EX-13 10 shw-12312015xex13.htm EXHIBIT 13 Exhibit

Exhibit 13
























































































































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

19


FINANCIAL SUMMARY
(millions of dollars except as noted and per share data)


 
2015
 
2014
 
2013
 
2012
 
2011
Operations
 
 
 
 
 
 
 
 
 
Net sales
$
11,339

 
$
11,130

 
$
10,186

 
$
9,534

 
$
8,766

Cost of goods sold
5,780

 
5,965

 
5,569

 
5,328

 
5,021

Selling, general and administrative expenses
3,914

 
3,823

 
3,468

 
3,260

 
2,961

Impairments and dissolution
 
 
 
 
 
 
4

 
5

Interest expense
62

 
64

 
63

 
43

 
42

Income before income taxes
1,549

 
1,258

 
1,086

 
907

 
742

Net income
1,054

 
866

 
753

 
631

 
442

Financial Position
 
 
 
 
 
 
 
 
 
Accounts receivable - net
$
1,114

 
$
1,131

 
$
1,098

 
$
1,033

 
$
990

Inventories
1,019

 
1,034

 
971

 
920

 
927

Working capital - net
517

 
(114
)
 
630

 
1,273

 
99

Property, plant and equipment - net
1,042

 
1,021

 
1,021

 
966

 
957

Total assets
5,792

 
5,706

 
6,383

 
6,235

 
5,229

Long-term debt
1,920

 
1,123

 
1,122

 
1,632

 
639

Total debt
1,963

 
1,805

 
1,722

 
1,705

 
993

Shareholders’ equity
868

 
996

 
1,775

 
1,792

 
1,517

Per Common Share Information
 
 
 
 
 
 
 
 
 
Average shares outstanding (thousands)
92,197

 
96,190

 
100,898

 
101,715

 
103,471

Book value
$
9.41

 
$
10.52

 
$
17.72

 
$
17.35

 
$
14.61

Net income - diluted (1) 
11.16

 
8.78

 
7.26

 
6.02

 
4.14

Net income - basic (1) 
11.38

 
8.95

 
7.41

 
6.15

 
4.22

Cash dividends
2.68

 
2.20

 
2.00

 
1.56

 
1.46

Financial Ratios
 
 
 
 
 
 
 
 
 
Return on sales
9.3
%
 
7.8
 %
 
7.4
%
 
6.6
%
 
5.0
%
Asset turnover
2.0
x
 
2.0
x
 
1.6
x
 
1.5
x
 
1.7
x
Return on assets
18.2
%
 
15.2
 %
 
11.8
%
 
10.1
%
 
8.4
%
Return on equity (2) 
105.8
%
 
48.8
 %
 
42.0
%
 
41.6
%
 
27.5
%
Dividend payout ratio (3)
30.5
%
 
30.3
 %
 
33.2
%
 
37.7
%
 
34.7
%
Total debt to capitalization
69.3
%
 
64.4
 %
 
49.2
%
 
48.8
%
 
39.6
%
Current ratio
1.2

 
1.0

 
1.2

 
1.7

 
1.0

Interest coverage (4) 
26.1
x
 
20.6
x
 
18.3
x
 
22.2
x
 
18.4
x
Net working capital to sales
4.6
%
 
(1.0
)%
 
6.2
%
 
13.3
%
 
1.1
%
Effective income tax rate (5)
32.0
%
 
31.2
 %
 
30.7
%
 
30.4
%
 
40.4
%
General
 
 
 
 
 
 
 
 
 
Capital expenditures
$
234

 
$
201

 
$
167

 
$
157

 
$
154

Total technical expenditures (6) 
150

 
155

 
144

 
140

 
130

Advertising expenditures
338

 
299

 
263

 
247

 
227

Repairs and maintenance
99

 
96

 
87

 
83

 
78

Depreciation
170

 
169

 
159

 
152

 
151

Amortization of intangible assets
28

 
30

 
29

 
27

 
30

Shareholders of record (total count)
6,987

 
7,250

 
7,555

 
7,954

 
8,360

Number of employees (total count)
40,706

 
39,674

 
37,633

 
34,154

 
32,988

Sales per employee (thousands of dollars)
$
279

 
$
281

 
$
271

 
$
279

 
$
266

Sales per dollar of assets
1.96

 
1.95

 
1.60

 
1.53

 
1.68

(1)
All earnings per share amounts are presented using the two-class method. See Note 15.
(2)
Based on net income and shareholders’ equity at beginning of year.
(3)
Based on cash dividends per common share and prior year’s diluted net income per common share.
(4)
Ratio of income before income taxes and interest expense to interest expense.
(5)
Based on income before income taxes.
(6)
See Note 1, page 49 of this report, for a description of technical expenditures.

20 

 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SUMMARY
The Sherwin-Williams Company, founded in 1866, and its consolidated wholly owned subsidiaries (collectively, the “Company”) are engaged in the development, manufacture, distribution and sale of paint, coatings and related products to professional, industrial, commercial and retail customers primarily in North and South America with additional operations in the Caribbean region, Europe and Asia. The Company is structured into four reportable segments – Paint Stores Group, Consumer Group, Global Finishes Group and Latin America Coatings Group (collectively, the “Reportable Segments”) – and an Administrative Segment in the same way it is internally organized for assessing performance and making decisions regarding allocation of resources. See pages 8 through 17 of this report and Note 18, on pages 72 through 75 of this report, for more information concerning the Reportable Segments.
The Company’s financial condition, liquidity and cash flow continued to be strong in 2015 as net operating cash topped $1.000 billion for the third straight year primarily due to improved operating results in our Paint Stores and Consumer Groups. Net working capital increased $630.9 million at December 31, 2015 compared to 2014 due to a significant decrease in current liabilities and an increase in current assets. Cash and cash equivalents along with cash flow from operations were used primarily to purchase $1.035 billion in treasury stock. Short-term borrowings decreased $640.0 million due to strong cash flow and issuance of long-term debt. On July 28, 2015, the Company issued $400.0 million of 3.45% Senior Notes due 2025 and $400.0 million of 4.55% Senior Notes due 2045. The proceeds will be used for general corporate purposes, including repayment of a portion of the Company’s outstanding short-term borrowings. The Company has been able to arrange sufficient short-term borrowing capacity at reasonable rates, and the Company has sufficient total available borrowing capacity to fund its current operating needs. Net operating cash increased $365.9 million to $1.447 billion in 2015 from $1.082 billion in 2014. Strong net operating cash provided the funds necessary to invest in new stores, manufacturing and distribution facilities, renovate and convert acquired stores, and return cash to shareholders through dividends and treasury stock purchases.
Results of operations for the Company were strong and improved in many areas in 2015, primarily due to an improving domestic architectural paint market. Consolidated net sales increased 1.9 percent in 2015 to $11.339 billion from $11.130 billion in 2014 due primarily to higher paint sales volume in the Paint Stores and Consumer Groups. Consolidated gross profit as a percent of consolidated net sales increased to 49.0 percent in 2015 from 46.4 percent in 2014 due primarily to increased paint sales volume and improved operating efficiency. Gross profit in
 
2014 included a titanium dioxide suppliers antitrust class action lawsuit settlement of $21.4 million received by the Company in the fourth quarter of 2014 (the "2014 TiO2 settlement"). Selling, general and administrative expenses (SG&A) increased $90.6 million in 2015 compared to 2014 and increased as a percent of consolidated net sales to 34.5 percent in 2015 as compared to 34.3 percent in 2014 due primarily due to new stores openings and expenses related to the launch of a new paint program at a national retailer partially offset by foreign currency translation rate fluctuations. Lower average borrowing rates more than offset higher average borrowing levels on total debt throughout 2015 resulting in decreased interest expense of $2.4 million in 2015. The effective income tax rate was 32.0 percent for 2015 and 31.2 percent for 2014. Diluted net income per common share increased 27.1 percent to $11.16 per share for 2015 from $8.78 per share a year ago.
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. Management utilized certain outside economic sources of information when developing the bases for their estimates and assumptions. Management used assumptions based on historical results, considering the current economic trends, and other assumptions to form the basis for determining appropriate carrying values of assets and liabilities that were not readily available from other sources. Actual results could differ from those estimates. Also, materially different amounts may result under materially different conditions, materially different economic trends or from using materially different assumptions. However, management believes that any materially different amounts resulting from materially different conditions or material changes in facts or circumstances are unlikely to significantly impact the current valuation of assets and liabilities that were not readily available from other sources.
All of the significant accounting policies that were followed in the preparation of the consolidated financial statements are disclosed in Note 1, on pages 46 through 49, of this report. The following procedures and assumptions utilized by management directly impacted many of the reported amounts in the consolidated financial statements.


21

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 

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 29 of this report. See Note 1, on page 46 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 are resolved, or if the financial condition of any of the Company’s customers were to deteriorate and their ability to make required payments became impaired, increases in these allowances may be required. At December 31, 2015, no individual customer constituted more than 5 percent of Accounts receivable.
 
Inventories
Inventories were stated at the lower of cost or market with cost determined principally on the last-in, first-out (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 50 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 dates 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 useful lives of finite-lived intangible assets in accordance with the Goodwill and Other Intangibles Topic of the ASC.


22 

 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

As required by the Goodwill and Other Intangibles Topic of the ASC, management performs impairment tests of goodwill and indefinite-lived intangible assets on an annual basis, as well as whenever an event occurs or circumstances change that indicate impairment has more likely than not occurred. The qualitative assessment allows companies to skip the annual two-step 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 optional 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, impairment of the reporting unit may exist. 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.
 
