EX-13 7 shw-12312017xex13.htm EXHIBIT 13 Exhibit
Exhibit 13
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FINANCIAL PERFORMANCE

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FINANCIAL TABLE OF CONTENTS
 
Financial Summary
 
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
Reports of Management and the Independent Registered Public Accounting Firm
 
 
Consolidated Financial Statements and Notes
 
 
Cautionary Statement Regarding Forward-Looking Information
 
 
Shareholder Information
 
 
Corporate Officers and Operating Management

17


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

 
2017
 
2016
 
2015
 
2014
 
2013
Operations
 
 
 
 
 
 
 
 
 
Net sales (1)
$
14,984

 
$
11,856

 
$
11,339

 
$
11,130

 
$
10,186

Cost of goods sold
8,203

 
5,933

 
5,780

 
5,965

 
5,569

Selling, general and administrative expenses
4,785

 
4,159

 
3,914

 
3,823

 
3,468

Amortization
207

 
26

 
28

 
30

 
29

Interest expense
263

 
154

 
62

 
64

 
63

Income from continuing operations before income taxes (2)
1,528

 
1,595

 
1,549

 
1,258

 
1,086

Net income from continuing operations (3)
1,814

 
1,133

 
1,054

 
866

 
753

Financial Position
 
 
 
 
 
 
 
 
 
Accounts receivable - net
$
2,105

 
$
1,231

 
$
1,114

 
$
1,131

 
$
1,098

Inventories
1,801

 
1,068

 
1,019

 
1,034

 
971

Working capital - net
479

 
798

 
515

 
(115
)
 
630

Property, plant and equipment - net
1,877

 
1,096

 
1,042

 
1,021

 
1,021

Total assets
19,958

 
6,753

 
5,779

 
5,699

 
6,383

Long-term debt
9,886

 
1,211

 
1,907

 
1,116

 
1,122

Total debt
10,521

 
1,953

 
1,950

 
1,799

 
1,722

Shareholders’ equity
3,692

 
1,878

 
868

 
996

 
1,775

Per Common Share Information
 
 
 
 
 
 
 
 
 
Average shares outstanding (thousands)
92,909

 
91,839

 
92,197

 
96,190

 
100,898

Book value
$
39.33

 
$
20.20

 
$
9.41

 
$
10.52

 
$
17.72

Net income from continuing operations - diluted (4)
19.11

 
11.99

 
11.15

 
8.77

 
7.25

Cash dividends
3.40

 
3.36

 
2.68

 
2.20

 
2.00

Financial Ratios
 
 
 
 
 
 
 
 
 
Return on sales
12.1
%
 
9.6
%
 
9.3
%
 
7.8
 %
 
7.4
%
Asset turnover
0.8
x
 
1.8
x
 
2.0
x
 
2.0
x
 
1.6
x
Return on assets
9.1
%
 
16.8
%
 
18.2
%
 
15.2
 %
 
11.8
%
Return on equity (5)
96.6
%
 
130.5
%
 
105.8
%
 
48.8
 %
 
42.0
%
Dividend payout ratio (6)
28.4
%
 
30.1
%
 
30.6
%
 
30.3
 %
 
33.2
%
Total debt to capitalization
74.0
%
 
51.0
%
 
69.2
%
 
64.4
 %
 
49.2
%
Current ratio
1.1

 
1.3

 
1.2

 
1.0

 
1.2

Interest coverage (7)
6.8
x
 
11.4
x
 
26.1
x
 
20.6
x
 
18.3
x
Net working capital to sales
3.2
%
 
6.7
%
 
4.5
%
 
(1.0
)%
 
6.2
%
Effective income tax rate (8)
25.1
%
 
29.0
%
 
32.0
%
 
31.2
 %
 
30.7
%
General
 
 
 
 
 
 
 
 
 
Earnings before interest, taxes, depreciation and amortization
$
2,283

 
$
1,947

 
$
1,809

 
$
1,521

 
$
1,336

Capital expenditures
223

 
239

 
234

 
201

 
167

Total technical expenditures (see Note 1)
216

 
153

 
150

 
155

 
144

Advertising expenditures
383

 
351

 
338

 
299

 
263

Repairs and maintenance
116

 
100

 
99

 
96

 
87

Depreciation
285

 
172

 
170

 
169

 
159

Shareholders of record (total count)
6,470

 
6,787

 
6,987

 
7,250

 
7,555

Number of employees (total count)
52,695

 
42,550

 
40,706

 
39,674

 
37,633

Sales per employee (thousands of dollars)
$
284

 
$
279

 
$
279

 
$
281

 
$
271

Sales per dollar of assets
0.75

 
1.76

 
1.96

 
1.95

 
1.60

(1) 
2017 includes Valspar sales since June 1, 2017.
(2) 
2017 includes acquisition and purchase accounting adjustments of $429.5 million and contribution from Valspar operations of $115.8 million. 2016 includes acquisition-related costs of $133.6 million.
(3) 
2017 includes the following: (a) one-time income tax benefit of $668.8 million from Deferred income tax reductions (see Note 14), (b) after-tax acquisition-related costs and purchase accounting adjustments of $285.1 million, and (c) after-tax contribution from Valspar operations of $76.0 million. 2016 includes after-tax acquisition-related costs of $81.5 million.
(4) 
2017 includes the following: (a) one-time benefit of $7.04 per share from Deferred income tax reductions, (b) charge of $3.00 per share for acquisition-related costs and purchase accounting impacts, and (c) $.80 per share contribution from Valspar operations. 2016 includes a charge of $.86 per share for acquisition-related costs.
(5) 
Based on net income and shareholders' equity at beginning of year.
(6) 
Based on cash dividends per common share and prior year's diluted net income per common share.
(7) 
Ratio of income before income taxes and interest expense to interest expense.
(8) 
Based on income from continuing operations before income taxes. 2017 excludes impact of one-time income tax benefit from the Deferred income tax reductions.


18 

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

SUMMARY
The Sherwin-Williams Company, founded in 1866, and its consolidated wholly owned subsidiaries (collectively, the Company) are engaged in the development, manufacture, distribution and sale of paint, coatings and related products to professional, industrial, commercial and retail customers primarily in North and South America with additional operations in the Caribbean region, Europe, Asia and Australia. On June 1, 2017, the Company completed the acquisition (Acquisition) of The Valspar Corporation (Valspar) (See Note 2) for a total purchase price of $8.939 billion, which significantly affected the existing business. As of the close of the Acquisition, our reporting segments changed to better reflect the operations of the combined Companies. 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 pages 8 through 15 of this report and Note 18, on pages 74 through 77 of this report, for more information concerning the Reportable Segments.
The Company’s financial condition, liquidity and cash flow continued to be strong in 2017 as net operating cash topped $1.000 billion for the fifth straight year primarily due to improved operating results in The Americas Group. Net working capital decreased $319.5 million at December 31, 2017 compared to 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 $685.6 million, while the current portion of long-term debt decreased $699.3 million resulting from the payment of 1.35% senior notes maturing in 2017. On May 16, 2017, in order to fund the Acquisition, the Company issued $6.000 billion of senior notes in a public offering. In April 2016, the Company entered into agreements for a $7.300 billion Bridge Loan and a $2.000 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 $2.000 billion on the Term Loan. As of December 31, 2017, the Term Loan had an outstanding balance of $850.0 million at an approximate interest rate of 2.62 percent. Total debt issuance costs related to all of the facilities of $63.6 million were incurred and recorded in Long-Term Debt as a reduction to the outstanding balances. Of this amount, $8.3 million was amortized and included in Interest expense for the year ended December 31, 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 increased $575.4 million in 2017 to a cash source of $1.884 billion from a cash source of $1.309 billion in 2016.
 
Strong net operating cash provided the funds necessary to acquire Valspar, invest in new stores, manufacturing and distribution facilities, return cash to shareholders through dividends, and pay down debt.
Consolidated net sales increased 26.4 percent in 2017 to $14.984 billion from $11.856 billion in 2016. The increase was due primarily to higher paint sales volume in The Americas Group and the addition of Valspar sales beginning in June. Excluding sales from Valspar, net sales from core Sherwin-Williams operations increased 5.6 percent during 2017. The increase in core operations was primarily due to increased sales volumes and pricing in The Americas Group and Performance Coatings Group partially offset by lower sales volumes in the Consumer Brands Group. Consolidated gross profit as a percent of consolidated net sales decreased to 45.3 percent in 2017 compared to 50.0 percent in 2016 due primarily to the Acquisition and related inventory purchase accounting adjustments and higher raw material costs, partially offset by increased paint volume. Selling, general and administrative expenses (SG&A) increased $650.9 million in 2017 compared to 2016 and decreased as a percent of consolidated net sales to 31.9 percent in 2017 from 34.9 percent in 2016 primarily due to the impact from Valspar operations. Amortization expense increased $181.4 million to $206.8 million in 2017 versus 2016 due primarily to the Acquisition and related purchase accounting fair value adjustments.
Interest expense increased $109.4 million in 2017 versus 2016 primarily due to increased debt levels to fund the Acquisition. Excluding the income tax benefit of $668.8 million from the Tax Cuts and Jobs Act of 2017 (Tax Act) and subsidiary mergers (collectively, Deferred income tax reductions), the effective income tax rate for income from continuing operations was 25.1 percent for 2017 and 29.0 percent for 2016. See Note 14 on pages 70 through 72 for more information on Income taxes. The Company also 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 and reduced diluted net income per common share by $.44 per share. See Notes 1 and 14 for more information. Diluted net income per common share increased 55.7 percent to $18.67 per share for 2017 from $11.99 per share in 2016. Diluted net income per common share from continuing operations was $19.11 per share in 2017, including a one-time benefit of $7.04 per share from the Deferred income tax reductions. Diluted net income per common share for 2017 was decreased by charges of $3.00 per share from Acquisition costs, including inventory purchase accounting adjustments and increased amortization of intangible assets. Valspar operations increased Diluted net income per common share by $.80 per share for 2017, including a $.92 per share charge from interest expense on new debt. Diluted net income per common share for

