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SHW > SEC Filings for SHW > Form 10-Q on 23-Apr-2014All Recent SEC Filings

Show all filings for SHERWIN WILLIAMS CO

Form 10-Q for SHERWIN WILLIAMS CO


23-Apr-2014

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 73 through 75, in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 for more information concerning the Reportable Segments. The Company's financial condition, liquidity and cash flow continued to be strong through the first three months of 2014 primarily due to improved operating results in our Paint Stores and Global Finishes Groups. Net working capital decreased $789.3 million at March 31, 2014 compared to the end of the first quarter of 2013 due to a significant increase in current liabilities and a decrease in current assets. Current portion of long-term debt increased $498.8 million resulting from the 3.125% Senior Notes becoming due in 2014 while cash and cash equivalents decreased $247.5 million resulting primarily from treasury stock purchases. 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 $8.0 million in the first three months of 2014 to a cash usage of $83.1 million from a cash usage of $91.1 million in 2013 primarily due to improved working capital management in the core business partially offset by impact on working capital from acquisitions.
Consolidated net sales increased 9.2 percent in the first quarter of 2014 to $2.367 billion from $2.167 billion in the first quarter of 2013 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 first quarter to 45.0 percent from 44.4 percent in 2013 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 37.4 percent from 35.9 percent in the first quarter of 2013 primarily due to timing of net new store openings in the quarter and acquisitions. Interest expense increased $1.1 million in the first quarter of 2014. The effective income tax rate for the first quarter of 2014 was 30.5 percent compared to 31.0 percent in 2013. Diluted net income per common share increased to $1.14 per share, including a $.12 per share loss from acquisitions, for the first quarter of 2014 from $1.11 per share a year ago.
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, 2013. There have been no significant changes in critical accounting policies, management estimates or accounting policies followed since the year ended December 31, 2013.


