EXHIBIT 13
The Sherwin-Williams Company
2003 Annual Report
COMMITTED TO EXCELLENCE [SHERWN WILLIAMS LOGO]
FOREWORD
THE PURSUIT OF EXCELLENCE
IS A COMMITMENT, NOT AN
ACHIEVEMENT. This commitment is a vital
part of the Sherwin-Williams culture. It is a pledge
that joins every Sherwin-Williams employee together
in service to our customers and shareholders.
NET EXTERNAL SALES BY OPERATING SEGMENT
(millions of dollars) Net External Sales % of Sales by Operating Segment
- ------------------------------------ ------------------ -------------------------------
Paint Stores Segment $3,469 64.1%
Consumer Segment $1,190 22.0%
Automotive Finishes Segment $ 457 8.5%
International Coatings Segment $ 285 5.3%
Administrative Segment $ 7 0.1%
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Total Consolidated Net Sales $5,408 100.0%
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TABLE OF CONTENTS
Financial Highlights 1
Summary of Operating Segments 4
Letter to Shareholders 6
Company Overview 10
Culture of Excellence 18
Stores Map 20
Financial Performance 21
The Sherwin-Williams Company recruits, selects and hires the best qualified
people available -- without discrimination based on race, religion, color,
creed, sex, national origin, age, disability, status as a special disabled
veteran, veteran of the Vietnam era, or any other unlawful consideration.
FINANCIAL
HIGHLIGHTS
(thousands of dollars except per share data) 2003 2002 2001
--------------- ------------- -------------
Net sales $ 5,407,764 $ 5,184,788 $ 5,066,005
=============== ============= =============
Income before cumulative effect of change in accounting principle $ 332,058 $ 310,701 $ 263,158
Cumulative effect of change in accounting principle - net of income taxes of (183,136)
$64,476
--------------- ------------- -------------
Net income $ 332,058 $ 127,565 $ 263,158
=============== ============= =============
Per common share:
Fully-diluted:
Income before cumulative effect of change in accounting principle $ 2.26 $ 2.04 $ 1.68
Cumulative effect of change in accounting principle - net of income
taxes (1.20)
--------------- ------------- -------------
Net income $ 2.26 $ .84 $ 1.68
Basic:
Income before cumulative effect of change in accounting principle $ 2.29 $ 2.07 $ 1.69
Cumulative effect of change in accounting principle - net of income
taxes (1.22)
--------------- ------------- -------------
Net income $ 2.29 $ .85 $ 1.69
Cash dividends $ .62 $ .60 $ .58
Book value $ 10.17 $ 9.01 $ 9.66
=============== ============= =============
Average common shares outstanding (thousands) 144,847 150,438 155,557
Return on sales (1) 6.1% 6.0% 5.2%
Return on net operating assets employed (RONAE) (2) 37.3% 35.7% 27.5%
Return on beginning shareholders' equity (1) 24.7% 20.9% 17.9%
Total debt to capitalization 26.0% 28.0% 29.3%
Interest coverage (3) 14.5x 13.3x 8.8x
Current ratio 1.5 1.4 1.3
Total technical expenditures (4) $ 88,369 $ 88,721 $ 86,222
SALES
(millions of dollars)
[BAR CHART]
2001 5,066
2002 5,185
2003 5,408
INCOME - (1)
(millions of dollars)
[BAR CHART]
2001 263
2002 311
2003 332
INCOME PER
SHARE - DILUTED (1)
[BAR CHART]
2001 1.68
2002 2.04
2003 2.26
(1) Based on income before cumulative effect of change in accounting principle.
See Note 2, pages 47 and 48 of this report.
(2) Based on income before income taxes and cumulative effect of change in
accounting principle divided by average net accounts receivable,
inventories, property, plant and equipment and accounts payable.
(3) Ratio of income before income taxes,cumulative effect of change in
accounting principle and interest expense to interest expense.
(4) See Note 1, page 45 of this report, for a description of technical
expenditures.
COMMITTED 1
TO EXCELLENCE
SHERWIN-WILLIAMS SERVES A DIVERSE CUSTOMER BASE SPANNING
A MULTITUDE OF MARKETS AND APPLICATIONS
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COVER THE
EARTH
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PAINT STORES
PRODUCTS SOLD: Paints, stains, caulks, applicators, wallcoverings,
floorcoverings, spray equipment and related products
MARKETS SERVED: Do-It-Yourselfers, professional painting contractors, home
builders, property managers, architects, interior designers, industrial, marine,
aviation, flooring and original equipment manufacturer (OEM) product finishes
MAJOR BRANDS SOLD: Sherwin-Williams(R), ProMar(R), SuperPaint(R), A-100(R),
PrepRite(R), Classic 99(R), Duration(R), Master Hide(R), Sher-Wood(R),
Powdura(R)
OUTLETS: 2,688 Sherwin-Williams stores in the United States, Canada, Mexico,
Puerto Rico and the Virgin Islands
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CONSUMER
PRODUCTS SOLD: Branded, private label and licensed brand paints, stains,
varnishes, industrial products, wood finishing products, applicators, corrosion
inhibitors, aerosols and related products
MARKETS SERVED: Do-It-Yourselfers, professional painting contractors and
industrial maintenance
MAJOR BRANDS SOLD: Dutch Boy(R), Krylon(R), Minwax(R), Cuprinol(R),
Thompson's(R) WaterSeal(R), Formby's(R), Red Devil(R), Pratt & Lambert(R),
Martin Senour(R), H&C(R), White Lightning(R), Dupli-Color(R) and Rubberset(R)
OUTLETS: Leading mass merchandisers, home centers, independent paint dealers,
hardware stores, automotive retailers and industrial distributors in the United
States, Canada and Mexico
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OPERATING
SEGMENTS
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AUTOMOTIVE FINISHES
PRODUCTS SOLD: High performance interior and exterior coatings for the
automotive, fleet and heavy truck markets, as well as associated
products
MARKETS SERVED: Automotive jobbers, wholesale distributors, collision repair
facilities, dealerships, fleet owners and refinishers, production shops, body
builders and OEM product finishers
MAJOR BRANDS SOLD: Sherwin-Williams(R), Martin Senour(R), Western(TM),
Lazzuril(TM), Excelo(TM), Baco(TM)and ScottWarren(TM)
OUTLETS: 194 company-operated branches in the United States, Canada,
Jamaica, Chile and Peru, and other operations throughout North and
South America, the Caribbean Islands and Europe
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INTERNATIONAL COATINGS
PRODUCTS SOLD: Architectural paints, stains, varnishes, industrial
maintenance products, aerosols, product finishes, wood finishing products
and related products
MARKETS SERVED: Do-It-Yourselfers, professional painting contractors,
independent dealers, industrial maintenance and OEM product finishes
MAJOR BRANDS SOLD: Sherwin-Williams(R), Dutch Boy(R), Krylon(R), Kem-Tone(R),
Martin Senour(R), Pratt & Lambert(R), Minwax(R), Sumare(TM), Ronseal(TM),
Globo(TM), Pulverlack(TM), Colorgin(TM), Andina(TM), Tri-Flow(R),
Thompson's(R)WaterSeal(R)and Marson(TM)
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OUTLETS: Distribution in 22 countries through wholly-owned subsidiaries,
joint ventures and licensees of technology, trademarks and trade-names,
including 61 company-operated architectural and industrial stores in
Chile, Brazil, Uruguay and Argentina
COMMITTED 5
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Christopher M. Connor Joseph M. Scaminace
Chairman and Chief Executive Officer President and Chief Operating Officer
WE ARE PLEASED TO REPORT ON ANOTHER GOOD YEAR FOR THE SHERWIN-WILLIAMS COMPANY.
Our consolidated net sales for the year grew 4.3% to $5.41 billion from
$5.18 billion in 2002. Income before the cumulative effect of change in
accounting principle increased 6.9% to $332.1 million from $310.7 million last
year, despite an after-tax $13.3 million headwind from a reduction in the net
pension credit. Diluted income per common share established another new record
high of $2.26 per share, which represents a 10.8% increase over last year's
previous high of $2.04 per share, before the cumulative effect of change in
accounting principle. Considering the slow start we experienced in the first
half of the year, we are pleased with our sales and earnings performance.
For the third year in a row, the Company's net operating cash flow exceeded
$550 million. Our Operational Excellence initiatives continued to help us
generate significant cash from operations. Each operating division remained
focused on reducing manufacturing and administrative costs and improving our
working capital management, which contributed substantially to our operating
profit improvement and cash generation. It is particularly noteworthy that we
were able to reduce our inventory days from 83 to 77 while maintaining the
necessary service levels to support a sales increase.
This cash was used to strengthen our balance sheet and make additional
investments towards building the future. Our debt to total capital ratio
improved to 26.0% in 2003 from
6 COMMITTED
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LETTER TO
SHAREHOLDERS
28.0% at year-end 2002. We invested $116.5 million in capital expenditures, and
our Consumer Segment purchased Accurate Dispersions, a manufacturer of
high-quality industrial and architectural colorants. We made cash dividend
payments of $90.7 million and purchased 7.9 million shares of the company's
common stock on the open market for treasury. At year-end, our cash and cash
equivalents stood at $302.8 million, an increase of $138.8 million over the end
of 2002. On the strength of our earnings and cash position, our Board of
Directors in 2004 approved a first quarter dividend of $0.17 per share, setting
us on course for our 26th consecutive year of increased dividends.
PAINT STORES SEGMENT - Net sales for our Paint Stores Group increased by 5.1% to
$3.5 billion from $3.3 billion in 2002. Comparable-store sales improved by 4.0%
over the prior year. Operating profit from the Segment finished at $403.4
million, an increase of 1.2% over 2002.
For the professional user of coatings products, our paint stores provide
the quality products and services to make their businesses more successful.
Contractor purchases continued to fuel solid growth in sales of architectural
paint and related products, which was further supported by increasing
do-it-yourself customer traffic throughout the year. We were also encouraged by
positive year-over-year sales comparisons in our industrial maintenance and
product finishes businesses in the latter half of the year.
In 2003, we added 45 net new stores, for a total of 2,688 stores located in
North America. We ended year two of a three-year program to refresh the
interiors of our stores with the completion of another 500 stores, and remain on
target to complete the entire chain by the end of 2004. As part of the refresh
program, all stores received an upgraded POS computer system that dramatically
reduces processing time, enabling our store personnel to spend more time
servicing customers and less time on administrative tasks.
Again in 2003, our stores introduced important new products that
incorporate advanced technologies designed to improve productivity and
performance. Our popular ProMar(R) interior paint line received multiple
enhancements, and we introduced a new paint system called Builders Solution(TM),
a high-build product line for use on drywall surfaces.
For our industrial maintenance customers, we continue to introduce new
products under the Express Tech(R) brand. This line of coatings offers
significant labor savings and productivity improvements that allow property and
equipment to be returned to service in less time.
Our Chemical Coatings Division was energized by an upturn in the domestic
manufacturing sector during the second half of 2003. With construction of our
new manufacturing facility in Shanghai complete, we are now better positioned to
support domestic OEM customers who have relocated their operations to that part
of the world.
CONSUMER SEGMENT - External net sales in the Consumer Segment increased 1.0% to
$1.2 billion in 2003 versus the prior year. An improving DIY market resulted in
stronger architectural paint sales and increased sales of aerosol and wood care
products at some of the Segment's largest retailers.
Operating profit for the Segment grew 3.3% to $199.0 million. This
operating profit improvement resulted from a combination of higher sales
volumes, manufacturing efficiencies related to increased volume and aggressive
expense control in accordance with our Operational Excellence program.
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Our Consumer Segment is organized into three operating divisions: Consumer,
Diversified Brands and Wood Care. In recent years, each of these divisions has
demonstrated how the combination of brand strength and innovation can result in
expanded distribution, market share gains and category growth. The introduction
of our new Krylon(R) Fusion for Plastic(TM) areosol paint in 2003 is the most
recent example. Unlike conventional spray paint, this new aerosol paint
technology bonds permanently to plastic, which opens up a whole new market for
the Krylon(R) brand. Consumer response to Krylon(R) Fusion for Plastic(TM), and
sales results, has been extraordinary. Similarly, since the introduction of our
revolutionary Twist & Pour(TM) container, our Dutch Boy(R) brand has gained
share in the DIY paint market every quarter.
AUTOMOTIVE FINISHES SEGMENT - Our Automotive Finishes Segment posted a 0.6%
sales increase to $456.7 million for the year, aided by a change in a Brazilian
subsidiary's fiscal year to a calendar year basis. Despite the negative effect
of currency fluctuations, sales improvements in the Segment's International
operating units more than offset domestic sales declines.
Operating profit for the Segment decreased 3.8% to $52.4 million for the
year from $54.5 million in 2002. Operating profit for the year declined as a
result of lower sales volume and unfavorable manufacturing absorption. We were
encouraged by the strong fourth quarter 2003 performance of our Automotive
Finishes Segment, which posted an 8.6% net sales increase and a 20.5%
improvement in operating profit.
In 2003, the Segment added 18 new branches in North America, bringing the
total number of company-operated branches in the U.S., Canada, Jamaica and Chile
to 194. During the year, we introduced advanced new primer technologies that
will increase the productivity of our shop customers. We also introduced our
unique Internet Scale system, which offers customers around the world instant
access to our vast color formula database.
INTERNATIONAL COATINGS SEGMENT - Net sales in our International Coatings Segment
increased 16.8% to $285.3 million in 2003. During the year, a Brazilian
subsidiary changed their fiscal year to a calendar year basis, adding an
additional month to the year's results. This was partially offset by the
negative impact of currency fluctuations during the year. The combined impact of
currency fluctuations and the change in fiscal year added $9.7 million in sales
to the Segment's 2003 results.
The International Segment realized an operating profit of $8.4 million in
2003 compared to an operating loss of $5.6 million in 2002. Results in 2002
included impairment charges of $11.9 million. The impact of the Brazilian
subsidiary's change in fiscal years to a calendar year basis more than offset
the effect of unfavorable currency exchange fluctuations for the year.
The poor economic conditions that have existed in South America show signs
of improving. Although market demand for architectural and industrial finishes
in the region continue to be somewhat constrained, we are expanding our
distribution and strengthening our brand offering. In Chile, we introduced our
Minwax(R) branded stains and varnishes, and in Brazil we further expanded our
architectural and industrial distribution platforms with the addition of some
important new accounts.
In the United Kingdom, our Ronseal(TM) wood care coatings are market
leaders, and the Ron-seal business delivered another outstanding year of
financial performance. For the second year in a row, we were recognized as
supplier-of-the-year by the leading home improvement store chain in the U.K.
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MANAGEMENT CHANGES - In May, Tom Brummett was appointed President and General
Manager of the Chemical Coatings division of our Paint Stores Segment.
Throughout his 40-year career with Sherwin-Williams, Tom has held various
positions in sales and marketing management within the Paint Stores
organization. Prior to this appointment, he served as President of the Eastern
Division of the Paint Stores Segment. Tom's strengths as both an operational
manager and strategic thinker will serve us well as our Chemical Coatings
division continues to build the manufacturing and technology infrastructure to
serve our customers around the globe.
Tim Drouilhet was appointed to succeed Tom as President of the Eastern
Division of the Paint Stores Segment. Since joining Sherwin-Williams in 1979,
Tim has excelled in the capacities of store manager, district manager and vice
president of sales, all within the Paint Stores Segment. We are confident that
Tim's motivational leadership, keen market insight and passion for the business
will keep the Eastern Division on the path of growth and profit improvement.
OUTLOOK FOR 2004
We are encouraged by the strength of our business in the latter half of
2003. The demand for architectural products has held up well and many commercial
and industrial market segments showed marked improvement as the year progressed.
However, we continue to believe that the recovery in the U.S. industrial sector
will develop slowly, and we have planned accordingly.
Our continued success in 2004 will rely on our ability to expand the
distribution of our brands and products by opening new stores at an accelerated
pace and by increasing our retail presence outside of our store network. We will
challenge our marketing and technical organizations to develop and commercialize
new, innovative products in less time, and our sales organizations to use these
products to gain market penetration and sell new customers. We will continue to
focus on the efficiency and productivity of our operations to ensure that an
ever-growing portion of each sales dollar goes to profit.
Our commitment to excellence has provided us with the inspiration and focus
to continue our mission of exceeding customer expectations. The caliber of our
workforce is truly exceptional and embodies excellence. We acknowledge their
hard work and innovative thinking, and in one voice we offer our thanks to our
customers, suppliers and shareholders for their continued trust and confidence.
/s/ Christopher M. Connor
- ------------------------------------
Christopher M. Connor
Chairman and Chief Executive Officer
/s/ Joseph M. Scaminace
- ------------------------------------
Joseph M. Scaminace
President and Chief Operating Officer
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SHERWIN-WILLIAMS STORES ARE THE EXCLUSIVE OUTLET FOR SHERWIN-WILLIAMS(R) BRANDED
ARCHITECTURAL AND INDUSTRIAL PAINTS, STAINS AND RELATED PRODUCTS. THE
UNPARALLELED QUALITY AND BREADTH OF THE PRODUCTS AND SERVICES WE OFFER ENABLED
OUR PAINT STORES SEGMENT TO ACHIEVE ANOTHER YEAR OF SOLID GROWTH AND FINANCIAL
PERFORMANCE.
Our unique platform of company-operated stores enables us to maintain
direct relationships with our customers, which include architectural and
industrial painting contractors, residential and commercial builders, property
managers, OEM product finishers and do-it-yourself homeowners. Ultimately, each
of our 2,688 stores has the responsibility to develop and deliver the quality of
service and field support each of these diverse customers require.
Our intensive customer focus took an important step forward in 2003.
Through a program called Sales Excellence, Sherwin-Williams sales
representatives are receiving intensive
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PAINT STORES
SEGMENT
sales training to help them better understand and fulfill customer needs. We
have also equipped our stores with a new point-of-sales system designed to free
up more time for our sales representatives to spend with customers and less time
on administrative tasks.
Excellence initiatives in the Paint Stores Segment include a commitment to
continuous improvement - even in our strongest product lines. In 2003, we
incorporated some significant technical enhancements into our best-selling
ProMar(R) line of interior paint to provide contractors with better hiding,
improved uniformity and easier touch-up - performance characteristics that
increase their productivity and their profits. Additionally, the architectural
community is now able to specify a higher quality paint due to superior burnish
and scrub resistance.
The Paint Stores Segment also introduced several important new products.
Builders Solution(TM) is an entirely new system designed to provide semi-custom
and custom homebuilders with a smooth, uniform finish on drywall surfaces. With
growing demand for products designed for use in the emerging prefinished siding
market, we also introduced the SuperPaint(R) Machine Finish product line. And,
to simplify projects for our do-it-yourself customer, we introduced our
exclusive Twist & Pour(TM) container in both the SuperPaint(R) and EverClean(R)
Interior product lines. This innovative container is easier to hold, open and
pour.
As the industry leader, Sherwin-Williams is committed to the research and
development of high-performance products that are environmentally friendly.
These initiatives continue to focus on improvements in manufacturing,
distribution and formulation methods to reduce emissions, save energy and use
more renewable raw materials. Examples of these high-performance products are
Harmony(R) Interior Latex Coating, a zero-VOC, low-odor coating for occupied
spaces, and Envirospec(TM), a low-VOC waterborne coating for use in industrial
markets.
INDUSTRIAL MAINTENANCE AND MARINE products from Sherwin-Williams are
heavy-duty, high-performance coatings formulated to withstand corrosion and the
harshest environments. Our success in this market has been driven by our ability
to deliver technology that works and maximizes productivity. Our ExpressTech(R)
line, featuring a proprietary
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Sherwin-Williams technology, continues to gain widespread customer acceptance on
projects where rapid project completion and return to service is essential.
Sales of our CHEMICAL COATINGS DIVISION improved in the second half of the
year, assisted in part by an improving manufacturing sector and several
significant new product introductions. We continue to strengthen our technology
platform with additions such as our Ultra-Cure(R) Water Reducible UV Curable
Coatings, and we opened a new R&D lab in Columbus, Ohio dedicated to
technological advancement and product development for the wood and composite
building product market. We also completed construction of our new plant in
Shanghai, which has been established to serve our domestic OEM customers who
have established manufacturing operations in this region.
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IN TODAY'S COMPETITIVE MARKETPLACE, A MAJORITY OF CONSUMER GOODS SUPPLIERS WOULD
AGREE THAT "BRAND IS KING." BUT THE MISSION OF OUR CONSUMER SEGMENT GOES BEYOND
SUPPLYING OUR RETAIL PARTNERS WITH STRONG BRANDS. WE ALSO PROVIDE
INDUSTRY-LEADING INNOVATIONS, UNMATCHED CUSTOMER SERVICE AND CATEGORY EXPERTISE.
With well-known brands like Minwax(R), Dutch Boy(R), Krylon(R) and Pratt &
Lambert(R), we continue expanding our North American distribution into a variety
of retail outlets such as home centers, hardware stores, independent paint
stores, industrial distributors, home improvement stores and mass merchandisers.
CONSUMER DIVISION - Helping consumers experience a positive and rewarding
decorating experience with industry-leading brands and product innovations
remains our central focus. While we are proud that our Dutch Boy(R) paint in our
revolutionary Twist & Pour(TM) container
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CONSUMER
SEGMENT
was the only paint product to be honored in Good Housekeeping's Eighth Annual
Good Buy Awards, we are equally pleased that a leading consumer publication
rated Dutch Boy(R) Dirt Fighter(R) paint a Best Buy. This combination of
innovative packaging and great value has enabled the Dutch Boy(R) brand to gain
market share every quarter since the introduction of the Twist & Pour(TM)
container. For consumers with smaller project needs, we successfully introduced
the Twist & Pour(TM) quart-sized container.
Market penetration of our Pratt & Lambert(R) line grew dramatically as a
result of a significant re-branding effort that included line conversion to
Twist & Pour(TM) packaging and new labeling, significant product performance
improvements, warranty enhancements and a return to consumer advertising. As a
result, the Ace Hardware Corporation, the nation's largest co-op hardware
distributor, elected to add the Pratt & Lambert Accolade(R) and RedSeal(R)
product lines to their product offering.
Our commitment to Operational Excellence throughout our network of 14
manufacturing facilities and eight distribution centers has earned us the
reputation as a highly efficient and reliable supply chain.
WOOD CARE DIVISION - A household name among consumers, and the market
leader in interior stains and finishes, Minwax(R) continued to build momentum in
2003. The flagship wood finish line introduced two new colors, English Chestnut
and Sedona Red, to bring the entire line to 20 colors. Our new Minwax(R) Water
Based Polyurethane for Floors was recognized by Popular Mechanics magazine
through its Editor's Choice Award at the National Hardware Show. Strong growth
of the entire Minwax(R) line led to a major expansion of our Flora, Illinois
facility. Last year also marked the kick-off of the 100th anniversary
celebration of the Minwax(R) brand, which will be promoted with consumers and
the media throughout 2004.
