Why did Sherwin-Williams' reported 2000 earnings collapse, and what was the underlying trend?

In Q4 2000, the company took a $352.0 million pre-tax ($293.6 million after-tax, or $1.80 per diluted share) impairment charge, mainly on goodwill in the Consumer Segment tied to the Thompson Minwax and Pratt & Lambert acquisitions. Reported 2000 net income was $16.0 million, or $0.10 per diluted share. Excluding the charge, 2000 net income was $309.7 million, or $1.90 per share. Against that base, 2001 net income of $263.2 million ($1.68 per share) was down about 15%. The impairment was non-cash and did not affect 2000 cash flow.

Is the dividend safe, and how has it been managed?

The dividend has grown for 22 consecutive years through 2001, with a compounded annual growth rate of 23.5% since its reinstatement in late 1979. The 2001 annual dividend was $0.58 per share, about 34.6% of prior-year adjusted earnings and above the company's stated 30% payout target. In February 2002 the board raised the quarterly dividend to $0.15 from $0.145, the 23rd consecutive first-quarter increase. Dividends paid in 2001 totaled $91.0 million, against operating cash flow of $561.6 million and free cash flow of $388.1 million, which suggests good coverage.

What are the most significant legal and environmental risks?

The most prominent risk is lead pigment and lead-based paint litigation. The company is a defendant in purported class actions, actions by the State of Rhode Island, and suits by counties, cities and school districts. Management says the litigation is without merit, expects more suits, and cannot predict the outcome or estimate costs, so it has accrued nothing. On environmental matters, the company carries about $111.0 million in long-term environmental accruals and says its southeast Chicago and PMC facilities could require costs significantly above current accruals, which could be material to a period's net income.

What is the outlook for 2002?

Management expects 2002 market conditions to be flat to slightly up from 2001, with domestic pockets of strength offset by continued weakness in foreign currencies and the broader economy. The company plans to open about 50 net new paint stores. It expects minimal volume improvement in International Coatings, given the Argentine devaluation. Consumer Segment sales will be affected by the disposition of the Cleaning Solutions Group and by a large retail customer's pending bankruptcy. Non-amortization of goodwill under SFAS 142 is expected to add about $24.7 million to 2002 net income, but the company has not yet determined whether 2002 impairment tests will produce a charge.

How did the company use its free cash flow in 2001?

Free cash flow of $388.1 million went largely to balance-sheet strengthening and shareholder returns. The company retired $123.1 million of total debt, including $10.0 million of early-redeemed 9.875% debentures and repayment of a $100 million 6.5% note at maturity in February 2002. It repurchased 6.7 million shares for $157.1 million, paid $91.0 million in dividends, and spent $15.2 million on acquisitions, including Mautz Paint's 33 stores. It also invested $82.6 million in capital expenditures and ended the year with $118.8 million in cash, up from $2.9 million.

SHW 10-K FY2001 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 14, 2002. Cited figures are marked; the original filing is the authoritative source.

The Sherwin-Williams Company (SHW) reported a difficult 2001 in which net sales fell 2.8% to $5.07 billion^a from $5.21 billion, and diluted EPS was $1.68, down from $1.90 before the prior year's impairment charge (reported 2000 EPS was $0.10 after a $293.6 million after-tax, $1.80/share impairment of long-lived assets, mostly Consumer Segment goodwill).

Management attributed the decline to a weak U.S. and South American economy, discontinued paint programs at certain Consumer Segment customers, and currency weakness. Segment results were mixed: Paint Stores, the largest segment at 63% of external sales, grew sales 0.7% to $3.21 billion^b but saw operating profit fall 5.1% to $390.5 million; Consumer sales dropped 9.0% and operating profit fell 24.1%; Automotive Finishes sales declined 5.9%; and International Coatings sales fell 8.9%, with operating profit down to $4.9 million. The strongest point for investors was cash generation.

Net operating cash flow was $561.6 million^c, and free cash flow (defined by the company as operating cash less capex and dividends) rose to a record $388.1 million. Management reduced receivables and inventory by a combined $133.6 million, cut SG&A for the first time in 20 years, and used the cash to retire $123.1 million of debt, buy back 6.7 million shares for $157.1 million, and acquire Mautz Paint's 33 stores. Total debt to capitalization improved to 29.3% from 33.5%.