19

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

2016 was decreased by charges of $.86 per share from Acquisition costs. Currency translation rate changes did not have a significant impact on diluted net income per common share in 2017.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation and fair presentation of the consolidated financial statements, accompanying notes and related financial information included in this report are the responsibility of management. The consolidated financial statements, accompanying notes and related financial information included in this report have been prepared in accordance with U.S. generally accepted accounting principles. The consolidated financial statements contain certain amounts that were based upon management’s best estimates, judgments and assumptions that were believed to be reasonable under the circumstances. Management considered the impact of the uncertain economic environment and utilized certain outside sources of economic information when developing the basis for their estimates and assumptions. The impact of the global economic conditions on the estimates and assumptions used by management was believed to be reasonable under the circumstances. Management used assumptions based on historical results, considering the current economic trends, and other assumptions to form the basis for determining appropriate carrying values of assets and liabilities that were not readily available from other sources. Actual results could differ from those estimates. Also, materially different amounts may result under materially different conditions, materially different economic trends or from using materially different assumptions. However, management believes that any materially different amounts resulting from materially different conditions or material changes in facts or circumstances are unlikely to significantly impact the current valuation of assets and liabilities that were not readily available from other sources.
All of the significant accounting policies that were followed in the preparation of the consolidated financial statements are disclosed in Note 1, on pages 46 through 50, of this report. The following procedures and assumptions utilized by management directly impacted many of the reported amounts in the consolidated financial statements.
Non-Traded Investments
The Company has investments in the U.S. affordable housing and historic renovation real estate markets and certain other investments that have been identified as variable interest entities. The Company does not have the power to direct the day-to-day operations of the investments and the risk of loss is limited to the amount of contributed capital, and therefore, the Company is not considered the primary beneficiary. In accordance with the Consolidation Topic of the ASC, the
 
investments are not consolidated. For affordable housing investments entered into prior to the January 1, 2015 adoption of ASU No. 2014-01, the Company uses the effective yield method to determine the carrying value of the investments. Under the effective yield method, the initial cost of the investments is amortized to income tax expense over the period that the tax credits are recognized. For affordable housing investments entered into on or after the January 1, 2015 adoption of ASU No. 2014-01, the Company uses the proportional amortization method. Under the proportional amortization method, the initial cost of the investments is amortized to income tax expense in proportion to the tax credits and other tax benefits received. The Company has no ongoing capital commitments, loan requirements or guarantees with the general partners that would require any future cash contributions other than the contractually committed capital contributions that are disclosed in the contractual obligations table on page 27 of this report. See Note 1, on page 46 of this report, for more information on non-traded investments.
Accounts Receivable
Accounts receivable were recorded at the time of credit sales net of provisions for sales returns and allowances. All provisions for allowances for doubtful collection of accounts are included in Selling, general and administrative expenses and were based on management’s best judgment and assessment, including an analysis of historical bad debts, a review of the aging of Accounts receivable and a review of the current creditworthiness of customers. Management recorded allowances for such accounts which were believed to be uncollectible, including amounts for the resolution of potential credit and other collection issues such as disputed invoices, customer satisfaction claims and pricing discrepancies. However, depending on how such potential issues are resolved, or if the financial condition of any of the Company’s customers were to deteriorate and their ability to make required payments became impaired, increases in these allowances may be required. At December 31, 2017, no individual customer constituted more than 5 percent of Accounts receivable.
Inventories
Inventories were stated at the lower of cost or market with cost determined principally on the last-in, first-out (LIFO) method based on inventory quantities and costs determined during the fourth quarter. Inventory quantities were adjusted during the fourth quarter as a result of annual physical inventory counts taken at all locations. If inventories accounted for on the LIFO method are reduced on a year-over-year basis, then liquidation of certain quantities carried at costs prevailing in prior years occurs. Management recorded the best estimate of net realizable value for obsolete and discontinued inventories based on historical experience and current trends through reductions to inventory cost by recording a provision included in

20 

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

Cost of goods sold. Where management estimated that the reasonable market value was below cost or determined that future demand was lower than current inventory levels, based on historical experience, current and projected market demand, current and projected volume trends and other relevant current and projected factors associated with the current economic conditions, a reduction in inventory cost to estimated net realizable value was made. See Note 3, on page 51 of this report, for more information regarding the impact of the LIFO inventory valuation.
Purchase Accounting, Goodwill and Intangible Assets
In accordance with the Business Combinations Topic of the ASC, the Company used the purchase method of accounting to allocate costs of acquired businesses to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. The excess costs of acquired businesses over the fair values of the assets acquired and liabilities assumed were recognized as Goodwill. The valuations of the acquired assets and liabilities will impact the determination of future operating results. In addition to using management estimates and negotiated amounts, the Company used a variety of information sources to determine the estimated fair values of acquired assets and liabilities including: third-party appraisals for the estimated value and lives of identifiable intangible assets and property, plant and equipment; third-party actuaries for the estimated obligations of defined benefit pension plans and similar benefit obligations; and legal counsel or other experts to assess the obligations associated with legal, environmental and other contingent liabilities. The business and technical judgment of management was used in determining which intangible assets have indefinite lives and in determining the useful lives of finite-lived intangible assets in accordance with the Goodwill and Other Intangibles Topic of the ASC.
As required by the Goodwill and Other Intangibles Topic of the ASC, management performs impairment tests of goodwill and indefinite-lived intangible assets on an annual basis, as well as whenever an event occurs or circumstances change that indicate impairment has more likely than not occurred. An optional qualitative assessment allows companies to skip the annual two-step quantitative test if it is not more likely than not that impairment has occurred based on monitoring key Company financial performance metrics and macroeconomic conditions. The qualitative assessment is performed when deemed appropriate.
In accordance with the Goodwill and Other Intangibles Topic of the ASC, management tests goodwill for impairment at the reporting unit level. A reporting unit is an operating segment per the Segment Reporting Topic of the ASC or one level below the operating segment (component level) as determined by the
 
availability of discrete financial information that is regularly reviewed by operating segment management or an aggregate of component levels of an operating segment having similar economic characteristics. At the time of goodwill impairment testing (if performing a quantitative assessment), management determines fair value through the use of a discounted cash flow valuation model incorporating discount rates commensurate with the risks involved for each reporting unit. If the calculated fair value is less than the current carrying value, then impairment of the reporting unit exists. The use of a discounted cash flow valuation model to determine estimated fair value is common practice in impairment testing. The key assumptions used in the discounted cash flow valuation model for impairment testing include discount rates, growth rates, cash flow projections and terminal value rates. Discount rates are set by using the Weighted Average Cost of Capital (“WACC”) methodology. The WACC methodology considers market and industry data as well as Company-specific risk factors for each reporting unit in determining the appropriate discount rates to be used. The discount rate utilized for each reporting unit is indicative of the return an investor would expect to receive for investing in such a business. Operational management, considering industry and Company-specific historical and projected data, develops growth rates, sales projections and cash flow projections for each reporting unit. Terminal value rate determination follows common methodology of capturing the present value of perpetual cash flow estimates beyond the last projected period assuming a constant WACC and low long-term growth rates. As an indicator that each reporting unit has been valued appropriately through the use of the discounted cash flow valuation model, the aggregate of all reporting units' fair value is reconciled to the total market capitalization of the Company.
The Company had six components, some of which are aggregated due to similar economic characteristics, to form three reporting units (also the operating segments) with goodwill as of October 1, 2017, the date of the annual impairment test. The annual impairment review performed as of October 1, 2017 did not result in any of the reporting units having impairment or deemed at risk for impairment.
In accordance with the Goodwill and Other Intangibles Topic of the ASC, management tests indefinite-lived intangible assets for impairment at the asset level, as determined by appropriate asset valuations at acquisition. Management utilizes the royalty savings method and valuation model to determine the estimated fair value for each indefinite-lived intangible asset or trademark. In this method, management estimates the royalty savings arising from the ownership of the intangible asset. The key assumptions used in estimating the royalty savings for impairment testing include discount rates, royalty rates, growth rates, sales projections and terminal value rates. Discount rates

21

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

used are similar to the rates developed by the WACC methodology considering any differences in Company-specific risk factors between reporting units and trademarks. Royalty rates are established by management and valuation experts and periodically substantiated by valuation experts. Operational management, considering industry and Company-specific historical and projected data, develops growth rates and sales projections for each significant trademark. Terminal value rate determination follows common methodology of capturing the present value of perpetual sales estimates beyond the last projected period assuming a constant WACC and low long-term growth rates. The royalty savings valuation methodology and calculations used in 2017 impairment testing are consistent with prior years. The annual impairment review performed as of October 1, 2017 resulted in an impairment of a trademark in The Americas Group of $2.0 million.
The discounted cash flow and royalty savings valuation methodologies require management to make certain assumptions based upon information available at the time the valuations are performed. Actual results could differ from these assumptions. Management believes the assumptions used are reflective of what a market participant would have used in calculating fair value considering the current economic conditions. See Note 4, on pages 51 through 52 of this report, for a discussion of goodwill and intangible assets and the impairment tests performed in accordance with the Goodwill and Other Intangibles Topic of the ASC.
Property, Plant and Equipment and Impairment of Long-Lived Assets
Property, plant and equipment was stated on the basis of cost and depreciated principally on a straight-line basis using industry standards and historical experience to estimate useful lives. In accordance with the Property, Plant and Equipment Topic of the ASC, if events or changes in circumstances indicated that the carrying value of long-lived assets may not be recoverable or the useful life had changed, impairment tests were performed or the useful life was adjusted. Undiscounted future cash flows were used to calculate the recoverable value of long-lived assets to determine if such assets were impaired. Where impairment was identified, management determined fair values for assets using a discounted cash flow valuation model, incorporating discount rates commensurate with the risks involved for each group of assets. Growth models were developed using both industry and Company historical results and forecasts. If the usefulness of an asset was determined to be impaired, then management estimated a new useful life based on the period of time for projected uses of the asset. Such models and changes in useful life required management to make certain assumptions based upon information available at the time the
 
valuation or determination was performed. Actual results could differ from these assumptions. Management believes the assumptions used are reflective of what a market participant would have used in calculating fair value or useful life considering the current economic conditions. All tested long-lived assets or groups of long-lived assets had undiscounted cash flows that were substantially in excess of their carrying value. See Notes 4 and 5, on pages 51 through 54 of this report, for a discussion of the reductions in carrying value or useful life of long-lived assets in accordance with the Property, Plant and Equipment Topic of the ASC.
Exit or Disposal Activities
Management is continually re-evaluating the Company’s operating facilities against its long-term strategic goals. Liabilities associated with exit or disposal activities are recognized as incurred in accordance with the Exit or Disposal Cost Obligations Topic of the ASC and property, plant and equipment is tested for impairment in accordance with the Property, Plant and Equipment Topic of the ASC. Provisions for qualified exit costs are made at the time a facility is no longer operational, include amounts estimated by management and primarily include post-closure rent expenses or costs to terminate the contract before the end of its term and costs of employee terminations. Adjustments may be made to liabilities accrued for qualified exit costs if information becomes available upon which more accurate amounts can be reasonably estimated. If impairment of property, plant and equipment exists, then the carrying value is reduced to fair value estimated by management. Additional impairment may be recorded for subsequent revisions in estimated fair value. See Note 5, on pages 52 through 54 of this report, for information concerning impairment of property, plant and equipment and accrued qualified exit costs.

