10-Q 1 shw-2017630_10q.htm 10-Q Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
 
FORM 10-Q
 
(Mark One)
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the Period Ended June 30, 2017
or
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the transition period from              to             
Commission file number 1-04851
 
THE SHERWIN-WILLIAMS COMPANY
(Exact name of registrant as specified in its charter)
 
OHIO
34-0526850
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
101 West Prospect Avenue,
Cleveland, Ohio
44115-1075
(Address of principal executive offices)
(Zip Code)
(216) 566-2000
(Registrant’s telephone number including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one:)
Large accelerated filer
x
 
Accelerated filer
o
 
 
 
 
 
Non-accelerated filer
o
(Do not check if a smaller reporting company)
Smaller reporting company
o
 
 
 
 
 
Emerging growth company
o
 
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

Common Stock, $1.00 Par Value – 93,410,169 shares as of June 30, 2017.




TABLE OF CONTENTS
 
 
 
 
 
 
 
EX-4.1
 
EX-4.2
 
EX-4.3
 
EX-4.4
 
EX-4.5
 
EX-4.6
 
EX-4.7
 
EX-4.8
 
EX-4.9
 
EX-4.10
 
EX-4.11
 
EX-4.12
 
EX-10.1
 
EX-10.2
 
EX-10.3
 
EX-31(a)
 
EX-31(b)
 
EX-32(a)
 
EX-32(b)
 
EX-101 INSTANCE DOCUMENT
 
EX-101 SCHEMA DOCUMENT
 
EX-101 PRESENTATION LINKBASE DOCUMENT
 
EX-101 CALCULATION LINKBASE DOCUMENT
 
EX-101 LABEL LINKBASE DOCUMENT
 
EX-101 DEFINITION LINKBASE DOCUMENT
 









PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
THE SHERWIN-WILLIAMS COMPANY AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME AND COMPREHENSIVE INCOME (UNAUDITED)
Thousands of dollars, except per share data
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2017
 
2016
 
2017
 
2016
Net sales
$
3,735,817

 
$
3,219,525

 
$
6,497,204

 
$
5,793,549

Cost of goods sold
1,998,761

 
1,583,624

 
3,416,874

 
2,895,803

Gross profit
1,737,056

 
1,635,901

 
3,080,330

 
2,897,746

Percent to net sales
46.5
%
 
50.8
%
 
47.4
%
 
50.0
%
Selling, general and administrative expenses
1,145,492

 
1,048,496

 
2,155,667

 
2,045,169

Percent to net sales
30.7
%
 
32.6
%
 
33.2
%
 
35.3
%
Other general expense - net
1,775

 
2,733

 
2,051

 
20,287

Amortization
28,918

 
5,584

 
35,088

 
11,366

Interest expense
56,729

 
40,878

 
82,424

 
66,610

Interest and net investment income
(3,091
)
 
(952
)
 
(4,371
)
 
(1,439
)
Other (income) expense - net
(1,770
)
 
(52
)
 
(6,137
)
 
174

Income from continuing operations before income taxes
509,003

 
539,214

 
815,608

 
755,579

Income taxes
148,352

 
161,150

 
215,805

 
212,639

Net income from continuing operations
360,651

 
378,064

 
599,803

 
542,940

 
 
 
 
 
 
 
 
Loss from discontinued operations (see Note 3)


 
 
 


 
 
Income taxes
41,540

 
 
 
41,540

 
 
Net loss from discontinued operations
(41,540
)
 

 
(41,540
)
 

 
 
 
 
 
 
 
 
Net income
$
319,111

 
$
378,064

 
$
558,263

 
$
542,940

 
 
 
 
 
 
 
 
Basic net income per common share
 
 
 
 
 
 
 
Continuing operations
$
3.89

 
$
4.12

 
$
6.47

 
$
5.93

Discontinued operations
(.45
)
 
 
 
(.45
)
 
 
Net income per common share
$
3.44

 
$
4.12

 
$
6.02

 
$
5.93

 
 
 
 
 
 
 
 
Diluted net income per common share
 
 
 
 
 
 
 
Continuing operations
$
3.80

 
$
3.99

 
$
6.34

 
$
5.76

Discontinued operations
(.44
)
 
 
 
(.44
)
 
 
Net income per common share
$
3.36

 
$
3.99

 
$
5.90

 
$
5.76

 
 
 
 
 
 
 
 
Average shares outstanding - basic
92,841,148

 
91,788,734

 
92,695,853

 
91,632,297

Average shares and equivalents outstanding - diluted
94,968,636

 
94,669,751

 
94,697,439

 
94,305,997

Comprehensive income
$
349,288

 
$
284,060

 
$
579,378

 
$
467,946

See notes to condensed consolidated financial statements.

2



THE SHERWIN-WILLIAMS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Thousands of dollars
 
June 30,
2017
 
December 31,
2016
 
June 30,
2016
Assets
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and cash equivalents
$
210,049

 
$
889,793

 
$
402,656

Accounts receivable, less allowance
2,377,874

 
1,230,987

 
1,473,078

Inventories:
 
 
 
 
 
Finished goods
1,468,671

 
898,627

 
975,366

Work in process and raw materials
386,266

 
169,699

 
176,866

 
1,854,937

 
1,068,326

 
1,152,232

Deferred income taxes
 
 
57,162

 
155,407

Other current assets
411,141

 
381,030

 
300,569

Total current assets
4,854,001

 
3,627,298

 
3,483,942

Goodwill
7,178,113

 
1,126,892

 
1,144,700

Intangible assets
6,002,534

 
255,010

 
247,070

Deferred pension assets
224,695

 
225,529

 
246,090

Other assets
568,138

 
421,904

 
471,618

Property, plant and equipment:
 
 
 
 
 
Land
259,415

 
115,555

 
119,608

Buildings
961,870

 
714,815

 
708,573

Machinery and equipment
2,595,633

 
2,153,437

 
2,109,786

Construction in progress
134,518

 
117,126

 
100,508

 
3,951,436

 
3,100,933

 
3,038,475

Less allowances for depreciation
2,061,519

 
2,005,045

 
1,966,218

 
1,889,917

 
1,095,888

 
1,072,257

Total Assets
$
20,717,398

 
$
6,752,521

 
$
6,665,677

 
 
 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Short-term borrowings
$
51,904

 
$
40,739

 
$
59,203

Accounts payable
1,783,648

 
1,034,608

 
1,289,406

Compensation and taxes withheld
395,867

 
398,045

 
311,111

Accrued taxes
320,890

 
76,765

 
230,294

Current portion of long-term debt
701,101

 
700,475

 
2,179

Other accruals
898,503

 
578,547

 
733,020

Total current liabilities
4,151,913

 
2,829,179

 
2,625,213

Long-term debt
10,751,284

 
1,211,326

 
1,909,217

Postretirement benefits other than pensions
253,434

 
250,397

 
251,812

Deferred income taxes
2,467,348

 
73,833

 
131,447

Other long-term liabilities
702,159

 
509,345

 
501,359

Shareholders’ equity:
 
 
 
 
 
Common stock—$1.00 par value:
 
 
 
 
 
93,410,169, 93,013,031 and 92,221,707 shares outstanding
 
 
 
 
 
at June 30, 2017, December 31, 2016 and June 30, 2016, respectively
117,071

 
116,563

 
116,259

Other capital
2,606,757

 
2,488,564

 
2,412,599

Retained earnings
4,448,788

 
4,049,497

 
3,616,095

Treasury stock, at cost
(4,262,120
)
 
(4,235,832
)
 
(4,236,235
)
Cumulative other comprehensive loss
(519,236
)
 
(540,351
)
 
(662,089
)
Total shareholders' equity
2,391,260

 
1,878,441

 
1,246,629

Total Liabilities and Shareholders’ Equity
$
20,717,398

 
$
6,752,521

 
$
6,665,677


See notes to condensed consolidated financial statements.

3



THE SHERWIN-WILLIAMS COMPANY AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS (UNAUDITED)
Thousands of dollars
 
Six Months Ended
 
June 30,
2017
 
June 30,
2016
OPERATING ACTIVITIES
 
 
 
Net income
$
558,263

 
$
542,940

Adjustments to reconcile net income to net operating cash:
 
 
 
Loss from discontinued operations
41,540

 
 
Depreciation
94,965

 
86,724

Amortization of intangible assets
35,088

 
11,366

Amortization of inventory step-up
36,278

 
 
Stock-based compensation expense
35,866

 
31,948

Amortization of credit facility and debt issuance costs
2,940

 
25,691

Provisions for qualified exit costs
12,828

 
1,422

Provisions for environmental-related matters
1,629

 
20,536

Defined benefit pension plans net cost
10,554

 
9,948

Net change in postretirement liability
(7,422
)
 
961

Other
(7,598
)
 
1,833

Change in working capital accounts - net
(239,495
)
 
(211,572
)
Costs incurred for environmental-related matters
(6,059
)
 
(6,716
)
Costs incurred for qualified exit costs
(8,904
)
 
(4,155
)
Other
25,660

 
(943
)
Net operating cash
586,133

 
509,983

 
 
 
 
INVESTING ACTIVITIES
 
 
 
Capital expenditures
(83,635
)
 
(114,081
)
Acquisitions of businesses, net of cash acquired and divestiture (see Note 3)
(8,806,282
)
 
 
Proceeds from sale of assets
37,131

 
2,039

Increase in other investments
(11,444
)
 
(36,950
)
Net investing cash
(8,864,230
)
 
(148,992
)
 
 
 
 
FINANCING ACTIVITIES
 
 
 
Net (decrease) increase in short-term borrowings
(228,785
)
 
15,318

Proceeds from long-term debt
7,984,375

 
 
Payments of long-term debt
(176
)
 
(84
)
Payments for credit facility and debt issuance costs
(45,454
)
 
(61,433
)
Payments of cash dividends
(158,934
)
 
(155,721
)
Proceeds from stock options exercised
79,157

 
43,708

Other
(26,420
)
 
(12,645
)
Net financing cash
7,603,763

 
(170,857
)
 
 
 
 
Effect of exchange rate changes on cash
(5,410
)
 
6,778

Net (decrease) increase in cash and cash equivalents
(679,744
)
 
196,912

Cash and cash equivalents at beginning of year
889,793

 
205,744

Cash and cash equivalents at end of period
$
210,049

 
$
402,656

 
 
 
 
Income taxes paid
$
121,115

 
$
73,636

Interest paid
31,816

 
66,583


See notes to condensed consolidated financial statements.

