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SHW > SEC Filings for SHW > Form 10-Q on 30-Oct-2013All Recent SEC Filings

Show all filings for SHERWIN WILLIAMS CO

Form 10-Q for SHERWIN WILLIAMS CO


30-Oct-2013

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
SUMMARY
The Sherwin-Williams Company, founded in 1866, and its consolidated wholly owned subsidiaries (collectively, the "Company") are engaged in the development, manufacture, distribution and sale of paint, coatings and related products to professional, industrial, commercial and retail customers primarily in North and South America with additional operations in the Caribbean region, Europe and Asia. The Company is structured into four reportable segments-Paint Stores Group, Consumer Group, Global Finishes Group and Latin America Coatings Group (collectively, the "Reportable Segments")-and an Administrative segment in the same way it is internally organized for assessing performance and making decisions regarding allocation of resources. See pages 6 through 15 and Note 18, on pages 74 through 76, in the Company's Annual Report on Form 10-K for the year ended December 31, 2012 for more information concerning the Reportable Segments. The Company's financial condition, liquidity and cash flow continued to be strong in the third quarter of 2013 primarily due to improved operating results in our Paint Stores, Consumer, and Global Finishes Groups. Net working capital increased $1.047 billion at September 30, 2013 compared to the end of the third quarter of 2012 due to an increase in cash and cash equivalents and a decrease in short-term borrowings, which was primarily due to the $700.0 million of 1.35% Senior Notes due 2017 and $300.0 million of 4.00% Senior Notes due 2042 issued on December 4, 2012. The Company has been able to arrange sufficient short-term borrowing capacity at reasonable rates, and the Company has sufficient total available borrowing capacity to fund its current operating needs. Net operating cash improved $208.6 million in the first nine months of 2013 to a cash source of $777.9 million from a cash source of $569.3 million in 2012 primarily due to an increase in net income of $73.5 million, improved working capital management, and a payment to the IRS for the 2011 ESOP settlement of $59.1 million in the first quarter of 2012 partially offset by a payment to the ESOP for the 2012 DOL settlement of $80.0 million in the first quarter of 2013.
Consolidated net sales increased 9.4 percent in the third quarter of 2013 to $2.847 billion from $2.603 billion in the third quarter of 2012, and increased 5.7 percent in the first nine months of 2013 to $7.728 billion from $7.313 billion in the first nine months of 2012 due primarily to higher paint sales volume in our Paint Stores Group. Consolidated gross profit as a percent of consolidated net sales increased in the third quarter to 45.5 percent from 44.2 percent in 2012 and increased to 45.2 percent from 43.9 percent in the first nine months due primarily to increased paint volume, improved operating efficiency and selling price increases. Selling, general and administrative expenses (SG&A) increased as a percent of consolidated net sales to 31.2 percent from 30.7 percent in the third quarter of 2012 and was flat at 32.4 percent in the first nine months primarily due to timing of net new store openings in the quarter and acquisitions. Interest expense increased $5.0 million in the third quarter and $14.8 million in the first nine months of 2013 due to increased long-term debt balances. The effective income tax rate for the third quarter of 2013 was 32.1 percent compared to 31.5 percent in 2012, and the rate for the first nine months of 2013 was 32.1 percent compared to 30.8 percent in 2012. Diluted net income per common share increased to $2.55 per share for the third quarter of 2013, including a 2013 charge of $.13 per share resulting from government tax assessments related to our Brazilian operations, from $2.24 per share a year ago and increased to $6.11 per share, including 2013 charges of $.21 per share related to the Brazil tax assessments, from $5.37 per share in the first nine months of 2012.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation and fair presentation of the consolidated unaudited interim financial statements and accompanying notes included in this report are the responsibility of management. The financial statements and footnotes have been prepared in accordance with U.S. generally accepted accounting principles for interim financial statements and contain certain amounts that were based upon management's best estimates, judgments and assumptions that were believed to be reasonable under the circumstances. Management considered the impact of the uncertain economic environment and utilized certain outside sources of economic information when developing the basis for their estimates and assumptions. The impact of the global economic conditions on the estimates and assumptions used by management was believed to be reasonable under the circumstances. Management used assumptions based on historical results, considering the current economic trends, and other assumptions to form the basis for determining appropriate carrying values of assets and liabilities that were not readily available from other sources. Actual results could differ from those estimates. Also, materially different amounts may result under materially different conditions, materially different economic trends or from using materially different assumptions. However, management believes that any materially different amounts resulting from materially different conditions or material changes in facts or circumstances are unlikely to significantly impact the current valuation of assets and liabilities that were not readily available from other sources. A comprehensive discussion of the Company's critical accounting policies and management estimates and significant accounting policies followed in the preparation of the financial statements is included in Management's Discussion and Analysis of Financial Condition and Results of Operations and in Note 1, on pages 48 through 51, in the Company's Annual