Other Liabilities
The Company retains risk for certain liabilities, primarily worker’s compensation claims, employee medical benefits, and automobile, property, general and product liability claims. Estimated amounts were accrued for certain worker’s compensation, employee medical and disability benefits, automobile and property claims filed but unsettled and estimated claims incurred but not reported based upon management’s estimated aggregate liability for claims incurred using historical experience, actuarial assumptions followed in the insurance industry and actuarially-developed models for estimating certain liabilities. Certain estimated general and product liability claims filed but unsettled were accrued based on management’s best estimate of ultimate settlement or actuarial calculations of

22 

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

potential liability using industry experience and actuarial assumptions developed for similar types of claims.
Defined Benefit Pension and Other Postretirement Benefit Plans
To determine the Company’s ultimate obligation under its defined benefit pension plans and postretirement benefit plans other than pensions, management must estimate the future cost of benefits and attribute that cost to the time period during which each covered employee works. To determine the obligations of such benefit plans, management uses actuaries to calculate such amounts using key assumptions such as discount rates, inflation, long-term investment returns, mortality, employee turnover, rate of compensation increases and medical and prescription drug costs. Management reviews all of these assumptions on an ongoing basis to ensure that the most current information available is being considered. An increase or decrease in the assumptions or economic events outside management’s control could have a direct impact on the Company’s results of operations or financial condition.
In accordance with the Retirement Benefits Topic of the ASC, the Company recognizes each plan’s funded status as an asset for overfunded plans and as a liability for unfunded or underfunded plans. Actuarial gains and losses and prior service costs are recognized and recorded in Cumulative other comprehensive loss, a component of Shareholders’ equity. The amounts recorded in Cumulative other comprehensive loss will continue to be modified as actuarial assumptions and service costs change, and all such amounts will be amortized to expense over a period of years through the net pension and net periodic benefit costs.
Pension costs for 2018 are expected to decrease due to higher expected return on plan assets and decreased amortization of net actuarial losses. Postretirement benefit plan costs for 2018 are expected to increase primarily due to higher service and interest costs. See Note 6, on pages 55 through 60 of this report, for information concerning the Company’s defined benefit pension plans and postretirement benefit plans other than pensions.
Debt
The fair values of the Company’s publicly traded long-term debt were based on quoted market prices. The fair values of the Company’s non-traded long-term debt were estimated using discounted cash flow analyses, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. See Note 1, on page 46 of this report, for the carrying amounts and fair values of the Company’s long-term debt, and Note 7, on pages 61 through 62 of this report, for a description of the Company’s long-term debt arrangements.
 
Environmental Matters
The Company is involved with environmental investigation and remediation activities at some of its currently and formerly owned sites and at a number of third-party sites. The Company accrues for environmental-related activities for which commitments or clean-up plans have been developed and for which costs can be reasonably estimated based on industry standards and professional judgment. All accrued amounts were recorded on an undiscounted basis. Environmental-related expenses included direct costs of investigation and remediation and indirect costs such as compensation and benefits for employees directly involved in the investigation and remediation activities and fees paid to outside engineering, actuarial, consulting and law firms. Due to uncertainties surrounding environmental investigations and remediation activities, the Company’s ultimate liability may result in costs that are significantly higher than currently accrued. See page 27 and Note 8, on pages 62 through 63 of this report, for information concerning the accrual for extended environmental-related activities and a discussion concerning unaccrued future loss contingencies.
Litigation and Other Contingent Liabilities
In the course of its business, the Company is subject to a variety of claims and lawsuits, including, but not limited to, litigation relating to product liability and warranty, personal injury, environmental, intellectual property, commercial, contractual and antitrust claims. Management believes that the Company has properly accrued for all known liabilities that existed and those where a loss was deemed probable for which a fair value was available or an amount could be reasonably estimated in accordance with all present U.S. generally accepted accounting principles. However, because litigation is inherently subject to many uncertainties and the ultimate result of any present or future litigation is unpredictable, the Company’s ultimate liability may result in costs that are significantly higher than currently accrued. In the event that the Company’s loss contingency is ultimately determined to be significantly higher than currently accrued, the recording of the liability may result in a material impact on net income for the annual or interim period during which such liability is accrued. Additionally, due to the uncertainties involved, any potential liability determined to be attributable to the Company arising out of such litigation may have a material adverse effect on the Company’s results of operations, liquidity or financial condition. See Note 9 on pages 63 through 66 of this report for information concerning litigation.
Income Taxes
The Company estimated income taxes in each jurisdiction that it operated. This involved estimating taxable earnings,

23

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

specific taxable and deductible items, the likelihood of generating sufficient future taxable income to utilize deferred tax assets and possible exposures related to future tax audits. To the extent these estimates change, adjustments to deferred and accrued income taxes will be made in the period in which the changes occur.
On December 22, 2017, the Tax Act was enacted. The Tax Act significantly revised the U.S. corporate income tax system by, among other things, lowering corporate income tax rates from 35% to 21%, implementing a territorial tax system and imposing a repatriation tax on deemed repatriated earnings of foreign subsidiaries. Staff Accounting Bulletin (SAB) No. 118 provides a measurement period that should not extend beyond one year from the enactment date for companies to complete the accounting under the Tax Act. In accordance with SAB No. 118, based on the information available as of December 31, 2017, the Company recorded provisional decreases in deferred tax liabilities which increased earnings for the year ended December 31, 2017. The majority of this benefit was driven by the effects of the implementation of the territorial tax system and the remeasurement of U.S. deferred tax liabilities on unremitted foreign earnings. The final impact of the Tax Act may differ from the provisional amounts recorded at December 31, 2017 due to changes in the Company's current interpretations and assumptions, clarification and implementation guidance that may be issued and actions the Company may take as a result of the Tax Act. See Note 14, on pages 70 through 72 of this report, for more information.
Stock-Based Compensation
The cost of the Company’s stock-based compensation is recorded in accordance with the Stock Compensation Topic of the ASC. The Company estimates the fair value of option rights using a Black-Scholes-Merton option pricing model which requires management to make estimates for certain assumptions. Management and a consultant continuously review the following significant assumptions: risk-free interest rate, expected life of options, expected volatility of stock and expected dividend yield of stock. An increase or decrease in the assumptions or economic events outside management’s control could have a direct impact on the Company’s results of operations. See Note 12, on pages 68 and 69 of this report, for more information on stock-based compensation.
Revenue Recognition
The Company’s revenue was primarily generated from the sale of products. All sales of products were recognized when shipped and title passed to unaffiliated customers. Collectibility of amounts recorded as revenue is reasonably assured at time of sale. Discounts were recorded as a reduction to sales in the same period as the sale resulting in an appropriate net sales amount for the period. Standard sales terms are final and returns or exchanges are not permitted unless expressly stated. Estimated
 
provisions for returns or exchanges, recorded as a reduction resulting in net sales, were established in cases where the right of return existed. The Company offered a variety of programs, primarily to its retail customers, designed to promote sales of its products. Such programs required periodic payments and allowances based on estimated results of specific programs and were recorded as a reduction resulting in net sales. The Company accrued the estimated total payments and allowances associated with each transaction at the time of sale. Additionally, the Company offered programs directly to consumers to promote the sale of its products. Promotions that reduced the ultimate consumer sale prices were recorded as a reduction resulting in net sales at the time the promotional offer was made, generally using estimated redemption and participation levels. The Company continually assesses the adequacy of accruals for customer and consumer promotional program costs earned but not yet paid. To the extent total program payments differ from estimates, adjustments may be necessary. Historically, these total program payments and adjustments have not been material. See Note 1 on page 50 for information on the new revenue standard.
FINANCIAL CONDITION, LIQUIDITY AND CASH FLOW
Overview
On June 1, 2017, the Company completed the Acquisition for a total purchase price of $8.939 billion. On May 16, 2017, the Company issued $6.000 billion of senior notes (New Notes) in a public offering. The net proceeds from the issuance of the New Notes were used to fund the Acquisition. In April 2016, the Company entered into a $7.300 billion bridge credit agreement (Bridge Loan) and a $2.000 billion term loan credit agreement (Term Loan) as committed financing for the Acquisition. On June 1, 2017, the Company terminated the agreement for the Bridge Loan and borrowed the full $2.000 billion on the Term Loan. The Company continues to maintain sufficient short-term borrowing capacity at reasonable rates, and the Company has sufficient cash on hand and total available borrowing capacity to fund its current operating needs.
The Acquisition significantly affected the Company's financial condition, liquidity and cash flow. See Note 2 for a table detailing the preliminary opening balance sheet. Net working capital decreased $319.5 million at December 31, 2017 compared to 2016 due to a significant increase in current liabilities partially offset by a significant increase in current assets primarily due to the Acquisition. Total debt at December 31, 2017 increased $8.568 billion to $10.521 billion from $1.953 billion at December 31, 2016 and increased as a percentage of total capitalization to 74.0 percent from 51.0 percent the prior year. At December 31, 2017, the Company had remaining short-term borrowing ability of $1.725 billion.

24 

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

Net operating cash increased $575.4 million in 2017 to a cash source of $1.884 billion from a cash source of $1.309 billion in 2016 due primarily to an increase in net income of $639.6 million and increased cash generated by changes in working capital partially offset by changes in non-cash items when compared to 2016. Net operating cash increased as a percent to sales to 12.6 percent in 2017 compared to 11.0 percent in 2016. During 2017, strong net operating cash continued to provide the funds necessary to invest in new stores, manufacturing and distribution facilities and return cash to shareholders through dividends. In 2017, the Company used a portion of Net operating cash and Cash and cash equivalents to spend $222.8 million in capital additions and improvements and pay $319.0 million in cash dividends to its shareholders of common stock.
Net Working Capital
Total current assets less Total current liabilities (net working capital) decreased $319.5 million to a surplus of $478.7 million at December 31, 2017 from a surplus of $798.1 million at December 31, 2016. The net working capital decrease is due to a significant increase in current liabilities partially offset by a significant increase in current assets. Cash and cash equivalents decreased $685.6 million and current portion of long-term debt decreased $699.3 million resulting from the payment of 1.35% senior notes becoming due in 2017 while Short-term borrowings increased $593.0 million. Accounts payable increased $756.9 million and other accruals increased $394.1 million primarily related to the Acquisition and Acquisition cost accruals. Accrued taxes increased $3.1 million and compensation, taxes withheld increased $110.1 million primarily due to the Acquisition and timing of payments. Accounts receivable increased $873.6 million and inventories increased $733.0 million primarily due to the Acquisition. As a result of the net effect of these changes, the Company’s current ratio decreased to 1.12 at December 31, 2017 from 1.28 at December 31, 2016. Accounts receivable as a percent of Net sales increased to 14.0 percent in 2017 from 10.4 percent in 2016. Accounts receivable days outstanding increased to 61 days in 2017 from 54 days in 2016. In 2017, provisions for allowance for doubtful collection of accounts increased $12.5 million, or 31.0 percent. Inventories as a percent of Net sales increased to 12.0 percent in 2017 from 9.0 percent in 2016 primarily due to the Acquisition. Inventory days outstanding was flat at 79 days in 2017 versus 2016. The Company has sufficient total available borrowing capacity to fund its current operating needs.
Goodwill and Intangible Assets
Goodwill, which represents the excess of cost over the fair value of net assets acquired in purchase business combinations, increased $5.687 billion in 2017 due to the preliminary
 
purchase accounting for the Acquisition and foreign currency translation rate fluctuations. Intangible assets increased $5.747 billion in 2017 primarily due to purchase accounting additions of $5.848 billion related to the Acquisition. Decreases from amortization of finite-lived intangible assets of $206.8 million and impairments of $2.0 million were partially offset by $15.1 million of capitalized software costs. Foreign currency translation rate fluctuations of $93.0 million and other adjustments accounted for the remaining increases. Acquired finite-lived intangible assets included customer relationships and intellectual property. Costs related to designing, developing, obtaining and implementing internal use software are capitalized and amortized in accordance with the Goodwill and Other Intangibles Topic of the ASC. See Note 4, on pages 51 through 52 of this report, for a description of goodwill, identifiable intangible assets and asset impairments recorded in accordance with the Goodwill and Other Intangibles Topic of the ASC and summaries of the remaining carrying values of goodwill and intangible assets.
Deferred Pension and Other Assets
Deferred pension assets of $296.7 million at December 31, 2017 represent the excess of the fair value of assets over the actuarially determined projected benefit obligations, primarily of the domestic salaried defined benefit pension plan. The increase in Deferred pension assets during 2017 of $71.2 million, from $225.5 million last year, was primarily due to a reduction in the discount rate to 3.6 percent, an increase in the fair value of plan assets and acquired Valspar plans. In accordance with the accounting prescribed by the Retirement Benefits Topic of the ASC, the increase in the value of the Deferred pension assets is offset in Cumulative other comprehensive loss and is amortized as a component of Net pension costs over a defined period of pension service. See Note 6, on pages 55 through 60 of this report, for more information concerning the excess fair value of assets over projected benefit obligations of the salaried defined benefit pension plan and the amortization of actuarial gains or losses relating to changes in the excess assets and other actuarial assumptions.
Other assets increased $80.1 million to $502.0 million at December 31, 2017 due primarily to a reclass of current deferred tax assets to non-current due to the adoption of ASU No. 2015-17. See Note 1, on pages 49 through 50 of this report, for more information on the impact of recently issued accounting standards.
Property, Plant and Equipment
Net property, plant and equipment increased $781.2 million to $1.877 billion at December 31, 2017 due primarily to the Acquisition of $833.0 million, capital expenditures of $222.8 million, and currency translation and other adjustments of