FINANCIAL CONDITION, LIQUIDITY AND CASH FLOW
Overview
The Company's financial condition, liquidity and cash flow continued to be strong through the first three months of 2014 primarily due to improved operating results in our Paint Stores and Global Finishes Groups. Net working capital decreased $789.3 million at March 31, 2014 compared to the end of the first quarter of 2013 due to a significant increase in current liabilities and a decrease in current assets. Cash and cash equivalents decreased $247.5 million primarily due to treasury stock purchases, accounts receivable increased $43.2 million, inventories increased $83.1 million and all other current assets increased $1.9 million. Short-term borrowings increased $19.1 million, while accounts payable increased $107.1 million, current portion of long-term debt increased $498.8 million resulting from the 3.125% Senior Notes becoming due in 2014, and all other current liabilities increased $45.1 million from March 31, 2013. Net working capital decreases were partially offset by net increases from acquisitions. 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 three months of 2014, accounts receivable increased $76.4 million when normal seasonal trends typically require significant growth in this category, and inventories increased $126.0 million primarily from acquisitions partially offset by lower core business inventories. Accounts payable increased $131.9 million primarily due to the seasonal increase in need for working capital along with increases from acquisitions, while short-term borrowings decreased $9.2 million and all other current liabilities decreased $198.6 million primarily due to timing of accrued taxes and other accrued expense payments. The Company's current ratio was 1.21 at March 31, 2014 compared to 1.73 at March 31, 2013 and 1.25 at December 31, 2013. Total debt at March 31, 2014 increased $8.1 million to $1.712 billion from $1.704 billion at March 31, 2013 and increased as a percentage of total capitalization to 50.9 percent from 48.4 percent at the end of the first quarter last year. Total debt decreased $9.9 million from December 31, 2013 and increased as a percentage of total capitalization from 49.2 percent. At March 31, 2014, the Company had remaining borrowing ability of $2.275 billion. Net operating cash improved $8.0 million in the first three months of 2014 to a cash usage of $83.1 million from a cash usage of $91.1 million in 2013. In the twelve month period from April 1, 2013 through March 31, 2014, the Company generated net operating cash of $1.092 billion, used $335.4 million in investing activities, and used $1.000 billion in financing activities. In that same period, the Company invested $164.8 million in capital additions and improvements, invested $79.9 million in acquisitions, had net proceeds from total debt of $11.2 million, purchased $944.2 million in treasury stock and paid $208.3 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 decreased $378.4 million during the first three months of 2014. Cash and cash equivalents on hand funded cash requirements for increased sales and normal seasonal increases in working capital, capital expenditures of $29.4 million, payments of cash dividends of $55.1 million, treasury stock purchases of $256.4 million and net payments made on long-term debt of $0.7 million. At March 31, 2014, the Company's current ratio was 1.21 compared to 1.25 at December 31, 2013 and 1.73 a year ago. The decrease resulted from the increase in current portion of long-term debt and decrease in cash and cash equivalents.
Goodwill and intangible assets decreased $4.9 million from December 31, 2013 and decreased $8.5 million from March 31, 2013. The net decrease during the first three months of 2014 was due primarily to amortization of $7.6 million. The net decrease over the twelve month period from March 31, 2013 resulted from amortization of $28.9 million partially offset by capitalization of software of $14.8 million and acquisitions of $5.6 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, 2013 for more information concerning goodwill and intangible assets.
Deferred pension assets increased $0.6 million during the first three months of 2014 and increased $52.7 million from March 31, 2013. 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 through 61, in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 for more information concerning the Company's benefit plan assets.
Other assets at March 31, 2014 increased $19.3 million in the first three months of 2014 and increased $48.7 million from a year ago. Both increases were due primarily to increased investments in affordable housing and historic renovation real estate properties along with increases in various other investments. Net property, plant and equipment decreased $17.0 million in the first three months of 2014 and increased $49.5 million in the twelve months since March 31, 2013. The decrease in the first three months was primarily due to depreciation expense of $41.4 million and changes in currency translation rates of $8.2 million partially offset by capital expenditures of $29.4 million, acquisitions of $2.7 million and sale or disposition of fixed assets of $0.5 million. Since March 31, 2013, capital expenditures


