The Sherwin-Williams Company
Annual Report 2018

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The Sherwin-Williams Company was founded by Henry Sherwin and Edward Williams in 1866. Today, we are a global leader in the manufacture, development, distribution and sale of paint, coatings and related products to professional, industrial, commercial and retail customers. Sherwin-Williams®, Valspar®, Dutch Boy®, HGTV HOME™ by Sherwin- T he Company manufactures products under well-known brands such as branded products are sold primarily through more than 5,100 company-operated more. With global headquarters in Cleveland, Ohio, Sherwin-Williams® Williams, Krylon®, Minwax®, Cabot®, Thompson’s® Water Seal® and many stores and facilities, while the Company’s other brands are sold through leading mass merchandisers, home centers, independent paint dealers, hardware stores, automotive retailers and industrial distributors. For more information, visit www.sherwin-williams.com. The Company is comprised of three reportable segments, which together provide our customers with innovative solutions to ensure their success, no matter where they work, or what surfaces they are coating. • The Americas Group operates the exclusive outlets for Sherwin-Williams® branded paints, stains, supplies, equipment and floor covering in the U.S., Canada and the Caribbean. The Group also manufactures and sells a wide range of architectural paint, industrial coatings and related products across Latin America through company-operated stores and dedicated dealers. • Consumer Brands Group sells one of the industry’s most recognized portfolios of branded and private-label products through retailers across North America and in parts of Europe, Australia, New Zealand and China, and also operates a highly efficient global supply chain for paint, coatings and related products. • Performance Coatings Group sells a wide range of industrial coatings and finishes to general industrial, industrial wood, protective and marine, coil & extrusion, packaging and automotive customers in more than 120 countries. The Sherwin-Williams Company is an equal opportunity employer. As such, we will recruit, hire, train and promote in all job titles based only on valid job requirements. All personnel actions will be administered without regard to the following “factors”: race, color, religion, sex, sexual orientation, gender identity, national origin, protected veteran status, disability, age, pregnancy, genetic informa- tion, creed, citizenship status, marital status, or any other consideration prohibited by law or by contract. Contents Our Global Footprint 1 Financial Highlights 2 Letter to Shareholders 8 At a Glance 10 The Americas Group 12 Consumer Brands Group 14 Performance Coatings Group 16 Shareholder Returns 17 Financial Performance The Sherwin-Williams Company 101 W. Prospect Avenue Cleveland, Ohio 44115-1075 www.sherwin-williams.com 2 0 1 8 A N N U A L R E P O R T 59948IMPO.(PDF_D17) Cover.indd 1 2/22/19 10:41 AM The Sherwin-Williams Company was founded by Henry Sherwin and Edward Williams in 1866. Today, we are a global leader in the manufacture, development, distribution and sale of paint, coatings and related products to professional, industrial, commercial and retail customers. Sherwin-Williams®, Valspar®, Dutch Boy®, HGTV HOME™ by Sherwin- T he Company manufactures products under well-known brands such as branded products are sold primarily through more than 5,100 company-operated more. With global headquarters in Cleveland, Ohio, Sherwin-Williams® Williams, Krylon®, Minwax®, Cabot®, Thompson’s® Water Seal® and many The Sherwin-Williams Company 101 W. Prospect Avenue Cleveland, Ohio 44115-1075 www.sherwin-williams.com stores and facilities, while the Company’s other brands are sold through leading mass merchandisers, home centers, independent paint dealers, hardware stores, automotive retailers and industrial distributors. For more information, visit www.sherwin-williams.com. The Company is comprised of three reportable segments, which together provide our customers with innovative solutions to ensure their success, no matter where they work, or what surfaces they are coating. • • • The Americas Group operates the exclusive outlets for Sherwin-Williams® branded paints, stains, supplies, equipment and floor covering in the U.S., Canada and the Caribbean. The Group also manufactures and sells a wide range of architectural paint, industrial coatings and related products across Latin America through company-operated stores and dedicated dealers. Consumer Brands Group sells one of the industry’s most recognized portfolios of branded and private-label products through retailers across North America and in parts of Europe, Australia, New Zealand and China, and also operates a highly efficient global supply chain for paint, coatings and related products. Performance Coatings Group sells a wide range of industrial coatings and finishes to general industrial, industrial wood, protective and marine, coil & extrusion, packaging and automotive customers in more than 120 countries. The Sherwin-Williams Company is an equal opportunity employer. As such, we will recruit, hire, train and promote in all job titles based only on valid job requirements. All personnel actions will be administered without regard to the following “factors”: race, color, religion, sex, sexual orientation, gender identity, national origin, protected veteran status, disability, age, pregnancy, genetic informa- tion, creed, citizenship status, marital status, or any other consideration prohibited by law or by contract. Contents Our Global Footprint 1 Financial Highlights 2 Letter to Shareholders 8 At a Glance 10 The Americas Group 12 Consumer Brands Group 14 Performance Coatings Group 16 Shareholder Returns 17 Financial Performance 2 0 1 8 A N N U A L R E P O R T 59948IMPO.(PDF_D17) Cover.indd 1 2/22/19 10:41 AM 21 branches CANADA 1 facility 241 paint stores 4 facilities 43 facilities 13 facilities 4,032 paint stores 223 branches UNITED STATES 2 facilities 81 paint stores CARIBBEAN LATIN AMERICA / SOUTH AMERICA 19 branches 342 paint stores 10 facilities 18 facilities West Virginia Wisconsin Wyoming 19 83 12 2 5 7 CANADA Alberta 28 British Columbia 49 Manitoba 9 New Brunswick Newfoundland Nova Scotia Ontario 94 Prince Edward Island 1 Quebec 39 Saskatchewan CARIBBEAN LATIN AMERICA Brazil Chile Ecuador Mexico Uruguay TOTAL 4,696 147 95 81 33 56 11 7 The Americas Group Consumer Brands Group Performance Coatings Group Corporate headquarters The Americas Group’s Stores UNITED STATES Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware District of Columbia Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan 72 7 66 46 269 79 41 17 5 313 159 13 27 155 95 43 45 58 69 25 85 62 116 Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington 64 57 77 18 23 25 22 98 24 142 164 9 199 55 56 200 12 87 10 92 339 37 11 125 105 Board of Directors 16 branches 9 facilities 25 facilities EMEAI ASIA-PACIFIC 3 branches 7 facilities 9 facilities 1. Christine A. Poon, 66* Executive in Residence 5. John G. Morikis, 55 Chairman, President and The Max M. Fisher College of Business Chief Executive Officer The Sherwin-Williams Company 9. Susan J. Kropf, 70 Retired, former President and Chief Operating Officer Avon Products, Inc. 6. Richard J. Kramer, 55* Chairman of the Board, 10. Michael H. Thaman, 55 Chairman and Chief Executive Officer 95 paint stores 6 facilities 2. Steven H. Wunning, 67 Chief Executive Officer and President Owens Corning Retired, former Group President The Goodyear Tire & Rubber Company AUSTRALIA/NEW ZEALAND 3. Arthur F. Anton, 61* Chairman and Chief Executive Officer and Chief Executive Officer Swagelok Company Lincoln Electric Holdings, Inc. 7. John M. Stropki, 68 Retired, former Chairman, President Our Global Footprint As a global leader in the development, manufacture and sale of paint, coatings and related products, Sherwin-Williams has an extensive retail presence throughout the Americas and growing service capabilities in Europe, Asia-Pacific and Australia/ New Zealand. • • • The Americas Group has 4,354 company-operated specialty paint stores in the United States, Canada and the Caribbean. More than 90 percent of the U.S. population lives within a 50-mile radius of a Sherwin-Williams store. The Americas Group operates 342 stores throughout Latin America and sells through more than 700 dedicated dealer outlets, primarily located in Brazil, Chile, Ecuador, Mexico and Uruguay. Consumer Brands Group includes company-operated outlets in Australia and New Zealand and a highly efficient global supply chain consisting of 95 manufacturing plants and distribution centers. Performance Coatings Group sells to a growing customer base in more than 120 countries around the world and has 282 company-operated general industrial, industrial wood, protective and marine, and automotive branches. The Ohio State University Retired, former Vice Chairman Johnson & Johnson Caterpillar Inc. 4. Matthew Thornton III, 60* Executive Vice President and Chief Operating Officer FedEx Freight FedEx Corporation *Audit Committee Member 8. David F. Hodnik, 71 Retired, former President and Chief Executive Officer Ace Hardware Corporation 2 1 3 5 8 9 6 7 4 10 59948IMPO.(PDF_D17) Cover.indd 2 2/22/19 10:41 AM Financial Highlights (thousands of dollars except per share data) 2 018 2 017 2 016 Net sales $ 17,534,493 $ 14,983,788 $ 11,855,602 Net income from continuing operations (1 )(2) $ 1,108,746 $ 1,769,488 $ 1,132,703 Per share: Diluted net income per share from continuing operations (1 )(3 ) Cash dividends Average shares outstanding – diluted (thousands) Return on sales (1 ) Return on assets (1 ) Return on beginning shareholders’ equity (1 )(4) Total debt to capitalization (1 ) Interest coverage (1 )(5) $ $ 11.67 3.44 94,988 6.3% 5.8% 30.4% 71.5% 4.7x $ $ 18.64 3.40 94,927 11.8% 8.9% 94.2% 74.3% 6.6x $ $ 11.99 3.36 94,488 9.6% 16.8% 130.5% 51.0% 11.4x Net Sales millions of dollars Net Income from Continuing Operations (1)(2) millions of dollars Diluted Net Income Per Share from Continuing Operations (1)(3) Net Operating Cash millions of dollars , 4 8 9 4 1 6 $ 5 8 1 1 $ , 4 3 5 7 1 $ , 9 6 7 1 $ , 3 3 1 1 $ , 9 0 1 1 $ , . 4 6 8 1 $ . 9 9 1 1 $ . 7 6 1 1 $ 4 4 9 1 $ , 4 8 8 1 $ , 9 0 3 1 $ , 16 17 18 16 17 18 16 17 18 16 17 18 (1) 2017 has been adjusted for a voluntary inventory accounting change made in 2018. (2) 2018 includes after-tax acquisition-related costs of $394.4 million, after-tax environmental expense provisions of $126.1 million, after-tax California litigation expense of $102.5 million and after-tax pension settlement expense of $28.3 million. 2017 includes a one-time income tax benefit of $668.8 million from Deferred income tax reductions and after-tax acquisition-related costs of $329.4 million. 2016 includes after-tax acquisition-related costs of $81.5 million. (3) 2018 includes charges of $4.15 per share for acquisition-related costs, $1.32 per share for environmental expense provisions, $1.09 per share for California litigation expense and $.30 per share for pension settlement expense. 2017 includes a one-time benefit of $7.04 per share from Deferred income tax reductions and a charge of $3.47 per share for acquisition-related costs. 2016 includes a charge of $.86 per share for acquisition-related costs. (4) Based on net income and shareholders’ equity at beginning of year. (5) Ratio of income before income taxes and interest expense to interest expense. 1 Letter to Shareholders We are pleased to report that Sherwin-Williams delivered record performance across many measures in 2018, including sales, earnings before interest, taxes, depreciation and amortization (EBITDA), and net operating cash. Our success stems from our continued focus on innovative products and services to help our customers improve their productivity, profitability and projects. progress on the integration of Valspar, the largest acquisition in our W e posted these outstanding results while also making tremendous material inflation for the second year in a row, which we responded to with selling history. Integration synergies in 2018 exceeded the target we set at the beginning of the year. We also faced significant and persistent raw price increases, some of which were still flowing in as we entered 2019. Tariffs, global trade uncertainty, interest rate hikes and other headwinds also impacted the operating environment. Still, Sherwin-Williams employees delivered. Specific financial highlights from 2018* include: • • • Sales increased $2.55 billion, or 17%, to a record $17.53 billion. Keeping in mind that the Valspar transaction closed on June 1, 2017, incremental Valspar sales from January through May 2018 increased consolidated sales by 12.4% for the year. Organic growth for the full year was 4.7%. EBITDA – or “Earnings Before Interest, Taxes, Depreciation and Amortization” – increased 4.4% to a record $2.32 billion. GAAP diluted net income per share for 2018 decreased to $11.67 per share from $18.20 per share in 2017. The $11.67 per share includes non-operating expenses of $2.71 per share and acquisition-related expenses of $4.15 per share. The $18.20 per share includes a charge of $0.44 related to discontinued operations, acquisition-related expenses of $3.47 per share and a one-time benefit of $7.04 per share from Deferred Income Tax Reductions. *2018 reported results include purchase accounting adjustments, acquisition transaction and integration costs, and other non-operating expenses related to environmental remediation, pension plan settlement, and California litigation expense. Our 2017 reported results include purchase accounting adjustments, acquisition transaction and integration costs, and a one-time benefit from Deferred income tax reductions. The Com- pany also made a voluntary inventory Accounting Change in the fourth quarter of 2018, driven by integration activities. As a result of this change, and in accordance with U.S. Generally Accepted Accounting Principles (GAAP), a retrospective one-time expense adjustment to cost of goods sold of $58.9 million, or $.47 per share, was made, resulting in revised GAAP 2017 fourth quarter and full year amounts. This revision increased acquisition-related costs and reduced previously reported segment profit for Performance Coatings and Consumer Brands Groups by $35.7 million and $23.2 million, respectively, for both the fourth quarter and full year 2017 compared to what was previously reported. 2 John G. Morikis, Chairman, President and Chief Executive Officer, and Allen J. Mistysyn, Senior Vice President – Finance and Chief Financial Officer • We believe investors gain a more meaningful view of our underlying performance by excluding non-operating and to return 1.525 million shares of common stock to treasury and retired $1.1 billion in debt. Net debt acquisition-related items from results in both years. On to adjusted EBITDA at the end of the year was this adjusted basis, 2018 diluted earnings per share from approximately 3.3 times. continuing operations increased 23.0% to $18.53 from $15.07 per share in 2017. Organic growth increased 4.7% and adjusted diluted net income per share from continuing operations increased 23% compared to the prior year. • Net operating cash for the year increased $60 million to a record $1.94 billion. This cash generation enabled us to continue investing in growth and return capital directly to our shareholders. During the year, we invested $251 million in our business through capital expenditures, paid $323 million in cash dividends, invested $613 million • Our acquisition integration effort is on track. We delivered approximately $180 million in synergy benefits to the income statement in 2018, about $30 million above the midpoint of our expectations at the start of the year. We exited the year with an annual synergy run rate of approximately $360 million. To date, we have completed 437 value-capture projects. An additional 157 projects are currently in progress with 53 more under evaluation. Amid these highlights, we did receive some disappointing news during the year, as the United States Supreme Court declined to hear our appeal of a lower court decision related to California lead paint abatement. This resulted in a pre-tax charge of $136.3 million, or one-third of the amount of an abatement fund as recalculated by the trial court. We continue to believe the California verdict is wrong on the facts and law, and we will vigorously defend any potential future litigation as we have in the past. 3 invested in this model in 2018, opening 76 net new stores, including 87 in North America, which was partially offset by some store consolidation in Latin America. Total store count at year-end was 4,696. Our service model also includes our e-business platform, which we enhanced in 2018 and which enables pro customers to better manage their businesses with 24/7 access to ordering, pricing, purchase history and more. Consumer Brands Group 2018 sales for the Consumer Brands Group increased $584.3 million, or 27.1% compared to 2017, to $2.74 billion. Incremental Valspar sales from the five months ended May 2018 increased Group sales 26.9% in the year. Segment profit increased 28.7% to $261.1 million due to incremental Valspar operations profit for the first five months of $75.8 million, increased selling prices and reduced impacts of a voluntary inventory accounting change, partially offset by increased raw material costs and lower sales to some of the Group’s customers. Reported segment operating margin increased to 9.5% in 2018 from 9.4% last year. Excluding purchase accounting expense in both years and the voluntary inventory accounting change adjustment to 2017, adjusted segment operating margin decreased to 13.6% in 2018 from 15.5% in 2017. The margin decrease was driven mainly by incremental expenses related to the launch of our new partnership with Lowe’s and raw material inflation, not all of which were anticipated. Since the acquisition of Valspar in June 2017, the Consumer Brands Group has integrated two distinct teams into one. Evidence of the value provided by this combination came early in 2018, as we announced an expanded partnership with Lowe’s. The partnership positions Lowe’s as the only national home center in the United States to offer our Valspar® brand paints and stains, HGTV HOME™ by Sherwin-Williams paints, Minwax®, Cabot® and Thompson’s® Water Seal® stains, Krylon® aerosols and Purdy® applicators. We executed six major product category resets and trained 20,000 Lowe’s associates during the year, providing Lowe’s customers with an improved experience throughout the paint department. We began to see the benefits of this expanded partnership in 2018, and our expectations for longer-term success remain high. The Americas Group introduced 25 new architectural products in North America, the eighth consecutive year of double-digit product introductions in the region. The Americas Group Sales for The Americas Group increased $507.9 million in 2018, or 5.6% compared to 2017, to $9.63 billion. This growth comes on top of a strong prior year during which sales grew 8.8%. Currency translation rate changes reduced 2018 sales by 1%. Comparable-store sales in the U.S., Canada and the Caribbean – that is, sales by stores open more than 12 calendar months – increased 5.1% in the year. Full-year segment profit increased 7.3% to $1.90 billion, and segment operating margin increased 30 basis points to 19.7% from 19.4% last year. Sales to residential repaint contractors remained our strongest customer end market in the year, with sales increasing by a double-digit percentage. All other customer categories were also positive for the year. We continued to serve these customers by investing in innovation. We introduced 25 new products in North America in 2018 – our eighth consecutive year of double-digit product introductions in the region – and 30 more in Latin America. Particularly well- received products include Loxon® Self-Cleaning Exterior Acrylic Coating, SuperDeck® Solid Color Stain with new Cool Feel® Color Technology, Extreme Block® Primer/Sealer and Duration Home® Interior Paint with Moisture Resistant Technology. Our value proposition rests on combining innovative products with premium service. We believe our company- operated stores offer professional painting contractors and DIYers the best service experience available. We further 4 We partner with other premier retailers as well, such as Menards, Ace, Orgill, Do-It-Best and others. The Valspar Performance Coatings Group 2018 sales for the Performance Coating Group increased acquisition also provides us with the opportunity to grow $1.46 billion, or 39.4% compared to 2017, to $5.17 billion. outside of North America through the Valspar®, Huarun® Incremental Valspar sales from the five months ended May and Wattyl® brands in Europe, China and Australia/New 2018 increased Group sales 34.3% in the year. Segment profit Zealand, respectively. increased 72.0% to $452.1 million due to incremental Valspar The success of each of our reportable segments is operations profit for the first five months of $97.6 million, supported by a highly efficient global supply chain and research and development organization, all managed within the Consumer Brands Group. This team performed admirably in 2018, keeping pace with the incremental load-in demand of the new Lowe’s program while also supporting what is traditionally the peak period of architectural paint sales We continued to innovate in the area of coatings that reduce impacts to the environment. volume in North America. This effort resulted in approximately selling price increases and reduced impacts of a voluntary $20 million in incremental costs that were not included in our inventory accounting change, partially offset by increased raw earnings outlook for the full year. Deep thanks goes to the many material costs and increased purchase accounting impacts. members of our global supply chain for their efforts in putting Reported segment operating margin increased to 8.8% in 2018 our customers first. Their dedication is a great source of pride from 7.1% last year. Excluding purchase accounting expense to all of us. in both years and a voluntary inventory accounting change This team also remained crucial to our acquisition value- adjustment to 2017, adjusted segment operating margin capture efforts in 2018, especially in the area of optimizing was essentially flat at 12.9% in 2018 compared to 13.0% in our manufacturing and distribution footprint. We consolidated 2017. Given the level of raw material inflation this segment four manufacturing plants and three distribution centers in experienced in 2018, flat operating margin year over year is 2018 while completing seven capacity expansion projects to evidence that our pricing actions have had success. support global growth. We also began to more fully realize the Like the Consumer Brands Group, this segment has benefits of our new distribution center in Waco, Texas, and new integrated distinct Sherwin-Williams and Valspar teams manufacturing facility in Nantong, China, both of which opened into a single global organization with a common purpose: in 2017. Health and safety remained priorities for us as well, delivering value to customers through differentiated products and we had 31 U.S. VPP Star sites and 12 OHSAS 18001 and and solutions that focus on both application performance and 45 ISO 14001 sites globally at the end of 2018. enhancing productivity. This starts with innovation, especially This team also operates our commercial transportation in the area of coatings that reduce impacts to the environment, fleet, which was honored again in 2018 with the SmartWay Excellence Award. This annual award honors top shipping and logistics company partners for superior environmental performance and additional actions to reduce freight emissions through effective collaboration and operational practices. The fleet also earned 2nd Place for the National Private Truck Council’s Fleet of the Year Safety Award. 5 segment early in 2018, with his 32 years of experience at Sherwin-Williams preparing him extremely well for the role. After joining the Company as a management trainee, Pete progressed through a variety of leadership roles, most recently as President & General Manager of the Mid Western Division of The Americas Group. Todd Stephenson succeeds Pete as President & General Manager of the Mid Western Division. Todd joined Sherwin- Williams in 1992 and most recently served as Senior Vice President of Sales, Protective & Marine Division, Performance Coatings Group. Tom Hablitzel was promoted to Senior Vice President, Enterprise Strategic Accounts, succeeding Mark Henderson, who retired after 36 years of service to the Company. Tom joined the Company in 2005 and most recently served as President of the Automotive Finishes Division, Performance Coatings Group. Justin Binns succeeds Tom as President & General Manager of the Automotive Finishes Division. Justin joined the Company in 2001 and takes on his new role after serving most recently as President & General Manager of the Eastern Division within The Americas Group. Mark Provenson succeeds Justin as President & General Manager of the Eastern Division. Mark joined Sherwin- Williams in 2000 and most recently served as Vice President of Sales, Mid Western Division. Jonathan Reid was promoted to President & General Manager of the South Western Division in The Americas Group, succeeding Monty Griffin, who retired after 33 years of service to the Company. Jon joined Sherwin- Williams in 1993 and most recently served as Vice President of Sales in the South Western Division. These seamless transitions during the year demonstrate our thoughtful approach to succession planning and the depth of our talent pool. Outlook We enter 2019 with confidence in the sustainability of demand across most of our end markets, and we see significant opportunities for profitable growth throughout the business. In The Americas Group, we will continue to invest in our store model and best-in-class products while executing on share of wallet and new account activation initiatives. In the Consumer Brands Group, we are excited by the exclusive national home center relationship and shared commitment to where the Performance Coatings Group continues to make advancements in next-generation waterborne technology, low- cure powder coatings, renewable bio-based raw materials, and non-isocyanate and non-formaldehyde formulated coatings. We’re also maximizing our large-batch/small-batch capabilities to serve a broader range of customer needs. All product categories managed by this Group generated growth in the year, led by General Industrial and Packaging, which were both up by double-digit percentages. General Industrial’s Color Express™ program is reducing the time it takes for powder finishers to match, receive and apply powder. And in Packaging, our ValPure® V70 Series of non-BPA epoxy coatings has emerged as a top choice among can coaters. Industrial Wood customers are benefiting from our latest flooring coatings, including Ultra-Cure® MarGuard™ Clear Topcoat, which provides resistance to stains, scratches and abrasion. In Automotive Finishes, our Ultra 9K™ Waterborne System is a great example of synergy, combining basecoat technologies from Valspar with primer and clearcoats from Sherwin-Williams to deliver a truly differentiated offering. For Coil & Extrusion customers, we continued to deliver value with our Fluropon® 70% Polyvinylidene Fluoride (PVDF) coatings for metal architecture. In the Protective and Marine space, our patented Firetex® FX6002 is an ultrafast-drying intumescent coating for structural steel surfaces that provides fire resistance for up to 2 hours. Leadership Announcements Our continued focus on internal talent development resulted in several leadership appointments during the year. Pete Ippolito was promoted to President of The Americas Group, succeeding Jay Davisson, who retired after 31 years of service to the Company. Pete took on leadership of our largest operating 6 growth we have with our largest retail partner, as well as by Historically, we have targeted dividends at about 30% of our strong relationships with other leading retailers. And in the prior-year GAAP earnings. At its February 2019 meeting, our Performance Coatings Group, we are focused on maximizing the Board of Directors approved a quarterly dividend increase of combined capabilities of our integrated organization across the 31% to $1.13 per share, up from $0.86 last year. It is also part various end markets and geographies we serve. We are also of our longstanding philosophy not to hold excess cash on confident in our team’s ability to execute on the key initiatives the balance sheet. We expect to use this cash to make open- that drive our success in the short and long term, and in our market purchases of Company stock in 2019 at a level beyond ability to continue delivering significant value to customers. We what is necessary to offset dilution from option exercises. On are well positioned and focused on what we can control. December 31, 2018, we had remaining authorization to acquire We expect 2019 sales to increase 4% to 7% compared to 2018. approximately 10.13 million shares. We will also continue to evaluate acquisitions that fit our strategy. Let me close this letter by thanking the more than 60,000 employees of Sherwin-Williams for their hard work and dedication. There is no better team in the industry, and I am continually inspired by your passion for our company There are a number of economic, political and social and our customers. I also offer my sincere thanks to you, our variables that are beyond our control, including government shareholders, for your continued trust and confidence in us. shutdowns, federal interest rate hikes, tariffs, global trade We expect to deliver strong performance in 2019 and in the uncertainty, immigration and security, among others. While it years to come. is our job to focus on those things we can control, and adapt to those things we cannot, these factors have the potential to affect our business and expand the range of potential outcomes in our results. Against this backdrop, we expect 2019 net sales to John G. Morikis increase 4% to 7% compared to 2018. In terms of profitability, Chairman, President and Chief Executive Officer we should continue to benefit from operating expense control, volume growth and acquisition synergies. One key assumption embedded in this outlook is that raw material inflation for 2019 will be in the low single digits compared to 2018. We expect the rate of year-over-year inflation will be highest in the first quarter, and, assuming stable petrochemical feedstocks and no supply disruptions, it should diminish as we go through the second half of 2019. Over the past two years, we allocated a significant share of capital generated to debt reduction, retiring approximately $1 billion in both 2017 and 2018. In 2019, we expect to begin moving back toward our more traditional capital allocation philosophy. Capital expenditures will remain modest, at approximately 1.7% of sales. We still expect to reduce debt by $600 million in 2019, which should reduce our net debt- to-EBITDA ratio to below 3 times by the end of the year. 7 2018 At a Glance The Americas Group 55% of total sales The Americas Group operates the exclusive outlets for Sherwin-Williams® branded paints, stains, supplies, equipment and floor covering in the United States, Canada and the Caribbean. The Group also manufactures and sells a wide range of architectural paints, industrial coatings and related products across Latin America through company- operated stores, dedicated dealers and selected retailers. PRODUCTS SOLD: Paints, stains, aerosols, applicators, caulks, varnishes, protective and marine coatings, spray equipment and related products in the United States, Canada, the Caribbean and Latin America. Wall covering and floor covering in the United States, Canada and the Caribbean. OEM product finishes in Latin America CUSTOMERS SERVED: Do-it-yourselfers, professional painting contractors, home builders, property maintenance, healthcare, hospitality, architects, interior designers, industrial, marine, flooring and original equipment manufacturer (OEM) product finishers MAJOR BRANDS SOLD: Sherwin-Williams®, A-100®, Cashmere®, Colorgin®, Condor®, Duracraft®, Duration Home®, Duration®, Emerald®, Harmony®, HGTV HOME™ by Sherwin-Williams, Kem Pro®, Kem Tone®, Krylon®, Loxon®, Marson®, Metalatex®, Minwax®, Novacor®, Paint Shield®, PrepRite®, ProClassic®, ProCraft®, ProConstructor®, ProIndustrial™, ProMar®, ProPark®, Solo®, Sumaré®, SuperDeck®, SuperPaint®, Ultra Protección®, Woodscapes® OUTLETS: 4,354 Sherwin-Williams paint stores in the United States, Canada and the Caribbean, and 342 in Brazil, Chile, Ecuador, Mexico and Uruguay. Dedicated dealers, home centers, distributors and hardware stores in Argentina, Brazil, Chile, Ecuador, Mexico and Uruguay. Licensee in El Salvador serves Central America 8 Consumer Brands Group Performance Coatings Group 16% of total sales 29% of total sales Our Consumer Brands Group sells one of the industry’s The Performance Coatings Group sells a broad range most recognized portfolios of branded and private-label of coatings and finishing solutions to general industrial, products through retailers across North America and in industrial wood, protective and marine, automotive, packaging parts of Europe, China, Australia and New Zealand. The and coil & extrusion customers in more than 120 countries. Group also operates a highly efficient global supply chain for paint, coatings and related products. PRODUCTS SOLD: Branded, private-label and licensed brand paints, stains, varnishes, industrial products, wood finishing products, wood preservatives, applicators, corrosion inhibitors, aerosols, caulks and adhesives, and related products CUSTOMERS SERVED: Do-it-yourselfers, professional painting contractors, industrial maintenance and flooring contractors MAJOR BRANDS SOLD: Accurate Dispersions™, Altax™, Bestt Liebco®, Cabot®, Conco®, Duckback®, Dupli-Color®, DuraSeal®, Dutch Boy®, Geocel®, Granosite®, H&C®, HGTV HOME™ by Sherwin-Williams, Huarun®, Kool Seal®, Krylon®, Minwax®, Pratt & Lambert®, Purdy®, Ronseal®, Rubberset®, Solver®, Sprayon®, SuperDeck®, Thompson’s® WaterSeal®, Tri-Flow®, Uniflex®, Valspar®, VHT®, Wattyl®, White Lightning® OUTLETS: Over 10,000 points of distribution with leading mass merchandisers, home centers, independent paint dealers, hardware stores, craft stores, fine art stores, automotive retailers and industrial distributors in the United States, Canada, Poland, United Kingdom, China, Australia and New Zealand PRODUCTS SOLD: Asset protection products, wood finishes, powder coatings, coatings for plastic and glass, aerosols, high-performance interior and exterior coatings for the automotive, aviation, fleet, packaging, heavy truck, material handling, agriculture and construction, and building products segments CUSTOMERS SERVED: Coatings for commercial construction, industrial maintenance, protective and marine, OEM coatings for military, heavy equipment, appliances, electronics, building products, furniture, cabinetry and flooring, architects and specifiers, bridge & highway, water & waste water treatment, collision repair facilities, dealerships, auto interior, fleet owners, auto refinishers, production shops, metal packaging and manufacturers MAJOR BRANDS SOLD: Sherwin-Williams®, Acrolon®, AcromaPro®, Arti™, ATX™, AWX Performance Plus™, Baco®, Conely®, DeBeer®, DFL™, Dimension®, Duraspar®, EcoDex®, Envirolastic®, Euronavy®, Excelo®, EzDex®, Fastline®, Finish 1™, Firetex®, Fluropon®, Genesis®, Heat-Flex®, House of Kolor®, Huarun®, Inchem®, Inver®, Kem Aqua®, Lanet™, Lazzuril®, Macropoxy®, Magnalux™, Martin Senour®, Matrix®, ML Campbell®, Oece™, PermaClad®, Planet Color™, Polane®, Powdura®, Prospray®, Sayerlack®, Sher-Wood®, Ultra-Cure®, Ultra™, USC®, ValPure® Valspar®, Wattyl® OUTLETS: 282 company-operated branches serving automotive, general industrial, industrial wood and coil customers in the United States, Australia, Belarus, Belgium, Brazil, Canada, Chile, China, Czech Republic, Denmark, Finland, France, Germany, India, Indonesia, Ireland, Italy, Lithuania, Malaysia, Mexico, Norway, Peru, Poland, Portugal, Romania, Russia, Singapore, Spain, Sweden, Thailand, Ukraine, United Kingdom and Vietnam. Distribution in 44 other countries through wholly owned subsidiaries, joint ventures, distributors, export options, and licensees of technology, trademarks and trade names 9 The Americas Group The Americas Group operates specialty stores that serve as the exclusive outlets for Sherwin-Willams® branded paints, stains, supplies, equipment and floor covering in the U.S., Canada and the Caribbean. The Group also serves Latin America through company-operated stores, dedicated dealers and selected retailers. In 2018, the Group delivered record performance as net sales increased 5.6% to $9.63 billion and segment profit grew 7.3% to $1.90 billion. and field reps are trained to understand their T hroughout the Americas, our store employees business service and support programs to offer highly products, color expertise, application know-how, customers’ needs. We then combine our innovative customized solutions that meet and exceed customer needs. This time-tested approach led to another strong year for • • • Extreme Block® Primer/Sealer reduces the need for repaints by sealing off stubborn stains such as smoke, fire and nicotine, making it ideal for quickly restoring a property to fresh condition. Its fast-drying formula helps contractors keep tight timelines and stay on schedule. Duration Home® Interior Paint with Moisture-Resistant Technology provides enhanced protection in damp environments and defends against unsightly water spotting. It is ideal for kitchens, bathrooms and laundry rooms. ProCraft® is a comprehensive mid-tier product line designed to meet the needs of painting professionals across our business. We opened 76 net new stores in 2018, bringing a variety of segments. We expanded our offering with new our total to 4,696 throughout the Americas. We also have more elastomeric, ceiling and texture paints. than 700 Sherwin-Williams dedicated dealers in Latin America, enabling us to further serve that region. We launched 25 new products in the U.S., Canada and the Caribbean and 30 in Latin America during the year. Among the highlights: Loxon® Self-Cleaning Exterior Acrylic Coating easily sheds dirt to keep properties looking fresh. Designed for Innovation extends beyond our products, too. For example, pro customers continued to adopt mysw.com, our e-business platform, enabling them to better manage their businesses with 24/7 access to ordering, pricing, purchase history and more. Our new ColorSnap™ Match tool lets users scan colors from any item, including paint, textiles, carpet, tile and accessories, exterior above-grade masonry, the self-cleaning formula then instantly find the closest Sherwin-Williams paint color and provides advanced durability, water shedding and wind- palette. We’ve also embraced augmented reality, as the new driven rain and dirt pickup resistance. Instant Paint feature in our ColorSnap® app allows customers SuperDeck® Solid Color Stain with Cool Feel® Color Technology can reduce deck surface temperatures by up to 20ºF compared to conventional technology, making to use their smartphone cameras to “try on and see” any of Sherwin-Williams 1,500 colors on their walls in real time. As we begin 2019, we’ll continue to invest in products and services that these spaces cooler and more enjoyable for homeowners help make our customers more successful. and their guests. • • 10 Achievements We were recognized for Outstanding Customer Satisfaction with Paint Retailers and Exterior Paint in the 2018 J.D. Power Paint Satisfaction Study.* We demonstrated “The Power of Paint” during our 7th Annual National Painting Week as more than 4,000 Sherwin-Williams employees donated 34,000 hours of their time to transform more than 200 community spaces in the U.S., Canada and the Caribbean, using Sherwin-Williams paint and supplies. Our new Paint Your Path™ initiative aims to help our professional customers create a stronger, more skilled painting workforce. Our long-term commitment supports employers and potential painters through career advocacy, education and recruitment resources. The National Association of Building Materials in Brazil (ANAMACO) awarded Colorgin® Spray Paint the Master Award for the best overall evaluation and best spraying ability. It also awarded Novacor™ Piso Floor Paint with First Place for best overall coverage. 11 *Sherwin-Williams received the highest score with exterior paints and second highest score among paint retailers in the J.D. Power 2018 Paint Satisfaction Study of customers’ satisfaction with purchased and applied paint. Visit jdpower.com/awards Consumer Brands Group The Consumer Brands Group offers one of the industry’s most recognized portfolios of branded and private-label products through retailers across North America, parts of Europe, China, Australia and New Zealand. It also operates a highly efficient and productive global supply chain. In 2018, the Group delivered record performance as net sales increased 27.1% to $2.74 billion and segment profit grew 28.7% to $261.1 million. channel partners with access to a portfolio of T he Consumer Brands Group provides strategic of this value proposition in 2018 than the announcement of high-touch service. There was no better illustration industry-leading brands supported by best-in-class, our expanded partnership with Lowe’s. Lowe’s is now the exclusive national home center in the United States to offer Valspar® paints, stains and applicators, HGTV HOME™ by Sherwin-Williams paints, Minwax®, Cabot® and Thompson’s® Water Seal® stains, Krylon® aerosols and Purdy® applicators. Both partners executed on significant enhancements to staffing, training, merchandising, advertising, product assortment and supply chain. We began to see the benefits of this expanded partnership in 2018, and our expectations for long-term profitable growth remain high. We also partner with other premier retailers such as Throughout the year, we continued to invest in new products to make our customers more successful, including: • • Valspar® exterior stain comes in a range of nature-inspired colors to help consumers tap their creativity and enjoy their best life outdoors. It provides all-weather protection in one coat and is available in transparent, semi-transparent and solid color formulations, as well as a clear finish. Dutch Boy® Forever™ paint + primer is a new line of stain- blocking interior and ceiling paints featuring Arm & Hammer™ Odor Eliminating technology. It is specially formulated to cover and block stubborn stains such as coffee, tea, ketchup, crayon and lipstick. Additionally, Forever™ paint has advanced washability, is stain and mildew resistant and is GREENGUARD® Gold certified. • Krylon® Fusion All-In-One™ is a premium product that bonds to difficult surfaces such as plastics and ready-to-assemble furniture without sanding or priming. The product provides maximum rust protection for all outdoor projects and offers a broad color palette with multiple finishes and sheens for indoors and out. Menards, Ace, Orgill, Do-It-Best and others. Outside of North We also completed important organizational work in 2018 that America, we have established niches in Europe, China and leaves us well positioned for future success. Since the acquisition Australia/New Zealand through our Valspar®, Huarun® and of Valspar in June 2017, we have integrated two distinct teams into Wattyl® brands, respectively. We continue to assess the most one. A leaner, more effective organizational structure is in place with promising opportunities for us to deliver value to customers in a deepened focus on employee communication, engagement and these regions. 