The Company had six reporting units with goodwill as of October 1, 2015, the date of the annual impairment test. The fair values of each of the reporting units exceeded their respective carrying values by more than ten percent and no goodwill impairment was recorded in 2015. The Company performed a sensitivity analysis on the discount rate, which is a significant assumption in the calculation of the fair values. With a one percentage point increase in the discount rate, the reporting units would continue to have fair values in excess of their respective carrying values.
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 2015 impairment testing are consistent with prior years.
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 Notes 2 and 4, on pages 50 through 51 of this report, for a discussion of businesses acquired, the estimated fair values of goodwill and identifiable intangible assets recorded at acquisition date and reductions in carrying value of goodwill and indefinite-lived intangible assets recorded as a result of impairment tests in accordance with the Goodwill and Other Intangibles Topic of the ASC.


23

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 

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 for assets using a discounted cash flow valuation model, incorporating discount rates commensurate with the risks involved for each group of assets. 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. Such models 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, except as noted in Note 4. See Notes 4 and 5, on pages 50 through 53 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 becomes available upon which more accurate amounts can be reasonably estimated. If impairment of property,
 
plant and equipment exists, then the carrying value is reduced to fair value estimated by management. Additional impairment may be recorded for subsequent revisions in estimated fair value. See Note 5, on pages 51 through 53 of this report, for information concerning impairment of property, plant and equipment and accrued qualified exit costs.
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 estimated aggregate liability for claims incurred using historical experience, actuarial assumptions followed in the insurance industry and actuarially-developed models for estimating certain liabilities. Certain estimated general and product liability claims filed but unsettled were accrued based on management’s best estimate of ultimate settlement or actuarial calculations of potential liability using industry experience and actuarial assumptions developed for similar types of claims.
Defined Benefit Pension and Other Postretirement Benefit Plans
To determine the Company’s ultimate obligation under its defined benefit pension plans and postretirement benefit plans other than pensions, management must estimate the future cost of benefits and attribute that cost to the time period during which each covered employee works. To determine the obligations of such benefit plans, management uses actuaries to calculate such amounts using key assumptions such as discount rates, inflation, long-term investment returns, mortality, employee turnover, rate of compensation increases and medical and prescription drug costs. Management reviews all of these assumptions on an ongoing basis to ensure that the most current information available is being considered. An increase or decrease in the assumptions or economic events outside management’s control could have a direct impact on the Company’s results of operations or financial condition.
In accordance with the Retirement Benefits Topic of the ASC, the Company recognizes each plan’s funded status as an asset for overfunded plans and as a liability for unfunded or underfunded plans. Actuarial gains and losses and prior service costs are recognized and recorded in Cumulative other comprehensive loss, a component of Shareholders’ equity. The amounts recorded in Cumulative other comprehensive loss will continue to be modified as actuarial assumptions and service


24 

 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

costs change, and all such amounts will be amortized to expense over a period of years through the net pension and net periodic benefit costs.
Effective July 1, 2009, the domestic salaried defined benefit pension plan was revised. Prior to July 1, 2009, the contribution was based on six percent of compensation for certain covered employees. Under the revised plan, such participants are credited with certain contribution credits that range from two percent to seven percent of compensation based on an age and service formula.
A reduction in the over-funded status of the Company’s defined benefit pension plans at December 31, 2008 due to the decrease in market value of equity securities held by the plans increased the future amortization of actuarial losses recognized in Cumulative comprehensive loss. This amortization increased net pension costs in 2013, 2014 and 2015. An increase in market value of equity securities held by the plans during 2013 and 2014 will decrease the future amortization of actuarial losses recognized in Cumulative comprehensive loss. The deficit in market value of equity securities held by the plans versus the expected returns in 2015 will increase the future amortization of actuarial losses. The amortization of actuarial losses on plan assets, only partially offset by an increase in discount rates on projected benefit obligations, will increase net pension costs in 2016. See Note 6, on pages 54 through 59 of this report, for information concerning the Company’s defined benefit pension plans and postretirement benefit plans other than pensions.
Debt
The fair values of the Company’s publicly traded long-term debt were based on quoted market prices. The fair values of the Company’s non-traded long-term debt were estimated using discounted cash flow analyses, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. See Note 1, on page 46 of this report, for the carrying amounts and fair values of the Company’s long-term debt, and Note 7, on page 60 of this report, for a description of the Company’s long-term debt arrangements.
Environmental Matters
The Company is involved with environmental investigation and remediation activities at some of its currently and formerly owned sites and at a number of third-party sites. The Company accrues for environmental-related activities for which commitments or clean-up plans have been developed and for which costs can be reasonably estimated based on industry standards and professional judgment. All accrued amounts were recorded on an 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 paid to outside engineering, actuarial, consulting and law firms. Due to uncertainties surrounding environmental investigations and remediation activities, the Company’s ultimate liability may result in costs that are significantly higher than currently accrued. See page 29 and Note 8, on pages 60 through 62 of this report, for information concerning the accrual for extended environmental-related activities and a discussion concerning unaccrued future loss contingencies.
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 principles. However, because litigation is inherently subject to many uncertainties and the ultimate result of any present or future litigation is unpredictable, the Company’s ultimate liability may result in costs that are significantly higher than currently accrued. In the event that the Company’s loss contingency is ultimately determined to be significantly higher than currently accrued, 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 involved, 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. See Note 9 on pages 62 through 65 of this report for information concerning litigation.
Income Taxes
The Company estimated income taxes in each jurisdiction that it operated. This involved estimating taxable earnings, specific taxable and deductible items, the likelihood of generating sufficient future taxable income to utilize deferred tax assets and possible exposures related to future tax audits. To the extent these estimates change, adjustments to deferred and accrued income taxes will be made in the period in which the changes occur.
See Note 14, on pages 69 and 70 of this report, for information concerning the Company’s unrecognized tax benefits, interest and penalties and current and deferred tax expense.


25

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 

Stock-Based Compensation
The cost of the Company’s stock-based compensation is recorded in accordance with the Stock Compensation Topic of the ASC. The Company follows the “modified prospective” method as described in the Topic whereby compensation cost is recognized for all share-based payments granted after December 31, 2005.
The Company estimates the fair value of option rights using a Black-Scholes-Merton option pricing model which requires management to make estimates for certain assumptions. Management and a consultant continuously review the following significant assumptions: risk-free interest rate, expected life of options, expected volatility of stock and expected dividend yield of stock. An increase or decrease in the assumptions or economic events outside management’s control could have a direct impact on the Company’s results of operations. See Note 12, on pages 67 and 68 of this report, for more information on stock-based compensation.
Revenue Recognition
The Company’s revenue was primarily generated from the sale of products. All sales of products were recognized when shipped and title had passed to unaffiliated customers. Collectibility of amounts recorded as revenue is reasonably assured at time of sale. Discounts were recorded as a reduction to sales in the same period as the sale resulting in an appropriate net sales amount for the period. Standard sales terms are final and returns or exchanges are not permitted unless expressly stated. Estimated provisions for returns or exchanges, recorded as a reduction resulting in net sales, were established in cases where the right of return existed. The Company offered a variety of programs, primarily to its retail customers, designed to promote sales of its products. Such programs required periodic payments and allowances based on estimated results of specific programs and were recorded as a reduction resulting in net sales. The Company accrued the estimated total payments and allowances associated with each transaction at the time of sale. Additionally, the Company offered programs directly to consumers to promote the sale of its products. Promotions that reduced the ultimate consumer sale prices were recorded as a reduction resulting in net sales at the time the promotional offer was made, generally using estimated redemption and participation levels. The Company continually assesses the adequacy of accruals for customer and consumer promotional program costs earned but not yet paid. To the extent total program payments differ from estimates, adjustments may be necessary. Historically, these total program payments and adjustments have not been material.

 
FINANCIAL CONDITION, LIQUIDITY AND CASH FLOW
Overview
The Company’s financial condition, liquidity and cash flow continued to be strong in 2015 as net operating cash topped $1.000 billion for the third straight year primarily due to improved operating results in our Paint Stores and Consumer Groups. Net working capital increased $630.9 million at December 31, 2015 compared to 2014 due to a significant decrease in current liabilities and an increase in current assets. Cash and cash equivalents along with cash flow from operations were used primarily to purchase $1.035 billion in treasury stock. Short-term borrowings decreased $640.0 million due to strong cash flow and issuance of long-term debt. On July 28, 2015, the Company issued $400.0 million of 3.45% Senior Notes due 2025 and $400.0 million of 4.55% Senior Notes due 2045. See the section that follows for more information regarding Net Working Capital. Total debt at December 31, 2015 increased $157.4 million to $1.963 billion from $1.805 billion at December 31, 2014 due primarily to the debt issuance on July 28, 2015. Total debt increased as a percentage of total capitalization to 69.3 percent from 64.4 percent at the end of 2014. At December 31, 2015, the Company had remaining borrowing ability of $2.078 billion.
Net operating cash increased $365.9 million to $1.447 billion in 2015 from $1.082 billion in 2014 due primarily to an increase in net income of $188.0 million and a reduction in working capital of $188.9 million due to timing of payments. Net operating cash increased as a percent to sales to 12.8 percent in 2015 compared to 9.7 percent in 2014. Strong Net operating cash provided the funds necessary to invest in new stores, manufacturing and distribution facilities, renovate and convert acquired stores and return cash to shareholders through dividends and treasury stock purchases. In 2015, the Company used Net operating cash and Cash and cash equivalents on hand to purchase $1.035 billion in treasury stock, spend $234.3 million in capital additions and improvements and pay $249.6 million in cash dividends to its shareholders of common stock.
Net Working Capital
Total current assets less Total current liabilities (net working capital) increased $630.9 million to a surplus of $517.0 million at December 31, 2015 from a deficit of $113.9 million at December 31, 2014. The net working capital increase is due to a significant decrease in current liabilities and an increase in current assets. Cash and cash equivalents increased $165.0 million. Short-term borrowings decreased $640.0 million. Accounts payable increased $115.4 million while Accrued taxes decreased $5.6 million and all other current liabilities, excluding current portion of long-term debt, decreased $8.5 million. Accounts receivable were