Report on Form 10-K for the year ended December 31, 2012. There have been no significant changes in critical accounting policies, management estimates or accounting policies followed since the year ended December 31, 2012.
FINANCIAL CONDITION, LIQUIDITY AND CASH FLOW
Overview
The Company's financial condition, liquidity and cash flow continued to be strong through the first nine months of 2013 primarily due to improving domestic architectural paint demand and improved operating results in our Paint Stores, Consumer and Global Finishes Groups. Net working capital increased $1.047 billion at September 30, 2013 compared to the end of the third quarter of 2012 due to an increase in cash and cash equivalents and a decrease in short-term borrowings. Cash and cash equivalents increased $980.5 million, accounts receivable increased $85.5 million, inventories increased $53.9 million and all other current assets increased $41.3 million. Short-term borrowings decreased $34.9 million while accounts payable increased $86.1 million and all other current liabilities increased $63.0 million from September 30, 2012. Net working capital increases were impacted primarily by cash proceeds of long-term debt acquired during the fourth quarter of 2012, acquisitions, increased sales and decreased short-term borrowing needs. The Company continues to maintain sufficient short-term borrowing capacity at reasonable rates and the Company has sufficient cash on hand and total available borrowing capacity to fund its current operating needs. In the first nine months of 2013, accounts receivable increased $316.1 million when normal seasonal trends typically require significant growth in this category along with increases in inventories of $97.3 million, primarily from acquisitions partially offset by lower core business inventories. Accounts payable increased $198.0 million, primarily due to the seasonal increase in need for working capital along with increases from acquisitions, while short-term borrowings increased $226.2 million and all other current liabilities increased $105.6 million, primarily due to timing of accrued taxes and other accrued expense payments partially offset by a payment to the ESOP for the 2012 DOL settlement of $80.0 million. The Company's current ratio was 1.57 at September 30, 2013 compared to 1.14 at September 30, 2012 and 1.68 at December 31, 2012. Total debt at September 30, 2013 increased $960.2 million to $1.930 billion from $969.4 million at September 30, 2012 and increased as a percentage of total capitalization to 50.8 percent from 35.3 percent at the end of the third quarter last year. Total debt increased $224.8 million from December 31, 2012 and increased as a percentage of total capitalization from 48.8 percent. At September 30, 2013, the Company had remaining borrowing ability of $2.083 billion. Net operating cash improved $208.6 million in the first nine months of 2013 to a cash source of $777.9 million from a cash source of $569.3 million in 2012. In the twelve month period from October 1, 2012 through September 30, 2013, the Company generated net operating cash of $1.097 billion, including a payment to the ESOP for the 2012 DOL settlement of $80.0 million in the first quarter of 2013, used $421.3 million in investing activities, and generated $308.7 million in financing activities. In that same period, the Company invested $162.6 million in capital additions and improvements, invested $145.1 million in acquisitions, had net proceeds from total debt of $954.0 million, purchased $616.7 million in treasury stock and paid $194.7 million in cash dividends to its shareholders of common stock.
Net Working Capital, Debt and Other Long-Term Assets and Liabilities Cash and cash equivalents increased $173.1 million during the first nine months of 2013. Cash and cash equivalents on hand funded cash requirements for increased sales and normal seasonal increases in working capital, capital expenditures of $108.5 million, payments of cash dividends of $154.4 million, treasury stock purchases of $492.0 million, acquisitions of businesses of $92.8 million and net payments made on long-term debt of $1.1 million. At September 30, 2013, the Company's current ratio was 1.57 compared to 1.68 at December 31, 2012 and 1.14 a year ago. The increase from a year ago was primarily due to a significant increase in cash and cash equivalents resulting from proceeds received from issuance of long-term debt during the fourth quarter of 2012 and a decrease in short-term borrowings.
Goodwill and intangible assets decreased $20.9 million from December 31, 2012 and increased $42.8 million from September 30, 2012. The net decrease during the first nine months of 2013 was due primarily to amortization of $21.5 million. The net increase over the twelve month period from September 30, 2012 resulted from acquisitions of $63.7 million, capitalization of software of $3.2 million and foreign currency translation of $8.4 million partially offset by amortization of $28.4 million and impairments of $4.1 million. See Note 4, on pages 52 to 53, in the Company's Annual Report on Form 10-K for the year ended December 31, 2012 for more information concerning goodwill and intangible assets.
Deferred pension assets increased $2.3 million during the first nine months of 2013 and increased $17.2 million from September 30, 2012. The increase in the last twelve months was due primarily to increases in the fair market value of equity securities held by the Company's defined benefit pension plans. See Note 6, on pages 56 to 62, in the Company's Annual Report on Form 10-K for the year ended December 31, 2012 for more information concerning the Company's benefit plan assets.
Other assets at September 30, 2013 increased $38.9 million in the first nine months of 2013, due primarily to increased investments in affordable housing and historic renovation real estate properties along with increases in various other