Known for its unmatched exterior waterproofing properties and ease of use,
our Thompson's(R) WaterSeal(TM) brand expanded its consumer offering with the
introduction of Thompson's(R) WaterSeal(TM) Deck and House Stains in both oil
and latex formulas. Also new for 2003, Dura Seal(R) X-Terra(R) is a water-based
finish for high traffic hardwood floors designed specifically for contractor
application.
DIVERSIFIED BRANDS DIVISION - Rarely does a single product introduction
create enough momentum to energize an entire paint category, but that's just
what occurred with the launch of Krylon(R) Fusion for Plastic(TM), the first
aerosol paint that bonds to plastic. This long-sought after
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technology has generated high interest among consumers as well as earning
industry praise. Krylon(R) Fusion for Plastic(TM) earned both an Innovation
Award from Handy magazine, and an Editor's Choice Award from Popular Mechanics.
Additionally, the recent introduction of our new Dupli-Color(R) Scratch Fix
2-in-1(TM) has enabled us to gain broader distribution with the nation's leading
automotive after-market retailers. As the market leader in aerosol paints, we
continue to benefit from our private label manufacturing relationships with
several mass merchants and distributors.
Our strong brand line-up is also evident in our Sherwin-Williams(R) brand
professional brushes and rollers, our Rubberset(R) applicator program and our
White Lightning(R) brand of caulks and sealants. Many of these caulks, brushes
and rollers are now featured in one of the nation's fastest growing home center
chains.
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A TOTAL COMMITMENT TO EXCELLENCE
IN TECHNOLOGY, DISTRIBUTION, PRODUCTS AND PROCESSES DRIVES OUR SOLUTION-BASED
PARTNERSHIPS WITH CUSTOMERS. AUTOMOTIVE, FLEET AND HEAVY-DUTY TRUCK FINISHERS
TURN TO OUR AUTOMOTIVE FINISHES SEGMENT FOR TECHNOLOGICALLY ADVANCED PRODUCTS
AND UNMATCHED SERVICES THAT HELP THEM SUCCEED.
For our customers, this success is measured in terms of their gains in
productivity, efficiency and quality. For example, our new SpectraPrime(TM) and
SpectraSeal(TM) primers utilize Ure-flex(TM) technology - the only OEM-certified
system that does not require the addition of a flex agent thereby reducing labor
and materials cost. Another industry first, our NP75 primer is a spreadable,
direct-to-metal isocyanate-free primer surfacer that results in faster prep time
for automobiles and trucks needing repair.
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AUTOMOTIVE
FINISHES
SEGMENT
Our commitment to technology has completely changed the manner in which our
customers select their color formulas. With the launch of our FormulaExpress(TM)
Internet Scale, our customers have direct access to the tens of thousands of
formulas in the color lab database residing in our World Automotive Center in
Warrensville, Ohio, This information is now available in real time as it is
formulated in our labs - providing customers with an enormous competitive
advantage.
The Automotive Finishes Segment has developed a comprehensive distribution
platform that includes thousands of outlets, both independent and company-owned.
Our total of 194 company-owned outlets is the largest such network in the
automotive finishes industry. Additionally, our products are widely available
through a strong network of independent distributors and jobbers. Our foreign
licensing agreements and wholly owned subsidiaries give us a presence in nearly
30 countries.
Internationally, we continue to strengthen our distribution platform in
Latin America and Europe. We also completed the acquisition of ScottWarren
France, which will expand our presence in the European vehicle refinish market.
Our involvement in NASCAR racing continues to create opportunities to
demonstrate our coatings technology and service capabilities. We are currently
the coatings supplier of choice for 16 Nextel Cup teams. In September, we
partnered with industry renowned color stylist
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Bob Fritz to create striking imagery for the pace car at NASCAR's Chevy Rock &
Roll 400 at Richmond International Speedway.
The 280-plus employees at our 350,000-square-foot global headquarters in
Ohio strive daily to improve our internal performance and efficiency. Every
product introduction complies with our Best Demonstrated Practices(TM), which
provide standardization of the repair process for each individual shop. With
this system, we can demonstrate value not only in terms of performance
characteristics such as dry time and gloss, but also how our products enhance a
customer's bottom line.
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OUR INTERNATIONAL COATINGS SEGMENT
WAS WELL POSITIONED IN 2003 TO TAKE FULL ADVANTAGE OF IMPROVED ECONOMIC
CONDITIONS IN THE MARKETS WHERE WE COMPETE. ON THE WHOLE, THE SEGMENT GREW
MARKET SHARE AND RECORDED SIGNIFICANT SALES AND PROFIT GROWTH.
Detailed analysis of our overseas markets determined that streamlining the
brands we offered would sharpen our focus and strengthen our product portfolio.
We continue to transfer advanced domestic technology that creates even further
differentiation of our coatings products.
Today, the International Coatings Segment has more than 1,700 employees
operating across six manufacturing sites and 65 company-operated stores - an
increase of seven stores from the previous year. We are engaged in three joint
ventures, and sell our products through 18 licensees in 15 countries.
BRAZIL - Brand strength and an ever-expanding distribution network and
customer base continue to shape our success in Brazil, our largest foreign
subsidiary. Our products are avail-
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INTERNATIONAL
COATINGS
SEGMENT
able through home centers, mass retailers and hardware stores. In 2003, we
generated significant gallon growth from new accounts opened during the year. We
are the market leader in aerosols with our Colorgin(TM) brand, which is
distributed through home centers, mass retailers and hardware stores. Our
advances in technology led to a successful introduction in 2003 of AquaCryl
Acrylic(TM) Enamel, the first waterborne synthetic enamel available in Brazil.
Our Sumare(TM) brand is sold through 25 company-operated stores and
directly to end-users. This powerful brand gives us market leadership in the
industrial maintenance category. In 2003, we won the paint business at Brazil's
largest truck trailer manufacturer. Our architectural coatings business remains
strong and we are enjoying success with our wood water-based products.
CHILE - Our solid market position and steady share gains in Chile are
attributable, in part, to an excellent distribution platform that includes
wholesale, retail outlets and direct retail sales. We participate in all major
paint categories from architectural, industrial and marine to aerosols and
chemical coatings. In addition to our leadership in aerosols with our Marson(TM)
brand and our familiar Andina(TM) brand - which serves the independent paint
dealer and hardware store channel - we made several important brand
introductions in 2003. Minwax(R) products were introduced into all channels, and
the integration of the General Polymers(TM) industrial floor product line is
ongoing. A new water-based enamel under the Pratt & Lambert(R) brand led to
incremental gallon gains in the architectural market.
ARGENTINA - After a challenging prior year due to currency devaluation,
high unemployment levels and a double-digit contraction in GNP, we rebounded
with exceptional sales performance in 2003. The architectural segment comprises
the majority of our market presence in Argentina. We were able to post gains
with our primary home center customer where we are strongly positioned. Our
sherwin.com program proved successful with our independent paint dealer
customer, as did our initiatives to reward dealer loyalty.
UNITED KINGDOM - Our product line ensures our strong market position in the
wood care coatings market in Great Britain and Ireland. We have extended our
[PICTURE]
leadership position in 2003 through the launch of new products such as
Ronseal(TM) Water-based Wood Preservers and Ronseal(TM) Quick & Easy Brushing
Wax, Liming Wax and Wood Dye. Our widely accepted existing products, along with
these new offerings, plus small can sales growth, helped drive another
impressive year of financial performance. In addition, the introduction of our
Colron(TM) product line enabled us to capture a share of the wood furniture care
market.
B&Q, the No. 1 home improvement store chain in the U.K. with more than 320
stores, honored us as its Supplier of the Year for an unprecedented second
consecutive year.
COMMITTED 17
TO EXCELLENCE
[PICTURE]
THERE IS A SPIRIT OF INNOVATION
AND CUSTOMER DEDICATION THAT HAS SHAPED THE SUCCESS OF THE SHERWIN-WILLIAMS
COMPANY FOR THE PAST 138 YEARS. THIS SPIRIT EXISTS COLLECTIVELY IN OUR CORPORATE
CULTURE AND INDIVIDUALLY AMONG OUR EMPLOYEES. WE ARE COMMITTED TO MAINTAINING AN
ENVIRONMENT WHERE THE TALENTED MEN AND WOMEN OF OUR COMPANY CAN EXCEL.
EARNING OUR STARS
Sherwin-Williams is committed to ensuring a workplace environment that
embraces excellence on every level. This commitment is particularly evident in
the area of workplace safety.
We are involved with federal initiatives like OSHA's Voluntary Protection
Program, established by the Department of Labor to recognize outstanding
occupational safety and health in the workplace. To receive VPP certification,
facilities must implement and follow a superior safety and health management
system built on four elements: management leadership and employee involvement,
worksite analysis, hazard prevention and control, and safety and health
training.
In 2003, our Consumer Division distribution center and truck fleet in Waco,
Texas won the VPP Star designation, the highest OSHA workplace safety award. Our
history with the VPP goes back to 1999, when our Consumer Division Emulsion
Plant in Chicago became the first coatings manufacturing facility in the U.S. to
receive the VPP Star. Our Wood Care Division plant in Olive Branch, Miss. also
received the Star designation in 2002. Eleven additional Sherwin-Williams
facilities are currently engaged in the process of VPP certification.
OSHA reports that most VPP sites show dramatic improvements in employee
retention, productivity, morale and quality, with injury rates well below the
industry average and lost workday incidence rates 52 percent below the industry
average. Of the more than 7 million workplaces in the United States, only 1,000
have achieved VPP recognition.
18 COMMITTED
TO EXCELLENCE
CULTURE OF
EXCELLENCE
MAKING GOOD WITH WOOD
The "Kids Making It" Woodworking Program is not just about teaching basic
woodworking skills. Developed by Jimmy Pierce in collaboration with the
Wilmington, N.C. Housing Authority, and funded by a grant from the North
Carolina Governor's Crime Commission, the program also instills positive values
and life skills to help prevent juvenile crime in public housing. For its
contribution to the community, "Kids Making It" won the annual Minwax(R)
Community Craftsman Award grand prize.
Minwax(R), part of the Wood Care Division of Sherwin-Williams, grants the
award to the individual or organization that has demonstrated exemplary
dedication to the betterment of their community through woodworking. As the
grand prize winner, the "Kids Making It" Woodworking Program received a monetary
grant, a supply of Minwax(R) products and a consultation with wood finishing
expert and author Bruce Johnson.
Two other programs were also honored. The Shasta (California) Woodworkers
Club and the Woodworkers Club of El Paso, Texas were named runners-up in the
contest for building and donating hundreds of wooden toys to Toys For Tots and
other U.S. Marine and Army toy campaigns.
CERTIFIED SERVICE
Our customers count on us for expert advice in the latest coatings
technologies and application methods. As the coatings industry leader, we are
committed to fielding the most knowledgeable workforce. We recently launched a
stringent new product certification course for all the technologically advanced
product launches in our Paint Stores Segment.
Under this program, every store manager and sales representative must
complete rigorous training and testing on the features and proper application of
each of our advanced new coatings. More than 3,100 reps and managers have
already passed the certification exam to sell our new 2004 releases, including
our ProXP(TM), DeckScapes(TM) and E-Barrier(TM) product lines. Product
certification training guarantees that our technological excellence is matched
by our sales excellence in the field.
[PICTURE]
WOMEN'S CLUB CELEBRATES 91ST ANNIVERSARY
Started in 1911 as the BUG Club - or Brighten-Up Girls Club, named for a
then-popular Sherwin-Williams paint called Brighten-Up Finishes - the
Sherwin-Williams Women's Club engages in a wide range of philanthropic work
while also promoting the business and social welfare of its members. The initial
membership of 20 women has grown to more than 300 today. The SWWC Ways and Means
Committee has organized dozens of fund-raising events from toy drives to raffles
to sales of food, books, household items and used office furniture. The SWWC
Philanthropy Committee has distributed thousands of dollars to more than 40
local and national charitable organizations. In support of the group's worthy
causes, the Sherwin-Williams Foundation matches donations made by the SWCC.
COMMITTED 19
TO EXCELLENCE
STORES MAP/
SUBSIDIARIES
[MAP]
SUBSIDIARIES
FOREIGN
Coatings S.R.L.
Compania Sherwin-Williams, S.A. de C.V.
Eurofinish S.r.l.
Productos Quimicos y Pinturas, S.A. de C.V.
Proquipsa, S.A. de C.V.
Pulverlack Nordeste Ltda.
Quetzal Pinturas, S.A. de C.V.
Ronseal (Ireland) Limited
Ronseal Limited
Scott Warren France SARL
Sherwin-Williams (Caribbean) N.V.
Sherwin-Williams (West Indies) Limited
Sherwin-Williams Argentina I.y C.S.A.
Sherwin-Williams Automotive Europe S.P.A.
Sherwin-Williams Automotive Mexico S. de R.L. de D.V.
Sherwin-Williams Automotive Northern Europe BVBA
Sherwin-Williams Canada Inc.
Sherwin-Williams Cayman Islands Limited
Sherwin-Williams Chile S.A.
Sherwin-Williams do Brasil Industria e Comercio Ltda.
Sherwin-Williams Paints(Dongguan)Company Limited
Sherwin-Williams Japan Co., Ltd.
Sherwin-Williams (Shanghai) Paints Company Limited
Sherwin-Williams Singapore PTE Ltd.
Sherwin-Williams Uruguay S.A.
The Sherwin-Williams Company Resources Limited
DOMESTIC
Contract Transportation Systems Co.
DIMC, Inc.
Dupli-Color Products Company
Omega Testing and Weathering Services LLC
Sherwin-Williams Finishes Corp.
Sherwin-Williams Realty Holdings, Inc.
SWIMC, Inc.
The Sherwin-Williams Acceptance Corporation
Thompson Minwax International Corp.
- - PAINT STORES
- - AUTOMOTIVE BRANCHES
Today, Sherwin-Williams has 2,943 paint stores and automotive branches
worldwide. More than 90% of the U.S. population lives within a 50-mile radius of
a Sherwin-Williams paint store.
20 COMMITTED
TO EXCELLENCE
FINANCIAL
COMMITTED TO FINANCIAL EXCELLENCE PERFORMANCE
[PICTURE]
FINANCIAL TABLE OF CONTENTS
Cautionary Statement Regarding Forward-Looking Information
22
Financial Summary
23
Management's Discussion and Analysis of Financial Condition and Results of
Operations
24
Report of Management
38
Report of Independent Auditors
39
Consolidated Financial Statements and Notes
40
Shareholder Information
67
Corporate Officers and Operating Presidents
68
21
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations," "Letter to Shareholders" and
elsewhere in this report constitute "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. These forward-looking statements are based upon
management's current expectations, estimates, assumptions and beliefs concerning
future events and conditions and may discuss, among other things, anticipated
future performance (including sales and earnings), expected growth, future
business plans and the costs and potential liability for environmental-related
matters and the lead pigment and lead-based paint litigation. Any statement that
is not historical in nature is a forward-looking statement and may be identified
by the use of words and phrases such as "expects," "anticipates," "believes,"
"will," "will likely result," "will continue," "plans to" and similar
expressions. Readers are cautioned not to place undue reliance on any
forward-looking statements. Forward-looking statements are necessarily subject
to risks, uncertainties and other factors, many of which are outside the control
of the Company, that could cause actual results to differ materially from such
statements and from the Company's historical results and experience.
These risks, uncertainties and other factors include such things as: (a)
general business conditions, strengths of retail and manufacturing economies and
the growth in the coatings industry; (b) competitive factors, including pricing
pressures and product innovation and quality; (c) changes in raw material
availability and pricing; (d) changes in the Company's relationships with
customers and suppliers; (e) the ability of the Company to attain cost savings
from productivity initiatives; (f) the ability of the Company to successfully
integrate past and future acquisitions into its existing operations, as well as
the performance of the businesses acquired; (g) changes in general domestic
economic conditions such as inflation rates, interest rates and tax rates; (h)
risks and uncertainties associated with the Company's expansion into and its
operations in China, South America and other foreign markets, including
inflation rates, recessions, foreign currency exchange rates, foreign investment
and repatriation restrictions, unrest and other external economic and political
factors; (i) the achievement of growth in developing markets, such as China,
Mexico and South America; (j) increasingly stringent domestic and foreign
governmental regulations including those affecting the environment; (k) inherent
uncertainties involved in assessing the Company's potential liability for
environmental remediation-related activities; (l) other changes in governmental
policies, laws and regulations, including changes in accounting policies and
standards and taxation requirements (such as new tax laws and new or revised tax
law interpretations); (m) the nature, cost, quantity and outcome of pending and
future litigation and other claims, including the lead pigment and lead-based
paint litigation and the affect of any legislation and administrative
regulations relating thereto; and (n) unusual weather conditions.
Readers are cautioned that it is not possible to predict or identify all of
the risks, uncertainties and other factors that may affect future results and
that the above list should not be considered to be a complete list. Any
forward-looking statement speaks only as of the date on which such statement is
made, and the Company undertakes no obligation to update or revise any
forward-looking statement, whether as a result of new information, future events
or otherwise.
22
FINANCIAL SUMMARY
(MILLIONS OF DOLLARS EXCEPT AS NOTED AND PER SHARE DATA)
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
OPERATIONS
NET SALES....................................... $ 5,408 $ 5,185 $ 5,066 $ 5,212 $ 5,004
COST OF GOODS SOLD.............................. 2,952 2,846 2,846 2,904 2,755
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.... 1,882 1,785 1,730 1,740 1,673
IMPAIRMENT OF OTHER ASSETS...................... 352
INTEREST EXPENSE................................ 39 40 55 62 61
INCOME BEFORE INCOME TAXES AND CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE...... 523 497 424 143 490
INCOME BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE................ 332 311 263 16 304
NET INCOME...................................... 332 128 263 16 304
FINANCIAL POSITION
INVENTORIES..................................... $ 638 $ 625 $ 633 $ 704 $ 703
ACCOUNTS RECEIVABLE - NET....................... 544 494 523 594 606
WORKING CAPITAL................................. 561 422 366 436 437
PROPERTY, PLANT AND EQUIPMENT - NET............. 650 665 673 722 712
TOTAL ASSETS.................................... 3,683 3,432 3,628 3,751 4,033
LONG-TERM DEBT.................................. 503 507 504 621 622
TOTAL DEBT...................................... 514 522 615 740 742
SHAREHOLDERS' EQUITY............................ 1,459 1,342 1,488 1,472 1,699
PER COMMON SHARE INFORMATION
AVERAGE SHARES OUTSTANDING (THOUSANDS).......... 144,847 150,438 155,557 161,912 167,925
BOOK VALUE...................................... $ 10.17 $ 9.01 $ 9.66 $ 9.22 $ 10.25
INCOME BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE - DILUTED...... 2.26 2.04 1.68 .10 1.80
INCOME BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE - BASIC........ 2.29 2.07 1.69 .10 1.81
NET INCOME - DILUTED............................ 2.26 .84 1.68 .10 1.80
NET INCOME - BASIC.............................. 2.29 .85 1.69 .10 1.81
CASH DIVIDENDS.................................. .62 .60 .58 .54 .48
FINANCIAL RATIOS
RETURN ON SALES (1)............................. 6.1% 6.0% 5.2% .3% 6.1%
ASSET TURNOVER.................................. 1.5x 1.5x 1.4x 1.4x 1.2x
RETURN ON ASSETS (1)............................ 9.0% 9.1% 7.3% .4% 7.5%
RETURN ON EQUITY (2)............................ 24.7% 20.9% 17.9% .9% 17.7%
DIVIDEND PAYOUT RATIO (1)....................... 27.3% 29.3% 34.6% 549.9% 26.6%
TOTAL DEBT TO CAPITALIZATION.................... 26.0% 28.0% 29.3% 33.5% 30.4%
CURRENT RATIO................................... 1.5 1.4 1.3 1.4 1.4
INTEREST COVERAGE (3)........................... 14.5x 13.3x 8.8x 3.3x 9.0x
WORKING CAPITAL TO SALES........................ 10.4% 8.1% 7.2% 8.4% 8.7%
EFFECTIVE INCOME TAX RATE (1)................... 36.5% 37.5% 38.0% 88.9% 38.0%
GENERAL
CAPITAL EXPENDITURES............................ $ 117 $ 127 $ 83 $ 133 $ 134
TOTAL TECHNICAL EXPENDITURES (4)................ 88 89 86 84 78
ADVERTISING EXPENDITURES........................ 239 222 236 276 265
REPAIRS AND MAINTENANCE......................... 52 52 48 48 46
DEPRECIATION.................................... 105 104 109 109 105
AMORTIZATION OF INTANGIBLE ASSETS............... 12 12 39 51 50
SHAREHOLDERS OF RECORD (TOTAL COUNT)............ 11,472 11,936 12,687 13,137 13,806
NUMBER OF EMPLOYEES (TOTAL COUNT)............... 25,777 25,752 25,789 26,095 25,697
SALES PER EMPLOYEE (THOUSANDS OF DOLLARS)....... $ 210 $ 201 $ 196 $ 200 $ 195
SALES PER DOLLAR OF ASSETS...................... 1.47 1.51 1.40 1.39 1.24
(1) Based on income before cumulative effect of change in accounting principle.
See Note 2, pages 47 and 48 of this report.
(2) Based on income before cumulative effect of change in accounting principle
and shareholders' equity at beginning of year.
(3) Ratio of income before income taxes, cumulative effect of change in
accounting principle and interest expense to interest expense.
(4) See Note 1, page 45 of this report, for a description of technical
expenditures.
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Sherwin-Williams Company (the Company), founded in 1866, is engaged in
the manufacture, distribution and sale of paints, coatings and related products
to professional, industrial, commercial and retail customers primarily in North
and South America. The Company is structured into five reportable segments -
Paint Stores, Consumer, Automotive Finishes, International Coatings
(collectively, the "Operating Segments") and Administrative - in the same way
that management internally organizes its business for assessing performance and
making decisions regarding allocation of resources. See Note 17, on pages 64
through 66 of this report, for more information concerning the Company's
reportable segments. In 2003, strong domestic architectural paint sales and a
favorable Do-It-Yourself (DIY) market that continued to gain momentum throughout
the year helped to offset soft domestic commercial architectural, industrial
maintenance and product finishes markets that struggled through the first three
quarters of the year with some improvement in the last quarter of 2003. The
domestic automotive refinish business was sluggish all year long and could not
maintain sales at last year's levels. Internationally, weak economic conditions
and unfavorable foreign currency exchange rates that existed in most South
American countries throughout the first half of 2003 improved during the last
half of the year. For the full year, increased gross margins from manufacturing
volume gains and other operational efficiencies more than offset an increase in
selling, general and administrative expenses resulting from the Company's
continuing investments in store growth, investment in the Asia/Pacific market
and a reduction in the net pension credit.
