The Sherwin-Williams Company — Q1 2016 Form 10-Q Summary
Business context and reporting period
The filing covers the unaudited three months ended March 31, 2016, compared with the same period in 2015. Sherwin-Williams develops, manufactures, distributes and sells paints, coatings and related products primarily in North and South America, with additional international operations. Reportable segments are Paint Stores, Consumer, Global Finishes and Latin America Coatings.
Key financial metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net sales | $2.574 billion | $2.450 billion | 5.1% increase |
| Gross profit | $1.262 billion | $1.132 billion | 11.4% increase |
| Gross margin | 49.0% | 46.2% | Up 280 basis points |
| Income before taxes | $216.4 million | $193.2 million | 12.0% increase |
| Net income | $147.1 million | $131.4 million | 11.9% increase |
| Diluted EPS | $1.57 | $1.38 | 13.8% increase |
| EBITDA | $290.8 million | $255.0 million | 14.0% increase |
| Net operating cash flow | $(79.8) million | $(55.1) million | Greater use of cash |
| Capital expenditures | $52.0 million | $42.9 million | Increase |
Net income represented approximately 5.7% of sales, while EBITDA represented approximately 11.3% of sales. SG&A increased to $1.002 billion, or 38.9% of sales, from 37.9%, reflecting higher operating costs, new-store timing and $31.0 million of Valspar acquisition costs. Interest expense rose to $25.7 million from $12.4 million, primarily because of debt issued in July 2015 and amortization of credit facility costs.
Liquidity, debt and balance sheet
- Cash and cash equivalents were $70.5 million at March 31, 2016, down $135.2 million during the quarter.
- Total debt was approximately $2.040 billion, consisting primarily of $1.909 billion of long-term debt and $128.7 million of short-term borrowings.
- Total debt decreased $485.2 million from March 31, 2015, while long-term debt increased $792.4 million and short-term borrowings decreased $1.277 billion.
- The current ratio was 1.28, compared with 0.82 at March 31, 2015 and 1.24 at December 31, 2015.
- Remaining short-term borrowing capacity was $2.001 billion, including $1.251 billion of unused capacity under the $1.350 billion credit agreement.
- The company entered into a $9.3 billion senior unsecured bridge facility to support the proposed Valspar acquisition; no amounts had been drawn at March 31. Related debt issuance costs were $60.1 million.
- The company was in compliance with its 3.50-to-1.00 consolidated leverage covenant at quarter-end.
- Shareholders’ equity increased to $1.001 billion from $867.9 million at December 31, 2015. The quarterly dividend increased from $0.67 to $0.84 per share.
Material changes versus the prior comparable period
- Sales growth was driven mainly by higher paint volume in the Paint Stores and Consumer Groups. Paint Stores same-store sales increased 9.4%.
- Paint Stores sales increased 10.5%, Consumer sales increased 7.5%, Global Finishes sales decreased 3.3%, and Latin America Coatings sales decreased 24.7%.
- Foreign currency translation reduced consolidated sales by approximately 2.8%; foreign-subsidiary sales declined 12.2% to $400.7 million.
- Gross margin improved because of higher paint volume, improved operating efficiency, lower raw-material costs and cost control in certain businesses.
- Segment income before taxes improved in Paint Stores, Consumer and Global Finishes, but Latin America Coatings shifted to a $0.9 million loss from $9.5 million of income.
- Operating cash flow worsened primarily because of increased working-capital usage. The company nevertheless generated $1.423 billion of operating cash flow during the twelve months ended March 31, 2016.
- Comprehensive income increased to $166.1 million from $75.1 million, partly reflecting favorable foreign-currency translation movements in accumulated other comprehensive loss.
Outlook, unusual items, risks and contingencies
- The filing does not provide formal quarterly or full-year earnings or sales guidance. Management stated that liquidity and cash flow remained strong and that available borrowing capacity was sufficient for current operating needs.
- On March 19, 2016, Sherwin-Williams agreed to acquire Valspar for $113 per share in cash, approximately $9.5 billion plus assumed debt. The consideration could fall to $105 per share if required divestitures exceed $650 million of net sales; the company may decline to close if required divestitures exceed $1.5 billion.
- The transaction remained subject to shareholder and regulatory approvals. Management identified execution, financing, integration, divestiture and synergy risks. Up to $9.3 billion of additional debt was expected to be incurred if the acquisition closed.
- Environmental provisions were $18.0 million in Q1 2016 versus $1.1 million in Q1 2015. Environmental accruals totaled approximately $165.9 million, with an unaccrued maximum of estimated possible outcomes $84.5 million above the minimum accrued amount.
- The company faces lead pigment and lead-based paint litigation, including a $1.15 billion Santa Clara County judgment that was under appeal. No amounts were accrued because management did not believe a loss was probable and could not estimate the potential loss range.
- Consorcio Comex-related arbitration claims alleged approximately $85 million of damages; the merits hearing concluded in April 2016, with a decision expected by the end of the third quarter of 2016. The company considered the claims without merit.
- An interest-rate-lock liability of $23.8 million was recorded in other accruals and accumulated other comprehensive loss in anticipation of future fixed-rate debt issuance.
- Other relevant risks include foreign-currency movements, raw-material and energy costs, economic conditions, competitive pricing, regulatory requirements, litigation, environmental liabilities and unusual weather.
Investor verification checklist
- Verify the final terms, regulatory approvals, divestitures, financing structure and closing status of the Valspar acquisition.
- Monitor post-acquisition leverage, interest expense, covenant compliance and the company’s ability to generate sufficient cash flow to service additional debt.
- Review quarterly working-capital trends and operating cash conversion, which were negative in the first quarter despite higher earnings.
- Track environmental accrual revisions and developments in lead-paint litigation, including the Santa Clara appeal and potential future claims.
- Assess whether foreign-currency pressure and Latin America weakness persist and offset continued strength in Paint Stores and Consumer.
- Confirm the effect of acquisition-related expenses, bridge-facility costs and interest-rate hedges on future earnings and comprehensive income.