investments, and increased $7.6 million from a year ago due primarily to increases in investments in affordable housing and historic renovation real estate properties.
Net property, plant and equipment increased $45.0 million in the first nine months of 2013 and increased $67.3 million in the twelve months since September 30, 2012. The increase in the first nine months was primarily due capital expenditures of $108.5 million and acquisitions of $58.1 million partially offset by depreciation expense of $117.7 million, sale or disposition of fixed assets of $2.3 million and changes in currency translation rates of $1.5 million. Since September 30, 2012, capital expenditures of $162.6 million, acquisitions of $60.2 million and changes in currency translation rates of $5.9 million were partially offset by depreciation expense of $156.6 million and dispositions or sale of assets with remaining net book value of $4.8 million. Capital expenditures during the first nine months of 2013 primarily represented expenditures associated with improvements and normal equipment replacement in manufacturing and distribution facilities in the Consumer Group and normal equipment replacement in the Paint Stores and Global Finishes Groups. Short-term borrowings related to the Company's domestic commercial paper program outstanding were $200.0 million at an average rate of .32 percent at September 30, 2013. There were no borrowings under certain other short-term revolving and letter of credit agreements at September 30, 2013. Short-term borrowings outstanding under various foreign programs at September 30, 2013 were $95.3 million with a weighted average interest rate of 6.4 percent. The Company had unused capacity of $850.0 million at September 30, 2013 under the commercial paper program that is backed by the Company's revolving credit agreement. On March 18, 2013, Sherwin-Williams Canada, Inc., a wholly owned subsidiary of the Company, increased the aggregate amount of its existing credit facility to CAD 150.0 million. The credit facility is being used for general corporate purposes, including refinancing indebtedness and for acquisitions. There were no significant changes in long-term debt during the third quarter of 2013. See Note 7, on pages 62 through 63, in the Company's Annual Report on Form 10-K for the year ended December 31, 2012 for more information concerning the Company's debt. Long-term liabilities for postretirement benefits other than pensions did not change significantly from December 31, 2012 and increased $20.8 million from September 30, 2012. The increase in the liability was due to the increase in the actuarially determined postretirement benefit obligation resulting from changes in actuarial assumptions and unfavorable claims experience. See Note 6, on pages 56 to 62, in the Company's Annual Report on Form 10-K for the year ended December 31, 2012 for more information concerning the Company's benefit plan obligations.
Other long-term liabilities at September 30, 2013 increased $79.3 million in the first nine months of 2013 and increased $74.4 million from a year ago primarily due to acquisitions' pension liabilities. Environmental-Related Liabilities
The operations of the Company, like those of other companies in the same industry, are subject to various federal, state and local environmental laws and regulations. These laws and regulations not only govern current operations and products, but also impose potential liability on the Company for past operations. Management expects environmental laws and regulations to impose increasingly stringent requirements upon the Company and the industry in the future. Management believes that the Company conducts its operations in compliance with applicable environmental laws and regulations and has implemented various programs designed to protect the environment and promote continued compliance.
Depreciation of capital expenditures and other expenses related to ongoing environmental compliance measures were included in the normal operating expenses of conducting business. The Company's capital expenditures, depreciation and other expenses related to ongoing environmental compliance measures were not material to the Company's financial condition, liquidity, cash flow or results of operations during the first nine months of 2013. Management does not expect that such capital expenditures, depreciation and other expenses will be material to the Company's financial condition, liquidity, cash flow or results of operations in 2013.
The Company is involved with environmental investigation and remediation activities at some of its currently and formerly owned sites (including sites which were previously owned and/or operated by businesses acquired by the Company). In addition, the Company, together with other parties, has been designated a potentially responsible party under federal and state environmental protection laws for the investigation and remediation of environmental contamination and hazardous waste at a number of third party sites, primarily Superfund sites. The Company may be similarly designated with respect to additional third party sites in the future.
The Company accrues for estimated costs of investigation and remediation activities at its currently and formerly owned sites and third party sites for which commitments or clean-up plans have been developed and when such costs can be reasonably estimated based on industry standards and professional judgment. These estimated costs are based on currently available facts regarding each site. The Company accrues a specific estimated amount when such an amount and a time frame in which the costs will be incurred can be reasonably determined. If the best estimate of costs can only be identified as a range and no