4



THE SHERWIN-WILLIAMS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Periods ended June 30, 2017 and 2016
NOTE 1—BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.
There have been no significant changes in critical accounting policies since December 31, 2016. Accounting estimates were revised as necessary during the first six months of 2017 based on new information and changes in facts and circumstances. Certain amounts in the 2016 condensed consolidated financial statements have been reclassified to conform to the 2017 presentation. See Note 14 for information on the changes in the Company's reportable segments.
The Company primarily uses the last-in, first-out (LIFO) method of valuing inventory. An actual valuation of inventory under the LIFO method can be made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations are based on management’s estimates of expected year-end inventory levels and costs are subject to the final year-end LIFO inventory valuation. In addition, interim inventory levels include management’s estimates of annual inventory losses due to shrinkage and other factors. The final year-end valuation of inventory is based on a cycle count program or an annual physical inventory count performed during the third and fourth quarters. For further information on inventory valuations and other matters, refer to the consolidated financial statements and footnotes thereto included in the Company’s Form 10-K for the year ended December 31, 2016.
The consolidated results for the three and six months ended June 30, 2017 are not necessarily indicative of the results to be expected for the year ending December 31, 2017.
NOTE 2—IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2017, the Company adopted the Accounting Standard Update (ASU) No. 2015-17, "Balance Sheet Classification of Deferred Taxes," which eliminates the requirement for separate presentation of current and non-current portions of deferred tax. Subsequent to adoption, all deferred tax assets and deferred tax liabilities are presented as non-current on the balance sheet. The changes have been applied prospectively as permitted by the ASU and prior years have not been restated. The adoption of this ASU does not have a material effect on the Company's results of operations, financial condition or liquidity.
In March 2017, the Financial Accounting Standards Board (FASB) issued ASU No. 2017-07, "Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Costs." The standard requires the service component of pension and other postretirement benefit expense to be presented in the same income statement lines as other employee compensation costs, however, the other components will be presented outside of operating income. In addition, only the service cost component will be eligible for capitalization in assets. The standard is effective starting in 2018, with early adoption permitted. Retrospective application is required for the guidance on the income statement presentation. Prospective application is required for the guidance on the cost capitalization in assets. The Company is in the process of evaluating the impact of the standard.
In January 2017, the FASB issued ASU No. 2017-04, “Simplifying the Test for Goodwill Impairment.” This standard simplifies the accounting for goodwill impairment by eliminating the Step 2 requirement to calculate the implied fair value of goodwill. Instead, if a reporting unit's carrying amount exceeds its fair value, an impairment charge will be recorded based on that difference. The impairment charge will be limited to the amount of goodwill allocated to that reporting unit. The standard will be applied prospectively and is effective for impairment tests performed after December 15, 2019, with early adoption permitted. The standard is not expected to have a material effect on the Company's results of operations, financial condition or liquidity.
In February 2016, the FASB issued ASU No. 2016-02, “Leases,” which consists of a comprehensive lease accounting standard. Under the new standard, assets and liabilities arising from most leases will be recognized on the balance sheet. Leases will be classified as either operating or financing, and the lease classification will determine whether expense is recognized on a straight line basis (operating leases) or based on an effective interest method (financing leases). The new standard is effective for interim and annual periods starting in 2019. A modified retrospective transition approach is required with certain practical

5



expedients available.  The Company has made significant progress with its assessment process, and anticipates this standard will have a material impact on its consolidated balance sheet. While the Company continues to assess all potential impacts of the standard, it currently believes the most significant impact relates to recording lease assets and related liabilities on the balance sheet for its retail operations in The Americas Group.
In January 2016, the FASB issued ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities,” which amends the guidance for certain aspects of recognition, measurement and disclosure of financial instruments. The standard is effective for interim and annual periods starting in 2018, and early adoption is not permitted. Although the Company continues to assess the potential impacts of the standard, it currently believes that the main impact will be that changes in fair value of marketable securities currently classified as available-for-sale will be recognized in earnings rather than in other comprehensive income. The standard is not expected to have a material effect on the Company's results of operations, financial condition or liquidity.
In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers," which consists of a comprehensive revenue recognition standard that will supersede nearly all existing revenue recognition guidance under U.S. GAAP. The standard is effective for interim and annual periods beginning after December 15, 2017. The Company has made significant progress with its assessment process. In addition, the Company is currently developing plans for enhancements to its information systems and internal controls in response to the new rule requirements. Although the Company previously disclosed that it planned to adopt the standard using the full retrospective method of adoption, due to the recent acquisition of The Valspar Corporation (Valspar) (see Note 3), the Company now expects to adopt the standard using the modified retrospective method. The Company is in the process of evaluating the impact on the results of operations, financial condition, liquidity and disclosures. In addition to expanded disclosures regarding revenue, this pronouncement may impact timing of recognition in some arrangements with variable consideration or contracts for the sale of goods or services.

6



NOTE 3ACQUISITIONS
On June 1, 2017, the Company completed the acquisition of Valspar at $113 per share in an all cash transaction for a total purchase price of $8.9 billion, net of divestiture proceeds of $431.0 million. As previously disclosed, on April 11, 2017, the Company and Valspar entered into a definitive agreement with Axalta Coating Systems Ltd. to divest the assets related to Valspar's North American industrial wood coatings business. The divestiture was also completed on June 1, 2017, and is reported as a discontinued operation with no pre-tax gain or loss but includes the tax expense effect of this separate transaction. Proceeds of $431.0 million were received for the divested assets sold. The divestiture resulted in a tax provision of $41.5 million, which reduced basic and diluted net income per common share for the three and six months ended June 30, 2017 by $.45 and $.44, respectively. The Valspar acquisition expands the Company's diversified array of brands and technologies, expands its global platform and adds new capabilities in its packaging and coil segments.
The preliminary allocation of the fair value of the Valspar acquisition is summarized in the table below. Allocations are based on the acquisition method of accounting and in-process third-party valuation appraisals. The allocation of the fair value will be finalized within the allowable measurement period.
(Millions of dollars)
 
 
 
Cash
$
127.8

Accounts receivable
817.5

Inventories
695.5

Indefinite-lived trademarks
1,140.0

Finite-lived intangible assets
4,629.8

Goodwill
6,067.7

Property, plant and equipment
824.8

All other assets
253.6

Accounts payable
(553.2
)
Long-term debt
(1,603.7
)
Deferred taxes
(2,461.9
)
All other liabilities
(1,003.8
)
Total
$
8,934.1

Total, net of cash
$
8,806.3

Finite-lived intangible assets include customer relationships of $3.0 billion and intellectual property and technology of $1.6 billion, which are being amortized over weighted average amortization periods ranging from 15 to 22 years. Based on the preliminary purchase accounting, goodwill of $4.6 billion and $1.5 billion was recognized in the Performance Coatings Group and the Consumer Brands Group, respectively, and relates primarily to expected synergies.
The Company's Net sales and Income from continuing operations for the three months ended June 30, 2017 include sales of $381.0 million and a profit before tax of $46.6 million related to the Valspar acquisition. Net income from continuing operations includes approximately $23.0 million of intangibles amortization expense and $36.3 million of inventory step-up amortization included in cost of sales. During the six months ended June 30, 2017 and 2016, the Company incurred transaction and integration related SG&A expense of $31.6 million and $35.6 million, respectively, and interest expense of $41.5 million and $26.6 million, respectively, related to the acquisition of Valspar.
The following pro forma information presents consolidated financial information as if Valspar had been acquired at the beginning of 2016. Pro forma adjustments have been made to exclude Valspar's North American industrial wood coatings business results and certain transaction and integration costs from all periods presented. Interest expense has been adjusted as though total debt outstanding at June 30, 2017 had been outstanding at January 1, 2016. Each quarter presented includes intangible amortization expense of approximately $68.9 million resulting from the preliminary purchase accounting. The full $108.8 million of inventory step-up amortization resulting from the preliminary purchase accounting asset step-up has been included in the first quarter of 2016 to reflect the pro forma transaction date of January 1, 2016, and thus the inventory step-up amortization of $36.3 million recorded in the second quarter of 2017 has been excluded. The unaudited pro forma consolidated financial information does not necessarily reflect the actual results that would have occurred had the acquisition taken place on January 1, 2016, nor is it it meant to be indicative of future results of operations of the combined companies under the ownership and operation of the Company.

7



(Thousands of dollars except per share data)
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2017
 
2016
 
2017
 
2016
Net sales
$
4,439,801

 
$
4,315,822

 
$
8,148,329

 
$
7,794,545

Net income from continuing operations
402,503

 
402,810

 
600,970

 
477,581

Net income per common share from
continuing operations:
 
 
 
 
 
 
 
Basic
$
4.34

 
$
4.39

 
$
6.48

 
$
5.21

Diluted
$
4.24

 
$
4.25

 
$
6.35

 
$
5.06


NOTE 4—DIVIDENDS
Dividends paid on common stock for each of the first two quarters of 2017 and 2016 were $.85 per common share and $.84 per common share, respectively.
NOTE 5—CHANGES IN CUMULATIVE OTHER COMPREHENSIVE LOSS
The following tables summarize the changes in Cumulative other comprehensive loss for the six months ended June 30, 2017 and 2016:
 
 
 
 
 
 
 
 
 
 
(Thousands of dollars)
Foreign Currency Translation Adjustments
 
Pension and Other Postretirement Benefit Adjustments
 
Unrealized Net Gains on Available-for-Sale Securities
 
Unrealized Net Gains (Losses) on Cash Flow Hedges
 
Total Cumulative Other Comprehensive (Loss) Income
Balance at December 31, 2016
$
(501,277
)
 
$
(125,096
)
 
$
1,015

 
$
85,007

 
$
(540,351
)
Amounts recognized in Other comprehensive loss (1)
51,250

 
 
 
870

 
(30,754
)
 
21,366

Amounts reclassified from Other comprehensive loss (2)


 
385

 
8

 
(644
)
 
(251
)
Net change
51,250

 
385

 
878

 
(31,398
)
 
21,115

Balance at June 30, 2017
$
(450,027
)
 
$
(124,711
)
 
$
1,893

 
$
53,609

 
$
(519,236
)

(1) Net of taxes of $(537) for unrealized net gains on available-for-sale securities and $18,895 for unrealized net losses on cash flow hedges.

(2) Net of taxes of $(195) for pension and other postretirement benefit adjustments, $(5) for realized losses on the sale of available-for-sale securities and $396 for realized gains on cash flow hedges.


