Business Context and Reporting Period
The Sherwin-Williams Company manufactures, distributes and sells paints, coatings and related products through The Americas Group, Consumer Brands Group and Performance Coatings Group. This Form 10-Q covers the three months ended March 31, 2019, compared with the three months ended March 31, 2018. Results are unaudited and interim results are not necessarily indicative of the full year.
Key Financial Metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $4.041 billion | $3.965 billion | +1.9% |
| Gross profit | $1.735 billion | $1.687 billion | +2.9% |
| Gross margin | 42.9% | 42.5% | +0.4 percentage points |
| Income before taxes | $298.9 million | $303.6 million | -1.6% |
| Net income | $245.2 million | $250.1 million | -2.0% |
| Diluted EPS | $2.62 | $2.62 | Flat |
| EBITDA | $533.3 million | $551.8 million | -3.3% |
| Net operating cash flow | $(36.0) million | $40.7 million | Declined $76.7 million |
SG&A increased to 30.8% of sales from 30.6%. The effective tax rate was 17.9%, compared with 17.6%. Cash and equivalents were $94.4 million at March 31, 2019, versus $155.5 million at December 31, 2018 and $158.6 million at March 31, 2018.
Total debt was $9.831 billion at March 31, 2019, including $824.8 million of short-term borrowings, $303.9 million of current long-term debt and $8.703 billion of long-term debt. Remaining short-term borrowing ability was $2.732 billion, including $1.232 billion of unused capacity under the global credit agreement. The company was in compliance with its 4.75-to-1.00 leverage covenant.
Investing cash usage was $72.2 million, including $51.4 million of capital expenditures. Financing cash provided $51.4 million, primarily because short-term borrowings increased by $496.2 million; this was partly offset by $305.1 million of treasury stock purchases and $104.8 million of dividends. The company generated $1.867 billion of operating cash during the twelve months ended March 31, 2019.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven by a new customer program, higher North American paint volume and price increases, partly offset by weaker non-U.S. demand and unfavorable currency translation, which reduced sales by 2.3%.
- The Americas Group sales increased 3.6%, while Consumer Brands Group sales decreased 0.3% and Performance Coatings Group sales increased 0.2%.
- Segment profit increased 18.5% in Consumer Brands and 8.7% in Performance Coatings, but declined 1.9% in The Americas Group.
- Gross margin improved because of price increases and reduced purchase-accounting effects, partly offset by higher raw-material costs and currency effects.
- Net income and pretax income declined despite higher sales, principally because of a $32.4 million domestic pension-plan settlement charge and higher administrative expenses. Q1 2019 diluted EPS included approximately $0.71 of acquisition-related costs and $0.27 of pension settlement expense.
- Operating cash flow turned negative primarily because of seasonal working-capital requirements. Accounts receivable increased $320.8 million and inventories increased $178.2 million during the quarter.
- The company adopted ASC 842 lease accounting, recognizing approximately $1.7 billion of operating lease right-of-use assets, $356.5 million of current lease liabilities and $1.371 billion of long-term lease liabilities at March 31, 2019. The adoption reduced opening retained earnings by $8.4 million but did not materially affect operations, cash flows or debt covenants.
- The company repurchased 750,000 shares for $305.1 million and had authorization remaining for 9.375 million shares at March 31, 2019.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide specific quantitative full-year sales or earnings guidance. Management stated that liquidity and borrowing capacity remained sufficient to fund current operating needs. Management expects environmental compliance expenditures to remain immaterial to 2019 financial condition, liquidity, cash flow and results of operations.
- Raw-material costs, commodity prices, interest rates, foreign currency movements, tariffs, weather, economic conditions and soft foreign-market demand may affect results.
- Environmental liabilities included $319.0 million of extended-activity accruals and $51.0 million of current investigation and remediation accruals. The unaccrued maximum of the estimated environmental loss range exceeded the recorded minimum by $116.4 million; ultimate costs remain uncertain.
- The California lead-paint public-nuisance litigation had a $401.1 million abatement fund after an $8.0 million setoff. Sherwin-Williams had accrued $136.3 million, but joint and several liability could expose it to the full fund amount. Payment timing and final responsibility remain uncertain.
- Other lead-pigment and lead-paint litigation remains unaccrued because management does not consider losses probable or reasonably estimable, but a significant adverse outcome could materially affect earnings, liquidity or financial condition.
- The domestic pension-plan settlement and acquisition-related costs were significant unusual items in Q1 2019. The company also continues to evaluate legacy operations and restructuring related to the Valspar acquisition.
Investor Verification Checklist
- Verify the sustainability of sales growth after the 2018 customer program benefit and the extent to which price increases offset raw-material inflation.
- Review segment trends, especially the decline in The Americas Group profit and continuing weakness in non-U.S. markets.
- Assess working-capital seasonality, negative first-quarter operating cash flow and reliance on short-term borrowings.
- Reconcile total debt, lease liabilities, covenant compliance and available borrowing capacity.
- Monitor the California abatement litigation, related insurance coverage proceedings and potential exposure beyond the $136.3 million accrual.
- Evaluate environmental accruals and the $116.4 million unaccrued maximum estimated range, recognizing that ultimate costs are uncertain.
- Adjust earnings analysis for acquisition-related costs, the $32.4 million pension settlement charge and currency effects.
- Confirm the effect of ASC 842 lease adoption on leverage, liquidity presentation and future lease obligations.