SHERWIN WILLIAMS CO quarterly report, Q2 FY2009

The Sherwin-Williams Company — 2009 Q2 Form 10-Q Summary

Business context and reporting period

The filing covers the three and six months ended June 30, 2009. Sherwin-Williams develops, manufactures, distributes and sells paints, coatings and related products through its Paint Stores, Consumer and Global Finishes operating segments, with additional administrative activities. Results were affected by the prolonged U.S. housing downturn, weaker global demand, reduced manufacturing volumes, tight credit markets and foreign-currency volatility.

Financial performance and condition

Metric	Three months ended June 30	Six months ended June 30
Net sales	$1.948 billion, down 12.6%	$3.499 billion, down 12.8%
Gross profit	$895.3 million; 46.0% margin	$1.576 billion; 45.0% margin
Income before taxes	$232.1 million, down 9.4%	$283.0 million, down 23.4%
Net income	$158.0 million, down 7.9%	$195.3 million, down 21.8%
Diluted EPS	$1.35, versus $1.45	$1.66, versus $2.07
Net operating cash flow	Not separately provided	$266.4 million, versus $262.8 million

Second-quarter net margin was approximately 8.1%, compared with approximately 7.7% in the prior-year quarter. Six-month net margin was approximately 5.6%, compared with approximately 6.2% in 2008.
Gross margin improved because of prior price increases, cost controls, favorable product mix, and lower freight and distribution costs, although lower volumes and site-closing costs reduced gross profit dollars.
SG&A declined $24.0 million in the quarter and $66.8 million year to date, but increased as a percentage of sales to 33.5% and 36.1%, respectively, because of lower revenue.
Cash and cash equivalents were $49.3 million at June 30, 2009, compared with $26.2 million at December 31, 2008.
Current assets were $1.978 billion and current liabilities were $1.904 billion, producing a current ratio of 1.04, compared with 0.92 at June 30, 2008 and 0.99 at December 31, 2008.
Total debt was approximately $800.7 million, down $438.8 million from June 30, 2008, and represented 31.6% of total capitalization versus 42.7% a year earlier. Remaining borrowing capacity was approximately $1.64 billion.
Six-month investing cash outflow was $91.9 million, including $40.9 million of capital expenditures and $14.1 million for acquisitions. Financing cash outflow was $158.9 million, including $83.2 million of dividends, $49.4 million of treasury-stock purchases and $19.6 million of long-term debt reduction.

Material changes versus the prior comparable period

Paint Stores Group sales declined 13.7% in the quarter and 13.3% year to date; comparable-store sales declined 13.5% and 13.1%, respectively. Paint volumes were down in the high-teens.
Consumer Group sales declined 4.5% in the quarter and 2.4% year to date, while second-quarter segment profit increased 12%; six-month segment profit declined 5%.
Global Finishes Group sales declined 16.2% in the quarter and 18.8% year to date. Segment profit declined 35% and 60%, respectively, reflecting lower volumes, unfavorable currency translation and higher manufacturing and distribution costs.
Foreign-subsidiary sales declined 14.6% in the quarter and 17.6% year to date; currency translation reduced those sales by 18.1% and 19.7%, respectively.
Interest expense declined $7.8 million in the quarter and $13.2 million year to date because of lower borrowings and rates.
The company closed 24 Paint Stores Group stores, three Consumer Group manufacturing facilities, and one Global Finishes manufacturing facility plus 13 branches during the first six months. It recorded $5.2 million of provisions for current closures and $4.5 million of adjustments to prior exit provisions.
Goodwill and intangible assets included a $23.9 million impairment charge in the 2008 comparative period; no comparable 2009 impairment charge was recorded in the income statement.
The company acquired Altax in Poland for $11.8 million, net of cash acquired, during the first quarter of 2009.

Outlook, commentary, risks and contingencies

Management described demand as remaining depressed and continued to expect challenging global economic conditions, but reported that liquidity and cash flow remained strong. The filing does not provide a clear quantitative sales or earnings guidance range. Management emphasized cost control, working-capital management, price increases, acquisitions and productivity initiatives.

Key operating risks include continued recessionary conditions, weak housing and construction markets, pricing pressure, raw-material and energy costs, customer and supplier changes, foreign-currency movements, acquisition integration and foreign-market exposure.
Environmental accruals totaled $176.3 million at June 30, 2009. The unaccrued maximum of estimated environmental outcomes exceeded the recorded minimum accrual by $112.7 million. Management could not estimate the ultimate exposure or timing, although it did not expect a material adverse effect on financial condition, liquidity or cash flow because remediation is expected to occur over an extended period.
The company was involved in ongoing lead-pigment and lead-based-paint litigation and had not accrued amounts for these matters because potential liabilities could not reasonably be estimated. A significant adverse outcome could materially affect results, liquidity or financial condition.
Product liability, warranty, environmental, commercial and other litigation exposures remain subject to significant uncertainty. The California Santa Clara proceeding remained stayed pending appellate review; several other public-nuisance matters had been dismissed or resolved favorably.
The company was in compliance with its consolidated leverage covenant at June 30, 2009. Borrowings included cross-default provisions that could accelerate debt upon specified defaults.
Management stated that foreign-currency and commodity hedging exposures were not expected to have a material adverse effect, although continuing market risk remained.
Disclosure controls and procedures were concluded to be effective, with no reported material change in internal control over financial reporting.

Important facts for investors to verify

Whether weak paint volumes and housing-related demand continued to pressure sales after June 30, 2009.
Whether gross-margin gains from pricing and cost controls could be sustained despite lower volumes, site closures and manufacturing underutilization.
The remaining environmental exposure, including the $112.7 million unaccrued range above recorded accruals.
The status and potential financial impact of lead-paint litigation and related insurance-coverage proceedings, for which no liability was accrued.
Debt reduction, available borrowing capacity and compliance with leverage covenants under continued economic stress.
The effect of currency movements and the performance and integration of recent acquisitions, including Altax.
Future share repurchases and dividends; 18.75 million shares remained authorized for repurchase at June 30, 2009.