Business Context and Reporting Period
The Sherwin-Williams Company develops, manufactures, distributes and sells paints, coatings and related products through its Paint Stores, Consumer and Global Finishes segments. This unaudited Form 10-Q covers the three and six months ended June 30, 2010, compared with the same periods in 2009.
Financial Performance and Position
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net sales | $2.143 billion | $1.948 billion | $3.709 billion | $3.499 billion |
| Gross profit | $971.9 million | $895.3 million | $1.664 billion | $1.576 billion |
| Gross margin | 45.4% | 46.0% | 44.9% | 45.0% |
| Income before taxes | $259.2 million | $232.1 million | $318.7 million | $283.0 million |
| Net income | $181.7 million | $158.0 million | $214.3 million | $195.3 million |
| Diluted EPS | $1.64 | $1.35 | $1.94 | $1.66 |
| Operating cash flow | Not separately provided | Not separately provided | $236.5 million | $266.4 million |
- Q2 sales increased 10.0% and six-month sales increased 6.0%. Segment Q2 sales growth was 6.4% for Paint Stores, 11.9% for Consumer and 18.8% for Global Finishes.
- Q2 net income increased 15.0% and six-month net income increased 9.7%. Diluted EPS benefited from lower average diluted shares following treasury-stock repurchases.
- EBITDA, as defined by management, was $325.2 million in Q2 and $436.0 million for the six months, compared with $285.8 million and $391.0 million, respectively, in 2009.
- SG&A declined to 32.3% of sales in Q2 from 33.5% and to 35.2% for the six months from 36.1%, reflecting expense control, partially offset by higher sales, acquisitions and foreign-currency effects.
- Cash and cash equivalents were $48.4 million at June 30, 2010. Total debt was $908.6 million, consisting principally of $199.5 million of short-term borrowings, $9.3 million of current long-term debt and $699.8 million of long-term debt.
- The current ratio was 1.17, compared with 1.04 at June 30, 2009 and 1.27 at December 31, 2009. Remaining borrowing capacity was $1.112 billion.
- Six-month investing cash outflows included $47.5 million of capital expenditures, $49.1 million for acquisitions and $59.0 million for other investments. Financing outflows included $175.5 million of treasury-stock purchases and $78.8 million of dividends.
Material Changes Versus the Prior Comparable Period
- Improved domestic architectural demand, global market conditions, acquisitions and favorable foreign-currency translation drove sales growth.
- Rising raw-material costs and uncertain supply reduced consolidated gross margin by 60 basis points in Q2 and 10 basis points for the six-month period despite pricing actions and cost savings.
- Interest expense increased by $16.0 million in Q2 and $15.4 million for the six months, primarily because of costs associated with repurchasing the Company’s 7.45% debentures.
- A one-time $11.4 million tax charge related to 2010 healthcare legislation increased the six-month effective tax rate to 32.8% from 31.0% and reduced six-month basic and diluted EPS by $0.11 and $0.10, respectively.
- The Company acquired Sayerlack Industrial Coatings effective April 1, 2010, for $53.8 million, strengthening the Global Finishes platform.
- During Q2, the Company repurchased $84.9 million principal amount of its 7.45% debentures and purchased 1.95 million shares for $149.7 million; it had authorization for an additional 8.4 million share repurchases at June 30.
- Total debt increased $107.9 million year over year, while operating cash flow declined $29.9 million because of seasonal working-capital needs and higher environmental and exit-related cash costs.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide a specific numerical earnings or revenue outlook. Management reported improving domestic and global demand but cautioned that economic conditions remained uncertain and that raw-material prices and supply were pressuring margins.
- Environmental-related accruals totaled $157.5 million at June 30, 2010. Potential exposure could be $100.5 million above the recorded accrual if outcomes reached the high end of estimated ranges.
- The Company faces unresolved lead-pigment and lead-based-paint litigation. No amounts were accrued because potential liability could not reasonably be estimated; a significant adverse outcome could materially affect results, liquidity or financial condition.
- The EPA notified the Company of alleged hazardous-waste violations at its Baltimore facility and indicated that it may seek a compliance order and civil penalty. The outcome was not predictable.
- Other risks include commodity and foreign-currency volatility, acquisition integration, economic conditions, regulatory changes, product liability, pension and postretirement obligations, and litigation.
- The Company was in compliance with its 3.00-to-1.00 leverage covenant at June 30, 2010. New euro and Canadian-dollar credit facilities were entered into on July 19, 2010 for general corporate purposes, refinancing and acquisitions.
- Seven Paint Stores Group stores and four Global Finishes Group branches were closed during the first six months of 2010. Remaining qualified exit-cost liabilities were $23.3 million at June 30.
Important Facts for Investors to Verify
- Whether raw-material inflation and supply constraints continue to erode gross margins despite pricing actions.
- The sustainability of sales growth, particularly the contribution from acquisitions and foreign-currency translation.
- Seasonal working-capital requirements, short-term borrowings and compliance with the leverage covenant.
- The ultimate cost and timing of environmental remediation and the Baltimore EPA matter.
- Potential exposure from lead-paint litigation, related insurance coverage proceedings and other product-liability claims.
- The integration and performance of Sayerlack and the effect of future acquisitions on leverage and cash flow.
- The impact of share repurchases, lower share count and the stated quarterly dividend policy on future EPS and shareholder returns.