26 

 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

down $16.3 million, Inventories were down $15.0 million and Deferred tax net assets were down $21.2 million while the remaining current assets decreased $20.4 million. The Company has sufficient total available borrowing capacity to fund its current operating needs. The significant decrease in Short-term borrowings and significant increase in Cash and cash equivalents caused the Company’s current ratio to improve to 1.24 at December 31, 2015 from 0.96 at December 31, 2014. Accounts receivable as a percent of Net sales decreased to 9.8 percent in 2015 from 10.2 percent in 2014. Accounts receivable days outstanding decreased to 54 days in 2015 from 55 days in 2014. In 2015, provisions for allowance for doubtful collection of accounts decreased $4.3 million, or 8.1 percent. Inventories decreased slightly as a percent of Net sales to 9.0 percent in 2015 from 9.3 percent in 2014 due primarily to tighter inventory management. Inventory days outstanding was down at 83 days in 2015 versus 86 days in 2014. Accounts payable increased in 2015 to $1.158 billion compared to $1.042 billion last year due primarily to increased purchases to service higher sales levels and timing of payments.
Goodwill and Intangible Assets
Goodwill, which represents the excess of cost over the fair value of net assets acquired in purchase business combinations, decreased $15.0 million in 2015 due primarily to foreign currency translation rate fluctuations.
Intangible assets decreased $33.8 million in 2015. Decreases from amortization of finite-lived intangible assets of $28.2 million and foreign currency translation rate fluctuations of $7.9 million were partially offset by $2.4 million of capitalized software costs. Acquired finite-lived intangible assets included assets such as covenants not to compete, customer lists and product formulations. 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 Notes 2 and 4, on pages 50 through 51 of this report, for a description of acquired 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.
Deferred Pension and Other Assets
Deferred pension assets of $244.9 million at December 31, 2015 represent the excess of the fair value of assets over the actuarially determined projected benefit obligations, primarily of the domestic salaried defined benefit pension plan. The decrease in Deferred pension assets during 2015 of $5.3 million, from $250.1 million last year, was due primarily to a decrease in the fair
 
value of equity securities held by the salaried defined benefit pension plan partially offset by a decrease in the projected benefit obligations resulting from changes in actuarial assumptions. In accordance with the accounting prescribed by the Retirement Benefits Topic of the ASC, the decrease in the value of the Deferred pension assets is offset in Cumulative other comprehensive loss and is amortized as a component of Net pension costs over a defined period of pension service. See Note 6, on pages 54 through 59 of this report, for more information concerning the excess fair value of assets over projected benefit obligations of the salaried defined benefit pension plan and the amortization of actuarial gains or losses relating to changes in the excess assets and other actuarial assumptions.
Other assets increased $26.9 million to $447.5 million at December 31, 2015 due primarily to long-term deposits and net increases in other investments. 
Property, Plant and Equipment
Net property, plant and equipment increased $20.8 million to $1.042 billion at December 31, 2015 due primarily to capital expenditures of $234.3 million partially offset by depreciation expense of $170.3 million, sale or disposition of assets with remaining net book value of $10.5 million and currency translation adjustments of $32.6 million. Capital expenditures during 2015 in the Paint Stores Group were primarily attributable to the opening of new paint stores, renovation and conversion of acquired stores and improvements in existing stores. In the Consumer Group, capital expenditures during 2015 were primarily attributable to improvements and normal equipment replacements in manufacturing and distribution facilities. Capital expenditures in the Global Finishes Group were primarily attributable to improvements in existing manufacturing and distribution facilities. The Administrative Segment incurred capital expenditures primarily for information systems hardware. In 2016, the Company expects to spend more than 2015 for capital expenditures. The predominant share of the capital expenditures in 2016 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.
Debt
There were no borrowings outstanding under the domestic commercial paper program at December 31, 2015 and 2013, respectively. There were $625.9 million in borrowings outstanding under this program at December 31, 2014 with a weighted-average interest rate of 0.3 percent. Borrowings outstanding


27

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 

under various foreign programs at December 31, 2015 were $39.5 million with a weighted-average interest rate of 7.0 percent. At December 31, 2014 and December 31, 2013, foreign borrowings were $53.6 million and $96.6 million with weighted-average interest rates of 6.0 percent and 7.8 percent, respectively. Long-term debt, including the current portion, increased $797.4 million during 2015 resulting primarily from long-term debt issued in 2015. On July 28, 2015, the Company issued $400.0 million of 3.45% Senior Notes due 2025 and $400.0 million of 4.55% Senior Notes due 2045. The notes are covered under a shelf registration filed with the Securities and Exchange Commission on July 28, 2015. The proceeds will be used for general corporate purposes, including repayment of a portion of the Company’s outstanding short-term borrowings.
On July 16, 2015, the Company and three of its wholly-owned subsidiaries, Sherwin-Williams Canada, Inc. (SW Canada), Sherwin-Williams Luxembourg S.à r.l. (SW Lux) and Sherwin-Williams UK Holding Limited, entered into a new five-year $1.350 billion credit agreement. The credit agreement is being used for general corporate purposes, including the financing of working capital requirements. The credit agreement replaced the previous credit agreements for each of the Company, SW Canada and SW Lux, dated July 8, 2011, June 29, 2012 and September 19, 2012, as amended, respectively. The credit agreement allows the Company to extend the maturity of the facility with two one-year extension options and to increase the aggregate amount of the facility to $1.850 billion, both of which are subject to the discretion of each lender. At December 31, 2015, there was $21.7 million of borrowings outstanding under this credit agreement.
On July 8, 2011, the Company entered into a five-year $1.050 billion revolving credit agreement, which replaced the existing three-year $500.0 million credit agreement. The credit agreement allows the Company to extend the maturity of the facility with two one-year extension options and to increase the aggregate amount of the facility to $1.300 billion, both of which are subject to the discretion of each lender.
See Note 7, on page 60 of this report, for a detailed description of the Company’s debt outstanding and other available financing programs.
Defined Benefit Pension and Other Postretirement Benefit Plans
In accordance with the accounting prescribed by the Retirement Benefits Topic of the ASC, the Company’s total liability for unfunded or underfunded defined benefit pension plans decreased $3.6 million to $50.6 million primarily due to changes in the actuarial assumptions of the Company's foreign plans. Postretirement benefits other than pensions decreased
 
$31.8 million to $263.4 million at December 31, 2015 due primarily to changes in the actuarial assumptions.
Effective July 1, 2009, the domestic salaried defined benefit pension plan was revised. Prior to July 1, 2009, the contribution was based on six percent of compensation for covered employees. Under the revised plan, such participants are credited with certain contribution credits that range from two percent to seven percent of compensation based on an age and service formula. Amounts previously recorded in Cumulative other comprehensive loss in accordance with the provisions of the Retirement Benefits Topic of the ASC were modified in 2009 resulting in a decrease in comprehensive loss due primarily to the change in the domestic salaried defined benefit pension plan and an increase in the excess plan assets over the actuarially calculated projected benefit obligation in the domestic defined benefit pension plans. Partially offsetting this decreased loss were modifications to actuarial assumptions used to calculate projected benefit obligations.
Effective October 1, 2011, the domestic salaried defined benefit pension plan was frozen for new hires, and all newly hired U.S. non-collectively bargained employees are eligible to participate in the Company’s domestic defined contribution plan.
The assumed discount rate used to determine the actuarial present value of projected defined benefit pension and other postretirement benefit obligations for domestic plans was increased from 3.95 percent to 4.40 percent at December 31, 2015 due to increased rates of high-quality, long-term investments and foreign defined benefit pension plans had similar discount rate increases for the same reasons. The rate of compensation increases used to determine the projected benefit obligations decreased to 3.1 percent in 2015 from 4.0 percent for domestic pension plans and was slightly higher on most foreign plans. In deciding on the rate of compensation increases, management considered historical Company increases as well as expectations for future increases. The expected long-term rate of return on assets remained at 6.0 percent for 2015 for domestic pension plans and was slightly lower for most foreign plans. In establishing the expected long-term rate of return on plan assets for 2015, management considered the historical rates of return, the nature of investments and an expectation for future investment strategies. The assumed health care cost trend rates used to determine the net periodic benefit cost of postretirement benefits other than pensions for 2015 were 6.5 percent for medical and prescription drug cost increases, both decreasing gradually to 4.5 percent in 2024. The assumed health care cost trend rates used to determine the benefit obligation at December 31, 2015 were between 11.5 percent and 5.0 percent for medical and prescription drug cost increases. In developing the


28 

 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

assumed health care cost trend rates, management considered industry data, historical Company experience and expectations for future health care costs.
For 2016 Net pension cost and Net periodic benefit cost recognition for domestic plans, the Company will use a discount rate of 4.40 percent, an expected long-term rate of return on assets of 6.0 percent, a rate of compensation increase of 3.1 percent and cost trend rates between 5.0 percent and 11.5 percent for health care and prescription drug cost increases. Slightly lower discount rates, rates of compensation increases and expected long-term rates of return on plan assets will be used for most foreign plans. Use of these assumptions and amortization of actuarial gains will result in a domestic Net pension cost in 2016 that is expected to be approximately $7.2 million higher than in 2015 and a Net periodic benefit cost for postretirement benefits other than pensions that is expected to decrease $3.5 million in 2016 compared to 2015. See Note 6, on pages 54 through 59 of this report, for more information on the Company’s obligations and funded status of its defined benefit pension plans and postretirement benefits other than pensions.
Other Long-Term Liabilities
Other long-term liabilities decreased $14.9 million during 2015 due primarily to a decrease in long-term commitments related to the affordable housing and historic renovation real estate properties of $30.1 million, a decrease in non-current deferred tax liabilities of $5.7 million, and a decrease in long-term pension liabilities of $4.3 million partially offset by an increase in accruals for extended environmental-related liabilities of $15.6 million.
 
