Business Context and Reporting Period
The Sherwin-Williams Company manufactures and sells paints, coatings and related products through The Americas Group, Consumer Brands Group and Performance Coatings Group. This unaudited Form 10-Q covers the three and nine months ended September 30, 2019, compared with the same periods in 2018.
Key Financial Metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net sales | $4.868 billion | $4.731 billion | $13.786 billion | $13.470 billion |
| Gross profit | $2.226 billion | $2.010 billion | $6.142 billion | $5.736 billion |
| Gross margin | 45.7% | 42.5% | 44.6% | 42.6% |
| Net income | $576.4 million | $354.0 million | $1.293 billion | $1.008 billion |
| Diluted EPS | $6.16 | $3.72 | $13.82 | $10.59 |
| Effective tax rate | 18.8% | 14.9% | 23.3% | 19.9% |
| EBITDA, as defined by management | $937.9 million | $655.7 million | $2.379 billion | $1.985 billion |
Approximate net margins were 11.8% in the third quarter and 9.4% for the first nine months. Nine-month operating cash flow was $1.661 billion, compared with $1.431 billion in 2018. Capital expenditures were $224.8 million and acquisitions used $72.6 million.
At September 30, 2019, cash and cash equivalents were $189.6 million. Total debt was approximately $8.908 billion, consisting of $435.7 million of short-term borrowings, $429.6 million of current long-term debt and $8.043 billion of long-term debt. Remaining short-term borrowing capacity was $3.094 billion, including $1.694 billion of unused global credit agreement capacity. The company was in compliance with its 3.75-to-1.00 leverage covenant.
Material Changes Versus Prior Comparable Period
- Third-quarter sales increased 2.9%; nine-month sales increased 2.3%.
- The Americas Group was the primary sales contributor, increasing 8.7% in the quarter and 5.9% year to date. Consumer Brands sales declined 11.9% in the quarter and 3.0% year to date, while Performance Coatings sales declined 0.3% and 1.4%, respectively.
- Gross margin expanded by 320 basis points in the quarter and 200 basis points year to date, reflecting higher North American volume, pricing, moderating raw-material costs and supply-chain efficiencies, partly offset by currency effects.
- Third-quarter income before taxes increased 70.7% and nine-month income before taxes increased 33.9%. SG&A rose 5.7% in the quarter and 3.3% year to date, with SG&A as a percentage of sales increasing to 27.6% and 28.4%, respectively.
- The company adopted ASC 842 leases in 2019, recognizing approximately $1.7 billion of operating lease right-of-use assets and $1.7 billion of related liabilities. The adoption had no material effect on operating results, cash flows or debt covenants.
- The company acquired a domestic packaging company and a European coatings company for an aggregate preliminary purchase price of $79.7 million.
Outlook, Commentary, Risks and Unusual Items
- Management described financial condition, liquidity and cash flow as strong and stated that available cash and borrowing capacity were sufficient for current operating needs. The filing does not provide specific sales or EPS guidance.
- Management cited higher North American paint volume and pricing as favorable factors, while noting softness in certain non-U.S. end markets and unfavorable foreign-currency translation. Currency translation reduced third-quarter sales by 0.9% and nine-month sales by 1.5%.
- The company issued $800.0 million of 2.95% senior notes due 2029 and $550.0 million of 3.80% senior notes due 2049, while repurchasing $1.010 billion of 2.25% notes due 2020 and $490.0 million of 2.75% notes due 2022. Debt extinguishment losses were $14.8 million.
- The California lead-paint litigation was resolved for total payments by the three defendants of $305.0 million. Sherwin-Williams’ estimated share was approximately $101.7 million, with a $25.0 million initial payment made in September. The remaining accrual was $76.7 million at September 30.
- Environmental liabilities totaled approximately $372.8 million, including $321.8 million in long-term liabilities and $51.0 million in current accruals. The company disclosed an additional unaccrued maximum of approximately $116.4 million for currently estimable environmental matters.
- Nine-month results included a $74.3 million tax provision related to the reversal of expected tax benefits from DC Solar investments, a $32.4 million pension settlement expense and acquisition-related costs. The company also faces continuing lead-paint litigation, including Pennsylvania proceedings and Wisconsin personal-injury claims.
- Other risks include raw-material and energy costs, foreign exchange, interest rates, customer and supplier relationships, acquisition integration, increasingly stringent environmental regulation, adverse weather and litigation outcomes.
Investor Verification Items
- Verify the sustainability of the 2019 gross-margin expansion and the contribution of pricing versus volume.
- Review the Consumer Brands and Performance Coatings sales declines, foreign-market softness and currency impacts.
- Assess leverage, near-term debt maturities, refinancing needs and compliance with the leverage covenant.
- Track the remaining California litigation payments, Pennsylvania and Wisconsin lead-paint proceedings, and potential environmental costs.
- Evaluate the effects of the DC Solar tax matter, including the $197.2 million unrecognized tax-benefit balance at September 30, 2019.
- Reconcile reported earnings with acquisition-related costs, litigation adjustments, pension settlement expense and other unusual items.