of $164.8 million and acquisitions of $56.2 million were partially offset by depreciation expense of $161.3 million, changes in currency translation rates of $6.9 million and dispositions or sale of assets with remaining net book value of $3.3 million. Capital expenditures during the first three months of 2014 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.
There were no borrowings under the Company's domestic commercial paper program outstanding nor certain other short-term revolving and letter of credit agreements at March 31, 2014. Short-term borrowings outstanding under various foreign programs at March 31, 2014 were $87.4 million with a weighted average interest rate of 7.9 percent. The Company had unused capacity of $1.050 billion at March 31, 2014 under the commercial paper program that is backed by the Company's revolving credit agreement. There were no significant changes in long-term debt during the first quarter of 2014. See Note 7, on pages 61 to 62, in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 for more information concerning the Company's debt.
Long-term liabilities for postretirement benefits other than pensions did not change significantly from December 31, 2013 and decreased $49.7 million from March 31, 2013. The decrease in the liability was due to the decrease in the actuarially determined postretirement benefit obligation resulting from changes in actuarial assumptions and favorable claims experience. See Note 6, on pages 56 to 61, in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 for more information concerning the Company's benefit plan obligations.
Other long-term liabilities at March 31, 2014 increased $2.5 million in the first three months of 2014 and increased $72.4 million from a year ago primarily due to an increase in non-current deferred tax 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 three months of 2014. 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 2014.
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 March 31, 2014 and 2013, the Company had accruals for environmental-related activities of $98.7 million and $110.6 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 $86.6 million higher than the accruals at March 31, 2014.
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 March 31, 2014. At March 31, 2014, $56.2 million, or 57.0 percent, related directly to these two sites. Of the aggregate unaccrued exposure at March 31, 2014, $59.3 million, or 68.5 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, 2013. There have been no significant changes in the investigative or remedial status of the two sites since December 31, 2013. 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 decreased $9.2 million to $87.4 million at March 31, 2014 from $96.6 million at December 31, 2013. Total long-term debt decreased $0.7 million to $1.625 billion at March 31, 2014 from $1.625 billion at December 31, 2013 and decreased $11.0 million from $1.636 billion at March 31, 2013. 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 first quarter of 2014 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, 2013.
Changes to the Company's accrual for product warranty claims in the first three months of 2014 are disclosed in Note 5.
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 other government-related entities, arising from the manufacture and sale of lead pigments and lead-based paints. The plaintiffs' claims have been based upon various legal theories, including negligence, strict liability, breach of warranty, negligent misrepresentations and omissions, fraudulent misrepresentations and omissions, concert of action, civil conspiracy, violations of unfair trade practice and consumer protection laws, enterprise liability, market share liability, public nuisance, unjust enrichment and other theories. The plaintiffs seek various damages and relief, including personal injury and property damage, costs relating to the detection and abatement of lead-based paint from buildings, costs associated with a public education campaign, medical monitoring costs and others. The Company has also been a defendant in legal proceedings arising from the manufacture and sale of non-lead-based paints that seek recovery based upon various legal theories, including the failure to adequately warn of potential exposure to lead during surface preparation when using non-lead-based paint on surfaces previously painted with lead-based paint. The Company believes that the litigation brought to date is without merit or subject to meritorious defenses and is vigorously defending such litigation. The Company has not settled any lead pigment or lead-based paint litigation. The Company expects that additional lead pigment and lead-based paint litigation may be filed against the Company in the future asserting similar or different legal theories and seeking similar or different types of damages and relief.
Notwithstanding the Company's views on the merits, litigation is inherently subject to many uncertainties, and the Company ultimately may not prevail. Adverse court rulings or determinations of liability, among other factors, could affect the lead pigment and lead-based paint litigation against the Company and encourage an increase in the number and nature of future claims and proceedings. In addition, from time to time, various legislation and administrative regulations have been enacted, promulgated or proposed to impose obligations on present and former manufacturers of lead pigments and lead-based paints respecting asserted health concerns associated with such products or to overturn the effect of court decisions in which the Company and other manufacturers have been successful.
Due to the uncertainties involved, management is unable to predict the outcome of the lead pigment and lead-based paint litigation, the number or nature of possible future claims and proceedings or the effect that any legislation and/or administrative regulations may have on the litigation or against the Company. In addition, management cannot reasonably determine the scope or amount of the potential costs and liabilities related to such litigation, or resulting from any such legislation and regulations. The Company has not accrued any amounts for such litigation. With respect to such litigation, including the public nuisance litigation, the Company does not believe that it is probable that a loss has occurred, and it is not possible to estimate the range of potential losses as there is no prior history of a loss of this nature and there is no substantive information upon which an estimate could be based. In addition, any potential liability that may result from any changes to legislation and regulations cannot reasonably be estimated. In the event any significant liability is determined to be attributable to the Company relating to such litigation, the recording of the liability may result in a material impact on net income for the annual or interim period during which such liability is accrued. Additionally, due to the uncertainties associated with the amount of any such liability and/or the nature of any other remedy which may be imposed in such litigation, any potential liability determined to be attributable to the Company arising out of such litigation may have a material adverse effect on the Company's results of operations, liquidity or financial condition. An estimate of the potential impact on the Company's results of operations, liquidity or financial condition cannot be made due to the aforementioned uncertainties. Public nuisance claim litigation. The Company and other companies are or were defendants in legal proceedings seeking recovery based on public nuisance liability theories, among other theories, brought by the State of Rhode Island, the City of St. Louis, Missouri, various cities and counties in the State of New Jersey, various cities in the State of Ohio and the State of Ohio, the City of Chicago, Illinois, the City of Milwaukee, Wisconsin and the County of Santa . . .

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