25

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

$63.1 million partially offset by depreciation expense of $285.0 million and sale or disposition of assets with remaining net book value of $52.7 million. Capital expenditures during 2017 in The Americas Group were primarily attributable to the opening of new paint stores and renovation and improvements in existing stores. In the Consumer Brands Group, capital expenditures during 2017 were primarily attributable to improvements and normal equipment replacements in manufacturing and distribution facilities. Capital expenditures in the Performance Coatings Group were primarily attributable to improvements in existing manufacturing and distribution facilities. The Administrative Segment incurred capital expenditures primarily for information systems hardware. In 2018, the Company expects to spend more than 2017 for capital expenditures. The predominant share of the capital expenditures in 2018 is expected to be for various productivity improvement and maintenance projects at existing manufacturing, distribution and research and development facilities, new store openings and new or upgraded information systems hardware. The Company does not anticipate the need for any specific long-term external financing to support these capital expenditures.
Debt
On June 2, 2017, the Company closed its previously announced exchange offers and consent solicitations (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 (Exchange Notes). On May 16, 2017, the Company issued $6.0 billion of New Notes in a public offering. The net proceeds from the issuance of the New Notes were used to fund the Acquisition. The interest rate locks entered into during 2016 settled in March 2017 resulting in a pretax gain of $87.6 million recognized in Cumulative other comprehensive other 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 2017, the amortization of the unrealized gain reduced interest expense by $5.2 million.
In April 2016, the Company entered into a $7.3 billion Bridge Loan and a $2.0 billion Term Loan as committed financing for the Acquisition, as disclosed in Note 2. On June 1, 2017, the Company terminated the agreement for the Bridge Loan and borrowed the full $2.0 billion on the Term Loan. As of December 31, 2017, the Term Loan had an outstanding balance of $850.0 million.
In August 2017, the Company entered into a floating rate loan of €225.0 million and a fixed rate loan of €20.0 million. The floating rate loan agreement bears interest at the six-month Euro Interbank Offered Rate plus a margin. The fixed rate loan bears interest at 0.92%. The proceeds will be used for general corporate purposes, including repaying a portion of outstanding short-term borrowings. The loans mature on August 23, 2021.
 
In September 2017, the Company entered into a five-year letter of credit agreement, subsequently amended, with an aggregate availability of $500.0 million. The credit agreement will be used for general corporate purposes. 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. At December 31, 2017, there was $350.0 million borrowings outstanding under these credit agreements. There were no borrowings outstanding at December 31, 2016. See Note 7, on pages 61 through 62 of this report, for a detailed description of the Company’s debt outstanding and other available financing programs.
Defined Benefit Pension and Other Postretirement Benefit Plans
In accordance with the accounting prescribed by the Retirement Benefits Topic of the ASC, the Company’s total liability for unfunded or underfunded defined benefit pension plans increased $40.6 million to $93.8 million primarily due to the acquired Valspar plans. Postretirement benefits other than pensions increased $25.7 million to $290.8 million at December 31, 2017 due primarily to the Acquisition and changes in the actuarial assumptions.
The assumed discount rate used to determine the actuarial present value of projected defined benefit pension and other postretirement benefit obligations for domestic plans was decreased from 4.2 percent to 3.6 percent at December 31, 2017 due to decreased rates of high-quality, long-term investments and foreign defined benefit pension plans had similar discount rate decreases for the same reasons. The rate of compensation increases used to determine the projected benefit obligations increased to 3.3 percent in 2017 from 3.4 percent for domestic pension plans and similar increases on most foreign plans. In deciding on the rate of compensation increases, management considered historical Company increases as well as expectations for future increases. The expected long-term rate of return on assets decreased from 6.0 percent to 5.0 percent at December 31, 2017 for domestic pension plans and was slightly lower for most foreign plans. In establishing the expected long-term rate of return on plan assets for 2017, management considered the historical rates of return, the nature of investments and an expectation for future investment strategies. The assumed health care cost trend rates used to determine the net periodic benefit cost of postretirement benefits other than pensions for 2017 were 5.5 percent and 10.5 percent, respectively, for medical and prescription drug cost increases, both decreasing gradually to 4.5 percent in 2026. In developing the assumed health care cost trend rates, management considered industry data, historical

26 

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

Company experience and expectations for future health care costs.
For 2018 Net pension cost and Net periodic benefit cost recognition for domestic plans, the Company will use a discount rate of 3.60 percent, an expected long-term rate of return on assets of 5.0 percent and a rate of compensation increase of 3.3 percent. Lower discount rates and expected long-term rates of return on plan assets will be used for most foreign plans. Use of these assumptions and amortization of actuarial losses will result in a domestic Net pension cost in 2018 that is expected to be approximately $1.5 million lower than in 2017. Net periodic benefit costs for postretirement benefits other than pensions is expected to increase $10.2 million in 2018 due to 2017 expense including a settlement gain of $9.3 million related to the termination of a life insurance benefit plan. See Note 6, on pages 55 through 60 of this report, for more information on the Company’s obligations and funded status of its defined benefit pension plans and postretirement benefits other than pensions.
Deferred Income Taxes
Deferred income taxes at December 31, 2017 increased $1.360 billion from a year ago primarily due to increased deferred tax liabilities related to intangible assets recorded in purchase accounting for the Acquisition, partially offset by the Deferred income tax reductions. See Note 2 on page 50 and 51 and Note 14 on pages 70 through 72 of this report for more information.
Other Long-Term Liabilities
Other long-term liabilities increased $175.1 million during 2017 due primarily to acquired liabilities from the Acquisition.
 
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 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 2018. See Note 8, on pages 62 through 63 of this report, for further information on environmental-related long-term liabilities.

Contractual Obligations and Commercial Commitments
The Company has certain obligations and commitments to make future payments under contractual obligations and commercial commitments. The following tables summarize such obligations and commitments as of December 31, 2017.
(thousands of dollars)
 
Payments Due by Period
Contractual Obligations
 
Total
 
Less than
1 Year
 
1–3 Years
 
3–5 Years
 
More than
5 Years
Long-term debt
 
$
9,917,040

 
$
1,179

 
$
1,922,807

 
$
2,669,434

 
$
5,323,620

Operating leases
 
1,855,528

 
391,009

 
645,826

 
416,013

 
402,680

Short-term borrowings
 
633,731

 
633,731

 
 
 
 
 
 
Interest on Long-term debt
 
4,225,057

 
341,319

 
630,641

 
512,690

 
2,740,407

Purchase obligations (1)
 
81,876

 
81,876

 
 
 
 
 
 
Other contractual obligations (2)
 
214,443

 
107,084

 
65,369

 
30,360

 
11,630

Total contractual cash obligations
 
$
16,927,675

 
$
1,556,198

 
$
3,264,643

 
$
3,628,497

 
$
8,478,337

(1) 
Relate to open purchase orders for raw materials at December 31, 2017.
(2) 
Relate primarily to estimated future capital contributions to investments in the U.S. affordable housing and historic renovation real estate partnerships and various other contractual obligations.


27

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

 
 
Amount of Commitment Expiration Per Period
Commercial Commitments
 
Total
 
Less than
1 Year
 
1–3 Years
 
3–5 Years
 
More than
5 Years
Standby letters of credit
 
$
75,272

 
$
75,272

 
 
 
 
 
 
Surety bonds
 
71,645

 
71,645

 
 
 
 
 
 
Other commercial commitments
 
8,777

 
8,777

 
 
 
 
 
 
Total commercial commitments
 
$
155,694

 
$
155,694

 
$

 
$

 
$


Warranties
The Company offers product warranties for certain products. The specific terms and conditions of such warranties vary depending on the product or customer contract requirements. Management estimated the costs of unsettled product warranty claims based on historical results and experience. Management periodically assesses the adequacy of the accrual for product warranty claims and adjusts the accrual as necessary. Warranty accruals were acquired in connection with the Acquisition. This amount primarily includes warranties for certain products under extended furniture protection plans along with product warranties for other products. In the U.S., revenue related to furniture protection plans is deferred and recognized over the contract life. Changes in the Company’s accrual for product warranty claims during 2017, 2016 and 2015, including customer satisfaction settlements during the year, were as follows:
(thousands of dollars)
2017
 
2016
 
2015
Balance at January 1
$
34,419

 
$
31,878

 
$
27,723

Charges to expense
39,707

 
38,954

 
43,484

Settlements
(53,143
)
 
(36,413
)
 
(39,329
)
Acquisition Liabilities
130,442

 

 

Balance at December 31
$
151,425

 
$
34,419

 
$
31,878

Shareholders’ Equity
Shareholders’ equity increased $1.814 billion to $3.692 billion at December 31, 2017 from $1.878 billion last year primarily due to an increase in retained earnings of $1.453 billion and an increase in Other capital of $234.6 million. Retained earnings increased $1.453 billion during 2017 due to net income of $1.772 billion partially offset by $319.0 million in cash dividends paid. The increase in Other capital of $234.6 million was due primarily to the recognition of stock-based compensation expense and stock option exercises. Cumulative other comprehensive loss decreased $155.5 million due primarily to favorable foreign currency translation effects of $147.9 million attributable to the strengthening of most foreign operations’ functional currencies against the U.S. dollar and $40.2 million in net actuarial gains and prior service costs of defined benefit pension and other postretirement benefit plans net of amortization partially offset by a $34.0 million reduction in the unrealized gain on the interest rate locks.
 