8



 
 
 
 
 
 
 
 
 
 
(Thousands of dollars)
Foreign Currency Translation Adjustments
 
Pension and Other Postretirement Benefit Adjustments
 
Unrealized Net (Losses) Gains on Available-for-Sale Securities
 
Unrealized Net Losses on Cash Flow Hedges
 
Total Cumulative Other Comprehensive (Loss) Income
Balance at December 31, 2015
$
(482,629
)
 
$
(104,346
)
 
$
(120
)
 
 
 
$
(587,095
)
Amounts recognized in Other comprehensive loss (3)
31,935

 
 
 
455

 
$
(107,948
)
 
(75,558
)
Amounts reclassified from Other comprehensive loss (4)
 
 
439

 
125

 
 
 
564

Net change
31,935

 
439

 
580

 
(107,948
)
 
(74,994
)
Balance at June 30, 2016
$
(450,694
)
 
$
(103,907
)
 
$
460

 
$
(107,948
)
 
$
(662,089
)

(3) Net of taxes of $(282) for unrealized net gains on available-for-sale securities and $66,721 for unrealized net losses on cash flow hedges.
(4) Net of taxes of $(45) for pension and other postretirement benefit adjustments and $(78) for realized losses on the sale of available-for-sale securities.
NOTE 6—PRODUCT WARRANTIES
Changes in the Company’s accrual for product warranty claims during the first six months of 2017 and 2016, including customer satisfaction settlements, were as follows:
 
(Thousands of dollars)
 
 
 
 
2017
 
2016
Balance at January 1
$
34,419

 
$
31,878

Charges to expense
16,434

 
15,763

Settlements
(16,698
)
 
(14,755
)
Acquisition
110,461

 
 
Balance at June 30
$
144,616

 
$
32,886

Warranty accruals of $110.5 million were acquired in connection with the Valspar acquisition. This amount includes warranties for certain products under extended furniture protection plans. In the U.S., revenue related to furniture protection plans is deferred and recognized over the contract life.
For further details on the Company’s accrual for product warranty claims, see Note 1 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.


9



NOTE 7—EXIT OR DISPOSAL ACTIVITIES
Liabilities associated with exit or disposal activities are recognized as incurred in accordance with the Exit or Disposal Cost Obligations Topic of the ASC. Qualified exit costs primarily include post-closure rent expenses, incremental post-closure costs 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. Concurrently, property, plant and equipment is tested for impairment in accordance with the Property, Plant and Equipment Topic of the ASC, and if impairment exists, the carrying value of the related assets is reduced to estimated fair value. Additional impairment may be recorded for subsequent revisions in estimated fair value.
In the six months ended June 30, 2017, four stores in The Americas Group and two branches in the Performance Coatings Group were closed due to lower demand or redundancy. Due to the Valspar acquisition, the Company has acquired exit or disposal cost reserve accruals and recorded severance and related cost provisions in the month of June.
The following table summarizes the activity and remaining liabilities associated with qualified exit costs at June 30, 2017:
(Thousands of dollars)
 
 
 
 
 
 
 
 
 
 
Exit Plan
 
Balance at December 31, 2016
 
Acquired Balances
 
Provisions in Cost of Goods Sold or SG&A
 
 Actual Expenditures Charged to Accrual
 
Balance at June 30, 2017
Administrative segment acquisition-related restructuring in 2017:
 
 
 
 
 
 
 
 
 
 
Severance and related costs
 
 
 
 
 
$
9,883

 
$
(3,761
)
 
$
6,122

Consumer Brands Group facilities shutdown in 2016:
 
 
 
 
 
 
 
 
 
 
Severance and related costs
 
$
907

 
$
4

 
2,823

 
(3,632
)
 
102

Performance Coatings Group stores shutdown in 2016:
 
 
 
 
 
 
 
 
 
 
Severance and related costs
 
136

 
2,271

 
8

 
(296
)
 
2,119

Other qualified exit costs
 
269

 
5

 
94

 
(143
)
 
225

The Americas Group stores shutdown in 2015:
 
 
 
 
 
 
 
 
 
 
Other qualified exit costs
 
195

 
 
 
10

 
(205
)
 

Consumer Brands Group facilities shutdown in 2015:
 
 
 
 
 
 
 
 
 
 
Severance and related costs
 
 
 
632

 
 
 
(3
)
 
629

Other qualified exit costs
 
 
 
629

 
 
 
(3
)
 
626

Performance Coatings Group stores shutdown in 2015:
 
 
 
 
 
 
 
 
 
 
Severance and related costs
 
 
 
396

 
10

 
 
 
406

Other qualified exit costs
 
433

 
427

 
 
 
(405
)
 
455

Severance and other qualified exit costs for facilities shutdown prior to 2015
 
1,908

 
92

 
 
 
(456
)
 
1,544

Totals
 
$
3,848

 
$
4,456

 
$
12,828


$
(8,904
)
 
$
12,228

For further details on the Company’s exit or disposal activities, see Note 5 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.


10



NOTE 8HEALTH CARE, PENSION AND OTHER BENEFITS
Shown below are the components of the Company’s net periodic benefit cost (credit) for domestic defined benefit pension plans, foreign defined benefit pension plans and postretirement benefits other than pensions:
 
(Thousands of dollars)
Domestic Defined
Benefit Pension Plans
 
Foreign Defined
Benefit Pension Plans
 
Postretirement
Benefits Other than
Pensions
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
Three Months Ended June 30:
 
 
 
 
 
 
 
 
 
 
 
Net periodic benefit cost:
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
5,459

 
$
5,489

 
$
2,287

 
$
1,198

 
$
471

 
$
561

Interest cost
7,191

 
6,643

 
1,864

 
2,081

 
2,593

 
2,753

Expected return on assets
(11,299
)
 
(12,567
)
 
(2,008
)
 
(1,846
)
 
 
 
 
Amortization of:
 
 
 
 
 
 
 
 
 
 
 
Prior service cost (credit)
340

 
301

 
 
 
 
 
(1,645
)
 
(1,645
)
Actuarial loss (gain)
1,662

 
1,153

 
(97
)
 
504

 
5

 
 
Settlement gain
 
 
 
 
 
 
 
 
(9,332
)
 
 
Net periodic benefit cost
$
3,353

 
$
1,019

 
$
2,046

 
$
1,937

 
$
(7,908
)
 
$
1,669

 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30:
 
 
 
 
 
 
 
 
 
 
 
Net periodic benefit cost (credit):
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
10,772

 
$
10,978

 
$
4,205

 
$
2,539

 
$
1,014

 
$
1,122

Interest cost
13,601

 
13,286

 
3,502

 
4,161

 
5,236

 
5,505

Expected return on assets
(21,608
)
 
(25,134
)
 
(3,772
)
 
(3,692
)
 
 
 
 
Amortization of:
 
 
 
 
 
 
 
 
 
 
 
Prior service cost (credit)
681

 
602

 
 
 
 
 
(3,290
)
 
(3,290
)
Actuarial loss (gain)
3,323

 
2,305

 
(150
)
 
865

 
16

 
 
Settlement (gain) loss
 
 
 
 


 
4,038

 
(9,332
)
 
 
Net periodic benefit cost (credit)
$
6,769

 
$
2,037

 
$
3,785

 
$
7,911

 
$
(6,356
)
 
$
3,337

The Company acquired new benefit plans in each category above as a result of the Valspar acquisition. The costs (credits) for these plans for the month of June 2017 are included in the tables above and are not significant. The settlement gain recognized in the second quarter of 2017 relates to the termination of a life insurance benefit plan. The settlement loss recognized in the first quarter of 2016 relates to the wind up of an acquired Canada plan. For further details on the Company’s health care, pension and other benefits, see Note 6 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.
NOTE 9—OTHER LONG-TERM LIABILITIES
The Company initially provides for estimated costs of environmental-related activities relating to its past operations and third party sites for which commitments or clean-up plans have been developed and when such costs can be reasonably estimated based on industry standards and professional judgment. These estimated costs are determined based on currently available facts regarding each site. If the best estimate of costs can only be identified as a range and no specific amount within that range can be determined more likely than any other amount within the range, the minimum of the range is provided. At June 30, 2017, the unaccrued maximum of the estimated range of possible outcomes is $86.1 million higher than the minimum.
The Company continuously assesses its potential liability for investigation and remediation-related activities and adjusts its environmental-related accruals as information becomes available upon which more accurate costs can be reasonably estimated and as additional accounting guidelines are issued. Actual costs incurred may vary from these estimates due to the inherent uncertainties involved including, among others, the number and financial condition of parties involved with respect to any given site, the volumetric contribution which may be attributed to the Company relative to that attributed to other parties, the nature and magnitude of the wastes involved, the various technologies that can be used for remediation and the determination of acceptable remediation with respect to a particular site.
Included in Other long-term liabilities at June 30, 2017 and 2016 were accruals for extended environmental-related activities of $160.2 million and $143.0 million, respectively. Estimated costs of current investigation and remediation activities of $30.4

