased Q1 diluted EPS by $0.34.
- Monitor raw-material costs and whether gross-margin pressure persists after the Q1 decline to 48.6%.
- Review the maturity and refinancing of the $700.8 million current portion of long-term debt and any debt raised for the Valspar transaction.
- Track developments in the Santa Clara County lead-paint litigation and other unaccrued lead-related claims.
- Evaluate the environmental liability range, including the $86.6 million excess of possible outcomes over the accrued minimum.
- Consider the effect of the prospective revenue-classification change when comparing future sales and margins with earlier periods.