Environmental-Related Liabilities
The operations of the Company, like those of other companies in the same industry, are subject to various federal, state and local environmental laws and regulations. These laws and regulations not only govern current operations and products, but also impose potential liability on the Company for past operations. Management expects environmental laws and regulations to impose increasingly stringent requirements upon the Company and the industry in the future. Management believes that the Company conducts its operations in compliance with applicable environmental laws and regulations and has implemented various programs designed to protect the environment and promote continued compliance. 
Depreciation of capital expenditures and other expenses related to ongoing environmental compliance measures were included in the normal operating expenses of conducting business. The Company’s capital expenditures, depreciation and other expenses related to ongoing environmental compliance measures were not material to the Company’s financial condition, liquidity, cash flow or results of operations during 2015. 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 2016. See Note 8, on pages 60 through 62 of this report, for further information on environmental-related long-term liabilities.

Contractual Obligations and Commercial Commitments
The Company has certain obligations and commitments to make future payments under contractual obligations and commercial commitments. The following table summarizes such obligations and commitments as of December 31, 2015:
(thousands of dollars)
 
Payments Due by Period
Contractual Obligations
 
Total
 
Less than
1 Year
 
1–3 Years
 
3–5 Years
 
More than
5 Years
Long-term debt
 
$
1,927,688

 
$
3,154

 
$
700,818

 
$
315

 
$
1,223,401

Operating leases
 
1,420,549

 
317,843

 
501,728

 
318,078

 
282,900

Short-term borrowings
 
39,462

 
39,462

 
 
 
 
 
 
Interest on Long-term debt
 
1,147,842

 
62,828

 
115,652

 
106,160

 
863,202

Purchase obligations (a)
 
52,052

 
52,052

 
 
 
 
 
 
Other contractual obligations (b)
 
212,965

 
93,572

 
52,072

 
44,956

 
22,365

Total contractual cash obligations
 
$
4,800,558

 
$
568,911

 
$
1,370,270

 
$
469,509

 
$
2,391,868

(a) 
Relate to open purchase orders for raw materials at December 31, 2015.
(b) 
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.

29

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 

 
 
Amount of Commitment Expiration Per Period
Commercial Commitments
 
Total
 
Less than
1 Year
 
1–3 Years
 
3–5 Years
 
More than
5 Years
Standby letters of credit
 
$
45,407

 
$
45,407

 
 
 
 
 
 
Surety bonds
 
64,470

 
64,470

 
 
 
 
 
 
Other commercial commitments
 
17,747

 
17,747

 
 
 
 
 
 
Total commercial commitments
 
$
127,624

 
$
127,624

 
$

 
$

 
$

Warranties
The Company offers product warranties for certain products. 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. 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 2015, 2014 and 2013, including customer satisfaction settlements during the year, were as follows:
(thousands of dollars)
2015
 
2014
 
2013
Balance at January 1
$
27,723

 
$
26,755

 
$
22,710

Charges to expense
43,484

 
37,879

 
33,265

Settlements
(39,329
)
 
(36,911
)
 
(29,220
)
Balance at December 31
$
31,878

 
$
27,723

 
$
26,755

Shareholders’ Equity
Shareholders’ equity decreased $128.6 million to $867.9 million at December 31, 2015 from $996.5 million last year. The decrease in Shareholders’ equity resulted primarily from the purchase of treasury stock for $1.035 billion, treasury stock received from stock option exercises of $34.4 million and an increase in Cumulative other comprehensive loss of $115.1 million partially offset by an increase in retained earnings of $804.2 million and an increase in Other capital of $250.8 million, due primarily to stock options exercised. The Company purchased 3.58 million shares of its common stock during 2015 for treasury. The Company acquires its common stock for general corporate purposes and, depending on its cash position and market conditions, it may acquire additional shares in the future. On October 21, 2015, the Board of Directors of the Company authorized the Company to purchase an additional 10.0 million shares of its common stock. The Company had remaining authorization from its Board of Directors at December 31, 2015 to purchase 11.65 million shares of its common stock. The increase of $115.1 million in Cumulative other comprehensive loss was due primarily to unfavorable foreign currency translation effects of $128.2 million attributable to the weakening of most foreign
 
operations’ functional currencies against the U.S. dollar partially offset by $13.8 million in net actuarial gains and prior service costs of defined benefit pension and other postretirement benefit plans net of amortization.
The increase in Other capital of $250.8 million was due primarily to the recognition of stock-based compensation expense, stock option exercises and related income tax effect. Retained earnings increased $804.2 million during 2015 due to net income of $1.054 billion partially offset by $249.6 million in cash dividends paid. The Company’s cash dividend per common share payout target is 30.0 percent of the prior year’s diluted net income per common share. The 2015 annual cash dividend of $2.68 per common share represented 30.5 percent of 2014 diluted net income per common share. The 2015 annual dividend represented the thirty-sixth consecutive year of dividend payments since the dividend was suspended in 1978. At a meeting held on February 17, 2016, the Board of Directors increased the quarterly cash dividend to $.84 per common share. This quarterly dividend, if approved in each of the remaining quarters of 2016, would result in an annual dividend for 2016 of $3.36 per common share or a 30.1 percent payout of 2015 diluted net income per common share. See the Statements of Consolidated Shareholders’ Equity, on page 45 of this report, and Notes 10, 11 and 12, on pages 65 through 68 of this report, for more information concerning Shareholders’ equity.
Cash Flow
Net operating cash increased $365.9 million to $1.447 billion in 2015 from $1.082 billion in 2014 due primarily to an increase in net income of $188.0 million and a reduction in working capital of $188.9 million due to timing of payments. Strong Net operating cash provided the funds necessary to invest in new stores, manufacturing and distribution facilities, renovate and convert acquired stores, pay down debt and return cash to shareholders through dividends and treasury stock purchases. Net investing cash improved $21.4 million to a usage of $288.6 million in 2015 from a usage of $310.1 million in 2014 due primarily due to reduced cash used for other investments of $45.4 million partially offset by increased capital expenditures of $33.8 million. Net financing cash improved $486.7 million to a usage of $980.4 million in 2015 from a usage of $1.467 billion in 2014 due primarily


30 

 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

to increased net proceeds of long-term debt of $1.297 billion, decreased treasury stock purchases of $453.4 million partially offset by net decreases in short-term borrowings of $1.222 billion and increased payments of cash dividends of $34.4 million. In 2015, the Company used Net operating cash and Cash and cash equivalents on hand to purchase $1.035 billion in treasury stock, spend $234.3 million in capital additions and improvements and pay $249.6 million in cash dividends to its shareholders of common stock.
Management considers a measurement of cash flow that is not 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 44 of this report. Free Cash Flow as defined and used by management is determined as follows: 
 
Year Ended December 31,
(thousands of dollars)
2015
 
2014
 
2013
Net operating cash
$
1,447,463

 
$
1,081,528

 
$
1,083,766

Capital expenditures
(234,340
)
 
(200,545
)
 
(166,680
)
Cash dividends
(249,647
)
 
(215,263
)
 
(204,978
)
Free cash flow
$
963,476

 
$
665,720

 
$
712,108


Litigation

DOL leveraged ESOP settlement. On February 20, 2013, the Company reached a settlement with the DOL of the DOL's investigation of transactions related to the Company's ESOP that were implemented on August 1, 2006 and August 27, 2003. The DOL had notified the Company, among others, of potential enforcement claims asserting breaches of fiduciary obligations and sought compensatory and equitable remedies. The Company resolved all ESOP related claims with the DOL by agreeing, in part, to make a one-time payment of $80.0 million to the ESOP,
 
resulting in a $49.2 million after tax charge to earnings in the fourth quarter of 2012. The Company made this required $80.0 million payment to the ESOP during the first quarter of 2013.

Government tax assessment settlements related to Brazilian operations. Charges totaling $28.7 million and $2.9 million were recorded to Cost of goods sold and SG&A, respectively, during the second and third quarters of 2013. The
charges were primarily related to import duty taxes paid to the Brazilian government related to the handling of import duties on products brought into the country for the years 2006 through 2012. The Company elected to pay the taxes through an existing voluntary amnesty program offered by the government to resolve these issues rather than contest them in court. The after-tax charges were $21.9 million for the full year 2013. The Company's import duty process in Brazil was changed to reach a final resolution of this matter with the Brazilian government.
Titanium dioxide suppliers antitrust class action lawsuit. The Company is a member of the plaintiff class related to Titanium Dioxide Antitrust Litigation that was initiated in 2010 against certain suppliers alleging various theories of relief arising from purchases of titanium dioxide made from 2003 through 2012. The Court approved a settlement less attorney fees and expense, and the Company timely submitted claims to recover its pro-rata portion of the settlement. There was no specified deadline for the claims administrator to complete the review of all claims submitted. In October 2014, the Company was notified that it would receive a disbursement of settlement funds, and the Company received a pro-rata disbursement net of all fees of approximately $21.4 million. The Company recorded this settlement gain in the fourth quarter of 2014.
See page 25 of this report and Note 9 on pages 62 through 65 for more information concerning litigation.
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 option and forward currency exchange contracts with maturity dates of less than twelve months in 2015, 2014 and 2013, primarily to hedge against value changes in foreign currency. There were no material derivative contracts outstanding at December 31, 2015, 2014 and 2013. The Company 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


31

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 

the Company’s financial condition, results of operations or cash flows. See Notes 1 and 13 on pages 47 and 69 of this report.
Financial Covenant
Certain borrowings contain a consolidated leverage covenant. The covenant states the Company’s leverage ratio is not to exceed 3.50 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, 2015, 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 7 on page 60 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 $80.4 million in 2015 compared to $74.6 million in 2014. At December 31, 2015, there were 11,333,455 shares of the Company’s common stock being held by the ESOP, representing 12.3 percent of the total number of voting shares outstanding. See Note 11, on pages 66 and 67 of this report, for more information concerning the Company’s ESOP and preferred stock.