11



million and $22.5 million are included in Other accruals at June 30, 2017 and 2016, respectively. Other accruals in the second quarter of 2017 increased $10.5 million due to environmental-related liabilities the Company assumed as a part of the preliminary opening balance sheet of Valspar and is subject to measurement period adjustments.
Three of the Company’s currently and formerly owned manufacturing sites account for the majority of the accrual for environmental-related activities and the unaccrued maximum of the estimated range of possible outcomes at June 30, 2017. At June 30, 2017, $149.9 million, or 78.6 percent of the total accrual, related directly to these three sites. In the aggregate unaccrued maximum of $86.1 million at June 30, 2017, $70.5 million, or 81.8 percent, related to the three manufacturing sites. While environmental investigations and remedial actions are in different stages at these sites, additional investigations, remedial actions and monitoring will likely be required at each site.
Management cannot presently estimate the ultimate potential loss contingencies related to these sites or other less significant sites until such time as a substantial portion of the investigation at the sites is completed and remedial action plans are developed. In the event any future loss contingency significantly exceeds the current amount accrued, the recording of the ultimate liability may result in a material impact on net income for the annual or interim period during which the additional costs are accrued. Management does not believe that any potential liability ultimately attributed to the Company for its environmental-related matters will have a material adverse effect on the Company’s financial condition, liquidity, or cash flow due to the extended period of time during which environmental investigation and remediation takes place. An estimate of the potential impact on the Company’s operations cannot be made due to the aforementioned uncertainties.
Management expects these contingent environmental-related liabilities to be resolved over an extended period of time. Management is unable to provide a more specific time frame due to the indefinite amount of time to conduct investigation activities at any site, the indefinite amount of time to obtain environmental agency approval, as necessary, with respect to investigation and remediation activities, and the indefinite amount of time necessary to conduct remediation activities.
For further details on the Company’s Other long-term liabilities, see Note 8 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.
NOTE 10 – LITIGATION
In the course of its business, the Company is subject to a variety of claims and lawsuits, including, but not limited to, litigation relating to product liability and warranty, personal injury, environmental, intellectual property, commercial, contractual and antitrust claims that are inherently subject to many uncertainties regarding the possibility of a loss to the Company. These uncertainties will ultimately be resolved when one or more future events occur or fail to occur confirming the incurrence of a liability or the reduction of a liability. In accordance with the Contingencies Topic of the ASC, the Company accrues for these contingencies by a charge to income when it is both probable that one or more future events will occur confirming the fact of a loss and the amount of the loss can be reasonably estimated. In the event that the Company’s loss contingency is ultimately determined to be significantly higher than currently accrued, the recording of the additional liability may result in a material impact on the Company’s results of operations, liquidity or financial condition for the annual or interim period during which such additional liability is accrued. In those cases where no accrual is recorded because it is not probable that a liability has been incurred and the amount of any such loss cannot be reasonably estimated, any potential liability ultimately determined to be attributable to the Company may result in a material impact on the Company’s results of operations, liquidity or financial condition for the annual or interim period during which such liability is accrued. In those cases where no accrual is recorded or exposure to loss exists in excess of the amount accrued, the Contingencies Topic of the ASC requires disclosure of the contingency when there is a reasonable possibility that a loss or additional loss may have been incurred.
Lead pigment and lead-based paint litigation. The Company’s past operations included the manufacture and sale of lead pigments and lead-based paints. The Company, along with other companies, is and has been a defendant in a number of legal proceedings, including individual personal injury actions, purported class actions, and actions brought by various counties, cities, school districts and other government-related entities, arising from the manufacture and sale of lead pigments and lead-based paints. The plaintiffs’ claims have been based upon various legal theories, including negligence, strict liability, breach of warranty, negligent misrepresentations and omissions, fraudulent misrepresentations and omissions, concert of action, civil conspiracy, violations of unfair trade practice and consumer protection laws, enterprise liability, market share liability, public nuisance, unjust enrichment and other theories. The plaintiffs seek various damages and relief, including personal injury and property damage, costs relating to the detection and abatement of lead-based paint from buildings, costs associated with a public education campaign, medical monitoring costs and others. The Company has also been a defendant in legal proceedings arising from the manufacture and sale of non-lead-based paints that seek recovery based upon various legal theories, including the failure to adequately warn of potential exposure to lead during surface preparation when using non-lead-based paint on surfaces previously painted with lead-based paint. The Company believes that the litigation brought to date is without merit or subject to meritorious defenses and is vigorously defending such litigation. The Company has not settled any material lead

12



pigment or lead-based paint litigation. The Company expects that additional lead pigment and lead-based paint litigation may be filed against the Company in the future asserting similar or different legal theories and seeking similar or different types of damages and relief.
Notwithstanding the Company’s views on the merits, litigation is inherently subject to many uncertainties, and the Company ultimately may not prevail. Adverse court rulings or determinations of liability, among other factors, could affect the lead pigment and lead-based paint litigation against the Company and encourage an increase in the number and nature of future claims and proceedings. In addition, from time to time, various legislation and administrative regulations have been enacted, promulgated or proposed to impose obligations on present and former manufacturers of lead pigments and lead-based paints respecting asserted health concerns associated with such products or to overturn the effect of court decisions in which the Company and other manufacturers have been successful.
Due to the uncertainties involved, management is unable to predict the outcome of the lead pigment and lead-based paint litigation, the number or nature of possible future claims and proceedings or the effect that any legislation and/or administrative regulations may have on the litigation or against the Company. In addition, management cannot reasonably determine the scope or amount of the potential costs and liabilities related to such litigation, or resulting from any such legislation and regulations. The Company has not accrued any amounts for such litigation. With respect to such litigation, including the public nuisance litigation, the Company does not believe that it is probable that a loss has occurred, and it is not possible to estimate the range of potential losses as there is no prior history of a loss of this nature and there is no substantive information upon which an estimate could be based. In addition, any potential liability that may result from any changes to legislation and regulations cannot reasonably be estimated. In the event any significant liability is determined to be attributable to the Company relating to such litigation, the recording of the liability may result in a material impact on net income for the annual or interim period during which such liability is accrued. Additionally, due to the uncertainties associated with the amount of any such liability and/or the nature of any other remedy which may be imposed in such litigation, any potential liability determined to be attributable to the Company arising out of such litigation may have a material adverse effect on the Company’s results of operations, liquidity or financial condition. An estimate of the potential impact on the Company’s results of operations, liquidity or financial condition cannot be made due to the aforementioned uncertainties.
Public nuisance claim litigation. The Company and other companies are or were defendants in legal proceedings seeking recovery based on public nuisance liability theories, among other theories, brought by the State of Rhode Island, the City of St. Louis, Missouri, various cities and counties in the State of New Jersey, various cities in the State of Ohio and the State of Ohio, the City of Chicago, Illinois, the City of Milwaukee, Wisconsin and the County of Santa Clara, California and other public entities in the State of California. Except for the Santa Clara County, California proceeding, all of these legal proceedings have been concluded in favor of the Company and other defendants at various stages in the proceedings.
The proceedings initiated by the State of Rhode Island included two jury trials. At the conclusion of the second trial, the jury returned a verdict finding that (i) the cumulative presence of lead pigment in paints and coatings on buildings in the State of Rhode Island constitutes a public nuisance, (ii) the Company, along with two other defendants, caused or substantially contributed to the creation of the public nuisance and (iii) the Company and two other defendants should be ordered to abate the public nuisance. The Company and two other defendants appealed and, on July 1, 2008, the Rhode Island Supreme Court, among other determinations, reversed the judgment of abatement with respect to the Company and two other defendants. The Rhode Island Supreme Court’s decision reversed the public nuisance liability judgment against the Company on the basis that the complaint failed to state a public nuisance claim as a matter of law.
The Santa Clara County, California proceeding was initiated in March 2000 in the Superior Court of the State of California, County of Santa Clara. In the original complaint, the plaintiffs asserted various claims including fraud and concealment, strict product liability/failure to warn, strict product liability/design defect, negligence, negligent breach of a special duty, public nuisance, private nuisance, and violations of California’s Business and Professions Code. A number of the asserted claims were resolved in favor of the defendants through pre-trial proceedings. The named plaintiffs in the Fourth Amended Complaint, filed on March 16, 2011, are the Counties of Santa Clara, Alameda, Los Angeles, Monterey, San Mateo, Solano and Ventura, the Cities of Oakland and San Diego and the City and County of San Francisco. The Fourth Amended Complaint asserted a sole claim for public nuisance, alleging that the presence of lead pigments for use in paint and coatings in, on and around residences in the plaintiffs’ jurisdictions constitutes a public nuisance. The plaintiffs sought the abatement of the alleged public nuisance that exists within the plaintiffs’ jurisdictions. A trial commenced on July 15, 2013 and ended on August 22, 2013. The court entered final judgment on January 27, 2014, finding in favor of the plaintiffs and against the Company and two other defendants (ConAgra Grocery Products Company and NL Industries, Inc.). The final judgment held the Company jointly and severally liable with the other two defendants to pay $1.15 billion into a fund to abate the public nuisance. The Company strongly disagrees with the judgment. On February 18, 2014, the Company filed a motion for new trial and a motion to vacate the judgment. The court denied these motions on March 24, 2014. On March 28, 2014, the Company filed a notice of appeal to the Sixth District Court of Appeal for the State of California. The filing of the notice of appeal effects an automatic stay of the

13



judgment without the requirement to post a bond. The appeal is fully briefed. On July 14, 2017, the Sixth District Court of Appeal scheduled the date for oral argument on the appeal for August 24, 2017. The Company expects the Sixth District Court of Appeal to issue its ruling within 90 days following oral argument. The Company believes that the judgment conflicts with established principles of law and is unsupported by the evidence. The Company has had a favorable history with respect to lead pigment and lead-based paint litigation, particularly other public nuisance litigation, and accordingly, the Company believes that it is not probable that a loss has occurred and it is not possible to estimate the range of potential loss with respect to the case.
Litigation seeking damages from alleged personal injury. The Company and other companies are defendants in a number of legal proceedings seeking monetary damages and other relief from alleged personal injuries. These proceedings include claims by children allegedly injured from ingestion of lead pigment or lead-containing paint and claims for damages allegedly incurred by the children’s parents or guardians. These proceedings generally seek compensatory and punitive damages, and seek other relief including medical monitoring costs. These proceedings include purported claims by individuals, groups of individuals and class actions.
The plaintiff in Thomas v. Lead Industries Association, et al., initiated an action in state court against the Company, other alleged former lead pigment manufacturers and the Lead Industries Association in September 1999. The claims against the Company and the other defendants included strict liability, negligence, negligent misrepresentation and omissions, fraudulent misrepresentation and omissions, concert of action, civil conspiracy and enterprise liability. Implicit within these claims is the theory of “risk contribution” liability (Wisconsin’s theory which is similar to market share liability, except that liability can be joint and several) due to the plaintiff’s inability to identify the manufacturer of any product that allegedly injured the plaintiff. The case ultimately proceeded to trial and, on November 5, 2007, the jury returned a defense verdict, finding that the plaintiff had ingested white lead carbonate, but was not brain damaged or injured as a result. The plaintiff appealed and, on December 16, 2010, the Wisconsin Court of Appeals affirmed the final judgment in favor of the Company and other defendants.
Wisconsin is the only jurisdiction to date to apply a theory of liability with respect to alleged personal injury (i.e., risk contribution/market share liability) that does not require the plaintiff to identify the manufacturer of the product that allegedly injured the plaintiff in the lead pigment and lead-based paint litigation. Although the risk contribution liability theory was applied during the Thomas trial, the constitutionality of this theory as applied to the lead pigment cases has not been judicially determined by the Wisconsin state courts. However, in an unrelated action filed in the United States District Court for the Eastern District of Wisconsin, Gibson v. American Cyanamid, et al., on November 15, 2010, the District Court held that Wisconsin’s risk contribution theory as applied in that case violated the defendants’ right to substantive due process and is unconstitutionally retroactive. The District Court's decision in Gibson v. American Cyanamid, et al., was appealed by the plaintiff to the United States Court of Appeals for the Seventh Circuit. On July 24, 2014, the United States Court of Appeals for the Seventh Circuit reversed the judgment and remanded the case back to the District Court for further proceedings. On January 16, 2015, the defendants filed a petition for certiorari in the United States Supreme Court seeking that Court's review of the Seventh Circuit's decision, and on May 18, 2015, the United States Supreme Court denied the defendants' petition. The case is currently pending in the District Court. Three cases also currently pending in the United States District Court for the Eastern District of Wisconsin (Ravon Owens v. American Cyanamid, et al., Cesar Sifuentes v. American Cyanamid, et al., and Glenn Burton, Jr. v. American Cyanamid, et al.) are being prepared for trial, although no trial dates have been set by the District Court.
In Yasmine Clark v. The Sherwin-Williams Company, et al., the Wisconsin Circuit Court, Milwaukee County, on March 25, 2014, held that the application to a pending case of Section 895.046 of the Wisconsin Statutes (which clarifies the application of the risk contribution theory) is unconstitutional as a violation of the plaintiff’s right to due process of law under the Wisconsin Constitution. On August 21, 2014, the Wisconsin Court of Appeals granted defendants' petition to hear the issue as an interlocutory appeal. On September 29, 2015, the Wisconsin Court of Appeals certified the appeal to the Wisconsin Supreme Court for its determination. Oral argument before the Wisconsin Supreme Court occurred on April 5, 2016. On April 15, 2016, the Wisconsin Supreme Court published its decision, deciding in a 3 to 3 split decision to remand the case back to the Wisconsin Court of Appeals for its consideration. The Wisconsin Court of Appeals dismissed the appeal on September 20, 2016 and remanded the case back to the Wisconsin Circuit Court for further proceedings. On April 18, 2017, the parties entered into a stipulation and order of dismissal without prejudice. On April 26, 2017, the Wisconsin Circuit Court dismissed the case without prejudice.
Insurance coverage litigation. The Company and its liability insurers, including certain underwriters at Lloyd’s of London, initiated legal proceedings against each other to primarily determine, among other things, whether the costs and liabilities associated with the abatement of lead pigment are covered under certain insurance policies issued to the Company. The Company’s action, filed on March 3, 2006 in the Common Pleas Court, Cuyahoga County, Ohio, is currently stayed and inactive. The liability insurers’ action, which was filed on February 23, 2006 in the Supreme Court of the State of New York, County of New York, has been dismissed. An ultimate loss in the insurance coverage litigation would mean that insurance