Consolidated net sales increased 4.3 percent in 2003 to $5.41 billion from
$5.18 billion in 2002. For 2003, income before cumulative effect of change in
accounting principle increased 6.9 percent to $332.1 million from $310.7 million
last year. Income before cumulative effect of change in accounting principle was
negatively impacted by a reduction in the net pension credit of $13.3 million
($20.9 million before income taxes) for the year 2003 compared to 2002. Diluted
net income per common share increased 10.8 percent to $2.26 per share for the
year from $2.04 per share a year ago, before the cumulative effect of change in
accounting principle. In the first quarter of 2002, the Company recorded an
after-tax transitional impairment charge of $183.1 million, or $1.21 per share,
as a cumulative effect of change in accounting principle for indefinite-lived
intangible assets and goodwill. Net income, after cumulative effect of change in
accounting principle, for the year 2002 was $127.6 million or $.84 per common
share.
The Company ended 2003 with $302.8 million in cash and cash equivalents -
an increase of $138.8 million over the end of 2002. The Company's current ratio
increased to 1.49 at December 31, 2003. Total debt declined to $513.6 million at
December 31, 2003 from $521.7 million at the end of last year and improved as a
percentage of total capitalization to 26.0 percent from 28.0 percent at the end
of 2002. Net operating cash flow was flat at $558.9 million in 2003. The primary
factors in maintaining a flat net operating cash flow were the improvement in
income before cumulative effect of change in accounting principle of $21.4
million, an increase in deferred taxes of $20.1 million and changes in working
capital accounts that generated cash of $4.5 million in 2003 compared to $84.4
million in 2002. Net operating cash flow activities during 2003 provided the
funds necessary to support the investment of $116.5 million in long-term assets,
debt reductions of $8.1 million, treasury stock purchases of $238.1 million,
cash dividend payments of $90.7 million and acquisitions of businesses of $48.4
million.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The consolidated financial statements and accompanying footnotes included
in this report have been prepared in accordance with accounting principles
generally accepted in the United States based upon management's best estimates
and judgments and giving due consideration to materiality. Management used
assumptions based on historical results and other assumptions that they believe
were reasonable 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 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.
All of the Company's significant accounting policies that were followed in
the preparation of the consolidated financial statements are disclosed in Note
1, on pages 44 through 47 of this report. The following procedures utilized by
management directly impacted many of the reported amounts in the consolidated
financial statements.
Management recorded an allowance for doubtful accounts to reduce accounts
receivable to their estimated net realizable value. Judgment was required in
order to make this assessment including an analysis of historical
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
bad debts, a review of the aging of accounts receivable and the current
creditworthiness of customers. As of December 31, 2003, no individual customer
constituted more than 5 percent of accounts receivable.
Inventories were stated at the lower of cost or market with cost determined
principally on the last-in, first-out (LIFO) method. Inventory quantities were
adjusted during the fourth quarter as a result of annual physical inventory
counts taken in all locations. Management recorded estimated reductions to
inventory cost representing the best estimate of net realizable value for
obsolete and discontinued inventories based on historical experience and current
trends.
Management's business and technical judgment was used in determining which
intangible assets have indefinite lives and in determining the useful lives of
finite-lived intangible assets in accordance with Statement of Financial
Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." As
required by SFAS No. 142, management performed transitional impairment testing
during the first quarter of 2002 and annual impairment testing of goodwill and
indefinite-lived intangible assets during the fourth quarters of 2003 and 2002.
Management estimated the fair values of goodwill and indefinite-lived intangible
assets using a discounted cash flow valuation model, incorporating discount
rates commensurate with the risks involved for each reporting unit. Growth
models were developed using both industry and company historical results and
forecasts. Such models required management to make certain assumptions based
upon information available at the time the valuation was performed, which could
differ from actual results. See Notes 2 and 3, pages 47 through 49 of this
report, for a discussion of the reductions in carrying value recorded.
Property, plant and equipment was stated on the basis of cost and
depreciated principally on a straight-line method using industry standards and
historical experience to estimate useful lives. In accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," whenever
events or changes in circumstances indicate that the carrying value of an asset
or asset group may not be recoverable or the useful life has changed, impairment
tests are performed. Undiscounted future cash flows are used to calculate the
fair value of long-lived assets to determine if such assets are impaired. Where
impairment is identified, management determines 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 are developed
using both industry and company historical results and forecasts. Such models
require management to make certain assumptions based upon information available
at the time the valuation is performed, which could differ from actual results.
See Note 3, page 48 of this report, concerning the reduction in carrying value
of long-lived assets of a foreign subsidiary in accordance with SFAS No. 144.
To determine the Company's ultimate obligation under its defined benefit
pension plans and other postretirement benefit plans, management must estimate
the future cost of benefits and attribute that cost to the time period during
which each covered employee works. To record the related net assets and
obligations of such benefit plans, management used assumptions related to
inflation, investment returns, mortality, employee turnover, rate of
compensation increases, medical costs and discount rates. Management, along with
third-party actuaries, reviews all of these assumptions on an ongoing basis to
ensure that the most reasonable information available is being considered.
Management believes these assumptions were within accepted industry ranges,
although an increase or decrease in the assumptions or economic events outside
management's control could have a direct impact on reported results of
operations. In determining the expected long-term rate of return on defined
benefit pension plan assets, management considered the historical rates of
return, the nature of investments and an expectation for future investment
strategies. For 2004 expense recognition, the Company will use a discount rate
of 6.0 percent, an expected rate of return on defined benefit pension plan
assets of 7.5 percent and a rate of compensation increase of 4.0 percent. Use of
these assumptions will result in a higher calculated pension expense. See Note
6, pages 52 through 55 of this report, for information concerning the Company's
defined benefit pension plans and postretirement benefits.
The Company is self-insured for certain liabilities, primarily worker's
compensation claims, employee benefits, and automobile, property and general
liability claims. Claims filed but unsettled and estimated claims incurred but
not reported were accrued based upon management's estimates of the aggregate
liability for claims incurred using historical experience and actuarial
assumptions followed in the insurance industry.
The Company is involved with environmental investigation and remediation
activities at some of its current and former sites and at a number of
third-party sites. The Company accrues for environmental remediation-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
historical
25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
experience. All accrued amounts are recorded on an undiscounted basis. Accrued
environmental remediation-related expenses include 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, consulting and law firms. See Note 8, on pages
56 and 57 of this report, for information concerning the accrual for extended
environmental-related activities. 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 pages
30 and 31 of this report for a discussion concerning unaccrued future loss
contingencies.
Management is continually re-evaluating the Company's operating facilities
against its long-term strategic goals. Effective January 1, 2003, SFAS No. 146,
"Accounting for Costs from Exit or Disposal Activities," was adopted by the
Company. SFAS No. 146 requires, among other things, that a liability for costs
associated with an exit or disposal activity be recognized when the liability is
incurred rather than at the time of commitment to a formal shutdown plan.
Estimates of such costs are determined by contractual agreement or estimated by
management based on historical experience. During 2003, a formal plan was
approved to close one manufacturing facility. No exit costs related to this
facility were accrued in 2003 in accordance with SFAS No. 146 and such costs are
not expected to be material in 2004. Through December 31, 2002, at the time of
commitment to a formal shutdown plan of an operating facility, provisions were
made for all estimated qualified exit costs in accordance with Emerging Issues
Task Force (EITF) 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity," and other related accounting
guidance. Concurrently, property, plant and equipment and other long-lived
assets are tested for impairment in accordance with SFAS No. 144 due to the
change in circumstances as indicated by the pending exit or disposal. If
impairment is determined to exist, the carrying value of the long-lived assets
is reduced to fair value estimated by management using a cash flow valuation
model, incorporating discount rates commensurate with the risks involved for
each group of assets. See Note 5, pages 50 and 51 of this report, for accrued
costs of exit or disposal activities and any reductions in carrying value of
long-lived assets.
The Company invests in the U.S. affordable housing and historic renovation
real estate markets. These investments have been identified as variable interest
entities. However, the Company is not the primary beneficiary and does not
consolidate the operations of the investments. The carrying amounts of these
non-traded investments, which approximate market value, are determined based on
cost less related income tax credits determined by the effective yield method.
See Note 1, on page 44 of this report, for more information on non-traded
investments. The Company's risk of loss from the partnership interests is
limited to the amount of its investment. 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 which are disclosed in the contractual
obligations table on page 32 of this report.
FINANCIAL CONDITION - 2003
The Company's financial condition continued to strengthen in 2003 due
primarily to improved profitability and control of working capital. The Company
ended the year with $302.8 million in cash and cash equivalents - an increase of
$138.8 million over the end of 2002. The Company's current ratio increased to
1.49 at December 31, 2003 from 1.39 at the end of 2002. Total debt declined to
$513.6 million at December 31, 2003 from $521.7 million at the end of last year
and improved as a percentage of total capitalization to 26.0 percent from 28.0
percent at the end of 2002. For the third year in a row, the Company's net
operating cash flow exceeded $550 million. Net operating cash flow was flat in
2003 at $558.9 million compared to $558.9 million in 2002. As shown in the
Statements of Consolidated Cash Flows, on page 42 of this report, the
improvement in income before cumulative effect of change in accounting principle
of $21.4 million, an increase in deferred taxes of $20.1 million and changes in
working capital accounts that generated cash of $4.5 million in 2003 compared to
$84.4 million in 2002 were the primary factors in maintaining a flat net
operating cash flow. Net operating cash flow activities during 2003 provided the
funds necessary to support the investment of $116.5 million in long-lived
assets, debt reductions of $8.1 million, treasury stock purchases of $238.1
million, cash dividend payments of $90.7 million and acquisitions of businesses
of $48.4 million. The Consolidated Balance Sheets and Statements of Consolidated
Cash Flows, on pages 40 and 42 of this report, provide more financial
information concerning the Company's financial position and cash flows.
Management considers a measurement of cash flow that is not in accordance
with accounting principles generally accepted in the United States to be a
useful tool in
26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
determining the discretionary amount of the Company's net operating cash.
Management reduces net operating cash, as shown in the Statements of
Consolidated Cash Flows, by the amount expended for capital expenditures and the
payment 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 following
value should not be compared to other entities unknowingly. The amount shown
below should not be considered an alternative to net operating cash or other
cash flow amounts in accordance with accounting principles generally accepted in
the United States disclosed in the Statements of Consolidated Cash Flows, on
page 42 of this report. Free Cash Flow as defined and used by management is
determined as follows:
(thousands of dollars)
2003 2002 2001
--------- --------- ---------
NET OPERATING CASH
(PAGE 42).................. $ 558,929 $ 558,917 $ 561,646
CAPITAL EXPENDITURES
(PAGE 42).................. (116,507) (126,530) (82,572)
PAYMENTS OF CASH
DIVIDENDS (PAGE 42)........ (90,689) (91,007) (90,984)
--------- --------- ---------
FREE CASH FLOW............. $ 351,733 $ 341,380 $ 388,090
========= ========= =========
Goodwill, which represents the excess of cost over the fair value of net
assets acquired in purchase business combinations, increased by a net $11.3
million and intangible assets increased a net $1.2 million in 2003. Increases in
goodwill and intangible assets occurred through purchase business combinations
completed in 2003. Decreases in intangible assets occurred from adjusting the
carrying values of certain intangibles for impairment as required by SFAS No.
142, partially offsetting the value of acquired intangibles. Foreign currency
adjustments and amortization of intangible assets with finite lives further
reduced the carrying values of intangible assets. Intangible assets with finite
lives include costs related to designing, developing, obtaining and implementing
internal use software that are capitalized and amortized in accordance with
Statement of Position (SOP) 98-1, "Accounting for the Cost of Computer Software
Developed or Obtained for Internal Use." See Note 3, on pages 48 and 49 of this
report, for a description of the asset impairments recorded in accordance with
SFAS No. 142 during the fourth quarter of 2003 and a tabular summary of the
carrying values of goodwill and intangible assets. In accordance with the
requirements of SFAS No. 142, goodwill and intangible assets deemed to have
indefinite lives are no longer amortized after January 1, 2002. Excluding
after-tax amortization expense of $24.1 million from 2001 to be comparable with
2002 and 2003, net income would have been $287.2 million or $1.83 per diluted
common share in 2001.
Deferred pension assets recognized in the Consolidated Balance Sheets of
$420.1 million at December 31, 2003 represent the recognized portion of the
excess of the fair market value of the assets in the Company's defined benefit
pension plans over the actuarially-determined projected benefit obligations. The
2003 increase in deferred pension assets of $5.5 million represents primarily
the recognition of the current year net pension credit of $2.1 million. The net
pension credit decreased $20.9 million in 2003 due primarily to the recognition
of a portion of the previously unrecognized actuarial loss. The unrecognized
actuarial loss relates primarily to a lower actual return on defined benefit
pension plan assets, primarily equity investments, compared to the expected
return and the effects of changes in assumptions. The expected long-term rate of
return on assets was lowered from 8.5 percent to 8.0 percent in 2002 and lowered
again to 7.5 percent in 2003 to reflect the lower expected returns on equity
investments in the future as a result of changing investment strategies. The
assumed discount rate used to compute the actuarial present value of projected
benefit obligations was decreased from 6.55 percent to 6.0 percent at December
31, 2003 due to decreased rates of high-quality, long-term investments. The net
pension credit is expected to remain approximately the same in 2004 due to the
net impact of changing assumptions and the continued recognition of a portion of
the unrecognized actuarial loss. See Note 6, on pages 52 and 53 of this report,
for a detailed description of the defined benefit pension plans and for more
financial information concerning the defined benefit pension plans' obligations,
assets and net pension credit.
Net property, plant and equipment decreased $14.4 million to $650.3 million
at December 31, 2003. The decrease was due primarily to depreciation expense of
$104.8 million, the sale and leaseback of certain warehouses with a net book
value of $32.4 million and other dispositions and retirements of fixed assets
with a net book value of $14.4 million. Partially offsetting these decreases in
fixed assets were capital expenditures of $116.5 million, foreign currency
translation adjustments of $8.9 million and fixed assets of $8.3 million
acquired in purchase business combinations. Capital expenditures during 2003 in
the Paint Stores Segment were primarily attributable to the opening of new paint
stores, new point-of-sale equipment, the relocation of certain stores and the
normal replacement and upgrading of store equipment. In the Consumer, Automotive
Finishes and
27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
International Coatings Segments, capital expenditures during 2003 were primarily
related to efficiency improvements in production and distribution facilities and
information systems hardware. The Administrative Segment incurred capital
expenditures primarily for upgrading the Company's headquarters building and
information systems hardware. In 2004, the Company expects to spend slightly
more for capital expenditures than in 2003. Most significant capital
expenditures will relate to various capacity and productivity improvement
projects at manufacturing and distribution facilities, new store openings,
upgrading store color matching equipment 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.
There were no short-term borrowings outstanding under the Company's
commercial paper program at December 31, 2003, 2002 or 2001. During the year,
borrowings were made under the Company's commercial paper program that is fully
backed by and limited to the borrowing availability under the Company's
revolving credit agreements. The aggregate maximum borrowing capacity under the
current revolving credit agreements as of January 3, 2004 is $608.0 million. Due
to the seasonality of the Company's business and the need for available cash
prior to the primary selling season and collecting accounts receivable, the
Company expects to borrow under the commercial paper program during 2004.
The current and long-term portions of debt decreased $4.4 million and $3.7
million, respectively, during 2003 due primarily to the payment of various
promissory notes and other obligations during the year. See Note 7, on pages 55
and 56 of this report, for a detailed description of the Company's long-term
debt outstanding and other financing programs available.
The Company's long-term liability for postretirement benefits other than
pensions increased $3.1 million to $216.9 million from $213.7 million due to the
excess of the net postretirement benefit obligation over the benefit payments.
The assumed discount rate used to calculate the actuarial present value of the
obligation for postretirement benefits other than pensions was decreased from
6.55 percent to 6.0 percent at December 31, 2003 due to the reduced rates of
high-quality, long-term investments. The assumed health care cost trend rates
were revised during 2003 for years 2004 through 2010. The revised rates reflect
escalating health care costs that continued to exceed the previously established
rates. Separate assumptions are now being utilized for health care costs of
participants of pre-65 age and those of 65 and older age. The assumed rates used
for 2004 are 10.0 percent for pre-65 age participants and 12.0 percent for those
participants 65 or older, decreasing gradually to 5.0 percent in 2014. See Note
6, on pages 54 and 55 of this report, for further information on the Company's
obligation for postretirement benefits other than pensions.
Other long-term liabilities increased $63.2 million during 2003 due
primarily to increases in long-term deferred taxes and taxes payable of $28.6
million, benefit and self-insurance liabilities of $13.3 million, contractually
committed capital contributions in the U.S. affordable housing and historic
renovation real estate markets of $2.8 million, environmental-related
liabilities of $2.6 million and other obligations. See Note 8, on pages 56 and
57 of this report, for information concerning the Company's
environmental-related and other long-term liabilities. See pages 30 and 31 of
this report for a discussion concerning unaccrued future environmental-related
loss contingencies.
Shareholders' equity increased $117.0 million during 2003 to $1,458.9
million at December 31, 2003 from $1,341.9 million last year. The increase in
shareholders' equity resulted primarily from increased retained earnings,
increased capital accounts and the reduction of cumulative other comprehensive
loss partially offset by the purchase of treasury stock. Retained earnings
increased $241.4 million during 2003 due to net income of $332.1 million
partially offset by $90.7 million in cash dividends paid. Net increases in
common stock and other capital of $84.7 million were due to the tax impact of
certain ESOP transactions and stock option activity. The reduction in cumulative
other comprehensive loss resulted primarily from favorable foreign currency
translation adjustments of $30.9 million. The Company purchased 8.0 million
shares of its common stock during 2003 for treasury at a cost of $238.1 million.
The Company acquires its common stock for general corporate purposes and,
depending on its cash position and market conditions, it may acquire additional
shares in the future. The Company had remaining authorization at December 31,
2003 to purchase 17.0 million shares of its common stock. See the Statements of
Consolidated Shareholders' Equity and Comprehensive Income, on page 43 of this
report, and Notes 9, 10 and 11, on pages 57 through 60 of this report, for more
information concerning shareholders' equity.
The changes in Cumulative other comprehensive loss consisted mainly of
favorable foreign currency translation adjustments in the Consolidated Balance
Sheets. The favorable foreign currency translation effect of $30.9 million in
2003 is attributable to the strengthening in most foreign operations' functional
currencies versus the U.S.
28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
dollar except the Mexican peso. The foreign currency translation loss increases
of $48.3 million in 2002 and $40.9 million in 2001 were attributable to
weaknesses in several foreign operations' functional currencies versus the U.S.
dollar, most notably the Argentine peso and the Brazilian real. Most
significantly, the Argentine government, beginning in January 2002, announced
plans to discontinue its currency board policy of maintaining a one-to-one fixed
exchange rate between the peso and U.S. dollar and attempted to implement a
controlled devaluation. The change in the currency translation rate of the
Argentine peso did not have a material impact on the overall results of
operations of the International Coatings Segment during 2002. However, the
related impact of the currency fluctuation on the Argentine economy and related
economies in South America caused sales and profits of the Argentina subsidiary
to decrease in 2002. Sales and profits recovered slightly in 2003 but have not
yet returned to pre-2002 levels. In addition, due to the reduction in the
currency exchange rate and in projected cash flows of the Argentina subsidiary,
an impairment of the current carrying values of long-lived assets of $9.0
million was charged against current operations during the first quarter of 2002.
See Note 3, on page 48 of this report, for more information concerning the
reduction in carrying value of long-lived assets.
The Company's cash dividend payout target per common share is 30.0 percent
of the prior year diluted net income per common share. The 2003 annual cash
dividend of $.62 per common share represented 30.4 percent of 2002 diluted
income per common share before cumulative effect of change in accounting
principle. The 2003 annual dividend represented the twenty-fifth consecutive
year of dividend payments since the dividend was suspended in 1978. At a meeting
held on February 4, 2004, the Board of Directors increased the quarterly cash
dividend to $.17 per common share. This quarterly dividend, if approved in each
of the remaining quarters of 2004, would result in an annual dividend for 2004
of $.68 per common share or a 30.1 percent payout of the prior year's diluted
net income per common share.
Management believes that it has properly valued the Company's assets and
recorded all known liabilities that existed as of the balance sheet date for
which a value is available or an amount can be reasonably estimated in
accordance with all present accounting principles generally accepted in the
United States. In addition, the Company may be subject to potential liabilities,
as described in the following, which cannot be reasonably estimated due to the
uncertainties involved.
The Company's past operations included the manufacture and sale of lead
pigments and lead-based paints. The Company, along with other companies, is a
defendant in a number of legal proceedings, including purported class actions,
separate actions brought by the State of Rhode Island, and actions brought by
various counties, cities, school districts and other government-related
entities, arising from the manufacture and sale of lead pigments and lead-based
paints. The plaintiffs are seeking recovery based upon various legal theories,
including negligence, strict liability, breach of warranty, negligent
misrepresentations and omissions, fraudulent misrepresentations and omissions,
concert of action, civil conspiracy, violations of unfair trade practices and
consumer protection laws, enterprise liability, market share liability,
nuisance, unjust enrichment and other theories. The plaintiffs seek various
damages and relief, including personal injury and property damage, costs
relating to the detection and abatement of lead-based paint from buildings,
costs associated with a public education campaign, medical monitoring costs and
others. The Company believes that the litigation is without merit and is
vigorously defending such litigation. The Company expects that additional lead
pigment and lead-based paint litigation may be filed against the Company in the
future asserting similar or different legal theories and seeking similar or
different types of damages and relief.
During September 2002, a jury trial commenced in the first phase of the
action brought by the State of Rhode Island against the Company and the other
defendants. The sole issue before the court in this first phase was whether lead
pigment in paint constitutes a public nuisance under Rhode Island law. This
first phase did not consider the issues of liability or damages, if any, related
to the public nuisance claim. In October 2002, the court declared a mistrial as
the jury, which was split four to two in favor of the defendants, was unable to
reach a unanimous decision. This was the first legal proceeding against the
Company to go to trial relating to the Company's lead pigment and lead-based
paint litigation. The State of Rhode Island has decided to retry the case.