specific amount within that range can be determined more likely than any other amount within the range, the minimum of the range is accrued by the Company in accordance with applicable accounting rules and interpretations. The Company continuously assesses its potential liability for investigation and remediation activities and adjusts its environmental-related accruals as information becomes available upon which more accurate costs can be reasonably estimated. At September 30, 2013 and 2012, the Company had accruals for environmental-related activities of $111.9 million and $123.6 million, respectively.
Due to the uncertainties of the scope and magnitude of contamination and the degree of investigation and remediation activities that may be necessary at certain currently or formerly owned sites and third party sites, it is reasonably likely that further extensive investigations may be required and that extensive remedial actions may be necessary not only on such sites but on adjacent properties. Depending on the extent of the additional investigations and remedial actions necessary, the Company's ultimate liability may result in costs that are significantly higher than currently accrued. If the Company's future loss contingency is ultimately determined to be at the maximum of the range of possible outcomes for every site for which costs can be reasonably estimated, the Company's aggregate accruals for environmental-related activities would be $81.9 million higher than the accruals at September 30, 2013. Two of the Company's currently and formerly owned sites accounted for the majority of the accruals for environmental-related activities and the unaccrued maximum of the estimated range of possible outcomes at September 30, 2013. At September 30, 2013, $58.2 million, or 52.0 percent, related directly to these two sites. Of the aggregate unaccrued exposure at September 30, 2013, $56.9 million, or 69.4 percent, related to the two sites. While environmental investigations and remedial actions are in different stages at these sites, additional investigations, remedial actions and/or monitoring will likely be required at each site. A comprehensive description of the two currently and formerly owned sites that account for the majority of the accruals for environmental-related activities is included in Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the year ended December 31, 2012. There have been no significant changes in the investigative or remedial status of the two sites since December 31, 2012.
Management cannot presently estimate the ultimate potential loss contingencies related to these two sites or other less significant sites until such time as a substantial portion of the investigative activities at each site is completed and remedial action plans are developed.
In accordance with the Asset Retirement Obligations Topic of the ASC, the Company has identified certain conditional asset retirement obligations at various current manufacturing, distribution and store facilities. These obligations relate primarily to asbestos abatement and closures of hazardous waste containment devices. Using investigative, remediation and disposal methods that are currently available to the Company, the estimated cost of these obligations is not significant.

In the event any future loss contingency significantly exceeds the current amount accrued, the recording of the ultimate liability may result in a material impact on net income for the annual or interim period during which the additional costs are accrued. Management does not believe that any potential liability ultimately attributed to the Company for its environmental-related matters or conditional asset retirement obligations will have a material adverse effect on the Company's financial condition, liquidity, or cash flow due to the extended period of time during which environmental investigation and remediation takes place. An estimate of the potential impact on the Company's operations cannot be made due to the aforementioned uncertainties.
Management expects these contingent environmental-related liabilities and conditional asset retirement obligations to be resolved over an extended period of time. Management is unable to provide a more specific time frame due to the indefinite amount of time to conduct investigation activities at any site, the indefinite amount of time to obtain governmental agency approval, as necessary, with respect to investigation and remediation activities, and the indefinite amount of time necessary to conduct remediation activities. Contractual Obligations, Commercial Commitments and Warranties Short-term borrowings increased $226.2 million to $295.3 million at September 30, 2013 from $69.0 million at December 31, 2012. Total long-term debt decreased $1.5 million to $1.634 billion at September 30, 2013 from $1.636 billion at December 31, 2012 and increased $995.1 million from $639.3 million at September 30, 2012. See the Financial Condition, Liquidity and Cash Flow section of this report for more information. There have been no other significant changes to the Company's contractual obligations and commercial commitments in the third quarter or the first nine months of 2013 as summarized in Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the year ended December 31, 2012. Changes to the Company's accrual for product warranty claims in the first nine months of 2013 are disclosed in Note 5.