12 alignment. Our value proposition is clear, and we are winning with key strategic partners. We are achieving our value-capture targets, and we will continue to execute on our initiatives in the areas of simplification, merchandising excellence, SKU reduction, brand rationalization, productivity enhancement and talent development. Achievements The Valspar Championship drives brand affinity, engages key customers and suppliers, and supports community and charitable partners. The 2018 event in Palm Harbor, Florida, was the highest-rated PGA Tour non-major Sunday telecast since 2013 and reached 27.4 million viewers with 150,000 fans in attendance. Our “Made with Love” campaign reinforced the Minwax® brand's position as “America’s No.1 Selling Interior Stain.” When shoppers buy applicators, we encourage them to “Make it Perfect. Make Sure it’s Purdy. The No. 1 Brand Preferred by Pros.” And a robust media campaign for Valspar® paint, inclusive of television, online video, programmatic display, paid search and social marketing, resulted in millions of impressions, views, clicks and incremental store visits. 13 Performance Coatings Group The Performance Coatings Group sells a broad range of coatings and finishing solutions through nearly 300 branches to general industrial, industrial wood, automotive, protective and marine, packaging and coil & extrusion customers throughout the world. In 2018, the Group delivered record performance as net sales increased 39.4% to $5.17 billion and segment profit grew 72.0% to $452.1 million. Performance Coatings Group shares a common T he diverse set of businesses that makes up the goal: delivering value to customers through differentiated products and solutions that focus on both application performance and enhancing productivity. Topcoat, a high-performance, UV-cure clearcoat, which provides advanced durability and resistance to chemicals, stains, scratches, scuffs and abrasions. We also introduced our Virtual Panel Studio, an online inspiration tool that provides furniture, kitchen cabinet and other wood product designers with access to a complete library of high-resolution images of finished wood panels. These panel images can be saved, downloaded, used in renderings and shared with customers or fellow collaborators to inspire future projects using innovative Sherwin-Williams® coatings. In the general industrial division, we’re reducing the time it Through an array of technologies and capabilities, we help our takes for powder finishers to match, receive and apply powder. The customers grow their businesses faster and more profitably. Color Express™ program uses an affordable handheld reader to This begins with innovation, especially in the area of coatings match color against powder products stocked at distribution centers that reduce impacts to the environment, where we continue to and available at Sherwin-Williams locations across North America. make advancements in next-generation waterborne technology, The combination of digital technology and locally stocked products low-cure powder coatings, products made with bio-based can reduce the matching process from weeks down to a few days. raw materials and non-isocyanate and non-formaldehyde Technology continues to drive rapid growth in our packaging formulated coatings. coatings offering. Our ValPure® V70 Series of non-BPA epoxy In automotive finishes, we continue to be at the forefront coatings has emerged as a top choice among can makers. It offers of the shift to waterborne coatings. The Ultra 9K™ Waterborne the performance benefits of epoxy coatings for food safety and Basecoat System combines basecoat technologies from Valspar preservation, answers the need for choices in the marketplace and with Sherwin-Williams primer and clearcoats. Designed to delivers on consumer preferences. drive productivity and efficiency in the shop, the Ultra 9K™ In the protective and marine space, our patented Firetex® system comes with an all-new color retrieval experience, a FX6002 is an ultrafast-drying intumescent coating for structural spectrophotometer and global color box – making even the steel surfaces that provides fire resistance for up to 2 hours. The most difficult color match easy. Our technology in this division ultrafast cure removes drying bottlenecks in the paint shop, and extends beyond the road and into the sky with new offerings also means rapid weather resistance for site-applied material. for aerospace customers. Jet Suede™, a new two-component For coil & extrusion customers, we continued to deliver value urethane topcoat, delivers an upscale, textured feel to with our Fluropon® 70% Polyvinylidene Fluoride (PVDF) coatings for aircraft interiors. metal architecture. These coatings offer extremely strong bonding For industrial wood customers, we launched a new line properties. They are most appropriate for monumental and high-end of flooring coatings, including Ultra-Cure® MarGuard™ Clear residential and commercial architecture as they provide excellent color and gloss retention. 14 Achievements We earned the SSPC (Society for Protective Coatings) Military Coatings Project Award of Excellence for coatings used in overhauling the USS George Washington (CVN-73), a thousand-foot U.S. Navy aircraft carrier. Using new coatings and technologies, innovative collaborations and solutions with less impact on the environment, we helped preserve and recoat critical areas, from topside to ballast tanks to interior fuel tanks. We earned the SSPC George Campbell Award for coatings used on the suspension spans and towers of the Walt Whitman Bridge, which spans the Delaware River from Pennsylvania to New Jersey. The Award recognizes a single outstanding achievement in the completion of a difficult or complex industrial coatings project. 15 Shareholder Returns Comparison of Cumulative Five-Year Total Return Five-Year Return $250 $200 $150 $100 2 013 2 014 2 015 2 016 2 017 2 018 Sherwin-Williams Co. S&P 500 Index Peer Group Peer group of companies comprised of the following: Akzo Nobel N.V., BASF SE, H.B. Fuller Company, Genuine Parts Company, The Home Depot, Inc., Lowe’s Companies, Inc., Masco Corporation, Newell Brands Inc., PPG Industries, Inc., RPM International Inc., Stanley Black & Decker Inc. and USG Corporation Stock Repurchase (millions of shares) 12.00 9.00 6.00 3.00 0.00 2 0 0 9 2 010 2 011 2 012 2 013 2 014 2 015 2 016* 2 017 * 2 018 * No open market purchases in 2016 and 2017 114.5 108.8 105.7 103.9 103.0 98.7 94.5 94.5 94.9 95.0 Average Common Shares Outstanding (fully diluted, in millions) Dividends Per Share $3.50 $3.00 $2.50 $2.00 $1.50 $1.00 $.50 $0.00 16 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 The graph at left compares the cumulative five-year total shareholder return on Sherwin-Williams common stock with the cumulative five-year total return of the companies listed on the Standard & Poor’s 500 Stock Index and a peer group of companies selected on a line-of-business basis. The cumulative five-year total return assumes $100 was invested on December 31, 2013 in Sherwin-Williams common stock, the S&P 500 and the peer group. The cumulative five-year total return, including reinvestment of dividends, represents the cumulative value through December 31, 2018. Returning Cash to Shareholders We have consistently returned a portion of our cash generated from operations to shareholders through cash dividends and share repurchases. In 2018, the Company increased its cash dividend 1.2 percent to $3.44 per share, marking the 40th consecutive year we increased our dividend. Share repurchases are also an efficient way of returning cash to shareholders in that they return sellers’ investment at market value and maximize the value of the remaining shares outstanding. We temporarily suspended share repurchases in 2016 and 2017, using cash to reduce total borrowings required to finance the Valspar transaction in 2016 and reducing debt by $1 billion in 2017. We returned to share repurchases in 2018, buying 1.53 million shares on the open market while also reducing debt by $1.1 billion. Over the past 10 years, we have reduced our average diluted common shares outstanding by more than 19 million shares. Financial Performance Financial Table of Contents Financial Summary Management’s Discussion and Analysis of Financial Condition and Results of Operations Reports of Management and the Independent Registered Public Accounting Firm Consolidated Financial Statements and Notes Cautionary Statement Regarding Forward-Looking Information Shareholder Information Corporate Officers and Operating Management 18 19 36 40 78 79 80 (cid:31) 17 Financial Summary (millions of dollars except as noted and per share data) Operations Net sales .................................................................. Cost of goods sold(2), (3) .............................................. Selling, general and administrative expenses(2) ............ Amortization ............................................................ Interest expense ....................................................... Income from continuing operations before income taxes(3), (4) ............................................................. Net income from continuing operations(3), (5) ................ Financial Position Accounts receivable – net .......................................... Inventories(3) ............................................................ Working capital – net(3) ............................................. Property, plant and equipment – net ........................... Total assets(3) ........................................................... Long-term debt ........................................................ Total debt ................................................................. Shareholders’ equity(3) .............................................. Per Share Information Average shares outstanding – diluted (thousands) ....... Book value(3) ............................................................ Net income from continuing operations – diluted(3), (6) ........................................................... Cash dividends .......................................................... Financial Ratios Return on sales(3) ...................................................... Asset turnover .......................................................... Return on assets(3) .................................................... Return on equity(3), (7) ................................................ Dividend payout ratio(8) ............................................ Total debt to capitalization(3) ..................................... Current ratio ............................................................. Interest coverage(3), (9) ............................................... Net working capital to sales(3) .................................... Effective income tax rate(10) ....................................... General Earnings before interest, taxes, depreciation and amortization(3) ...................................................... Capital expenditures ................................................. Total technical expenditures (see Note 1) .................... Advertising expenditures ........................................... Repairs and maintenance ........................................... Depreciation ............................................................. Shareholders of record (total count) ........................... Number of employees (total count) ............................ Sales per employee (thousands of dollars) .................. Sales per dollar of assets ............................................ 2018 2017(1) 2016 2015 2014 $ $ $ $ $ $ 17,534 10,116 5,034 318 367 1,360 1,109 2,019 1,815 47 1,777 19,134 8,708 9,344 3,731 14,984 8,265 4,798 207 263 1,469 1,769 2,105 1,742 420 1,877 19,900 9,886 10,521 3,648 $ $ 11,856 5,933 4,159 26 154 1,595 1,133 1,231 1,068 798 1,096 6,753 1,211 1,953 1,878 $ $ 11,339 5,780 3,914 28 62 1,549 1,054 1,114 1,019 515 1,042 5,779 1,907 1,950 868 11,130 5,965 3,823 30 64 1,258 866 1,131 1,034 (115) 1,021 5,699 1,116 1,799 996 94,988 40.07 $ 94,927 38.86 94,488 20.20 $ 94,543 9.41 98,075 10.52 $ $ $ 11.67 3.44 6.3% 0.9x 5.8% 30.4% 18.5% 71.5% 1.0 4.7x 0.3% 18.5% 2,323 251 254 358 132 278 6,244 53,368 329 0.92 $ $ $ $ 18.64 3.40 11.8% 0.8x 8.9% 94.2% 28.4% 74.3% 1.1 6.6x 2.8% 25.1% 2,225 223 216 374 116 285 6,470 52,695 284 0.75 11.99 3.36 9.6% 1.8x 16.8% 130.5% 30.1% 51.0% 1.3 11.4x 6.7% 29.0% 1,947 239 153 351 100 172 6,787 42,550 279 1.76 11.15 2.68 9.3% 2.0x 18.2% 105.8% 30.6% 69.2% 1.2 26.1x 4.5% 32.0% 1,809 234 150 338 99 170 6,987 40,706 279 1.96 $ $ $ $ 8.77 2.20 7.8% 2.0x 15.2% 48.8% 30.3% 64.4% 1.0 20.6x (1.0)% 31.2% 1,521 201 155 299 96 169 7,250 39,674 281 1.95 $ $ (1) 2017 includes Valspar financial results since June 1, 2017. (2) 2017 has been adjusted for the adoption of ASU No. 2017-07. See Note 1. (3) 2017 has been adjusted for an inventory accounting change made in 2018. See Note 1. (4) 2018 includes acquisition-related costs of $484.4 million, environmental expense provisions of $167.6 million, California litigation expense of $136.3 million and pension plan settlement expense of $37.6 million. 2017 includes acquisition-related costs of $488.6 million. 2016 includes acquisition-related costs of $133.6 million. (5) 2018 includes after-tax acquisition-related costs of $394.4 million, after-tax environmental expense provisions of $126.1 million, after-tax California litigation expense of $102.5 million and after-tax pension settlement expense of $28.3 million. 2017 includes a one-time income tax benefit of $668.8 million from Deferred income tax reductions (see Note 15) and after-tax acquisition related costs of $329.4 million. 2016 includes after-tax acquisition-related costs of $81.5 million. (6) 2018 includes charges of $4.15 per share for acquisition-related costs, $1.32 per share for environmental expense provisions, $1.09 per share for California litigation expense and $0.30 per share for pension settlement expense. 2017 includes a one-time benefit of $7.04 per share from Deferred income tax reductions (see Note 15) and a charge of $3.47 per share for acquisition-related costs. 2016 includes a charge of $0.86 per share for acquisition-related costs. (7) Based on net income and shareholders’ equity at beginning of year. (8) Based on cash dividends per common share and prior year’s diluted net income per common share. (9) Ratio of income before income taxes and interest expense to interest expense. (10) Based on income from continuing operations before income taxes. 2017 excludes impact of one-time income tax benefit primarily related to Tax Cuts and Jobs Act. (cid:31) 18 Management’s Discussion and Analysis of Financial Condition and Results of Operations Summary A voluntary inventory accounting change was made in the The Sherwin-Williams Company, founded in 1866, and its fourth quarter of 2018 driven by the Company’s integration consolidated wholly owned subsidiaries (collectively, the activities that impacted the application of last-in, first-out (LIFO) Company) are engaged in the development, manufacture, accounting method (Inventory Accounting Change) (See Note 1). distribution and sale of paint, coatings and related products to As a result of the Inventory Accounting Change in accordance with professional, industrial, commercial and retail customers primarily U.S. generally accepted accounting principles, a retrospective in North and South America with additional operations in the one-time adjustment was made to increase cost of goods sold Caribbean region, Europe, Asia and Australia. On June 1, 2017, the $58.9 million and related income tax credit $14.6 million which Company completed the acquisition (Acquisition) of The Valspar decreased net income $44.3 million and diluted net income per Corporation (Valspar) (See Note 4) for a total purchase price of share $.47 for the year ended December 31, 2017. Also, the $8.939 billion, which significantly affected the existing business. Inventory Accounting Change increased acquisition-related costs As of the close of the Acquisition, our reporting segments changed and decreased previously reported segment profit for to better reflect the operations of the combined companies. The Performance Coatings and Consumer Brands Groups by Company is structured into three reportable segments – The $35.7 million and $23.2 million, respectively, for the year ended Americas Group, Consumer Brands Group and Performance December 31, 2017. All impacted amounts have been adjusted in Coatings Group (collectively, the Reportable Segments) – and an this report for the Inventory Accounting Change for the year Administrative Segment in the same way it is internally organized ended December 31, 2017. for assessing performance and making decisions regarding Consolidated net sales increased 17.0 percent in 2018 to allocation of resources. See pages 8 through 15 of this report and $17.534 billion from $14.984 billion in 2017. The increase was due Note 19, on pages 75 through 77 of this report, for more primarily to incremental Valspar sales from the five months ended information concerning the Reportable Segments. May 2018 (Incremental Valspar), higher paint sales volume in The The Company’s financial condition, liquidity and cash flow Americas Group and selling price increases. Incremental Valspar sales continued to be strong in 2018 as net operating cash was a record increased net sales 12.4 percent for the year ended December 31, $1.944 billion primarily due to improved operating results from all 2018. As a result of the new revenue standard (ASC 606) adopted in three Reportable Segments. Net working capital decreased the first quarter of 2018, certain advertising support that was $373.0 million at December 31, 2018 compared to 2017 due to a previously classified as selling, general and administrative expenses is significant increase in other accruals included in current liabilities now classified as a reduction of revenue with no effect on net income. and a decrease in current assets. Cash and cash equivalents The new revenue standard decreased consolidated net sales less than decreased $48.7 million, while Other accruals and the California one percent in 2018. Consolidated gross profit as a percent of litigation accrual increased $168.4 million and $136.3 million, consolidated net sales decreased to 42.3 percent in 2018 compared respectively. On May 16, 2017, in order to fund the Acquisition, the to 44.8 percent in 2017 due primarily to the Acquisition and higher Company issued $6.000 billion of senior notes in a public offering. raw material costs, partially offset by price increases. Selling, general In April 2016, the Company entered into agreements for a and administrative expenses (SG&A) increased $236.1 million in 2018 $7.300 billion Bridge Loan and a $2.000 billion Term Loan as compared to 2017 and decreased as a percent of consolidated net committed financing for the Acquisition. On June 1, 2017, the sales to 28.7 percent in 2018 from 32.0 percent in 2017 primarily due Company terminated the agreement for the Bridge Loan and to the impact from Valspar operations. Amortization expense borrowed the full $2.000 billion on the Term Loan. The remaining increased $111.3 million to $318.1 million in 2018 versus 2017 due balance of the Term Loan was paid off in 2018 and the agreement primarily to the Acquisition and related purchase accounting was terminated. The Company has been able to arrange sufficient intangible amortization of twelve months in 2018 versus seven short-term borrowing capacity at reasonable rates, and the months in 2017. Other general expense-net increased $168.3 million in Company continues to have sufficient total available borrowing 2018 versus 2017 primarily due to a significant increase in capacity to fund its current operating needs. Net operating cash environmental provisions. increased $59.7 million in 2018 to a cash source of $1.944 billion Interest expense increased $103.3 million in 2018 versus 2017 from a cash source of $1.884 billion in 2017. primarily due to higher average annual debt levels related to the Strong net operating cash provided the funds necessary to Acquisition. The California litigation expense recorded in 2018 was invest in new stores and manufacturing and distribution facilities, $136.3 million. The effective income tax rate for 2018 was return cash to shareholders through dividends and treasury stock 18.5 percent. Excluding the income tax benefit of $668.8 million purchases, and pay down debt. from the Tax Cuts and Jobs Act of 2017 (Tax Act) and subsidiary (cid:31) 19 Management’s Discussion and Analysis of Financial Condition and Results of Operations mergers (collectively, Deferred income tax reductions), the unlikely to significantly impact the current valuation of assets and effective income tax rate for income from continuing operations liabilities that were not readily available from other sources. was 25.1 percent for 2017. See Note 15 on pages 71 through 73 for All of the significant accounting policies that were followed in more information on Income taxes. The Company also recorded an the preparation of the consolidated financial statements are income tax provision of $41.5 million in the second quarter of 2017 disclosed in Note 1, on pages 45 through 49, of this report. The related to the divestiture of Valspar’s North American industrial following procedures and assumptions utilized by management wood coatings business, which is reported as a discontinued directly impacted many of the reported amounts in the operation and reduced diluted net income per share by $.44 per consolidated financial statements. share. See Notes 1 and 15 for more information. Diluted net income per share for 2018 decreased to $11.67 per share from $18.20 per share for 2017. Diluted net income per share in 2018 included per share charges for acquisition-related costs of $4.15 and other non-operating expenses totaling $2.71. Other non-operating expenses included environmental provisions of $1.32, California litigation of $1.09 and pension plan settlement expense of $.30 per share. Currency translation rate changes decreased diluted net income per share in the year by $.21 per share. Diluted net income per share in 2017 included a one-time benefit of $7.04 per share from Deferred income tax reductions, a one-time charge of $.44 per share for discontinued operations and a charge of $3.47 per share for acquisition-related costs. Critical Accounting Policies and Estimates The preparation and fair presentation of the consolidated financial statements, accompanying notes and related financial information included in this report are the responsibility of management. The consolidated financial statements, accompanying notes and related financial information included in this report have been prepared in accordance with U.S. generally accepted accounting principles. The consolidated financial statements 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 Non-Traded Investments The Company has investments in the U.S. affordable housing and historic renovation real estate markets and certain other investments that have been identified as variable interest entities. The Company does not have the power to direct the day-to-day operations of the investments and the risk of loss is limited to the amount of contributed capital, and therefore, the Company is not considered the primary beneficiary. In accordance with the Consolidation Topic of the ASC, the investments are not consolidated. For affordable housing investments entered into prior to the January 1, 2015 adoption of ASU No. 2014-01, the Company uses the effective yield method to determine the carrying value of the investments. Under the effective yield method, the initial cost of the investments is amortized to income tax expense over the period that the tax credits are recognized. For affordable housing investments entered into on or after the January 1, 2015 adoption of ASU No. 2014-01, the Company uses the proportional amortization method. Under the proportional amortization method, the initial cost of the investments is amortized to income tax expense in proportion to the tax credits and other tax benefits received. The Company has no ongoing capital commitments, loan requirements or guarantees with the general partners that would require any future cash contributions other than the contractually committed capital contributions that are disclosed in the contractual obligations table on page 28 of this report. See Note 1, on page 45 of this report, for more information on non-traded investments. Accounts Receivable Accounts receivable were recorded at the time of credit sales net of provisions for sales returns and allowances. All provisions for allowances for doubtful collection of accounts are included in Selling, general and administrative expenses and were based on management’s best judgment and assessment, including an analysis of historical bad debts, a review of the aging of Accounts receivable and a review of the current creditworthiness of customers. Management recorded allowances for such accounts which were believed to be uncollectible, including amounts for the resolution of potential credit and other collection issues such as disputed invoices, customer satisfaction claims and pricing discrepancies. However, depending on how such potential issues (cid:31) 20 Management’s Discussion and Analysis of Financial Condition and Results of Operations are resolved, or if the financial condition of any of the Company’s useful lives of finite-lived intangible assets in accordance with the customers were to deteriorate and their ability to make required Goodwill and Other Intangibles Topic of the ASC. payments became impaired, increases in these allowances may be As required by the Goodwill and Other Intangibles Topic of the required. At December 31, 2018, no individual customer ASC, management performs impairment tests of goodwill and constituted more than 5 percent of Accounts receivable. indefinite-lived intangible assets on an annual basis, as well as Inventories Inventories were stated at the lower of cost or market with cost determined principally on the LIFO method based on inventory quantities and costs determined during the fourth quarter. Inventory quantities were adjusted during the fourth quarter as a result of annual physical inventory counts taken at all locations. If inventories accounted for on the LIFO method are reduced on a year-over-year basis, then liquidation of certain quantities carried at costs prevailing in prior years occurs. Management recorded the best estimate of net realizable value for obsolete and discontinued inventories based on historical experience and current trends through reductions to inventory cost by recording a provision included in Cost of goods sold. Where management estimated that the reasonable market value was below cost or determined that future demand was lower than current inventory levels, based on historical experience, current and projected market demand, current and projected volume trends and other relevant current and projected factors associated with the current economic conditions, a reduction in inventory cost to estimated net realizable value was made. See Note 3, on page 51 of this report, for more information regarding the impact of the LIFO inventory valuation. Purchase Accounting, Goodwill and Intangible Assets In accordance with the Business Combinations Topic of the ASC, the Company used the purchase method of accounting to allocate costs of acquired businesses to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. The excess costs of acquired businesses over the fair values of the assets acquired and liabilities assumed were recognized as Goodwill. The valuations of the acquired assets and liabilities will impact the determination of future operating results. In addition to using management estimates and negotiated amounts, the Company used a variety of information sources to determine the estimated fair values of acquired assets and liabilities including: third-party appraisals for the estimated value and lives of identifiable intangible assets and property, plant and equipment; third-party actuaries for the estimated obligations of defined benefit pension plans and similar benefit obligations; and legal counsel or other experts to assess the obligations associated with legal, environmental and other contingent liabilities. The business and technical judgment of management was used in determining which intangible assets have indefinite lives and in determining the whenever an event occurs or circumstances change that indicate impairment has more likely than not occurred. An optional qualitative assessment allows companies to skip the annual quantitative test if it is not more likely than not that impairment has occurred based on monitoring key Company financial performance metrics and macroeconomic conditions. The qualitative assessment is performed when deemed appropriate. In accordance with the Goodwill and Other Intangibles Topic of the ASC, management tests goodwill for impairment at the reporting unit level. A reporting unit is an operating segment per the Segment Reporting Topic of the ASC or one level below the operating segment (component level) as determined by the availability of discrete financial information that is regularly reviewed by operating segment management or an aggregate of component levels of an operating segment having similar economic characteristics. At the time of goodwill impairment testing (if performing a quantitative assessment), management determines fair value through the use of a discounted cash flow valuation model incorporating discount rates commensurate with the risks involved for each reporting unit. If the calculated fair value is less than the current carrying value, then impairment of the reporting unit exists. The use of a discounted cash flow valuation model to determine estimated fair value is common practice in impairment testing. The key assumptions used in the discounted cash flow valuation model for impairment testing include discount rates, growth rates, cash flow projections and terminal value rates. Discount rates are set by using the Weighted Average Cost of Capital (“WACC”) methodology. The WACC methodology considers market and industry data as well as Company-specific risk factors for each reporting unit in determining the appropriate discount rates to be used. The discount rate utilized for each reporting unit is indicative of the return an investor would expect to receive for investing in such a business. Operational management, considering industry and Company-specific historical and projected data, develops growth rates, sales projections and cash flow projections for each reporting unit. Terminal value rate determination follows common methodology of capturing the present value of perpetual cash flow estimates beyond the last projected period assuming a constant WACC and low long-term growth rates. As an indicator that each reporting unit has been valued appropriately through the use of the discounted cash flow valuation model, the aggregate of all reporting units’ fair value is reconciled to the total market capitalization of the Company. (cid:31) 21 Management’s Discussion and Analysis of Financial Condition and Results of Operations The Company had six components, some of which are aggregated due to similar economic characteristics, to form three reporting units (also the operating segments) with goodwill as of October 1, 2018, the date of the annual impairment test. The annual impairment review performed as of October 1, 2018 did not result in any of the reporting units having impairment or deemed at risk for impairment. In accordance with the Goodwill and Other Intangibles Topic of the ASC, management tests indefinite-lived intangible assets for impairment at the asset level, as determined by appropriate asset valuations at acquisition. Management utilizes the royalty savings method and valuation model to determine the estimated fair value for each indefinite-lived intangible asset or trademark. In this method, management estimates the royalty savings arising from the ownership of the intangible asset. The key assumptions used in estimating the royalty savings for impairment testing include discount rates, royalty rates, growth rates, sales projections and terminal value rates. Discount rates used are similar to the rates developed by the WACC methodology considering any differences in Company-specific risk factors between reporting units and trademarks. Royalty rates are established by management and valuation experts and periodically substantiated by valuation experts. Operational management, considering industry and Company-specific historical and projected data, develops growth rates and sales projections for each significant trademark. Terminal value rate determination follows common methodology of capturing the present value of perpetual sales estimates beyond the last projected period assuming a constant WACC and low long-term growth rates. The royalty savings valuation methodology and calculations used in 2018 impairment testing are consistent with prior years. The annual impairment review performed as of October 1, 2018 did not result in an impairment. The discounted cash flow and royalty savings valuation methodologies require management to make certain assumptions based upon information available at the time the valuations are performed. Actual results could differ from these assumptions. Management believes the assumptions used are reflective of what a market participant would have used in calculating fair value considering the current economic conditions. See Note 5, on pages 52 through 53 of this report, for a discussion of goodwill and intangible assets and the impairment tests performed in accordance with the Goodwill and Other Intangibles Topic of the ASC. Property, Plant and Equipment and Impairment of Long-Lived Assets Property, plant and equipment was stated on the basis of cost and depreciated principally on a straight-line basis using industry standards and historical experience to estimate useful lives. In accordance with the Property, Plant and Equipment Topic of the ASC, if events or changes in circumstances indicated that the carrying value of long-lived assets may not be recoverable or the useful life had changed, impairment tests were performed or the useful life was adjusted. Undiscounted future cash flows were used to calculate the recoverable value of long-lived assets to determine if such assets were impaired. Where impairment was identified, management determined fair values under the Fair Value Topic of the ASC. Growth models were developed using both industry and Company historical results and forecasts. If the usefulness of an asset was determined to be impaired, then management estimated a new useful life based on the period of time for projected uses of the asset. Fair value approaches and changes in useful life required management to make certain assumptions based upon information available at the time the valuation or determination was performed. Actual results could differ from these assumptions. Management believes the assumptions used are reflective of what a market participant would have used in calculating fair value or useful life considering the current economic conditions. All tested long-lived assets or groups of long-lived assets had undiscounted cash flows that were substantially in excess of their carrying value. See Notes 5 and 6, on pages 52 through 55 of this report, for a discussion of the reductions in carrying value or useful life of long-lived assets in accordance with the Property, Plant and Equipment Topic of the ASC. Exit or Disposal Activities Management is continually re-evaluating the Company’s operating facilities against its long-term strategic goals. Liabilities associated with exit or disposal activities are recognized as incurred in accordance with the Exit or Disposal Cost Obligations Topic of the ASC and property, plant and equipment is tested for impairment in accordance with the Property, Plant and Equipment Topic of the ASC. Provisions for qualified exit costs are made at the time a facility is no longer operational, include amounts estimated by management and primarily include post-closure rent expenses or costs to terminate the contract before the end of its term and costs of employee terminations. Adjustments may be made to liabilities accrued for qualified exit costs if information (cid:31) 22 Management’s Discussion and Analysis of Financial Condition and Results of Operations becomes available upon which more accurate amounts can be as actuarial assumptions and service costs change, and all such reasonably estimated. If impairment of property, plant and amounts will be amortized to expense over a period of years equipment exists, then the carrying value is reduced to fair value through the net pension and net periodic benefit costs. estimated by management. Additional impairment may be Pension costs for 2019 are expected to decrease significantly recorded for subsequent revisions in estimated fair value. See due to pension settlement lump sum activity in 2018 and annuity Note 6, on pages 53 through 55 of this report, for information contract purchases planned for 2019. The annuity contract concerning impairment of property, plant and equipment and purchases in 2019 are expected to result in a settlement charge of accrued qualified exit costs. approximately $30 million to $40 million in the first quarter of Other Liabilities The Company retains risk for certain liabilities, primarily worker’s compensation claims, employee medical benefits, and automobile, property, general and product liability claims. Estimated amounts were accrued for certain worker’s compensation, employee medical and disability benefits, automobile and property claims filed but unsettled and estimated claims incurred but not reported based upon management’s 2019. The Company will use any remaining overfunded cash surplus balances to fund future company contributions to a replacement defined contribution plan. Postretirement benefit plan costs for 2019 are expected to be approximately the same as 2018 due to similar actuarial assumptions being applied. See Note 7, on pages 55 through 60 of this report, for information concerning the Company’s defined benefit pension plans and postretirement benefit plans other than pensions. estimated aggregate liability for claims incurred using historical Debt experience, actuarial assumptions followed in the insurance The fair values of the Company’s publicly traded long-term industry and actuarially-developed models for estimating certain debt were based on quoted market prices. The fair values of the liabilities. Certain estimated general and product liability claims Company’s non-traded long-term debt were estimated using filed but unsettled were accrued based on management’s best discounted cash flow analyses, based on the Company’s current estimate of ultimate settlement or actuarial calculations of incremental borrowing rates for similar types of borrowing potential liability using industry experience and actuarial arrangements. See Note 1, on page 45 of this report, for the assumptions developed for similar types of claims. carrying amounts and fair values of the Company’s long-term Defined Benefit Pension and Other Postretirement Benefit Plans To determine the Company’s ultimate obligation under its debt, and Note 8, on pages 61 through 62 of this report, for a description of the Company’s long-term debt arrangements. defined benefit pension plans and postretirement benefit plans Environmental Matters other than pensions, management must estimate the future cost The Company is involved with environmental investigation and of benefits and attribute that cost to the time period during which remediation activities at some of its currently and formerly owned each covered employee works. To determine the obligations of sites and at a number of third-party sites. The Company accrues such benefit plans, management uses actuaries to calculate such for environmental-related activities for which commitments or amounts using key assumptions such as discount rates, inflation, clean-up plans have been developed and for which costs can be long-term investment returns, mortality, employee turnover, rate reasonably estimated based on industry standards and of compensation increases and medical and prescription drug professional judgment. All accrued amounts were recorded on an costs. Management reviews all of these assumptions on an undiscounted basis. Environmental-related expenses included ongoing basis to ensure that the most current information direct costs of investigation and remediation and indirect costs available is being considered. An increase or decrease in the such as compensation and benefits for employees directly assumptions or economic events outside management’s control involved in the investigation and remediation activities and fees could have a direct impact on the Company’s results of operations paid to outside engineering, actuarial, consulting and law firms. or financial condition. Due to uncertainties surrounding environmental investigations and In accordance with the Retirement Benefits Topic of the ASC, remediation activities, the Company’s ultimate liability may result the Company recognizes each plan’s funded status as an asset for in costs that are significantly higher than currently accrued. See overfunded plans and as a liability for unfunded or underfunded page 28 and Note 9, on pages 62 through 63 of this report, for plans. Actuarial gains and losses and prior service costs are information concerning the accrual for extended environmental- recognized and recorded in Cumulative other comprehensive loss, related activities and a discussion concerning unaccrued future a component of Shareholders’ equity. The amounts recorded in loss contingencies. Cumulative other comprehensive loss will continue to be modified (cid:31) 23 Management’s Discussion and Analysis of Financial Condition and Results of Operations Litigation and Other Contingent Liabilities 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. Management believes that the Company has properly accrued for all known liabilities that existed and those where a loss was deemed probable for which a fair value was available or an amount could be reasonably estimated in accordance with all present U.S. generally accepted accounting During the second quarter of 2018, the Company made purchase accounting adjustments related to the Acquisition which resulted in the reversal of income tax benefits related to the remeasurement of U.S. deferred tax liabilities. No other material adjustments were made under SAB No. 118 for the 2018 tax year. The Company has completed its analysis of the Tax Act in the fourth quarter and the accounting under the Tax Act has been finalized. See Note 15, on pages 71 through 73 of this report, for more information. principles. However, because litigation is inherently subject to Stock-Based Compensation many uncertainties and the ultimate result of any present or future The cost of the Company’s stock-based compensation is litigation is unpredictable, the Company’s ultimate liability may recorded in accordance with the Stock Compensation Topic of the result in costs that are significantly higher than currently accrued. ASC. The Company estimates the fair value of option rights using a In the event that the Company’s loss contingency is ultimately Black-Scholes-Merton option pricing model which requires determined to be significantly higher than currently accrued, the management to make estimates for certain assumptions. recording of the liability may result in a material impact on net Management and a consultant continuously review the following income for the annual or interim period during which such liability significant assumptions: risk-free interest rate, expected life of is accrued. Additionally, due to the uncertainties involved, any options, expected volatility of stock and expected dividend yield potential liability determined to be attributable to the Company of stock. An increase or decrease in the assumptions or economic arising out of such litigation may have a material adverse effect on events outside management’s control could have a direct impact the Company’s results of operations, liquidity or financial on the Company’s results of operations. See Note 13, on pages 68 condition. See Note 10 on pages 63 through 67 of this report for and 70 of this report, for more information on stock-based information concerning litigation. Income Taxes compensation. Revenue Recognition The Company estimated income taxes in each jurisdiction that The Company’s revenue was primarily generated from the sale it operated. This involved estimating taxable earnings, specific of products. All sales of products were recognized when shipped taxable and deductible items, the likelihood of generating and title passed to unaffiliated customers. Collectibility of amounts sufficient future taxable income to utilize deferred tax assets and recorded as revenue is probable at time of sale. Discounts were possible exposures related to future tax audits. To the extent recorded as a reduction to sales in the same period as the sale these estimates change, adjustments to deferred and accrued resulting in an appropriate net sales amount for the period. income taxes will be made in the period in which the changes Standard sales terms are final and returns or exchanges are not occur. permitted unless expressly stated. Estimated provisions for On December 22, 2017, the Tax Act was enacted. The Tax Act returns or exchanges, recorded as a reduction resulting in net significantly revised the U.S. corporate income tax system by, sales, were established in cases where the right of return existed. among other things, lowering corporate income tax rates from The Company offered a variety of programs, primarily to its retail 35% to 21%, implementing a territorial tax system and imposing a customers, designed to promote sales of its products. Such repatriation tax on deemed repatriated earnings of foreign programs required periodic payments and allowances based on subsidiaries. Staff Accounting Bulletin (SAB) No. 118 provides a estimated results of specific programs and were recorded as a measurement period that should not extend beyond one year reduction resulting in net sales. The Company accrued the from the enactment date for companies to complete the estimated total payments and allowances associated with each accounting under the Tax Act. In accordance with SAB No. 118, transaction at the time of sale. Additionally, the Company offered based on the information available as of December 31, 2018, the programs directly to consumers to promote the sale of its Company recorded provisional decreases in deferred tax liabilities products. Promotions that reduced the ultimate consumer sale which increased earnings for the year ended December 31, 2017. prices were recorded as a reduction resulting in net sales at the The majority of this benefit was driven by the effects of the time the promotional offer was made, generally using estimated implementation of the territorial tax system and the redemption and participation levels. The Company continually remeasurement of U.S. deferred tax liabilities on unremitted assesses the adequacy of accruals for customer and consumer foreign earnings. promotional program costs earned but not yet paid. To the extent (cid:31) 24 Management’s Discussion and Analysis of Financial Condition and Results of Operations total program payments differ from estimates, adjustments may Net Working Capital be necessary. Historically, these total program payments and adjustments have not been material. See Note 2 on page 49 for information on the new revenue standard. Financial Condition, Liquidity and Cash Flow Overview On June 1, 2017, the Company completed the Acquisition for a total purchase price of $8.939 billion. On May 16, 2017, the Company issued $6.000 billion of senior notes (New Notes) in a public offering. The net proceeds from the issuance of the New Notes were used to fund the Acquisition. In April 2016, the Company entered into a $7.300 billion bridge credit agreement (Bridge Loan) and a $2.000 billion term loan credit agreement (Term Loan) as committed financing for the Acquisition. On June 1, 2017, the Company terminated the agreement for the Bridge Loan and borrowed the full $2.000 billion on the Term Loan. 