Additional legal proceedings pending in other jurisdictions have been scheduled
for trial during 2004, and the Company believes it is possible that additional
legal proceedings could be scheduled for trial during 2004 and subsequent years.
Litigation is inherently subject to many uncertainties. Adverse court
rulings or determinations of liability could affect the lead pigment and
lead-based paint litigation against the Company and encourage an increase in the
number and nature of future claims and proceedings. In addition, from time to
time, various legislation and administrative regulations have been enacted or
proposed
29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
to impose obligations on present and former manufacturers of lead pigments and
lead-based paints respecting asserted health concerns associated with such
products and to overturn court decisions in which the Company and other
manufacturers have been successful. Due to the uncertainties involved,
management is unable to predict the outcome of the lead pigment and lead-based
paint litigation, the number or nature of possible future claims and
proceedings, or the affect that any legislation and/or administrative
regulations may have on the litigation or against the Company. In addition,
management cannot reasonably determine the scope or amount of the potential
costs and liabilities related to such litigation, or any such legislation and
regulations. The Company has not accrued any amounts for such litigation. Any
potential liability that may result from such litigation or such legislation and
regulations cannot reasonably be estimated. However, based upon, among other
things, the outcome of such litigation to date, management does not currently
believe that the costs or potential liability ultimately determined to be
attributable to the Company arising out of such litigation will have a material
adverse effect on the Company's results of operations, liquidity or financial
condition.
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 are 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 2003. 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 2004.
The Company is involved with environmental investigation and remediation
activities at some of its current and former sites (including sites which were
previously owned and/or operated by businesses acquired by the Company). In
addition, the Company, together with other parties, has been designated a
potentially responsible party under federal and state environmental protection
laws for the investigation and remediation of environmental contamination and
hazardous waste at a number of third-party sites, primarily Superfund sites. The
Company may be similarly designated with respect to additional third-party sites
in the future.
The Company accrues for estimated costs of investigation and remediation
activities at its current, former and third party sites for which commitments or
clean-up plans have been developed and when such costs can be reasonably
estimated based on industry standards and professional judgment. These estimated
costs are based on currently available facts regarding each site. The Company
accrues a specific estimated amount when such an amount and a time frame in
which the costs will be incurred can be reasonably determined. If the best
estimate of costs can only be identified as a range and no specific amount
within that range can be determined more likely than any other amount within the
range, the minimum of the range is accrued by the Company in accordance with
applicable accounting rules and interpretations. The Company continuously
assesses its potential liability for investigation and remediation activities
and adjusts its environmental-related accruals as information becomes available
upon which more accurate costs can be reasonably estimated. At December 31,
2003, 2002 and 2001, the Company had accruals for environmental-related
activities of $133.4 million, $128.6 million and $130.9 million, respectively.
Due to the uncertainties surrounding environmental investigation and
remediation activities, the Company's liability may result in costs that are
significantly higher than currently accrued. If the Company's future loss
contingency is ultimately determined to be at the maximum of the range of
possible outcomes for every site for which costs can be reasonably estimated,
the Company's aggregate accruals for environmental-related activities would be
$99.8 million higher than the accruals at December 31, 2003.
Three of the Company's current and former manufacturing sites, described
below, account for the majority of the accrual for environmental-related
activities and the unaccrued maximum of the estimated range of possible outcomes
at December 31, 2003. Included in the accruals of $133.4 million at December 31,
2003 is $71.8 million related directly to these three sites. In the aggregate
unaccrued exposure of $99.8 million at December 31, 2003, $41.1 million relates
to the three manufacturing sites.
30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
While environmental investigations and remedial actions are in different stages
at these sites, additional investigations, remedial actions and monitoring will
likely be required at each site.
The first of these sites is a former manufacturing facility in New Jersey
that is in the early investigative stage of the environmental-related process.
Although contamination exists at the site and adjacent areas, the extent and
magnitude of the contamination has not yet been fully quantified. Due to the
uncertainties of the scope and magnitude of contamination and the degree of
remediation that may be necessary relating to this site, it is reasonably
likely that further extensive investigation may be required and that extensive
remedial actions may be necessary not only at the former manufacturing site but
along an adjacent waterway. Depending on the extent of the additional
investigation and remedial actions necessary, the ultimate liability for this
site may exceed the amount currently accrued and the maximum of the range of
reasonably possible outcomes currently estimated by management.
The second site is a current manufacturing facility located in Illinois.
The environmental issues at this site have been determined to be associated with
historical operations. While the majority of the investigative work has been
completed at this site and some remedial actions taken, agreement on a proposed
remedial action plan has not been obtained from the appropriate governmental
agency. The third site is a current manufacturing facility in California.
Similar to the Illinois site noted above, the environmental issues at this site
have been determined to be associated with historical operations. The majority
of the investigative activities have been completed at this site, some remedial
actions have been taken and a proposed remedial action plan has been formulated
but currently no clean up goals have been approved by the lead governmental
agency. In both the Illinois and California sites, the potential liabilities
relate to clean-up goals that have not yet been established and the degree of
remedial actions that may be necessary to achieve these goals.
Management cannot presently estimate the potential loss contingencies
related to these sites or other less significant sites until such time as a
substantial portion of the investigation at the sites is completed and remedial
action plans are developed. In the event any future loss contingency
significantly exceeds the current amount accrued, the recording of the ultimate
liability may result in a material impact on net income for the annual or
interim period during which the additional costs are accrued. Management does
not believe that any potential liability ultimately attributed to the Company
for its environmental-related matters will have a material adverse effect on
the Company's financial condition, liquidity, or cash flow due to the extended
period of time during which environmental investigation and remediation takes
place. An estimate of the potential impact on the Company's operations cannot be
made due to the aforementioned uncertainties.
Management expects these contingent environmental-related liabilities to be
resolved over an extended period of time. Management is unable to provide a more
specific time frame due to the indefinite amount of time to conduct
investigation activities at any site, the indefinite amount of time to obtain
governmental agency approval, as necessary, with respect to investigation and
remediation activities, and the indefinite amount of time necessary to conduct
remediation activities.
The Company is exposed to market risk associated with interest rates and
foreign currency exposure. 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. At December
31, 2001 and during the first two quarters of 2002, the Company partially hedged
risks associated with fixed interest rate debt by entering into various interest
rate swap agreements (see Note 7, on pages 55 and 56 of this report). The
interest rate swap agreements were unwound during the second quarter of 2002 and
the Company received $4.8 million. This premium was recorded as an increase in
the value of the underlying debt instruments and is being amortized to reduce
interest expense over the original life of the swaps. The Company also entered
into foreign currency option and forward contracts to hedge against value
changes in foreign currency (see Note 12, on page 61 of this report). The
Company believes it may experience continuing losses from foreign currency
translation. However, the Company does not expect currency translation,
transaction or hedging contract losses will have a material adverse effect on
the Company's financial condition, results of operations or cash flows.
Certain borrowings contain a minimum net worth covenant. At December 31,
2003, the Company was in compliance with the covenant. The Company's Notes,
Debentures and revolving credit agreements (see Note 7, on pages 55 and 56 of
this report) 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. Management believes that such an
event is not reasonably likely to occur.
The Company has certain obligations and commit-
31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ments to make future payments under contractual obligations and commercial
commitments. The following table summarizes such obligations and commitments as
of December 31, 2003:
(thousands of dollars)
Payments Due by Period
-----------------------------------------------------------------------
Contractual Obligations Total Within 1 Year 2-3 Years 4-5 Years After 5 Years
- ---------------------------------- ---------- ------------- ---------- ---------- -------------
Long-term debt ................... $ 513,588 $ 10,596 $ 783 $ 200,031 $ 302,178
Operating leases ................. 538,571 127,539 198,769 112,383 99,880
Purchase obligations (1) ......... 156,566 156,566
Other contractual obligations (2). 22,755 12,559 7,891 1,654 651
---------- ---------- ---------- ---------- ----------
Total contractual obligations .... $1,231,480 $ 307,260 $ 207,443 $ 314,068 $ 402,709
========== ========== ========== ========== ==========
(1) Relates to open purchase orders for raw materials at December 31, 2003.
(2) Primarily represents the Company's estimated future capital commitments to
its investments in U.S. affordable housing and historic renovation real
estate partnerships and information technology maintenance contracts.
Amount of Commitment Expiration Per Period
-------------------------------------------------------------------------
Commercial Commitments Total Within 1 Year 2-3 Years 4-5 Years After 5 Years
- ---------------------------------- ----------- ------------- --------- --------- -------------
Standby letters of credit ........ $ 13,282 $ 13,282
Surety bonds ..................... 23,320 23,320
Other commercial commitments ..... 1,138 640 $ 384 $ 114
----------- ------------ ------ -------
Total commercial commitments ..... $ 37,740 $ 37,242 $ 384 $ 114
=========== ============ ====== =======
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 estimates and accrues the costs of
unsettled product warranty claims based on historical results and experience.
Management periodically assesses the adequacy of the accrual for product
warranty claims and adjusts the accrual as necessary.
Changes in the accrual for product warranty claims during 2003, 2002 and
2001, which includes customer satisfaction settlements, were as follows:
(thousands of dollars)
2003 2002 2001
-------- -------- --------
Balance at January 1 ..... $ 15,510 $ 14,074 $ 13,783
Charges to expense ....... 28,745 25,023 28,771
Settlements .............. (27,700) (23,587) (28,480)
-------- -------- --------
Balance at December 31 ... $ 16,555 $ 15,510 $ 14,074
======== ======== ========
RESULTS OF OPERATIONS - 2003 vs. 2002
Shown below is net sales and the percentage change for the current period
by reportable segment:
(thousands of dollars)
2003 Change 2002
---------- ------ ----------
Paint Stores ............ $3,468,857 5.1% $3,302,074
Consumer ................ 1,189,666 1.0% 1,178,199
Automotive Finishes ..... 456,739 0.6% 453,811
International Coatings .. 285,282 16.8% 244,252
Administrative .......... 7,220 11.9% 6,452
---------- ---- ----------
$5,407,764 4.3% $5,184,788
========== ==== ==========
Consolidated net sales for 2003 increased due to strong domestic
architectural paint sales and a favorable DIY market that continued to gain
momentum throughout the year. These gains helped to offset soft domestic
commercial architectural, industrial maintenance, product finishes markets that
struggled through the first three quarters of the year with some improvement in
the last quarter of 2003. The domestic automotive refinish market was sluggish
all year and could not maintain sales at last year's level. Sales improvement in
the international automotive operating units more than offset the domestic
shortfall. Internationally, weak economic conditions in most South American
countries and unfavorable foreign currency exchange rates that existed in the
first half of the year in most South American currencies improved slightly
during the last half of the year. A change in the fiscal year of the South
American subsidiaries to a calendar year basis increased consolidated sales by
adding one month's results. The impact of changing the fiscal year to a calendar
year basis more than offset the effect of unfavorable currency exchange
fluctuations for the year. The net effect of the change to a calendar year and
currency fluctuations increased consolidated net sales by $8.4 million for the
full year 2003.
Net sales in the Paint Stores Segment in 2003 increased due primarily to
increases in architectural paint volume sales to contractors and DIY customers
that were partially offset by weak sales in the industrial maintenance and
product finishes categories. Sales from stores opened more
32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
than twelve calendar months increased 4.0 percent in 2003. During 2003, the
Paint Stores Segment opened 51 new stores and closed 6 resulting in a net
increase of 45 stores - no stores were added through acquisition in 2003. At the
end of 2003, this Segment had 2,688 stores in operation in the United States,
Canada, Mexico, Puerto Rico and the Virgin Islands. The Paint Stores Segment's
objective is to expand its store base an average of three percent each year. In
2002, the Paint Stores Segment began a three-year project to remerchandise and
refresh the interior design of its outdated existing stores. The cost of the
refresh project is charged to current operations and is accomplished primarily
by in-store personnel resulting in a high-impact, low-cost method of enhancing
the shopping environment in the stores. During 2003, a total of 495 stores were
completed bringing the total completed over the life of the project to 1,335
stores. It is expected that in 2004 the remaining outdated stores' interiors
will be refreshed. Also in 2003, the Paint Stores Segment completed a two-year
project by upgrading the point-of-sale devices in the remaining half of its
stores.
Consumer Segment sales throughout the year have increasingly benefited from
the improving DIY market resulting in stronger architectural sales at some of
the Segment's largest retailers and increased sales of aerosol and wood care
products. In 2004, this Segment plans to continue its aggressive promotions of
its new and existing products and expanding its customer base.
The Automotive Finishes Segment's external net sales increase for the year
resulted primarily from sales improvement in the international operating units
of the Segment that more than offset soft domestic sales. The sales increase for
the year was negatively impacted by unfavorable currency exchange fluctuations
that were partially offset by a change in the fiscal year of consolidated South
American subsidiaries to a calendar year basis. The net impact of the
unfavorable currency exchange fluctuations and change to a calendar year
decreased net sales $1.8 million for the year. There were 194 automotive
branches open at the end of 2003 in the United States, Canada, Chile, Jamaica
and Peru. In 2004, this Segment expects to continue its improvement in the
international markets while working to improve its domestic customer base in a
soft market.
External net sales in the International Coatings Segment increased due
primarily to strengthening South American economies and a change in the fiscal
year of South American subsidiaries to a calendar year basis, adding an
additional month sales results, partially offset by unfavorable currency
exchange rates for the year. The change to a calendar year and currency exchange
fluctuations increased net sales for the Segment by $9.7 million for the full
year. Sales volume accounted for the majority of the sales improvement over 2002
as the South American economies showed signs of improving although market demand
for architectural and product finishes products in the region continue to be
somewhat constrained. Sales in the U.K. subsidiary continue to be strong
compared to a year ago. Selective price increases throughout the Segment and
some reversal of the prior years' shift to lower priced products also helped
improve sales.
Consolidated gross profit increased $116.7 over last year and increased as
a percent of sales to 45.4 percent from 45.1 percent in 2002. Higher
consolidated sales volume levels accounted for approximately $98.6 million of
the gross profit improvement. A reduction in the net pension credit of $5.9
million reduced consolidated gross profit for the year. Higher-margin product
sales mix and lower product costs in the Paint Stores Segment combined with
moderating raw material costs, improved overhead absorption related to
architectural paint volume gains and manufacturing expense reductions in the
Consumer Segment enhanced consolidated gross profit margins approximately $16.5
million. The Automotive Finishes Segment's margins improved slightly over 2002
due to moderating raw material costs, favorable customer/product sales mix and
improved manufacturing absorption due to cost reductions. The International
Coatings Segment's margins were lower than last year due to economic and
competitive pressures and the higher cost of dollar-denominated raw materials.
Consolidated selling, general and administrative (SG&A) expenses for 2003
increased $97.1 million, or 5.4 percent, to $1.88 billion versus $1.78 billion
last year. As a percent of sales, SG&A expenses increased to 34.8 percent from
34.4 percent in 2002. Higher SG&A expenses were due primarily to expenses
associated with additional investment in our businesses, a decrease in the net
pension credit of $15.0 million and an increase in intangible asset impairment
charges of $9.7 million. In the Paint Stores Segment, SG&A expenses increased
$88.3 million due primarily to continued investments in new stores and in the
Asia/Pacific market and a reduction in the net pension credit of $10.5 million.
The Consumer Segment's SG&A expenses decreased $11.8 million and the percentage
of sales ratio was favorable to last year due primarily to continued cost
control, higher sales levels and a $3.6 million reduction in intangible asset
impairment charges that were partially offset by a $1.6 million reduction in the
net pension credit. In the Automotive Segment, SG&A expenses as a percent of
sales increased over last year due primarily to the sales short-
33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
fall and a reduction of $1.3 million in the net pension credit that were
partially offset by tight expense control. In the International Coatings
Segment, SG&A expenses increased $7.2 million in U.S. dollar spending but
declined as a percentage of sales due primarily to increased sales levels and
tight expense control. The Administrative Segment's SG&A expenses increased $7.5
million due primarily to an intangible asset impairment charge of $8.7 million
and increased fees for outside professional and consulting services, partially
offset by reduced spending for software licenses.
During the first quarter of 2002, a reduction of $8,997 was charged to Cost
of Goods Sold ($6,502) and SG&A expenses ($2,495) for the impairment of fair
values of long-lived assets of the Argentine subsidiary in accordance with SFAS
No. 144. In addition to the impairment review conducted during the first quarter
of 2002, in accordance with SFAS No. 142 annual impairment reviews are being
conducted as of October 1 of each year. In the fourth quarter of 2003, an
impairment was charged to SG&A expenses for $1,013 due to the reduction in fair
values of indefinite-lived intangible assets. An impairment of capitalized
software costs was also recorded in the fourth quarter of 2003 and charged to
SG&A expenses for $11,441. As of the October 1, 2002 annual impairment review
date, an impairment of goodwill and indefinite-lived intangibles of $3,607 was
recorded and charged to Cost of Goods Sold ($801) and SG&A expenses ($2,806).
See Notes 2 and 3, on pages 47 through 49 of this report, for more information
concerning the impairment of goodwill, intangible assets and long-lived assets
in accordance with SFAS No. 142 and No. 144.
Shown below is operating profit and the percent change for the current
period by reportable segment:
(thousands of dollars)
2003 Change 2002
--------- ------- ---------
Paint Stores ............ $ 403,379 1.2% $ 398,546
Consumer ................ 198,984 3.3% 192,549
Automotive Finishes ..... 52,375 (3.8%) 54,458
International Coatings .. 8,370 248.8% (5,624)
Administrative .......... (140,182) 1.8% (142,765)
--------- ----- ---------
$ 522,926 5.2% $ 497,164
========= ===== =========
Paint Stores Segment operating profit for the year increased due to higher
sales volumes and improved gross margins as a result of a favorable product
sales mix partially offset by continued margin pressure of product finishes
products. This Segment's operating profit was adversely affected by a reduction
of $11.3 million in the net pension credit, the investment by the Segment in the
Asia/Pacific market, incremental expenses associated with new stores, continuing
increases in health care costs and increased utility costs earlier in the year.
The operating profit improvement for the Consumer Segment resulted primarily
from higher sales levels, tight expense control and manufacturing efficiencies
relating to the sales volume increase despite a reduction of $5.9 million in the
net pension credit. Operating profit reduction in the Automotive Finishes
Segment resulted primarily from low sales volume, related unfavorable
manufacturing absorption and a reduction of $1.8 million in the net pension
credit compared to last year. There was no significant impact on operating
profit in this Segment from the fiscal year change or foreign currency
fluctuations. The International Segment's operating profit increased due
primarily to a reduction of $11.9 million in impairment charges, the beginning
stabilization of the South American economies and improving currency exchange
rates relating to dollar-denominated raw materials. There was no significant
impact on operating profit in this Segment from the fiscal year change or
foreign currency fluctuations.
Interest expense decreased $1.7 million in 2003 versus 2002 due to average
short-term borrowing rates that were 50 average basis points lower in 2003 and
lower average outstanding short-term and long-term debt.
Other expense - net decreased $2.8 million in 2003 compared to 2002 due
primarily to foreign currency related losses that decreased $7.0 million
partially offset by net expenses of financing and investing activities that
increased $1.8 million, provisions for environmental matters that increased $1.6
million and a reduction in dividend and royalty income of $0.5 million.
Decreases in foreign currency exchange losses were due primarily to the
favorable exchange rates experienced in most South American currencies,
particularly during the last half of 2003. Increases in expenses of financing
and investing activities were due primarily to charges incurred relating to the
Company's foreign operations. See Note 12, on pages 60 and 61 of this report,
for more information concerning the Other expense - net caption.
Effective January 1, 2002, the Company adopted SFAS No. 142. In accordance
with the requirements of that pronouncement, indefinite-lived intangible assets
and goodwill were reviewed for possible impairment. Due to the reduction in fair
value of certain acquired trademarks and businesses, related principally to
international acquisitions and the acquisition of Thompson Minwax Holding Corp.,
the Company recorded an after-tax transitional impairment charge of $183.1
million, or $1.21 per share, in the first quarter of 2002. The transitional
impairment charge was recorded as a cumulative effect of change in accounting
principle in accordance with SFAS No. 142.
34
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Income before income taxes and cumulative effect of change in accounting
principle increased $25.8 million primarily as a result of increased gross
profit exceeding SG&A expenses by $19.6 million. Net income increased $204.5
million in 2003 due primarily to the cumulative effect of change in accounting
principle recorded in 2002 and to the reduction in the effective tax rate to
36.5 percent in 2003 from 37.5 percent last year. For the year, diluted income
per common share before cumulative effect of change in accounting principle
increased to $2.26 per share from $2.04 per share in 2002. Diluted net income
per common share in 2003 was $2.26 per share compared to $.84 per share for 2002
due primarily to the cumulative effect of change in accounting principle net of
income taxes of $1.20 per share for the full year of 2002.
Management considers a measurement that is not in accordance with
accounting principles generally accepted in the United States a useful
measurement of the operational profitability of the Company. Some investment
professionals also utilize such a measurement as an indicator of the value of
profits and cash that are generated strictly from operating activities, putting
aside working capital and certain other balance sheet changes. For this
measurement, management increases net income for significant non-operating and
non-cash expense items to arrive at an amount known as "Earnings Before
Interest, Taxes, Depreciation and Amortization" (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 cash flows from operating activities as an indicator of operating
performance or as a measure of liquidity. The reader should refer to the
determination of net income and cash flows from operating activities in
accordance with accounting principles generally accepted in the United States
disclosed in the Statements of Consolidated Income and Statements of
Consolidated Cash Flows, on page 41 and 42 of this report. EBITDA as used by
management is calculated as follows:
(thousands of dollars)
2003 2002 2001
-------- -------- --------
Net income (Page 41) ..... $332,058 $127,565 $263,158
Cumulative effect of
change in accounting
principle (Page 41) .... 183,136
Interest expense
(Page 41) .............. 38,742 40,475 54,627
Income taxes (Page 41) ... 190,868 186,463 161,291
Depreciation (Page 42) ... 104,803 103,659 109,187
Amortization (Page 42) ... 11,761 11,989 38,911
-------- -------- --------
EBITDA ................... $678,232 $653,287 $627,174
======== ======== ========
RESULTS OF OPERATIONS - 2002 vs. 2001
Shown below is net revenues and the percentage change for the current
period by reportable segment:
(thousands of dollars)
2002 Change 2001
---------- ------ ----------
Paint Stores ............. $3,302,074 3.7% $3,185,156
Consumer ................. 1,178,199 3.2% 1,141,958
Automotive Finishes ...... 453,811 (2.2%) 464,230
International Coatings ... 244,252 (8.8%) 267,958
Administrative ........... 6,452 (3.7%) 6,703
---------- ---- ----------
$5,184,788 2.3% $5,066,005
========== ==== ==========
Consolidated net sales for 2002 increased due to strong domestic
architectural paint sales resulting from a favorable DIY market and aggressive
promotion of new products and new color palettes. Curtailing the sales
improvement was sluggishness in the domestic commercial architectural,
industrial maintenance, product finishes and automotive product lines. Poor
economic conditions in South America related to weak currency exchange rates in
Argentina and Brazil continued to negatively impact international sales in U.S.
dollars. Unfavorable foreign currency exchange fluctuations reduced consolidated
net sales approximately $74.9 million in 2002.
