Sherwin-Williams Company: Q2 2012 Form 10-Q Summary
Business context and reporting period
The Sherwin-Williams Company develops, manufactures, distributes and sells paints, coatings and related products to professional, industrial, commercial and retail customers, primarily in North and South America. The filing covers the three and six months ended June 30, 2012, compared with the same periods in 2011. Reportable segments are Paint Stores, Consumer, Global Finishes and Latin America Coatings.
Financial performance and key metrics
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $2.573 billion | $2.355 billion | $4.709 billion | $4.210 billion |
| Net income | $227.8 million | $179.1 million | $328.0 million | $247.4 million |
| Diluted EPS | $2.17 | $1.66 | $3.13 | $2.29 |
| Gross margin | 44.7% | 43.4% | 43.8% | 43.2% |
| SG&A as a percentage of sales | 31.5% | 32.1% | 33.3% | 34.4% |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $202.1 million | $108.2 million |
- Q2 sales increased 9.3%; six-month sales increased 11.9%. Management attributed growth primarily to higher paint volume and selling-price increases.
- Q2 net income increased 27.2% and six-month net income increased 32.6%. Diluted EPS increased 30.7% in Q2 and 36.7% for the six months, supported by higher earnings and fewer average shares outstanding.
- Gross profit increased $127.8 million in Q2 and $240.3 million for the six months. Margin expansion reflected pricing and volume benefits, partially offset by higher raw-material costs.
- Q2 EBITDA, as defined by management, was $382.0 million versus $313.0 million; six-month EBITDA was $579.2 million versus $462.1 million. EBITDA is a non-GAAP measure and should not be viewed as a substitute for net income or operating cash flow.
- Cash and cash equivalents were $46.6 million at June 30, 2012, versus $32.7 million at December 31, 2011 and $71.6 million at June 30, 2011.
- Total debt was approximately $1.245 billion, representing 44.7% of total capitalization, compared with approximately $1.225 billion and 41.2% a year earlier. Short-term borrowings were $605.0 million, including $543.9 million of domestic commercial paper.
- Remaining borrowing ability was $1.643 billion. The current ratio was 1.04, compared with 1.10 a year earlier and 1.05 at December 31, 2011. Management stated that liquidity and borrowing capacity were sufficient for current operating needs.
- Six-month investing cash usage was $90.1 million, including $70.0 million of capital expenditures and $44.0 million for acquisitions. Financing cash usage was $95.9 million, including $362.6 million of treasury-stock purchases and $80.4 million of dividends, partially funded by $260.2 million of increased short-term borrowings.
Material changes versus the prior comparable period
- Paint Stores Group sales increased 14.6% in Q2 and 17.2% for the six months; income before taxes increased 29.2% and 37.8%, respectively.
- Consumer Group sales increased 5.9% in Q2 and 7.1% for the six months, while income before taxes increased 31.6% and 32.8%.
- Global Finishes Group sales increased 3.3% in Q2 and 6.9% for the six months, while income before taxes increased 58.8% and 54.3%. Acquisitions contributed to sales growth, while unfavorable currency translation reduced reported sales.
- Latin America Coatings Group sales declined 4.5% in Q2 and increased only 1.2% for the six months. Income before taxes declined 41.3% in Q2 and 12.1% for the six months, primarily because of unfavorable currency translation and higher raw-material costs.
- Domestic architectural paint demand improved. Comparable-store sales in the Paint Stores Group increased 13.9% in Q2 and 16.6% for the six months; paint volume increased by high-single-digit percentages in both periods.
- SG&A increased in dollars because of higher sales, new stores, incentive compensation and information-system costs, but declined as a percentage of sales due to operating leverage and expense control.
- The company acquired Geocel Corporation effective June 1, 2012, strengthening its sealants and adhesives business. Leighs Paints, acquired in 2011, expanded the Global Finishes platform.
- The company repurchased approximately 3.30 million shares during the first six months and had authorization to repurchase 17.75 million additional shares at June 30, 2012. The board subsequently increased the quarterly dividend from $0.365 to $0.39 per common share.
Outlook, risks, contingencies and unusual items
- The filing does not provide a specific full-year earnings or sales guidance range. Management indicated that results for the six months are not necessarily indicative of the full year.
- Key operating risks include economic conditions, construction and retail demand, pricing pressure, raw-material and energy costs, foreign currency fluctuations, acquisition integration, competition, weather and increasingly stringent environmental regulations.
- Environmental-related accruals were $126.8 million at June 30, 2012. The estimated unaccrued maximum of the possible outcomes exceeded the recorded accrual by $97.7 million; management stated that the ultimate liability cannot presently be estimated.
- The company faces ongoing lead-pigment and lead-based-paint litigation and has not accrued amounts for these matters. Management believes the claims lack merit or are subject to strong defenses, but a significant adverse determination could materially affect results, liquidity or financial condition.
- The Department of Labor investigation into leveraged ESOP transactions remained open. The DOL notified the company and certain directors and the ESOP trustee of potential fiduciary-breach claims seeking compensatory and equitable remedies. No amounts were accrued.
- The company was in compliance with its leverage covenants at June 30, 2012. Certain debt agreements contain default and cross-default provisions that could accelerate borrowings upon a default.
- Five Paint Stores Group stores, two Global Finishes branches, one Global Finishes facility and four Latin America Coatings stores were closed during the first six months due to lower demand or redundancy. The remaining qualified exit-cost liability was $10.1 million at June 30, 2012.
- The effective tax rate was 30.5% in Q2 and 30.2% for the six months, modestly above the respective 2011 rates. Reductions in unrecognized tax benefits were primarily related to expiration of statutes for 2006 and 2007 federal tax years.
Most important facts for investors to verify
- Whether domestic architectural demand and high-single-digit paint-volume growth continued after June 30, 2012.
- Whether pricing actions continued to offset raw-material inflation without weakening demand or margins.
- The sustainability of cash generation given seasonal working-capital needs, increased short-term borrowing and substantial share repurchases.
- Post-quarter-end debt balances, covenant headroom and actual utilization of the company’s available credit facilities.
- The integration and earnings contribution of Geocel, Leighs Paints and other recent acquisitions.
- Developments in the Santa Clara County lead-paint litigation, other lead-related claims and the DOL leveraged-ESOP investigation, none of which had recorded accruals at the filing date.
- The ultimate environmental remediation costs, which could exceed recorded accruals by the disclosed $97.7 million maximum exposure estimate.
- Whether the increased quarterly dividend and remaining share-repurchase authorization remain consistent with liquidity and leverage objectives.