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. The Acquisition significantly affected the Company’s financial condition, liquidity and cash flow. See Note 4 for a table detailing the final opening balance sheet. Net working capital decreased $373.0 million at December 31, 2018 compared to 2017 due to a significant increase in other accruals included in current liabilities and a decrease in current assets. Total debt at December 31, 2018 decreased $1.177 billion to $9.344 billion from $10.521 billion at December 31, 2017 and decreased as a percentage of total capitalization to 71.5 percent from 74.3 percent the prior year. At December 31, 2018, the Company had remaining short-term borrowing ability of $3.209 billion. Net operating cash increased $59.7 million in 2018 to a cash source of $1.944 billion from a cash source of $1.884 billion in 2017 due primarily to increased cash generated by changes in working capital and favorable changes in non-cash items when compared to 2017, partially offset by a reduction in net income of $619.2 million. Net operating cash decreased as a percent to sales to 11.1 percent in 2018 compared to 12.6 percent in 2017. During 2018, strong net operating cash continued to provide the funds necessary to pay down total net debt, invest in new stores and manufacturing and distribution facilities, and return cash to shareholders through treasury stock purchases and dividends paid. In 2018, the Company used a portion of Net operating cash and Cash and cash equivalents to pay down total net debt $1.154 billion, purchase $613.3 million in treasury stock, spend $251.0 million in capital additions and improvements and pay $322.9 million in cash dividends to its shareholders of stock. Total current assets less Total current liabilities (net working capital) decreased $373.0 million to a surplus of $46.7 million at December 31, 2018 from a surplus of $419.8 million at December 31, 2017. The net working capital decrease is due to a significant increase in other accruals included in current liabilities and a decrease in current assets. Accounts payable increased $7.9 million and other accruals increased $168.4 million both due to timing of payments. The California litigation accrual of $136.3 million was recorded in 2018. Cash and cash equivalents decreased $48.7 million and Short-term borrowings decreased $305.3 million resulting from the 1.35% senior notes becoming due in 2019 while the current portion of long-term debt increased $306.0 million. Accounts receivable decreased $85.8 million and inventories increased $72.8 million primarily due to increased cost. As a result of the net effect of these changes, the Company’s current ratio decreased to 1.01 at December 31, 2018 from 1.11 at December 31, 2017. Accounts receivable as a percent of Net sales decreased to 11.5 percent in 2018 from 14.0 percent in 2017. Accounts receivable days outstanding remained unchanged at 61 days in 2018 and 2017. In 2018, provisions for allowance for doubtful collection of accounts decreased $7.1 million, or 13.4 percent. Inventories as a percent of Net sales decreased to 10.4 percent in 2018 from 11.6 percent in 2017 primarily due to tighter inventory management. Inventory days outstanding increased to 81 days in 2018 versus 78 days in 2017. The Company has sufficient total available borrowing capacity to fund its current operating needs. Goodwill and Intangible Assets Goodwill, which represents the excess of cost over the fair value of net assets acquired in purchase business combinations, increased $142.4 million in 2018 due to final purchase accounting measurement period adjustments for the Acquisition of $213.6 million partially offset by foreign currency translation rate fluctuations of $71.2 million. Intangible assets decreased $800.8 million in 2018 primarily due to final purchase accounting measurement period adjustments for the Acquisition of $310.5 million, amortization of finite-lived intangible assets of $318.1 million and foreign currency translation rate fluctuations of $173.4 million. Acquired finite-lived intangible assets included customer relationships and intellectual property. Costs related to designing, developing, obtaining and implementing internal use software are capitalized and amortized in accordance with the Goodwill and Other Intangibles Topic of the ASC. See Note 5, on pages 52 through 53 of this report, for a description of goodwill, identifiable intangible assets and asset impairments recorded in accordance with the Goodwill and Other Intangibles Topic of the ASC and summaries of the remaining carrying values of goodwill and intangible assets. (cid:31) 25 Management’s Discussion and Analysis of Financial Condition and Results of Operations Deferred Pension and Other Assets Debt Deferred pension assets of $270.7 million at December 31, 2018 On June 2, 2017, the Company closed its previously announced represent the excess of the fair value of assets over the actuarially exchange offers and consent solicitations (Exchange Offer) for the determined projected benefit obligations, primarily of the outstanding senior notes of Valspar. Pursuant to the Exchange domestic salaried defined benefit pension plan. The decrease in Offer, the Company issued an aggregate principal amount of Deferred pension assets during 2018 of $26.1 million from approximately $1.478 billion (Exchange Notes). On May 16, 2017, $296.7 million last year was primarily due to actual returns on plan the Company issued $6.0 billion of New Notes in a public offering. assets being lower than expected returns. In accordance with the The net proceeds from the issuance of the New Notes were used accounting prescribed by the Retirement Benefits Topic of the to fund the Acquisition. The interest rate locks entered into during ASC, the decrease in the value of the Deferred pension assets is 2016 settled in March 2017 resulting in a pretax gain of offset in Cumulative other comprehensive loss and is amortized as $87.6 million recognized in Cumulative other comprehensive other a component of Net pension costs over a defined period of loss. This gain is being amortized from Cumulative other pension service. See Note 7, on pages 55 through 60 of this report, comprehensive loss to a reduction of interest expense over the for more information concerning the excess fair value of assets terms of the New Notes. For 2018, the amortization of the over projected benefit obligations of the salaried defined benefit unrealized gain reduced interest expense by $8.3 million. pension plan and the amortization of actuarial gains or losses In April 2016, the Company entered into a $7.3 billion Bridge relating to changes in the excess assets and other actuarial Loan and a $2.0 billion Term Loan as committed financing for the assumptions. Acquisition, as disclosed in Note 4. On June 1, 2017, the Company Other assets increased $82.0 million to $584.0 million at terminated the agreement for the Bridge Loan and borrowed the December 31, 2018 due primarily to increases in customer contract full $2.0 billion on the Term Loan. As of December 31, 2018, the assets. Property, Plant and Equipment Net property, plant and equipment decreased $100.3 million to $1.777 billion at December 31, 2018 due primarily to depreciation expense of $278.2 million and sale or disposition of assets with remaining net book value of $99.0 million partially offset by capital expenditures of $251.0 million, and currency translation and other adjustments of $25.9 million. Capital expenditures during 2018 in The Americas Group were primarily attributable to the opening of new paint stores and renovation and improvements in existing stores. In the Consumer Brands Group, capital expenditures during 2018 were primarily attributable to improvements and normal equipment replacements in manufacturing and distribution facilities. Capital expenditures in the Performance Coatings Group were primarily attributable to improvements in existing manufacturing and distribution facilities. The Administrative Segment incurred capital expenditures primarily for information systems hardware. In 2019, the Company expects to spend more than 2018 for capital expenditures. The predominant share of the capital expenditures in 2019 is expected to be for various productivity improvement and maintenance projects at existing manufacturing, distribution and research and development facilities, new store openings and new or upgraded information systems hardware. The Company does not anticipate the need for any specific long-term external financing to support these capital expenditures. Term Loan had no outstanding principal balance and the agreement was terminated. In August 2017, the Company entered into a floating rate loan of €225.0 million and a fixed rate loan of €20.0 million. The floating rate loan agreement bears interest at the six-month Euro Interbank Offered Rate plus a margin. The fixed rate loan bears interest at 0.92%. The proceeds will be used for general corporate purposes, including repaying a portion of outstanding short-term borrowings. The loans mature on August 23, 2021. On July 19, 2018, the Company and three of its wholly-owned subsidiaries, Sherwin-Williams Canada, Inc., Sherwin-Williams Luxembourg S.à r.l and Sherwin-Williams UK Holding Limited (all together with the Company, the Borrowers), entered into a new five-year $2.000 billion credit agreement (New Credit Agreement). The New Credit Agreement may be used for general corporate purposes, including the financing of working capital requirements. The New Credit Agreement replaced a credit agreement dated July 16, 2015, as amended, which was terminated. The New Credit Agreement allows the Company to extend the maturity of the facility with two one-year extension options and the Borrowers to increase the aggregate amount of the facility to $2.750 billion, both of which are subject to the discretion of each lender. In addition, the Borrowers may request letters of credit in an amount of up to $250.0 million. At December 31, 2018, there were no short-term borrowings under the New Credit Agreement. Borrowings outstanding under various other foreign programs were $37.0 million at December 31, 2018 with a weighted average interest rate of 9.3%. (cid:31) 26 Management’s Discussion and Analysis of Financial Condition and Results of Operations In September 2017, the Company entered into a five-year letter defined benefit pension plans increased to 3.0 percent at of credit agreement, subsequently amended on multiple dates, December 31, 2018 from 2.73 percent at December 31, 2017 with an aggregate availability of $625.0 million at December 31, primarily due to higher interest rates. The assumed discount rate 2018. On May 6, 2016, the Company entered into a five-year credit used to determine the projected benefit obligation for other agreement, subsequently amended on multiple dates. This credit postretirement benefit obligations increased to 4.2 percent at agreement gives the Company the right to borrow and to obtain December 31, 2018 from 3.6 percent at December 31, 2017 for the the issuance, renewal, extension and increase of a letter of credit same reason. The rate of compensation increases used to up to an aggregate availability of $875.0 million at December 31, determine the projected benefit obligations at December 31, 2018 2018. Both of these credit agreements are being used for general was 3.2 percent for domestic pension plans and 3.7 percent for corporate purposes. At December 31, 2018, there were no foreign pension plans, which was comparable to the rates used in borrowings outstanding under these credit agreements. There the prior year. In deciding on the rate of compensation increases, were $350.0 million borrowings outstanding at December 31, 2017 management considered historical Company increases as well as and no borrowings outstanding at December 31, 2016. There were expectations for future increases. The expected long-term rate of $291.4 million borrowings outstanding under the Company’s return on assets remained 5.0 percent at December 31, 2018 for domestic commercial paper program at December 31, 2018. There domestic pension plans and was slightly lower for most foreign were $274.8 million borrowings outstanding at December 31, 2017 plans. In establishing the expected long-term rate of return on and no borrowings outstanding at December 31, 2016. See Note 8, plan assets for 2018, management considered the historical rates on pages 61 through 62 of this report, for a detailed description of of return, the nature of investments and an expectation for future the Company’s debt outstanding and other available financing investment strategies. The assumed health care cost trend rates programs. Defined Benefit Pension and Other Postretirement Benefit Plans The Company’s domestic defined benefit pension plan for salaried employees was terminated during 2018 and the participants were moved to a replacement defined contribution plan. The Company is in the process of settling the liabilities of the terminated plan through a combination of (i) lump sum payments to eligible participants who elected to receive them and (ii) the purchase of annuity contracts for participants who either did not elect lump sums or were already receiving benefit payments. The lump sum payments were paid in December 2018 and resulted in a settlement charge of $37.6 million in 2018. The annuity contract purchases in 2019 are expected to result in a settlement charge of approximately $30 million to $40 million in the first quarter of 2019. The Company will use any remaining overfunded cash surplus balances to fund future company contributions to a replacement defined contribution plan. The Company’s domestic defined benefit pension plan for hourly employees continues to operate. In accordance with the accounting prescribed by the used to determine the net periodic benefit cost of postretirement benefits other than pensions for 2018 were 5.0 percent and 11.0 percent, respectively, for medical and prescription drug cost increases, both decreasing gradually to 4.5 percent in 2026. In developing the assumed health care cost trend rates, management considered industry data, historical Company experience and expectations for future health care costs. For 2019 Net pension cost for the ongoing domestic pension plan, the Company will use a discount rate of 4.4 percent, an expected long-term rate of return on assets of 5.0 percent and a rate of compensation increase of 3.2 percent. Lower discount rates and expected long-term rates of return on plan assets will be used for most foreign plans. For 2019 Net periodic benefit costs for postretirement benefits other than pensions, the Company will use a discount rate of 4.21 percent. Net pension cost in 2019 for the ongoing domestic pension plan is expected to be approximately $4.6 million. Net periodic benefit costs for postretirement benefits other than pensions in 2019 is expected to be comparable to 2018 expense. See Note 7, on pages 55 through 60 of this report, for more information on the Company’s obligations and funded status of its defined benefit pension plans and postretirement benefits Retirement Benefits Topic of the ASC, the Company’s total liability for unfunded or underfunded defined benefit pension plans other than pensions. decreased $13.2 million to $80.7 million primarily due to changes Deferred Income Taxes in the actuarial assumptions. Postretirement benefits other than Deferred income taxes at December 31, 2018 decreased pensions decreased $16.2 million to $274.6 million at December 31, $288.7 million from a year ago primarily due to the final purchase 2018 due primarily to changes in the actuarial assumptions. accounting measurement period adjustments for the Acquisition The assumed discount rate used to determine the projected and the impact of amortization of intangible assets and reversal of benefit obligation for domestic defined benefit pension plans was the associated deferred tax liabilities. See Note 4 on page 51 and 3.6 percent at December 31, 2018 and 2017. The assumed discount Note 15 on pages 71 through 73 of this report for more information. rate used to determine the projected benefit obligation for foreign (cid:31) 27 Management’s Discussion and Analysis of Financial Condition and Results of Operations Other Long-Term Liabilities Other long-term liabilities increased $324.8 million during 2018 due primarily to net increases of $142.9 million in environmental- Company conducts its operations in compliance with applicable environmental laws and regulations and has implemented various programs designed to protect the environment and promote related long-term liabilities and a liability of $225.3 million incurred continued compliance. in 2018 resulting from real estate financing lease transactions, partially offset by decreases in other long-term liabilities. See Note 9, on pages 62 through 63 of this report, for further information on Operating Leases. 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 Contractual Obligations and Commercial Commitments 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 2018. 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 2019. See Note 9, on pages 62 through 63 of this report, for further information on environmental-related long-term liabilities. The Company has certain obligations and commitments to make future payments under contractual obligations and commercial commitments. The following tables summarize such obligations and commitments as of December 31, 2018. (thousands of dollars) Contractual Obligations Long-term debt ................................................. Interest on Long-term debt ................................ Operating leases ................................................ Short-term borrowings ...................................... California litigation accrual ................................. Real estate financing transactions ....................... Purchase obligations(1) ....................................... Other contractual obligations(2) .......................... Payments Due by Period Total $ 9,056,373 3,796,353 1,906,527 328,403 136,333 225,914 77,758 285,123 Less than 1 Year $ 301,149 308,057 412,211 328,403 136,333 13,516 77,758 190,884 1–3 Years 3–5 Years $ 1,781,380 542,939 676,564 $ 1,650,540 445,129 425,329 More than 5 Years $ 5,323,304 2,500,228 392,423 27,033 27,958 157,407 62,472 19,149 12,618 Total contractual cash obligations ....................... $ 15,812,784 $ 1,768,311 $ 3,090,388 $ 2,568,105 $ 8,385,980 (1) Relate to open purchase orders for raw materials at December 31, 2018. (2) Relate primarily to estimated future capital contributions to investments in the U.S. affordable housing and historic renovation real estate partnerships and various other contractual obligations. Commercial Commitments Total Standby letters of credit .......................................................... Surety bonds .......................................................................... $ 65,622 86,429 Less than 1 Year $ 65,622 86,429 1–3 Years 3–5 Years More than 5 Years Total commercial commitments ............................................... $ 152,051 $ 152,051 $ — $ — $ — Amount of Commitment Expiration Per Period (cid:31) 28 Management’s Discussion and Analysis of Financial Condition and Results of Operations Warranties Directors at December 31, 2018 to purchase 10.13 million shares of The Company offers product warranties for certain products. its common stock. The specific terms and conditions of such warranties vary depending on the product or customer contract requirements. Management estimated the costs of unsettled product warranty claims based on historical results and experience and included an amount in Other accruals. Management periodically assesses the adequacy of the accrual for product warranty claims and adjusts the accrual as necessary. Changes in the Company’s accrual for product warranty claims during 2018, 2017 and 2016, including customer satisfaction settlements during the year, were as follows: Balance at January 1 ............. Charges to expense ............. Settlements ........................ Acquisition, divestiture and 2018 2017 2016 $ 151,425 31,706 (57,843) $ 34,419 39,707 (53,143) $ 31,878 38,954 (36,413) other adjustments ............ (68,221) 130,442 Balance at December 31 ....... $ 57,067 $ 151,425 $ 34,419 Warranty accruals acquired in connection with the Acquisition include warranties for certain products under extended furniture protection plans. The furniture protection plan business was divested during 2018 for an immaterial amount that approximated net book value. Shareholders’ Equity The Company’s 2018 annual cash dividend of $3.44 per share represented 18.9 percent of 2017 diluted net income per share. The 2018 annual dividend represented the fortieth consecutive year of dividend payments since the dividend was suspended in 1978. The Company is temporarily modifying its practice of paying 30.0 percent of the prior year’s diluted net income per share in cash dividend. At a meeting held on February 13, 2019, the Board of Directors increased the quarterly cash dividend to $1.13 per share. This quarterly dividend, if approved in each of the remaining quarters of 2019, would result in an annual dividend for 2019 of $4.52 per share or a 38.7 percent payout of 2018 diluted net income per share. See the Statements of Consolidated Shareholders’ Equity, on page 44 of this report, and Notes 11, 12 and 13, on pages 67 through 70 of this report, for more information concerning Shareholders’ equity. Cash Flow Net operating cash increased $59.7 million in 2018 to a cash source of $1.944 billion from a cash source of $1.884 billion in 2017 due primarily to increased cash generated by changes in working capital and favorable changes in non-cash items when compared to 2017, partially offset by a reduction in net income of $619.2 million. Net operating cash decreased as a percent to sales to 11.1 percent in 2018 compared to 12.6 percent in 2017. During 2018, strong net Shareholders’ equity increased $82.9 million to $3.731 billion at operating cash continued to provide the funds necessary to pay December 31, 2018 from $3.648 billion last year primarily due to an down total net debt, invest in new stores and manufacturing and increase in retained earnings of $788.1 million and an increase in distribution facilities, and return cash to shareholders through Other capital of $173.3 million, partially offset by purchase of treasury stock purchases and dividends paid. Net investing cash Treasury stock and Treasury stock received from stock option usage decreased $8.796 billion to a usage of $251.6 million in 2018 exercises totaling $634.3 million and an increase in Cumulative from a usage of $9.047 billion in 2017 due primarily to cash paid for other comprehensive loss of $245.1 million. Retained earnings the Acquisition of $8.810 billion and decreases in cash used for increased $788.1 million during 2018 due to net income of other investments of $22.5 million, partially offset by increased $1.109 billion partially offset by $322.9 million in cash dividends capital expenditures of $28.2 million and decreased proceeds from paid. The increase in Other capital of $173.3 million was due sale of assets of $8.9 million. Net financing cash usage increased primarily to the recognition of stock-based compensation expense $8.261 billion to a usage of $1.747 billion in 2018 from a source of and stock option exercises. The increase in Cumulative other $6.514 billion in 2017 due primarily to decreased proceeds from comprehensive loss of $245.1 million was due primarily to long-term debt of $8.275 billion, decreased net short-term unfavorable foreign currency translation effects of $254.3 million borrowings of $657.3 million, treasury stock purchases in 2018 of and $6.2 million reduction in the unrealized gain on the interest $613.3 million and decreased proceeds from stock options rate locks, partially offset by $17.8 million in net actuarial loss and exercised of $52.8 million, partially offset by decreased payments prior service costs of defined benefit pension and other of long-term debt of $1.000 billion and proceeds from real estate postretirement benefit plans net of amortization. financing transactions in 2018 of $225.3 million. In 2018, the The Company purchased 1.525 million shares of its common Company used Net operating cash and Cash and cash equivalents stock for treasury during 2018. The Company acquires its common on hand to spend $251.0 million in capital additions and stock for general corporate purposes, and depending on its cash improvements, make treasury stock purchases of $613.3 million, position and market conditions, it may acquire shares in the future. pay $322.9 million in cash dividends to its shareholders of common The Company had remaining authorization from its Board of stock and pay down long-term debt $852.6 million and short-term borrowings $300.9 million. (cid:31) 29 Management’s Discussion and Analysis of Financial Condition and Results of Operations Management considers a measurement of cash flow that is not Financial Covenant in accordance with U.S. generally accepted accounting principles to be a useful tool in its determination of appropriate uses of the Company’s Net operating cash. Management reduces Net operating cash, as shown in the Statements of Consolidated Cash Flows, by the amount reinvested in the business for Capital expenditures and the return of investment to its shareholders by the payments of cash dividends. The resulting value is referred to by management as “Free Cash Flow” which may not be comparable to values considered by other entities using the same terminology. The reader is cautioned that the Free Cash Flow measure should not be compared to other entities unknowingly, and it does not consider certain non-discretionary cash flows, such as mandatory debt and interest payments. The amount shown below should not be considered an alternative to Net operating cash or other cash flow amounts provided in accordance with U.S. generally accepted accounting principles disclosed in the Statements of Consolidated Cash Flows, on page 43 of this report. Free Cash Flow as defined and used by management is determined as follows: (thousands of dollars) Net operating cash ......... Capital expenditures ...... Cash dividends .............. Year Ended December 31, 2017 2018 2016 $1,943,700 $1,883,968 $1,308,572 (239,026) (312,082) (250,957) (322,934) (222,767) (319,029) Free cash flow ............... $1,369,809 $ 1,342,172 $ 757,464 Litigation See page 24 of this report and Note 10 on pages 63 through 67 Certain borrowings contain a consolidated leverage covenant. The covenant states the Company’s leverage ratio is not to exceed 4.75 to 1.00. The leverage ratio is defined as the ratio of total indebtedness (the sum of Short-term borrowings, Current portion of long-term debt and Long-term debt) at the reporting date to consolidated “Earnings Before Interest, Taxes, Depreciation and Amortization” (EBITDA) for the 12-month period ended on the same date. Refer to the “Results of Operations” caption below for a reconciliation of EBITDA to Net income. At December 31, 2018, the Company was in compliance with the covenant. The Company’s Notes, Debentures and revolving credit agreement contain various default and cross-default provisions. In the event of default under any one of these arrangements, acceleration of the maturity of any one or more of these borrowings may result. See Note 8 on pages 61 through 62 of this report. Employee Stock Ownership Plan (ESOP) Participants in the Company’s ESOP are allowed to contribute up to the lesser of twenty percent of their annual compensation or the maximum dollar amount allowed under the Internal Revenue Code. The Company matches six percent of eligible employee contributions. The Company’s matching contributions to the ESOP charged to operations were $104.7 million in 2018 compared to $90.7 million in 2017. At December 31, 2018, there were 9,353,926 shares of the Company’s common stock being held by the ESOP, representing 10.0 percent of the total number of voting shares outstanding. See Note 12, on page 68 of this report, for more information concerning the Company’s ESOP. for more information concerning litigation. Results of Operations—2018 vs. 2017 Market Risk The Company is exposed to market risk associated with interest rate, foreign currency and commodity fluctuations. The Company occasionally utilizes derivative instruments as part of its overall financial risk management policy, but does not use derivative instruments for speculative or trading purposes. The Company entered into foreign currency forward contracts with maturity dates of less than twelve months in 2018, 2017 and 2016, primarily to hedge against value changes in foreign currency. There were no material foreign currency forward contracts Shown below are net sales and segment profit and the percentage change for the current period by segment for 2018 and 2017: (thousands of dollars) Year Ended December 31, 2018 2017 Change Net Sales: The Americas Group ........... $ 9,625,139 $ 9,117,279 2,154,729 Consumer Brands Group ..... Performance Coatings 2,739,053 5.6% 27.1% Group ............................. Administrative .................... 5,166,380 3,921 3,706,134 5,646 39.4% -30.6% outstanding at December 31, 2018, 2017 and 2016. The Company Net sales ............................ $17,534,493 $14,983,788 17.0% believes it may be exposed to continuing market risk from foreign currency exchange rate and commodity price fluctuations. However, the Company does not expect that foreign currency exchange rate and commodity price fluctuations or hedging contract losses will have a material adverse effect on the Company’s financial condition, results of operations or cash flows. See Notes 1 and 14 on pages 46 and 71 of this report. (cid:31) 30 (thousands of dollars) Year Ended December 31, 2018 2017 Change Income Before Income Taxes: 7.3% The Americas Group ................. $1,898,403 $1,769,466 28.7% 202,813 Consumer Brands Group ........... 262,782 Performance Coatings Group ..... 72.0% (765,751) -63.5% Administrative .......................... 261,068 452,089 (1,251,910) Income before income taxes ...... $1,359,650 $ 1,469,310 -7.5% Management’s Discussion and Analysis of Financial Condition and Results of Operations Consolidated net sales for 2018 increased due primarily to decreased net sales 0.1 percent compared to 2017. In 2018, the Incremental Valspar, higher paint sales volume in The Americas Performance Coatings Group opened 3 new branches and closed Group and selling price increases. Incremental Valspar sales 11 locations decreasing the total from 290 to 282 branches open in increased net sales 12.4 percent for the year ended December 31, the United States, Canada, Mexico, South America, Europe and 2018. As a result of the new revenue standard (ASC 606) adopted Asia at year-end. In 2019, the Performance Coatings Group plans in the first quarter of 2018, certain advertising support that was to continue expanding its worldwide presence and improving its previously classified as selling, general and administrative customer base. expenses is now classified as a reduction of revenue with no effect Net sales in the Administrative segment, which primarily on net income. The new revenue standard decreased consolidated consists of external leasing revenue of excess headquarters space net sales less than 1 percent in the year and quarter. Currency and leasing of facilities no longer used by the Company in its translation rate changes decreased 2018 consolidated net sales by primary business, decreased by an insignificant amount in 2018. 0.6 percent. Net sales of all consolidated foreign subsidiaries Consolidated gross profit increased $699.8 million in 2018 due increased 36.1 percent to $4.028 billion for 2018 versus primarily to Incremental Valspar sales, higher paint sales volume, $2.960 billion for 2017 due primarily to Incremental Valspar sales. reduced impacts of purchasing accounting costs on cost of sales, Net sales of all operations other than consolidated foreign and selling price increases, partially offset by raw material cost subsidiaries increased 12.3 percent to $13.507 billion for 2018 increases and incremental supply chain costs for load-in demand versus $12.024 billion for 2017. of a new customer program. Consolidated gross profit as a percent Net sales in The Americas Group increased due primarily to to net sales decreased to 42.3 percent from 44.8 percent in 2017 higher architectural paint sales volume across most end market due primarily to a full year of Valspar sales, raw material cost segments and selling price increases. Net sales from stores in U.S. increases, incremental supply chain costs for load-in demand of a and Canada open for more than twelve calendar months increased new customer program and the impact of adopting ASC 606, 5.1 percent in the year and 2.9 percent in the quarter over last partially offset by higher paint sales volume, reduced impacts of year’s comparable periods. Currency translation rate changes purchasing accounting costs on cost of sales, and selling price reduced net sales by 1.0 percent compared to 2017. During 2018, increases. The Americas Group’s gross profit for 2018 increased The Americas Group opened 91 new stores and closed 15 $225.0 million compared to 2017 due primarily to higher paint redundant locations for a net increase of 76 stores, increasing the sales volume and selling price increases, partially offset by higher total number of stores in operation at December 31, 2018 to 4,696 raw material costs. The Americas Group’s gross profit margins in the United States, Canada, Latin America and the Caribbean. declined primarily due to increased raw material costs, partially The Americas Group’s objective is to expand its store base an offset by higher paint sales volume and selling price increases. The average of 2.5 percent each year, primarily through internal Consumer Brands Group’s gross profit increased $132.4 million due growth. Sales of products other than paint increased primarily to Incremental Valspar sales, reduced impacts of approximately 5.4 percent for the year over 2017. A discussion of purchasing accounting costs on cost of sales, and selling price changes in volume versus pricing for sales of products other than increases, partially offset by raw material cost increases and paint is not pertinent due to the wide assortment of general incremental supply chain costs for load-in demand of a new merchandise sold. customer program. The Consumer Brands Group’s gross profit Net sales of the Consumer Brands Group increased in 2018 margins declined primarily due to raw material cost increases and primarily due to Incremental Valspar sales, selling price increases incremental supply chain costs for load-in demand of a new and a new customer program, partially offset by lower volume customer program and the impact of adopting ASC 606, partially sales to some of the Group’s retail customers and the impact of offset by reduced impacts of purchasing accounting costs on cost adopting ASC 606. Incremental Valspar sales increased Group net of sales, and selling price increases. The Performance Coatings sales 26.9 percent in the year. The adoption of ASC 606 reduced Group’s gross profit for 2018 increased $390.7 million due Group net sales by 4.8 percent. In 2019, the Consumer Brands primarily to Incremental Valspar sales, reduced impacts of Group plans to continue promotions of new and existing products purchasing accounting costs on cost of sales, and selling price and expand its customer base and product assortment at existing increases, partially offset by raw material cost increases. The customers. Performance Coatings Group’s gross profit margins declined The Performance Coatings Group’s net sales in 2018 increased primarily due to raw material cost increases, partially offset by due primarily to Incremental Valspar sales and selling price reduced impacts of purchasing accounting costs on cost of sales, increases. Incremental Valspar sales increased Group net sales and selling price increases. Acquisition-related purchase 34.3 percent in the year. Currency translation rate changes accounting impacts were lower in 2018 in cost of sales for the (cid:31) 31 Management’s Discussion and Analysis of Financial Condition and Results of Operations Consumer Brands and Performance Coatings Groups by As required by the Goodwill and Other Intangibles Topic of the $54.8 million and $68.2 million, respectively, versus 2017. ASC, management performed an annual impairment test of SG&A increased by $236.1 million due primarily to the inclusion goodwill and indefinite-lived intangible assets as of October 1, of Incremental Valspar SG&A, increased expenses to support 2018 which did not result in any impairment. The impairment tests higher sales levels and net new store openings, partially offset by in 2017, resulted in a $2.0 million impairment of trademarks realized administrative and selling synergies from the Acquisition recorded in The Americas Group. See Note 5, on pages 52 and 53 and the adoption of ASC 606. SG&A decreased as a percent of of this report, for more information concerning the impairment of sales to 28.7 percent in 2018 from 32.0 percent in 2017 primarily intangible assets. due to realized administrative and selling synergies from the Interest expense increased $103.3 million in 2018 primarily due Acquisition, improved expense control and the adoption of ASC to higher average debt levels related to the Acquisition. 