Net sales in the Paint Stores Segment in 2002 increased due primarily to
double-digit increases in architectural paint volume sales to contractors and
DIY customers. These sales increases were partially offset by flat or declining
sales of the domestic commercial architectural, industrial maintenance and
product finishes categories. Comparable-store sales, which include sales only
from stores open for more than twelve calendar months, increased 1.9 percent in
2002. During 2002, the Paint Stores Segment added 70 net new stores - 46 net new
stores were opened and 24 stores were added through acquisition. At the end of
2002, this Segment had 2,643 stores in operation in the United States, Canada,
Mexico, Puerto Rico and the Virgin Islands. The Paint Stores Segment's objective
is to expand its store base an average of three percent each year. In addition,
the Paint Stores Segment added new color features to its entire store chain
during 2002, refreshed the interior design, signage and color of about one-third
of the existing stores and upgraded the point-of-sale devices in half of the
stores.
External net sales of the Consumer Segment benefited from the improving DIY
market. The Segment continued its aggressive promotion of many new and existing
paint, aerosol and wood care products. Sales in the improving DIY market and
sales of new products more than offset the adverse effects of a sluggish
domestic economy and sales declines to Kmart Corporation that was operating
under a bankruptcy reorganization plan and in the Clean-
35
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ing Solutions Business Unit.
The Automotive Finishes Segment's external net sales decreased in 2002.
Improved vehicle refinish sales were not enough to offset unfavorable currency
exchange rates and price competition. The effects of unfavorable currency
exchange fluctuations relative to 2001 reduced net sales for the Segment by
approximately $9.8 million in 2002. There were 179 automotive branches open at
the end of 2002 in the United States, Canada, Chile and Jamaica.
External net sales in the International Coatings Segment were down due
primarily to unfavorable currency exchange rates. Net sales for the Segment were
adversely impacted approximately $32.5 million in 2002 by unfavorable currency
exchange fluctuations. Poor economic conditions in Brazil and in Argentina,
following an attempt by the government to control the value of the peso at the
beginning of 2002, adversely impacted sales volumes and sales in local
currencies for the year. In spite of the poor economic conditions that existed,
the International Coatings Segment achieved a sales volume increase of 5.6
percent. Competitive pricing and a shift in sales to lower priced products
caused the shortfall in sales compared to the volume gain. Due to the
relationship of competitive pricing and lower priced product sales, it is not
possible to determine the impact each had on the sales shortfall.
Consolidated gross profit increased $119.0 over 2001 and increased as a
percent of sales to 45.1 percent from 43.8 percent in 2001. Higher consolidated
sales volume levels accounted for $58.1 million of the gross profit improvement.
Higher-margin product sales mix and lower product costs in the Paint Stores
Segment combined with moderating raw material costs, improved overhead
absorption related to architectural paint volume gains and manufacturing expense
reductions due to plant closures in the Consumer Segment enhanced consolidated
gross profit margins approximately $62.4 million. The Automotive Finishes
Segment's margins were essentially flat during 2002 due to moderating raw
material costs early in the year, favorable customer/product sale mix and
improved manufacturing absorption due to cost reductions that could not offset a
shortfall in volume of OEM coatings and similar products. The International
Coatings Segment's margins were lower than 2001 due to economic and competitive
pressures. This Segment's margins were also lower due to a $9.0 million
impairment charge during the first quarter of 2002 recorded for property, plant
and equipment in Argentina in accordance with SFAS No. 144. Certain raw material
costs began to rise during the last quarter of 2002 and international economic
and competitive pressures continued.
Consolidated SG&A expenses for 2002 increased $54.7 million, or 3.2
percent, to $1.78 billion versus $1.73 billion in 2001. As a percent of sales,
SG&A expenses increased to 34.4 percent from 34.1 percent in 2001. Increased
spending was primarily due to higher expenses associated with additional
investment in our businesses. In the Paint Stores Segment, SG&A expenses
increased $88.4 million primarily due to additional investments in new and
acquired stores and new color palettes. The Consumer Segment's SG&A expenses
decreased $18.1 million and the percentage of sales ratio was favorable to 2001
due primarily to continuing cost control and higher sales levels. In the
Automotive Segment, SG&A expenses as a percent of sales were flat with 2001 due
to the sales shortfall that was partially offset by tight expense control. In
the International Coatings Segment, SG&A expenses declined $24.9 million in U.S.
dollar spending as well as a percentage of sales primarily due to currency
exchange rate fluctuations and tight expense control. The Administrative
Segment's SG&A expenses increased $13.2 million due primarily to increased
spending related to information technology hardware and software licenses and
increased fees for outside professional and consulting services.
Interest expense decreased $14.2 million in 2002 versus 2001 due to average
short-term borrowing rates that were 282 average basis points lower in 2002 and
lower average outstanding short-term and long-term debt.
Other expense-net increased $6.7 million in 2002 compared to 2001
primarily due to foreign currency related losses that increased $6.2 million,
provisions for environmental matters that increased $3.0 million and expenses
from financing and investing activities that increased $9.1 million. Partially
offsetting these increases was a reduction in the provisions for disposition and
termination of operations of $7.1 million and a reduction in other expenses of
$4.3 million. Increases in expenses from financing and investing activities were
due primarily to non-recurring gains realized from the sale of certain fixed
assets of $8.0 million in 2001 that were partially offset by lower financing
expenses related to lower long-term debt outstanding in 2002.
Effective January 1, 2002, the Company adopted SFAS No. 142. In accordance
with the requirements of that pronouncement, indefinite-lived intangible assets
and goodwill were reviewed for possible impairment. Due to the reduction in fair
value of certain acquired trademarks and businesses, related principally to
international acquisitions and the acquisition of Thompson Minwax Holding Corp.,
the Company recorded an after-tax transitional impairment charge of $183.1
million, or $1.21 per share, in the first quarter of 2002. The transitional
impairment charge was recorded as a cumulative
36
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
effect of change in accounting principle in accordance with SFAS No. 142.
During the first quarter of 2002, a reduction of $8,997 was charged to Cost
of Goods Sold ($6,502) and SG&A expenses ($2,495) for the impairment of fair
values of long-lived assets of the Argentine subsidiary in accordance with SFAS
No.144. In addition to the impairment review conducted during the first quarter
of 2002, in accordance with SFAS No. 142 annual impairment reviews are being
conducted as of October 1 of each year. In the fourth quarter of 2002, an
impairment of goodwill and indefinite-lived intangibles of $3,607 was recorded
and charged to Cost of Goods Sold ($801) and SG&A expenses ($2,806). See Notes 2
and 3, on pages 47 through 49 of this report, for more information concerning
the impairment of goodwill, intangible assets and long-lived assets in
accordance with SFAS No. 142 and No. 144.
Shown below is operating profit and the percentage change for the current
period by reportable segment:
(thousands of dollars) 2002 Change 2001
--------- -------- ---------
Paint Stores ............. $ 398,546 2.7% $ 388,010
Consumer ................. 192,549 73.8% 110,791*
Automotive Finishes ...... 54,458 6.3% 51,233
International Coatings ... (5,624) (100.1%) 4,760
Administrative ........... (142,765) (9.5%) (130,345)
--------- ------ ---------
$ 497,164 18.5% $ 424,449*
========= ====== =========
* Includes amortization expense of $21 million in the Consumer Segment and
$29 million in income before income taxes and cumulative effect of change
in accounting principle for goodwill and intangible assets that are no
longer amortized as of January 1, 2002 in accordance with SFAS No. 142. The
effect on any other segment was not significant.
Paint Stores Segment operating profit increased due to improved gross
margins that were partially offset by investments incurred to support the launch
of new color palettes, maintain the store opening program, provide exceptional
in-store service and maintain quality customer service across all product lines.
The operating profit for the Consumer Segment increased due to higher sales
levels, improved overhead absorption due to architectural paint volume gains,
manufacturing expense reductions due to plant closures, administrative cost
reductions and moderating raw material costs earlier in the year. Operating
profit improvements in the Automotive Finishes Segment resulted primarily from
moderating raw material costs earlier in the year, lower manufacturing costs and
administrative expense control. The decrease in operating profit for the
International Coatings Segment was due to $11.9 million of impairment charges of
long-lived assets.
Income before income taxes and cumulative effect of change in accounting
principle increased $72.7 million as a result of increased gross profit, net
investment income and reduced interest expense. This improvement was partially
offset by increased SG&A expenses and Other expense-net of $61.4 million. Net
income declined $135.6 million in 2002 due primarily to the cumulative effect of
change in accounting principle of $183.1 million net of income taxes. For the
year, diluted income per common share before cumulative effect of change in
accounting principle increased to $2.04 per share compared to $1.68 per share in
2001. Diluted net income per common share for 2002 was $.84 per share due to the
cumulative effect of change in accounting principle net of income taxes of $1.20
per share for the full year of 2002. In accordance with the requirements of SFAS
No. 142, goodwill and intangible assets deemed to have indefinite lives are no
longer amortized after January 1, 2002. Adding back after-tax amortization
expense of $24.1 million to net income of $263.2 million in 2001 to be
comparable with 2002, the resultant net income amount would have been $287.3
million. This net income amount divided by fully-diluted average common shares
and equivalents outstanding during 2001 results in an adjusted diluted net
income per common share amount of $1.83 per share in 2001 for comparative
purposes only to 2002 amounts that exclude such amortization expense.
37
\
REPORT OF MANAGEMENT
Shareholders
The Sherwin-Williams Company
We have prepared the accompanying consolidated financial statements and
related information included herein for the years ended December 31, 2003, 2002
and 2001. The primary responsibility for the integrity of the financial
information rests with management. This information is prepared in accordance
with accounting principles generally accepted in the United States, based upon
our best estimates and judgments and giving due consideration to materiality.
The Company maintains accounting and control systems which are designed to
provide reasonable assurance that assets are safeguarded from loss or
unauthorized use and which produce records adequate for preparation of financial
information. There are limits inherent in all systems of internal control based
on the recognition that the cost of such systems should not exceed the benefits
to be derived. We believe our systems provide this appropriate balance.
The Board of Directors pursues its responsibility for these financial
statements through the Audit Committee, composed exclusively of independent
directors. The Committee meets periodically with management, internal auditors
and our independent auditors to discuss the adequacy of financial controls, the
quality of financial reporting and the nature, extent and results of the audit
effort. Both the internal auditors and independent auditors have private and
confidential access to the Audit Committee at all times.
/s/ C. M. Connor
C. M. Connor
Chairman and Chief Executive Officer
/s/ S. P. Hennessy
S. P. Hennessy
Senior Vice President-Finance and Chief Financial Officer
/s/ J. L. Ault
J. L. Ault
Vice President-Corporate Controller
38
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
The Sherwin-Williams Company
Cleveland, Ohio
We have audited the accompanying consolidated balance sheets of The
Sherwin-Williams Company and subsidiaries as of December 31, 2003, 2002 and
2001, and the related statements of consolidated income, cash flows and
shareholders' equity and comprehensive income for each of the three years in the
period ended December 31, 2003. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
The Sherwin-Williams Company and subsidiaries at December 31, 2003, 2002 and
2001, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 2003, in conformity
with accounting principles generally accepted in the United States.
As disclosed in Note 2 to the consolidated financial statements, in 2002
the Company changed its method of accounting for goodwill and
indefinite-lived intangible assets.
/s/ ERNST & YOUNG LLP
Cleveland, Ohio
January 24, 2004
39
CONSOLIDATED BALANCE SHEETS
(Thousands of dollars)
December 31,
---------------------------------------------
2003 2002 2001
----------- ----------- -----------
ASSETS
CURRENT ASSETS:
CASH AND CASH EQUIVALENTS .................................. $ 302,813 $ 164,012 $ 118,814
ACCOUNTS RECEIVABLE, LESS ALLOWANCE ........................ 544,070 493,935 523,278
INVENTORIES:
FINISHED GOODS ........................................... 552,657 534,984 530,916
WORK IN PROCESS AND RAW MATERIALS ........................ 85,580 89,666 101,847
----------- ----------- -----------
638,237 624,650 632,763
DEFERRED INCOME TAXES ...................................... 86,616 116,228 104,672
OTHER CURRENT ASSETS ....................................... 143,408 107,168 127,418
----------- ----------- -----------
TOTAL CURRENT ASSETS ..................................... 1,715,144 1,505,993 1,506,945
GOODWILL ..................................................... 563,531 552,207 672,397
INTANGIBLE ASSETS ............................................ 187,202 186,039 304,506
DEFERRED PENSION ASSETS ...................................... 420,133 414,589 393,587
OTHER ASSETS ................................................. 146,348 108,884 77,802
PROPERTY, PLANT AND EQUIPMENT:
LAND ....................................................... 58,514 62,069 64,447
BUILDINGS .................................................. 425,712 436,214 441,418
MACHINERY AND EQUIPMENT .................................... 1,091,215 1,034,286 1,024,701
CONSTRUCTION IN PROGRESS ................................... 36,353 44,936 34,070
----------- ----------- -----------
1,611,794 1,577,505 1,564,636
LESS ALLOWANCES FOR DEPRECIATION ........................... 961,544 912,905 891,948
----------- ----------- -----------
650,250 664,600 672,688
----------- ----------- -----------
TOTAL ASSETS ................................................. $ 3,682,608 $ 3,432,312 $ 3,627,925
=========== =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
ACCOUNTS PAYABLE ........................................... $ 587,935 $ 522,339 $ 454,410
COMPENSATION AND TAXES WITHHELD ............................ 168,758 146,987 141,640
CURRENT PORTION OF LONG-TERM DEBT .......................... 10,596 15,001 111,852
OTHER ACCRUALS ............................................. 297,800 297,991 326,854
ACCRUED TAXES .............................................. 89,081 101,178 106,597
----------- ----------- -----------
TOTAL CURRENT LIABILITIES ................................ 1,154,170 1,083,496 1,141,353
LONG-TERM DEBT ............................................... 502,992 506,682 503,517
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS .................. 216,853 213,749 209,963
OTHER LONG-TERM LIABILITIES .................................. 349,736 286,495 285,328
SHAREHOLDERS' EQUITY:
PREFERRED STOCK - CONVERTIBLE, PARTICIPATING, NO PAR VALUE:
284,657, 41,806 AND 168,305 SHARES OUTSTANDING AT
DECEMBER 31, 2003, DECEMBER 31, 2002 AND
DECEMBER 31, 2001, RESPECTIVELY .......................... 284,657 41,806 168,305
UNEARNED ESOP COMPENSATION ................................. (284,657) (41,806) (168,305)
COMMON STOCK - $1.00 PAR VALUE: 143,406,707,
148,910,487 AND 153,978,356 SHARES OUTSTANDING AT
DECEMBER 31, 2003, DECEMBER 31, 2002 AND
DECEMBER 31, 2001, RESPECTIVELY .......................... 212,409 209,836 208,031
OTHER CAPITAL .............................................. 347,779 265,635 200,643
RETAINED EARNINGS .......................................... 2,398,854 2,157,485 2,120,927
TREASURY STOCK, AT COST .................................... (1,270,917) (1,029,894) (837,284)
CUMULATIVE OTHER COMPREHENSIVE LOSS ........................ (229,268) (261,172) (204,553)
----------- ----------- -----------
TOTAL SHAREHOLDERS' EQUITY ............................... 1,458,857 1,341,890 1,487,764
----------- ----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ................... $ 3,682,608 $ 3,432,312 $ 3,627,925
=========== =========== ===========
See notes to consolidated financial statements.
40
STATEMENTS OF CONSOLIDATED INCOME
(thousands of dollars except per share data)
Year ended December 31,
-------------------------------------------
2003 2002 2001
----------- ----------- -----------
NET SALES ........................................... $ 5,407,764 $ 5,184,788 $ 5,066,005
COST OF GOODS SOLD .................................. 2,952,469 2,846,201 2,846,376
GROSS PROFIT ........................................ 2,455,295 2,338,587 2,219,629
PERCENT TO NET SALES ............................... 45.4% 45.1% 43.8%
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ........ 1,881,664 1,784,527 1,729,855
PERCENT TO NET SALES ............................... 34.8% 34.4% 34.1%
INTEREST EXPENSE .................................... 38,742 40,475 54,627
INTEREST AND NET INVESTMENT INCOME .................. (6,668) (5,050) (4,087)
OTHER EXPENSE - NET ................................. 18,631 21,471 14,785
----------- ----------- -----------
INCOME BEFORE INCOME TAXES AND CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE ........... 522,926 497,164 424,449
INCOME TAXES ........................................ 190,868 186,463 161,291
----------- ----------- -----------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE ............................ 332,058 310,701 263,158
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE -
NET OF INCOME TAXES OF $64,476 ..................... (183,136)
----------- ----------- -----------
NET INCOME .......................................... $ 332,058 $ 127,565 $ 263,158
=========== =========== ===========
INCOME PER SHARE:
BASIC:
BEFORE CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE .......................... $ 2.29 $ 2.07 $ 1.69
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE - NET OF INCOME TAXES .................. (1.22)
----------- ----------- -----------
NET INCOME ........................................ $ 2.29 $ 0.85 $ 1.69
=========== =========== ===========
DILUTED:
BEFORE CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE .......................... $ 2.26 $ 2.04 $ 1.68
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE - NET OF INCOME TAXES .................. (1.20)
----------- ----------- -----------
NET INCOME ........................................ $ 2.26 $ 0.84 $ 1.68
=========== =========== ===========
See notes to consolidated financial statements.
41
STATEMENTS OF CONSOLIDATED CASH FLOWS
(thousands of dollars)
Year Ended December 31,
-----------------------------------
2003 2002 2001
--------- --------- ---------
OPERATING ACTIVITIES
NET INCOME ............................................... $ 332,058 $ 127,565 $ 263,158
ADJUSTMENTS TO RECONCILE NET INCOME TO NET OPERATING CASH:
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE ..... 183,136
DEPRECIATION ............................................ 104,803 103,659 109,187
AMORTIZATION OF INTANGIBLE ASSETS ....................... 11,761 11,989 38,911
IMPAIRMENT OF LONG-LIVED ASSETS HELD FOR USE ............ 12,454 19,948
IMPAIRMENT OF LONG-LIVED ASSETS HELD FOR DISPOSAL ....... 6,402
PROVISIONS FOR QUALIFIED EXIT COSTS ..................... 14 262 5,302
PROVISIONS FOR ENVIRONMENTAL-RELATED MATTERS ............ 10,237 8,609 5,609
DEFERRED INCOME TAXES ................................... 39,872 19,747 15,677
DEFINED BENEFIT PENSION PLANS NET CREDIT ................ (2,072) (23,013) (29,366)
INCOME TAX EFFECT OF ESOP ON OTHER CAPITAL .............. 24,665 22,380 22,902
NET INCREASE IN POSTRETIREMENT LIABILITY ................ 3,904 4,086 2,990
FOREIGN CURRENCY RELATED LOSSES ......................... 1,460 8,435 2,277
DECREASE IN NON-TRADED INVESTMENTS ...................... 20,276 9,278
OTHER ................................................... 10,516 11,660 1,101
CHANGE IN WORKING CAPITAL ACCOUNTS:
(INCREASE) DECREASE IN ACCOUNTS RECEIVABLE .............. (39,361) 3,588 61,497
(INCREASE) DECREASE IN INVENTORIES ...................... (153) (229) 72,132
INCREASE IN ACCOUNTS PAYABLE ............................ 60,149 81,733 10,233
(DECREASE) INCREASE IN ACCRUED TAXES .................... (12,117) (5,483) 31,468
OTHER ................................................... (4,027) 4,778 17,035
UNUSUAL TAX-RELATED PAYMENT .............................. (65,677)
COSTS INCURRED FOR ENVIRONMENTAL - RELATED MATTERS ....... (7,005) (12,036) (17,565)
COSTS INCURRED FOR QUALIFIED EXIT COSTS .................. (1,580) (3,663) (3,326)
DECREASE (INCREASE) IN MINIMUM PENSION LIABILITY ......... 82 (8,334)
OTHER .................................................... (7,007) (9,178) 11,699
--------- --------- ---------
NET OPERATING CASH ...................................... 558,929 558,917 561,646
INVESTING ACTIVITIES
CAPITAL EXPENDITURES ..................................... (116,507) (126,530) (82,572)
ACQUISITIONS OF BUSINESSES ............................... (48,374) (26,649) (15,162)
INCREASE IN OTHER INVESTMENTS ............................ (27,875) (16,144) (16,614)
PROCEEDS FROM SALE OF ASSETS ............................. 47,847 11,778 9,866
OTHER .................................................... 8,856 (15,016) 13,590
--------- --------- ---------
NET INVESTING CASH ...................................... (136,053) (172,561) (90,892)
FINANCING ACTIVITIES
NET DECREASE IN SHORT-TERM BORROWINGS .................... (106,854)
(DECREASE) INCREASE IN LONG-TERM DEBT .................... (1,531) 6,633
PAYMENTS OF LONG-TERM DEBT ............................... (6,564) (101,938) (16,210)
PAYMENTS OF CASH DIVIDENDS ............................... (90,689) (91,007) (90,984)
PROCEEDS FROM STOCK OPTIONS EXERCISED .................... 47,468 37,516 17,798
TREASURY STOCK PURCHASED ................................. (238,148) (190,320) (157,088)
OTHER .................................................... (1,310) (4,727) (786)
--------- --------- ---------
NET FINANCING CASH ...................................... (290,774) (343,843) (354,124)
EFFECT OF EXCHANGE RATE CHANGES ON CASH .................. 6,699 2,685 (712)
--------- --------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS ................ 138,801 45,198 115,918
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR ........... 164,012 118,814 2,896
--------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR ................. $ 302,813 $ 164,012 $ 118,814
========= ========= =========
TAXES PAID ON INCOME ..................................... $ 106,950 $ 103,447 $ 129,435
INTEREST PAID ON DEBT .................................... 39,029 42,041 55,769
See notes to consolidated financial statements.