14



proceeds could be unavailable under the policies at issue to mitigate any ultimate abatement related costs and liabilities. The Company has not recorded any assets related to these insurance policies or otherwise assumed that proceeds from these insurance policies would be received in estimating any contingent liability accrual. Therefore, an ultimate loss in the insurance coverage litigation without a determination of liability against the Company in the lead pigment or lead-based paint litigation will have no impact on the Company’s results of operation, liquidity or financial condition. As previously stated, however, the Company has not accrued any amounts for the lead pigment or lead-based paint litigation and any significant liability ultimately determined to be attributable to the Company relating to such litigation may result in a material impact on the Company’s results of operations, liquidity or financial condition for the annual or interim period during which such liability is accrued.
NOTE 11—OTHER
Other general expense - net
Included in Other general expense - net were the following:
(Thousands of dollars)
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2017
 
2016
 
2017
 
2016
Provisions for environmental matters - net
$
1,110

 
$
2,507

 
$
1,629

 
$
20,536

Loss (gain) on sale or disposition of assets
665

 
226

 
422

 
(249
)
Total
$
1,775

 
$
2,733

 
$
2,051

 
$
20,287

Provisions for environmental matters - net represent site-specific increases or decreases to environmental-related accruals as information becomes available upon which more accurate costs can be reasonably estimated and as additional accounting guidelines are issued. Environmental-related accruals are not recorded net of insurance proceeds in accordance with the Offsetting Subtopic of the Balance Sheet Topic of the ASC. See Note 9 for further details on the Company’s environmental-related activities.
The loss (gain) on disposition of assets represents net realized losses (gains) associated with the sale or disposal of fixed assets previously used in the conduct of the primary business of the Company.
Other (income) expense - net
Included in Other (income) expense - net were the following:
 
(Thousands of dollars)
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2017
 
2016
 
2017
 
2016
Dividend and royalty income
$
(1,198
)
 
$
(999
)
 
$
(3,042
)
 
$
(2,165
)
Net expense from banking activities
2,513

 
2,108

 
4,985

 
4,371

Foreign currency transaction related losses (gains)
976

 
1,819

 
(2,610
)
 
3,509

Other income
(5,937
)
 
(5,450
)
 
(10,897
)
 
(10,330
)
Other expense
1,876

 
2,470

 
5,427

 
4,789

Total
$
(1,770
)
 
$
(52
)
 
$
(6,137
)
 
$
174

Foreign currency transaction related losses (gains) represent net realized losses (gains) on U.S. dollar-denominated liabilities of foreign subsidiaries and net realized and unrealized losses (gains) from foreign currency option and forward contracts. There were no material foreign currency option and forward contracts outstanding at June 30, 2017 and 2016.
Other income and Other expense included items of revenue, gains, expenses and losses that were unrelated to the primary business purpose of the Company. There were no other items within the other income or other expense caption that were individually significant.

15



NOTE 12—INCOME TAXES
The effective tax rate for income from continuing operations was 29.1 percent and 26.5 percent for the second quarter and first six months of 2017, respectively, compared to 29.9 percent and 28.1 percent for the second quarter and first six months of 2016, respectively. The Company recorded an income tax provision of $41.5 million in the second quarter of 2017 related to the divestiture of Valspar's North American industrial wood coatings business, which is reported as a discontinued operation. See Note 3. Excluding the impact of share-based payments, the effective tax rate was 32.7 percent for both the second quarter and first six months of 2017 compared to 32.1 percent for both the second quarter and first six months of 2016.
During the second quarter of 2017, the Company recorded a preliminary deferred income tax liability of approximately $2.4 billion based on the preliminary purchase price accounting for Valspar and is subject to measurement period adjustments.
At December 31, 2016, the Company had $32.8 million in unrecognized tax benefits, the recognition of which would have an effect of $27.7 million on the effective tax rate. Included in the balance of unrecognized tax benefits at December 31, 2016 was $2.6 million related to tax positions for which it is reasonably possible that the total amounts could significantly change during the next twelve months. This amount represents a decrease in unrecognized tax benefits comprised primarily of items related to federal audits of partnership investments and expiring statutes in federal, foreign and state jurisdictions. In the second quarter of 2017, the Company acquired $19.9 million of unrecognized tax benefits as a part of the preliminary opening balance sheet of Valspar and is subject to measurement period adjustments.
The Company classifies all income tax related interest and penalties as income tax expense. At December 31, 2016, the Company had accrued $9.3 million for the potential payment of income tax interest and penalties.
There were no significant changes to any of the balances of unrecognized tax benefits at December 31, 2016 during the first six months of 2017 with the exception of the unrecognized tax benefits recorded as a part of the acquisition of Valspar.
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. The IRS is currently auditing refund claims that the Company filed for the 2010, 2011 and 2012 tax years and the 2014 and 2015 tax years of a Valspar subsidiary. During the second quarter of 2017, the IRS informed the Company that it will commence an audit of the 2014 and 2015 tax years by the end of 2017. As of June 30, 2017, the federal statute of limitations has not expired for the 2013, 2014 and 2015 tax years.
As of June 30, 2017, the Company is subject to non-U.S. income tax examinations for the tax years of 2010 through 2016. In addition, the Company is subject to state and local income tax examinations for the tax years 2003 through 2016.


16



NOTE 13—NET INCOME PER COMMON SHARE

Basic and diluted earnings per share are calculated using the treasury stock method.
(Thousands of dollars except per share data)
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2017
 
2016
 
2017
 
2016
Basic
 
 
 
 
 
 
 
Average common shares outstanding
92,841,148

 
91,788,734

 
92,695,853

 
91,632,297

Net income
 
 
 
 
 
 
 
Continuing operations
$
360,651

 
$
378,064

 
$
599,803

 
$
542,940

Discontinued operations (2)
(41,540
)
 

 
(41,540
)
 

Net income
$
319,111

 
$
378,064

 
$
558,263

 
$
542,940

Basic net income per common share
 
 
 
 
 
 
 
Continuing operations
$
3.89

 
$
4.12

 
$
6.47

 
$
5.93

Discontinued operations (2)
(0.45
)
 

 
(0.45
)
 

Net income per common share
$
3.44

 
$
4.12

 
$
6.02

 
$
5.93

 
 
 
 
 
 
 
 
Diluted
 
 
 
 
 
 
 
Average common shares outstanding
92,841,148

 
91,788,734

 
92,695,853

 
91,632,297

Stock options and other contingently issuable shares (1)
2,055,422

 
2,318,192

 
1,935,690

 
2,114,844

Non-vested restricted stock grants
72,066

 
562,825

 
65,896

 
558,856

Average common shares outstanding assuming dilution
94,968,636

 
94,669,751

 
94,697,439

 
94,305,997

Net income
 
 
 
 
 
 
 
Continuing operations
$
360,651

 
$
378,064

 
$
599,803

 
$
542,940

Discontinued operations (2)
(41,540
)
 

 
(41,540
)
 

Net income
$
319,111

 
$
378,064

 
$
558,263

 
$
542,940

Diluted net income per common share
 
 
 
 
 
 
 
Continuing operations
$
3.80

 
$
3.99

 
$
6.34

 
$
5.76

Discontinued operations (2)
(0.44
)
 

 
(0.44
)
 

Net income per common share
$
3.36

 
$
3.99

 
$
5.90

 
$
5.76

 
(1) 
Stock options and other contingently issuable shares excludes 16,013 and 47,273 shares due to their anti-dilutive effect for the three and six months ended June 30, 2016. There are no shares excluded for the three and six months ended June 30, 2017.
(2) 
Relates to the divestiture of Valspar's North American industrial wood coatings business. See Note 3.
NOTE 14—REPORTABLE SEGMENT INFORMATION
The Company reports segment information in the same way that management internally organizes its business for assessing performance and making decisions regarding allocation of resources in accordance with the Segment Disclosures Topic of the ASC. Upon completion of the Valspar acquisition in the second quarter of 2017 (see Note 3), the Company made important changes to its organizational and reporting structure that resulted in establishing three new reportable segments. The Americas Group reportable segment includes the Company's previous Paint Stores Group and Latin America Coatings Group, along with a specialty retail business of Valspar. The Americas Group operates stores in the United States, Canada, Latin America, and the Caribbean islands servicing the needs of architectural and industrial painting contractors and do-it-yourself homeowners. The Americas Group sells a variety of architectural paints, coatings and related products through dedicated dealers, home centers, distributors, hardware stores and other retailers throughout Latin America. The Consumer Brands Group reportable segment includes the Company's previous Consumer Group along with Valspar's previous Consumer Paints segment, excluding Valspar's automotive refinishes products business. The Consumer Brands Group supplies a broad portfolio of branded and private-label architectural paints, stains, varnishes, industrial products, wood finishes products, wood preservatives, applicators, corrosion inhibitors, aerosols, caulks and adhesives to retailers and distributors throughout North America, as well as in Australia, China and Europe. The Consumer Brands Group also supports the Company's other businesses around the world with new product research and development, manufacturing, distribution and logistics. The Performance Coatings Group