606, partially offset by increased expenses to support higher sales Other expense (income) – net had an unfavorable change by levels and net new store openings. In The Americas Group, SG&A $52.8 million of expense in 2018 compared to 2017. This change increased $92.6 million for the year due primarily to increased was mainly due to a pension plan settlement expense of spending due to the number of new store openings and general $37.6 million recorded in 2018 in the Administrative segment and comparable store expenses to support higher sales levels. The was a result of elected lump sum cash payouts to defined benefit Consumer Brands Group’s SG&A increased by $32.1 million for the plan participants. In addition, foreign currency related transaction year primarily due to the inclusion of Incremental Valspar SG&A losses increased $7.1 million in 2018, primarily in The Americas and increased expenses to support higher sales levels, partially Group and Consumer Brands Group. There were no other items offset by realized administrative and selling synergies from the within Other income or Other expense that were individually Acquisition and adoption of ASC 606. The Performance Coatings significant at December 31, 2018. Note 7, on page 55 to 60 of this Group’s SG&A increased by $126.5 million for the year primarily report, for more information concerning Pension information. See due to the inclusion of Incremental Valspar SG&A and increased Note 14 on page 70 of this report for more information concerning expenses to support higher sales levels, partially offset by realized Other expense (income) – net. administrative and selling synergies from the Acquisition. The Consolidated Income before income taxes in 2018 decreased Administrative segment’s SG&A decreased $15.1 million primarily $109.7 million resulting from an increase of $236.1 million in SG&A, due to decreased Acquisition-related costs and realized Other general expense – net increase of $168.3 million, the 2018 administrative synergies from the Acquisition, partially offset by California litigation charge of $136.3 million, an increase of Incremental Valspar SG&A. $109.3 million in amortization and impairment expenses in total, an Amortization and impairment expenses in total increased increase of $103.3 million in interest expense, and increased Other $109.3 million in 2018 primarily due to a full year of amortization of expense (income) – net of $52.8 million, partially offset by an Acquisition-related intangibles. Amortization of Acquisition-related increase of $699.8 million in gross profit. Income before income intangibles increased by $72.1 million and $34.9 million for the taxes increased $128.9 million, $189.3 million and $58.3 million in Performance Coatings and Consumer Brands Groups, respectively. The Americas, Performance Coating, and Consumer Brands The California litigation charge of $136.3 million was recorded Groups, respectively, when compared to 2017. The Administrative in the third quarter 2018. See Note 10, on page 63 to 67 of this segment expenses decreased Income before income taxes report, for more information concerning Litigation. $486.2 million more than in 2017 resulting primarily from increased Other general expense – net increased $168.3 million in 2018 Acquisition-related expenses, increased Interest expense, and compared to 2017. The increase was mainly caused by an increase non-operating charges for environmental provisions, California of $164.3 million of expense in the Administrative segment, litigation, and pension settlement charges. primarily due to an increase in provisions for environmental matters The effective income tax rate for 2018 was 18.5 percent. of $160.8 million and a year-over-year increase in gain on sale of Excluding the income tax benefit of $668.8 million from the assets of $3.5 million. The Company reached a series of agreements Deferred income tax reductions, the effective income tax rate for with the Environmental Protection Agency for remediation plans income from continuing operations was 25.1 percent for 2017. The with cost estimates at one of the Company’s four major sites which Company also recorded an income tax provision of $41.5 million in required significant environmental provisions be recorded during the second quarter of 2017 related to the divestiture of Valspar’s 2018. See Note 9, on page 62 and 63 of this report, for more North American industrial wood coatings business, which is information concerning Other long-term liabilities and reported as a discontinued operation and reduced diluted net environmental matters. See Note 14, on page 70 of this report, for income per share by $.44 per share. Diluted net income per share more information concerning Other general expense – net. for 2018 decreased to $11.67 per share from $18.20 per share for (cid:31) 32 Management’s Discussion and Analysis of Financial Condition and Results of Operations 2017. Diluted net income per share in 2018 included per share Results of Operations–2017 vs. 2016 charges for acquisition-related costs of $4.15 and other Shown below are net sales and segment profit and the non-operating expenses totaling $2.71. Other non-operating percentage change for the current period by segment for 2017 and expenses included environmental provisions of $1.32, California 2016: litigation of $1.09 and pension plan settlement expense of $.30 per share, respectively. Currency translation rate changes decreased diluted net income per share in the year by $.21 per share. Diluted net income per share in 2017 included a one-time benefit of $7.04 per share from Deferred income tax reductions, a one-time charge of $.44 per share for discontinued operations and a charge of $3.47 per share for acquisition-related costs. Management considers a measurement that is not in accordance with U.S. generally accepted accounting principles a useful measurement of the operational profitability of the Company. Some investment professionals also utilize such a (thousands of dollars) 2017 2016 Change Year Ended December 31, Net Sales: The Americas Group ....... Consumer Brands $ 9,117,279 $ 8,377,083 8.8% Group ......................... 2,154,729 1,527,515 41.1% Performance Coatings Group ......................... Administrative ................ 3,706,134 5,646 1,946,004 5,000 90.4% 12.9% Net sales ........................ $14,983,788 $11,855,602 26.4% Year Ended December 31, measurement as an indicator of the value of profits and cash that (thousands of dollars) 2017 2016 Change are generated strictly from operating activities, putting aside working capital and certain other balance sheet changes. For this measurement, management increases Net income for significant non-operating and non-cash expense items to arrive at an amount known as EBITDA. The reader is cautioned that the following value for EBITDA should not be compared to other entities unknowingly. EBITDA should not be considered an alternative to Net income or Income Before Income Taxes: The Americas Group .......... Consumer Brands Group .... Performance Coatings Group ........................... Administrative .................. Income before income $1,769,466 $1,605,306 301,041 202,813 10.2% -32.6% 262,782 (765,751) 257,187 (568,301) 2.2% -34.7% Net operating cash as an indicator of operating performance or as taxes ............................ $ 1,469,310 $ 1,595,233 -7.9% a measure of liquidity. The reader should refer to the determination of Net income and Net operating cash in Consolidated net sales for 2017 increased due primarily to the accordance with U.S. generally accepted accounting principles addition of Valspar sales beginning in June and higher paint sales disclosed in the Statements of Consolidated Income and Statements of Consolidated Cash Flows, on pages 40 and 43 of this report. EBITDA as used by management is calculated as follows: (thousands of dollars) Net income from continuing operations ................ Interest Expense .......... Income Taxes ............... Depreciation ................ Amortization ............... EBITDA from continuing operations ................ Year Ended December 31, 2017 2018 2016 $ 1,108,746 $ 1,769,488 $ 1,132,703 154,088 462,530 172,074 25,404 263,471 (300,178) 284,997 206,764 366,734 250,904 278,169 318,112 $2,322,665 $2,224,542 $1,946,799 volume in The Americas Group. Excluding Valspar net sales, net sales increased 5.6 percent in the year. Currency translation rate changes increased 2017 consolidated net sales by 0.3 percent. Net sales of all consolidated foreign subsidiaries increased 71.9 percent to $2.960 billion for 2017 versus $1.722 billion for 2016 due primarily to the addition of Valspar sales since June. Net sales of all operations other than consolidated foreign subsidiaries increased 18.7 percent to $12.024 billion for 2017 versus $10.133 billion for 2016. Net sales in the The Americas Group increased in 2017 due primarily to higher architectural paint sales volume across all end market segments and selling price increases. Net sales from stores in the U.S., Canada and Latin America open for more than twelve calendar months increased 6.3 percent for the full year. During (cid:31) 33 Management’s Discussion and Analysis of Financial Condition and Results of Operations 2017, The Americas Group opened 114 new stores and closed 13 Performance Coatings Group’s gross profit for 2017 increased redundant locations for a net increase of 101 stores, increasing the $387.0 million due primarily to inclusion of Valspar sales and total number of stores in operation at December 31, 2017 to 4,620 favorable currency translation rate changes, partially offset by in the United States, Canada, Latin America and the Caribbean. higher raw material costs and Acquisition-related inventory The Americas Group’s objective is to expand its store base an purchase accounting adjustments. Acquisition-related purchase average of 2.5 percent each year, primarily through internal accounting adjustments decreased Consumer Brands and growth. Sales of products other than paint increased Performance Coatings Groups’ gross profit by $72.4 million and approximately 14.3 percent for the year over 2016. A discussion of $74.9 million, respectively, for 2017. Both Consumer Brands and changes in volume versus pricing for sales of products other than Performance Coatings Groups’ gross profit margins were lower paint is not pertinent due to the wide assortment of general due to inclusion of Valspar sales, higher raw material costs and merchandise sold. Acquisition-related inventory purchase accounting adjustments to Net sales of the Consumer Brands Group increased in 2017 inventory, partially offset by selling price increases. primarily due to the inclusion of Valspar sales since June, partially SG&A increased by $657.4 million due primarily to the offset by lower volume sales to some of the Group’s retail inclusion of Valspar SG&A, increased expenses to support higher customers. Valspar sales increased Group net sales 49.4 percent in sales levels and net new store openings, as well as increased the year. In 2018, the Consumer Brands Group plans to continue Acquisition expenses in the Administrative segment. Acquisition promotions of new and existing products and expand of its expenses in the Administrative segment were $131.2 million and customer base and product assortment at existing customers. $58.4 million in 2017 and 2016, respectively. SG&A decreased as a The Performance Coatings Group’s net sales in 2017 increased percent of sales to 32.0 percent in 2017 from 34.9 percent in 2016 due primarily to the inclusion of Valspar sales and selling price primarily due to the addition of Valspar sales beginning in June. increases. Currency translation rate changes increased net sales Excluding Valspar SG&A and Acquisition expenses, SG&A as a 1.5 percent for 2017. In 2017, the Performance Coatings Group percent of sales was 33.7 percent and 34.4 percent in 2017 and opened 4 new branches and closed 2 locations increasing the total 2016, respectively. In The Americas Group, SG&A increased from 288 to 290 branches open in the United States, Canada, $147.1 million for the year due primarily to increased spending due Mexico, South America, Europe and Asia at year-end. In 2018, the to the number of new store openings and general comparable Performance Coatings Group plans to continue expanding its store expenses to support higher sales levels. The Consumer worldwide presence and improving its customer base. Brands Group’s SG&A increased by $171.9 million for the year from Net sales in the Administrative segment, which primarily inclusion of Valspar SG&A, partially offset by improved expense consist of external leasing revenue of excess headquarters space control and integration synergies. The Performance Coatings and leasing of facilities no longer used by the Company in its Group’s SG&A increased by $254.1 million for the year primarily primary business, decreased by an insignificant amount in 2017. due to inclusion of Valspar SG&A, partially offset by improved Consolidated gross profit increased $797.5 million in 2017 due expense control and integration synergies. The Administrative primarily to Valspar sales since June and higher paint sales segment’s SG&A increased $84.4 million primarily due to volume, partially offset by raw material cost increases. increased Acquisition-related costs. Consolidated gross profit as a percent to net sales decreased to Amortization and impairment expenses in total increased 44.8 percent from 49.9 percent in 2016 due primarily to Valspar $172.7 million in 2017 primarily due to amortization of Acquisition- sales, Acquisition-related inventory purchase accounting related intangibles. Amortization of Acquisition-related intangibles adjustments and raw material cost increases, partially offset by was $127.8 million and $54.4 million for the Performance Coatings higher paint sales volume. The Americas Group’s gross profit for and Consumer Brands Groups, respectively. Impairment of 2017 increased $297.7 million compared to 2016 due primarily to goodwill and intangibles expenses decreased $8.7 million in 2017. higher paint sales volume and selling price increases, partially Other general expense – net increased $8.5 million in 2017 offset by higher raw material costs. The Americas Group’s gross compared to 2016. The increase was mainly caused by an increase of profit margins declined primarily due to increased raw material $10.5 million of expense in the Administrative segment, primarily due costs, partially offset by higher paint sales volume and selling price to a year-over-year decrease in gain on sale of assets of $38.0 million increases. The Consumer Brands Group’s gross profit increased partially offset by a decrease in provisions for environmental matters $122.0 million due primarily to the inclusion of Valspar sales, of $27.5 million. See Note 14, on page 70 of this report, for more partially offset by increased raw material costs, Acquisition- information concerning Other general expense – net. related inventory purchase accounting adjustments and lower As required by the Goodwill and Other Intangibles Topic of the sales volumes at certain customers compared to 2016. The ASC, management performed an annual impairment test of (cid:31) 34 Management’s Discussion and Analysis of Financial Condition and Results of Operations goodwill and indefinite-lived intangible assets as of October 1, 2016 resulting primarily from Acquisition expenses and increased 2017. The impairment tests in 2017 resulted in $2.0 million Interest expense. impairment of trademarks recorded in The Americas Group. The Net income increased in 2017 primarily due to the one-time impairment tests in 2016, resulted in $10.7 million impairment in benefit of $668.8 million from Deferred income tax reductions, goodwill from the same reporting unit. See Note 5, on pages 52 which resulted in a consolidated effective income tax rate of and 53 of this report, for more information concerning the 20.4 percent, improved operating results in The Americas Group impairment of intangible assets. and the inclusion of Valspar operating results, partially offset by Interest expense increased $109.4 million in 2017 primarily due Acquisition costs. to Acquisition-related debt incurred. Excluding the impact of the Deferred income tax reductions, Other (income) expense – net increased $20.9 million in 2017 the effective income tax rate for continuing operations was compared to 2016. This increase was mainly due to an increase in 25.1 percent for 2017 and 29.0 percent for 2016, primarily due to foreign currency related transaction losses of $6.9 million in 2017, the year over year impacts of Employee share-based payments. primarily in The Americas Group and Consumer Brands Group. Diluted net income per common share increased 51.8 percent to There were no other items within Other income or Other expense $18.2 per share for 2017 from $11.99 per share in 2016. Diluted net that were individually significant at December 31, 2017. See Note income per common share from continuing operations was $18.64 14 on page 70 of this report for more information concerning per share in 2017, including a one-time benefit of $7.04 per share Other (income) expense – net. from the Deferred income tax reductions. Diluted net income per Consolidated Income before income taxes in 2017 decreased common share for 2017 was decreased by charges of $3.47 per $125.9 million resulting from an increase of $657.4 million in SG&A, share from Acquisition costs, including inventory purchase an increase of $172.7 million in amortization and impairment accounting adjustments and increased amortization of intangible expenses in total, and an increase of $109.4 million in interest assets. Valspar operations increased Diluted net income per expense, partially offset by an increase of $797.5 million in gross common share by $.80 per share for 2017, including a $.92 per profit. Income before income taxes increased $164.2 million in The share charge from interest expense on new debt. Diluted net Americas Group and $5.6 million in the Performance Coatings income per common share for 2016 was decreased by charges of Group, but decreased $98.2 million in the Consumer Brands Group, $.86 per share from Acquisition costs. Currency translation rate when compared to 2016. The Administrative segment expenses changes did not have a significant impact on diluted net income decreased Income before income taxes $197.5 million more than in per common share in 2017. (cid:31) 35 Report of Management on Internal Control Over Financial Reporting Shareholders of The Sherwin-Williams Company We are responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. We recognize that internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and is subject to the possibility of human error or the circumvention or the overriding of internal control. Therefore, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, we believe we have designed into the process safeguards to reduce, though not eliminate, this risk. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In order to ensure that the Company’s internal control over financial reporting was effective as of December 31, 2018, we conducted an assessment of its effectiveness under the supervision and with the participation of our management group, including our principal executive officer and principal financial officer. This assessment was based on the criteria established in the 2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment of internal control over financial reporting under the criteria established in Internal Control – Integrated Framework, we have concluded that, as of December 31, 2018, the Company’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our internal control over financial reporting as of December 31, 2018 has been audited by Ernst & Young LLP, an independent registered public accounting firm, and their report on the effectiveness of our internal control over financial reporting is included on page 37 of this report. J. G. Morikis Chairman, President and Chief Executive Officer A. J. Mistysyn Senior Vice President – Finance and Chief Financial Officer J. M. Cronin Senior Vice President – Corporate Controller (cid:31) 36 Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting The Board of Directors and Shareholders of The Sherwin-Williams Company Opinion on Internal Control over Financial Reporting We have audited The Sherwin-Williams Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, The Sherwin-Williams Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of The Sherwin-Williams Company as of December 31, 2018, 2017, and 2016, and the related statements of consolidated income and comprehensive income, cash flows and shareholders’ equity for each of the three years in the period ended December 31, 2018, and the related notes and our report dated February 22, 2019 expressed an unqualified opinion thereon. Basis for Opinion The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Cleveland, Ohio February 22, 2019 (cid:31) 37 Report of Management on the Consolidated Financial Statements Shareholders of The Sherwin-Williams Company We are responsible for the preparation and fair presentation of the consolidated financial statements, accompanying notes and related financial information included in this report of The Sherwin-Williams Company and its consolidated subsidiaries (collectively, the “Company”) as of December 31, 2018, 2017 and 2016 and for the years then ended in accordance with U.S. generally accepted accounting principles. The consolidated financial information included in this report contains certain amounts that were based upon our best estimates, judgments and assumptions that we believe were reasonable under the circumstances. We have conducted an assessment of the effectiveness of internal control over financial reporting based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. As discussed in the Report of Management on Internal Control Over Financial Reporting on page 36 of this report, we concluded that the Company’s internal control over financial reporting was effective as of December 31, 2018. The Board of Directors pursues its responsibility for the oversight of the Company’s accounting policies and procedures, financial statement preparation and internal control over financial reporting through the Audit Committee, comprised exclusively of independent directors. The Audit Committee is responsible for the appointment and compensation of the independent registered public accounting firm. The Audit Committee meets at least quarterly with financial management, internal auditors and the independent registered public accounting firm to review the adequacy of financial controls, the effectiveness of the Company’s internal control over financial reporting and the nature, extent and results of the audit effort. Both the internal auditors and the independent registered public accounting firm have private and confidential access to the Audit Committee at all times. We believe that the consolidated financial statements, accompanying notes and related financial information included in this report fairly reflect the form and substance of all material financial transactions and fairly present, in all material respects, the consolidated financial position, results of operations and cash flows as of and for the periods presented. J. G. Morikis Chairman, President and Chief Executive Officer A. J. Mistysyn Senior Vice President – Finance and Chief Financial Officer J. M. Cronin Senior Vice President – Corporate Controller (cid:31) 38 Report of Independent Registered Public Accounting Firm on the Consolidated Financial Statements To The Board of Directors and Shareholders of The Sherwin-Williams Company Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of The Sherwin-Williams Company (the “Company”) as of December 31, 2018, 2017 and 2016, and the related statements of consolidated income and comprehensive income, cash flows and shareholders’ equity for each of the three years in the period ended December 31, 2018, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2018, 2017 and 2016, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), The Sherwin-Williams Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 22, 2019 expressed an unqualified opinion thereon. Change in Accounting Principle As discussed in Note 1 to the consolidated financial statements, in 2018 the Company elected to reduce the number of pools used for determining inventory cost under the last-in, first-out (LIFO) method of accounting for inventory in the United States. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. We have served as the Company‘s auditor since 1908. Cleveland, Ohio February 22, 2019 (cid:31) 39 Statements of Consolidated Income and Comprehensive Income (thousands of dollars except per share data) Year Ended December 31, 2017 2018 2016 Net sales ......................................................................................................................... Cost of goods sold(1), (2) ..................................................................................................... $17,534,493 10,115,931 $14,983,788 8,264,988 $11,855,602 5,934,344 Gross profit(1), (2) ............................................................................................................... Percent to net sales(1), (2) ................................................................................................ Selling, general and administrative expenses(2) ................................................................... Percent to net sales ...................................................................................................... Other general expense – net ............................................................................................. Amortization ................................................................................................................... Impairment of goodwill and trademarks ............................................................................. Interest expense .............................................................................................................. Interest and net investment income ................................................................................... California litigation expense .............................................................................................. Other expense (income) – net(2) ........................................................................................ Income from continuing operations before income taxes(1) .................................................. Income tax expense (credit)(1) ........................................................................................... 7,418,562 42.3% 5,033,780 28.7% 189,122 318,112 366,734 (5,286) 136,333 20,117 1,359,650 250,904 6,718,800 44.8% 4,797,641 32.0% 20,865 206,764 2,022 263,471 (8,571) 5,921,258 49.9% 4,140,260 34.9% 12,368 25,404 10,688 154,088 (4,960) (32,702) (11,823) 1,469,310 (300,178) 1,595,233 462,530 Net income from continuing operations(1) .......................................................................... 1,108,746 1,769,488 1,132,703 Loss from discontinued operations .................................................................................... Income taxes ................................................................................................................... 41,540 Net loss from discontinued operations ............................................................................... — (41,540) — Net income(1) ................................................................................................................... $ 1,108,746 $ 1,727,948 $ 1,132,703 Basic net income per share: ............................................................................................... Continuing operations(1) ................................................................................................ Discontinued operations ................................................................................................ Net income per share(1) .............................................................................................. Diluted net income per share ............................................................................................. Continuing operations(1) ................................................................................................ Discontinued operations ................................................................................................ Net income per share(1) .............................................................................................. $ $ $ $ 11.92 11.92 11.67 11.67 $ $ $ $ 19.04 (.44) 18.60 18.64 (.44) 18.20 $ $ $ $ 12.33 12.33 11.99 11.99 (1) The year ended December 31, 2017 has been adjusted for an inventory accounting change. See Note 1. (2) The years ended December 31, 2017 and 2016 have been adjusted for the adoption of ASU No. 2017-07. See Note 1. See notes to consolidated financial statements. (cid:31) 40 Statements of Consolidated Income and Comprehensive Income (thousands of dollars except per share data) Net income(1) ........................................................................................................................ Other comprehensive (loss) income, net of tax: Foreign currency translation adjustments ............................................................................ Pension and other postretirement benefit adjustments: Year Ended December 31, 2018 2017 2016 $ 1,108,746 $1,727,948 $1,132,703 (254,306) 147,930 (18,648) Amounts recognized in Other comprehensive (loss) income(2) ........................................... Amounts reclassified from Other comprehensive (loss) income(3) ...................................... (13,473) 31,245 47,995 (7,762) (28,385) 7,635 Unrealized net gains on available-for sale securities: Amounts recognized in Other comprehensive (loss) income(4) ........................................... Amounts reclassified from Other comprehensive (loss) income(5) ...................................... Unrealized net (losses) gains on cash flow hedges: Amounts recognized in Other comprehensive (loss) income(6) ........................................... Amounts reclassified from Other comprehensive (loss) income(7) ................................... 17,772 40,233 (20,750) 2,026 (720) 1,306 (30,765) (3,223) (33,988) 1,046 89 1,135 85,007 85,007 — (6,210) (6,210) Other comprehensive (loss) income ....................................................................................... (242,744) 155,481 46,744 Comprehensive income(1) ...................................................................................................... $ 866,002 $1,883,429 $1,179,447 (1) The year ended December 31, 2017 has been adjusted for an inventory accounting change. See Note 1. (2) Net of taxes of $6,799, $(19,313) and $17,200 in 2018, 2017 and 2016, respectively. (3) Net of taxes of $(10,291), $4,764 and $(4,691) in 2018, 2017 and 2016, respectively. (4) Net of taxes of $(1,244) and $(643) in 2017 and 2016, respectively. (5) Net of taxes of $442 and $(55) in 2017 and 2016, respectively. (6) Net of taxes of $18,884 and $(52,226) in 2017 and 2016, respectively. (7) Net of taxes of $2,045 and $1,978 in 2018 and 2017, respectively. See notes to consolidated financial statements. (cid:31) 41 Consolidated Balance Sheets (thousands of dollars) 2018 December 31, 2017 2016 Assets Current assets: Cash and cash equivalents ................................................................................... Accounts receivable, less allowance ...................................................................... Inventories: Finished goods(1) .......................................................................................... Work in process and raw materials ................................................................ Deferred income taxes ........................................................................................ Other current assets ............................................................................................ $ 155,505 2,018,768 $ 204,213 2,104,555 $ 889,793 1,230,987 1,426,366 388,909 1,815,275 1,356,429 386,036 1,742,465 354,939 355,697 898,627 169,699 1,068,326 57,162 381,030 Total current assets ...................................................................................... 4,344,487 4,406,930 3,627,298 Property, plant and equipment: Land .................................................................................................................. Buildings ............................................................................................................ Machinery and equipment .................................................................................... Construction in progress ...................................................................................... Less allowances for depreciation .......................................................................... Goodwill ................................................................................................................... Intangible assets ........................................................................................................ Deferred pension assets ............................................................................................. Other assets .............................................................................................................. 244,608 979,140 2,668,492 147,931 4,040,171 2,263,332 1,776,839 6,956,702 5,201,579 270,664 584,008 254,676 962,094 2,572,963 177,056 3,966,789 2,089,674 115,555 714,815 2,153,437 117,126 3,100,933 2,005,045 1,877,115 1,095,888 6,814,345 6,002,361 296,743 502,023 1,126,892 255,010 225,529 421,904 Total Assets(1) ............................................................................................................ $ 19,134,279 $ 19,899,517 $ 6,752,521 Liabilities and Shareholders’ Equity Current liabilities: Short-term borrowings ........................................................................................ Accounts payable ............................................................................................... Compensation and taxes withheld ........................................................................ Accrued taxes ..................................................................................................... Current portion of long-term debt ........................................................................ California litigation accrual ................................................................................... Other accruals .................................................................................................... Total current liabilities .................................................................................. Long-term debt ......................................................................................................... Postretirement benefits other than pensions ................................................................ Deferred income taxes(1) ............................................................................................ Other long-term liabilities ........................................................................................... Shareholders’ equity: Common stock – $1.00 par value: 93,116,762, 93,883,645 and 93,013,031 shares outstanding at December 31, 2018, 2017 and 2016, respectively ........................................................................... Other capital ....................................................................................................... Retained earnings(1) ............................................................................................ Treasury stock, at cost ......................................................................................... Cumulative other comprehensive loss ................................................................... $ 328,403 1,799,424 504,547 80,766 307,191 136,333 1,141,083 4,297,747 8,708,057 257,621 1,130,872 1,009,237 $ 633,731 1,791,552 508,166 79,901 1,179 $ 40,739 1,034,608 398,045 76,765 700,475 972,651 3,987,180 9,885,745 274,675 1,419,601 684,442 578,547 2,829,179 1,211,326 250,397 73,833 509,345 118,373 2,896,448 6,246,548 (4,900,690) (629,934) 117,561 2,723,183 5,458,416 (4,266,416) (384,870) 116,563 2,488,564 4,049,497 (4,235,832) (540,351) Total shareholders’ equity(1) .......................................................................... 3,730,745 3,647,874 1,878,441 Total Liabilities and Shareholders’ Equity(1) .................................................................. $ 19,134,279 $ 19,899,517 $ 6,752,521 (1) December 31, 2017 has been adjusted for an inventory accounting change. See Note 1. See notes to consolidated financial statements. (cid:31) 42 Statements of Consolidated Cash Flows (thousands of dollars) Year Ended December 31, 2017 2018 2016 Operating Activities Net income(1) .................................................................................................................... Adjustments to reconcile net income to net operating cash: Loss from discontinued operations .................................................................................. Depreciation .................................................................................................................. Amortization of intangible assets ..................................................................................... Amortization of inventory purchase accounting adjustments(1) ........................................... Impairment of goodwill and trademarks ........................................................................... Amortization of credit facility and debt issuance costs ...................................................... Provisions for environmental-related matters ................................................................... Provisions for qualified exit costs ..................................................................................... Deferred income taxes(1) ................................................................................................. Defined benefit pension plans net cost ............................................................................. Stock-based compensation expense ................................................................................ Net decrease in postretirement liability ............................................................................ Decrease in non-traded investments ................................................................................ Loss (gain) on sale or disposition of assets ....................................................................... Other ............................................................................................................................ Change in working capital accounts: Decrease (increase) in accounts receivable ...................................................................... (Increase) in inventories ................................................................................................. Increase (decrease) in accounts payable .......................................................................... Increase (decrease) in accrued taxes ............................................................................... Increase in accrued compensation and taxes withheld ....................................................... Decrease (increase) in refundable income taxes ................................................................ Increase in California litigation accrual ............................................................................. Other ............................................................................................................................ Costs incurred for environmental-related matters ................................................................ Costs incurred for qualified exit costs .................................................................................. Other ................................................................................................................................ $ 1,108,746 $ 1,727,948 $ 1,132,703 278,169 318,112 12,133 176,297 14,923 (143,378) 36,371 82,588 (15,863) 72,453 12,825 (13,839) 18,424 (119,510) 113,786 2,717 4,640 20,092 136,333 (46,773) (17,718) (21,256) (86,572) 41,540 284,997 206,764 113,833 2,022 8,313 15,443 50,503 (620,730) 18,153 90,292 (17,865) 65,703 5,422 1,051 (49,850) (89,959) 166,687 (20,878) 11,286 (15,520) 16,270 (13,792) (45,422) (68,243) 172,074 25,404 10,688 63,759 42,932 3,038 (68,241) 14,851 72,109 (12,373) 64,689 (30,564) 5,334 (113,855) (52,577) (118,893) (2,159) 60,632 (1,343) 56,215 (15,178) (6,267) 5,594 Net operating cash ......................................................................................................... 1,943,700 1,883,968 1,308,572 Investing Activities Capital expenditures .......................................................................................................... Acquisitions of businesses, net of cash acquired ................................................................... Proceeds from sale of assets ............................................................................................... Increase in other investments ............................................................................................. (250,957) 38,354 (39,037) (222,767) (8,810,315) 47,246 (61,526) (239,026) 38,434 (103,182) Net investing cash .......................................................................................................... (251,640) (9,047,362) (303,774) Financing Activities Net (decrease) increase in short-term borrowings ................................................................ Proceeds from long-term debt ............................................................................................ Payments of long-term debt ............................................................................................... Payments for credit facility and debt issuance costs ............................................................. Payments of cash dividends ............................................................................................... Proceeds from stock options exercised ................................................................................ Treasury stock purchased ................................................................................................... Proceeds from real estate financing transactions .................................................................. Other ................................................................................................................................ Net financing cash .......................................................................................................... Effect of exchange rate changes on cash ............................................................................. Net (decrease) increase in cash and cash equivalents ........................................................... Cash and cash equivalents at beginning of year .................................................................... (300,942) (852,627) (5,185) (322,934) 90,745 (613,312) 225,345 32,257 (1,746,653) 5,885 (48,708) 204,213 Cash and cash equivalents at end of year ............................................................................. $ 155,505 Taxes paid on income ........................................................................................................ Interest paid on debt .......................................................................................................... $ 292,169 368,045 356,320 8,275,169 (1,852,812) (49,376) (319,029) 143,579 (899) 500 (1,111) (65,119) (312,082) 86,831 (39,761) (15,473) 6,514,090 (36,276) (685,580) 889,793 (307,353) (13,396) 684,049 205,744 $ $ 204,213 $ 889,793 419,695 220,630 $ 477,786 153,850 (1) The year ended December 31, 2017 has been adjusted for an inventory accounting change. See Note 1. See notes to consolidated financial statements. (cid:31) 43 Statements of Consolidated Shareholders’ Equity (thousands of dollars except per share data) Balance at January 1, 2016 .............. Net income ................................... Other comprehensive income ......... Stock-based compensation activity ...................................... Cash dividends – $3.36 per share .... Balance at December 31, 2016 ......... Net income(1) ................................ Other comprehensive income ......... Stock-based compensation activity ...................................... Acquired noncontrolling interest ..... Cash dividends – $3.40 per share .... Balance at December 31, 2017(1) ...... Net income ................................... Other comprehensive loss .............. Adjustment to initially apply ASU 2016-01 ..................................... Treasury stock purchased ............... Stock-based compensation activity ...................................... Noncontrolling interest activity ....... Cash dividends – $3.44 per share .... Common Stock Other Capital $ 115,761 $2,330,426 Retained Earnings $3,228,876 1,132,703 Treasury Stock Cumulative Other Comprehensive Loss $ (4,220,058) $(587,095) 46,744 802 158,138 (15,774) 116,563 2,488,564 998 232,351 2,268 117,561 2,723,183 812 172,447 818 (312,082) 4,049,497 1,727,948 (319,029) 5,458,416 1,108,746 2,320 (322,934) (4,235,832) (540,351) 155,481 (30,584) (4,266,416) (384,870) (242,744) (2,320) (613,312) (20,962) Total $ 867,910 1,132,703 46,744 143,166 (312,082) 1,878,441 1,727,948 155,481 202,765 2,268 (319,029) 3,647,874 1,108,746 (242,744) — (613,312) 152,297 818 (322,934) Balance at December 31, 2018 ......... $118,373 $2,896,448 $ 6,246,548 $(4,900,690) $ (629,934) $3,730,745 (1) Net income, Retained earnings, and Total shareholders’ equity for the year ended December 31, 2017 has been adjusted for an inventory accounting change. See Note 1. See notes to consolidated financial statements. (cid:31) 44 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Note 1 – Significant Accounting Policies Investments in securities: Investments classified as Consolidation. The consolidated financial statements include available-for-sale are carried at fair market value. See the the accounts of The Sherwin-Williams Company and its wholly recurring fair value measurement table on page 46. owned subsidiaries (collectively, the Company). Inter-company Non-traded investments: The Company has investments accounts and transactions have been eliminated. in the U.S. affordable housing and historic renovation real Inventory Accounting Change. During the fourth quarter of 2018, estate markets and certain other investments that have been the Company made a voluntary change in accounting principle to identified as variable interest entities. However, because the reduce the number of pools used for determining inventory cost Company does not have the power to direct the day-to-day under the last-in, first-out (LIFO) method of accounting for inventory operations of the investments and the risk of loss is limited to in the United States. Following the continued Valspar (See Note 4) the amount of contributed capital, the Company is not integration of the operations, systems, processes, manufacturing and considered the primary beneficiary. In accordance with the distribution facilities, management determined that while keeping Consolidation Topic of the Financial Accounting Standards separate historical LIFO pools were possible to maintain, it was not Board (FASB) Accounting Standards Codification (ASC), the preferable. The Company believes the elected change is preferable investments are not consolidated. For affordable housing because it reduces the likelihood of liquidations of similar product investments entered into prior to the January 1, 2015 adoption types and achieves conformity in the composition of all pools. of Accounting Standard Update (ASU) No. 2014-01, the Comparative financial statements of 2017 have been adjusted to Company uses the effective yield method to determine the apply the inventory accounting change retrospectively. There was no carrying value of the investments. Under the effective yield effect on periods prior to the acquisition of Valspar in 2017. The method, the initial cost of the investments is amortized to adjustments to the 2017 financial statements are summarized in the income tax expense over the period that the tax credits are Adjustments and Reclassifications section at the end of this Note 1. recognized. For affordable housing investments entered into Use of estimates. The preparation of consolidated financial on or after the January 1, 2015 adoption of ASU No. 2014-01, statements in conformity with U.S. generally accepted accounting the Company uses the proportional amortization method. principles requires management to make estimates, judgments Under the proportional amortization method, the initial cost and assumptions that affect the amounts reported in the of the investments is amortized to income tax expense in consolidated financial statements and accompanying notes. Actual proportion to the tax credits and other tax benefits received. results could differ from those amounts. The carrying amounts of the investments, included in Other Nature of operations. The Company is engaged in the assets, were $181,171, $189,386 and $193,413 at December 31, development, manufacture, distribution and sale of paint, coatings 2018, 2017 and 2016, respectively. The liabilities recorded on and related products to professional, industrial, commercial and the balance sheets for estimated future capital contributions retail customers primarily in North and South America, with to the investments were $182,994, $179,026 and $178,584 at additional operations in the Caribbean region, Europe, Asia and December 31, 2018, 2017 and 2016, respectively. Australia. Short-term borrowings: The carrying amounts reported Reportable segments. See Note 19 for further details. for Short-term borrowings approximate fair value. Cash flows. Management considers all highly liquid Long-term debt (including current portion): The fair investments with a maturity of three months or less when values of the Company’s publicly traded debt, shown below, purchased to be cash equivalents. are based on quoted market prices. The fair values of the Fair value of financial instruments. The following methods Company’s non-traded debt, also shown below, are estimated and assumptions were used by the Company in estimating its fair using discounted cash flow analyses, based on the Company’s value disclosures for financial instruments: current incremental borrowing rates for similar types of Cash and cash equivalents: The carrying amounts reported borrowing arrangements. The Company’s publicly traded for Cash and cash equivalents approximate fair value. debt and non-traded debt are classified as level 1 and level 2, Short-term investments: The carrying amounts reported respectively, in the fair value hierarchy. See Note 8. for Short-term investments approximate fair value. 2018 December 31, 2017 Carrying Amount $8,731,731 283,517 Fair Value $8,330,222 272,689 Carrying Amount $8,742,739 1,144,185 Fair Value $9,054,277 1,088,630 2016 Carrying Amount $1,907,704 4,097 Fair Value $1,912,646 3,783 Publicly traded debt ................ Non-traded debt ..................... (cid:31) 45 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Derivative instruments: The Company utilizes derivative In 2016, the Company entered into a series of interest rate lock instruments as part of its overall financial risk management policy. agreements which were designated as cash flow hedges. The The Company entered into foreign currency forward contracts interest rate locks settled during 2017. See Note 8. with maturity dates of less than twelve months in 2018, 2017, and Fair value measurements. The following table summarizes 2016, primarily to hedge against value changes in foreign currency. the Company’s assets and liabilities measured on a recurring basis See Note 14. There were no material foreign currency option and in accordance with the Fair Value Measurements and Disclosures forward contracts outstanding at December 31, 2018, 2017 and Topic of the ASC: 2016. Assets: Fair Value at December 31, 2018 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Deferred compensation plan assets(1) .................. Liabilities: Deferred compensation plan liabilities(2) .............. $ $ 52,460 62,599 $ $ 27,019 $ 25,441 62,599 (1) The deferred compensation plan assets consists of the investment funds maintained for the future payments under the Company’s executive deferred compensation plans, which are structured as rabbi trusts. The investments are marketable securities accounted for under the Debt and Equity Securities Topic of the ASC. The level 1 investments are valued using quoted market prices multiplied by the number of shares. The level 2 investments are valued based on vendor quotes. The cost basis of the investment funds is $53,719. (2) The deferred compensation plan liabilities are the Company’s liabilities under its deferred compensation plans. The liabilities represent the fair value of the participant shadow accounts, and the value is based on quoted market prices in active markets for identical assets. Except for the acquisition-related fair value measurements Intangible assets. Intangible assets include indefinite-lived described in Note 4, there were no assets and liabilities measured trademarks, customer relationships and intellectual property. As at fair value on a nonrecurring basis. The acquisition-related fair required by the Goodwill and Other Intangibles Topic of the ASC, value measurements qualified as level 3 measurements. indefinite-lived trademarks are not amortized, but instead are Accounts receivable and allowance for doubtful accounts. tested annually for impairment, and between annual tests Accounts receivable were recorded at the time of credit sales net whenever an event occurs or circumstances indicate potential of provisions for sales returns and allowances. The Company impairment. See Note 5. The costs of finite-lived intangible assets recorded an allowance for doubtful accounts of $45,883, $52,997 are amortized on a straight-line basis over the expected period of and $40,450 at December 31, 2018, 2017 and 2016, respectively, to benefit, which ranges primarily from 15 to 20 years. reduce Accounts receivable to their estimated net realizable value. Impairment of long-lived assets. In accordance with the The allowance was based on an analysis of historical bad debts, a Property, Plant and Equipment Topic of the ASC, management review of the aging of Accounts receivable and the current evaluates the recoverability and estimated remaining lives of long- creditworthiness of customers. Accounts receivable balances are lived assets whenever events or changes in circumstances indicate written-off against the allowance if a final determination of that the carrying amount may not be recoverable or the useful life uncollectibility is made. All provisions for allowances for doubtful has changed. See Notes 5 and 6. collection of accounts are related to the creditworthiness of Property, plant and equipment. Property, plant and accounts and are included in Selling, general and administrative equipment is stated on the basis of cost. Depreciation is provided expenses. by the straight-line method. Depreciation and amortization are Reserve for obsolescence. The Company recorded a reserve included in the appropriate Cost of goods sold or Selling, general for obsolescence of $105,871, $103,698 and $87,715 at and administrative expense caption on the Statements of December 31, 2018, 2017 and 2016, respectively, to reduce Consolidated Income. Included in Property, plant and equipment Inventories to their estimated net realizable value. are leasehold improvements. The major classes of assets and Goodwill. Goodwill represents the cost in excess of fair value ranges of annual depreciation rates are: of net assets acquired in business combinations accounted for by the purchase method. In accordance with the Intangibles Topic of the ASC, goodwill is tested for impairment on an annual basis and in between annual tests if events or circumstances indicate potential impairment. See Note 5. Buildings ...................................................... Machinery and equipment .............................. Furniture and fixtures .................................... Automobiles and trucks ................................. 4.0% – 20.0% 10.0% – 20.0% 6.7% – 33.3% 10.0% – 33.3% (cid:31) 46 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Standby letters of credit. The Company occasionally enters (ESOP) in accordance with the Employee Stock Ownership Plans into standby letter of credit agreements to guarantee various Subtopic of the Compensation – Stock Ownership Topic of the operating activities. These agreements provide credit availability ASC. The Company recognized compensation expense for to the various beneficiaries if certain contractual events occur. amounts contributed to the ESOP. See Note 12. Amounts outstanding under these agreements totaled $65,622, Defined benefit pension and other postretirement benefit $75,272 and $43,658 at December 31, 2018, 2017 and 2016, plans. The Company accounts for its defined benefit pension and respectively. other postretirement benefit plans in accordance with the Product warranties. The Company offers assurance type Retirement Benefits Topic of the ASC, which requires the product warranties for certain products. The specific terms and recognition of a plan’s funded status as an asset for overfunded conditions of such warranties vary depending on the product or plans and as a liability for unfunded or underfunded plans. See customer contract requirements. Management estimated the costs Note 7. of unsettled product warranty claims based on historical results Stock-based compensation. The cost of the Company’s and experience and included an amount in Other accruals. stock-based compensation is recorded in accordance with the Management periodically assesses the adequacy of the accrual for Stock Compensation Topic of the ASC. See Note 13. product warranty claims and adjusts the accrual as necessary. Foreign currency translation. All consolidated non-highly Changes in the Company’s accrual for product warranty claims inflationary foreign operations use the local currency of the during 2018, 2017 and 2016, including customer satisfaction country of operation as the functional currency and translated the settlements during the year, were as follows: local currency asset and liability accounts at year-end exchange Balance at January 1 ................. Charges to expense .................. Settlements ............................. Acquisition, divestiture and 2018 2017 2016 $ 151,425 $ 34,419 $ 31,878 38,954 (36,413) 31,706 (57,843) 39,707 (53,143) other adjustments ................ (68,221) 130,442 rates while income and expense accounts were translated at average exchange rates. The resulting translation adjustments were included in Cumulative other comprehensive loss, a component of Shareholders’ equity. Cumulative other comprehensive loss. At December 31, 2018, the ending balance of Cumulative other comprehensive loss Balance at December 31 ............ $ 57,067 $ 151,425 $ 34,419 included adjustments for foreign currency translation of $607,652, Warranty accruals acquired in connection with the Valspar acquisition include warranties for certain products under extended furniture protection plans. The furniture protection plan business was divested during 2018 for an immaterial amount that approximated net book value. Environmental matters. Capital expenditures for ongoing environmental compliance measures were recorded in Property, plant and equipment, and related expenses were included in the normal operating expenses of conducting business. The Company is involved with environmental investigation and remediation activities at some of its currently and formerly owned sites and at net prior service costs and net actuarial losses related to pension and other postretirement benefit plans of $67,091 and unrealized net gains on interest rate lock cash flow hedges of $44,809. At December 31, 2017 and 2016, the ending balance of Cumulative other comprehensive loss included adjustments for foreign currency translation of $353,346 and $501,277, respectively, net prior service costs and net actuarial losses related to pension and other postretirement benefit plans of $84,863 and $125,096, respectively, and unrealized gains on marketable equity securities of $2,320 and $1,015, respectively. At December 31, 2017, the ending balance of Cumulative other comprehensive loss also included unrealized net gains on interest rate lock hedges of a number of third-party sites. The Company accrued for $51,019. environmental-related activities for which commitments or clean-up plans have been developed and when such costs could be reasonably estimated based on industry standards and Revenue recognition. The Company recognized revenue when products were shipped and title passed to unaffiliated customers. Collectibility of amounts recorded as revenue was professional judgment. All accrued amounts were recorded on an probable at the time of recognition. See Note 2. undiscounted basis. Environmental-related expenses included direct costs of investigation and remediation and indirect costs such as compensation and benefits for employees directly involved in the investigation and remediation activities and fees Customer and vendor consideration. The Company offered certain customers rebate and sales incentive programs which were classified as reductions in Net sales. Such programs were in the form of volume rebates, rebates that constituted a percentage of paid to outside engineering, consulting and law firms. See Notes 9 sales or rebates for attaining certain sales goals. The Company and 14. received consideration from certain suppliers of raw materials in Employee Stock Purchase and Savings Plan. The Company the form of volume rebates or rebates that constituted a accounts for the Employee Stock Purchase and Savings Plan (cid:31) 47 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) percentage of purchases. These rebates were recognized on an Selling, general and administrative expenses is now classified as a accrual basis by the Company as a reduction of the purchase price reduction of revenue. This reclassification had no effect on Net of the raw materials and a subsequent reduction of Cost of goods income, and therefore, there was no adjustment to the opening sold when the related product was sold. balance of retained earnings. The Company does not expect the Costs of goods sold. Included in Costs of goods sold were adoption of the new revenue standard to have a material impact costs for materials, manufacturing, distribution and related on its Net income on an ongoing basis. See Note 2 for additional support. Distribution costs included expenses related to the information. distribution of products including inbound freight charges, Effective January 1, 2018, the Company adopted ASU purchase and receiving costs, warehousing costs, internal transfer No. 2017-07, “Improving the Presentation of Net Periodic Pension costs and other costs incurred to ship products. Also included in Cost and Net Periodic Postretirement Benefit Costs.” The standard Costs of goods sold were total technical expenditures, which requires the service component of pension and other included research and development costs, quality control, product postretirement benefit expense to be presented in the same formulation expenditures and other similar items. Research and income statement lines as other employee compensation costs, development costs included in technical expenditures were and the other components to be presented outside of operating $51,922, $58,474 and $58,041 for 2018, 2017 and 2016, income. The guidance on the presentation of components of respectively. See Note 10. pension and other postretirement benefit expense was adopted Selling, general and administrative expenses. Selling costs retrospectively, as required, and the practical expedient allowing included advertising expenses, marketing costs, employee and estimates for comparative periods using the information store costs and sales commissions. The cost of advertising was previously disclosed in the pension and other postretirement expensed as incurred. The Company incurred $357,843, $374,059 benefit plan note was elected. As a result of this ASU, 2018 and $351,002 in advertising costs during 2018, 2017 and 2016, pension and other postretirement benefit plan expense of $3,483, respectively. General and administrative expenses included human $13,930 and $26,888 was recorded in Cost of goods sold, SG&A resources, legal, finance and other support and administrative and Other expense (income) – net, respectively. The functions. reclassifications in the 2017 and 2016 financial statements are Earnings per share. Common stock held in a revocable trust summarized in the Adjustments and Reclassifications section at (see Note 11) was not included in outstanding shares for basic or the end of this note. diluted income per share calculations. All references to “shares” or “per share” information throughout this report relate to shares and are stated on a diluted per share basis, unless otherwise indicated. Basic and diluted net income per share were calculated using the treasury stock method in accordance with the Earnings Per Common Share Topic of the ASC. Basic net income per share amounts were computed based on the weighted-average number of shares outstanding during the year. Diluted net income per share amounts were computed based on the weighted-average number of shares outstanding plus all dilutive securities potentially outstanding during the year. See Note 16. Impact of recently issued accounting standards. Effective January 1, 2018, the Company adopted ASU No. 2014-09, “Revenue from Contracts with Customers,” and all the related amendments (ASC 606). ASC 606 consists of a comprehensive revenue recognition standard, which requires the recognition of revenue when promised goods or services are transferred to customers in an amount that reflects the consideration to which the entity expects to be entitled. The Company adopted the standard using the modified retrospective method and applied it to all contracts. Under the modified retrospective method, the comparative periods are not restated. The only significant change that resulted from the new revenue standard was that certain advertising support of $103,108 that was previously classified as Effective January 1, 2018, the Company adopted ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities,” which amends the guidance for certain aspects of recognition, measurement and disclosure of financial instruments. As a result of this standard, changes in fair value of available-for-sale marketable securities that were previously recognized in other comprehensive income are now recognized in earnings. In addition, in accordance with the guidance, the Company reclassified its opening unrealized gains balance of $2,320 to Retained earnings. The adoption of this standard did not have a significant impact on the Company’s results of operations, financial condition or liquidity. In February 2016, the FASB issued ASU No. 2016-02, “Leases,” which consists of a comprehensive lease accounting standard (ASC 842). Under the new standard, right-of-use assets and lease liabilities arising from most leases will be recognized on the balance sheet and enhanced disclosures on key quantitative and qualitative information about leasing arrangements will be required. Leases will be classified as either operating or financing, and the lease classification will determine whether expense is recognized on a straight-line basis (operating leases) or based on separately amortizing the right-of-use asset and applying an effective interest method on the lease liability (financing leases). (cid:31) 48 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) The new standard is effective for interim and annual periods and controls. The Company has made enhancements to its starting in 2019, and the Company will apply the transitional financial information systems and internal controls in response to package of practical expedients allowed by the standard to not the new rule requirements including the implementation of a lease reassess the identification, classification and initial direct costs of tracking software for managing and reporting information related leases commencing before the effective date of Topic 842. The to leases. Upon adoption, the Company is prepared to provide Company also will apply the practical expedient to not separate expanded disclosures in the consolidated financial statements and lease and non-lease components to new leases as well as existing it expects to recognize assets and liabilities of between leases through transition, and will make an accounting policy approximately $1.6 billion and $1.8 billion. The adoption of ASC election to not apply recognition requirements of the guidance to 842 is not expected to have a material impact on the Company’s short-term leases. The Company does not expect to elect the results of operations, cash flows or debt covenants. hindsight transitional practical expedient to determine lease term Adjustments and Reclassifications. Certain amounts in the on existing leases. In July 2018, the FASB issued ASU No. 2018-11, notes to the consolidated financial statements for 2016 and 2017 “Leases: Targeted Improvements,” which provides an optional have been adjusted and reclassified to conform to the 2018 transition method that allows entities to initially apply the new presentation. lease standard at the adoption date and recognize a cumulative- The table below summarizes the adjustments and effect adjustment to the opening balance of retained earnings in reclassifications in the 2017 and 2016 Consolidated Income the period of adoption while comparative periods presented will Statements. In addition, the Inventory Accounting Change continue to be in accordance with ASC Topic 840. The Company reduced previously reported 2017 Inventories, Deferred income will use the optional transition method and apply the lease taxes and retained earnings by $58,910, $14,595 and $44,315, standard as of January 1, 2019 and does not anticipate a material respectively, and reduced previously reported 2017 segment profit cumulative-effect adjustment to the opening balance of retained for Performance Coatings and Consumer Brands Groups by earnings. The Company is nearing completion of its assessment $35,722 and $23,188, respectively. Although there were changes to process and its determination of the expanded disclosure certain captions on the Cash flow statement due to the Inventory regarding leases, as well as the impact to the consolidated Accounting Change, Cash flow from operations was not changed financial statements. This final assessment includes contract for 2017. The effect of continuing to apply the historical analysis and updating accounting policies and related processes accounting to 2018 would not have been material. (millions of dollars except per share data) Cost of goods sold .................................... Selling, general and administrative expenses .............................................. Other income ............................................ Income from continuing operations before income taxes ......................................... Income tax (credit) expense ...................... Net income from continuing operations ...... Net income ............................................... Diluted net income per share from continuing operations ............................ Diluted net income per share ..................... Year Ended December 31, 2017 Previously Reported Adoption of ASU 2017-07 Inventory Accounting Change Adjusted Year Ended December 31, 2016 Adoption of ASU 2017-07 Previously Reported Adjusted $ 8,202.6 $ 3.5 $ 58.9 $ 8,265.0 $ 5,932.9 $ 1.4 $ 5,934.3 4,785.4 (17.0) 12.2 (15.7) 4,797.6 (32.7) 4,134.5 (4.6) 5.8 (7.2) 4,140.3 (11.8) 1,528.2 (285.6) 1,813.8 1,772.3 19.11 18.67 $ $ $ (58.9) (14.6) (44.3) $ (44.3) $ $ (.47) (.47) $ $ $ 1,469.3 (300.2) 1,769.5 1,727.9 $ 1,595.2 462.5 1,132.7 1,132.7 18.64 $ 18.20 $ 11.99 11.99 1,595.2 462.5 1,132.7 1,132.7 11.99 11.99 $ $ $ Note 2 – Revenue agreement or any form of contract with the Company. These sales The Company manufactures and sells paint, stains, supplies, are paid for at the time of sale in cash, credit card, or may be on equipment and floor covering through company-operated stores, account with the vast majority of customers having terms branded and private label products through retailers, and a broad between 30 and 60 days, not to exceed one year. Many customers range of industrial coatings directly to global manufacturing who purchase on account take advantage of early payment customers through company-operated branches. A large portion discounts offered by paying within 30 days of being invoiced. The of the Company’s revenue is recognized at a point in time and Company estimates variable consideration for these sales on the made to customers who are not engaged in a long-term supply basis of both historical information and current trends to estimate (cid:31) 49 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) the expected amount of discounts to which customers are likely to obligations. Under these circumstances, the Company recognizes be entitled. a contract asset and amortizes these prepayments over the The remaining revenue is governed by long-term supply expected benefit life of the long-term contract typically on a agreements and related purchase orders (“contracts”) that specify straight-line basis. Management judgment is required when shipping terms and aspects of the transaction price including estimating sales-based variable consideration, determining rebates, discounts and other sales incentives, such as advertising whether it is constrained, measuring obligations for returns, support. Contracts are at standalone pricing. The performance refunds, and determining amortization periods for prepayments. obligation in these contracts is determined by each of the The majority of variable consideration in the Company’s individual purchase orders and the respective stated quantities, contracts include a form of volume rebate, discounts, and other with revenue being recognized at a point in time when obligations incentives, where the customer receives a retrospective under the terms of the agreement are satisfied. This generally percentage rebate based on the amount of their purchases. In occurs with the transfer of control of our products to the these situations, the rebates are accrued as a fixed percentage of customer. Sales, value add, and other taxes we collect concurrent sales and recorded as a reduction of net sales until paid to the with revenue-producing activities are excluded from revenue. customer per the terms of the supply agreement. Forms of Refer to Note 19 for the Company’s disaggregation of Net sales by variable consideration such as tiered rebates, whereby a customer reportable segment. As the reportable segments are aligned by receives a retrospective price decrease dependent on the volume similar economic factors, trends and customers, this of their purchases, are calculated using a forecasted percentage to disaggregation best depicts how the nature, amount, timing and determine the most likely amount to accrue. Management creates uncertainty of revenue and cash flows are affected by economic a baseline calculation using historical sales and then utilizing factors. forecast information, estimates the anticipated sales volume each The Company has made payments or credits for rebates or quarter to calculate the expected reduction to sales. The incentives at the beginning of a long-term contract where future remainder of the transaction price is fixed as agreed upon with the revenue is expected and before satisfaction of performance customer, limiting estimation of revenues including constraints. The Company’s Accounts receivable and current and long-term contract assets and liabilities are summarized in the following table. Balance at January 1, 2018 ................................... $ 2,104,555 $ 33,031 $ 135,150 $ 208,909 $ 8,745 Balance at December 31, 2018 .............................. 2,018,768 56,598 213,954 272,857 8,745 Accounts Receivable, Less Allowance Contract Assets (Current) Contract Assets (Long-Term) Contract Liabilities (Current) Contract Liabilities (Long-Term) The difference between the opening and closing balances of liabilities are excluded from the table above and discussed in Note the Company’s contract assets and contract liabilities primarily 1. Amounts recognized during the year from deferred liabilities to results from the timing difference between the Company’s Revenue were not material. The Company records a right of return performance and the customer’s payment. liability within each of its operations to accrue for expected Provisions for estimated returns are established and the customer returns. Historical actual returns are used to estimate expected costs continue to be recognized as contra-revenue per future returns as a percentage of current sales. Obligations for ASC 606 when the products are sold. The Company only offers an returns and refunds were not material individually or in the assurance type warranty on products sold, and there is no material aggregate. service to the customer beyond fixing defects that existed at the time of sale and no warranties are sold separately. Warranty (cid:31) 50 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Note 3 – Inventories The preliminary and final allocation of the fair value of the Inventories were principally stated at the lower of cost or Acquisition is summarized in the following table. The allocation of market with cost determined on the last-in, first-out (LIFO) the fair value is based on the acquisition method of accounting method. The following presents the effect on inventories, net and third-party valuation appraisals. The measurement period income and net income per share had the Company used the adjustments resulted from differences between the preliminary first-in, first-out (FIFO) inventory valuation method adjusted for and final report of third-party valuation appraisals. income taxes at the statutory rate in effect at each reporting date and assuming no other adjustments. Management believes that the use of LIFO results in a better matching of costs and revenues. This information is presented to enable the reader to make comparisons with companies using the FIFO method of inventory valuation. The decrease in percentage of total inventories on LIFO from 2016 to 2017 was due to the acquisition of Valspar (See Note 4) which only carried approximately 40 percent of its inventory on the LIFO method. Certain amounts in the table below for 2017 have been adjusted to reflect the Inventory Accounting Change (see Note 1). Percentage of total 2018 2017 2016 inventories on LIFO ........ 72% 71% 79% Excess of FIFO over LIFO ... $436,010 $288,186 $253,353 Note 4 – Acquisitions (millions of dollars) Cash ............... Accounts receivable .... Inventories ...... Indefinite-lived trademarks .. Finite-lived intangible assets .......... Goodwill ......... Property, plant and equipment ... All other assets .......... Accounts Preliminary Allocation (as reported at December 31, 2017) $ 129.1 Measurement Period Adjustments Final Allocation (as reported at June 30, 2018) $ 129.1 817.5 684.5 $ (0.1) 817.5 684.4 775.9 (161.6) 614.3 5,071.8 5,675.2 (148.9) 213.6 4,922.9 5,888.8 833.0 231.1 7.7 4.0 840.7 235.1 (553.2) (1,603.5) On June 1, 2017, the Company completed the acquisition of The payable ....... (553.2) Valspar Corporation (Valspar) at $113 per share in an all cash transaction for a total purchase price of $8.9 billion, net of divestiture proceeds of $431.0 million (Acquisition). On April 11, Long-term debt ............ (1,603.5) Deferred taxes ........... (2,028.9) 113.0 (1,915.9) 2017, the Company and Valspar entered into a definitive All other agreement with Axalta Coating Systems Ltd. to divest the assets liabilities ...... (1,093.1) (27.7) (1,120.8) related to Valspar’s North American industrial wood coatings business. The divestiture was also completed on June 1, 2017, and is reported as a discontinued operation with no pre-tax gain or Total ............... Total, net of $ 8,939.4 cash ............ $ 8,810.3 $ 8,939.4 $ 8,810.3 loss, but includes the tax expense effect of this separate transaction. Proceeds of $431.0 million were received for the divested assets sold. The divestiture resulted in a tax provision of $41.5 million, which reduced basic and diluted net income per share by $.44 for the year ended December 31, 2017. The Acquisition expanded the Company’s diversified array of brands and technologies, expanded its global platform and added new capabilities in its packaging and coil businesses. Finite-lived intangible assets include customer relationships of $3.2 billion and intellectual property and technology of $1.7 billion, which are being amortized over weighted average amortization periods ranging from 15 to 20 years. The measurement period adjustments for finite-lived intangible assets resulted in a $7.7 million reduction of amortization expense in the second quarter of 2018 that related to prior periods ($5.4 million for the year ended December 31, 2017. Goodwill of $2.0 billion, $1.1 billion, and $2.8 billion was recorded in The Americas Group, Consumer Brands Group, and Performance Coatings Group, respectively, and relates primarily to expected synergies. The results of operations for Valspar are included in the Company’s consolidated financial statements from the date of acquisition. (cid:31) 51 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Note 5 – Goodwill, Intangible and Long-lived Assets for impairment annually, and interim impairment tests are In accordance with the Property, Plant and Equipment Topic of performed whenever an event occurs or circumstances change the ASC, whenever events or changes in circumstances indicate that indicate an impairment has more likely than not occurred. that the carrying value of long-lived assets may not be recoverable October 1 has been established for the annual impairment review. or the useful life may have changed, impairment tests are to be At the time of impairment testing, values are estimated separately performed. Undiscounted cash flows are to be used to calculate for goodwill and trademarks with indefinite lives using a valuation the recoverable value of long-lived assets to determine if such model, incorporating discount rates commensurate with the risks assets are impaired. Where impairment is identified, a valuation involved for each group of assets. An optional qualitative model, incorporating discount rates commensurate with the risks assessment may alleviate the need to perform the quantitative involved for each group of assets, is to be used to determine the goodwill impairment test when impairment is unlikely. fair value for the assets to measure any potential impairment. No The annual impairment review performed as of October 1, 2018 material impairments were recorded in 2018, 2017 or 2016. did not result in any goodwill or trademark impairment. The annual The Company recorded goodwill of $5.9 billion, finite-lived impairment review performed as of October 1, 2017 resulted in intangibles of $4.9 billion and indefinite-lived trademarks of trademark impairment of $2,022 in The Americas Group related to $614.3 million in connection with the Acquisition. See Note 4. lower than anticipated sales of an acquired brand and no goodwill In accordance with the Goodwill and Other Intangibles Topic of impairment. The annual impairment review performed as of the ASC, goodwill and indefinite-lived intangible assets are tested October 1, 2016 resulted in goodwill and trademark impairment in The Americas Group of $10,455 and $233, respectively. A summary of changes in the Company’s carrying value of goodwill by Reportable Segment is as follows: Goodwill Balance at January 1, 2016(1) ........................................................... Impairment charged to operations .............................................. Currency and other adjustments ................................................. Balance at December 31, 2016(2) ..................................................... Acquisition ................................................................................ Currency and other adjustments ................................................. The Americas Group $ 295,052 (10,455) 813 285,410 2,276,127 (5,928) Consumer Brands Group Performance Coatings Group $ 701,071 $ 147,210 (1,197) 699,874 1,473,239 60,128 (5,602) 141,608 1,925,878 (41,991) Balance at December 31, 2017(2) ..................................................... 2,555,609 2,233,241 2,025,495 Acquisition adjustments ............................................................. Currency and other adjustments ................................................. (273,922) (25,133) (413,248) (66,124) 900,764 20,020 Consolidated Totals $ 1,143,333 (10,455) (5,986) 1,126,892 5,675,244 12,209 6,814,345 213,594 (71,237) Balance at December 31, 2018(2) ..................................................... $2,256,554 $1,753,869 $2,946,279 $6,956,702 (1) Net of accumulated impairment losses of $8,904 ($8,113 in the Consumer Brands Group and $791 in the Performance Coatings Group). (2) Net of accumulated impairment losses of $19,359 ($10,455 in The Americas Group, $8,113 in the Consumer Brands Group and $791 in the Performance Coatings Group). (cid:31) 52 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) A summary of the Company’s carrying value of intangible assets is as follows: Finite-Lived Intangible Assets Software Customer Relationships Intellectual Property All Other Subtotal Trademarks With Indefinite Lives Total Intangible Assets December 31, 2018 Weighted-average amortization period .................................. Gross ....................................... Accumulated amortization ........ $ 7 years 165,198 (127,303) 15 years $3,103,665 (326,333) 20 years $ 1,730,337 (136,985) 13 years $ 315,008 (256,155) 17 years $ 5,314,208 (846,776) Net value .............................. $ 37,895 $2,777,332 $ 1,593,352 $ 58,853 $4,467,432 $ 734,147 $ 5,201,579 December 31, 2017 Weighted-average amortization period .................................. Gross ....................................... Accumulated amortization ........ 7 years $ 165,019 (116,621) 15 years $ 3,361,675 (129,568) 20 years $1,774,000 (51,742) 13 years $ 329,440 (257,506) 17 years $ 5,630,134 (555,437) Net value .............................. $ 48,398 $ 3,232,107 $ 1,722,258 $ 71,934 $5,074,697 $927,664 $6,002,361 December 31, 2016 Weighted-average amortization period .................................. Gross ....................................... Accumulated amortization ........ 