42
STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY AND
COMPREHENSIVE INCOME (thousands of dollars except per share data)
Cumulative
Unearned Other
ESOP Comprehensive
Preferred Compen- Common Other Retained Treasury Income
Stock sation Stock Capital Earnings Stock (Loss) Total
--------- --------- --------- -------- ---------- ----------- ------------ ----------
BALANCE AT JANUARY 1, 2001 ......... $ 206,848 $158,650 $1,948,753 $ (678,778) $ (163,609) $1,471,864
COMPREHENSIVE INCOME:
NET INCOME ........................ 263,158 263,158
FOREIGN CURRENCY TRANSLATION ...... (40,944) (40,944)
----------
COMPREHENSIVE INCOME ............. 222,214
TREASURY STOCK PURCHASED ........... (157,088) (157,088)
ISSUANCE OF PREFERRED STOCK
TO PRE-FUND ESOP .................. $ 250,000 $(250,000)
INCOME TAX EFFECT OF ESOP .......... 22,902 22,902
REDEMPTION OF PREFERRED STOCK ...... (81,695) 81,695
STOCK ISSUED (TENDERED) FOR
EXERCISE OF OPTIONS ............... 1,031 19,947 (532) 20,446
STOCK TENDERED IN CONNECTION
WITH RESTRICTED STOCK GRANTS ...... (886) (886)
RESTRICTED STOCK GRANTS (NET
ACTIVITY) .. ...................... 152 979 1,131
STOCK ACQUIRED FOR TRUST ........... (1,835) (1,835)
CASH DIVIDENDS -- $.58 PER SHARE ... (90,984) (90,984)
--------- --------- --------- -------- ---------- ----------- ------------ ----------
BALANCE AT DECEMBER 31, 2001 ....... 168,305 (168,305) 208,031 200,643 2,120,927 (837,284) (204,553) 1,487,764
COMPREHENSIVE INCOME:
NET INCOME ........................ 127,565 127,565
FOREIGN CURRENCY TRANSLATION ...... (48,285) (48,285)
MINIMUM PENSION LIABILITY,
NET OF TAXES OF $3,572 ........... (8,334) (8,334)
----------
COMPREHENSIVE INCOME ............ 70,946
TREASURY STOCK PURCHASED ........... (3,040) (187,280) (190,320)
REDEMPTION OF PREFERRED STOCK ...... (126,499) 126,499
INCOME TAX EFFECT OF ESOP .......... 22,380 22,380
STOCK ISSUED (TENDERED) FOR
EXERCISE OF OPTIONS ............... 1,792 41,498 (4,562) 38,728
STOCK TENDERED IN CONNECTION
WITH RESTRICTED STOCK GRANTS ...... (768) (768)
RESTRICTED STOCK GRANTS (NET
ACTIVITY) .. ...................... 13 3,082 3,095
STOCK ACQUIRED FOR TRUST ........... (76) (76)
REVOCABLE TRUST STOCK SOLD -
INCLUDING REALIZED GAIN ........... 1,148 1,148
CASH DIVIDENDS -- $.60 PER SHARE ... (91,007) (91,007)
--------- --------- --------- -------- ---------- ----------- ------------ ----------
BALANCE AT DECEMBER 31, 2002 ....... 41,806 (41,806) 209,836 265,635 2,157,485 (1,029,894) (261,172) 1,341,890
COMPREHENSIVE INCOME:
NET INCOME ........................ 332,058 332,058
FOREIGN CURRENCY TRANSLATION ...... 31,822 31,822
MINIMUM PENSION LIABILITY,
NET OF TAXES OF ($35) ............ 82 82
----------
COMPREHENSIVE INCOME ............. 363,962
TREASURY STOCK PURCHASED ........... (238,148) (238,148)
ISSUANCE OF PREFERRED STOCK
TO PRE-FUND ESOP .................. 350,000 (350,000)
REDEMPTION OF PREFERRED STOCK ...... (107,149) 107,149
INCOME TAX EFFECT OF ESOP .......... 24,665 24,665
STOCK ISSUED (TENDERED) FOR
EXERCISE OF OPTIONS ............... 2,172 52,239 (743) 53,668
STOCK TENDERED IN CONNECTION
WITH RESTRICTED STOCK GRANTS ...... (2,132) (2,132)
RESTRICTED STOCK GRANTS (NET
ACTIVITY) .. ...................... 401 5,240 5,641
CASH DIVIDENDS -- $.62 PER SHARE ... (90,689) (90,689)
--------- --------- --------- -------- ---------- ----------- ------------ ----------
BALANCE AT DECEMBER 31, 2003 ....... $ 284,657 $(284,657) $ 212,409 $347,779 $2,398,854 $(1,270,917) $ (229,268) $1,458,857
========= ========= ========= ======== ========== =========== ============ ==========
See notes to consolidated financial statements.
43
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 Company, its wholly-owned subsidiaries and its majority-owned equity
investments. Inter-company accounts and transactions have been eliminated.
USE OF ESTIMATES. The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes. Actual
results could differ from those estimates.
NATURE OF OPERATIONS. The Company is engaged in the manufacture,
distribution and sale of coatings and related products to professional,
industrial, commercial and retail customers primarily in North and South
America.
REPORTABLE SEGMENTS. See Note 17.
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 management in estimating the fair value disclosures for financial
instruments:
CASH AND CASH EQUIVALENTS: The carrying amounts reported in the
Consolidated Balance Sheets for Cash and cash equivalents approximate fair
value.
INVESTMENTS IN SECURITIES: Included in Other assets, classified as
available for sale securities, are certain long-term investments in two
separate funds maintained for payment of health care benefits and
non-qualified benefits of certain qualified employees. The estimated fair
values of securities in the health care benefits fund, based on quoted
market prices, were $827, $4,092, and $10,182 at December 31, 2003, 2002,
and 2001, respectively. The estimated fair values of securities in the
non-qualified benefits fund, based on quoted market prices, were $20,643 at
December 31, 2003. Certain other assets were maintained for payment of
non-qualified benefits at December 31, 2002 and 2001.
LONG-TERM DEBT (INCLUDING CURRENT PORTION): The fair values of the
Company's publicly traded debt, shown below, are based on quoted market
prices. The fair values of the Company's non-traded debt, also shown below,
are estimated using discounted cash flow analyses, based on the Company's
current incremental borrowing rates for similar types of borrowing
arrangements. See Note 7 for information concerning interest rate swap
contracts.
DERIVATIVE INSTRUMENTS: The Company utilizes derivative instruments as
part of its overall financial risk management policy. The Company entered
into interest rate swap contracts during 2003, 2002 and 2001 primarily to
hedge against interest rate risks. See Note 7. The Company also entered
into option and forward currency exchange contracts in 2003, 2002 and 2001
primarily to hedge against foreign currency risk exposure. See Note 12. The
Company does not use derivative instruments for speculative or trading
purposes.
NON-TRADED INVESTMENTS: The Company invests in the U.S. affordable
housing and historic renovation real estate markets. These investments have
been identified as variable interest entities. However, the Company is not
the primary beneficiary and does not consolidate the operations of the
investments in accordance with FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities." The Company's risk of loss from these
non-traded investments is limited to the amount of its contributed capital.
The carrying amounts of these non-traded investments, included in Other
assets, were $20,695, $11,117 and $13,485 at December 31, 2003, 2002, and
2001, respectively. The carrying amounts of these investments, which
approximate market value, are determined based on cost less related income
tax credits determined by the effective yield method.
INVESTMENT IN LIFE INSURANCE. On October 1, 2003, the Company surrendered
its broad-based corporate owned life insurance policies. The net expense
associated with such investment is included in Other expense - net. Such expense
was immaterial to Income before income taxes and cumulative effect of change in
accounting principle.
DECEMBER 31,
----------------------------------------------------------
2003 2002 2001
------------------ ------------------ ------------------
CARRYING FAIR Carrying Fair Carrying Fair
AMOUNT VALUE Amount Value Amount Value
-------- -------- -------- -------- -------- --------
PUBLICLY TRADED DEBT.. $505,621 $574,106 $508,134 $543,971 $603,762 $598,529
NON-TRADED DEBT....... 8,786 8,068 13,549 12,390 13,184 12,571
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
A receivable of $9,841 for the remaining amounts due under the program is
included in Other assets.
IMPAIRMENT OF LONG-LIVED ASSETS. Management evaluates the recoverability
and estimated remaining lives of long-lived assets at each balance sheet date.
An impairment or change in useful life is recorded whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable or the
useful life has changed in accordance with SFAS No. 144. See Note 3.
GOODWILL. Goodwill represents the cost in excess of fair value of net
assets acquired in business combinations accounted for by the purchase method.
For acquisitions prior to July 1, 2001, goodwill was amortized until December
31, 2001 on a straight-line basis over the expected period of benefit ranging
from 10 to 40 years. Accumulated amortization of goodwill was $104,746 as of
December 31, 2001. Effective January 1, 2002, the Company adopted SFAS No. 142
that discontinues amortization of goodwill and requires goodwill to be tested
periodically for impairment. See Note 3.
INTANGIBLES. Intangible assets include trademarks, non-compete covenants
and certain intangible property rights. Prior to January 1, 2002, intangible
assets were amortized on a straight-line basis over the expected period of
benefit ranging from 2 to 40 years. Effective January 1, 2002, pursuant to the
adoption of SFAS No. 142, trademarks have been classified as indefinite-lived
assets and are no longer amortized. The cost of non-compete covenants and
certain intangible property rights continue to be amortized on a straight-line
basis over the expected period of benefit as follows:
Useful Life
-----------
Non-compete covenants................. 2 - 10 years
Certain intangible property rights.... 3 - 20 years
Accumulated amortization of intangible assets, net of write-offs of
fully-amortized intangible assets in 2001, was $99,832, $99,524 and $99,797 at
December 31, 2003, 2002, and 2001, respectively. See Note 3.
PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment is stated on
the basis of cost. Depreciation is provided principally by the straight-line
method. The major classes of assets and ranges of depreciation rates are as
follows:
Buildings....................... 2% - 6-2/3%
Machinery and equipment......... 4% - 33-1/3%
Furniture and fixtures.......... 5% - 33-1/3%
Automobiles and trucks.......... 10% - 33-1/3%
LETTERS OF CREDIT. The Company occasionally enters into standby letter of
credit agreements to guarantee various operating activities. These agreements,
which expire in 2004, provide credit availability to the various beneficiaries
if certain contractual events occur. Amounts outstanding under these agreements
totaled $13,282, $13,273 and $14,400 at December 31, 2003, 2002, and 2001,
respectively.
FOREIGN CURRENCY TRANSLATION. All consolidated non-highly inflationary
foreign operations use the local currency of the country of operation as the
functional currency and translate the local currency asset and liability
accounts at year-end exchange rates while income and expense accounts are
translated at average exchange rates. The resulting translation adjustments are
included in Cumulative other comprehensive loss, a component of Shareholders'
equity.
COMPREHENSIVE INCOME. At December 31, 2003 and 2002, the ending accumulated
balance of Cumulative other comprehensive loss consisted of adjustments for
foreign currency translation of $221,926 and $252,838, respectively, and a
minimum pension liability of $8,252 and $8,334, respectively. At December 31,
2001, the ending accumulated balance of Cumulative other comprehensive loss
consisted solely of foreign currency translation adjustments.
REVENUE RECOGNITION. All revenues are recognized when products are shipped
and title has passed to unaffiliated customers.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. The Company records an allowance for
doubtful accounts to reduce accounts receivable to their net realizable value.
The allowance is based upon an analysis of historical bad debts, a review of the
aging of accounts receivables and the current creditworthiness of customers.
SHIPPING AND HANDLING COSTS. All costs the Company incurs to ship products
are included in Cost of goods sold in the Statements of Consolidated Income.
TECHNICAL EXPENDITURES. Total technical expenditures include research and
development costs, quality control, product formulation expenditures and other
similar items. Research and development costs included in technical expenditures
were $34,391, $36,019 and $37,193 for 2003, 2002, and 2001, respectively.
ADVERTISING EXPENSES. The cost of advertising is expensed as incurred. The
Company incurred $238,754, $221,572 and $236,259 in advertising costs during
2003, 2002, and 2001, respectively.
ENVIRONMENTAL MATTERS. Capital expenditures for ongoing environmental
compliance measures are recorded in the Consolidated Balance Sheets, and related
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
expenses are included in the normal operating expenses of conducting business.
The Company is involved with environmental investigation and remediation
activities at some of its current and former sites and at a number of
third-party sites. The Company accrues for environmental remediation-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
historical experience. All accrued amounts are recorded on an undiscounted
basis. Accrued environmental remediation-related expenses include 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, consulting and law firms. See
Notes 8 and 12.
EMPLOYEE STOCK PURCHASE AND SAVINGS PLAN AND PREFERRED STOCK. The Company
accounts for the Employee Stock Purchase and Savings Plan (ESOP) in accordance
with SOP No. 93-6, "Employers' Accounting for Employee Stock Ownership Plans."
The Company recognizes compensation expense for amounts contributed to the ESOP
and the ESOP uses dividends on unallocated preferred shares to service debt.
Unallocated preferred shares held by the ESOP are not considered outstanding in
calculating earnings per share of the Company. See Note 10.
STOCK-BASED COMPENSATION. At December 31, 2003, the Company had two
stock-based compensation plans accounted for under the recognition and
measurement principles of Accounting Principles Board Opinion (APBO) No. 25,
"Accounting for Stock Issued to Employees," and related interpretations, as more
fully described in Note 11. Pro-forma information regarding the impact of
stock-based compensation on net income and earnings per share is required by
SFAS No. 123, "Accounting for Stock-Based Compensation." Such pro-forma
information, determined as if the Company had accounted for its employee stock
options under the fair value method of that statement, is illustrated in the
following table:
2003 2002 2001
-------- -------- --------
NET INCOME, AS REPORTED.... $332,058 $127,565 $263,158
ADD: TOTAL STOCK-BASED
COMPENSATION EXPENSE
INCLUDED IN THE
DETERMINATION OF NET
INCOME AS REPORTED, NET
OF RELATED TAX EFFECTS.... 3,667 2,013 735
LESS: TOTAL STOCK-BASED
COMPENSATION EXPENSE
DETERMINED UNDER FAIR
VALUE BASED METHOD FOR
ALL AWARDS, NET OF
RELATED TAX EFFECTS....... (12,138) (11,455) (10,001)
-------- -------- --------
PRO-FORMA NET INCOME....... $323,587 $118,123 $253,892
======== ======== ========
INCOME PER SHARE:
BASIC - AS REPORTED....... $ 2.29 $ .85 $ 1.69
BASIC - PRO-FORMA......... $ 2.23 $ .79 $ 1.63
DILUTED - AS REPORTED..... $ 2.26 $ .84 $ 1.68
DILUTED - PRO-FORMA....... $ 2.20 $ .78 $ 1.62
The fair value for these options was estimated at the date of grant using a
Black-Scholes option-pricing model with the following weighted-average
assumptions for all options granted:
2003 2002 2001
------ ------ ------
RISK-FREE INTEREST RATE ................. 2.24% 2.15% 4.00%
EXPECTED LIFE OF OPTION ................. 3 YEARS 3 Years 3 Years
EXPECTED DIVIDEND YIELD OF STOCK......... 2.28% 2.18% 2.00%
EXPECTED VOLATILITY OF STOCK ............ .290 .333 .353
The Black-Scholes option-pricing model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, it is management's opinion that the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
EARNINGS PER SHARE. Shares of preferred stock held in an unallocated
account of the ESOP (see Note 10) and common stock held in a revocable trust
(see Note 9) are not considered outstanding shares for basic or diluted income
per share calculations. All references to "shares or per share information"
throughout this report relate to common shares, unless otherwise indicated.
Basic income per common share amounts are computed based on the weighted-average
number of common shares outstanding during the year. Diluted income per common
share amounts are computed based on the weighted-average number of common shares
outstanding plus all dilutive securities potentially outstanding during the
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
year. See Note 14. All references to income or losses per common share
throughout this report are stated on a diluted per common share basis, unless
otherwise indicated.
PRODUCT 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 estimates and accrues
the costs of unsettled product warranty claims based on historical results and
experience. Management periodically assesses the adequacy of the accrual for
product warranty claims and adjusts the accrual as necessary.
Changes in the Company's accrual for product warranty claims during 2003,
2002 and 2001, including customer satisfaction settlements during the year, were
as follows:
2003 2002 2001
-------- -------- --------
Balance at January 1 ...... $ 15,510 $ 14,074 $ 13,783
Charges to expense ....... 28,745 25,023 28,771
Settlements ............... (27,700) (23,587) (28,480)
-------- -------- --------
Balance at December 31 .... $ 16,555 $ 15,510 $ 14,074
======== ======== ========
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS. In January 2003, the FASB
issued Interpretation No. 46, "Consolidation of Variable Interest Entities."
Interpretation No. 46 requires variable interest entities to be consolidated by
their primary beneficiaries if the entities do not effectively disperse the
risks and rewards of ownership among their owners and other parties involved.
Adoption of Interpretation No. 46 did not have an effect on the Company's
results of operations, financial condition or liquidity. See non-traded
investments section above for the Company's variable interest entities. In May
2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
requires that certain financial instruments, which under previous guidance could
be accounted for as equity, be classified as liabilities in statements of
financial position. SFAS No. 150 is effective for financial instruments entered
into or modified after May 31, 2003. Adoption of SFAS No. 150 did not have an
effect on the Company's results of operations, financial condition or liquidity.
In December 2003, the FASB issued Financial Staff Position (FSP) No. 106-1,
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003." In accordance with FSP No.
106-1, the Company has elected to defer recognizing the effects of the Medicare
Prescription Drug, Improvement and Modernization Act of 2003 in the accounting
for the health care benefits under SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions," and in providing disclosures
related to the health care benefits required by revised SFAS No. 132,
"Employers' Disclosures about Pensions and Other Postretirement Benefits," until
authoritative guidance on the accounting for the federal subsidy is issued (see
Note 6). Management has not yet determined the effect FSP No. 106-1 will have on
the Company's results of operations, financial condition or liquidity.
RECLASSIFICATION. Certain amounts in the 2002 and 2001 consolidated
financial statements have been reclassified to conform with the 2003
presentation.
NOTE 2--CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 2002, the Company adopted SFAS No. 142. In accordance
with SFAS No. 142, goodwill and intangible assets deemed to have indefinite
lives are no longer amortized. Excluding after-tax amortization expense of
$24,090 from 2001 to be comparable with 2003 and 2002, net income would have
been $287,248 or $1.83 per diluted common share in 2001.
During the first quarter of 2002, the Company completed the transitional
impairment test required by SFAS No. 142 and recognized an impairment charge of
$247,612 ($183,136 after taxes or $1.21 per diluted common share) to reduce the
carrying values of goodwill and certain indefinite-lived intangible assets to
their estimated fair values. The transitional impairment charge was accounted
for as a cumulative effect of change in accounting principle. The transitional
impairment charge for goodwill totaled $129,392 ($105,714 after taxes or $.70
per diluted common share) and related primarily to international operations in
the International Coatings and Automotive Finishes Segments. Weakened foreign
currency exchange rates and economic conditions, particularly in South America,
negatively impacted profit and cash flow in U.S. dollars. The transitional
impairment charge for indefinite-lived intangible assets aggregated $118,220
($77,422 after taxes or $.51 per diluted common share). The impairment of
indefinite-lived intangible assets related principally to trademarks in the
Consumer Segment associated with the acquisition of Thompson Minwax Holding
Corp. and
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
was due primarily to a shortfall in sales from levels anticipated at the time of
acquisition. In addition, certain trademarks in the International Coatings
Segment were impaired. Fair values are estimated separately for goodwill and
indefinite-lived intangible assets using a discounted cash flow valuation model,
incorporating discount rates commensurate with the risks involved for each group
of assets.
NOTE 3--GOODWILL AND INTANGIBLE ASSETS
During 2003, the Company recorded additions of $19,555 in intangible
assets, primarily related to the acquisition of Accurate Dispersions, with
$17,540 of technology-based assets allocated to all other intangible assets.
Acquired intangible assets subject to amortization are amortized over
weighted-average periods of seven years for software and 17 years for all other
intangible assets. No significant residual value is estimated for these assets.
Goodwill and intangible assets that are no longer amortized are required by
SFAS No. 142 to be periodically tested for impairment. October 1 has been
established for the annual impairment review of goodwill and indefinite-lived
intangible assets. Fair values are estimated separately for goodwill and
indefinite-lived intangible assets using a discounted cash flow valuation model,
incorporating discount rates commensurate with the risks involved for each group
of assets. The annual impairment review performed as of October 1, 2003 resulted
in reductions in the carrying value of certain indefinite-lived intangible
assets of $1,013, which was charged to Selling, general and administrative
expenses. The impairment of indefinite-lived intangible assets related to
lower-than-anticipated sales of certain acquired domestic brands. Also, during
the fourth quarter of 2003, an impairment of capitalized costs of software
occurred due to the replacement and significant changes in the utilization of
certain software. A reduction in the carrying value of capitalized software
costs of $3,784 and $7,657 was charged to Selling, general and administrative
expenses in the Consumer and Administrative Segments, respectively.
During the first quarter of 2002, a devaluation of the Argentine peso
indicated that an impairment of other long-lived assets for the Argentina
subsidiary was probable. Fair values and the resulting impairment were
determined in accordance with SFAS No. 144. A reduction of $8,997 in the
carrying value of other long-lived assets of the Automotive and International
Coatings Segments' Argentina reporting units was charged to Cost of goods sold
($6,502) and Selling, general and administrative expenses ($2,495) in the first
quarter of 2002. The annual impairment review of all appropriate assets
performed as of October 1, 2002 resulted in reductions in the carrying values of
goodwill of $2,401 and indefinite-lived intangible assets of $1,206. The total
of $3,607 was charged to Cost of goods sold ($801) and Selling, general and
administrative expenses ($2,806) in the fourth quarter of 2002. The impairment
of goodwill related to a cash flow shortfall in certain international operations
acquired in the acquisition of Thompson Minwax Holding Corp. and the impairment
of indefinite-lived intangible assets related to lower-than-anticipated sales of
certain acquired domestic and international brands. Also, during the fourth
quarter of 2002, an impairment of other long-lived assets in the Consumer
Segment was deemed probable relating to the capitalized costs of software due to
the replacement and significant changes in the utilization of certain software.
A reduction in the carrying value of capitalized software costs of $7,344 was
charged to Selling, general and administrative expenses.
Amortization of finite-lived intangible assets is as follows for the next
five years: $12,400 in 2004, $10,000 in 2005, $8,400 in 2006, $7,600 in 2007 and
$6,300 in 2008.
SFAS No. 142 required a complete review of the useful life and
classification of all intangible and other assets. As a result, certain assets
have been reclassified from Other assets to Intangible assets in the 2001
accompanying Consolidated Balance Sheet to conform to the 2003 and 2002
classifications.