32 

 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS - 2015 vs. 2014
Shown below are net sales and segment profit and the percentage change for the current period by segment for 2015 and 2014:
 
Year Ended December 31,
(thousands of dollars)
2015
 
2014
 
Change
Net Sales:
 
 
 
 
 
Paint Stores Group
$
7,208,951

 
$
6,851,581

 
5.2
 %
Consumer Group
1,577,955

 
1,420,757

 
11.1
 %
Global Finishes Group
1,916,300

 
2,080,854

 
-7.9
 %
Latin America Coatings Group
631,015

 
771,378

 
-18.2
 %
Administrative
5,083

 
4,963

 
2.4
 %
Net sales
$
11,339,304

 
$
11,129,533

 
1.9
 %
 
 
 
 
 
 
 
Year Ended December 31,
(thousands of dollars)
2015
 
2014
 
Change
Income Before Income Taxes:
 
 
 
 
 
Paint Stores Group
$
1,433,504

 
$
1,201,420

 
19.3
 %
Consumer Group
308,833

 
252,859

 
22.1
 %
Global Finishes Group
201,881

 
201,129

 
0.4
 %
Latin America Coatings Group
18,494

 
40,469

 
-54.3
 %
Administrative
(413,746
)
 
(437,651
)
 
5.5
 %
Income before
income taxes
$
1,548,966

 
$
1,258,226

 
23.1
 %
Consolidated net sales for 2015 increased due primarily to higher paint sales volume in the Paint Stores and Consumer Groups. Unfavorable currency translation rate changes decreased 2015 consolidated net sales 3.3 percent. Net sales of all consolidated foreign subsidiaries were down 18.8 percent to $1.789 billion for 2015 versus $2.204 billion for 2014 due primarily to unfavorable foreign currency translation rates. Net sales of all operations other than consolidated foreign subsidiaries were up 7.0 percent to $9.550 billion for 2015 versus $8.926 billion for 2014.
Net sales in the Paint Stores Group in 2015 increased primarily due to higher architectural paint sales volume across all end market segments. Net sales from stores open for more than twelve calendar months increased 4.2 percent for the full year. During 2015, the Paint Stores Group opened 113 new stores and closed 30 redundant locations for a net increase of 83 stores, increasing the total number of stores in operation at December 31, 2015 to 4,086 in the United States, Canada and the Caribbean. The Paint Stores Group’s objective is to expand its
 
store base an average of two and a half percent each year, primarily through internal growth. Sales of products other than paint increased approximately 8.0 percent for the year over 2014. A discussion of changes in volume versus pricing for sales of products other than paint is not pertinent due to the wide assortment of general merchandise sold.
Net sales of the Consumer Group increased due primarily to a new agreement to sell architectural paint under the HGTV HOME® by Sherwin-Williams brand through a large U.S. national retailer's stores network. Sales of wood care coatings, brushes, rollers, caulk and other paint related products, were all up at least mid to high-single digits as compared to 2014 while sales of aerosol products were down slightly. A discussion of changes in volume versus pricing for sales of products other than paint is not pertinent due to the wide assortment of paint-related merchandise sold. The Consumer Group plans to continue its promotions of new and existing products in 2016 and continue expanding its customer base and product assortment at existing customers.
The Global Finishes Group’s net sales in 2015, when stated in U.S. dollars, decreased due primarily to unfavorable currency translation rate changes. Paint sales volume percentage increased slightly as compared to 2014. Unfavorable currency translation rate changes in the year decreased net sales by 7.5 percent for 2015. In 2015, the Global Finishes Group opened 3 new branches and closed 7 locations decreasing the total from 300 to 296 branches open in the United States, Canada, Mexico, South America, Europe and Asia at year-end. In 2016, the Global Finishes Group expects to continue expanding its worldwide presence and improving its customer base.
The Latin America Coatings Group’s net sales in 2015, when stated in U.S. dollars, decreased due primarily to unfavorable currency translation rate changes and lower paint sales volume partially offset by selling price increases. Paint sales volume percentage decreased in the mid-single digits as compared to 2014. Unfavorable currency translation rate changes in the year decreased net sales by 19.3 percent for 2015. In 2015, the Latin America Coatings Group opened 17 new stores and closed 2 locations for a net increase of 15 stores, increasing the total to 291 stores open in North and South America at year-end. In 2016, the Latin America Coatings Group expects to continue expanding its regional presence and improving its customer base.
Net sales in the Administrative segment, which primarily consist of external leasing revenue of excess headquarters space and leasing of facilities no longer used by the Company in its primary business, increased by an insignificant amount in 2015.
Consolidated gross profit increased $394.7 million in 2015 and improved as a percent to net sales to 49.0 percent from


33

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 

46.4 percent in 2014 due primarily to higher paint sales volume, improved operating efficiencies, and decreasing raw material costs partially offset by unfavorable currency translation rate changes. Gross profit for 2014 included the 2014 TiO2 settlement of $21.4 million received by the Company in the fourth quarter of 2014. The Paint Stores Group’s gross profit for 2015 increased $329.3 million compared to 2014 due primarily to higher paint sales volume. The Paint Stores Group's gross profit margins increased for that same reason. The Consumer Group’s gross profit increased $133.6 million due primarily to improved operating efficiency and increased paint sales volume. The Consumer Group’s gross profit margins increased for those same reasons. The Global Finishes Group’s gross profit for 2015 decreased $29.0 million due primarily unfavorable currency translation rate changes partially offset by improved operating efficiencies and decreasing raw material costs. The Global Finishes Group’s gross profit increased as a percent of sales due primarily to improved operating efficiencies and decreasing raw material costs. Foreign currency translation rate fluctuations decreased Global Finishes Group’s gross profit by $51.4 million for 2015. The Latin America Coatings Group’s gross profit for 2015 decreased $43.9 million and decreased as a percent of sales, when stated in U.S. dollars, primarily due to unfavorable currency translation rate changes and increasing raw material costs. Unfavorable currency translation rate changes and lower volume sales were only partially offset by selling price increases in 2015 compared to 2014. Foreign currency translation rate fluctuations decreased gross profit by $41.5 million for 2015. The Administrative segment’s gross profit increased by $4.8 million.
SG&A increased by $90.6 million due primarily to increased expenses to support higher sales levels and net new store openings as well as the impact from a new paint program launch at a national retailer. SG&A increased as a percent of sales to 34.5 percent in 2015 from 34.3 percent in 2014 primarily due to those same reasons. In the Paint Stores Group, SG&A increased $95.4 million for the year due primarily to increased spending due to the number of new store openings and general comparable store expenses to support higher sales levels. The Consumer Group’s SG&A increased by $79.7 million for the year due to a new paint program launch at a national retailer. The Global Finishes Group’s SG&A decreased by $37.4 million for the year relating primarily to foreign currency translation rate fluctuations reducing SG&A by $44.2 million. The Latin America Coatings Group’s SG&A decreased by $22.0 million for the year relating primarily to foreign currency translation rate fluctuations of $27.9 million. The Administrative segment’s SG&A decreased $25.2 million primarily due to incentive compensation.
 
Other general expense - net decreased $7.2 million in 2015 compared to 2014. The decrease was mainly caused by a decrease of $6.1 million of expense in the Administrative segment, primarily due to a year-over-year decrease in provisions for environmental matters of $5.0 million. See Note 13, on pages 68 and 69 of this report, for more information concerning Other general expense - net.
As required by the Goodwill and Other Intangibles Topic of the ASC, management performed an annual impairment test of goodwill and indefinite-lived intangible assets as of October 1, 2015. The impairment tests in 2015 and 2014 resulted in no impairment of goodwill and trademarks. See Note 4, on pages 50 and 51 of this report, for more information concerning the impairment of intangible assets.
Interest expense, included in the Administrative segment, decreased $2.4 million in 2015 versus 2014 due primarily to lower borrowing rates partially offset by higher average debt levels.
Other expense (income) - net decreased to $6.1 million expense from $15.4 million income in 2014. This was primarily due to a $6.3 million gain on the early termination of a customer agreement recorded in the Global Finishes Group and a $6.2 million realized gain resulting from final asset valuations related to the acquisition of the U.S./Canada business of Comex recorded in the Administrative segment, both recorded in the third quarter of 2014. Additionally, foreign currency related transaction losses of $9.5 million in 2015 versus foreign currency related transaction losses of $3.6 million in 2014, primarily in the Global Finishes and Latin America Coatings Groups, were unfavorable comparisons. See Note 13, on page 69 of this report, for more information concerning Other expense (income) - net.
Consolidated Income before income taxes in 2015 increased $290.7 million due primarily to an increase of $394.7 million in gross profit partially offset by an increase of $90.6 million in SG&A and an increase of $13.5 million in interest expense, interest and net investment income and other expenses. Income before income taxes increased $232.1 million in the Paint Stores Group, $56.0 million in the Consumer Group, and $0.8 million in the Global Finishes Group but decreased $22.0 million in the Latin America Coatings Group when compared to 2014. The Administrative segment had a favorable impact on Income before income taxes of $23.9 million when compared to 2014. Segment profit of all consolidated foreign subsidiaries decreased 34.5 percent to $75.8 million for 2015 versus $115.6 million for 2014. Segment profit of all operations other than consolidated foreign subsidiaries increased 28.9 percent to $1.473 billion for 2015 versus $1.143 billion for 2014.