17



reportable segment includes the Company's previous Global Finishes Group and Valspar's previous Coatings Group segment. The Performance Coatings Group also includes Valspar's automotive refinishes products business, which was previously reported under Valspar's Consumer Paints segment. Valspar’s North American industrial wood coatings business, which was previously reported under the Valspar's Coatings Group segment, was divested. The Performance Coatings Group develops and sells industrial coatings for wood finishing and general industrial (metal and plastic) applications, automotive refinish, protective and marine coatings, coil coatings, packaging coatings and performance-based resins and colorants worldwide. In addition, a specialty coatings business previously in the Company's Consumer Group is now included in the Performance Coatings Group. Prior period segment reporting has been adjusted to reflect the updated reportable segments.
(Thousands of dollars)
Three Months Ended June 30, 2017
 
The Americas
Group
 
Consumer Brands
Group
 
Performance
Coatings
Group
 
Administrative
 
Consolidated
Totals
Net external sales
$
2,437,655

 
$
536,441

 
$
761,094

 
$
627

 
$
3,735,817

Intersegment transfers
2,020

 
864,337

 
7,231

 
(873,588
)
 
 
Total net sales and intersegment transfers
$
2,439,675

 
$
1,400,778

 
$
768,325

 
$
(872,961
)
 
$
3,735,817

 
 
 
 
 
 
 
 
 
 
Segment profit
$
532,687

 
$
76,064

 
$
62,345

 

 
$
671,096

Interest expense

 
 
 
 
 
$
(56,729
)
 
(56,729
)
Administrative expenses and other
 
 
 
 
 
 
(105,364
)
 
(105,364
)
Income from continuing operations
     before income taxes *
$
532,687

 
$
76,064

 
$
62,345

 
$
(162,093
)
 
$
509,003


* Income from continuing operations before income taxes for the Consumer Brands Group and Performance Coatings Group includes inventory step-up amortization of $14.5 million and $21.8 million, respectively, and intangibles amortization of $5.7 million and $17.2 million, respectively, based on the preliminary purchase accounting. Income from continuing operations before income taxes for the Administrative segment includes $26.6 million of acquisition-related expenses included in SG&A.

 
Three Months Ended June 30, 2016
 
The Americas
Group
 
Consumer Brands
Group
 
Performance
Coatings
Group
 
Administrative
 
Consolidated
Totals
Net external sales
$
2,241,566

 
$
462,473

 
$
514,198

 
$
1,288

 
$
3,219,525

Intersegment transfers
9,960

 
763,956

 
6,025

 
(779,941
)
 
 
Total net sales and intersegment transfers
$
2,251,526

 
$
1,226,429

 
$
520,223

 
$
(778,653
)
 
$
3,219,525

 
 
 
 
 
 
 
 
 
 
Segment profit
$
499,347

 
$
103,157

 
$
70,377

 
 
 
$
672,881

Interest expense

 
 
 
 
 
$
(40,878
)
 
(40,878
)
Administrative expenses and other
 
 
 
 
 
 
(92,789
)
 
(92,789
)
Income from continuing operations
before income taxes
$
499,347

 
$
103,157

 
$
70,377

 
$
(133,667
)
 
$
539,214


18



 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2017
 
The Americas
Group
 
Consumer Brands
Group
 
Performance
Coatings
Group
 
Administrative
 
Consolidated
Totals
Net external sales
$
4,389,401

 
$
859,807

 
$
1,245,548

 
$
2,448

 
$
6,497,204

Intersegment transfers
4,361

 
1,560,175

 
11,031

 
(1,575,567
)
 
 
Total net sales and intersegment transfers
$
4,393,762

 
$
2,419,982

 
$
1,256,579

 
$
(1,573,119
)
 
$
6,497,204

 
 
 
 
 
 
 
 
 
 
Segment profit
$
837,911

 
$
131,978

 
$
119,457

 
 
 
$
1,089,346

Interest expense
 
 
 
 
 
 
$
(82,424
)
 
(82,424
)
Administrative expenses and other
 
 
 
 
 
 
(191,314
)
 
(191,314
)
Income from continuing operations
before income taxes **
$
837,911

 
$
131,978

 
$
119,457

 
$
(273,738
)
 
$
815,608


** Income from continuing operations before income taxes for the Consumer Brands Group and Performance Coatings Group includes inventory step-up amortization of $14.5 million and $21.8 million, respectively, and intangibles amortization of $5.7 million and $17.2 million, respectively, based on the preliminary purchase accounting. Income from continuing operations before income taxes for the Administrative segment includes $31.6 million of acquisition-related expenses included in SG&A.

 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2016
 
The Americas
Group
 
Consumer Brands
Group
 
Performance
Coatings
Group
 
Administrative
 
Consolidated
Totals
Net external sales
$
3,982,060

 
$
827,093

 
$
981,830

 
$
2,566

 
$
5,793,549

Intersegment transfers
18,653

 
1,377,586

 
7,981

 
(1,404,220
)
 
 
Total net sales and intersegment transfers
$
4,000,713

 
$
2,204,679

 
$
989,811

 
$
(1,401,654
)
 
$
5,793,549

 
 
 
 
 
 
 
 
 
 
Segment profit
$
751,953

 
$
163,030

 
$
123,050

 
 
 
$
1,038,033

Interest expense
 
 
 
 
 
 
$
(66,610
)
 
(66,610
)
Administrative expenses and other
 
 
 
 
 
 
(215,844
)
 
(215,844
)
Income from continuing operations
before income taxes
$
751,953

 
$
163,030

 
$
123,050

 
$
(282,454
)
 
$
755,579

In the reportable segment financial information, Segment profit was total net sales and intersegment transfers less operating costs and expenses. Domestic intersegment transfers were accounted for at the approximate fully absorbed manufactured cost, based on normal capacity volumes, plus customary distribution costs. International intersegment transfers were accounted for at values comparable to normal unaffiliated customer sales. The Administrative segment includes the administrative expenses of the Company’s corporate headquarters site. Also included in the Administrative segment was interest expense, interest and investment income, certain expenses related to closed facilities and environmental-related matters, and other expenses which were not directly associated with the reportable segments. The Administrative segment did not include any significant foreign operations. Also included in the Administrative segment was a real estate management unit that is responsible for the ownership, management and leasing of non-retail properties held primarily for use by the Company, including the Company’s headquarters site, and disposal of idle facilities. Sales of this segment represented external leasing revenue of excess headquarters space or leasing of facilities no longer used by the Company in its primary businesses. Gains and losses from the sale of property were not a significant operating factor in determining the performance of the Administrative segment.
As of June 30, 2017, identifiable assets for The Americas Group, Consumer Brands Group, Performance Coatings Group and Administrative segments were $2.262 billion, $5.739 billion, $11.239 billion and $1.477 billion, respectively. These amounts include preliminary purchase accounting adjustments for Goodwill and Intangibles. The allocation of the fair value will be finalized within the allowable measurement period. As of June 30, 2016, identifiable assets for The Americas Group, Consumer Brands Group, Performance Coatings Group and Administrative segments were $2.142 billion, $2.328 billion, $829.0 million and $1.367 billion, respectively.
Net external sales and segment profit of all consolidated foreign subsidiaries were $603.3 million and $.7 million, respectively, for the second quarter of 2017, and $454.5 million and $17.1 million, respectively, for the second quarter of 2016. Net external sales and segment profit of all consolidated foreign subsidiaries were $1.022 billion and $14.5 million, respectively, for the six months of 2017, and $855.2 million and $27.3 million, respectively, for the six months of 2016. Long-lived assets of these

19



subsidiaries totaled $1.698 billion and $506.8 million at June 30, 2017 and June 30, 2016, respectively. The increase in net external sales and long-lived assets is primarily due to the Valspar acquisition. Domestic operations accounted for the remaining net external sales, segment profits and long-lived assets. No single geographic area outside the United States was significant relative to consolidated net external sales, income before taxes, or consolidated long-lived assets.
Export sales and sales to any individual customer were each less than 10 percent of consolidated sales to unaffiliated customers during all periods presented.
NOTE 15FAIR VALUE MEASUREMENTS
The Fair Value Measurements and Disclosures Topic of the ASC applies to the Company’s financial and non-financial assets and liabilities. The guidance applies when other standards require or permit the fair value measurement of assets and liabilities. The Company did not have any fair value measurements unrelated to purchase accounting for its non-financial assets and liabilities during the second quarter. Deferred compensation assets and liabilities of $23,830 were acquired in connection with the Valspar acquisition. See Note 3. The following table presents the Company’s financial assets and liabilities that are measured at fair value on a recurring basis, categorized using the fair value hierarchy:
(Thousands of dollars)
 
 
 
 
 
 
 
 
 
 
Quoted Prices
 
 
 
 
 
 
 
in Active
 
 
 
Significant
 
Fair Value at
 
Markets for
 
Significant Other
 
Unobservable
 
June 30,
 
Identical Assets
 
Observable Inputs
 
Inputs
 
2017
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Deferred compensation plan assets (1)
$
53,562

 
$
28,700

 
$
24,862

 

Liabilities:
 
 
 
 
 
 
 
Deferred compensation plan liabilities (2)
$
64,001

 
$
64,001

 

 

 
(1) 
The deferred compensation plan assets consist of the investment funds maintained for the future payments under the Company’s executive deferred compensation plans, which are structured as rabbi trusts. The investments are marketable securities accounted for under the Debt and Equity Securities Topic of the ASC. The level 1 investments are valued using quoted market prices multiplied by the number of shares. The level 2 investments are valued based on vendor or broker models. The cost basis of the investment funds is $49,638.

(2) The deferred compensation plan liabilities are the Company’s liabilities under its executive deferred compensation plan. The liabilities represent the fair value of the participant shadow accounts, and the value is based on quoted market prices.

