The Sherwin-Williams Company: 2017 Q2 Form 10-Q Summary
Business context and reporting period
The filing covers the three and six months ended June 30, 2017. Sherwin-Williams develops, manufactures, distributes and sells paints, coatings and related products through The Americas Group, Consumer Brands Group and Performance Coatings Group. The company completed its acquisition of Valspar on June 1, 2017, making the quarter the first reporting period including Valspar operations.
Key financial metrics
| Metric | Three months ended June 30, 2017 | Three months ended June 30, 2016 | Six months ended June 30, 2017 | Six months ended June 30, 2016 |
|---|---|---|---|---|
| Net sales | $3.736 billion | $3.220 billion | $6.497 billion | $5.794 billion |
| Gross profit | $1.737 billion | $1.636 billion | $3.080 billion | $2.898 billion |
| Gross margin | 46.5% | 50.8% | 47.4% | 50.0% |
| Income from continuing operations | $360.7 million | $378.1 million | $599.8 million | $542.9 million |
| Net income | $319.1 million | $378.1 million | $558.3 million | $542.9 million |
| Diluted EPS | $3.36 | $3.99 | $5.90 | $5.76 |
| Net operating cash flow | Not presented for the quarter | Not presented for the quarter | $586.1 million | $510.0 million |
Second-quarter sales increased 16.0%, while six-month sales increased 12.1%. Continuing-operations income before taxes declined 5.6% in the quarter to $509.0 million but increased 7.9% for the six months to $815.6 million. EBITDA from continuing operations was $645.0 million in the quarter and $1.028 billion for the six months.
- Cash and cash equivalents were $210.0 million at June 30, 2017, compared with $889.8 million at December 31, 2016.
- Total debt was approximately $11.5 billion, equal to 82.8% of total capitalization, compared with $1.97 billion and 61.3% at June 30, 2016.
- Current assets were $4.854 billion and current liabilities were $4.152 billion, producing a current ratio of 1.17.
- The company had $1.820 billion of remaining short-term borrowing ability and no borrowings under its $500 million general-purpose credit agreement.
- Capital expenditures were $83.6 million for the first six months, and cash dividends paid were $158.9 million.
Material changes versus the prior comparable period
- Valspar contributed $381.0 million of sales and $46.6 million of pretax profit during June 2017.
- The Valspar acquisition had a total purchase price of $8.9 billion, net of $431.0 million of divestiture proceeds. The company recognized approximately $6.1 billion of goodwill and $5.8 billion of intangible assets in preliminary purchase accounting.
- Gross margin declined primarily because of Valspar purchase-accounting adjustments, including $36.3 million of inventory step-up amortization, higher raw-material costs and a change in revenue classification.
- Amortization expense increased by approximately $23 million in both the quarter and six months because of acquisition-related intangible assets.
- Interest expense increased by $15.9 million in the quarter and $15.8 million for the six months because of acquisition-related debt.
- Acquisition-related costs, inventory step-up amortization and increased intangible amortization reduced diluted EPS by approximately $0.72 in the quarter and $0.80 for the six months.
- The Americas Group sales increased 8.7% in the quarter and 10.2% for the six months; Performance Coatings sales increased 48.0% and 26.9%, respectively. Consumer Brands sales increased 16.0% in the quarter and 4.0% for the six months, but segment profit declined 26.3% and 19.0%.
Outlook, risks, contingencies and unusual items
- Management stated that liquidity and cash flow remained strong and that available cash and borrowing capacity were sufficient for current operating needs. The filing does not provide a specific earnings or sales guidance target.
- The company issued $6.0 billion of new senior notes, exchanged approximately $1.478 billion of Valspar senior notes and borrowed $2.0 billion under a five-year term loan to finance the acquisition.
- The company was in compliance with its 5.25-to-1.00 consolidated leverage covenant at June 30, 2017. Debt agreements include default and cross-default provisions that could accelerate borrowings upon default.
- Environmental accruals totaled approximately $190.6 million, including $160.2 million in other long-term liabilities and $30.4 million in other accruals. The unaccrued maximum of the estimated range of possible environmental outcomes exceeded the minimum accrued amount by $86.1 million.
- The company had not accrued amounts for lead-pigment and lead-based-paint litigation. A California public-nuisance judgment held the company jointly and severally liable for $1.15 billion; the judgment was stayed pending appeal, with oral argument scheduled for August 24, 2017. Management stated that a loss was not considered probable and that the potential loss could not be estimated.
- Product-warranty accruals increased to $144.6 million at June 30, 2017, including $110.5 million acquired from Valspar.
- Management identified acquisition integration, realization of expected synergies, elevated leverage, interest rates, raw-material costs, foreign exchange, economic conditions, environmental obligations and litigation as significant risks.
- Internal control assessments did not include Valspar because it was acquired during the period. Valspar represented $381.0 million of second-quarter sales and approximately $14.2 billion of assets at June 30, 2017.
Important facts for investors to verify
- Final purchase-price accounting for Valspar, including goodwill, intangible assets, deferred taxes and amortization periods, remained subject to measurement-period adjustments.
- The pace and cost of integrating Valspar and the extent to which projected revenue growth and cost synergies are realized.
- Debt-service capacity, refinancing requirements and compliance with leverage and other debt covenants following the acquisition.
- The effect of acquisition-related amortization, inventory step-up charges and integration costs on reported margins and EPS.
- Developments in the California lead-paint appeal, other lead-related litigation and environmental remediation liabilities.
- The potential balance-sheet impact of the pending lease-accounting standard and future changes to revenue-recognition accounting.