7 years $ 144,557 (103,735) 11 years $ 313,613 (240,217) 10 years $ 458,170 (343,952) Net value .............................. $ 40,822 $ — $ — $ 73,396 $ 114,218 $ 140,792 $ 255,010 Amortization of finite-lived intangible assets is estimated as demand or redundancy. The Company continues to evaluate all follows for the next five years: $306,227 in 2019, $305,820 in legacy operations in response to the Acquisition in order to 2020, $303,348 in 2021, $302,359 in 2022 and $298,047 in 2023. optimize restructured operations. Provisions of $12,251 and $2,672 Note 6 – Exit or Disposal Activities for severance and other qualified exit costs, along with other 2018 activity, were charged to the Administrative Segment and Management is continually re-evaluating the Company’s Performance Coatings Group, respectively. There were $612 of operating facilities, including acquired operating facilities, against provisions recorded for severance and other qualified exit costs its long-term strategic goals. Liabilities associated with exit or related to manufacturing facilities, distribution facilities, stores and disposal activities are recognized as incurred in accordance with branches closed prior to 2018. the Exit or Disposal Cost Obligations Topic of the ASC. Provisions During 2017, 13 stores in The Americas Group and 2 branches in for qualified exit costs are made at the time a facility is no longer the Performance Coatings Group were closed due to lower operational. Qualified exit costs primarily include post-closure rent demand or redundancy. Accruals for exit and disposal activities of expenses or costs to terminate the contract before the end of its $4,456 were acquired in connection with the Acquisition. These term and costs of employee terminations. Adjustments may be Acquisition-related restructuring charges were recorded in the made to liabilities accrued for qualified exit costs if information Administrative segment as presented in the table below. becomes available upon which more accurate amounts can be Provisions of $47,308 and $143 for severance and other qualified reasonably estimated. Concurrently, property, plant and exit costs related to the Acquisition and other 2017 activity were equipment is tested for impairment in accordance with the charged to the Administrative Segment and Performance Coatings Property, Plant and Equipment Topic of the ASC, and if Group, respectively. Provisions for severance and other qualified impairment exists, the carrying value of the related assets is exit costs related to manufacturing facilities, distribution facilities, reduced to estimated fair value. Additional impairment may be stores and branches closed prior to 2017 of $3,052 were recorded. recorded for subsequent revisions in estimated fair value. During 2016, 16 stores in The Americas Group, 13 branches in Adjustments to prior provisions and additional impairment the Performance Coatings Group and 2 facilities in Consumer charges for property, plant and equipment of closed sites being Brands Group were closed due to lower demand or redundancy. held for disposal are recorded in Other general expense – net. Provisions for severance and other qualified exit cost of $1,020 During 2018, 15 stores in The Americas Group and 11 branches and $505 were charged to Consumer Brands Group and in the Performance Coatings Group were closed due to lower (cid:31) 53 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Performance Coatings Group, respectively. Provisions for expected to be incurred by the end of 2019. The remaining portion severance and other qualified exit costs related to manufacturing of the ending accrual for facilities shutdown prior to 2016 primarily facilities, distribution facilities, stores and branches closed prior to represented post-closure contractual expenses related to certain 2016 of $1,513 were recorded. owned facilities which are closed and being held for disposal. The At December 31, 2018, a portion of the remaining accrual for Company cannot reasonably estimate when such matters will be qualified exit costs relating to facilities shutdown prior to 2016 is concluded to permit disposition. The following tables summarize the activity and remaining liabilities associated with qualified exit costs: Exit Plan Administrative segment acquisition-related restructuring: Balance at December 31, 2017 Provisions in Cost of goods sold or SG&A Actual expenditures charged to accrual Balance at December 31, 2018 Severance and related costs ................................................ Other qualified exit costs ..................................................... $ 6,019 5,541 $ 12,043 208 $ (16,939) (1,503) $ 1,123 4,246 Performance Coatings Group facilities shutdown in 2018: Severance and related costs ................................................ Other qualified exit costs ..................................................... Performance Coatings Group branches shutdown in 2017: Severance and related costs ................................................ Other qualified exit costs ..................................................... Consumer Brands Group facilities shutdown in 2016: Severance and related costs ................................................ Performance Coatings Group branches shutdown in 2016: Severance and related costs ................................................ Other qualified exit costs ........................................................ Severance and other qualified exit costs for facilities shutdown prior to 2016 ....................................................................... 14 121 21 111 1,558 13 2,047 274 338 (13) (1,426) (235) (224) (21) (77) (818) — 621 53 235 — — 34 740 Totals ................................................................................ $ 13,385 $ 14,923 $ (21,256) $ 7,052 Exit Plan Administrative segment Acquisition-related restructuring in 2017: Severance and related costs .......................... Other qualified exit costs ............................... Performance Coatings Group stores shutdown in 2017: Severance and related costs .......................... Other qualified exit costs ............................... Consumer Brands Group facilities shutdown in 2016: Severance and related costs .......................... Performance Coatings Group stores shutdown in 2016: Severance and related costs .......................... Other qualified exit costs ............................... The Americas Group stores shutdown in 2015: Other qualified exit costs ............................... Performance Coatings Group stores shutdown in 2015: Other qualified exit costs ............................... Severance and other qualified exit costs for Balance at December 31, 2016 Acquired Balances Provisions in Cost of goods sold or SG&A Actual expenditures charged to accrual Balance at December 31, 2017 $ 3,303 1,153 $ 38,739 8,569 $ (36,023) (4,181) $ 6,019 5,541 14 129 (8) $ 907 2,910 (3,796) 136 269 195 433 97 20 25 (136) (255) (215) (446) (362) — 14 121 21 — 111 — 12 1,546 facilities shutdown prior to 2015 ..................... 1,908 Totals .......................................................... $ 3,848 $ 4,456 $ 50,503 $ (45,422) $ 13,385 (cid:31) 54 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Balance at December 31, 2015 Provisions in Cost of goods sold or SG&A Actual expenditures charged to accrual Balance at December 31, 2016 Exit Plan Consumer Brands Group facilities shutdown in 2016: Severance and related costs ................................................ $ 1,020 $ (113) $ 907 Performance Coatings Group stores shutdown in 2016: Severance and related costs ................................................ Other qualified exit costs ..................................................... The Americas Group stores shutdown in 2015: Other qualified exit costs ..................................................... $ 12 Performance Coatings Group stores shutdown in 2015: Severance and related costs ................................................ Other qualified exit costs ..................................................... 1,096 2,750 The Americas Group stores shutdown in 2014: Other qualified exit costs ..................................................... Consumer Brands Group facilities shutdown in 2014: Severance and related costs ................................................ Other qualified exit costs ..................................................... Performance Coatings Group exit of business in 2014: Severance and related costs ................................................ Other qualified exit costs ..................................................... Severance and other qualified exit costs for facilities 184 445 52 430 353 shutdown prior to 2014 .................................................... 1,755 136 369 481 499 430 103 (100) (298) (1,096) (2,816) (81) (46) (39) (430) (600) (648) 136 269 195 — 433 103 399 13 — 183 1,210 Totals ................................................................................ $ 7,077 $ 3,038 $ (6,267) $ 3,848 Note 7 – Pension, Health Care and Postretirement Benefits other than Pensions was $65,220, $38,426 and $36,731 for 2018, 2017 and 2016, respectively. The contribution percentage ranges from two The Company provides pension benefits to substantially all percent to seven percent of compensation for covered employees full-time employees through primarily noncontributory defined based on an age and service formula. Assets in employee accounts contribution or defined benefit plans and certain health care and of the domestic defined contribution pension plan are invested in life insurance benefits to domestic active employees and eligible various investment funds as directed by the participants. These retirees. In accordance with the Retirement Benefits Topic of the investment funds did not own a significant number of shares of the ASC, the Company recognizes an asset for overfunded defined Company’s common stock for any year presented. benefit pension or other postretirement benefit plans and a The Company’s annual contributions for its foreign defined liability for unfunded or underfunded plans. In addition, actuarial contribution pension plans, which are based on various gains and losses and prior service costs of such plans are recorded percentages of compensation for covered employees up to certain in Cumulative other comprehensive loss, a component of limits, were $19,462, $10,480 and $6,676 for 2018, 2017 and 2016, Shareholders’ equity. The amounts recorded in Cumulative other respectively. Assets in employee accounts of the foreign defined comprehensive loss will continue to be modified as actuarial contribution pension plans are invested in various investment assumptions and service costs change, and all such amounts will funds. These investment funds did not own a significant number of be amortized to expense over a period of years through the net shares of the Company’s common stock for any year presented. pension cost (credit) and net periodic benefit cost. Defined benefit pension plans. Prior to December 31, 2017, Health care plans. The Company provides certain domestic the Company had one salaried and one hourly domestic defined health care plans that are contributory and contain cost-sharing benefit pension plan. In connection with the Acquisition, the features such as deductibles and coinsurance. There were 26,323, Company acquired Valspar’s domestic defined benefit pension 26,565 and 22,708 active employees entitled to receive benefits plan. Effective December 31, 2017, the three domestic defined under these plans at December 31, 2018, 2017 and 2016, benefit pension plans were merged into one plan. In 2018, this plan respectively. The cost of these benefits for active employees, was split into two separate overfunded plans: one that will which includes claims incurred and claims incurred but not continue to operate and one that was frozen and subsequently reported, amounted to $298,800, $281,158 and $220,589 for 2018, terminated during 2018. The Company is in the process of settling 2017 and 2016, respectively. the liabilities of the terminated plan through a combination of Defined contribution pension plans. The Company’s annual (i) lump sum payments to eligible participants who elected to contribution for its domestic defined contribution pension plan receive them and (ii) the purchase of annuity contracts for (cid:31) 55 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) participants who either did not elect lump sums or were already obligation of $632,797, fair value of plan assets of $847,013 and receiving benefit payments. The lump sum payments were paid in excess plan assets of $214,216. December 2018 and resulted in a settlement charge of The Company has thirty-one foreign defined benefit pension $37.6 million in 2018. The annuity contracts were purchased in plans, twelve of which were acquired through the Acquisition. At 2019 and are expected to result in a settlement charge of December 31, 2018, twenty-four of the Company’s foreign defined approximately $30 million to $40 million in the first quarter of benefit pension plans were unfunded or underfunded, with 2019. The Company will use any remaining overfunded cash combined accumulated benefit obligations, projected benefit surplus balances to fund future company contributions to a obligations, fair values of net assets and deficiencies of plan assets replacement defined contribution plan. of $168,395, $199,881, $119,232 and $80,649, respectively. At December 31, 2018, the domestic defined benefit pension The Company expects to make the following benefit payments plans were overfunded, with a projected benefit obligation of for all domestic and foreign defined benefit pension plans: $524,675, fair value of plan assets of $776,961 and excess plan $49,259 in 2019; $46,809 in 2020; $46,469 in 2021; $46,104 in assets of $252,286. The plans were funded in accordance with all 2022; $46,532 in 2023; and $226,112 in 2024 through 2028. The applicable regulations at December 31, 2018. At December 31, Company expects to contribute $5,295 to the foreign plans in 2017, the domestic defined benefit pension plan was overfunded, 2019. with a projected benefit obligation of $916,175, fair value of plan The estimated net actuarial losses and prior service costs for assets of $1,188,638 and excess plan assets of $272,463. At the defined benefit pension plans that are expected to be December 31, 2016, the domestic salaried and hourly defined amortized from Cumulative other comprehensive loss into the net benefit pension plan were overfunded, with a projected benefit pension costs in 2019 are $1,033 and $1,397, respectively. The following table summarizes the components of the net pension costs and Cumulative other comprehensive loss related to the defined benefit pension plans: Net pension cost (credit): Domestic Defined Benefit Pension Plans 2017 2018 2016 Foreign Defined Benefit Pension Plans 2016 2017 2018 Service cost ......................................................... Interest cost ......................................................... Expected return on plan assets .............................. Amortization of prior service cost .......................... Amortization of actuarial losses ............................. $ 7,259 32,161 (53,005) 3,530 Ongoing pension cost (credit) ............................ Settlement cost (credit) ........................................ Curtailment cost ................................................... (10,055) 37,648 825 $ 21,711 31,085 (48,275) 1,362 6,210 12,093 (1,990) $ 22,291 26,498 (50,197) 1,205 4,532 4,329 $ 8,160 9,486 (10,837) $ 7,039 8,177 (9,070) $ 4,225 7,441 (6,915) 1,518 8,327 (374) 1,833 7,979 71 1,540 6,291 4,231 Net pension cost ............................................... 28,418 10,103 4,329 7,953 8,050 10,522 Other changes in plan assets and projected benefit obligation recognized in Cumulative other comprehensive loss (before taxes): Net actuarial losses (gains) arising during the year ................................................................. Prior service cost arising during the year ................ Amortization of actuarial losses ............................. Amortization of prior service cost .......................... (Loss) gain recognized for settlement .................... Prior service cost recognized for curtailment .......... Loss arising from curtailment ................................ Exchange rate (loss) gain recognized during the year ................................................................. Total recognized in Cumulative other 29,927 4,577 (3,530) (37,648) (825) (742) (65,829) 844 (6,210) (1,362) 1,990 18,926 2,081 (4,532) (1,205) (5,107) (13,960) 17,030 (1,518) (1,833) (1,540) 374 (71) (1,890) 4,133 (11,627) comprehensive loss ....................................... (8,241) (70,567) 15,270 (8,141) (11,731) 3,863 Total recognized in net pension cost and Cumulative other comprehensive loss ............. $ 20,177 $(60,464) $ 19,599 $ (188) $ (3,681) $ 14,385 (cid:31) 56 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Service cost is recorded in Cost of goods sold and Selling, maximize the long-term return of assets for a prudent level of risk. general and administrative expense. All other components of Net In determining the expected long-term rate of return on defined pension costs are recorded in Other expense (income) – net. See benefit pension plan assets, management considers the historical Note 1 for information on the adoption of ASU No. 2017-07. rates of return, the nature of investments and an expectation of The Company employs a total return investment approach for future investment strategies. The target allocations for plan assets the domestic and foreign defined benefit pension plan assets. A are 35 – 65 percent equity securities and 35 – 55 percent fixed mix of equities and fixed income investments are used to income securities. The following tables summarize the fair value of the defined benefit pension plan assets at December 31, 2018, 2017 and 2016. The presentation is in accordance with the Retirement Benefits Topic of the ASC, as updated by ASU No. 2015-07 (see Note 1). Fair value at December 31, 2018 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Investments at fair value: Equity investments(1) ............................................... Fixed income investments(2) ..................................... Other assets(3) ......................................................... $ Total investments in fair value hierarchy ........................ Investments measured at NAV or its equivalent(4) .......... 215,812 609,926 38,413 864,151 166,376 Total investments ........................................................ $ 1,030,527 $ 123,982 462,777 $ 586,759 $ $ 91,830 147,149 38,413 277,392 Fair value at December 31, 2017 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Investments at fair value: Equity investments(1) ............................................... Fixed income investments(2) ..................................... Other assets(3) ......................................................... $ Total investments in fair value hierarchy ........................ Investments measured at NAV or its equivalent(4) .......... 514,983 380,902 39,196 935,081 533,561 Total investments ........................................................ $ 1,468,642 $ 409,911 146,816 $ 556,727 $ $ 105,072 234,086 39,196 378,354 Fair value at December 31, 2016 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Investments at fair value: Equity investments(1) ............................................... Fixed income investments(2) ..................................... Other assets(3) ......................................................... $ Total investments in fair value hierarchy ........................ Investments measured at NAV or its equivalent(4) .......... 393,045 294,103 14,643 701,791 310,230 Total investments ........................................................ $ 1,012,021 $ 321,152 144,668 $ 465,820 $ $ 71,893 149,435 14,643 235,971 (1) This category includes actively managed equity assets that track primarily to the S&P 500. (2) This category includes government and corporate bonds that track primarily to the Barclays Capital Aggregate Bond Index. (3) This category includes real estate and pooled investment funds. (4) This category includes pooled investment funds and private equity funds that are measured at NAV or its equivalent using the practical expedient. Therefore, these investments are not classified in the fair value hierarchy. Included as equity investments in the domestic defined benefit representing 15.2 percent of total domestic plan assets. Dividends pension plan assets at December 31, 2018 were 300,000 shares of received on the Company’s common stock during 2018 totaled the Company’s common stock with a market value of $118,038, $1,032. (cid:31) 57 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) The following table summarizes the obligations, plan assets and assumptions used for the defined benefit pension plans, which are all measured as of December 31: Accumulated benefit obligations at end of year ............................................................. $ 520,958 $ 913,363 $ 630,159 $280,046 $ 308,164 $ 172,047 Domestic Defined Benefit Pension Plans 2017 2018 2016 Foreign Defined Benefit Pension Plans 2016 2017 2018 Projected benefit obligations: Balances at beginning of year ........................ Service cost ................................................. Interest cost ................................................. Actuarial (gains) losses ................................. Acquisition ................................................... Contributions and other ................................ Settlements ................................................. Effect of foreign exchange ............................ Benefits paid ................................................ Plan assets: Balances at beginning of year ........................ Actual returns on plan assets ......................... Acquisition ................................................... Contributions and other ................................ Settlements ................................................. Effect of foreign exchange ............................ Benefits paid ................................................ $ 916,175 7,259 32,161 (13,552) 3,834 (379,064) $ 632,797 21,711 31,085 67,945 246,894 844 (43,381) $ 624,791 22,291 26,498 8,132 $ 349,597 8,160 9,486 (20,958) 2,081 1,572 (6,319) (16,226) (9,467) $ 206,873 7,039 8,177 (4,002) 115,045 1,397 (758) 22,938 (7,112) $ 201,854 4,225 7,441 43,736 947 (14,862) (30,360) (6,108) (42,138) (41,720) (50,996) 1,188,638 9,525 847,013 182,049 244,677 (379,064) (43,381) 858,605 39,404 280,004 (4,896) 165,008 16,282 82,314 6,048 (758) 18,222 (7,112) 162,339 33,569 15,019 (14,862) (24,949) (6,108) 8,278 (6,319) (14,034) (9,467) (42,138) (41,720) (50,996) Balances at end of year ................................. 524,675 916,175 632,797 315,845 349,597 206,873 Balances at end of year ................................. 776,961 1,188,638 847,013 253,566 280,004 165,008 Excess (deficient) plan assets over projected benefit obligations ........................................ $ 252,286 $ 272,463 $ 214,216 $ (62,279) $ (69,593) $ (41,865) Assets and liabilities recognized in the Consolidated Balance Sheets: Deferred pension assets ................................ Other accruals .............................................. Other long-term liabilities .............................. Amounts recognized in Cumulative other comprehensive loss: Net actuarial losses ....................................... Prior service costs ........................................ Weighted-average assumptions used to determine projected benefit obligations: Discount rate ................................................ Rate of compensation increase ...................... Weighted-average assumptions used to determine net pension costs: Discount rate ................................................ Expected long-term rate of return on assets ... Rate of compensation increase ...................... $ 252,286 $ 272,463 $ 214,216 $ 18,378 (2,716) (77,941) $ 24,280 (2,523) (91,350) $ 11,313 (1,522) (51,656) $ 252,286 $ 272,463 $ 214,216 $(62,279) $(69,593) $ (41,865) $ (56,335) (5,719) $(64,799) (5,496) $(134,847) (6,015) $ (25,732) $ (33,873) $(45,604) $ (62,054) $(70,295) $(140,862) $ (25,732) $ (33,873) $(45,604) 3.60% 3.17% 3.60% 3.33% 4.20% 3.38% 3.04% 3.65% 2.73% 3.69% 3.21% 4.43% 3.60% 5.00% 3.33% 4.15% 5.00% 3.30% 4.40% 6.00% 3.14% 2.73% 3.84% 3.69% 3.88% 4.75% 4.33% 4.20% 4.70% 4.00% (cid:31) 58 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Postretirement Benefits Other Than Pensions. Employees retirement, subject to the terms of the unfunded plans. There of the Company hired in the United States prior to January 1, were 2,987, 3,486 and 4,524 retired employees entitled to 1993 who are not members of a collective bargaining unit, and receive such postretirement benefits at December 31, 2018, 2017 certain groups of employees added through acquisitions, are and 2016, respectively. eligible for health care and life insurance benefits upon The following table summarizes the obligation and the assumptions used for postretirement benefits other than pensions: Postretirement Benefits Other than Pensions 2017 2016 2018 Benefit obligation: Balance at beginning of year – unfunded ............................................................ Service cost ..................................................................................................... Interest cost ..................................................................................................... Acquisition ...................................................................................................... Actuarial (gain) loss .......................................................................................... Plan amendments ............................................................................................. Benefits paid .................................................................................................... $ 290,823 1,994 10,178 (9,047) (77) (19,237) $ 265,137 2,105 10,749 17,010 11,637 $ 263,383 2,244 11,009 7,548 (15,815) (19,047) Balance at end of year – unfunded ..................................................................... $ 274,634 $ 290,823 $ 265,137 Liabilities recognized in the Consolidated Balance Sheets: Postretirement benefits other than pensions ....................................................... Other accruals .................................................................................................. $ (257,621) (17,013) $(274,675) (16,148) $(250,397) (14,740) $(274,634) $(290,823) $ (265,137) Amounts recognized in Cumulative other comprehensive loss: Net actuarial losses ........................................................................................... Prior service credits .......................................................................................... $ (32,774) 6,134 $ (44,147) 12,625 $ (23,211) 19,205 Weighted-average assumptions used to determine benefit obligation: Discount rate ................................................................................................... Health care cost trend rate – pre-65 ................................................................... Health care cost trend rate – post-65 ................................................................. Prescription drug cost increases ........................................................................ Employer Group Waiver Plan (EGWP) trend rate ................................................ Weighted-average assumptions used to determine net periodic benefit cost: Discount rate ................................................................................................... Health care cost trend rate – pre-65 ................................................................... Health care cost trend rate – post-65 ................................................................. Prescription drug cost increases ........................................................................ $ (26,640) $ (31,522) $ (4,006) 4.21% 6.69% 4.94% 9.75% 9.75% 3.61% 7.00% 5.00% 11.00% 3.61% 7.00% 5.00% 11.00% 11.00% 4.10% 6.00% 5.50% 10.50% 4.10% 6.00% 5.50% 10.50% 10.60% 4.30% 6.00% 5.00% 11.50% (cid:31) 59 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) The following table summarizes the components of the net periodic benefit cost and Cumulative other comprehensive loss related to postretirement benefits other than pensions: Postretirement Benefits Other than Pensions 2017 2016 2018 Net periodic benefit cost (credit): Service cost ................................................................................................................................ Interest cost ............................................................................................................................... Amortization of actuarial losses .................................................................................................... Amortization of prior service credit .............................................................................................. Net periodic benefit cost .......................................................................................................... Settlement credit ........................................................................................................................ $ 1,994 10,178 2,326 (6,569) 7,929 $ 2,105 10,749 32 (6,579) 6,307 (9,332) $ 2,244 11,009 (6,578) 6,675 Net periodic benefit cost (credit) .............................................................................................. 7,929 (3,025) 6,675 Other changes in projected benefit obligation recognized in Cumulative other comprehensive loss (before taxes): Net actuarial (gain) loss arising during the year ............................................................................. Prior service credit arising during the year ..................................................................................... Amortization of actuarial losses .................................................................................................... Settlement cost ........................................................................................................................... Amortization of prior service credit .............................................................................................. (9,047) (78) (2,326) 6,569 11,637 7,548 (32) 9,332 6,579 6,578 14,126 Total recognized in Cumulative other comprehensive loss ........................................................... (4,882) 27,516 Total recognized in net periodic benefit cost and Cumulative other comprehensive loss ................ $ 3,047 $ 24,491 $ 20,801 The estimated net actuarial losses and prior service (credits) The Company expects to make retiree health care benefit cash for postretirement benefits other than pensions that are expected payments as follows: 2019 ............................................................. 2020 ............................................................. 2021 .............................................................. 2022 ............................................................. 2023 ............................................................. 2024 through 2028 ........................................ Total expected benefit cash payments ............. Expected Cash Payments $ 17,013 18,757 19,391 19,969 19,991 98,836 $193,957 to be amortized from Cumulative other comprehensive loss into net periodic benefit cost in 2019 are $535 and $(4,997), respectively. The assumed health care cost trend rate and prescription drug cost increases used to determine the net periodic benefit cost for postretirement health care benefits for 2019 both decrease in each successive year until reaching 4.5 percent in 2026. The assumed health care and prescription drug cost trend rates have a significant effect on the amounts reported for the postretirement health care benefit obligation. A one-percentage-point change in assumed health care and prescription drug cost trend rates would have had the following effects at December 31, 2018: One-Percentage Point (Decrease) Increase Effect on total of service and interest cost components ............ Effect on the postretirement benefit obligation .................................. $ 132 $ (132) $3,602 $(3,636) (cid:31) 60 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Note 8 – Debt Long-term debt Due Date 2018 2017 2016 2.25% Senior Notes(1) ................................................................................ 3.45% Senior Notes(1) ............................................................................... 2.75% Senior Notes(1) ................................................................................ 4.50% Senior Notes(1) ............................................................................... Term Loan ............................................................................................... 3.125% Senior Notes(1) .............................................................................. 4.20% Senior Notes(2) ............................................................................... 3.45% Senior Notes .................................................................................. 4.55% Senior Notes .................................................................................. 3.95% Senior Notes(2) ............................................................................... 7.25% Senior Notes(2) ............................................................................... 4.00% Senior Notes .................................................................................. Floating Rate Loan ................................................................................... 3.30% Senior Notes(2) ............................................................................... 4.40% Senior Notes(2) .............................................................................. 7.375% Debentures .................................................................................. 0.92% Fixed Rate Loan ............................................................................. 7.45% Debentures .................................................................................... 2.00% to 8.0% Promissory Notes ............................................................... 2020 2027 2022 2047 2022 2024 2022 2025 2045 2026 2019 2042 2021 2025 2045 2027 2021 2097 Through 2027 $ 1,496,015 1,485,023 1,242,850 1,229,373 496,287 416,815 397,621 394,082 360,822 296,251 257,371 249,304 238,747 119,029 22,877 3,500 2,090 $ 1,493,106 1,483,244 1,240,758 1,228,647 847,337 495,602 422,370 397,260 393,859 362,381 319,394 296,094 269,247 249,207 238,334 118,982 23,933 3,500 2,490 $396,898 393,637 295,938 118,936 3,500 2,417 $8,708,057 $9,885,745 $1,211,326 (1) Senior notes issued in 2017 to fund the Acquisition (2) Senior notes acquired in 2017 through the Acquisition Maturities of long-term debt are as follows for the next five On June 2, 2017 the Company closed its previously announced years: $301,149 in 2019; $1,500,375 in 2020; $281,005 in 2021, exchange offers and consent solicitations (Exchange Offer) for the $1,650,268 in 2022 and $272 in 2023. Interest expense on long- outstanding senior notes of Valspar. Pursuant to the Exchange term debt was $343,119, $257,350 and $75,509 for 2018, 2017 and Offer, the Company issued an aggregate principal amount of 2016, respectively. approximately $1.478 billion (Exchange Notes). The Exchange Among other restrictions, the Company’s notes, debentures Notes are unsecured senior obligations of the Company. The and revolving credit agreement contain certain covenants relating Company did not receive any cash proceeds from the issuance of to liens, ratings changes, merger and sale of assets, consolidated the Exchange Notes. leverage and change of control, as defined in the agreements. In the event of default under any one of these arrangements, In August 2017, the Company entered into a floating rate loan of €225.0 million and a fixed rate loan of €20.0 million. The floating acceleration of the maturity of any one or more of these rate loan agreement bears interest at the six-month Euro borrowings may result. The Company was in compliance with all Interbank Offered Rate plus a margin. The fixed rate loan bears covenants for all years presented. interest at 0.92%. The proceeds are being used for general On May 16, 2017, the Company issued $6.0 billion of senior corporate purposes. The loans mature on August 23, 2021. notes (collectively the “New Notes”) in a public offering. The net In April 2016, the Company entered into agreements for a proceeds from the issuance of the New Notes were used to fund $7.3 billion Bridge Loan and a $2.0 billion Term Loan as committed the Acquisition. See Note 4. The interest rate locks entered into in financing for the Acquisition. On June 1, 2017, the Company 2016 settled in March 2017 resulting in a pretax gain of terminated the agreement for the Bridge Loan and borrowed the $87.6 million recognized in Cumulative other comprehensive loss. full $2.0 billion on the Term Loan. During 2018, the Company paid This gain is being amortized from Cumulative other the outstanding balance on the Term Loan and the agreement was comprehensive loss to a reduction of interest expense over the terminated. terms of the New Notes. For the year ended December 31, 2018, the amortization of the unrealized gain reduced interest expense by $8.3 million. (cid:31) 61 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Short-term borrowings. On July 19, 2018, the Company and Company conducts its operations in compliance with applicable three of its wholly-owned subsidiaries, Sherwin-Williams Canada, environmental laws and regulations and has implemented various Inc., Sherwin-Williams Luxembourg S.à r.l and Sherwin-Williams programs designed to protect the environment and promote UK Holding Limited (all together with the Company, the continued compliance. Borrowers), entered into a new five-year $2.000 billion credit The Company is involved with environmental investigation and agreement (New Credit Agreement). The New Credit Agreement remediation activities at some of its currently and formerly owned may be used for general corporate purposes, including the sites (including sites which were previously owned and/or financing of working capital requirements. The New Credit operated by businesses acquired by the Company). In addition, Agreement replaced a credit agreement dated July 16, 2015, as the Company, together with other parties, has been designated a amended, which was terminated. The New Credit Agreement potentially responsible party under federal and state allows the Company to extend the maturity of the facility with two environmental protection laws for the investigation and one-year extension options and the Borrowers to increase the remediation of environmental contamination and hazardous waste aggregate amount of the facility to $2.750 billion, both of which at a number of third-party sites, primarily Superfund sites. In are subject to the discretion of each lender. In addition, the general, these laws provide that potentially responsible parties Borrowers may request letters of credit in an amount of up to may be held jointly and severally liable for investigation and $250.0 million. At December 31, 2018, there were no short-term remediation costs regardless of fault. The Company may be borrowings under the New Credit Agreement. Borrowings similarly designated with respect to additional third-party sites in outstanding under various other foreign programs were the future. $37.0 million at December 31, 2018 with a weighted average The Company initially provides for estimated costs of interest rate of 9.3%. environmental-related activities relating to its past operations and In September 2017, the Company entered into a five-year letter third-party sites for which commitments or clean-up plans have of credit agreement, subsequently amended on multiple dates, been developed and when such costs can be reasonably estimated with an aggregate availability of $625.0 million at December 31, based on industry standards and professional judgment. These 2018. On May 6, 2016, the Company entered into a five-year credit estimated costs are determined based on currently available facts agreement, subsequently amended on multiple dates. This credit regarding each site. If the best estimate of costs can only be agreement gives the Company the right to borrow and to obtain identified as a range and no specific amount within that range can the issuance, renewal, extension and increase of a letter of credit be determined more likely than any other amount within the range, up to an aggregate availability of $875.0 million at December 31, the minimum of the range is provided. The Company continuously 2018. Both of these credit agreements are being used for general assesses its potential liability for investigation and remediation- corporate purposes. At December 31, 2018, there were no related activities and adjusts its environmental-related accruals as borrowings outstanding under these credit agreements. There information becomes available upon which more accurate costs can were $350.0 million borrowings outstanding at December 31, 2017 be reasonably estimated and as additional accounting guidelines and no borrowings outstanding at December 31, 2016. are issued. Included in Other long-term liabilities at December 31, There were $291.4 million borrowings outstanding under the 2018, 2017 and 2016 were accruals for extended environmental- Company’s domestic commercial paper program at December 31, related activities of $322,459, $179,593 and $163,847, respectively. 