34 

 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Net income increased $188.0 million in 2015 due to the increase in Income before income taxes.
The effective income tax rate for 2015 was 32.0 percent. The effective income tax rate for 2014 was 31.2 percent. Diluted net income per common share increased 27.1 percent to $11.16 per share for 2015 from $8.78 per share a year ago. Unfavorable currency translation rate changes decreased diluted net income per common share by $.26 per share.
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 measurement as an indicator of the value of profits and cash that 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 Net operating cash as an indicator of operating performance or as a measure of liquidity. The reader should refer to the determination of Net income and Net operating cash in accordance with U.S. generally accepted accounting principles disclosed in the Statements of Consolidated Income and Statements of Consolidated Cash Flows, on pages 42 and 44 of this report. EBITDA as used by management is calculated as follows:
 
Year Ended December 31,
(thousands of dollars)
2015
 
2014
 
2013
Net income
$
1,053,849

 
$
865,887

 
$
752,561

Interest expense
61,791

 
64,205

 
62,714

Income taxes
495,117

 
392,339

 
333,397

Depreciation
170,323

 
169,087

 
158,763

Amortization
28,239

 
29,858

 
29,031

EBITDA
$
1,809,319

 
$
1,521,376

 
$
1,336,466



 
RESULTS OF OPERATIONS - 2014 vs. 2013
Shown below are net sales and segment profit and the percentage change for the current period by segment for 2014 and 2013
  
Year Ended December 31,
(thousands of dollars)
2014
 
2013
 
Change
Net Sales:
 
 
 
 
 
Paint Stores Group
$
6,851,581

 
$
6,002,143

 
14.2
 %
Consumer Group
1,420,757

 
1,341,689

 
5.9
 %
Global Finishes Group
2,080,854

 
2,004,530

 
3.8
 %
Latin America Coatings Group
771,378

 
832,450

 
-7.3
 %
Administrative
4,963

 
4,720

 
5.1
 %
Net sales
$
11,129,533

 
$
10,185,532

 
9.3
 %
 
 
 
 
 
 
  
Year Ended December 31,
(thousands of dollars)
2014
 
2013
 
Change
Income Before Income Taxes:
 
 
 
 
 
Paint Stores Group
$
1,201,420

 
$
990,523

 
21.3
 %
Consumer Group
252,859

 
242,061

 
4.5
 %
Global Finishes Group
201,129

 
170,591

 
17.9
 %
Latin America Coatings Group
40,469

 
38,645

 
4.7
 %
Administrative
(437,651
)
 
(355,862
)
 
-23.0
 %
Income before
income taxes
$
1,258,226

 
$
1,085,958

 
15.9
 %
Consolidated net sales for 2014 increased due primarily to higher paint sales volume in the Paint Stores Group and acquisitions. One acquisition completed in 2013 increased consolidated net sales 3.1 percent. Unfavorable currency translation rate changes decreased 2014 consolidated net sales 1.4 percent. Net sales of all consolidated foreign subsidiaries were up 3.5 percent to $2.204 billion for 2014 versus $2.130 billion for 2013 due primarily to acquisitions and selling price increases. Unfavorable foreign currency translation rates reduced net sales for all consolidated foreign subsidiaries during 2014 by 6.2 percent. Net sales of all operations other than consolidated foreign subsidiaries were up 10.8 percent to $8.926 billion for 2014 versus $8.056 billion for 2013.
Net sales in the Paint Stores Group in 2014 increased primarily due to higher architectural paint sales volume across all end market segments and acquisitions. Acquisitions increased net sales 4.5 percent for the year. Net sales from stores open for more than twelve calendar months increased 8.8 percent for the


35

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 

full year. During 2014, the Paint Stores Group opened 109 new stores and closed 14 redundant locations for a net increase of 95 stores, increasing the total number of stores in operation at December 31, 2014 to 4,003 in the United States, Canada and the Caribbean. The Paint Stores Group’s objective is to expand its store base an average of three percent each year, primarily through internal growth. Sales of products other than paint increased approximately 13.7 percent for the year over 2013. A discussion of changes in volume versus pricing for sales of products other than paint is not pertinent due to the wide assortment of general merchandise sold.
Net sales of the Consumer Group increased due primarily to acquisitions and higher volume sales to most of the Group's retail customers. Acquisitions increased net sales 3.4 percent compared to 2013. Sales of wood care coatings, brushes, rollers, caulk and other paint related products, excluding acquisitions, were all up at least mid to high-single digits as compared to 2013 while sales of aerosol products were down slightly. A discussion of changes in volume versus pricing for sales of products other than paint is not pertinent due to the wide assortment of paint-related merchandise sold. In December 2014, the Consumer Group announced a new agreement to sell architectural paint under the HGTV HOME® by Sherwin-Williams brand through a large U.S. national retailer's stores network.
The Global Finishes Group’s net sales in 2014, when stated in U.S. dollars, increased due primarily to selling price increases and higher paint sales volume partially offset by unfavorable currency translation rate changes. Paint sales volume percentage increased in the low-single digits as compared to 2013. Unfavorable currency translation rate changes in the year decreased net sales by 1.6 percent for 2014. In 2014, the Global Finishes Group opened 1 new branch and closed 1 location to remain flat at 300 branches open in the United States, Canada, Mexico, South America, Europe and Asia at year-end.
The Latin America Coatings Group’s net sales in 2014, when stated in U.S. dollars, decreased due primarily to unfavorable currency translation rate changes partially offset by selling price increases. Paint sales volume percentage decreased in the low-single digits as compared to 2013. Unfavorable currency translation rate changes in the year decreased net sales by 12.3 percent for 2014. In 2014, the Latin America Coatings Group opened 3 new stores and closed 9 locations for a net decrease of 6 stores, decreasing the total to 276 stores open in North and South America at year-end.
Net sales in the Administrative segment, which primarily consist of external leasing revenue of excess headquarters space and leasing of facilities no longer used by the Company in its primary business, increased by an insignificant amount in 2014.
 
Consolidated gross profit increased $547.9 million in 2014 and improved as a percent to net sales to 46.4 percent from 45.3 percent in 2013 due primarily to higher paint sales volume partially offset by dilution from acquisitions and unfavorable currency translation rate changes. Further improving the gross profit comparable results were the 2014 TiO2 settlement of $21.4 million received by the Company in the fourth quarter of 2014, recorded primarily in the Paint Stores Group, and charges relating to the Brazil government tax assessments in 2013. The Paint Stores Group’s gross profit for 2014 increased $486.1 million compared to 2013 due primarily to higher paint sales volume and acquisitions and increased as a percent of sales due primarily to higher paint sales volume partially offset by acquisitions. Acquisitions increased Paint Stores Group's gross profits by $107.1 million, or 39.9 percent of acquisition net sales. The Consumer Group’s gross profit increased $32.7 million due primarily to increased production volume and improved operating efficiencies and was flat as a percent of sales for 2014 compared to 2013 due to dilution from acquisitions. Acquisitions increased Consumer Group's gross profits by $15.3 million, or 33.6 percent of acquisition net sales. The Global Finishes Group’s gross profit for 2014 increased $35.4 million due primarily to selling price increases and improved operating efficiencies partially offset by unfavorable currency translation rate changes. The Global Finishes Group’s gross profit increased as a percent of sales due primarily to selling price increases and improved operating efficiencies partially offset by unfavorable currency translation rate changes. Foreign currency translation rate fluctuations decreased Global Finishes Group’s gross profit by $11.8 million for 2014. The Latin America Coatings Group’s gross profit for 2014 increased $0.6 million and increased as a percent of sales. Charges of $28.7 million recorded during 2013 reduced gross profit related to the Brazil government tax assessments for 2013. Unfavorable currency translation rate changes and lower volume sales were only partially offset by selling price increases in 2014 compared to 2013. Foreign currency translation rate fluctuations decreased gross profit by $30.6 million for 2014. The Administrative segment’s gross profit decreased by $6.9 million.
SG&A increased by $355.3 million due primarily to increased expenses to support higher sales levels in nearly all Reportable Segments and acquisitions. Acquisitions added $156.8 million of SG&A in 2014, representing 49.6 percent of acquisition net sales. SG&A increased as a percent of sales to 34.3 percent in 2014 from 34.0 percent in 2013 primarily due to acquisitions. In the Paint Stores Group, SG&A increased $278.3 million for the year due primarily to increased spending due to the number of new store openings and increased expenses to maintain customer service and acquisitions SG&A, including integration costs, of