NOTE 16DEBT
The table below summarizes the carrying amount and fair value of the Company’s publicly traded debt and non-publicly traded debt in accordance with the Fair Value Measurements and Disclosures Topic of the ASC. The fair values of the Company’s publicly traded debt are based on quoted market prices. The fair values of the Company’s non-publicly traded debt are estimated using discounted cash flow analyses, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. The Company’s publicly traded debt and non-publicly traded debt are classified as level 1 and level 2, respectively, in the fair value hierarchy.
(Thousands of dollars)
 
 
 
 
 
 
 
 
June 30, 2017
 
June 30, 2016
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
Publicly traded debt
$
9,448,274

 
$
9,660,353

 
$
1,906,672

 
$
2,021,174

Non-publicly traded debt
2,004,111

 
1,863,095

 
4,724

 
4,451

On June 2, 2017 the Company closed its previously announced exchange offers and consent solicitations (collectively, the "Exchange Offer") for the outstanding senior notes of Valspar. Pursuant to the Exchange Offer, the Company issued an aggregate principal amount of approximately $1.478 billion (collectively the "Exchange Notes"). The Exchange Notes are

20



unsecured senior obligations of the Company. The Company did not receive any cash proceeds from the issuance of the Exchange Notes. The Exchange Notes are summarized in the table below.
(Thousands of dollars)
 
 
 
 
Due Date
 
Principal
7.250% Senior Notes
2019
 
$
277,176

4.200% Senior Notes
2022
 
385,909

3.300% Senior Notes
2025
 
235,324

3.950% Senior Notes
2026
 
331,342

4.400% Senior Notes
2045
 
248,354

 
 
 
$
1,478,105

On May 16, 2017, the Company issued $6.0 billion of senior notes (collectively the "New Notes") in a public offering. The net proceeds from the issuance of the New Notes were used to fund the acquisition of Valspar. The New Notes are summarized in the table below.
(Thousands of dollars)
 
 
 
 
Due Date
 
Principal
2.250% Senior Notes
2020
 
$
1,500,000

2.750% Senior Notes
2022
 
1,250,000

3.125% Senior Notes
2024
 
500,000

3.450% Senior Notes
2027
 
1,500,000

4.500% Senior Notes
2047
 
1,250,000

 
 
 
$
6,000,000

As previously disclosed, the interest rate locks entered into in 2016 settled in March 2017 resulting in a pretax gain of $87.6 million recognized in Cumulative other comprehensive loss. This gain is being amortized from Cumulative other comprehensive loss to a reduction of interest expense over the terms of the New Notes. For the three months ended June 30, 2017, the amortization of the unrealized gain reduced interest expense by $1.0 million.
In April 2016, the Company entered into agreements for a $7.3 billion Bridge Loan and a $2.0 billion Term Loan as committed financing for the Valspar acquisition. See Note 3. On June 1, 2017, the Company terminated the agreement for the Bridge Loan and borrowed the full $2.0 billion on the Term Loan. The Term Loan is pre-payable without penalty and carries a 5 year maturity with a variable interest rate of London Interbank Offered Rate plus an additional 1.25% or approximately 2.36% interest rate for the month of June 2017.
During the first six months of 2017, the Company amended the five-year credit agreement entered into in May 2016 to increase the aggregate availability to $500.0 million. The credit agreement will be used for general corporate purposes. There were no borrowings outstanding under this credit agreement at June 30, 2017.
NOTE 17NON-TRADED INVESTMENTS
The Company has invested in the U.S. affordable housing and historic renovation real estate markets. These non-traded investments have been identified as variable interest entities. However, because 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, 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 carrying amount of the affordable housing and historic renovation investments, included in Other assets, was $212.1 million and $226.3 million at June 30, 2017 and 2016, respectively. The liability for estimated future capital contributions to the investments was $170.4 million and $186.9 million at June 30, 2017 and 2016, respectively.

21



Item 2. MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
SUMMARY
The Sherwin-Williams Company, founded in 1866, and its consolidated wholly owned subsidiaries (collectively, the “Company”) are engaged in the development, manufacture, distribution and sale of paints, 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, Asia and Australia. The Company is structured into three reportable segments—The Americas Group, Consumer Brands Group and Performance 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 Note 14 for more information.
The Company’s financial condition, liquidity and cash flow continued to be strong through the first six months of 2017 primarily due to improved operating results in The Americas and Performance Coatings Groups and lower expenses in the Administrative segment. Net working capital decreased $156.6 million at June 30, 2017 compared to the end of the second quarter of 2016 due to a significant increase in current liabilities partially offset by a significant increase in current assets primarily due to the acquisition of The Valspar Corporation (Valspar or the Acquisition) (see Note 3). Cash and cash equivalents decreased $192.6 million while current portion of long-term debt increased $698.9 million resulting from 1.35% senior notes becoming due in 2017. The Company has been able to arrange sufficient short-term borrowing capacity at reasonable rates, and the Company continues to have sufficient total available borrowing capacity to fund its current operating needs. Net operating cash improved $76.2 million in the first six months of 2017 to a cash source of $586.1 million from a cash source of $510.0 million in 2016.
Consolidated net sales increased 16.0 percent in the second quarter of 2017 to $3.736 billion from $3.220 billion in the second quarter of 2016 and increased 12.1 percent in the first six months of 2017 to $6.497 billion from $5.794 billion. The increase was due primarily to the Acquisition which increased sales 11.8 percent in the second quarter and 6.6 percent in the first six months. In addition, strong paint sales volume in The Americas Group and the impact of a change in revenue classification beginning in the third quarter 2016 related to grossing up third-party service revenue and related costs, which were previously netted and immaterial in prior periods, more than offset a decrease in the Consumer Brands Group. Consolidated gross profit as a percent of consolidated net sales decreased in the second quarter of 2017 to 46.5 percent compared to 2016 at 50.8 percent and decreased in the first six months to 47.4 percent from 50.0 percent due primarily to the Acquisition and related purchase accounting fair value adjustments, the impact of the change in revenue classification and higher raw material costs partially offset by increased paint volume. Selling, general and administrative expenses (SG&A) decreased as a percent of consolidated net sales to 30.7 percent from 32.6 percent in the second quarter of 2016 and decreased to 33.2 percent from 35.3 percent in the first six months primarily due to the impact from Valspar operations in June. Amortization expense increased just over $23 million in both the second quarter and first six months of 2017 versus 2016 due primarily to the Acquisition and related purchase accounting fair value adjustments and one month of amortization expense.
Interest expense increased $15.9 million and $15.8 million, respectively, in the second quarter and first six months of 2017 versus 2016 primarily due to increased debt levels to fund the Acquisition. The effective income tax rate for the second quarter of 2017 was 29.1 percent compared to 29.9 percent in 2016 and the rate for the first six months of 2017 was 26.5 percent compared to 28.1 percent in 2016. The decrease in the effective tax rate for the second quarter and six months of 2017 compared to 2016 was primarily due to the impact of the Acquisition. Excluding the impact of the Acquisition, the effective income tax rate was 28.2 percent and 30.3 percent for the second quarter of 2017 and 2016, respectively, and 26.2 percent and 29.0 percent for the first six months of 2017 and 2016, respectively. Diluted net income per common share in the quarter decreased to $3.36 per share from $3.99 per share in 2016. Diluted net income per common share in six months increased to $5.90 per share from $5.76 per share in 2016. Diluted net income per common share from continuing operations (excluding the $.44 per share charge related to the divestiture) in the quarter and six months was $3.80 and $6.34 per share, respectively. Second quarter and six months 2017 diluted net income per common share include a $.72 and $.80 per share charge, respectively, from Acquisition related costs, inventory purchase accounting adjustment amortization and increased amortization of intangibles. Second quarter and six months 2016 diluted net income per common share included a $.16 and $.40 per share charge from Acquisition costs, respectively.

22



CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation and fair presentation of the consolidated unaudited interim financial statements and accompanying notes included in this report are the responsibility of management. The financial statements and footnotes have been prepared in accordance with U.S. generally accepted accounting principles for interim financial statements and contain certain amounts that were based upon management’s best estimates, judgments and assumptions that were believed to be reasonable under the circumstances. Management considered the impact of the uncertain economic environment and utilized certain outside sources of economic information when developing the basis for their estimates and assumptions. The impact of the global economic conditions on the estimates and assumptions used by management was believed to be reasonable under the circumstances. Management used assumptions based on historical results, considering the current economic trends, and other assumptions to form the basis for determining appropriate carrying values of assets and liabilities that were not readily available from other sources. Actual results could differ from those estimates. Also, materially different amounts may result under materially different conditions, materially different economic trends or from using materially different assumptions. However, management believes that any materially different amounts resulting from materially different conditions or material changes in facts or circumstances are unlikely to significantly impact the current valuation of assets and liabilities that were not readily available from other sources.
A comprehensive discussion of the Company’s critical accounting policies and management estimates and significant accounting policies followed in the preparation of the financial statements is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Note 1, on pages 44 through 48, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. There have been no significant changes in critical accounting policies, management estimates or accounting policies followed since the year ended December 31, 2016. See Note 6 for accounting policy information regarding warranties and deferred revenue related to furniture protection plans for the Acquisition.
FINANCIAL CONDITION, LIQUIDITY AND CASH FLOW
Overview
On June 1, 2017, the Company completed the acquisition of Valspar for a total purchase price of $8.9 billion. On May 16, 2017, the Company issued $6.0 billion of senior notes (collectively the "New Notes") in a public offering. The net proceeds from the issuance of the New Notes were used to fund the Acquisition. In April 2016, the Company entered into a $7.3 billion bridge credit agreement (Bridge Loan) and a $2.0 billion term loan credit agreement (Term Loan) as committed financing for the Acquisition. On June 1, 2017, the Company terminated the agreement for the Bridge Loan and borrowed the full $2.0 billion on the Term Loan. The Company continues to maintain sufficient short-term borrowing capacity at reasonable rates, and the Company has sufficient cash on hand and total available borrowing capacity to fund its current operating needs.
The Acquisition significantly affected the Company’s financial condition, liquidity and cash flow. See Note 3 for a table detailing the Acquisition preliminary opening balance sheet. Net working capital decreased $156.6 million at June 30, 2017 compared to the end of the second quarter of 2016 due to a significant increase in current liabilities partially offset by a significant increase in current assets primarily due to the Acquisition. Cash and cash equivalents decreased $192.6 million while current portion of long-term debt increased $698.9 million resulting from 1.35% senior notes becoming due in 2017. In the first six months of 2017, cash and cash equivalents decreased $679.7 million, accounts receivable increased $1.147 billion and inventories increased $786.6 million when normal seasonal trends typically require significant growth in these categories. Accounts payable increased $749.0 million and other accruals increased $320.0 million, primarily due to Acquisition cost accruals. Short-term borrowings increased $11.2 million. Accrued taxes increased $244.1 million and compensation and taxes withheld liabilities decreased $2.2 million both primarily due to timing of payments. Total debt at June 30, 2017 increased $9.534 billion to $11.504 billion from $1.971 billion at June 30, 2016 and increased as a percentage of total capitalization to 82.8 percent from 61.3 percent at the end of the second quarter last year. Total debt increased $9.552 billion from December 31, 2016 and increased as a percentage of total capitalization from 51.0 percent to 82.8 percent. At June 30, 2017, the Company had remaining short-term borrowing ability of $1.820 billion. Net operating cash improved $76.2 million in the first six months of 2017 to a cash source of $586.1 million from a cash source of $510.0 million in 2016. In the twelve month period from July 1, 2016 through June 30, 2017, the Company generated net operating cash of $1.385 billion.
Net Working Capital, Debt and Other Long-Term Assets and Liabilities
Cash and cash equivalents decreased $679.7 million during the first six months of 2017. Cash and cash equivalents on hand funded cash requirements for increased sales and normal seasonal increases in working capital, capital expenditures of $83.6 million, and payments of cash dividends of $158.9 million. At June 30, 2017, the Company’s current ratio was 1.17 compared to 1.28 at December 31, 2016 and 1.33 a year ago.