The company also raised its first-quarter dividend for a 23rd consecutive year, to $0.15^d per quarter from $0.145. Key risks include pending lead pigment and lead-based paint litigation, for which the company has accrued no amounts and says it cannot reasonably estimate exposure; environmental liabilities, including a potentially material exposure at its southeast Chicago and PMC facilities; the bankruptcy of a large Consumer Segment retail customer; a planned Argentine currency devaluation; and a 2002 SFAS 142 goodwill impairment test whose outcome management has not yet determined. Management guides to 2002 market conditions that are flat to slightly up, with 'pockets of strength' domestically.

02—Key points

Key Highlights

Net sales fell 2.8% to $5.07 billion in 2001, and diluted EPS was $1.68 versus $1.90 before the prior year's impairment charge; reported 2000 EPS was $0.10.
Record free cash flow of $388.1 million, up from $242.4 million in 2000, driven by a $133.6 million combined reduction in receivables and inventory.
Paint Stores Segment (63% of external sales) grew sales 0.7% to $3.21 billion, but operating profit fell 5.1% to $390.5 million; Consumer Segment operating profit dropped 24.1% to $108.2 million.
Balance sheet strengthened: total debt to capitalization fell to 29.3% from 33.5%, and $123.1 million of debt was retired.
Repurchased 6.7 million shares for $157.1 million and raised the quarterly dividend to $0.15 (annual $0.58 in 2001), extending a 23-year streak of dividend increases.
Lead pigment and lead-based paint litigation is ongoing; the company has accrued no amounts and says it cannot reasonably estimate potential liability.
Environmental exposure at the southeast Chicago and PMC facilities may exceed current accruals and could be material to a given period's net income.

03—Questions

Frequently Asked Questions

Why did Sherwin-Williams' reported 2000 earnings collapse, and what was the underlying trend?
In Q4 2000, the company took a $352.0 million pre-tax ($293.6 million after-tax, or $1.80 per diluted share) impairment charge, mainly on goodwill in the Consumer Segment tied to the Thompson Minwax and Pratt & Lambert acquisitions. Reported 2000 net income was $16.0 million, or $0.10 per diluted share. Excluding the charge, 2000 net income was $309.7 million, or $1.90 per share. Against that base, 2001 net income of $263.2 million ($1.68 per share) was down about 15%. The impairment was non-cash and did not affect 2000 cash flow.
Is the dividend safe, and how has it been managed?
The dividend has grown for 22 consecutive years through 2001, with a compounded annual growth rate of 23.5% since its reinstatement in late 1979. The 2001 annual dividend was $0.58 per share, about 34.6% of prior-year adjusted earnings and above the company's stated 30% payout target. In February 2002 the board raised the quarterly dividend to $0.15 from $0.145, the 23rd consecutive first-quarter increase. Dividends paid in 2001 totaled $91.0 million, against operating cash flow of $561.6 million and free cash flow of $388.1 million, which suggests good coverage.
What are the most significant legal and environmental risks?
The most prominent risk is lead pigment and lead-based paint litigation. The company is a defendant in purported class actions, actions by the State of Rhode Island, and suits by counties, cities and school districts. Management says the litigation is without merit, expects more suits, and cannot predict the outcome or estimate costs, so it has accrued nothing. On environmental matters, the company carries about $111.0 million in long-term environmental accruals and says its southeast Chicago and PMC facilities could require costs significantly above current accruals, which could be material to a period's net income.
What is the outlook for 2002?
Management expects 2002 market conditions to be flat to slightly up from 2001, with domestic pockets of strength offset by continued weakness in foreign currencies and the broader economy. The company plans to open about 50 net new paint stores. It expects minimal volume improvement in International Coatings, given the Argentine devaluation. Consumer Segment sales will be affected by the disposition of the Cleaning Solutions Group and by a large retail customer's pending bankruptcy. Non-amortization of goodwill under SFAS 142 is expected to add about $24.7 million to 2002 net income, but the company has not yet determined whether 2002 impairment tests will produce a charge.
How did the company use its free cash flow in 2001?
Free cash flow of $388.1 million went largely to balance-sheet strengthening and shareholder returns. The company retired $123.1 million of total debt, including $10.0 million of early-redeemed 9.875% debentures and repayment of a $100 million 6.5% note at maturity in February 2002. It repurchased 6.7 million shares for $157.1 million, paid $91.0 million in dividends, and spent $15.2 million on acquisitions, including Mautz Paint's 33 stores. It also invested $82.6 million in capital expenditures and ended the year with $118.8 million in cash, up from $2.9 million.

04—Continue

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