2018. There were $274.8 million borrowings outstanding at Included in Other accruals at December 31, 2018, 2017 and 2016 December 31, 2017 and no borrowings outstanding at were accruals for estimated costs of current investigation and December 31, 2016. Note 9 – Other Long-Term Liabilities remediation activities of $51,038, $28,556 and $19,969, respectively. See Note 14 regarding provisions for environmental matters-net and related increases to the environmental accrued The operations of the Company, like those of other companies liabilities at December 31, 2018. in our industry, are subject to various domestic and foreign Actual costs incurred may vary from the accrued estimates due environmental laws and regulations. These laws and regulations to the inherent uncertainties involved including, among others, the not only govern current operations and products, but also impose number and financial condition of parties involved with respect to potential liability on the Company for past operations. any given site, the volumetric contribution which may be Management expects environmental laws and regulations to attributed to the Company relative to that attributed to other impose increasingly stringent requirements upon the Company parties, the nature and magnitude of the wastes involved, the and the industry in the future. Management believes that the various technologies that can be used for remediation (cid:31) 62 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) and the determination of acceptable remediation with respect to a distribution and store facilities. These obligations relate primarily particular site. If the Company’s future loss contingency is to asbestos abatement, hazardous waste Resource Conservation ultimately determined to be at the unaccrued maximum of the and Recovery Act (RCRA) closures, well abandonment, estimated range of possible outcomes for every site for which transformers and used oil disposals and underground storage tank costs can be reasonably estimated, the Company’s accrual for closures. Using investigative, remediation and disposal methods environmental-related activities would be $117,518 higher than the that are currently available to the Company, the estimated costs of minimum accruals at December 31, 2018. Four of the Company’s currently and formerly owned manufacturing sites account for the majority of the accrual for environmental-related activities and the unaccrued maximum of the estimated range of possible outcomes at December 31, 2018. At December 31, 2018, $326,202, or 87.2 percent of the total accrual, related directly to these four sites. In the aggregate unaccrued maximum of $117,518 at December 31, 2018, $93,191, or 79.3 percent, related to the four manufacturing sites. While environmental investigations and remedial actions are in different stages at these sites, additional investigations, remedial actions and monitoring will likely be required at each site. Management cannot presently estimate the ultimate potential loss contingencies related to these sites or other less significant sites until such time as a substantial portion of the investigation at the sites is completed and remedial action plans are developed. 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 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 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 environmental agency approval, as necessary, with respect to investigation and remediation activities, and the indefinite amount of time necessary to conduct remediation activities. The Asset Retirement and Environmental Obligations Topic of the ASC requires a liability to be recognized for the fair value of a conditional asset retirement obligation if a settlement date and fair value can be reasonably estimated. The Company recognizes a liability for any conditional asset retirement obligation when sufficient information is available to reasonably estimate a settlement date to determine the fair value of such a liability. The Company has identified certain conditional asset retirement obligations at various current and closed manufacturing, these obligations were accrued and are not significant. The recording of additional liabilities for future conditional asset retirement obligations may result in a material impact on net income for the annual or interim period during which the costs are accrued. Management does not believe that any potential liability ultimately attributed to the Company for its 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 over which sufficient information may become available regarding the closure or modification of any one or group of the Company’s facilities. An estimate of the potential impact on the Company’s operations cannot be made due to the aforementioned uncertainties. Note 10 – 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. (cid:31) 63 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Lead pigment and lead-based paint litigation. The administrative regulations may have on the litigation or against Company’s past operations included the manufacture and sale of the Company. In addition, management cannot reasonably lead pigments and lead-based paints. The Company, along with determine the scope or amount of the potential costs and other companies, is and has been a defendant in a number of legal liabilities related to such litigation, or resulting from any such proceedings, including individual personal injury actions, legislation and regulations. Except with respect to the litigation in purported class actions, and actions brought by various counties, California discussed below, the Company has not accrued any cities, school districts and other government-related entities, amounts for such litigation because the Company does not believe arising from the manufacture and sale of lead pigments and lead- it is probable that a loss has occurred, and the Company believes it based paints. The plaintiffs’ claims have been based upon various is not possible to estimate the range of potential losses as there is legal theories, including negligence, strict liability, breach of no substantive information upon which an estimate could be warranty, negligent misrepresentations and omissions, fraudulent based. In addition, any potential liability that may result from any 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 material 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 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 or any such liability is higher than any amount currently accrued for 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; the County of Santa Clara, California, and other public entities in the State of California; and Lehigh and Montgomery Counties in Pennsylvania. Except for the Santa Clara County, California proceeding and the pending Pennsylvania proceedings, all of these legal proceedings have been concluded in favor of the Company and other defendants at various stages in the proceedings. Santa Clara County, California Proceeding. The Santa Clara County, California proceeding was initiated in March 2000 in the Superior Court of the State of California, County of Santa Clara. In the original complaint, the plaintiffs asserted various claims including fraud and concealment, strict product liability/failure to warn, strict product liability/design defect, negligence, negligent breach of a special duty, public nuisance, private nuisance, and violations of California’s Business and Professions Code. A number of the asserted claims were resolved in favor of the defendants through pre-trial proceedings. The named plaintiffs in the Fourth (cid:31) 64 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Amended Complaint, filed on March 16, 2011, are the Counties of Motion for Good Faith Settlement on July 12, 2018 and Santa Clara, Alameda, Los Angeles, Monterey, San Mateo, Solano subsequently denied NL Industries’ Motion. NL Industries has filed and Ventura, as well as the Cities of Oakland and San Diego and a petition for writ of mandate with the Sixth District Court of the City and County of San Francisco. The Fourth Amended Appeal seeking to obtain immediate appellate review and reversal Complaint asserted a sole claim for public nuisance, alleging that of the denial of its motion. On July 16, 2018, the Company filed a the presence of lead pigments for use in paint and coatings in, on Petition for Writ of Certiorari with the Supreme Court of the and around residences in the plaintiffs’ jurisdictions constitutes a United States seeking discretionary review. On October 15, 2018, public nuisance. The plaintiffs sought the abatement of the alleged the Supreme Court of the United States denied the Company’s public nuisance that exists within the plaintiffs’ jurisdictions. A trial Petition for Writ of Certiorari. commenced on July 15, 2013 and ended on August 22, 2013. The The trial court has selected a receiver for the abatement fund, court entered final judgment on January 27, 2014, finding in favor but the terms of an order appointing the receiver have not been of the plaintiffs and against the Company and two other determined and will be the subject of a further hearing scheduled defendants (ConAgra Grocery Products Company and NL for March 7, 2019. The trial court has stayed the entry of judgment Industries, Inc.). The final judgment held the Company jointly and pending the decision of the Sixth District Court of Appeal on NL severally liable with the other two defendants to pay $1.15 billion Industries’ petition for writ of mandate, but otherwise has ruled into a fund to abate the public nuisance. The Company strongly that, within sixty days of entry of judgment, the Company, disagrees with the judgment. ConAgra and NL Industries shall pay into the abatement fund all On February 18, 2014, the Company filed a motion for new trial amounts due. and a motion to vacate the judgment. The court denied these Although the Company believes it is probable that a loss has motions on March 24, 2014. On March 28, 2014, the Company filed occurred, the ultimate amount of such loss and the timing of any a notice of appeal to the Sixth District Court of Appeal for the payments remains uncertain and could change in the future due to State of California. Oral argument before the Sixth District Court of the numerous possible outcomes and uncertainties, including, but Appeal was held on August 24, 2017. On November 14, 2017, the not limited to, (i) the final amount of the abatement fund that will Sixth District Court of Appeal entered its decision, which affirmed be paid, particularly because participation in the abatement the trial court’s judgment of liability with respect to residences program by eligible homeowners is voluntary and it is uncertain built before 1951 and reversed and vacated the trial court’s what percentage of eligible homeowners will participate or how judgment with respect to residences built after 1950. The Sixth claims will be administered, and (ii) the portion of the abatement District Court of Appeal directed the trial court to: (i) recalculate fund for which the Company, the two other defendants and others the amount of the abatement fund to limit the fund to the amount are determined to be responsible. However, the Company has necessary to cover the cost of inspecting and remediating pre-1951 accrued $136.3 million for this litigation, which is one-third of the residences; and (ii) hold an evidentiary hearing to appoint a amount of the abatement fund. It is possible that the Company suitable receiver. On November 29, 2017, the Company and the may change the amount accrued for this litigation based on the two other defendants filed separate Petitions for Rehearing, which facts and circumstances. Because of joint and several liability, it is the Sixth District Court of Appeal denied on December 6, 2017. possible the Company could ultimately be liable for the total The Sixth District Court of Appeal’s decision became final on amount of the abatement fund. In the event any liability is higher December 14, 2017. On December 22, 2017, the Company and the than any amount currently accrued for such litigation, the two other defendants submitted separate Petitions for Review to recording of any liability may result in a material impact on the the California Supreme Court. On February 14, 2018, the California Company’s results of operations, liquidity or financial condition for Supreme Court issued an order denying the Petitions for Review. the annual or interim period during which such liability is accrued. On April 17, 2018, the parties filed their briefs with the trial Pennsylvania Proceedings. Two proceedings in Pennsylvania court regarding the recalculation of the amount of the abatement were initiated in October 2018. The County of Montgomery, fund. The plaintiffs proposed $730.0 million as the amount of the Pennsylvania filed a Complaint against the Company and several abatement fund, and the Company and the other two defendants other former lead-based paint and lead pigment manufacturers in jointly proposed a maximum amount of no more than the Court of Common Pleas of Montgomery County, Pennsylvania. $409.1 million. On August 17, 2018, the trial court held a hearing The County of Lehigh, Pennsylvania also filed a Complaint against regarding the recalculation of the amount of the abatement fund. the Company and several other former lead-based paint and lead On September 4, 2018, the trial court ruled that the amount of the pigment manufacturers in the Court of Common Pleas of Lehigh abatement fund is $409.1 million. On May 17, 2018, NL Industries County, Pennsylvania. The Company removed both actions to the filed a Motion for Good Faith Settlement, which the Company and United States District Court for the Eastern District of Pennsylvania ConAgra opposed. The trial court held a hearing on NL Industries’ on November 28, 2018. The plaintiffs filed a motion for (cid:31) 65 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) remand in each action on January 7, 2019, which the defendants plaintiff to identify the manufacturer of the product that allegedly will oppose. In both actions, the counties request declaratory relief injured the plaintiff in the lead pigment and lead-based paint establishing the existence of a public nuisance and the defendants’ litigation. Although the risk contribution liability theory was contribution to it, the abatement of an ongoing public nuisance applied during the Thomas trial, the constitutionality of this theory arising from the presence of lead-based paint in housing as applied to the lead pigment cases has not been judicially throughout the applicable county, an injunction against future determined by the Wisconsin state courts. However, in an illicit conduct, and the costs of litigation and attorneys’ fees. unrelated action filed in the United States District Court for the In October 2018, the Company filed a Complaint in the United Eastern District of Wisconsin, Gibson v. American Cyanamid, et al., States District Court for the Eastern District of Pennsylvania on November 15, 2010, the District Court held that Wisconsin’s risk against the Pennsylvania Counties of Delaware, Erie and York contribution theory as applied in that case violated the seeking injunctive and declaratory relief to prevent the violation of defendants’ right to substantive due process and is the Company’s rights under the First Amendment and Due Process unconstitutionally retroactive. The District Court’s decision in Clause of the U.S. Constitution. The Company voluntarily Gibson v. American Cyanamid, et al., was appealed by the plaintiff dismissed defendant Erie County on November 9, 2018 and to the United States Court of Appeals for the Seventh Circuit. On defendant York County on November 21, 2018. Defendant July 24, 2014, the United States Court of Appeals for the Seventh Delaware County has filed a motion to dismiss the Complaint, Circuit reversed the judgment and remanded the case back to the which is pending. District Court for further proceedings. On January 16, 2015, the Litigation seeking damages from alleged personal injury. defendants filed a petition for certiorari in the United States The Company and other companies are defendants in a number of Supreme Court seeking that Court’s review of the Seventh Circuit’s legal proceedings seeking monetary damages and other relief decision, and on May 18, 2015, the United States Supreme Court from alleged personal injuries. These proceedings include claims denied the defendants’ petition. The case is currently pending in by children allegedly injured from ingestion of lead pigment or the District Court. lead-containing paint and claims for damages allegedly incurred The United States District Court for the Eastern District of by the children’s parents or guardians. These proceedings Wisconsin has consolidated three cases (Ravon Owens v. generally seek compensatory and punitive damages, and seek American Cyanamid, et al., Cesar Sifuentes v. American Cyanamid, other relief including medical monitoring costs. These proceedings et al., and Glenn Burton, Jr. v. American Cyanamid, et al.) for include purported claims by individuals, groups of individuals and purposes of trial and set a trial date for May 6, 2019. The parties class actions. are preparing for trial. The plaintiff in Thomas v. Lead Industries Association, et al., In Maniya Allen, et al. v. American Cyanamid, et al., also initiated an action in Wisconsin state court against the Company, pending in the United States District Court for the Eastern District other alleged former lead pigment manufacturers and the Lead of Wisconsin, cases involving six of the 146 plaintiffs were selected Industries Association in September 1999. The claims against the for discovery. In Dijonae Trammell, et al. v. American Cyanamid, et Company and the other defendants included strict liability, al., also pending in the United States District Court for the Eastern negligence, negligent misrepresentation and omissions, fraudulent District of Wisconsin, discovery for one of the three plaintiffs was misrepresentation and omissions, concert of action, civil consolidated with the six Allen cases referenced above. The conspiracy and enterprise liability. Implicit within these claims is parties have selected four of the cases to proceed to expert the theory of “risk contribution” liability (Wisconsin’s theory which discovery and to prepare for trial. No dates for expert discovery, is similar to market share liability, except that liability can be joint pretrial dispositive motions, or trial have been set by the District and several) due to the plaintiff’s inability to identify the Court in the Allen and Trammell cases. manufacturer of any product that allegedly injured the plaintiff. Other lead-based paint and lead pigment litigation. In Mary The case ultimately proceeded to trial and, on November 5, 2007, Lewis v. Lead Industries Association, et al. pending in the Circuit the jury returned a defense verdict, finding that the plaintiff had Court of Cook County, Illinois, parents seek to recover the cost of ingested white lead carbonate, but was not brain damaged or their children’s blood lead testing against the Company and three injured as a result. The plaintiff appealed and, on December 16, other defendants that made (or whose alleged corporate 2010, the Wisconsin Court of Appeals affirmed the final judgment predecessors made) white lead pigments. The Circuit Court has in favor of the Company and other defendants. certified a statewide class and a Chicago subclass of parents or Wisconsin is the only jurisdiction to date to apply a theory of legal guardians of children who lived in high-risk zip codes liability with respect to alleged personal injury (i.e., risk identified by the Illinois Department of Health and who were contribution/market share liability) that does not require the screened for lead toxicity between August 1995 and February 2008. Excluded from the class are those parents or (cid:31) 66 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) guardians who have incurred no expense, liability or obligation to without a determination of liability against the Company in the pay for the cost of their children’s blood lead testing. In 2017, the lead pigment or lead-based paint litigation will have no impact on Company and other defendants moved for summary judgment on the Company’s results of operation, liquidity or financial condition. the grounds that the three named plaintiffs have not paid and As previously stated, however, except with respect to the have no obligation or liability to pay for their children’s blood lead litigation in California discussed above, the Company has not testing because Medicaid paid for the children of two plaintiffs and accrued any amounts for the lead pigment or lead-based paint private insurance paid for the third plaintiff without any evidence litigation and any significant liability ultimately determined to be of a co-pay or deductible. The Circuit Court granted the motion, attributable to the Company relating to such litigation may result but on September 7, 2018, the Appellate Court reversed with in a material impact on the Company’s results of operations, respect to the two plaintiffs for whom Medicaid paid for their liquidity or financial condition for the annual or interim period children’s testing. Defendants filed a petition with the Supreme during which such liability is accrued. Court of Illinois for discretionary review. By order entered January 31, 2019, that court has allowed defendants’ petition for Note 11 – Capital Stock leave to appeal. At December 31, 2018, there were 300,000,000 shares of Insurance coverage litigation. The Company and its liability common stock and 30,000,000 shares of serial preferred stock insurers, including certain underwriters at Lloyd’s of London, authorized for issuance. Of the authorized serial preferred stock, initiated legal proceedings against each other to determine, 3,000,000 shares are designated as cumulative redeemable serial among other things, whether the costs and liabilities associated preferred and 1,000,000 shares are designated as convertible with the abatement of lead pigment are covered under certain serial preferred stock. See Note 12. Under the 2006 Equity and insurance policies issued to the Company. The Company’s action, Performance Incentive Plan (2006 Employee Plan), 23,700,000 filed on March 3, 2006 in the Common Pleas Court, Cuyahoga shares may be issued or transferred. See Note 13. An aggregate of County, Ohio, is currently stayed and inactive. On January 9, 2019, 9,643,433, 10,715,939 and 7,720,815 shares of common stock at the Company filed an unopposed motion to lift the stay with the December 31, 2018, 2017 and 2016, respectively, were reserved for trial court, which was granted, allowing the case to proceed. The the exercise and future grants of option rights and future grants of liability insurers’ action, which was filed on February 23, 2006 in restricted stock and restricted stock units. See Note 13. Shares the Supreme Court of the State of New York, County of New York, outstanding shown in the following table included 489,647, has been dismissed. An ultimate loss in the insurance coverage 489,260 and 488,714 shares of common stock held in a revocable litigation would mean that insurance proceeds could be trust at December 31, 2018, 2017 and 2016, respectively. The unavailable under the policies at issue to mitigate any ultimate revocable trust is used to accumulate assets for the purpose of abatement related costs and liabilities. The Company has not funding the ultimate obligation of certain non-qualified benefit recorded any assets related to these insurance policies or plans. Transactions between the Company and the trust are otherwise assumed that proceeds from these insurance policies accounted for in accordance with the Deferred Compensation – would be received in estimating any contingent liability accrual. Rabbi Trusts Subtopic of the Compensation Topic of the ASC, Therefore, an ultimate loss in the insurance coverage litigation which requires the assets held by the trust be consolidated with the Company’s accounts. (cid:31) 67 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Balance at January 1, 2016 ........................................................................................................................ Shares tendered as payment for option rights exercised .......................................................................... Shares issued for exercise of option rights .............................................................................................. Shares tendered in connection with grants of restricted stock .................................................................. Net shares issued for grants of restricted stock ....................................................................................... Balance at December 31, 2016 ................................................................................................................... Shares tendered as payment for option rights exercised .......................................................................... Shares issued for exercise of option rights .............................................................................................. Shares tendered in connection with grants of restricted stock .................................................................. Net shares canceled of restricted stock .................................................................................................. Balance at December 31, 2017 ................................................................................................................... Shares tendered as payment for option rights exercised .......................................................................... Shares issued for exercise of option rights .............................................................................................. Shares tendered in connection with grants of restricted stock .................................................................. Net shares issued for grants of restricted stock ....................................................................................... Treasury stock purchased ..................................................................................................................... Shares in Treasury Shares Outstanding 23,514,054 3,441 59,916 23,577,411 16,545 82,777 23,676,733 1,159 52,144 1,525,000 92,246,525 (3,441) 733,876 (59,916) 95,987 93,013,031 (16,545) 1,152,015 (82,777) (182,079) 93,883,645 (1,159) 661,599 (52,144) 149,821 (1,525,000) Balance at December 31, 2018 ................................................................................................................... 25,255,036 93,116,762 Note 12 – Stock Purchase Plan account under the ESOP are voted by the trustee under As of December 31, 2018, 39,941 employees contributed to the instructions from each individual plan member. Shares for which Company’s ESOP, a voluntary defined contribution plan available no instructions are received are voted by the trustee in the same to all eligible salaried employees. Participants are allowed to proportion as those for which instructions are received. contribute, on a pretax or after-tax basis, up to the lesser of twenty percent of their annual compensation or the maximum Note 13 – Stock-Based Compensation dollar amount allowed under the Internal Revenue Code. The The 2006 Employee Plan authorizes the Board of Directors, or Company matches one hundred percent of all contributions up to a committee of the Board of Directors, to issue or transfer up to an six percent of eligible employee contributions. Such participant aggregate of 23,700,000 shares of common stock, plus any shares contributions may be invested in a variety of investment funds or a relating to awards that expire, are forfeited or canceled. The Company common stock fund and may be exchanged between Company issues new shares upon exercise of option rights and investments as directed by the participant. Participants are vesting of restricted stock units (RSUs). The Employee Plan permitted to diversify both future and prior Company matching permits the granting of option rights, appreciation rights, contributions previously allocated to the Company common stock restricted stock, RSUs, performance shares and performance units fund into a variety of investment funds. to eligible employees. At December 31, 2018, no appreciation The Company made contributions to the ESOP on behalf of rights, performance shares or performance units had been granted participating employees, representing amounts authorized by under the 2006 Employee Plan. employees to be withheld from their earnings, of $170,326, The 2006 Stock Plan for Nonemployee Directors $138,731 and $127,697 in 2018, 2017 and 2016, respectively. The (Nonemployee Director Plan) authorizes the Board of Directors, or Company’s matching contributions to the ESOP charged to a committee of the Board of Directors, to issue or transfer up to an operations were $104,715, $90,682 and $85,525 for 2018, 2017 and aggregate of 200,000 shares of common stock, plus any shares 2016, respectively. relating to awards that expire, are forfeited or are canceled. The At December 31, 2018, there were 9,353,926 shares of the Nonemployee Director Plan permits the granting of option rights, Company’s common stock being held by the ESOP, representing appreciation rights, restricted stock and RSUs to members of the 10.0 percent of the total number of voting shares outstanding. Board of Directors who are not employees of the Company. At Shares of Company common stock credited to each member’s December 31, 2018, no option rights or appreciation rights had been granted under the Nonemployee Director Plan. (cid:31) 68 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) In connection with the Acquisition (see Note 4), the Company The risk-free interest rate is based upon the U.S. Treasury yield assumed certain outstanding RSUs of Valspar granted under the curve at the time of grant. The expected life of option rights was Amended and Restated 2015 Omnibus Equity Plan. Upon close of calculated using a scenario analysis model. Historical data was the Acquisition, the Valspar RSUs were converted into RSUs used to aggregate the holding period from actual exercises, post- relating to common stock of the Company. vesting cancellations and hypothetical assumed exercises on all The cost of the Company’s stock-based compensation is outstanding option rights. The expected dividend yield of stock is recorded in accordance with the Stock Compensation Topic of the the Company’s best estimate of the expected future dividend ASC. At December 31, 2018, the Company had total unrecognized yield. Expected volatility of stock was calculated using historical stock-based compensation expense of $130,748 that is expected and implied volatilities. The Company applied an estimated to be recognized over a weighted-average period of 1.06 years. forfeiture rate of 2.00 percent to the 2018 grants. This rate was Stock-based compensation expense during 2018, 2017 and 2016 calculated based upon historical activity and is an estimate of was $82,588, $90,292 and $72,109, respectively. The related tax granted shares not expected to vest. If actual forfeitures differ benefit was $20,461, $34,343 and $27,442 during 2018, 2017 and from the expected rate, the Company may be required to make 2016, respectively. Subsequent to the adoption of ASU additional adjustments to compensation expense in future periods. No. 2016-09 in 2016, excess tax benefits from share-based Grants of option rights for non-qualified and incentive stock payments are recognized in the income tax provision rather than options have been awarded to certain officers and key employees in other capital when exercised. For the years ended December 31, under the 2006 Employee Plan and the 2003 Stock Plan. The 2018, 2017 and 2016, the Company’s tax benefit from options option rights generally become exercisable to the extent of exercised reduced the income tax provision by $43,371, $86,540, one-third of the optioned shares for each full year following the and $44,233 respectively. date of grant and generally expire ten years after the date of Option rights. The fair value of the Company’s option rights grant. Unrecognized compensation expense with respect to option was estimated at the date of grant using a Black-Scholes- Merton rights granted to eligible employees amounted to $61,050 at option-pricing model with the following weighted-average December 31, 2018. The unrecognized compensation expense is assumptions for all options granted: being amortized on a straight-line basis over the three-year 2018 2017 2016 Risk-free interest rate .................... 2.99% 1.97% 1.24% Expected life of vesting period and is expected to be recognized over a weighted- average period of 1.10 years. The weighted-average per share grant date fair value of options granted during 2018, 2017 and 2016 was $90.86, $77.14 option rights ....... 5.05 years 5.05 years 5.05 years and $49.36, respectively. The total intrinsic value of option rights Expected dividend exercised during 2018, 2017, and 2016 was $190,227, $255,482 and yield of stock ....... .89% .85% 1.06% $129,230, respectively. The total fair value of options vested Expected volatility of stock .............. .211 .213 .212 during 2018, 2017 and 2016 was $38,580, $31,292 and $32,476, respectively. There were no outstanding option rights for nonemployee directors at December 31, 2018, 2017 and 2016. A summary of the Company’s non-qualified and incentive stock option right activity is shown in the following table: 2018 Weighted- Average Exercise Price Per Share Optioned Shares Aggregate Intrinsic Value Optioned Shares 2017 Weighted- Average Exercise Price Per Share Aggregate Intrinsic Value Optioned Shares 2016 Weighted- Average Exercise Price Per Share Aggregate Intrinsic Value Outstanding beginning of year .... Granted .................................... Exercised .................................. Forfeited ................................... Expired ..................................... 4,646,313 $204.33 410.00 137.03 327.08 238.26 565,336 (662,218) (60,288) (3,894) 5,163,709 $ 163.61 377.84 689,506 123.16 (1,154,698) 267.02 (49,977) 236.97 (2,227) 5,219,506 $ 141.58 271.46 108.81 232.83 176.28 712,967 (733,876) (26,653) (8,235) Outstanding end of year ............. 4,485,249 $ 238.53 $704,160 4,646,313 $204.33 $ 955,810 5,163,709 $ 163.61 $545,531 Exercisable at end of year ........... 3,274,780 $ 188.48 $ 671,269 3,288,237 $ 156.43 $833,938 3,783,755 $130.59 $522,921 (cid:31) 69 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) The weighted-average remaining term for options outstanding The weighted-average per share fair value of RSUs granted at the end of 2018, 2017 and 2016 was 6.09, 6.28 and 6.25 years, during 2018, 2017 and 2016 was $404.08, $313.88 and $257.99, respectively. The weighted-average remaining term for options respectively. exercisable at the end of 2018, 2017 and 2016 was 5.01, 5.11 and 5.20 years, respectively. Shares reserved for future grants of Note 14 – Other option rights, restricted stock and RSUs were 5,135,822, 6,041,092 Other general expense—net. Included in Other general and 2,557,106 at December 31, 2018, 2017 and 2016, respectively. expense—net were the following: RSUs. Grants of RSUs, which generally require three years of continuous employment from the date of grant before vesting and receiving the stock without restriction, have been awarded to certain officers and key employees under the 2006 Employee Provisions for environmental matters—net ............. 2018 2017 2016 $176,297 $ 15,443 $ 42,932 Plan. The February 2018, 2017 and 2016 grants consisted of Loss (gain) on sale or performance-based awards that vest at the end of a three-year disposition of assets ... 12,825 5,422 (30,564) period based on the Company’s achievement of specified financial Total ............................ $ 189,122 $20,865 $ 12,368 goals relating to earnings per share and return on net assets employed. The February 2015 grant consisted of a combination of Provisions for environmental matters–net represent initial performance-based awards and time-based awards. The provisions for site-specific estimated costs of environmental performance based awards vest at the end of a three-year period investigation or remediation and increases or decreases to based on the Company’s achievement of specified financial goals environmental-related accruals as information becomes available relating to earnings per share. The time-based awards generally upon which more accurate costs can be reasonably estimated and vest at the end of a three-year period based on continuous as additional accounting guidelines are issued. Environmental- employment. related accruals are not recorded net of insurance proceeds in Unrecognized compensation expense with respect to grants of accordance with the Offsetting Subtopic of the Balance Sheet RSUs to eligible employees amounted to $68,103 at December 31, Topic of the ASC. During 2018, the Company reached a series of 2018 and is being amortized on a straight-line basis over the agreements on remediation plans at one of the Company’s four vesting period and is expected to be recognized over a weighted- major sites, resulting in a significant increase to provisions for average period of 0.91 years. environmental matters–net for 2018. See Note 9 for further details Grants of RSUs have been awarded to nonemployee directors on the Company’s environmental-related activities. under the Nonemployee Director Plan. These grants generally vest The loss (gain) on sale or disposition of assets represents the and stock is received without restriction to the extent of one-third net realized loss (gain) associated with the sale or disposal of of the RSUs for each year following the date of grant. property, plant and equipment and intangible assets previously Unrecognized compensation expense with respect to grants of used in the conduct of the primary business of the Company. The RSUs to nonemployee directors amounted to $1,595 at 2016 gain primarily relates to the sale of a closed domestic facility. December 31, 2018 and is being amortized on a straight-line basis Other expense (income)—net. Included in Other expense over the three-year vesting period and is expected to be (income)—net were the following: recognized over a weighted-average period of 0.88 years. A summary of the Company’s RSU activity for the years ended December 31 is shown in the following table: Outstanding at beginning of year ..... Granted ...................... Exchanged Valspar awards (net of forfeitures) .............. Vested ....................... Forfeited .................... Outstanding at end of year ........................ 2018 2017 2016 335,796 116,636 397,326 112,647 467,744 99,662 (150,576) (11,454) 51,009 (215,433) (9,753) (166,405) (3,675) 290,402 335,796 397,326 2018 2017 2016 Dividend and royalty income ................... $ (4,276) $ (7,648) $ (4,573) Net expense from financing activities .. 9,658 9,843 8,667 Foreign currency transaction related losses ..................... Domestic pension plan settlement expense ................. Miscellaneous pension income ................... Other income ............. Other expense ............ 7,532 450 7,335 37,648 (10,761) (32,219) 12,535 (15,728) (32,570) 12,951 (7,236) (25,279) 9,263 Total ......................... $ 20,117 $(32,702) $ (11,823) (cid:31) 70 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) The Net expense from financing activities includes the net tax year. The Company completed its analysis of the Tax Act in the expense relating to changes in the Company’s financing fees. fourth quarter of 2018 and the accounting under the Tax Act has Foreign currency transaction related losses represent net been finalized. realized losses on U.S. dollar-denominated liabilities of foreign Deferred income taxes reflect the net tax effects of temporary subsidiaries and net realized and unrealized losses from foreign differences between the carrying amounts of assets and liabilities currency option and forward contracts. There were no material for financial reporting purposes and the amounts used for income foreign currency option and forward contracts outstanding at tax purposes using the enacted tax rates and laws that are December 31, 2018, 2017 and 2016. currently in effect. Significant components of the Company’s See Note 7 for information on the Domestic pension plan deferred tax assets and liabilities as of December 31, 2018, 2017 settlement expense and Miscellaneous pension income. See Note 1 and 2016 were as follows: for information on the adoption of ASU No. 2017-07. Other income and Other expense included items of revenue, gains, expenses and losses that were unrelated to the primary business purpose of the Company. There were no items within Other income or Other expense that were individually significant at December 31, 2018, 2017 and 2016. Note 15 – Income Taxes On December 22, 2017, the Tax Cuts and Jobs Act (Tax Act) was enacted. The Tax Act significantly revised the U.S. corporate income tax system by, among other things, lowering corporate income tax rates from 35% to 21%, implementing a territorial tax system and imposing a repatriation tax on deemed repatriated earnings of foreign subsidiaries. Staff Accounting Bulletin (SAB) No. 118 provided a measurement period that should not extend beyond one year from the enactment date for companies to complete the accounting under the Tax Act. In accordance with SAB No. 118, based on the information available as of December 31, 2017 the Company recorded a provisional reduction of income taxes of $607,919 as a result of the Tax Act. The Company’s deferred tax liabilities were reduced by $560,198 due to the lower income tax rate. The remaining $47,721 is the effects of the implementation of the territorial tax system and the remeasurement of U.S. deferred tax liabilities on unremitted foreign earnings. As a result of the Inventory Accounting Change (see Note 1), Cost of goods sold was increased for the year ended December 31, 2017 while income tax provision was reduced by $14,595, including a reversal of $7,853 income tax benefit related to the remeasurement of U.S. deferred tax liabilities in 2017 for the Tax Act. Related amounts in this Income Tax Note have been revised due to the impact of the Inventory Accounting Change for the year ended December 31, 2017. During the second quarter of 2018, the Company made purchase accounting adjustments related to the Acquisition which resulted in the reversal of $27,455 of income tax benefits related to the remeasurement of U.S. deferred tax liabilities. No other material adjustments were made under SAB No. 118 for the 2018 Deferred tax assets: Exit costs, environmental and other similar items ................. Employee related and benefit items ................. Other items ........... Total deferred 2018 2017 2016 $ 84,517 $ 50,193 $ 74,535 96,963 161,578 104,098 113,184 166,313 148,910 tax assets ....... 343,058 267,475 389,758 Deferred tax liabilities: Depreciation and amortization ...... LIFO inventories .... Other items ........... Total deferred 1,303,620 64,502 29,464 1,506,650 66,580 49,670 254,430 83,659 59,746 tax liabilities ... 1,397,586 1,622,900 397,835 Net deferred tax liabilities ............... $1,054,528 $ 1,355,425 $ 8,077 As of December 31, 2018, the Company’s net deferred income tax liability relates primarily to deferred tax liabilities recorded for intangible assets acquired through the Acquisition. Netted against the Company’s other deferred tax assets were valuation allowances of $73,543, $44,101 and $17,292 at December 31, 2018, 2017 and 2016, respectively. The increase in the valuation allowance in 2018 is primarily due to net operating losses of certain foreign subsidiaries, as well as foreign tax credit carryforwards due to uncertainty of their realization. The Company has $23,210 of domestic net operating loss carryforwards acquired through acquisitions that have expiration dates through the tax year 2037, foreign tax credits of $18,781 that expire in calendar years 2027 through 2028 and foreign net operating losses of $340,007. The foreign net operating losses are related to various jurisdictions that provide for both indefinite carryforward periods and others with carryforward periods that range from the tax years 2018 to 2038. (cid:31) 71 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Significant components of the provisions for income taxes Excluding the tax benefit recorded in the 2017 tax year for the were as follows: Current: 2018 2017 2016 Federal ................. Foreign ................. State and local ...... $ 288,755 53,155 52,372 $ 269,330 53,442 39,320 $438,244 31,125 61,402 enactment of the Tax Act, the 2018 effective tax rate was significantly lower than the 2017 effective tax rate. The decrease in the effective tax rate was primarily due to the overall impact of the Tax Act in 2018 and the favorable tax benefits from the reduction in the corporate domestic income tax rate from 35% to 21%. The Company received tax benefits in 2018 from filing amended U.S. Total current ...... 