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
A summary of changes in the Company's carrying value of goodwill by reportable
operating segment is as follows:
Automotive International Consolidated
Goodwill Paint Stores Consumer Finishes Coatings Totals
-------- ------------ ------------ ------------ ------------- ------------
Balance at January 1, 2001 ............. $ 81,132 $ 463,763 $ 55,860 $ 104,792 $ 705,547
Acquisitions ........................ 4,905 727 5,632
Amortization ........................ (3,747) (13,697) (1,825) (2,870) (22,139)
Currency and other adjustments ...... (404) (12) (4,404) (11,823) (16,643)
------------ ------------ ------------ ------------- ------------
Balance at December 31, 2001 ........... 81,886 450,054 49,631 90,826 672,397
Acquisitions ........................ 13,230 1,417 14,647
Transitional impairments ............ (5,387) (16,571) (19,009) (88,425) (129,392)
Impairment charged to operations .... (2,401) (2,401)
Currency and other adjustments ...... 746 (3,790) (3,044)
------------ ------------ ------------ ------------- ------------
BALANCE AT DECEMBER 31, 2002 ........... 89,729 434,229 28,249 552,207
ACQUISITIONS ........................ 11,855 11,855
CURRENCY AND OTHER ADJUSTMENTS ...... 74 42 (647) (531)
------------ ------------ ------------ ------------- ------------
BALANCE AT DECEMBER 31, 2003 ........... $ 89,803 $ 446,126 $ 27,602 $ $ 563,531
============ ============ ============ ============= ============
A summary of the Company's carrying value of intangible assets is as follows:
Finite-lived intangible assets Trademarks Total
------------------------------------ with indefinite intangible
Software All other Subtotal lives assets
---------- ---------- ---------- --------------- ----------
DECEMBER 31, 2003
- -----------------
WEIGHTED-AVERAGE AMORTIZATION PERIOD ........ 11 YEARS 15 YEARS 12 YEARS
GROSS ....................................... $ 53,163 $ 82,974 $ 136,137 $ 150,897 $ 287,034
ACCUMULATED AMORTIZATION .................... (2,959) (59,295) (62,254) (37,578) (99,832)
---------- ---------- ---------- --------------- ----------
NET VALUE ................................ $ 50,204 $ 23,679 $ 73,883 $ 113,319 $ 187,202
========== ========== ========== =============== ==========
December 31, 2002
- -----------------
Weighted-average amortization period ........ 12 years 14 years 12 years
Gross ....................................... $ 65,157 $ 70,200 $ 135,357 $ 150,206 $ 285,563
Accumulated amortization .................... (8,449) (54,311) (62,760) (36,764) (99,524)
---------- ---------- ---------- --------------- ----------
Net value ................................ $ 56,708 $ 15,889 $ 72,597 $ 113,442 $ 186,039
========== ========== ========== =============== ==========
December 31, 2001
- -----------------
Weighted-average amortization period ........ 12 years 15 years 13 years
Gross ....................................... $ 68,917 $ 66,854 $ 135,771 $ 268,532 $ 404,303
Accumulated amortization .................... (11,900) (49,375) (61,275) (38,522) (99,797)
---------- ---------- ---------- --------------- ----------
Net value ................................ $ 57,017 $ 17,479 $ 74,496 $ 230,010 $ 304,506
========== ========== ========== =============== ==========
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
NOTE 4 -- INVENTORIES
Inventories are stated at the lower of cost or market with cost determined
principally on the last-in, first-out (LIFO) method. The following presents the
effect on inventories, net income and net income per share had the Company used
the first-in, first-out (FIFO) inventory valuation method adjusted for income
taxes at the statutory rate and assuming no other adjustments. This information
is presented to enable the reader to make comparisons with companies using the
FIFO method of inventory valuation.
2003 2002 2001
---------- ---------- ----------
PERCENTAGE OF TOTAL
INVENTORIES ON LIFO ............ 88% 87% 88%
EXCESS OF FIFO OVER LIFO .......... $ 96,591 $ 100,226 $ 112,669
INCREASE (DECREASE) IN
NET INCOME DUE TO LIFO ......... 2,213 8,088 (1,567)
INCREASE (DECREASE) IN
NET INCOME PER SHARE
DUE TO LIFO .................... .02 .05 (.01)
NOTE 5 -- DISPOSITION AND TERMINATION OF OPERATIONS
Management is continually re-evaluating the Company's operating
facilities against its long-term strategic goals. Prior to January 1, 2003, upon
commitment to a formal shutdown plan of an operating facility, provisions were
made for all estimated qualified exit costs in accordance with EITF No. 94-3.
Effective January 1, 2003, the Company recognizes liabilities associated with
exit or disposal activities as incurred in accordance with SFAS No. 146.
Qualifying exit costs primarily include post-closure rent expenses, incremental
post-closure costs and costs of employee terminations. Adjustments may be made
to prior provisions for qualified exit costs if information becomes available
upon which more accurate amounts can be reasonably estimated. Provisions for
qualifying exit costs and subsequent adjustments are summarized in the table
below. Concurrently, property, plant and equipment is tested for impairment in
accordance with SFAS No. 144 and, if impairment exists, the carrying value of
the related assets is reduced to estimated fair value. Charges for the
impairment of long-lived assets held for disposal, included in Other expense -
net, was $6,402 in 2001. There was no charge for the impairment of long-lived
assets in 2003 or 2002. Adjustments may be made for subsequent revisions in
estimated fair value, not to exceed original asset carrying value before
impairment. Adjustments of $22 and $34 were made at December 31, 2003 and 2002,
representing reductions in expense.
During 2003, a formal plan was approved to close one manufacturing
facility in the Consumer Segment. In accordance with SFAS No. 146, no exit costs
related to this facility were accrued during 2003. At the time of closure in
2004, the anticipated exit costs are not expected to be significant. The useful
lives of the assets related to this facility were reduced in accordance with
SFAS No. 144. No formal shutdown plans were approved during 2002. During the
fourth quarter of 2001, formal plans were approved to close two manufacturing
facilities in the Paint Stores and Consumer Segments. Qualified exit costs were
accrued and asset impairment charges recorded for all of these facilities.
The following table summarizes the activity and remaining liabilities
associated with qualified exit costs:
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
Actual Adjustments to
Balance at Provisions in expenditures prior provisions Balance at
December 31, Cost of goods charged to in Other December 31,
Exit Plan 2002 sold accrual expense - net 2003
- -------------------------------------- ------------ ------------- ------------ ---------------- ------------
CONSUMER MANUFACTURING FACILITY:
SEVERANCE AND RELATED COSTS ......... $ 133 $ (133)
OTHER EXIT COSTS .................... 2,790 (641) $ (91) $ 2,058
PAINT STORES MANUFACTURING FACILITY:
OTHER EXIT COSTS .................... 333 (105) (228)
EXIT COSTS INITIATED PRIOR TO 2001.... 13,221 (700) 333 12,854
------------ ------------- ------------ ---------------- ------------
TOTALS ............................... $ 16,477 $ (1,579) $ 14 $ 14,912
============ ============= ============ ================ ============
Actual Adjustments to
Balance at Provisions in expenditures prior provisions Balance at
December 31, Cost of goods charged to in Other December 31,
Exit Plan 2001 sold accrual expense - net 2002
- -------------------------------------- ------------ ------------- ------------ ---------------- ------------
Consumer manufacturing facility:
Severance and related costs ......... $ 1,454 $ (1,321) $ 133
Other exit costs .................... 1,946 (256) $ 1,100 2,790
Paint Stores manufacturing facility:
Severance and related costs ......... 710 (667) (43)
Other exit costs .................... 290 43 333
Exit costs initiated prior to 2001.... 15,479 (1,420) (838) 13,221
------------ ------------- ------------ ---------------- ------------
Totals ............................... $ 19,879 $ (3,664) $ 262 $ 16,477
============ ============= ============ ================ ============
Actual Adjustments to
Balance at Provisions in expenditures prior provisions Balance at
December 31, Cost of goods charged to in Other December 31,
Exit Plan 2000 sold accrual expense - net 2001
- -------------------------------------- ------------ ------------- ------------ ---------------- ------------
Consumer manufacturing facility:
Severance and related costs ......... $ 1,454 $ 1,454
Other exit costs .................... 1,946 1,946
Paint Stores manufacturing facility:
Severance and related costs ......... 710 710
Other exit costs .................... 290 290
Exit costs initiated prior to 2001.... $ 17,903 $ (3,326) $ 902 15,479
------------ ------------- ------------ ---------------- ------------
Totals ............................... $ 17,903 $ 4,400 $ (3,326) $ 902 $ 19,879
============ ============= ============ ================ ============
Less than 5 percent of the ending accrual for qualified exit costs at
December 31, 2003 relates to facilities shutdown in 2001 that are expected to be
incurred by the end of 2004. The remaining portion of the ending accrual
primarily represents post-closure contractual and demolition expenses related to
certain owned facilities which are closed and being held for disposal or
involved in ongoing environmental-related remediation activities. The Company
cannot reasonably estimate when such matters will be concluded to permit
disposition.
NOTE 6 -- HEALTH CARE, PENSION AND OTHER BENEFITS
The Company provides certain health care benefits for active employees.
The plans are contributory and contain cost-sharing features such as deductibles
and coinsurance. There were 16,286, 16,301 and 16,512 active employees entitled
to receive benefits under these plans as of December 31, 2003, 2002 and 2001,
respectively. The cost of these benefits for active employees, which includes
claims incurred and claims incurred but not reported, amounted to $80,888,
$70,169 and $68,158 for 2003, 2002, and 2001, respectively. The Company has a
fund, to which it no longer intends to contribute, that provides for payment of
health care benefits of qualified employees. Distributions from the fund were
$8,542, $8,134 and $8,113 in 2003, 2002, and 2001, respectively.
The Company provides pension benefits to substantially all employees through
noncontributory defined
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
contribution or defined benefit plans.
The Company's annual contribution for its domestic defined contribution
pension plan, which is based on six percent of compensation for covered
employees, was $41,531 and $41,569 for 2003 and 2002, respectively. Effective
January 1, 2002, the domestic defined contribution pension plan ceased admitting
new participants. Prior to January 1, 2002, the Company's annual contribution
was based on five percent of compensation for covered employees and amounted to
$35,991 in 2001. Assets in employee accounts of the domestic defined
contribution pension plan are invested in various mutual funds as directed by
the participants. These mutual funds do not own a significant number of shares
of the Company's common stock.
The Company's annual contribution for its foreign defined contribution
pension plans, which is based on various percentages of compensation for covered
employees up to certain limits, was $1,236, $1,260 and $1,458 for 2003, 2002,
and 2001, respectively. Assets in employee accounts of the foreign defined
contribution pension plans are invested in various mutual funds. These mutual
funds do not own a significant number of shares of the Company's common stock.
Effective January 1, 2002, the domestic salaried defined benefit
pension plan, which was frozen since 1984, was revised to allow for new
participants. Eligible domestic salaried employees hired or re-hired on or after
January 1, 2002 become participants in the revised domestic salaried defined
benefit pension plan upon completion of six months of service. All participants
in the domestic salaried defined benefit pension plan prior to the revision will
retain the previous defined benefit formula for computing benefits with certain
modifications for active employees. All employees who become participants
subsequent to January 1, 2002 will be credited with contribution credits that
are the equivalent of six percent of their earnings. Contribution credits will
be converted into units to account for each participant's benefits, although
these units will not constitute an actual allocation of assets. These
participants will receive a variable annuity benefit upon retirement or a
distribution upon termination (if vested). The variable annuity benefit is
subject to the hypothetical returns achieved on each participant's allocation of
units from investments in various mutual funds as directed by the participant.
Contribution credits to the revised domestic salaried defined benefit pension
plan will be initially funded through the existing excess of plan assets over
benefit obligations.
Substantially all other employees not covered by domestic or foreign
defined contribution pension plans or the revised domestic salaried defined
benefit pension plan participate in various other smaller domestic or foreign
defined benefit pension plans.
The Company employs a total return investment approach for the domestic
and foreign defined benefit pension plan assets. A mix of equities and fixed
income investments are used to maximize the long-term return of assets for a
prudent level of risk. In determining the expected long-term rate of return on
defined benefit pension plan assets, management considers the historical rates
of return, the nature of investments and an expectation of future investment
strategies. At December 31, 2003, defined benefit pension plan assets were
invested as follows:
Domestic Foreign
Plans Plans
----- -----
Equity investments........................ 64% 67%
Fixed income investments.................. 34% 32%
Cash and other investments................ 2% 1%
Included as equity investments in the domestic defined benefit pension
plan at December 31, 2003 were 1,600,000 shares of the Company's common stock
with a market value of $55,584, which was 10.4 percent of total domestic defined
benefit pension plan assets. Dividends received during the year on Company
common stock was $1,039.
At December 31, 2003, one of the Company's foreign defined benefit
pension plans was under-funded by $8,451 with a projected benefit obligation of
$33,700, an accumulated benefit obligation of $27,535, and a fair value of plan
assets of $19,084. In addition, the Company has one unfunded foreign defined
benefit pension plan with an accumulated benefit obligation of $452.
Contributions to the foreign defined benefit pension plans are expected to be
$624 in 2004.
The following table summarizes the obligations and assets of the
defined benefit pension plans, which are all measured as of December 31:
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
Domestic Foreign
Defined Benefit Pension Plans Defined Benefit Pension Plans
-------------------------------------- --------------------------------------
2003 2002 2001 2003 2002 2001
---------- ---------- ---------- ---------- ---------- ----------
ACCUMULATED BENEFIT OBLIGATION
AT END OF YEAR ........................... $ 218,804 $ 186,980 $ 178,671 $ 32,323 $ 23,295 $ 13,683
PROJECTED BENEFIT OBLIGATION:
BALANCE AT BEGINNING OF YEAR ............. $ 190,711 $ 186,174 $ 177,510 $ 30,089 $ 17,674 $ 17,369
SERVICE COST ............................. 7,036 4,214 2,235 1,358 968 717
INTEREST COST ............................ 12,066 12,016 12,103 1,959 1,383 989
ACTUARIAL LOSS (GAIN) .................... 30,276 218 5,273 (368) 8,313 514
PLAN AMENDMENTS, MERGERS AND OTHER ....... 1,206 875 4,646 235 202
EFFECT OF FOREIGN EXCHANGE ............... 3,373 1,838 (448)
BENEFITS PAID ............................ (15,824) (13,117) (11,822) (875) (322) (1,669)
---------- ---------- ---------- ---------- ---------- ----------
BALANCE AT END OF YEAR ................... 224,265 190,711 186,174 40,182 30,089 17,674
PLAN ASSETS:
BALANCE AT BEGINNING OF YEAR ............. 464,110 515,889 532,428 15,732 22,103 22,026
ACTUAL RETURN ON PLAN ASSETS ............. 88,023 (35,282) (2,159) 4,765 (9,510) 1,192
OTHER - NET .............................. (2,969) (3,380) (2,558) 1,842 1,242 1,138
EFFECT OF FOREIGN EXCHANGE ............... 1,669 2,219 (584)
BENEFITS PAID ............................ (15,824) (13,117) (11,822) (875) (322) (1,669)
---------- ---------- ---------- ---------- ---------- ----------
BALANCE AT END OF YEAR ................... 533,340 464,110 515,889 23,133 15,732 22,103
EXCESS (DEFICIENCY) OF PLAN ASSETS
OVER PROJECTED BENEFIT OBLIGATION:
BALANCE AT END OF YEAR ................. 309,075 273,399 329,715 (17,049) (14,357) 4,429
UNRECOGNIZED ACTUARIAL LOSS (GAIN) ..... 108,297 137,690 57,396 18,922 18,368 (662)
UNRECOGNIZED PRIOR SERVICE COST ........ 1,726 2,684 2,345 388
---------- ---------- ---------- ---------- ---------- ----------
EXCESS RECOGNIZED IN THE
CONSOLIDATED BALANCE SHEETS .............. $ 419,098 $ 413,773 $ 389,456 $ 2,261 $ 4,011 $ 3,767
========== ========== ========== ========== ========== ==========
EXCESS RECOGNIZED IN THE CONSOLIDATED
BALANCE SHEETS CONSISTS OF:
DEFERRED PENSION ASSETS ................ $ 419,098 $ 413,773 $ 389,456 $ 1,069 $ 816 $ 4,131
BENEFIT LIABILITY INCLUDED
IN OTHER LONG-TERM LIABILITIES ...... (6,982) (7,391)
BENEFIT LIABILITY INCLUDED
IN OTHER ACCRUALS ................... (3,615) (1,320) (364)
CUMULATIVE OTHER
COMPREHENSIVE LOSS .................. 11,789 11,906
---------- ---------- ---------- ---------- ---------- ----------
$ 419,098 $ 413,773 $ 389,456 $ 2,261 $ 4,011 $ 3,767
========== ========== ========== ========== ========== ==========
WEIGHTED-AVERAGE ASSUMPTIONS
USED TO DETERMINE PROJECTED
BENEFIT OBLIGATION:
DISCOUNT RATE .......................... 6.00% 6.55% 6.75% 5.73% 5.50% 6.00%
RATE OF COMPENSATION INCREASE .......... 4.00% 4.00% 4.50% 3.67% 3.50% 3.50%
WEIGHTED-AVERAGE ASSUMPTIONS USED TO
DETERMINE NET PENSION (CREDIT) COST:
DISCOUNT RATE .......................... 6.55% 6.75% 7.00% 5.50% 6.00% 6.50%
EXPECTED LONG-TERM RATE OF RETURN
ON ASSETS ........................... 8.00% 8.50% 8.50% 8.00% 8.50% 8.50%
RATE OF COMPENSATION INCREASE .......... 4.00% 4.50% 5.00% 3.50% 3.50% 3.50%
NET PENSION (CREDIT) COST:
SERVICE COST ............................. $ 7,036 $ 4,214 $ 2,235 $ 1,358 $ 968 $ 717
INTEREST COST ............................ 12,066 12,016 12,103 1,959 1,383 989
EXPECTED RETURN ON ASSETS ................ (36,485) (43,349) (44,768) (1,465) (1,525) (1,585)
RECOGNITION OF:
UNRECOGNIZED PRIOR SERVICE COST ........ 958 867 850 294
UNRECOGNIZED ACTUARIAL LOSS (GAIN) ..... 11,100 1,935 123 1,107 478 (30)
---------- ---------- ---------- ---------- ---------- ----------
NET PENSION (CREDIT) COST ................ $ (5,325) $ (24,317) $ (29,457) $ 3,253 $ 1,304 $ 91
========== ========== ========== ========== ========== ==========
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
Employees of the Company who were hired prior to January 1, 1993 and
who are not members of a collective bargaining unit, and certain groups of
employees added through acquisitions, are eligible for health care and life
insurance benefits upon retirement from active service, subject to the terms,
conditions and limitations of the applicable plans. There were 4,727, 4,719 and
4,837 retired employees entitled to receive benefits as of December 31, 2003,
2002, and 2001, respectively. The plans are unfunded.
The assumed health care cost trend rate for 2004 was revised during the
year ended December 31, 2003 to 10.0 percent and 12.0 percent for participants
under age 65 and age 65 and older, respectively. These trend rate assumptions
decrease in each successive year until reaching 5.0 percent in 2014. Assumed
health care cost trend rates have a significant effect on the amounts reported
for the postretirement health care benefit obligation. A one-percentage-point
change in assumed health care cost trend rates would have the following effects
as of December 31, 2003:
One-Percentage-Point
-----------------------
Increase (Decrease)
---------- ----------
Effect on total of service and
interest cost components ...................... $ 583 $ (565)
Effect on the postretirement
benefit obligation ............................ $ 10,297 $ (9,864)
A summary of the obligation for postretirement health care and life
insurance benefits is as follows:
Postretirement Benefits Other than Pensions
--------------------------------------------
2003 2002 2001
------------ ------------ ------------
BENEFIT OBLIGATION:
BALANCE AT BEGINNING OF YEAR .................................... $ 261,807 $ 267,118 $ 247,936
SERVICE COST .................................................... 4,334 3,898 3,753
INTEREST COST ................................................... 16,787 16,567 16,301
ACTUARIAL LOSS (GAIN) ........................................... 35,495 (3,806) 14,012
PLAN AMENDMENTS ................................................. (6,778)
BENEFITS PAID ................................................... (15,974) (15,192) (14,884)
------------ ------------ ------------
BALANCE AT END OF YEAR .......................................... 302,449 261,807 267,118
UNFUNDED BENEFIT OBLIGATION RECOGNIZED IN
THE CONSOLIDATED BALANCE SHEETS:
UNFUNDED BENEFIT OBLIGATION AT END OF YEAR ................... (302,449) (261,807) (267,118)
UNRECOGNIZED ACTUARIAL LOSS .................................. 78,559 45,706 51,134
UNRECOGNIZED PRIOR SERVICE CREDIT ............................ (8,963) (12,848) (8,879)
------------ ------------ ------------
UNFUNDED BENEFIT OBLIGATION RECOGNIZED IN
THE CONSOLIDATED BALANCE SHEETS: ................................ $ (232,853) $ (228,949) $ (224,863)
============ ============ ============
UNFUNDED BENEFIT OBLIGATION RECOGNIZED IN THE
CONSOLIDATED BALANCE SHEETS CONSISTS OF:
BENEFIT LIABILITY INCLUDED IN OTHER LONG-TERM LIABILITIES .... $ (216,853) $ (213,749) $ (209,963)
BENEFIT LIABILITY INCLUDED IN OTHER ACCRUALS ................. (16,000) (15,200) (14,900)
------------ ------------ ------------
$ (232,853) $ (228,949) $ (224,863)
============ ============ ============
WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE
BENEFIT OBLIGATION:
DISCOUNT RATE ................................................ 6.00% 6.55% 6.75%
HEALTH CARE COST TREND RATE - PRE-65 ......................... 10.00% 8.90% 9.50%
HEALTH CARE COST TREND RATE - POST-65 ........................ 12.00% 8.90% 9.50%
WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE
NET PERIODIC BENEFIT COST:
DISCOUNT RATE ................................................ 6.55% 6.75% 7.00%
HEALTH CARE COST TREND RATE .................................. 8.90% 9.50% 6.00%
NET PERIODIC BENEFIT COST:
SERVICE COST .................................................... $ 4,334 $ 3,898 $ 3,753
INTEREST COST ................................................... 16,787 16,567 16,301
RECOGNITION OF:
UNRECOGNIZED PRIOR SERVICE CREDIT ............................ (3,885) (3,885) (2,809)
UNRECOGNIZED ACTUARIAL LOSS .................................. 2,546 2,341 660
------------ ------------ ------------
NET PERIODIC BENEFIT COST ....................................... $ 19,782 $ 18,921 $ 17,905
============ ============ ============
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) was signed into law. The Act introduces a
prescription drug benefit under Medicare (Medicare Part D) as well as a federal
subsidy to sponsors of retiree health care benefit plans that provide a benefit
that is at least actuarially equivalent to Medicare Part D. In accordance with
FSP No. 106-1, the Company has elected to defer recognizing the effects of the
Act in the accounting for the health care benefits under SFAS No. 106 and in
providing disclosures related to the health care benefits required by revised
SFAS No. 132 until authoritative guidance on the accounting for the federal
subsidy is issued. Accordingly, any measures of the accumulated postretirement
benefit obligation or net periodic postretirement benefit cost do not reflect
the effect of the Act. Authoritative guidance on the accounting for the federal
subsidy is pending and that guidance, when issued, could require the Company to
change previously reported information.