36 

 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

$140.5 million, or 52.4 percent of acquisition net sales. The Consumer Group’s SG&A increased by $22.4 million for the year due to increased sales levels and acquisitions SG&A of $14.9 million, or 32.6 percent of acquisition net sales. The Global Finishes Group’s SG&A increased by $13.9 million for the year relating primarily to increased sales levels partially offset by foreign currency translation rate fluctuations reducing SG&A by $9.9 million. The Latin America Coatings Group’s SG&A decreased by $4.5 million for the year relating primarily to foreign currency translation rate fluctuations of $18.7 million partially offset by increased expenses in local currencies due to high inflation and increased information systems costs. The Administrative segment’s SG&A increased $45.3 million primarily due to acquisition integration efforts, information systems costs and incentive compensation, including stock-based compensation expense.
Other general expense - net increased $35.0 million in 2014 compared to 2013. The increase was mainly caused by an increase of $35.5 million of expense in the Administrative segment, primarily due to a year-over-year increase in provisions for environmental matters of $38.8 million partially offset by decreased loss on sale or disposal of assets of $3.8 million. See Note 13, on pages 68 and 69 of this report, for more information concerning Other general expense - net.
As required by the Goodwill and Other Intangibles Topic of the ASC, management performed an annual impairment test of goodwill and indefinite-lived intangible assets as of October 1, 2014. The impairment tests in 2014 and 2013 resulted in no impairment of goodwill and trademarks. See Note 4, on pages 50 and 51 of this report, for more information concerning the impairment of intangible assets.
Interest expense, included in the Administrative segment, increased $1.5 million in 2014 versus 2013 due primarily to higher average debt levels partially offset by a one-time interest expense charge of $3.4 million from early retirement of debt during the fourth quarter of 2013.
Other (income) expense - net increased to $15.4 million income from $0.9 million expense in 2013. This was primarily due to a $6.3 million gain on the early termination of a customer agreement recorded in the Global Finishes Group and a $6.2
 
million realized gain resulting from final asset valuations related to the acquisition of the U.S./Canada business of Comex recorded in the Administrative segment. Additionally, foreign currency related transaction losses of $3.6 million in 2014 versus foreign currency related transaction losses of $7.7 million in 2013, primarily in the Global Finishes and Latin America Coatings Groups, were favorable comparisons. See Note 13, on page 69 of this report, for more information concerning Other (income) expense - net.
Consolidated Income before income taxes in 2014 increased $172.3 million due primarily to an increase of $547.9 million in gross profit partially offset by an increase of $355.3 million in SG&A and an increase of $20.4 million in interest expense, interest and net investment income and other expenses. Income before income taxes increased $210.9 million in the Paint Stores Group, $30.5 million in the Global Finishes Group $10.8 million in the Consumer Group and $1.8 million in the Latin America Coatings Group when compared to 2013. The Administrative segment had an unfavorable impact on Income before income taxes of $81.8 million when compared to 2013. Segment profit of all consolidated foreign subsidiaries increased 8.9 percent to $115.6 million for 2014 versus $106.2 million for 2013 due primarily to increase in gross profit of $56.7 million, which included charges in 2013 to Cost of goods sold due to the Brazil government tax assessments, partially offset by an increase in SG&A of $41.3 million and increased Other expense - net of $5.3 million. Segment profit of all operations other than consolidated foreign subsidiaries increased 16.6 percent to $1.143 billion for 2014 versus $979.8 million for 2013.
Net income increased $113.3 million in 2014 due to the increase in Income before income taxes.
The effective income tax rate for 2014 was 31.2 percent. The effective income tax rate for 2013 was 30.7 percent. Diluted net income per common share increased 20.9 percent to $8.78 per share for 2014, which included charges of $.22 per share related to environmental provisions and an $.18 per share loss from acquisitions partially offset by an increase of $.13 per share related to the 2014 TiO2 settlement, from $7.26 per share a year ago, which included charges of $.21 per share relating to Brazil government tax assessments.


37


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, 2015, 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, 2015, 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, 2015 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 39 of this report.

J. G. Morikis
President and Chief Executive Officer


S. P. Hennessy
Senior Vice President - Finance and Chief Financial Officer


A. J. Mistysyn
Senior Vice President - Corporate Controller

38 


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The Board of Directors and Shareholders of The Sherwin-Williams Company
We have audited The Sherwin-Williams Company’s internal control over financial reporting as of December 31, 2015, 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). The Sherwin-Williams 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 conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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.
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.
In our opinion, The Sherwin-Williams Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of The Sherwin-Williams Company as of December 31, 2015, 2014 and 2013, and the related consolidated statements of income and comprehensive income, cash flows and shareholders’ equity for each of the three years in the period ended December 31, 2015 and our report dated February 24, 2016 expressed an unqualified opinion thereon.







Cleveland, Ohio
February 24, 2016

39


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, 2015, 2014 and 2013 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 38 of this report, we concluded that the Company’s internal control over financial reporting was effective as of December 31, 2015.
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
President and Chief Executive Officer


S. P. Hennessy
Senior Vice President - Finance and Chief Financial Officer

A. J. Mistysyn
Senior Vice President - Corporate Controller

40 


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON THE CONSOLIDATED FINANCIAL STATEMENTS


The Board of Directors and Shareholders of The Sherwin-Williams Company
We have audited the accompanying consolidated balance sheets of The Sherwin-Williams Company as of December 31, 2015, 2014 and 2013, and the related consolidated statements of income and comprehensive income, cash flows and shareholders’ equity for each of the three years in the period ended December 31, 2015. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Sherwin-Williams Company at December 31, 2015, 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2015, 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, 2015, 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 24, 2016 expressed an unqualified opinion thereon.




Cleveland, Ohio
February 24, 2016
 


41

STATEMENTS OF CONSOLIDATED INCOME AND COMPREHENSIVE INCOME
(thousands of dollars except per common share data)

 
Year Ended December 31,
 
2015
 
2014
 
2013
 
 
 
 
 
 
Net sales
$
11,339,304

 
$
11,129,533

 
$
10,185,532

Cost of goods sold
5,780,078

 
5,965,049

 
5,568,966

 
 
 
 
 
 
Gross profit
5,559,226

 
5,164,484

 
4,616,566

Percent to net sales
49.0
%
 
46.4
%
 
45.3
%
 
 
 
 
 
 
Selling, general and administrative expenses
3,913,518

 
3,822,966

 
3,467,681

Percent to net sales
34.5
%
 
34.3
%
 
34.0
%
 
 
 
 
 
 
Other general expense - net
30,268

 
37,482

 
2,519

Interest expense
61,791

 
64,205

 
62,714

Interest and net investment income
(1,399
)
 
(2,995
)
 
(3,242
)
Other expense (income) - net
6,082

 
(15,400
)
 
936

 
 
 
 
 
 
Income before income taxes
1,548,966

 
1,258,226

 
1,085,958

Income taxes
495,117

 
392,339

 
333,397

 
 
 
 
 
 
Net income
$
1,053,849

 
$
865,887

 
$
752,561

 
 
 
 
 
 
Net income per common share:
 
 
 
 
 
Basic
$
11.38

 
$
8.95

 
$
7.41

Diluted
$
11.16

 
$
8.78

 
$
7.26



 
Year Ended December 31,
 
2015
 
2014
 
2013
 
 
 
 
 
 
Net income
$
1,053,849

 
$
865,887

 
$
752,561

 
 
 
 
 
 
Other comprehensive (loss) income, net of tax:
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
(128,245
)
 
(103,441
)
 
(46,748
)
 
 
 
 
 
 
Employee benefit plans:
 
 
 
 
 
Net actuarial gains (losses) and prior service costs
 
 
 
 
 
arising during period (1)
7,974

 
(56,536
)
 
85,051

Less: amortization of net actuarial losses and
 
 
 
 
 
prior service costs included in Net pension costs (2)
5,847

 
8,980

 
10,933

 
13,821

 
(47,556
)
 
95,984

 
 
 
 
 
 
Unrealized net (losses) gains on available-for-sale securities:
 
 
 
 
 
Unrealized holding (losses) gains
 
 
 
 
 
arising during period (3)
(1,191
)
 
366

 
134

Less: reclassification adjustments for losses (gains)
 
 
 
 
 
included in net income (4)
478

 
(283
)
 
(25
)
 
(713
)
 
83

 
109

 
 
 
 
 
 
Other comprehensive (loss) income
(115,137
)
 
(150,914
)
 
49,345

 
 
 
 
 
 
Comprehensive income
$
938,712

 
$
714,973

 
$
801,906

(1) Net of taxes of $(3,399), $24,954 and $(63,343), in 2015, 2014 and 2013, respectively.
(2) Net of taxes of $(1,647), $(2,712) and $(7,643), in 2015, 2014 and 2013, respectively.
(3) Net of taxes of $736, $(228) and $(84), in 2015, 2014 and 2013, respectively.
(4) Net of taxes of $(296), $178 and $17 in 2015, 2014 and 2013, respectively.

See notes to consolidated financial statements.