394,282 362,092 530,771 income tax returns and favorable adjustments to the 2017 U.S. Deferred: Federal ................. Foreign ................. State and local ...... (102,149) (35,276) (5,953) (486,669) (42,292) (91,769) (56,891) (2,121) (9,229) Total deferred .... (143,378) (620,730) (68,241) Total provisions (credits) for income taxes ......... $ 250,904 $ (258,638) $462,530 Under provisions of the Tax Act, the Company received an income tax benefit in 2018 of $8,590 related to foreign derived intangible income and incurred a $5,515 income tax expense related to Global Intangible Low Taxed Income (GILTI). The Company has made an accounting policy election to record GILTI as a period cost. Significant components of income before income taxes as used for income tax purposes, were as follows: income tax return filed in 2018. Due to the reduction in the federal benefit related to the deduction of state and local income taxes, the impact of state and local income taxes increased in 2018 compared to 2017. The tax benefit related to employee share based payments decreased in 2018 compared to 2017 due to a decrease in the excess tax benefit related to Company stock options exercised by current and former employees of the Company and a reduction in the benefit of the deduction for U.S. income tax purposes from 35% to 21%. The Tax Act eliminated the favorable deduction for domestic production activities. The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. The IRS is currently auditing the Company’s 2014 and 2015 income tax returns. There has been no significant adjustments proposed by the IRS at this point in the audits. The IRS and the Joint Committee of Taxation have approved refund claims for the 2010, 2011 and 2012 tax years. The Company will receive approximately 2018 2017 2016 $5,000 of tax and interest related to the refund claims. In addition, Domestic .............. Foreign ................ $1,309,279 50,371 $ 1,415,572 53,738 $1,504,990 90,243 the IRS concluded the refund claim audit for the 2014 tax year of the Company’s Valspar subsidiary and has approved refunds of $1,359,650 $1,469,310 $ 1,595,233 $5,426 and submitted them to the Joint Committee of Taxation for A reconciliation of the statutory federal income tax rate to the limitations has not expired for the 2013, 2014, 2015, 2016 and 2017 effective tax rate follows: tax years. approval. As of December 31, 2018, the federal statute of As of December 31, 2018, the Company is subject to non-U.S. income tax examinations for the tax years of 2013 through 2017. In addition, the Company is subject to state and local income tax examinations for the tax years 1998 through 2018. Statutory federal income tax rate ......... 21.0% 35.0% 35.0% 2018 2017 2016 Effect of: State and local income taxes ......... Investment vehicles ...................... Domestic production activities ...... Employee share-based 3.2 (1.2) 2.1 (1.4) (3.1) 2.3 (1.5) (2.9) payments ................................. (3.2) (5.9) (2.8) Research and development credits ..................................... Amended returns and refunds ....... Other—net ................................... (1.3) (1.6) (.3) (.9) (.9) (.4) (.2) (.9) Subtotal ............................................. 16.6% 24.5% 29.0% Effect of: Tax Act ........................................ Subsidiary mergers ....................... 1.9 (40.8) (4.2) Reported effective tax rate .................. 18.5% (20.5)% 29.0% (cid:31) 72 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) A reconciliation of the beginning and ending amount of related to a number of positions taken on current and amended unrecognized tax benefits is as follows: income tax returns filed in the U.S. federal, and various state and 2018 2017 2016 Balance at beginning of year ............................ $ 59,001 $ 32,805 $ 33,873 Additions from the Acquisition .................. 12,396 18,928 Additions based on tax positions related to the current year ................ Additions for tax positions of prior years .......................... Reductions for tax positions of prior years .......................... Settlements .................... Lapses of statutes of 12,890 6,780 5,674 10,968 4,033 3,890 (1,993) (1,380) (1,168) (368) (5,901) (3,763) limitations ................... (2,393) (2,009) (968) Balance at end of year ..... $89,489 $ 59,001 $ 32,805 An additional $12,396 in unrecognized tax benefits were recorded in 2018 related to the Acquisition. Other increases in the balance of unrecognized tax benefits at December 31, 2018 were Note 16 – Net Income Per Share foreign jurisdictions. At December 31, 2018, 2017 and 2016, the Company had unrecognized tax benefits of $82,960, $49,520, $27,686, respectively, the recognition of which would have an effect on the effective tax rate. Included in the balance of unrecognized tax benefits at December 31, 2018 is $14,509 related to tax positions for which it is reasonably possible that the total amounts could significantly change during the next twelve months. This amount represents a decrease in unrecognized tax benefits comprised primarily of items related to federal audits of partnership investments and expiring statutes in federal, foreign and state jurisdictions. The Company classifies all income tax related interest and penalties as income tax expense. During the year ended December 31, 2018, there was an increase in income tax interest and penalties of $4,899. There was a decrease in income tax interest and penalties of $790 and an increase of $1,410 for the years ended December 31, 2017 and 2016, respectively. At December 31, 2018, 2017 and 2016, the Company has separately accrued $24,757, $14,592 and $9,275, respectively, for the potential payment of interest and penalties. 2018 2017 2016 Basic Average shares outstanding ..................................................................................... 92,992,457 92,908,638 91,838,603 Net income Continuing operations(1) ........................................................................................ Discontinued operations ....................................................................................... $ 1,108,746 $ 1,769,488 (41,540) Net income(1) .................................................................................................... $ 1,108,746 $ 1,727,948 Basic net income per share Continuing operations(1) ........................................................................................ Discontinued operations ....................................................................................... Net income per share(1) ..................................................................................... $ $ 11.92 11.92 $ $ 19.04 (.44) 18.60 $ $ $ $ 1,132,703 1,132,703 12.33 12.33 Diluted Average shares outstanding .................................................................................. Stock options and other contingently issuable shares(2) ........................................... Non-vested restricted stock grants ........................................................................ 92,992,457 1,938,586 57,027 92,908,638 1,931,157 87,418 91,838,603 2,089,921 559,562 Average shares outstanding assuming dilution ........................................................ 94,988,070 94,927,213 94,488,086 Net income Continuing operations(1) .................................................................................... Discontinued operations .................................................................................... $ 1,108,746 $ 1,769,488 (41,540) Net income(1) .................................................................................................... $ 1,108,746 $ 1,727,948 Diluted net income per share Continuing operations(1) ........................................................................................ Discontinued operations ....................................................................................... Net income per share(1) ..................................................................................... $ $ 11.67 11.67 $ $ 18.64 (.44) 18.20 $ $ $ $ 1,132,703 1,132,703 11.99 11.99 (1) The year ended December 31, 2017 has been adjusted for an inventory accounting change. See Note 1. (2) Stock options and other contingently issuable shares excludes 28,321, 638,795 and 62,935 shares at December 31, 2018, 2017 and 2016, respectively, due to their anti- dilutive effect. Basic and diluted net income per share are calculated using the treasury stock method. (cid:31) 73 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) Note 17 – Summary of Quarterly Results of Operations (Unaudited) Net sales ........................................................................ Gross profit .................................................................... Net income ..................................................................... Net income per share—basic ............................................ Net income per share—diluted ......................................... Net sales ........................................................................ Gross profit .................................................................... Net income ..................................................................... Net income per share—basic ............................................ Net income per share—diluted ......................................... 1st Quarter 2nd Quarter $3,965,006 1,686,847 250,127 2.68 2.62 $4,773,796 2,038,628 403,604 4.34 4.25 1st Quarter 2nd Quarter $ 2,761,387 1,343,053 239,152 2.58 2.53 $ 3,735,817 1,734,617 319,111 3.44 3.36 2018 3rd Quarter $ 4,731,470 2,010,404 354,027 3.80 3.72 2017 3rd Quarter $4,507,020 1,901,827 316,606 3.40 3.33 4th Quarter $ 4,064,221 1,682,683 100,988 1.09 1.07 4th Quarter $3,979,564 1,739,303 853,079 9.14 8.92 Full Year $17,534,493 7,418,562 1,108,746 11.92 11.67 Full Year $14,983,788 6,718,800 1,727,948 18.60 18.20 Net income for the fourth quarter of 2018 included increased Note 18 – Operating Leases provisions for environmental matters of $135,904 related to one of The Company leases certain stores, warehouses, the Company’s four major sites and pension plan settlement manufacturing facilities, office space and equipment. Renewal expense of $37,648 resulting from the election of lump sum cash options are available on the majority of leases and, under certain payouts to defined benefit plan participants. See Note 14 for conditions, options exist to purchase certain properties. Rental information on the provision for environmental matters and Note 7 expense for operating leases, recognized on a straight-line basis for information on the pension plan settlement expense. Net over the lease term in accordance with the Leases Topic of the income in the fourth quarter of 2017 included a tax benefit of ASC was $552,658, $464,616 and $417,549 for 2018, 2017 and $668,779 related to Deferred income tax reductions. 2016, respectively. Certain store leases require the payment of The effect of retrospectively applying the Inventory contingent rentals based on sales in excess of specified minimums. Accounting Change (see Note 1) was recorded in the fourth Contingent rentals included in rent expense were $68,180, quarter of 2017. The impact of the change was not material to any $63,300 and $58,865 in 2018, 2017 and 2016, respectively. Rental other period presented. Therefore the results for the second and income, as lessor, from real estate leasing activities and sublease third quarter of 2017 and the first, second and third quarter of 2018 rental income for all years presented was not significant. The have not been retrospectively adjusted. following schedule summarizes the future minimum lease payments under noncancellable operating leases having initial or remaining terms in excess of one year at December 31, 2018: 2019 ..................................................................... 2020 .................................................................... 2021 ..................................................................... 2022 .................................................................... 2023 .................................................................... Later years ........................................................... $ 412,211 369,570 306,994 245,437 179,892 392,423 Total minimum lease payments .............................. $1,906,527 (cid:31) 74 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) During 2018, the Company completed transactions to sell and by manufacturing facilities in the Consumer Brands Group. In subsequently leaseback certain real estate properties and received addition, each store sells select purchased associated products. proceeds totaling $225,345. The transactions were accounted for The Americas Group sells a variety of architectural paints, coatings as financing transactions primarily due to the Company’s and related products through dedicated dealers, home centers, continuing involvement resulting from the length of the lease term distributors, hardware stores and other retailers throughout Latin in comparison to the remaining economic life of the real estate America. The Americas Group meets regional customer demands properties. The financing transactions have related future through developing, licensing, manufacturing, distributing and obligations of $225,914 at December 31, 2018. selling a variety of architectural paints, coatings and related products in North and South America. The loss of any single Note 19 – Reportable Segment Information customer would not have a material adverse effect on the business The Company reports its segment information in the same way of this segment. At December 31, 2018, The Americas Group that management internally organizes its business for assessing consisted of operations from subsidiaries in 10 foreign countries. performance and making decisions regarding allocation of During 2018, this segment opened 76 net new stores, consisting of resources in accordance with the Segment Reporting Topic of the 91 new stores opened (74 in the United States, 16 in Canada, and 1 ASC. The Company has three reportable operating segments: The in South America) and 15 stores closed (1 in the United States, 2 in Americas Group, Consumer Brands Group and Performance Canada, 11 in South America and 1 in Mexico). In 2017 and 2016, this Coatings Group (individually, a Reportable Segment and segment opened 101 and 142 net new stores, respectively. A map collectively, the Reportable Segments). Factors considered in on the cover flap of this report shows the number of paint stores determining the three Reportable Segments of the Company and their geographic location. The CODM uses discrete financial include the nature of business activities, the management information about The Americas Group, supplemented with structure directly accountable to the Company’s chief operating information by geographic region, product type and customer decision maker (CODM) for operating and administrative activities, type, to assess performance of and allocate resources to The availability of discrete financial information and information Americas Group as a whole. In accordance with ASC 280-10-50-9, presented to the Board of Directors. The Company reports all The Americas Group as a whole is considered the operating other business activities and immaterial operating segments that segment, and because it meets the criteria in ASC 280-10-50-10, it are not reportable in the Administrative segment. See pages 8 is also considered a Reportable Segment. through 15 of this report for more information about the Reportable Segments. The Consumer Brands Group supplies a broad portfolio of branded and private-label architectural paints, stains, varnishes, The Company’s CODM has been identified as the Chief Executive industrial products, wood finishes products, wood preservatives, Officer because he has final authority over performance assessment applicators, corrosion inhibitors, aerosols, caulks and adhesives to and resource allocation decisions. Because of the diverse operations retailers and distributors throughout North America, as well as in of the Company, the CODM regularly receives discrete financial Australia, New Zealand, China and Europe. The Consumer Brands information about each Reportable Segment as well as a significant Group also supports the Company’s other businesses around the amount of additional financial information about certain divisions, world with new product research and development, business units or subsidiaries of the Company. The CODM uses all manufacturing, distribution and logistics. Approximately 55.82% of such financial information for performance assessment and resource the total sales of the Consumer Brands Group in 2018 were allocation decisions. The CODM evaluates the performance of and allocates resources to the Reportable Segments based on segment intersegment transfers of products primarily sold through The Americas Group. At December 31, 2018, the Consumer Brands profit or loss and cash generated from operations. The accounting Group consisted of operations in the United States and policies of the Reportable Segments are the same as those described subsidiaries in 6 foreign countries. Sales and marketing of certain in Note 1 of this report. controlled brand and private labeled products is performed by a The Americas Group consisted of 4,696 company-operated direct sales staff. The products distributed through third-party specialty paint stores in the United States, Canada, Latin America customers are intended for resale to the ultimate end-user of the and the Caribbean region at December 31, 2018. Each store in this product. The Consumer Brands Group had sales to certain segment is engaged in servicing the needs of architectural and industrial paint contractors and do-it-yourself homeowners. The customers that, individually, may be a significant portion of the sales of the segment. However, the loss of any single customer Americas Group company-owned stores market and sell Sherwin- would not have a material adverse effect on the overall Williams® and other controlled brand architectural paint and profitability of the segment. This segment incurred most of the coatings, protective and marine products, OEM product finishes Company’s capital expenditures related to ongoing environmental and related products. The majority of these products are produced compliance measures at sites currently in operation. The CODM (cid:31) 75 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) uses discrete financial information about the Consumer Brands headquarters site, and disposal of idle facilities. Sales of this Group, supplemented with information by product type and segment represents external leasing revenue of excess customer type, to assess performance of and allocate resources to headquarters space or leasing of facilities no longer used by the the Consumer Brands Group as a whole. In accordance with ASC Company in its primary businesses. Material gains and losses from 280-10-50-9, the Consumer Brands Group as a whole is the sale of property are infrequent and not a significant operating considered the operating segment, and because it meets the factor in determining the performance of the Administrative criteria in ASC 280-10-50-10, it is also considered a Reportable segment. Segment. Net external sales of all consolidated foreign subsidiaries were The Performance Coatings Group develops and sells industrial $4,027,775, $2,959,785 and $1,722,246 for 2018, 2017 and 2016, coatings for wood finishing and general industrial (metal and respectively. plastic) applications, automotive refinish, protective and marine Long-lived assets consisted of Property, plant and equipment, coatings, coil coatings, packaging coatings and performance- Goodwill, Intangible assets, Deferred pension assets and Other based resins and colorants worldwide. This segment licenses assets. The aggregate total of long-lived assets for the Company certain technology and trade names worldwide. Sherwin-Williams® was $14,789,793, $15,492,586 and, $3,125,222 at December 31, and other controlled brand products are distributed through The 2018, 2017 and 2016, respectively. Long-lived assets of Americas Group and this segment’s 282 company-operated consolidated foreign subsidiaries totaled $3,289,794, $3,691,035 branches and by a direct sales staff and outside sales and $477,889 at December 31, 2018, 2017 and 2016, respectively. representatives to retailers, dealers, jobbers, licensees and other Total Assets of the Company were $19,134,279, $19,899,517 and third-party distributors. The Performance Coatings Group had $6,752,521 at December 31, 2018, 2017 and 2016, respectively. Total sales to certain customers that, individually, may be a significant assets of consolidated foreign subsidiaries were $4,809,356, portion of the sales of the segment. However, the loss of any $5,253,995 and $1,233,666, which represented 25.1 percent, single customer would not have a material adverse effect on the 26.4 percent and 18.3 percent of the Company’s total assets at overall profitability of the segment. During 2018, this segment December 31, 2018, 2017 and 2016, respectively. opened 3 new branches and closed 11 branches for a net decrease No single geographic area outside the United States was of 8 branches. At December 31, 2018, the Performance Coatings significant relative to consolidated net external sales or Group consisted of operations in the United States and consolidated long-lived assets. Export sales and sales to any subsidiaries in 45 foreign countries. The CODM uses discrete individual customer were each less than 10 percent of financial information about the Performance Coatings Group consolidated sales to unaffiliated customers during all years reportable segment, supplemented with information about presented. geographic divisions, business units and subsidiaries, to assess In the reportable segment financial information that follows, performance of and allocate resources to the Performance Segment profit was total net sales and intersegment transfers less Coatings Group as a whole. In accordance with ASC 280-10-50-9, operating costs and expenses. Identifiable assets were those the Performance Coatings Group as a whole is considered the directly identified with each reportable segment. The operating segment, and because it meets the criteria in ASC Administrative segment assets consisted primarily of cash and 280-10-50-10, it is also considered a Reportable Segment. A map cash equivalents, investments, deferred pension assets and on the cover flap of this report shows the number of branches and headquarters property, plant and equipment. The margin for each their geographic locations. reportable segment was based upon total net sales and The Administrative segment includes the administrative intersegment transfers. Domestic intersegment transfers were expenses of the Company’s corporate headquarters site. Also primarily accounted for at the approximate fully absorbed included in the Administrative segment is interest expense, manufactured cost, based on normal capacity volumes, plus interest and investment income, certain expenses related to customary distribution costs for paint products. Non-paint closed facilities and environmental-related matters, and other domestic and all international intersegment transfers were expenses which are not directly associated with the Reportable accounted for at values comparable to normal unaffiliated Segments. The Administrative segment does not include any customer sales. All intersegment transfers are eliminated within significant foreign operations. Also included in the Administrative the Administrative segment. Certain amounts in the following segment is a real estate management unit that is responsible for table for 2017 have been adjusted to reflect the Inventory the ownership, management and leasing of non-retail properties Accounting Change (see Note 1). held primarily for use by the Company, including the Company’s (cid:31) 76 Notes to Consolidated Financial Statements (thousands of dollars unless otherwise indicated) (millions of dollars) The Americas Group Consumer Brands Group Performance Coatings Group Administrative 2018 The Americas Group Consumer Brands Group Performance Coatings Group Administrative Net external sales .......................................... Intersegment transfers ................................... Total net sales and intersegment transfers ....... Segment profit .............................................. Interest expense ............................................ Administrative expenses and other ................. Income from continuing operations before income taxes ............................................. Reportable segment margins .......................... Identifiable assets .......................................... Capital expenditures ...................................... Depreciation ................................................. Amortization ................................................. $9,625 1 $9,626 $ 1,898 $ 1,898 19.7% $ 4,071 70 72 5 $ 2,739 3,460 $ 6,199 $ 261 $ 261 4.2% $ 5,385 96 89 97 $ 5,166 22 $ 5,188 $ 452 $ 452 8.7% $ 8,535 61 78 211 2017 Net external sales .......................................... Intersegment transfers ................................... Total net sales and intersegment transfers ....... Segment profit .............................................. Interest expense ............................................ Administrative expenses and other ................. Income from continuing operations before income taxes ............................................. Reportable segment margins .......................... Identifiable assets .......................................... Capital expenditures ...................................... Depreciation ................................................. Amortization ................................................. $ 9,117 6 $ 9,123 $ 1,769 $ 1,769 19.4% $4,359 69 75 4 $ 2,155 3,162 $ 5,317 $ 203 $ 203 3.8% $ 5,816 95 92 61 $ 3,706 22 $ 3,728 $ 263 $ 263 7.1% $ 8,265 37 69 135 The Americas Group Consumer Brands Group 2016 Performance Coatings Group Net external sales ................................................. Intersegment transfers .......................................... Total net sales and intersegment transfers .............. Segment profit ..................................................... Interest expense ................................................... Administrative expenses and other ........................ Income from continuing operations before income taxes ................................................................ Reportable segment margins ................................. Identifiable assets ................................................. Capital expenditures ............................................. Depreciation ........................................................ Amortization ........................................................ $8,377 39 $8,416 $1,606 $1,606 19.1% $ 2,148 100 76 4 $ 1,528 2,775 $4,303 $ 301 $ 301 7.0% $2,005 99 47 5 $1,946 15 $ 1,961 $ 257 $ 257 13.1% $ 818 19 20 9 Consolidated Totals $ 17,534 $ 17,534 $ 2,611 (367) (884) $ 4 (3,483) $(3,479) $ (367) (884) $ (1,251) $ 1,360 $ 1,143 24 39 5 $ 19,134 251 278 318 Consolidated Totals $ 14,984 $ 14,984 $ 2,235 (263) (503) $ 6 (3,190) $ (3,184) $ (263) (503) $ (766) $ 1,469 $ 1,460 22 49 7 $ 19,900 223 285 207 Administrative $ 5 (2,829) $(2,824) $ (154) (415) Consolidated Totals $ 11,856 $ 11,856 $ 2,164 (154) (415) $ (569) $ 1,595 $ 1,782 21 29 7 $ 6,753 239 172 25 (cid:31) 77 Cautionary Statement Regarding Forward-looking Information Certain statements contained in “Management’s Discussion additional anticipated cost synergies resulting from the and Analysis of Financial Condition and Results of Operations,” Acquisition and the timing thereof; (g) competitive factors, “Letter to Shareholders” and elsewhere in this report constitute including pricing pressures and product innovation and quality; “forward-looking statements” within the meaning of the federal (h) our ability to attain cost savings from productivity initiatives; securities laws. These forward-looking statements are based upon (i) risks and uncertainties associated with our expansion into and management’s current expectations, estimates, assumptions and our operations in Asia, Europe, South America and other foreign beliefs concerning future events and conditions and may discuss, markets, including general economic conditions, inflation rates, among other things, anticipated future performance (including recessions, foreign currency exchange rates, foreign investment sales and earnings), expected growth, future business plans and and repatriation restrictions, legal and regulatory constraints, civil the costs and potential liability for environmental-related matters unrest and other external economic and political factors; (j) the and the lead pigment and lead-based paint litigation. Any achievement of growth in foreign markets, such as Asia, Europe statement that is not historical in nature is a forward-looking and South America; (k) increasingly stringent domestic and statement and may be identified by the use of words and phrases foreign governmental regulations, including those affecting health, such as “believe,” “expect,” “may,” “will,” “should,” “project,” safety and the environment; (l) inherent uncertainties involved in “could,” “plan,” “goal,” “potential,” “seek,” “intend” or “anticipate” assessing our potential liability for environmental-related or the negative thereof or comparable terminology. activities; (m) other changes in governmental policies, laws and Readers are cautioned not to place undue reliance on any regulations, including changes in tariff policies, as well as changes forward-looking statements. Forward-looking statements are in accounting policies and standards and taxation requirements necessarily subject to risks, uncertainties and other factors, many (such as new tax laws and new or revised tax law interpretations); of which are outside our control, that could cause actual results to (n) the nature, cost, quantity and outcome of pending and future differ materially from such statements and from our historical litigation and other claims, including the lead pigment and lead- results and experience. These risks, uncertainties and other factors based paint litigation, and the effect of any legislation and include such things as: (a) general business conditions, strengths administrative regulations relating thereto; and (o) adverse of retail and manufacturing economies and growth in the coatings weather conditions and natural disasters. industry; (b) changes in general domestic economic conditions Readers are cautioned that it is not possible to predict or such as inflation rates, interest rates, tax rates, unemployment identify all of the risks, uncertainties and other factors that may rates, higher labor and healthcare costs, recessions, and changing affect future results and that the above list should not be government policies, laws and regulations; (c) changes in raw considered to be a complete list. Any forward-looking statement material and energy supplies and pricing; (d) changes in our speaks only as of the date on which such statement is made, and relationships with customers and suppliers; (e) our ability to we undertake no obligation to update or revise any forward- successfully integrate past and future acquisitions into our existing looking statement, whether as a result of new information, future operations, including Valspar, as well as the performance of the events or otherwise except as otherwise required by law. businesses acquired; (f) risks inherent in the achievement of (cid:31) 78 Shareholder Information Transfer Agent & Registrar Our transfer agent, EQ Shareowner Services, maintains the records for our registered shareholders and can help with a wide variety of shareholder related services, including the direct deposit of dividends and online access to your account. Contact: EQ Shareowner Services P.O. Box 64874 St. Paul, MN 55164-0874 www.shareowneronline.com 1-800-468-9716 Toll-free 651-450-4064 outside the United States Annual Meeting The annual meeting of shareholders will be held in the Landmark Conference Independent Registered Public Accounting Firm Ernst & Young LLP Center, 927 Midland Building, Cleveland, Ohio 101 W. Prospect Avenue, Cleveland, Ohio on Wednesday, April 17, 2019 at 9:00 A.M., local time. Headquarters 101 W. Prospect Avenue Cleveland, Ohio 44115-1075 (216) 566-2000 www.sherwin.com Investor Relations Robert J. Wells Senior Vice President – Corporate Communications and Public Affairs The Sherwin-Williams Company 101 W. Prospect Avenue Cleveland, Ohio 44115- 1075 Stock Trading Sherwin-Williams Common Stock – Symbol, SHW – is traded on the New York Stock Exchange. Dividend Reinvestment Program A dividend reinvestment program is available to shareholders of common stock. For information, contact Equiniti Trust Company. Form 10-K The Company’s Annual Report on Form 10-K, filed with the Securities and Exchange Commission, is available without charge. To obtain a copy, contact Investor Relations. Common Stock Trading Statistics High ........................................................................ Low ........................................................................ Close December 31 ................................................... Shareholders of record ............................................. Shares traded (thousands) ........................................ 2018 $ 477.98 365.24 393.46 6,244 180,900 2017 $ 414.34 274.54 410.04 6,488 154,970 2016 $ 312.10 239.35 268.74 6,787 212,100 2015 $ 292.44 218.94 259.60 6,996 195,560 2014 $266.25 174.29 263.04 7,250 152,913 Quarterly Stock Prices and Dividends Quarter 1st ................... 2nd ................. 3rd .................. 4th .................. 2018 High $ 432.84 407.57 477.98 457.00 Low $385.25 367.66 406.76 365.24 2017 Dividend Quarter $.860 .860 .860 .860 1st ................... 2nd ................. 3rd ................. 4th ................. High $315.36 361.03 359.72 414.34 Low Dividend $274.54 308.35 328.97 359.43 $.850 .850 .850 .850 (cid:31) 79 Corporate Officers and Operating Management Corporate Officers Operating Management John G. Morikis, 55* Chairman, President and Chief Executive Officer Allen J. Mistysyn, 50* Senior Vice President - Finance and Chief Financial Officer Jane M. Cronin, 51* Senior Vice President - Corporate Controller Mary L. Garceau, 46* Senior Vice President, General Counsel and Secretary Thomas P. Gilligan, 58* Senior Vice President - Human Resources Robert J. Wells, 61* Senior Vice President - Corporate Communications and Public Affairs Lawrence J. Boron, 60 Vice President - Taxes and Assistant Secretary John D. Hullibarger, 38 Vice President - Corporate Audit and Loss Prevention Jeffrey J. Miklich, 44 Vice President and Treasurer Stephen J. Perisutti, 56 Vice President, Deputy General Counsel and Assistant Secretary Bryan J. Young, 43 Vice President - Corporate Strategy & Development Joel D. Baxter, 58* President & General Manager Global Supply Chain Division Consumer Brands Group Justin T. Binns, 43 President & General Manager Automotive Finishes Division Performance Coatings Group Lee B. Diamond, 49 President & General Manager Canada Division The Americas Group Aaron M. Erter, 45* President Consumer Brands Group Peter J. Ippolito, 54* President The Americas Group Bruce G. Irussi, 58 President & General Manager General Industrial Coatings Division Performance Coatings Group Karl J. Jorgenrud, 42 President & General Manager Protective & Marine Division Robert F. Lynch, 58 President & General Manager Retail - North America Consumer Brands Group Mark A. Provenson, 45 President & General Manager Eastern Division The Americas Group Jonathan N. Reid, 47 President & General Manager South Western Division The Americas Group David B. Sewell, 50* President Performance Coatings Group Samuel W. Shoemaker, 57 President & General Manager Global Packaging, Coil, and Coatings Resins & Colorants Division Performance Coatings Group Todd A. Stephenson, 49 President & General Manager Mid Western Division The Americas Group Todd V. Wipf, 54 Performance Coatings Group President & General Manager Dennis H. Karnstein, 52 President & General Manager Industrial Wood Coatings Division Performance Coatings Group Southeastern Division The Americas Group * Executive Officer as defined by the Securities Exchange Act of 1934 (cid:31) 80 21 branches CANADA 1 facility 241 paint stores 4 facilities 43 facilities 13 facilities 4,032 paint stores 223 branches UNITED STATES 2 facilities 81 paint stores CARIBBEAN LATIN AMERICA / SOUTH AMERICA 19 branches 18 facilities 342 paint stores 10 facilities The Americas Group Consumer Brands Group Performance Coatings Group Corporate headquarters New Hampshire Manitoba The Americas Group’s Stores UNITED STATES Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware District of Columbia Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland 72 7 66 46 79 41 17 269 5 313 159 13 27 155 95 43 45 58 69 25 85 62 Massachusetts Michigan 116 Minnesota Mississippi Missouri Montana Nebraska Nevada New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington 64 57 77 18 23 25 22 98 24 142 164 9 199 55 56 200 12 87 10 92 339 37 11 125 105 West Virginia Wisconsin Wyoming CANADA Alberta British Columbia 49 New Brunswick Newfoundland Nova Scotia Ontario Prince Edward Island 1 Quebec Saskatchewan CARIBBEAN LATIN AMERICA 19 83 12 28 9 5 2 7 94 39 7 81 95 56 33 Brazil Chile Ecuador Mexico Uruguay TOTAL 147 11 4,696 Board of Directors 16 branches 9 facilities 25 facilities EMEAI ASIA-PACIFIC 3 branches 7 facilities 9 facilities 95 6 paint stores facilities AUSTRALIA/NEW ZEALAND Our Global Footprint As a global leader in the development, manufacture and sale of paint, coatings and related products, Sherwin-Williams has an extensive retail presence throughout the Americas and growing service capabilities in Europe, Asia-Pacific and Australia/ New Zealand. States, Canada and the Caribbean. More than 90 percent of the U.S. population lives within a 50-mile radius of a Sherwin-Williams store. The Americas Group operates 342 stores throughout Latin America and sells through more than 700 dedicated dealer outlets, primarily located in Brazil, Chile, Ecuador, Mexico and Uruguay. • Consumer Brands Group includes company-operated outlets in Australia and New Zealand and a highly efficient global supply chain consisting of 95 manufacturing plants and distribution centers. • Performance Coatings Group sells to a growing customer base in more than 120 countries around the world and has 282 company-operated general industrial, industrial wood, protective and marine, and automotive branches. 1. Christine A. Poon, 66* Executive in Residence The Max M. Fisher College of Business The Ohio State University Retired, former Vice Chairman Johnson & Johnson 2. Steven H. Wunning, 67 Retired, former Group President Caterpillar Inc. 3. Arthur F. Anton, 61* Chairman and Chief Executive Officer Swagelok Company 5. John G. Morikis, 55 9. Susan J. Kropf, 70 Chairman, President and Chief Executive Officer The Sherwin-Williams Company Retired, former President and Chief Operating Officer Avon Products, Inc. 10. Michael H. Thaman, 55 Chairman and Chief Executive Officer Owens Corning 6. Richard J. Kramer, 55* Chairman of the Board, Chief Executive Officer and President The Goodyear Tire & Rubber Company 7. John M. Stropki, 68 Retired, former Chairman, President and Chief Executive Officer Lincoln Electric Holdings, Inc. 4. Matthew Thornton III, 60* 8. David F. Hodnik, 71 Executive Vice President and Chief Operating Officer FedEx Freight FedEx Corporation Retired, former President and Chief Executive Officer Ace Hardware Corporation • The Americas Group has 4,354 company-operated specialty paint stores in the United *Audit Committee Member 2 1 3 5 4 6 7 8 9 10 59948IMPO.(PDF_D17) Cover.indd 2 2/22/19 10:41 AM The Sherwin-Williams Company was founded by Henry Sherwin and Edward Williams in 1866. Today, we are a global leader in the manufacture, development, distribution and sale of paint, coatings and related products to professional, industrial, commercial and retail customers. Sherwin-Williams®, Valspar®, Dutch Boy®, HGTV HOME™ by Sherwin- T he Company manufactures products under well-known brands such as branded products are sold primarily through more than 5,100 company-operated more. With global headquarters in Cleveland, Ohio, Sherwin-Williams® Williams, Krylon®, Minwax®, Cabot®, Thompson’s® Water Seal® and many stores and facilities, while the Company’s other brands are sold through leading mass merchandisers, home centers, independent paint dealers, hardware stores, automotive retailers and industrial distributors. For more information, visit www.sherwin-williams.com. The Company is comprised of three reportable segments, which together provide our customers with innovative solutions to ensure their success, no matter where they work, or what surfaces they are coating. • The Americas Group operates the exclusive outlets for Sherwin-Williams® branded paints, stains, supplies, equipment and floor covering in the U.S., Canada and the Caribbean. The Group also manufactures and sells a wide range of architectural paint, industrial coatings and related products across Latin America through company-operated stores and dedicated dealers. • Consumer Brands Group sells one of the industry’s most recognized portfolios of branded and private-label products through retailers across North America and in parts of Europe, Australia, New Zealand and China, and also operates a highly efficient global supply chain for paint, coatings and related products. • Performance Coatings Group sells a wide range of industrial coatings and finishes to general industrial, industrial wood, protective and marine, coil & extrusion, packaging and automotive customers in more than 120 countries. The Sherwin-Williams Company is an equal opportunity employer. As such, we will recruit, hire, train and promote in all job titles based only on valid job requirements. All personnel actions will be administered without regard to the following “factors”: race, color, religion, sex, sexual orientation, gender identity, national origin, protected veteran status, disability, age, pregnancy, genetic informa- tion, creed, citizenship status, marital status, or any other consideration prohibited by law or by contract. Contents Our Global Footprint 1 Financial Highlights 2 Letter to Shareholders 8 At a Glance 10 The Americas Group 12 Consumer Brands Group 14 Performance Coatings Group 16 Shareholder Returns 17 Financial Performance The Sherwin-Williams Company 101 W. Prospect Avenue Cleveland, Ohio 44115-1075 www.sherwin-williams.com 2 0 1 8 A N N U A L R E P O R T 59948IMPO.(PDF_D17) Cover.indd 1 2/22/19 10:41 AM

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