The Company did not make any open market purchases of its common stock for treasury during 2017. The Company acquires its common stock for general corporate purposes, and depending on its cash position and market conditions, it may acquire shares in the future. The Company had remaining authorization from its Board of Directors at December 31, 2017 to purchase 11.65 million shares of its common stock.
The Company's 2017 annual cash dividend of $3.40 per common share represented 28.4 percent of 2016 diluted net income per common share. The 2017 annual dividend represented the thirty-ninth consecutive year of dividend payments since the dividend was suspended in 1978. The Company is temporarily modifying its practice of paying 30.0 percent of the prior year’s diluted net income per common share in cash dividend. At a meeting held on February 14, 2018, the Board of Directors increased the quarterly cash dividend to $.86 per common share. This quarterly dividend, if approved in each of the remaining quarters of 2018, would result in an annual dividend for 2018 of $3.44 per common share or an 18.4 percent payout of 2017 diluted net income per common share. See the Statements of Consolidated Shareholders’ Equity, on page 44 of this report, and Notes 10, 11 and 12, on pages 67 through 69 of this report, for more information concerning Shareholders’ equity.
Cash Flow
Net operating cash increased $575.4 million to $1.884 billion in 2017 from $1.309 billion in 2016 due primarily to an increase in net income of $639.6 million and increased cash generated by changes in working capital, partially offset by changes in deferred income tax liabilities and other non-cash items when compared to 2016. Strong net operating cash provided the funds necessary to invest in new stores, manufacturing and distribution facilities, return cash to shareholders through dividends, and pay down debt from the Acquisition. Net investing cash usage increased $8.744 billion to a usage of $9.047 billion in 2017 from a usage of $303.8 million in 2016 due primarily to cash paid for the Acquisition of $8.810 billion, partially offset by decreases in cash used for other investments of $41.7 million and capital expenditures of $16.3 million and increased proceeds from sale of assets of $8.8 million. Net financing cash increased $6.821 billion to a source of $6.514 billion in 2017 from a usage of $307.4 million in 2016 due primarily to increased Net Proceeds from long-term debt of $6.422 billion, increased short-term borrowings of $357.2 million and higher proceeds from stock options exercised of

28 

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

$56.7 million, partially offset by increased payments of cash dividends of $6.9 million and increased cash used in all other financing activities of $24.3 million. In 2017, the Company used Net operating cash and Cash and cash equivalents on hand to spend $222.8 million in capital additions and improvements, pay $319.0 million in cash dividends to its shareholders of common stock, fund the Acquisition and pay down long-term debt of $1.853 billion.
Management considers a measurement of cash flow that is not in accordance with U.S. generally accepted accounting principles to be a useful tool in its determination of appropriate uses of the Company’s Net operating cash. Management reduces Net operating cash, as shown in the Statements of Consolidated Cash Flows, by the amount reinvested in the business for Capital expenditures and the return of investment to its shareholders by the payments of cash dividends. The resulting value is referred to by management as “Free Cash Flow” which may not be comparable to values considered by other entities using the same terminology. The reader is cautioned that the Free Cash Flow measure should not be compared to other entities unknowingly, and it does not consider certain non-discretionary cash flows, such as mandatory debt and interest payments. The amount shown below should not be considered an alternative to Net operating cash or other cash flow amounts provided in accordance with U.S. generally accepted accounting principles disclosed in the Statements of Consolidated Cash Flows, on page 43 of this report. Free Cash Flow as defined and used by management is determined as follows: 
 
Year Ended December 31,
(thousands of dollars)
2017
 
2016
 
2015
Net operating cash
$
1,883,968

 
$
1,308,572

 
$
1,447,463

Capital expenditures
(222,767
)
 
(239,026
)
 
(234,340
)
Cash dividends
(319,029
)
 
(312,082
)
 
(249,647
)
Free cash flow
$
1,342,172

 
$
757,464

 
$
963,476

Litigation
See page 23 of this report and Note 9 on pages 63 through 66 for more information concerning litigation.
Market Risk
The Company is exposed to market risk associated with interest rate, foreign currency and commodity fluctuations. The Company occasionally utilizes derivative instruments as part of its overall financial risk management policy, but does not use derivative instruments for speculative or trading purposes. The
 
Company entered into foreign currency option and forward currency exchange contracts with maturity dates of less than twelve months in 2017, 2016 and 2015, primarily to hedge against value changes in foreign currency. There were no material foreign currency option and forward contracts outstanding at December 31, 2017, 2016 and 2015. 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. See Notes 1 and 13 on pages 46 and 70 of this report.
Financial Covenant
Certain borrowings contain a consolidated leverage covenant. The covenant states 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 “Earnings Before Interest, Taxes, Depreciation and Amortization” (EBITDA) for the 12-month period ended on the same date. Refer to the “Results of Operations” caption below for a reconciliation of EBITDA to Net income. At December 31, 2017, the Company was in compliance with the covenant. The Company’s Notes, Debentures and revolving credit agreement contain various default and cross-default provisions. In the event of default under any one of these arrangements, acceleration of the maturity of any one or more of these borrowings may result. See Note 7 on pages 61 through 62 of this report.
Employee Stock Ownership Plan (ESOP)
Participants in the Company’s ESOP are allowed to contribute up to the lesser of twenty percent of their annual compensation or the maximum dollar amount allowed under the Internal Revenue Code. The Company matches six percent of eligible employee contributions. The Company’s matching contributions to the ESOP charged to operations were $90.7 million in 2017 compared to $85.5 million in 2016. At December 31, 2017, there were 10,033,576 shares of the Company’s common stock being held by the ESOP, representing 10.7 percent of the total number of voting shares outstanding. See Note 11, on page 67 of this report, for more information concerning the Company’s ESOP.


29

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

RESULTS OF OPERATIONS - 2017 vs. 2016
Shown below are net sales and segment profit and the percentage change for the current period by segment for 2017 and 2016:
 
Year Ended December 31,
(thousands of dollars)
2017
 
2016
 
Change
Net Sales:
 
 
 
 
 
The Americas Group
$
9,117,279

 
$
8,377,083

 
8.8
 %
Consumer Brands Group
2,154,729

 
1,527,515

 
41.1
 %
Performance Coatings Group
3,706,134

 
1,946,004

 
90.4
 %
Administrative
5,646

 
5,000

 
12.9
 %
Net sales
$
14,983,788

 
$
11,855,602

 
26.4
 %
 
 
 
 
 
 
 
Year Ended December 31,
(thousands of dollars)
2017
 
2016
 
Change
Income Before Income Taxes:
 
 
 
 
 
The Americas Group

$
1,769,466

 
$
1,605,306

 
10.2
 %
Consumer Brands Group
226,001

 
301,041

 
-24.9
 %
Performance Coatings Group
298,503

 
257,187

 
16.1
 %
Administrative
(765,751
)
 
(568,301
)
 
-34.7
 %
Income before
income taxes
$
1,528,219

 
$
1,595,233

 
-4.2
 %
Consolidated net sales for 2017 increased due primarily to the addition of Valspar sales beginning in June and higher paint sales volume in The Americas Group. Excluding Valspar net sales, net sales increased 5.6 percent in the year. Currency translation rate changes increased 2017 consolidated net sales by 0.3 percent. Net sales of all consolidated foreign subsidiaries increased 71.9 percent to $2.960 billion for 2017 versus $1.722 billion for 2016 due primarily to the addition of Valspar sales since June. Net sales of all operations other than consolidated foreign subsidiaries increased 18.7 percent to $12.024 billion for 2017 versus $10.133 billion for 2016.
Net sales in the The Americas Group increased in 2017 due primarily to higher architectural paint sales volume across all end market segments and selling price increases. Net sales from stores in the U.S., Canada and Latin America open for more than twelve calendar months increased 6.3 percent for the full year. During 2017, The Americas Group opened 114 new stores and closed 13 redundant locations for a net increase of 101 stores, increasing the total number of stores in operation at December 31, 2017 to 4,620 in the United States, Canada, Latin America and the Caribbean. The Americas Group’s objective is to expand its store base an average of 2.5 percent each year, primarily through internal growth. Sales of products other than paint increased approximately14.3 percent for the year over 2016. A discussion of changes in volume versus pricing for sales
 
of products other than paint is not pertinent due to the wide assortment of general merchandise sold.
Net sales of the Consumer Brands Group increased in 2017 primarily due to the inclusion of Valspar sales since June, partially offset by lower volume sales to some of the Group's retail customers. Valspar sales increased Group net sales 49.4 percent in the year. In 2018, the Consumer Brands Group plans to continue promotions of new and existing products and expand of its customer base and product assortment at existing customers.
The Performance Coatings Group’s net sales in 2017 increased due primarily to the inclusion of Valspar sales and selling price increases. Currency translation rate changes increased net sales 1.5 percent for 2017. In 2017, the Performance Coatings Group opened 4 new branches and closed 2 locations increasing the total from 288 to 290 branches open in the United States, Canada, Mexico, South America, Europe and Asia at year-end. In 2018, the Performance Coatings Group plans to continue expanding its worldwide presence and improving its customer base.
Net sales in the Administrative segment, which primarily consist of external leasing revenue of excess headquarters space and leasing of facilities no longer used by the Company in its primary business, decreased by an insignificant amount in 2017.
Consolidated gross profit increased $858.5 million in 2017 due primarily to Valspar sales since June and higher paint sales volume, partially offset by raw material cost increases. Consolidated gross profit as a percent to net sales decreased to 45.3 percent from 50.0 percent in 2016 due primarily to Valspar sales, Acquisition-related inventory purchase accounting adjustments and raw material cost increases, partially offset by higher paint sales volume. The Americas Group’s gross profit for 2017 increased $297.7 million compared to 2016 due primarily to higher paint sales volume and selling price increases, partially offset by higher raw material costs. The Americas Group’s gross profit margins declined primarily due to increased raw material costs, partially offset by higher paint sales volume and selling price increases. The Consumer Brands Group’s gross profit increased $146.9 million due primarily to the inclusion of Valspar sales, partially offset by increased raw material costs, Acquisition-related inventory purchase accounting adjustments and lower sales volumes at certain customers compared to 2016. The Performance Coatings Group’s gross profit for 2017 increased $422.9 million due primarily to inclusion of Valspar sales and favorable currency translation rate changes, partially offset by higher raw material costs and Acquisition-related inventory purchase accounting adjustments. Acquisition-related purchase accounting adjustments decreased Consumer Brands and Performance Coatings Groups' gross profit by $49.2 million and $39.2 million, respectively, for 2017. Both Consumer Brands and Performance Coatings Groups' gross profit margins were lower due to inclusion of Valspar sales, higher raw material costs and Acquisition-related inventory purchase accounting adjustments to inventory, partially offset by selling price increases.

30 

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

SG&A increased by $650.9 million due primarily to the inclusion of Valspar SG&A, increased expenses to support higher sales levels and net new store openings, as well as increased Acquisition expenses in the Administrative segment. Acquisition expenses in the Administrative segment were $131.2 million and $58.4 million in 2017 and 2016, respectively. SG&A decreased as a percent of sales to 31.9 percent in 2017 from 34.9 percent in 2016 primarily due to the addition of Valspar sales beginning in June. Excluding Valspar SG&A and Acquisition expenses, SG&A as a percent of sales was 33.6 percent and 34.4 percent in 2017 and 2016, respectively. In The Americas Group, SG&A increased $144.6 million for the year due primarily to increased spending due to the number of new store openings and general comparable store expenses to support higher sales levels. The Consumer Brands Group’s SG&A increased by $168.3 million for the year from inclusion of Valspar SG&A, partially offset by improved expense control and integration synergies. The Performance Coatings Group’s SG&A increased by $253.2 million for the year primarily due to inclusion of Valspar SG&A, partially offset by improved expense control and integration synergies. The Administrative segment’s SG&A increased $84.8 million primarily due to increased Acquisition-related costs.
Amortization and impairment expenses in total increased $172.7 million in 2017 primarily due to amortization of Acquisition-related intangibles. Amortization of Acquisition-related intangibles was $127.8 million and $54.4 million for the Performance Coatings and Consumer Brands Groups, respectively. Impairment of goodwill and intangibles expenses decreased $8.7 million in 2017.
Other general expense - net increased $8.5 million in 2017 compared to 2016. The increase was mainly caused by an increase of $10.5 million of expense in the Administrative segment, primarily due to a year-over-year decrease in gain on sale of assets of $38.0 million partially offset by a decrease in provisions for environmental matters of $27.5 million. See Note 13, on page 69 and 70 of this report, for more information concerning Other general expense - net.
As required by the Goodwill and Other Intangibles Topic of the ASC, management performed an annual impairment test of goodwill and indefinite-lived intangible assets as of October 1, 2017. The impairment tests in 2017 resulted in $2.0 million impairment of trademarks recorded in The Americas Group. The impairment tests in 2016, resulted in $10.7 million impairment in goodwill from the same reporting unit. See Note 4, on pages 51 and 52 of this report, for more information concerning the impairment of intangible assets.
Interest expense increased $109.4 million in 2017 primarily due to Acquisition-related debt incurred.
Other (income) expense - net increased $12.4 million in 2017 compared to 2016. This increase was mainly due to an
 
increase in foreign currency related transaction losses of $6.9 million in 2017, primarily in The Americas Group and Consumer Brands Group. There were no other items within Other income or Other expense that were individually significant at December 31, 2017. See Note 13 on page 70 of this report for more information concerning Other (income) expense - net.
Consolidated Income before income taxes in 2017 decreased $67.0 million resulting from an increase of $650.9 million in SG&A, an increase of $172.7 million in amortization and impairment expenses in total, and an increase of $109.4 million in interest expense, partially offset by an increase of $858.5 million in gross profit. Income before income taxes increased $164.2 million in The Americas Group and $41.3 million in the Performance Coatings Group, but decreased $75.0 million in the Consumer Brands Group, when compared to 2016. The Administrative segment expenses decreased Income before income taxes $197.5 million more than in 2016 resulting primarily from Acquisition expenses and increased Interest expense.
Net income increased in 2017 primarily due to the one-time benefit of $668.8 million from Deferred income tax reductions, which resulted in a consolidated effective income tax rate of (18.7) percent, improved operating results in The Americas Group and the inclusion of Valspar operating results, partially offset by Acquisition costs.
Excluding the impact of the Deferred income tax reductions, the effective income tax rate for continuing operations was 25.1 percent for 2017 and 29.0 percent for 2016, primarily due to the year over year impacts of Employee share-based payments. Diluted net income per common share increased 55.7 percent to $18.67 per share for 2017 from $11.99 per share in 2016. Diluted net income per common share from continuing operations was $19.11 per share in 2017, including a one-time benefit of $7.04 per share from the Deferred income tax reductions. Diluted net income per common share for 2017 was decreased by charges of $3.00 per share from Acquisition costs, including inventory purchase accounting adjustments and increased amortization of intangible assets. Valspar operations increased Diluted net income per common share by $.80 per share for 2017, including a $.92 per share charge from interest expense on new debt. Diluted net income per common share for 2016 was decreased by charges of $.86 per share from Acquisition costs. Currency translation rate changes did not have a significant impact on diluted net income per common share in 2017.
Management considers a measurement that is not in accordance with U.S. generally accepted accounting principles a useful measurement of the operational profitability of the Company. Some investment professionals also utilize such a measurement as an indicator of the value of profits and cash that are generated strictly from operating activities, putting aside working capital and certain other balance sheet changes. For this

31

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

measurement, management increases Net income for significant non-operating and non-cash expense items to arrive at an amount known as EBITDA. The reader is cautioned that the following value for EBITDA should not be compared to other entities unknowingly. EBITDA should not be considered an alternative to Net income or Net operating cash as an indicator of operating performance or as a measure of liquidity. The reader should refer to the determination of Net income and Net operating cash in accordance with U.S. generally accepted accounting principles disclosed in the Statements of Consolidated Income and Statements of Consolidated Cash Flows, on pages 40 and 43 of this report. EBITDA as used by management is calculated as follows:
 
Year Ended December 31,
(thousands of dollars)
2017
 
2016
 
2015
Net income from
continuing
operations
$
1,813,802

 
$
1,132,703

 
$
1,053,849

Interest Expense
263,471

 
154,088

 
61,791

Income Taxes
(285,583
)
 
462,530

 
495,117

Depreciation
284,997

 
172,074

 
170,323

Amortization
206,764

 
25,404

 
28,237

EBITDA from
continuing
operations
$
2,283,451

 
$
1,946,799

 
$
1,809,317

Valspar EBITDA *
160,563

 
(60,630
)
 
 
EBITDA from continuing operations without Valspar
$
2,122,888

 
$
2,007,429

 
$
1,809,317

* Valspar EBITDA for 2017 includes Valspar operations since June 1, 2017, purchase accounting items and acquisition costs. Valspar EBITDA for 2016 includes acquisition costs only.


 
RESULTS OF OPERATIONS - 2016 vs. 2015
Shown below are net sales and segment profit and the percentage change for the current period by segment for 2016 and 2015
 
Year Ended December 31,
(thousands of dollars)
2016
 
2015
 
Change
Net Sales:
 
 
 
 
 
The Americas Group

$
8,377,083

 
$
7,839,966

 
6.9
 %
Consumer Brands Group

1,527,515

 
1,577,955

 
-3.2
 %
Performance Coatings Group

1,946,004

 
1,916,300

 
1.6
 %
Administrative
5,000

 
5,083

 
-1.6
 %
Net sales
$
11,855,602

 
$
11,339,304

 
4.6
 %
 
 
 
 
 
 
  
Year Ended December 31,
(thousands of dollars)
2016
 
2015
 
Change
Income Before Income Taxes:
 
 
 
 
 
The Americas Group
$
1,605,306

 
$
1,451,998

 
10.6
 %
Consumer Brands Group
301,041

 
308,833

 
-2.5
 %
Performance Coatings Group
257,187

 
201,881

 
27.4
 %
Administrative
(568,301
)
 
(413,746
)
 
-37.4
 %
Income before
income taxes
$
1,595,233

 
$
1,548,966

 
3.0
 %
Consolidated net sales for 2016 increased due primarily to higher paint sales volume in The Americas Group and the impact of the Revenue reclassification beginning in the third quarter related to grossing up third-party service revenue and related costs which were previously netted and immaterial in prior periods. The Revenue reclassification increased sales in the year 1.1 percent. This prospective change primarily impacts The Americas and the Performance Coatings Groups. This change had no impact on segment profit, but reduced segment profit as a percent to net sales of the affected groups. Unfavorable currency translation rate changes decreased 2016 consolidated net sales 1.4 percent. Net sales of all consolidated foreign subsidiaries were down 3.7 percent to $1.722 billion for 2016 versus $1.789 billion for 2015 due primarily to unfavorable foreign currency translation rates. Net sales of all operations other than consolidated foreign subsidiaries were up 6.1 percent to $10.133 billion for 2016 versus $9.550 billion for 2015.

32 

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

Net sales in The Americas Group in 2016 increased primarily due to higher architectural paint sales volume across all end market segments. Net sales from stores open for more than twelve calendar months increased 5.3 percent for the full year. During 2016, The Americas Group opened 158 new stores and closed 16 redundant locations for a net increase of 142 stores, increasing the total number of stores in operation at December 31, 2016 to 4,519 in the United States, Canada, Latin America and the Caribbean. The Americas Group’s objective is to expand its store base an average of two and a half percent each year, primarily through internal growth. Sales of products other than paint increased approximately 7.0 percent for the year over 2015. A discussion of changes in volume versus pricing for sales of products other than paint is not pertinent due to the wide assortment of general merchandise sold.
Net sales of the Consumer Brands Group increased primarily due to higher volume sales to most of the Group's retail customers, partially offset by unfavorable currency translation rate changes decreased net sales 1.1 percent in the year. Sales of wood care coatings, brushes, rollers, caulk and other paint related products, were all up at least mid to high-single digits as compared to 2015 while sales of aerosol products were down slightly. A discussion of changes in volume versus pricing for sales of products other than paint is not pertinent due to the wide assortment of paint-related merchandise sold.
The Performance Coatings Group’s net sales in 2016, when stated in U.S. dollars, decreased due primarily to unfavorable currency translation rate changes. Unfavorable currency translation rate changes in the year decreased net sales by 2.6 percent for 2016. In 2016, the Performance Coatings Group opened 5 new branches and closed 13 locations decreasing the total from 296 to 288 branches open in the United States, Canada, Mexico, South America, Europe and Asia at year-end.
Net sales in the Administrative segment, which primarily consist of external leasing revenue of excess headquarters space and leasing of facilities no longer used by the Company in its primary business, decreased by an insignificant amount in 2016.
Consolidated gross profit increased $363.0 million in 2016 and improved as a percent to net sales to 50.0 percent from 49.0 percent in 2015 due primarily to higher paint sales volume and improved operating efficiencies partially offset by unfavorable currency translation rate changes. Excluding the effect of the Revenue reclassification, consolidated gross profit percent to net sales was 50.4 percent for 2016. The Americas Group’s gross profit for 2016 increased $338.9 million compared to 2015 due primarily to higher paint sales volume. The Americas Group's gross profit margins increased primarily due to higher paint sales volume partially offset by the effect of the Revenue reclassification. The Consumer Brands Group’s gross profit increased $19.8 million due primarily to improved operating efficiency and increased paint sales volume. The Consumer
 
Brands Group’s gross profit margins increased for those same reasons. The Performance Coatings Group’s gross profit for 2016 increased $8.8 million due primarily to improved operating efficiencies and decreasing raw material costs partially offset by unfavorable currency translation rate changes. The Performance Coatings Group’s gross profit increased as a percent of sales for those same reasons. Foreign currency translation rate fluctuations decreased Performance Coatings Group’s gross profit by $15.7 million for 2016. The Administrative segment’s gross profit decreased by $4.4 million.
SG&A increased by $245.9 million due primarily to increased expenses to support higher sales levels and net new store openings as well as the impact of Acquisition expenses of $58.4 million recorded in the Administrative segment. SG&A increased as a percent of sales to 35.1 percent in 2016 from 34.5 percent in 2015 primarily due to those same reasons. In The Americas Group, SG&A increased $177.7 million for the year due primarily to the number of new store openings and general comparable store expenses to support higher sales levels. The Consumer Brands Group’s SG&A increased by $6.5 million for the year in support of increased sales levels. The Performance Coatings Group’s SG&A decreased by $22.1 million for the year relating primarily to foreign currency translation rate fluctuations reducing SG&A by $16.0 million. The Administrative segment’s SG&A increased $83.8 million primarily due to Acquisition expenses and incentive compensation.
Other general expense - net decreased $17.9 million in 2016 compared to 2015. The decrease was mainly caused by a decrease of $19.2 million of expense in the Administrative segment, primarily due to a year-over-year increase in gain on sale of assets of $29.8 million partially offset by an increase in provisions for environmental matters of $11.9 million. See Note 13, on page 69 and 70 of this report, for more information concerning Other general expense - net.
As required by the Goodwill and Other Intangibles Topic of the ASC, management performed an annual impairment test of goodwill and indefinite-lived intangible assets as of October 1, 2016. The impairment tests in 2016 resulted in $10.7 million impairment of goodwill and trademarks recorded in The Americas Group for the Latin America operating unit. See Note 4, on pages 51 and 52 of this report, for more information concerning the impairment of intangible assets.
Amortization of credit facility costs incurred in early 2016 and interest on debt issued in July 2015 increased interest expense $92.3 million in 2016.
Other (income) expense - net increased to $4.6 million income from $6.1 million expense in 2015. This was primarily due to decreased net expense from banking activities of $2.4 million and decreased miscellaneous net expenses of $5.2 million both primarily recorded in the Administrative segment.

33

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

Additionally, foreign currency related transaction losses of $7.3 million in 2016 compared to $9.5 million in 2015, primarily in The Americas Group and the Performance Coatings Group. See Note 13, on page 70 of this report, for more information concerning Other expense (income) - net.
Consolidated Income before income taxes in 2016 increased $46.3 million due primarily to an increase of $363.0 million in gross profit partially offset by an increase of $245.9 million in SG&A and an increase of $60.2 million in interest expense, interest and net investment income and other expenses. Income before income taxes increased $153.3 million in The Americas Group, $10.4 million in the Consumer Brands Group, and $37.1 million in the Performance Coatings Group when compared to 2015. The Administrative segment had a decreased impact on Income before income taxes of $154.6 million when compared to 2015 resulting primarily from Acquisition expenses and increased interest expense. Segment profit of all consolidated foreign subsidiaries decreased 20.7 percent to $60.1 million for 2016 versus $75.8 million for 2015. Segment profit of all operations other than consolidated foreign subsidiaries increased 4.2 percent to $1.535 billion for 2016 versus $1.473 billion for 2015.
 
Net income increased $78.9 million in 2016 primarily due to the increase in Income before income taxes and the Income tax accounting change.
The effective income tax rate was 29.0 percent for 2016 and 32.0 percent for 2015. The decrease in the effective tax rate in 2016 compared to 2015 was primarily due to the Income tax accounting change. Excluding the impact of Acquisition expense tax benefits and the adoption of ASU No. 2016-09, the effective income tax rate was 32.3 percent for 2016. Diluted net income per common share increased 7.5 percent to $11.99 per share for 2016, including an $.86 per share charge for expenses associated with the Acquisition partially offset by an increase of $.40 per share related to the Income tax accounting change, from $11.15 per share a year ago. Unfavorable currency translation rate changes decreased diluted net income per common share by $.14 per share for the year.


34 

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







 




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35


REPORT OF MANAGEMENT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING

Shareholders of The Sherwin-Williams Company
We are responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. We recognize that internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and is subject to the possibility of human error or the circumvention or the overriding of internal control. Therefore, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, we believe we have designed into the process safeguards to reduce, though not eliminate, this risk. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In order to ensure that the Company’s internal control over financial reporting was effective as of December 31, 2017, we conducted an assessment of its effectiveness under the supervision and with the participation of our management group, including our principal executive officer and principal financial officer. This assessment was based on the criteria established in the 2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
On June 1, 2017, the Company completed the acquisition of the Valspar Corporation (Valspar). As permitted by the Securities and Exchange Commission, management excluded the Valspar operations from its assessment of internal control over financial reporting as of December 31, 2017. Valspar operations constituted 13 percent and 36 percent of total assets and net assets, respectively, as of December 31, 2017, and 16 percent of sales and 3 percent of net income for the year then ended. Valspar operations will be included in the Company's assessment as of December 31, 2018.
Based on our assessment of internal control over financial reporting under the criteria established in Internal Control – Integrated Framework, we have concluded that, as of December 31, 2017, the Company’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our internal control over financial reporting as of December 31, 2017 has been audited by Ernst & Young LLP, an independent registered public accounting firm, and their report on the effectiveness of our internal control over financial reporting is included on page 37 of this report.

morikissignaturea03.jpg
J. G. Morikis
Chairman, President and Chief Executive Officer

mistysynsignaturesmall.jpg
A. J. Mistysyn
Senior Vice President - Finance and Chief Financial Officer

jmcsignaturefeb2017a01.jpg
J. M. Cronin
Senior Vice President - Corporate Controller

36 


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

The Board of Directors and Shareholders of The Sherwin-Williams Company

Opinion on Internal Control over Financial Reporting
We have audited The Sherwin-Williams Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, The Sherwin-Williams Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria.
As indicated in the accompanying Report of Management on Internal Control over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Valspar, which is included in the 2017 consolidated financial statements of the Company and constituted 13 percent and 36 percent of total and net assets, respectively, as of December 31, 2017 and 16 percent and 3 percent of total revenues and net income, respectively, for the year then ended. Our audit of internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of Valspar.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of The Sherwin-Williams Company as of December 31, 2017, 2016, and 2015, and the related consolidated statements of income and comprehensive income, cash flows and shareholders’ equity for each of the three years in the period ended December 31, 2017, and the related notes and our report dated February 23, 2018 expressed an unqualified opinion thereon.

Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

eya01a03a01a05.jpg
Cleveland, Ohio
February 23, 2018

37


REPORT OF MANAGEMENT ON THE
CONSOLIDATED FINANCIAL STATEMENTS


Shareholders of The Sherwin-Williams Company
We are responsible for the preparation and fair presentation of the consolidated financial statements, accompanying notes and related financial information included in this report of The Sherwin-Williams Company and its consolidated subsidiaries (collectively, the “Company”) as of December 31, 2017, 2016 and 2015 and for the years then ended in accordance with U.S. generally accepted accounting principles. The consolidated financial information included in this report contains certain amounts that were based upon our best estimates, judgments and assumptions that we believe were reasonable under the circumstances.
We have conducted an assessment of the effectiveness of internal control over financial reporting based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. As discussed in the Report of Management on Internal Control Over Financial Reporting on page 36 of this report, we concluded that the Company’s internal control over financial reporting was effective as of December 31, 2017.
The Board of Directors pursues its responsibility for the oversight of the Company’s accounting policies and procedures, financial statement preparation and internal control over financial reporting through the Audit Committee, comprised exclusively of independent directors. The Audit Committee is responsible for the appointment and compensation of the independent registered public accounting firm. The Audit Committee meets at least quarterly with financial management, internal auditors and the independent registered public accounting firm to review the adequacy of financial controls, the effectiveness of the Company’s internal control over financial reporting and the nature, extent and results of the audit effort. Both the internal auditors and the independent registered public accounting firm have private and confidential access to the Audit Committee at all times.
We believe that the consolidated financial statements, accompanying notes and related financial information included in this report fairly reflect the form and substance of all material financial transactions and fairly present, in all material respects, the consolidated financial position, results of operations and cash flows as of and for the periods presented.
morikissignaturea03.jpg
J. G. Morikis
Chairman, President and Chief Executive Officer

mistysynsignaturesmall.jpg
A. J. Mistysyn
Senior Vice President - Finance and Chief Financial Officer

jmcsignaturefeb2017a01.jpg
J. M. Cronin
Senior Vice President - Corporate Controller

38 


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


To the Board of Directors and Shareholders of The Sherwin-Williams Company
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of The Sherwin-Williams Company (the Company) as of December 31, 2017, 2016 and 2015, and the related consolidated statements of income and comprehensive income, cash flows and shareholders' equity for each of the three years in the period ended December 31, 2017, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2017, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), The Sherwin-Williams Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 23, 2018 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.


eya01a03a01a05.jpg

We have served as the Company‘s auditor since 1908.
Cleveland, Ohio
February 23, 2018

 


39

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


 
Year Ended December 31,
 
2017
 
2016
 
2015
 
 
 
 
 
 
Net sales
$
14,983,788

 
$
11,855,602

 
$
11,339,304

Cost of goods sold
8,202,577

 
5,932,851

 
5,779,691

Gross profit
6,781,211

 
5,922,751

 
5,559,613

Percent to net sales
45.3
%
 
50.0
%
 
49.0
%
Selling, general and administrative expenses
4,785,415

 
4,134,517

 
3,885,668

Percent to net sales
31.9
%
 
34.9
%
 
34.3
%
Other general expense - net
20,865

 
12,368

 
30,268

Amortization
206,764

 
25,404

 
28,237

Impairment of goodwill and trademarks
2,022

 
10,688

 

Interest expense
263,471

 
154,088

 
61,791

Interest and net investment income
(8,571
)
 
(4,960
)
 
(1,399
)
Other (income) expense - net
(16,974
)
 
(4,587
)
 
6,082

 
 
 
 
 
 
Income from continuing operations before income taxes
1,528,219

 
1,595,233

 
1,548,966

Income tax (credit) expense
(285,583
)
 
462,530

 
495,117

 
 
 
 
 
 
Net income from continuing operations
1,813,802

 
1,132,703

 
1,053,849

 
 
 
 
 
 
 
 
 
 
 
 
Loss from discontinued operations

 

 

Income taxes
41,540

 


 


Net loss from discontinued operations
(41,540
)
 

 

 
 
 
 
 
 
Net income
$
1,772,262

 
$
1,132,703

 
$
1,053,849

 
 
 
 
 
 
Basic net income per common share:
 
 
 
 
 
Continuing operations
$
19.52

 
$
12.33

 
$
11.43

Discontinued operations
(.44
)
 

 

Net income per common share
$
19.08

 
$
12.33

 
$
11.43

 
 
 
 
 
 
Diluted net income per common share
 
 
 
 
 
Continuing operations
$
19.11

 
$
11.99

 
$
11.15

Discontinued operations
(.44
)
 

 

Net income per common share
$
18.67

 
$
11.99

 
$
11.15

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 










See notes to consolidated financial statements.


40 

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

 
Year Ended December 31,
 
2017
 
2016
 
2015
 
 
 
 
 
 
Net income
$
1,772,262

 
$
1,132,703

 
$
1,053,849

 
 
 
 
 
 
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
147,930

 
(18,648
)
 
(128,245
)
 
 
 
 
 
 
Pension and other postretirement benefit adjustments:
 
 
 
 
 
Amounts recognized in Other
 
 
 
 
 
comprehensive loss (1)
47,995

 
(28,385
)
 
7,974

Amounts reclassified from Other
 
 
 
 
 
comprehensive loss (2)
(7,762
)
 
7,635

 
5,847

 
40,233

 
(20,750
)
 
13,821

Unrealized net gains (losses) on available-for-sale securities:
 
 
 
 
 
Amounts recognized in Other
 
 
 
 
 
comprehensive loss (3)
2,026

 
1,046

 
(1,191
)
Amounts reclassified from Other
 
 
 
 
 
comprehensive loss (4)
(720
)
 
89

 
478

 
1,306

 
1,135

 
(713
)
 
 
 
 
 
 
Unrealized net gains on cash flow hedges:
 
 
 
 
 
Amounts recognized in Other
 
 
 
 
 
comprehensive loss (5)
(30,765
)
 
85,007

 

Amounts reclassified from
 
 
 
 
 
Other comprehensive loss (6)
(3,223
)
 
 
 
 
 
(33,988
)
 
85,007

 

Other comprehensive income (loss)
155,481

 
46,744

 
(115,137
)
Comprehensive income
$
1,927,743

 
$
1,179,447

 
$
938,712


(1) Net of taxes of $(19,313), $17,200 and $(3,399), in 2017, 2016 and 2015, respectively.
(2) Net of taxes of $4,764, $(4,691) and $(1,647), in 2017, 2016 and 2015, respectively.
(3) Net of taxes of $(1,244), $(643) and $736, in 2017, 2016 and 2015, respectively.
(4) Net of taxes of $442, $(55) and $(296) in 2017, 2016 and 2015, respectively.
(5) Net of taxes of $18,884 and $(52,226) in 2017 and 2016, respectively.
(6) Net of taxes of $1,978 in 2017.


























See notes to consolidated financial statements.

41

CONSOLIDATED BALANCE SHEETS
(thousands of dollars)

 
December 31,
 
2017
 
2016
 
2015
Assets
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and cash equivalents
$
204,213

 
$
889,793

 
$
205,744

Accounts receivable, less allowance
2,104,555

 
1,230,987

 
1,114,275

Inventories:
 
 
 
 
 
Finished goods
1,415,339

 
898,627

 
840,603

Work in process and raw materials
386,036

 
169,699

 
177,927

 
1,801,375

 
1,068,326

 
1,018,530

Deferred income taxes

 
57,162

 
87,883

Other current assets
355,697

 
381,030

 
230,748

Total current assets
4,465,840

 
3,627,298

 
2,657,180

 
 
 
 
 
 
Goodwill
6,814,345

 
1,126,892

 
1,143,333

Intangible assets
6,002,361

 
255,010

 
255,371

Deferred pension assets
296,743

 
225,529

 
244,882

Other assets
502,023

 
421,904

 
436,309

Property, plant and equipment:
 
 
 
 
 
Land
254,676

 
115,555

 
119,530

Buildings
962,094

 
714,815

 
696,202

Machinery and equipment
2,572,963

 
2,153,437

 
2,026,617

Construction in progress
177,056

 
117,126

 
81,082

 
3,966,789

 
3,100,933

 
2,923,431

Less allowances for depreciation
2,089,674

 
2,005,045

 
1,881,569

 
1,877,115

 
1,095,888

 
1,041,862

Total Assets
$
19,958,427

 
$
6,752,521

 
$
5,778,937

 
 
 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Short-term borrowings
$
633,731

 
$
40,739

 
$
39,462

Accounts payable
1,791,552

 
1,034,608

 
1,157,561

Compensation and taxes withheld
508,166

 
398,045

 
338,256

Accrued taxes
79,901

 
76,765

 
81,146

Current portion of long-term debt
1,179

 
700,475

 
3,154

Other accruals
972,651

 
578,547

 
522,280

Total current liabilities
3,987,180

 
2,829,179

 
2,141,859

 
 
 
 
 
 
Long-term debt
9,885,745

 
1,211,326

 
1,907,278

Postretirement benefits other than pensions
274,675

 
250,397

 
248,523

Deferred income taxes
1,434,196

 
73,833

 
138,709

Other long-term liabilities
684,443

 
509,345

 
474,658

 
 
 
 
 
 
Shareholders’ equity:
 
 
 
 
 
Common stock - $1.00 par value:
 
 
 
 
 
93,883,645, 93,013,031, and 92,246,525 shares outstanding
 
 
 
 
 
at December 31, 2017, 2016 and 2015, respectively
117,561

 
116,563

 
115,761

Other capital
2,723,183

 
2,488,564

 
2,330,426

Retained earnings
5,502,730

 
4,049,497

 
3,228,876

Treasury stock, at cost
(4,266,416
)
 
(4,235,832
)
 
(4,220,058
)
Cumulative other comprehensive loss
(384,870
)
 
(540,351
)
 
(587,095
)
Total shareholders’ equity
3,692,188

 
1,878,441

 
867,910

 
 
 
 
 
 
Total Liabilities and Shareholders’ Equity
$
19,958,427

 
$
6,752,521

 
$
5,778,937

See notes to consolidated financial statements.

42 

STATEMENTS OF CONSOLIDATED CASH FLOWS
(thousands of dollars)

 
Year Ended December 31,
Operating Activities
2017
 
2016
 
2015
Net income
$
1,772,262

 
$
1,132,703

 
$
1,053,849

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

41,540

 

 

Depreciation
284,997

 
172,074

 
170,323

Amortization of intangible assets
206,764

 
25,404

 
28,237

Amortization of inventory purchase accounting adjustments
54,924

 

 

Impairment of goodwill and trademarks
2,022

 
10,688

 

Amortization of credit facility and debt issuance costs
8,313

 
63,759

 
3,096

Provisions for environmental-related matters
15,443

 
42,932

 
31,071

Provisions for qualified exit costs
50,503

 
3,038

 
9,761

Deferred income taxes
(606,135
)
 
(68,241
)
 
4,976

Defined benefit pension plans net cost
18,153

 
14,851

 
6,491

Stock-based compensation expense
90,292

 
72,109

 
72,342

Net decrease in postretirement liability
(17,865
)
 
(12,373
)
 
(6,645
)
Decrease in non-traded investments
65,703

 
64,689

 
65,144

Loss (gain) on sale or disposition of assets
5,422

 
(30,564
)
 
(803
)
Other
1,051

 
5,334

 
3,617

Change in working capital accounts:
 
 
 
 
 
(Increase) in accounts receivable
(49,850
)
 
(113,855
)
 
(56,873
)
(Increase) in inventories
(89,959
)
 
(52,577
)
 
(40,733
)
Increase (decrease) in accounts payable
166,687

 
(118,893
)
 
160,111

(Decrease) increase in accrued taxes
(20,878
)
 
(2,159
)
 
4,606

Increase (decrease) in accrued compensation and taxes withheld
11,286

 
60,632

 
(13,128
)
(Increase) decrease in refundable income taxes
(15,520
)
 
(1,343
)
 
19,230

Other
16,270

 
56,215

 
(955
)
Costs incurred for environmental-related matters
(13,792
)
 
(15,178
)
 
(11,995
)
Costs incurred for qualified exit costs
(45,422
)
 
(6,267
)
 
(11,200
)
Other
(68,243
)
 
5,594

 
(43,059
)
Net operating cash
1,883,968

 
1,308,572

 
1,447,463

 
 
 
 
 
 
Investing Activities
 
 
 
 
 
Capital expenditures
(222,767
)
 
(239,026
)
 
(234,340
)
Acquisitions of businesses, net of cash acquired
(8,810,315
)
 
 
 

Proceeds from sale of assets
47,246

 
38,434

 
11,300

Increase in other investments
(61,526
)
 
(103,182
)
 
(65,593
)
Net investing cash
(9,047,362
)
 
(303,774
)
 
(288,633
)
 
 
 
 
 
 
Financing Activities
 
 
 
 
 
Net increase (decrease) in short-term borrowings
356,320

 
(899
)
 
(630,226
)
Proceeds from long-term debt
8,275,169

 
500

 
797,514

Payments of long-term debt
(1,852,812
)
 
(1,111
)
 

Payments for credit facility and debt issuance costs
(49,376
)
 
(65,119
)
 
 
Payments of cash dividends
(319,029
)
 
(312,082
)
 
(249,647
)
Proceeds from stock options exercised
143,579

 
86,831

 
89,990

Income tax effect of stock-based compensation exercises and vesting

 

 
89,691

Treasury stock purchased
 
 

 
(1,035,291
)
Other
(39,761
)
 
(15,473
)
 
(42,384
)
Net financing cash
6,514,090

 
(307,353
)
 
(980,353
)
Effect of exchange rate changes on cash
(36,276
)
 
(13,396
)
 
(13,465
)
Net (decrease) increase in cash and cash equivalents
(685,580
)
 
684,049

 
165,012

Cash and cash equivalents at beginning of year
889,793

 
205,744

 
40,732

Cash and cash equivalents at end of year
$
204,213

 
$
889,793

 
$
205,744

Taxes paid on income
$
419,695

 
$
477,786

 
$
335,119

Interest paid on debt
220,630

 
153,850

 
48,644


See notes to consolidated financial statements.

43

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



 
Common
Stock
 
Other
Capital
 
Retained
Earnings
 
Treasury
Stock
 
Cumulative
Other
Comprehensive
Loss
 
Total
Balance at January 1, 2015
$
114,525

 
$
2,079,639

 
$
2,424,674

 
$
(3,150,410
)
 
$
(471,958
)
 
$
996,470

Net income
 
 
 
 
1,053,849

 
 
 
 
 
1,053,849

Other comprehensive loss
 
 
 
 
 
 
 
 
(115,137
)
 
(115,137
)
Treasury stock purchased
 
 
 
 
 
 
(1,035,291
)
 
 
 
(1,035,291
)
Stock-based compensation activity
1,236

 
161,096

 
 
 
(34,357
)
 
 
 
127,975

Income tax effect of stock compensation
 
 
89,691

 
 
 
 
 
 
 
89,691

Cash dividends -- $2.68 per common share
 
 
 
 
(249,647
)
 
 
 
 
 
(249,647
)
Balance at December 31, 2015
115,761

 
2,330,426

 
3,228,876

 
(4,220,058
)
 
(587,095
)
 
867,910

Net income
 
 
 
 
1,132,703

 
 
 
 
 
1,132,703

Other comprehensive income
 
 
 
 
 
 
 
 
46,744

 
46,744

Stock-based compensation activity
802

 
158,138

 
 
 
(15,774
)
 
 
 
143,166

Cash dividends -- $3.36 per common share
 
 
 
 
(312,082
)
 
 
 
 
 
(312,082
)
Balance at December 31, 2016
116,563

 
2,488,564

 
4,049,497

 
(4,235,832
)
 
(540,351
)
 
1,878,441

Net income
 
 
 
 
1,772,262

 
 
 
 
 
1,772,262

Other comprehensive income
 
 
 
 
 
 
 
 
155,481

 
155,481

Stock-based compensation activity
998

 
232,351

 
 
 
(30,584
)
 
 
 
202,765

Acquired noncontrolling interest
 
 
2,268

 
 
 
 
 
 
 
2,268

Cash dividends -- $3.40 per common share
 
 
 
 
(319,029
)
 
 
 
 
 
(319,029
)
Balance at December 31, 2017
$
117,561

 
$
2,723,183

 
$
5,502,730

 
$
(4,266,416
)
 
$
(384,870
)
 
$
3,692,188

 
See notes to consolidated financial statements.





44 









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45

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(thousands of dollars unless otherwise indicated)
 

NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES
Consolidation. The consolidated financial statements include the accounts of The Sherwin-Williams Company and its wholly owned subsidiaries (collectively, the Company). Inter-company accounts and transactions have been eliminated. In order to facilitate our year-end closing process, Valspar foreign subsidiaries’ financial results are included in our consolidated financial statements on a one-month lag.
Use of estimates. The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those amounts.
Nature of operations. The Company is engaged in the development, manufacture, distribution and sale of paint, coatings and related products to professional, industrial, commercial and retail customers primarily in North and South America, with additional operations in the Caribbean region, Europe, Asia and Australia.
Reportable segments. See Note 18 for further details.
Cash flows. Management considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.
Fair value of financial instruments. The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts reported for Cash and cash equivalents approximate fair value.
Short-term investments: The carrying amounts reported for Short-term investments approximate fair value.
Investments in securities: Investments classified as available-for-sale are carried at market value. See the recurring fair value measurement table on page 47.
Non-traded investments: The Company has investments in the U.S. affordable housing and historic
 
renovation real estate markets and certain other investments that have been identified as variable interest entities. 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 Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC), the investments are not consolidated. For affordable housing investments entered into prior to the January 1, 2015 adoption of Accounting Standard Update (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, 201