Contingent Liabilities
Life Shield Engineered Systems, LLC (Life Shield), a wholly-owned subsidiary of the Company, ceased operations in 2012. Life Shield developed and manufactured blast and fragment mitigating systems. The blast and fragment mitigating systems create a potentially higher level of product liability for the Company (as an owner of and supplier to Life Shield) than is normally associated with coatings and related products currently manufactured, distributed and sold by the Company.
Certain of Life Shield's technology has been designated as Qualified Anti-Terrorism Technology and granted a Designation under the Support Anti-Terrorism by Fostering Effective Technologies Act of 2002 (SAFETY Act) and the regulations adopted pursuant to the SAFETY Act. Under the SAFETY Act, the potentially higher level of possible product liability for Life Shield relating to the technology granted the Designation is limited to $6.0 million per occurrence in the event any such liability arises from an Act of Terrorism (as defined in the SAFETY Act). The limitation of liability provided for under the SAFETY Act does not apply to any technology not granted a designation or certification as a Qualified Anti-Terrorism Technology, nor in the event that any such liability arises from an act or event other than an Act of Terrorism. Life Shield maintains insurance for liabilities up to the $6.0 million per occurrence limitation caused by failure of its products in the event of an Act of Terrorism.

Management of the Company has reviewed the potential increased liabilities associated with Life Shield's systems and determined that potential liabilities arising from an Act of Terrorism that could ultimately affect the Company will be appropriately insured or limited by current regulations. However, due to the uncertainties involved in the future development, usage and application of Life Shield's systems, the number or nature of possible future claims and legal proceedings, or the effect that any change in legislation and/or administrative regulations may have on the limitations of potential liabilities, management cannot reasonably determine the scope or amount of any potential costs and liabilities for the Company related to Life Shield or to Life Shield's systems. Any potential liability for the Company that may result from Life Shield or Life Shield's systems cannot reasonably be estimated. However, based upon, among other things, the limitation of liability under the SAFETY Act in the event of an Act of Terrorism, management does not currently believe that the costs or potential liability ultimately determined to be attributable to the Company through its ownership of Life Shield, or as a supplier to Life Shield arising from the use of Life Shield's systems will have a material adverse effect on the Company's results of operations, liquidity or financial conditions. Litigation
In the course of its business, the Company is subject to a variety of claims and lawsuits, including, but not limited to, litigation relating to product liability and warranty, personal injury, environmental, intellectual property, commercial, contractual and antitrust claims that are inherently subject to many uncertainties regarding the possibility of a loss to the Company. These uncertainties will ultimately be resolved when one or more future events occur or fail to occur confirming the incurrence of a liability or the reduction of a liability. In accordance with the Contingencies Topic of the ASC, the Company accrues for these contingencies by a charge to income when it is both probable that one or more future events will occur confirming the fact of a loss and the amount of the loss can be reasonably estimated. In the event that the Company's loss contingency is ultimately determined to be significantly higher than currently accrued, the recording of the additional liability may result in a material impact on the Company's results of operations, liquidity or financial condition for the annual or interim period during which such additional liability is accrued. In those cases where no accrual is recorded because it is not probable that a liability has been incurred and the amount of any such loss cannot be reasonably estimated, any potential liability ultimately determined to be attributable to the Company may result in a material impact on the Company's results of operations, liquidity or financial condition for the annual or interim period during which such liability is accrued. In those cases where no accrual is recorded or exposure to loss exists in excess of the amount accrued, the Contingencies Topic of the ASC requires disclosure of the contingency when there is a reasonable possibility that a loss or additional loss may have been incurred.
Lead pigment and lead-based paint litigation. The Company's past operations included the manufacture and sale of lead pigments and lead-based paints. The Company, along with other companies, is and has been a defendant in a number of legal proceedings, including individual personal injury actions, purported class actions, and actions brought by various counties, cities, school districts and . . .

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