42 

CONSOLIDATED BALANCE SHEETS
(thousands of dollars)

 
December 31,
 
2015
 
2014
 
2013
Assets
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and cash equivalents
$
205,744

 
$
40,732

 
$
744,889

Accounts receivable, less allowance
1,114,275

 
1,130,565

 
1,097,751

Inventories:
 
 
 
 
 
Finished goods
840,603

 
841,784

 
779,057

Work in process and raw materials
177,927

 
191,743

 
191,758

 
1,018,530

 
1,033,527

 
970,815

Deferred income taxes
87,883

 
109,087

 
104,496

Other current assets
232,442

 
252,869

 
240,766

Total current assets
2,658,874

 
2,566,780

 
3,158,717

 
 
 
 
 
 
Goodwill
1,143,333

 
1,158,346

 
1,178,687

Intangible assets
255,371

 
289,127

 
313,299

Deferred pension assets
244,882

 
250,144

 
302,446

Other assets
447,533

 
420,625

 
407,975

Property, plant and equipment:
 
 
 
 
 
Land
119,530

 
125,691

 
125,131

Buildings
696,202

 
698,202

 
715,096

Machinery and equipment
2,026,617

 
1,952,037

 
1,838,590

Construction in progress
81,082

 
59,330

 
62,563

 
2,923,431

 
2,835,260

 
2,741,380

Less allowances for depreciation
1,881,569

 
1,814,230

 
1,719,997

 
1,041,862

 
1,021,030

 
1,021,383

Total Assets
$
5,791,855

 
$
5,706,052

 
$
6,382,507

 
 
 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Short-term borrowings
$
39,462

 
$
679,436

 
$
96,551

Accounts payable
1,157,561

 
1,042,182

 
998,484

Compensation and taxes withheld
338,256

 
360,458

 
337,637

Accrued taxes
81,146

 
86,744

 
79,504

Current portion of long-term debt
3,154

 
3,265

 
502,948

Other accruals
522,280

 
508,581

 
513,433

Total current liabilities
2,141,859

 
2,680,666

 
2,528,557

 
 
 
 
 
 
Long-term debt
1,920,196

 
1,122,715

 
1,122,373

Postretirement benefits other than pensions
248,523

 
277,892

 
268,874

Other long-term liabilities
613,367

 
628,309

 
688,168

 
 
 
 
 
 
Shareholders’ equity:
 
 
 
 
 
Common stock - $1.00 par value:
 
 
 
 
 
92,246,525, 94,704,173 and 100,129,380 shares outstanding
 
 
 
 
 
at December 31, 2015, 2014 and 2013, respectively
115,761

 
114,525

 
112,902

Preferred stock - convertible, no par value:
 
 
 
 
 
    40,406 shares outstanding at December 31, 2013
 
 
 
 
40,406

Unearned ESOP compensation
 
 
 
 
(40,406
)
Other capital
2,330,426

 
2,079,639

 
1,847,801

Retained earnings
3,228,876

 
2,424,674

 
1,774,050

Treasury stock, at cost
(4,220,058
)
 
(3,150,410
)
 
(1,639,174
)
Cumulative other comprehensive loss
(587,095
)
 
(471,958
)
 
(321,044
)
Total shareholders’ equity
867,910

 
996,470

 
1,774,535

 
 
 
 
 
 
Total Liabilities and Shareholders’ Equity
$
5,791,855

 
$
5,706,052

 
$
6,382,507

See notes to consolidated financial statements.

43

STATEMENTS OF CONSOLIDATED CASH FLOWS
(thousands of dollars)

 
Year Ended December 31,
Operating Activities
2015
 
2014
 
2013
Net income
$
1,053,849

 
$
865,887

 
$
752,561

Adjustments to reconcile net income to net operating cash:
 
 
 
 
 
Depreciation
170,323

 
169,087

 
158,763

Amortization of intangible assets
28,239

 
29,858

 
29,031

Provisions for environmental-related matters
31,071

 
36,046

 
(2,751
)
Provisions for qualified exit costs
9,761

 
13,578

 
4,682

Deferred income taxes
4,976

 
(19,038
)
 
27,775

Defined benefit pension plans net cost
6,491

 
990

 
20,641

Stock-based compensation expense
72,342

 
64,735

 
58,004

Net (decrease) increase in postretirement liability
(6,645
)
 
(718
)
 
5,233

Decrease in non-traded investments
65,144

 
63,365

 
57,261

(Gain) loss on disposition of assets
(803
)
 
1,436

 
5,207

Other
6,711

 
203

 
(27,214
)
Change in working capital accounts:
 
 
 
 
 
(Increase) in accounts receivable
(56,873
)
 
(80,252
)
 
(41,473
)
(Increase) decrease in inventories
(40,733
)
 
(101,112
)
 
25,031

Increase in accounts payable
160,111

 
78,603

 
34,685

Increase in accrued taxes
4,606

 
13,187

 
11,314

(Decrease) increase in accrued compensation and taxes withheld
(13,128
)
 
29,513

 
24,435

Increase (decrease) in refundable income taxes
19,230

 
(36,601
)
 
13,244

DOL settlement accrual
 
 
 
 
(80,000
)
Other
(955
)
 
(20,029
)
 
43,804

Costs incurred for environmental-related matters
(11,995
)
 
(9,676
)
 
(12,539
)
Costs incurred for qualified exit costs
(11,200
)
 
(10,882
)
 
(7,419
)
Other
(43,059
)
 
(6,652
)
 
(16,509
)
Net operating cash
1,447,463

 
1,081,528

 
1,083,766

 
 
 
 
 
 
Investing Activities
 
 
 
 
 
Capital expenditures
(234,340
)
 
(200,545
)
 
(166,680
)
Acquisitions of businesses, net of cash acquired
 
 
 
 
(79,940
)
Proceeds from sale of assets
11,300

 
1,516

 
3,045

Increase in other investments
(65,593
)
 
(111,021
)
 
(94,739
)
Net investing cash
(288,633
)
 
(310,050
)
 
(338,314
)
 
 
 
 
 
 
Financing Activities
 
 
 
 
 
Net (decrease) increase in short-term borrowings
(630,226
)
 
591,423

 
31,634

Proceeds from long-term debt
797,514

 
1,474

 
473

Payments of long-term debt
 
 
(500,661
)
 
(10,932
)
Payments of cash dividends
(249,647
)
 
(215,263
)
 
(204,978
)
Proceeds from stock options exercised
89,990

 
100,069

 
69,761

Income tax effect of stock-based compensation exercises and vesting
89,691

 
68,657

 
47,527

Treasury stock purchased
(1,035,291
)
 
(1,488,663
)
 
(769,271
)
Other
(42,384
)
 
(24,111
)
 
(17,522
)
Net financing cash
(980,353
)
 
(1,467,075
)
 
(853,308
)
Effect of exchange rate changes on cash
(13,465
)
 
(8,560
)
 
(9,845
)
Net increase (decrease) in cash and cash equivalents
165,012

 
(704,157
)
 
(117,701
)
Cash and cash equivalents at beginning of year
40,732

 
744,889

 
862,590

Cash and cash equivalents at end of year
$
205,744

 
$
40,732

 
$
744,889

Taxes paid on income
$
335,119

 
$
310,039

 
$
200,748

Interest paid on debt
48,644

 
67,306

 
61,045


See notes to consolidated financial statements.

44 

STATEMENTS OF CONSOLIDATED SHAREHOLDERS’ EQUITY
(thousands of dollars except per common share data)



 
Common
Stock
 
Preferred
Stock
 
Unearned
ESOP
Compen-sation
 
Other
Capital
 
Retained
Earnings
 
Treasury
Stock
 
Cumulative
Other
Comprehensive
Loss
 
Total
Balance at January 1, 2013
$
111,623

 
$
101,086

 
$
(101,086
)
 
$
1,673,788

 
$
1,226,467

 
$
(849,685
)
 
$
(370,389
)
 
$
1,791,804

Net income
 
 
 
 
 
 
 
 
752,561

 
 
 
 
 
752,561

Other comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
49,345

 
49,345

Treasury stock purchased
 
 
 
 
 
 
 
 
 
 
(769,271
)
 
 
 
(769,271
)
Redemption of preferred stock
 
 
(60,680
)
 
60,680

 
 
 
 
 
 
 
 
 


Stock options exercised
1,128

 
 
 
 
 
68,633

 
 
 
(20,218
)
 
 
 
49,543

Income tax effect of stock compensation
 
 
 
 
 
 
47,527

 
 
 
 
 
 
 
47,527

Restricted stock and stock option grants
(net activity)
151

 
 
 
 
 
57,853

 
 
 
 
 
 
 
58,004

Cash dividends -- $2.00 per common share
 
 
 
 
 
 
 
 
(204,978
)
 
 
 
 
 
(204,978
)
Balance at December 31, 2013
112,902

 
40,406

 
(40,406
)
 
1,847,801

 
1,774,050

 
(1,639,174
)
 
(321,044
)
 
1,774,535

Net income
 
 
 
 
 
 
 
 
865,887

 
 
 
 
 
865,887

Other comprehensive loss
 
 
 
 
 
 
 
 
 
 
 
 
(150,914
)
 
(150,914
)
Treasury stock purchased
 
 
 
 
 
 
 
 
 
 
(1,488,663
)
 
 
 
(1,488,663
)
Redemption of preferred stock
 
 
(40,406
)
 
40,406

 
 
 
 
 
 
 
 
 


Stock options exercised
1,423

 
 
 
 
 
98,646

 
 
 
(22,573
)
 
 
 
77,496

Income tax effect of stock compensation
 
 
 
 
 
 
68,657

 
 
 
 
 
 
 
68,657

Restricted stock and stock option grants
(net activity)
200

 
 
 
 
 
64,535

 
 
 
 
 
 
 
64,735

Cash dividends -- $2.20 per common share
 
 
 
 
 
 
 
 
(215,263
)
 
 
 
 
 
(215,263
)
Balance at December 31, 2014
114,525

 

 

 
2,079,639

 
2,424,674

 
(3,150,410
)
 
(471,958
)
 
996,470

Net income
 
 
 
 
 
 
 
 
1,053,849

 
 
 
 
 
1,053,849

Other comprehensive loss
 
 
 
 
 
 
 
 
 
 
 
 
(115,137
)
 
(115,137
)
Treasury stock purchased
 
 
 
 
 
 
 
 
 
 
(1,035,291
)
 
 
 
(1,035,291
)
Stock options exercised
1,134

 
 
 
 
 
88,856

 
 
 
(34,357
)
 
 
 
55,633

Income tax effect of stock compensation
 
 
 
 
 
 
89,691

 
 
 
 
 
 
 
89,691

Restricted stock and stock option grants
(net activity)
102

 
 
 
 
 
72,240

 
 
 
 
 
 
 
72,342

Cash dividends -- $2.68 per common share
 
 
 
 
 
 
 
 
(249,647
)