23



Goodwill and intangible assets increased $11.799 billion from December 31, 2016 and increased $11.789 billion from June 30, 2016. The net increase during the first six months of 2017 was primarily due to the Acquisition and capitalized software additions of $11.838 billion and $6.0 million, respectively, partially offset by amortization of $35.1 million and foreign currency translation of $9.9 million. The net increase over the twelve month period from June 30, 2016 was primarily due to the Acquisition and capitalized software additions of $11.839 billion and $27.3 million, respectively, partially offset by amortization of $49.4 million, goodwill impairment of $10.7 million and foreign currency translation of $17.5 million. Based on the preliminary purchase accounting, goodwill of $4.6 billion and $1.5 billion was recognized in the Performance Coatings Group and the Consumer Brands Group, respectively. See Note 4, on pages 49 and 50, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 for more information concerning goodwill and intangible assets.
Deferred pension assets decreased $0.8 million during the first six months of 2017 and decreased $21.4 million from June 30, 2016. The decrease in the last twelve months was due to increased pension benefit obligations, primarily due to changes in actuarial assumptions, and a decrease in the fair value of plan assets. See Note 6, on pages 54 through 59, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 for more information concerning the Company’s benefit plan assets.
Other assets at June 30, 2017 increased $146.2 million in the first six months of 2017 and increased $96.5 million from a year ago primarily due to the reclass of current deferred tax assets to non-current due to the adoption of ASU No. 2015-17. See Note 2.
Net property, plant and equipment increased $794.0 million in the first six months of 2017 and increased $817.7 million in the twelve months since June 30, 2016. The increase in the first six months was primarily due to acquired property plant and equipment of $824.8 million, capital expenditures of $83.6 million and changes in currency translation rates of $18.1 million, partially offset by depreciation expense of $95.0 million and sale or disposition of fixed assets of $37.6 million. Since June 30, 2016, acquired property plant and equipment of $824.8 million, capital expenditures of $208.6 million and changes in currency translation rates of $8.5 million were partially offset by depreciation expense of $180.3 million and sale or disposition of fixed assets of $43.7 million. Capital expenditures during the first six months of 2017 primarily represented expenditures associated with improvements and normal equipment replacement in manufacturing and distribution facilities in the Consumer Brands Group, normal equipment replacement in The Americas and Performance Coatings Groups, and information systems hardware in the Administrative Segment.
On June 2, 2017 the Company closed its previously announced exchange offers and consent solicitations (collectively, the "Exchange Offer") for the outstanding senior notes of Valspar. Pursuant to the Exchange Offer, the Company issued an aggregate principal amount of approximately $1.478 billion (collectively the "Exchange Notes"). On May 16, 2017, the Company issued $6.0 billion of senior notes (collectively the "New Notes") in a public offering. The net proceeds from the issuance of the New Notes were used to fund the Acquisition. As previously disclosed, the interest rate locks entered into in 2016 settled in March 2017 resulting in a pretax gain of $87.6 million recognized in Cumulative other comprehensive loss. This gain is being amortized from Cumulative other comprehensive loss to a reduction of interest expense over the terms of the New Notes. For the three months ended June 30, 2017, the amortization of the unrealized gain reduced interest expense by $1.0 million. The Company expects to amortize unrealized gains of $8.3 million from Cumulative other comprehensive loss to Interest expense during the next twelve months. In April 2016, the Company entered into agreements for a $7.3 billion Bridge Loan and a $2.0 billion Term Loan as committed financing for the Acquisition. On June 1, 2017, the Company terminated the agreement for the Bridge Loan and borrowed the full $2.0 billion on the Term Loan.
In May 2016 and subsequently amended in 2017, the Company entered into a five-year $500.0 million credit agreement. The credit agreement will be used for general corporate purposes. There were no borrowings outstanding under this credit agreement at June 30, 2017. See Note 7, on pages 60 and 61, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 for more information concerning the Company’s debt.
At June 30, 2017, there were no borrowings outstanding under the commercial paper program, and short-term borrowings under the Company's global five-year $1.350 billion credit agreement were $30.2 million with a weighted average interest rate of 1.4 percent. Short-term borrowings under various other foreign programs were $21.7 million with a weighted average interest rate of 9.7 percent. The Company had unused capacity of $1.320 billion at June 30, 2017 under the credit agreement.
Long-term liabilities for postretirement benefits other than pensions did not change significantly from December 31, 2016 and June 30, 2016. See Note 6, on pages 54 through 59, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 for more information concerning the Company’s benefit plan obligations.
Deferred income taxes at June 30, 2017 increased $2.394 billion in the first six months of 2017 and increased $2.336 billion from a year ago primarily due to increased deferred tax liabilities as a result of the Acquisition.

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Environmental-Related Liabilities
The operations of the Company, like those of other companies in the same industry, are subject to various federal, state and local environmental laws and regulations. These laws and regulations not only govern current operations and products, but also impose potential liability on the Company for past operations. Management expects environmental laws and regulations to impose increasingly stringent requirements upon the Company and the industry in the future. Management believes that the Company conducts its operations in compliance with applicable environmental laws and regulations and has implemented various programs designed to protect the environment and promote continued compliance.
Depreciation of capital expenditures and other expenses related to ongoing environmental compliance measures were included in the normal operating expenses of conducting business. The Company’s capital expenditures, depreciation and other expenses related to ongoing environmental compliance measures were not material to the Company’s financial condition, liquidity, cash flow or results of operations during the first six months of 2017. 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 2017. See Note 9 for further information on environmental-related long-term liabilities.
Contractual Obligations, Commercial Commitments and Warranties
Short-term borrowings increased $11.2 million to $51.9 million at June 30, 2017 from $40.7 million at December 31, 2016. Total long-term debt increased $9.541 billion to $11.452 billion at June 30, 2017 from $1.912 billion at December 31, 2016, and increased $9.541 billion from $1.911 billion at June 30, 2016.
On June 1, 2017, the Company completed the Acquisition. As of December 31, 2016, Valspar had marketing commitments and operating leases of $199.3 million and $128.6 million, respectively. There have been no other significant changes to the Company’s contractual obligations and commercial commitments in the second quarter of 2017 as summarized in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.
Changes to the Company’s accrual for product warranty claims in the first six months of 2017 are disclosed in Note 6.
Litigation
See Note 10 for information concerning litigation.
Shareholders’ Equity
Shareholders’ equity increased $512.8 million to $2.391 billion at June 30, 2017 from $1.878 billion at December 31, 2016 and increased $1.145 billion from $1.247 billion at June 30, 2016. The increase in Shareholders’ equity for the first six months of 2017 resulted primarily from net income of $558.3 million, an increase in Other capital of $118.2 million resulting primarily from stock option exercises, and a decrease in Cumulative other comprehensive loss of $21.1 million, partially offset by cash dividends paid on common stock of $158.9 million. Since June 30, 2016, net income of $1.148 billion, an increase in Other capital of $194.2 million, and a decrease in Cumulative other comprehensive loss of $142.9 million more than offset cash dividends paid on common stock of $315.3 million in twelve months. During the first six months of 2017 and fiscal year 2016, the Company did not purchase any shares of its common stock for treasury purposes through open market purchases. 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. The Company had remaining authorization at June 30, 2017 to purchase 11.65 million shares of its common stock. In February 2017, the Board of Directors increased the quarterly cash dividend from $.84 per common share to $.85 per common share. This quarterly dividend will result in an annual dividend for 2017 of $3.40 per common share or a 28.4 percent payout of 2016 diluted net income per common share.
Cash Flow
Net operating cash improved $76.2 million in the first six months of 2017 to a cash source of $586.1 million from a cash source of $510.0 million in 2016 primarily due to cash generated from increased net income from continuing operations and cash received of $87.6 million for the settlement of the interest rate lock agreements. Net investing cash usage increased $8.715 billion in the first six months of 2017 to a usage of $8.864 billion from a usage of $149.0 million in 2016 primarily due to the completion of the Acquisition. Net financing cash sources increased $7.775 billion to a source of $7.604 billion in the first six months of 2017 from a usage of $170.9 million in 2016 primarily due to proceeds from long-term debt (see Note 16). In the twelve month period from July 1, 2016 through June 30, 2017, the Company generated net operating cash of $1.385 billion, used $9.019 billion in investing activities and generated $7.467 billion in financing activities.

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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 believes it may be exposed to continuing market risk from foreign currency exchange rate and commodity price fluctuations. However, the Company does not expect that foreign currency exchange rate and commodity price fluctuations or hedging contract losses will have a material adverse effect on the Company’s financial condition, results of operations or cash flows.
Financial Covenant
Certain borrowings contain a consolidated leverage covenant. The covenant states that upon close of the Acquisition, the Company’s leverage ratio is not to exceed 5.25 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 pro forma “Earnings Before Interest, Taxes, Depreciation, and Amortization” (EBITDA) for the combined companies for the twelve month period ended on the same date. Refer to the “Results of Operations” caption below for a reconciliation of EBITDA to Net income. At June 30, 2017, the Company was in compliance with the covenant. The Company’s Notes, Debentures and revolving credit agreements 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 pages 60 and 61, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 for more information concerning the Company’s debt and related covenant.
RESULTS OF OPERATIONS
Shown below are net sales and income before taxes by segment for the second quarter:
(Thousands of dollars)
Three Months Ended
June 30,
 
 
 
Six Months Ended
June 30,
 
 
 
2017
 
2016
 
Change
 
2017
 
2016
 
Change
Net Sales: