The Sherwin-Williams Company — Form 10-Q Summary
Business context and reporting period
The filing covers the three months ended March 31, 2018. Sherwin-Williams develops, manufactures, distributes and sells paints, coatings and related products through The Americas Group, Consumer Brands Group and Performance Coatings Group. Results include the Valspar acquisition completed June 1, 2017, making year-over-year comparisons not fully comparable.
Key financial metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $3.965 billion | $2.761 billion | 43.6% increase |
| Gross profit | $1.687 billion | $1.343 billion | 25.6% increase |
| Gross margin | 42.5% | 48.6% | Down 610 basis points |
| SG&A as a percentage of sales | 30.6% | 36.6% | Down 600 basis points |
| Income before taxes | $303.6 million | $306.6 million | 1.0% decrease |
| Net income | $250.1 million | $239.2 million | 4.6% increase |
| Diluted EPS | $2.62 | $2.53 | 3.6% increase |
| Net operating cash flow | $40.7 million | $231.8 million | Decrease of $191.1 million |
Net margin was approximately 6.3% in Q1 2018 versus 8.7% in Q1 2017. EBITDA, as defined by management, was $551.8 million versus $383.1 million; the filing cautions that EBITDA is a non-GAAP measure and is not a substitute for net income or operating cash flow.
- Cash and cash equivalents were $158.6 million at March 31, 2018, compared with $204.2 million at December 31, 2017 and $1.018 billion at March 31, 2017.
- Total debt was $10.812 billion, or 74.6% of total capitalization, versus $1.954 billion and 48.6% a year earlier. Long-term debt was $9.891 billion and short-term borrowings were $920.0 million.
- The current ratio was 1.13. Remaining short-term borrowing ability was $1.715 billion, and the company stated that available liquidity was sufficient for current operating needs.
- Q1 investing cash usage was $40.6 million, including $42.3 million of capital expenditures. Financing cash usage was $27.4 million, including $81.0 million of dividends and $241.1 million of treasury-stock purchases, partially offset by increased short-term borrowings.
- Accounts receivable were $2.326 billion and inventories were $2.002 billion at March 31, 2018.
Material changes versus the prior comparable period
- Valspar contributed $1.067 billion of sales and $80.7 million of pretax profit in Q1 2018. The acquisition was the principal driver of consolidated sales growth and substantially increased goodwill, intangible assets and debt.
- Gross margin declined primarily because of higher raw-material costs and unfavorable product mix. SG&A leverage improved because of realized administrative synergies from Valspar.
- Amortization increased by $78.9 million to $85.0 million, primarily from acquired intangible assets. Interest expense increased by $65.9 million to $91.5 million due primarily to acquisition-related debt.
- Q1 2018 included $194.0 million of acquisition-related expenses, including purchase-accounting impacts and increased amortization. Management stated that these items reduced diluted EPS by approximately $0.95; Q1 2017 acquisition-related costs reduced diluted EPS by approximately $0.08.
- The effective tax rate decreased to 17.6% from 22.0%, primarily due to the Tax Cuts and Jobs Act. The company had recorded a provisional $607.9 million tax benefit at December 31, 2017 and reported no significant change to that balance during Q1.
- The company repurchased 600,000 shares for $241.1 million and increased its quarterly dividend to $0.86 per share. Remaining repurchase authorization was 11.05 million shares.
- The company adopted ASC 606, which reclassified $13.4 million of advertising support from SG&A to a reduction of sales in Q1 2018 without affecting net income.
Guidance, outlook, risks and unusual items
The filing does not provide a specific quantitative earnings or sales outlook. Management stated that operating liquidity remained sufficient and identified higher raw-material costs, acquisition integration, expected synergies, foreign-exchange movements, commodity prices and competitive pressures as important factors affecting future results.
- The company was in compliance with its consolidated leverage covenant, which limits the leverage ratio to 5.25 to 1.00. Debt agreements include default and cross-default provisions that could accelerate borrowings.
- The Santa Clara County lead-paint litigation resulted in a judgment requiring a $1.15 billion abatement fund, although an appellate decision limited the case to pre-1951 residences and required recalculation of the fund. The company intends to seek U.S. Supreme Court review, has accrued no amount for the litigation, and cannot reasonably estimate its potential loss. Joint and several liability could expose the company to the full fund.
- Environmental accruals included approximately $177.8 million of extended liabilities and $27.0 million for current investigation and remediation activities. The unaccrued maximum of estimated outcomes was $98.5 million above the minimum estimate.
- Ten Americas Group stores and two Performance Coatings Group branches were closed during the quarter as part of demand and post-acquisition restructuring actions.
- The company expects the new lease standard, effective in 2019, to have a material balance-sheet impact, principally from recognizing lease assets and liabilities for retail operations in The Americas Group.
- Valspar was not yet included in management's assessment of internal control over financial reporting; inclusion is planned for December 31, 2018. Disclosure controls and procedures were deemed effective as of March 31, 2018.
Investor verification checklist
- Verify the sustainability of Valspar revenue, margins, cost synergies and integration benefits once acquisition-related charges decline.
- Assess leverage, refinancing needs, interest-rate exposure and compliance with the 5.25-to-1.00 leverage covenant.
- Monitor raw-material inflation and the company’s ability to recover costs through pricing without further margin erosion.
- Review operating cash conversion, working-capital requirements and the effect of inventory and receivables growth on liquidity.
- Track the Santa Clara lead-paint litigation, environmental matters and any resulting accruals or cash obligations.
- Reconcile reported EPS with acquisition-related costs, purchase-accounting amortization and the lower tax rate.
- Evaluate the balance-sheet impact of the 2019 lease accounting adoption and the company’s future internal-control assessment of Valspar.