NOTE 7 -- LONG-TERM DEBT
Due Date 2003 2002 2001
------------ ---------- ---------- ----------
6.85% Notes ......................................... 2007 $ 203,173 $ 204,202 $ 199,839
7.375% Debentures ................................... 2027 149,921 149,917 149,914
7.45% Debentures .................................... 2097 147,932 149,420 149,414
5% to 8.5% Promissory Notes ......................... Through 2007 1,285 1,643 3,319
9.875% Debentures ................................... 2016 1,500 1,500 1,500
10.25% Promissory Note partially secured
by land and building ............................. 2003 1,108
---------- ---------- ----------
Long-term debt before SFAS No. 133 adjustments ... 503,811 506,682 505,094
Fair value adjustments to 6.85% Notes in
accordance with SFAS No. 133 ..................... (819) (1,577)
---------- ---------- ----------
$ 502,992 $ 506,682 $ 503,517
========== ========== ==========
Maturities of long-term debt are as follows for the next five years:
$10,596 in 2004; $749 in 2005; $34 in 2006; $199,984 in 2007, and $47 in 2008.
Interest expense on long-term debt was $37,460, $37,029, and $44,582
for 2003, 2002, and 2001, respectively.
Among other restrictions, the Company's Notes, Debentures and revolving
credit agreement contain certain covenants relating to liens, merger and sale of
assets, consolidated net worth and change of control as defined in the
agreements. 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.
The Company is in compliance with all covenants.
During 2003, the Company entered into two separate interest rate swap
contracts. Both interest rate swap contracts were with a bank to hedge against
changes in the fair value of a portion of the Company's 6.85% Notes. Each
interest rate swap contract had a notional amount of $25,000. The Company agreed
to receive interest at a fixed rate of 6.85% and pay interest at six-month
London Interbank Offered Rates plus points that vary by contract. These
contracts were designated as perfect fair value hedges of the 6.85% Notes.
Accordingly, changes in the fair value of these contracts were recorded as
assets or liabilities and offset changes in the carrying value of the 6.85%
Notes. The fair value of the interest rate swap contracts represents unrealized
losses of $819 at December 31, 2003 and is included in Other long-term
liabilities. The weighted average interest rate on these contracts was 5.35% at
December 31, 2003. Management believes the risk of incurring losses related to
credit risk of these contracts is remote.
During 2001, the Company entered into four separate interest rate swap
contracts and entered into an additional two interest rate swap contracts in
2002. All six interest rate swap contracts were with a bank to hedge against
changes in the fair value of a portion of the Company's 6.85% Notes. Each
interest rate swap contract had a notional amount of $25,000. The Company agreed
to receive interest at a fixed rate of 6.85% and pay interest at six-month
London Interbank Offered Rates plus points that vary by contract. These
contracts were designated as perfect fair value hedges of the 6.85% Notes.
Accordingly, changes in the fair value
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
of these contracts were recorded as assets or liabilities and offset changes in
the carrying value of the 6.85% Notes. During 2002, the Company unwound all of
the interest rate swap contracts and received a net premium of $4,762 from the
bank for discontinuation of the contracts. The net premium increased the
carrying amount of the 6.85% Notes and is being amortized to income over the
remaining maturity of the Notes using the effective interest method. At December
31, 2001, the fair value of the four separate interest rate swap contracts
represented unrealized losses of $1,577 which was included in Other long-term
liabilities. The weighted-average interest rate on these four swap contracts was
3.98 percent at December 31, 2001. There were no interest rate swap agreements
outstanding at December 31, 2002.
The Company has a multi-year amended revolving credit agreement. The
current agreement with an effective date of January 3, 2001 is a multi-year
agreement aggregating $608,000, with $190,400, and $417,600 expiring on January
3, 2005 and 2006, respectively. There were no borrowings outstanding under the
revolving credit agreement during all years presented.
There were no borrowings outstanding under the Company's commercial
paper program at December 31, 2003, 2002 and 2001, respectively. The Company
uses the revolving credit agreement to satisfy its commercial paper program's
dollar for dollar liquidity requirement. Effective January 3, 2004, the
aggregate maximum borrowing capacity under the revolving credit agreements
limits the commercial paper program to a maximum borrowing capability of
$608,000.
On October 6, 1997, the Company issued $50,000 of debt securities
consisting of 5.5% notes, due October 15, 2027, with provisions that the
holders, individually or in the aggregate, may exercise a put option annually on
October 15th that would require the Company to repay the securities. On October
15, 2000 and 1999, individual debt security holders exercised put options
requiring the Company to repay an aggregate of $46,905 of these debt securities.
The remaining balance of these debt securities of $3,095 is included in Current
portion of long-term debt at December 31, 2003, 2002 and 2001.
On December 8, 1997, the Company filed a shelf registration with the
Securities and Exchange Commission covering $150,000 of unsecured debt
securities with maturities greater than nine months from the date of issue. The
registration was effective December 24, 1997. The Company may issue these
securities from time to time in one or more series and will offer the securities
on terms determined at the time of sale. There were no borrowings outstanding
under this registration at December 31, 2003, 2002, and 2001.
On August 18, 1998, the Company filed a universal shelf registration
statement with the Securities and Exchange Commission to issue debt securities,
common stock and warrants up to $1,500,000. The registration was effective
September 8, 1998. There were no borrowings outstanding under this registration
at December 31, 2003, 2002, and 2001.
NOTE 8 -- OTHER LONG-TERM LIABILITIES
The operations of the Company, like those of other companies in our
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.
The Company is involved with environmental investigation and
remediation activities at some of its current and former sites (including sites
which were previously owned and/or operated by businesses acquired by the
Company). In addition, the Company, together with other parties, has been
designated a potentially responsible party under federal and state environmental
protection laws for the investigation and remediation of environmental
contamination and hazardous waste at a number of third-party sites, primarily
Superfund sites. In general, these laws provide that potentially responsible
parties may be held jointly and severally liable for investigation and
remediation costs regardless of fault. The Company may be similarly designated
with respect to additional third-party sites in the future.
The Company initially provides for estimated costs of
environmental-related activities relating to its past operations and third-party
sites for which commitments or clean-up plans have been developed and when such
costs can be reasonably estimated based on industry standards and historical
experience. These estimated costs are determined based on currently available
facts regarding each site. If the best estimate of costs can only
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
be identified as a range and no specific amount within that range can be
determined more likely than any other amount within the range, the minimum of
the range is provided. The unaccrued maximum of the estimated range of possible
outcomes is $99,750 higher than the minimum. The Company continuously assesses
its potential liability for investigation and remediation-related activities and
adjusts its environmental-related accruals as information becomes available upon
which more accurate costs can be reasonably estimated and as additional
accounting guidelines are issued. Actual costs incurred may vary from these
estimates due to the inherent uncertainties involved including, among others,
the number and financial condition of parties involved with respect to any given
site, the volumetric contribution which may be attributed to the Company
relative to that attributed to other parties, the nature and magnitude of the
wastes involved, the various technologies that can be used for remediation and
the determination of acceptable remediation with respect to a particular site.
Included in Other long-term liabilities at December 31, 2003, 2002, and
2001 were accruals for extended environmental-related activities of $107,688,
$105,110 and $111,003 respectively. Estimated costs of current investigation and
remediation activities of $25,697, $23,499 and $19,917 are included in Other
accruals at December 31, 2003, 2002 and 2001, respectively.
Three of the Company's current and former manufacturing sites account
for the majority of the accrual for environmental-related activities and the
unaccrued maximum of the estimated range of possible outcomes at December 31,
2003. Included in the accruals of $133,385 at December 31, 2003 is $71,840
related directly to these three sites. In the aggregate unaccrued exposure of
$99,750 at December 31, 2003, $41,098 relates to the three manufacturing sites.
While environmental investigations and remedial actions are in different stages
at these sites, additional investigations, remedial actions and monitoring will
likely be required at each site.
Management cannot presently estimate the potential loss contingencies
related to these sites or other less significant sites until such time as a
substantial portion of the investigation at the sites is completed and remedial
action plans are developed. In the event any future loss contingency
significantly exceeds the current amount accrued, the recording of the ultimate
liability may result in a material impact on net income for the annual or
interim period during which the additional costs are accrued. Management does
not believe that any potential liability ultimately attributed to the Company
for its environmental-related matters will have a material adverse effect on the
Company's financial condition, liquidity, or cash flow due to the extended
period of time during which environmental investigation and remediation takes
place. An estimate of the potential impact on the Company's operations cannot be
made due to the aforementioned uncertainties.
Management expects these contingent environmental-related liabilities
to be resolved over an extended period of time. Management is unable to provide
a more specific time frame due to the indefinite amount of time to conduct
investigation activities at any site, the indefinite amount of time to obtain
governmental agency approval, as necessary, with respect to investigation and
remediation activities, and the indefinite amount of time necessary to conduct
remediation activities.
NOTE 9 -- CAPITAL STOCK
At December 31, 2003, there were 300,000,000 shares of common stock and
30,000,000 shares of serial preferred stock authorized for issuance. Of the
authorized serial preferred stock, 3,000,000 shares have been designated as
cumulative redeemable serial preferred stock which may be issued pursuant to the
Company's shareholders' rights plan if the Company becomes the target of
coercive and unfair takeover tactics and 1,000,000 shares have been designated
as convertible participating serial preferred stock (see Note 10). An aggregate
of 22,081,368 shares, 16,157,277 shares and 17,964,052 shares of common stock at
December 31, 2003, 2002 and 2001, respectively, were reserved for future grants
of restricted stock and the exercise and future grants of stock options. Common
shares outstanding shown in the following table include 475,628 shares, 475,628
shares and 507,943 shares of common stock held in a revocable trust at December
31, 2003, 2002, and 2001, respectively. The revocable trust is used to
accumulate assets for the purpose of funding the ultimate obligation of certain
non-qualified benefit plans. Transactions between the Company and the trust are
accounted for in accordance with EITF No. 97-14, "Accounting for Deferred
Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and
Invested," which requires the assets held by the trust be consolidated with the
Company's accounts.
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
Common shares Common shares
in Treasury Outstanding
------------- -------------
Balance at January 1, 2001 ...................................... 47,289,303 159,558,335
Shares tendered as payment for options exercised ............. 19,995 (19,995)
Shares issued for exercise of stock options .................. 1,031,486
Shares tendered in connection with restricted stock grants ... 42,970 (42,970)
Net shares issued under restricted stock grants .............. 151,500
Treasury stock purchased ..................................... 6,700,000 (6,700,000)
------------- -------------
Balance at December 31, 2001 .................................... 54,052,268 153,978,356
Shares tendered as payment for options exercised ............. 173,044 (173,044)
Shares issued for exercise of stock options .................. 1,791,675
Net shares issued under restricted stock grants .............. 13,500
Treasury stock purchased ..................................... 6,700,000 (6,700,000)
------------- -------------
Balance at December 31, 2002 .................................... 60,925,312 148,910,487
Shares tendered as payment for options exercised ............. 23,950 (23,950)
Shares issued for exercise of stock options .................. 2,171,839
Shares tendered in connection with restricted stock grants ... 75,669 (75,669)
Net shares issued under restricted stock grants .............. 401,000
Treasury stock purchased ..................................... 7,977,000 (7,977,000)
------------- -------------
Balance at December 31, 2003 .................................... 69,001,931 143,406,707
============= =============
NOTE 10 -- STOCK PURCHASE PLAN AND PREFERRED STOCK
As of December 31, 2003, 12,524 employees contributed to the Company's
ESOP, a voluntary defined contribution plan available to all eligible salaried
employees. Effective January 1, 2002, the ESOP was amended to allow participants
to contribute, on a pre-tax basis only, the lesser of 20 percent of their annual
compensation or the maximum dollar amount allowed under the Internal Revenue
Code. Such participant contributions may be invested in a variety of mutual
funds or a Company common stock fund. Effective January 1, 2004, the ESOP was
further amended to permit participants to diversify 100 percent of employee
contributions previously allocated to the Company common stock fund into a
variety of mutual funds. The Company matches current contributions up to 6
percent of annual compensation. Company matching contributions are required to
be invested in the Company common stock fund. Prior to January 1, 2002,
participants in the ESOP were allowed to contribute up to 11 percent of their
annual compensation, up to 7 percent of which could be made on a pre-tax basis,
to purchase common shares of the Company or invest in a government fund.
Employees making contributions to purchase Company common stock received a
matching contribution from the Company of 50 percent of the employee's pre- and
post-tax contributions, up to a maximum of 7 percent of their annual
compensation, plus an additional variable match based on the Company's return on
equity (54 percent for the year ended 2001). See Note 6 for information related
to changes in other annual contributions from the Company effective January 1,
2002.
The Company made contributions to the ESOP on behalf of participating
employees, representing amounts authorized by employees to be withheld from
their earnings on a pre-tax basis, of $40,662, $38,921 and $27,374 in 2003,
2002, and 2001, respectively. The Company's matching contributions to the ESOP
charged to operations were $31,331, $27,916 and $33,744 for 2003, 2002, and
2001, respectively.
At December 31, 2003, there were 23,981,415 shares of the Company's
common stock being held by the ESOP, representing 16.7 percent of the total
number of voting shares outstanding. Shares of Company common stock credited to
each member's account under the ESOP are voted by the trustee under instructions
from each individual plan member. Shares for which no instructions are received,
along with any unallocated shares held in the ESOP, are voted by the trustee in
the same proportion as those for which instructions are received.
On April 18, 2001, the Company issued 250,000 shares of convertible
participating serial preferred stock, no par value with cumulative quarterly
dividends of ten dollars per share (Preferred stock), for $250,000 to the ESOP.
The ESOP financed the acquisition of the Preferred stock by borrowing $250,000
from the Company at the rate of 8 percent per annum. The Preferred stock was
held in an unallocated account by the ESOP until
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
compensation expense related to the Company's contributions was earned at which
time contributions were credited to the members' accounts. At December 31, 2002
and 2001, there were no allocated or committed-to-be-released shares of
Preferred stock outstanding. The ESOP redeemed the remaining 41,806 shares of
Preferred stock for cash in 2003. In 2002 and 2001, the ESOP redeemed 126,499
shares and 81,695 shares of Preferred stock for cash, respectively.
On August 27, 2003, the Company issued 350,000 shares of Preferred
stock for $350,000 to the ESOP. The ESOP financed the acquisition of the
Preferred stock by borrowing $350,000 from the Company at the rate of 4.5
percent per annum. This borrowing is payable over ten years in equal quarterly
installments. Each share of Preferred stock is entitled to one vote upon all
matters presented to the Company's shareholders, and the holder of the Preferred
stock and the holders of the common stock generally vote together as one class.
The Preferred stock is held in an unallocated account by the ESOP until
compensation expense related to the Company's contributions is earned at which
time contributions will be credited to the members' accounts. The Preferred
stock is redeemable and convertible into the Company's common stock at the
option of the ESOP based on the relative fair value of the Preferred stock and
common stock at time of conversion. In the event the Preferred stock is
redeemed, the Company has the option to pay the redemption amount in cash,
common stock or any combination thereof. At December 31, 2003, there were no
allocated or committed-to-be-released shares of Preferred stock outstanding. The
ESOP redeemed 65,343 shares of Preferred stock for cash in 2003.
NOTE 11 -- STOCK PLAN
The Company's 2003 Stock Plan permits the granting of stock options,
restricted stock and stock appreciation rights to eligible employees. The 2003
Stock Plan was adopted during 2002 to succeed the Company's 1994 Stock Plan that
expired February 16, 2003, which succeeded the 1984 Stock Plan that expired
February 15, 1994. Although no further grants may be made under either the 1994
or 1984 Stock Plan, all rights granted under such plans remain. The number of
shares which may be awarded under the 2003 Stock Plan will not exceed 8,500,000
shares, plus the shares authorized but not granted under the 1994 Stock Plan as
of the expiration thereof. No stock appreciation rights have been granted.
Grants of restricted stock, which generally require four years of
continuous employment from the date of grant before vesting and receiving the
shares without restriction, have been awarded to certain officers and key
employees under the 2003 and 1994 Stock Plans. The number of shares to be
received without restriction under the 2003 Stock Plan is based on the Company's
achievement of specified financial goals relating to average return on average
equity and earnings before interest, taxes, depreciation and amortization. The
number of shares to be received without restriction under the 1994 Stock Plan is
based on the Company's performance relative to a peer group of companies. During
2003 and 2001, 199,500 shares and 116,000 shares, respectively, of restricted
stock vested and were delivered to officers and key employees. No shares of
restricted stock vested during 2002. There were 603,000 shares of restricted
stock outstanding at December 31, 2003. Unamortized deferred compensation
expense with respect to the restricted stock grants amounted to $12,853, $3,267
and $5,691 at December 31, 2003, 2002, and 2001, respectively, and is being
amortized over the four-year vesting period. Deferred compensation expense
aggregated $5,641, $3,097 and $1,130 in 2003, 2002 and 2001, respectively.
A summary of restricted stock granted during 2003, 2002, and 2001 is as
follows:
2003 2002 2001
----------- ----------- -----------
SHARES GRANTED .................... 401,000 13,500 188,500
WEIGHTED-AVERAGE FAIR VALUE
OF RESTRICTED SHARES
GRANTED DURING YEAR ............ $ 27.37 $ 26.22 $ 25.72
Grants of non-qualified and incentive stock options have been awarded
to certain officers and key employees under the plans at prices not less than
fair market value of the shares, as defined by the plans, at the date of grant.
The options generally become exercisable to the extent of one-third of the
optioned shares for each full year following the date of grant and generally
expire ten years after the date of grant. The number of options and period of
service required before the options may be exercised are determined by the Board
of Directors at the time of grant. No options may be exercised more than ten
years from the date of the grant.
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
A summary of the Company's non-qualified and incentive stock option
activity and related information for the years ended December 31, 2003, 2002 and
2001 is shown in the following table:
2003 2002 2001
--------------------------- --------------------------- ---------------------------
WEIGHTED- Weighted- Weighted-
AVERAGE Average Average
OPTIONED EXERCISE Optioned Exercise Optioned Exercise
SHARES PRICE Shares Price Shares Price
------------ ------------ ------------ ------------ ------------ ------------
Outstanding beginning of year ..... 15,178,222 $ 23.90 14,129,176 $ 23.19 12,588,310 $ 22.47
Granted ........................... 2,431,500 30.96 3,064,900 25.47 3,070,700 24.29
Exercised ......................... (2,171,839) 21.86 (1,791,675) 20.94 (1,031,486) 17.26
Canceled .......................... (338,752) 26.37 (224,179) 24.03 (498,348) 24.10
------------ ------------ ------------ ------------ ------------ ------------
Outstanding end of year ........... 15,099,131 $ 25.27 15,178,222 $ 23.90 14,129,176 $ 23.19
============ ============ ============ ============ ============ ============
Exercisable at end of year ........ 9,716,381 $ 23.91 9,258,221 $ 23.69 7,681,476 $ 23.75
Weighted-average fair value of
options granted during year .... $ 5.76 $ 5.48 $ 5.36
Reserved for future grants ........ 7,070,782 979,055 3,834,876
Exercise prices for optioned shares outstanding as of December 31, 2003
ranged from $16.09 to $35.34. A summary of these options by range of exercise
prices is as follows:
Outstanding Exercisable
------------------------------------------- --------------------------
Weighted-
Average
Weighted- Remaining Weighted-
Range of Optioned Average Contractual Optioned Average
Exercise Prices Shares Exercise Price Life (years) Shares Exercise Price
- -------------------- ---------- -------------- ------------ -------- --------------
$16.09 - $ 22.89 ... 3,696,466 $ 20.01 5.7 3,648,156 $ 19.98
$24.31 - $ 35.34 ... 11,402,665 26.98 7.3 6,068,225 26.28
---------- -------------- -------------- ---------- --------------
15,099,131 $ 25.27 6.9 9,716,381 $ 23.91
========== ============== ============== ========== ==============
The Company's 1997 Stock Plan for Nonemployee Directors provides for
the granting of stock options and restricted stock to members of the Board of
Directors who are not employees of the Company. There were 400,000 shares
authorized as available for grant under the 1997 Stock Plan. The Board of
Directors authorizes grants made pursuant to the 1997 Stock Plan. As of December
31, 2003, there were 216,667 shares available for grant under the 1997 Stock
Plan.
The Company has elected to follow APBO No. 25 and related
interpretations, in accounting for its employee stock options. Under APBO No.
25, because the exercise price of the Company's employee stock options is not
less than the market price of the shares at the date of grant, no compensation
expense is recognized in the financial statements. See Note 1 for pro-forma
information and the alternative fair value accounting provided for under SFAS
No. 123.
NOTE 12 -- OTHER EXPENSE - NET
Included in the Other expense - net caption of the Statements of
Consolidated Income are the following:
2003 2002 2001
---------- ---------- ----------
DIVIDEND AND ROYALTY
INCOME ......................... $ (2,877) $ (3,341) $ (3,922)
NET EXPENSE (INCOME) OF
FINANCING AND INVESTING
ACTIVITIES ..................... 9,071 7,284 (1,796)
PROVISIONS FOR ENVIRONMENTAL
MATTERS - NET (SEE NOTE 8) ..... 10,237 8,609 5,609
NET EXPENSE (INCOME)
OF DISPOSITION AND
TERMINATIONS OF
OPERATIONS (SEE NOTE 5) ........ (8) 168 7,304
FOREIGN CURRENCY EXCHANGE
LOSSES - NET ................... 1,460 8,435 2,277
OTHER INCOME ...................... (1,429) (4,154) (3,478)
OTHER EXPENSE ..................... 2,177 4,470 8,791
---------- ---------- ----------
$ 18,631 $ 21,471 $ 14,785
========== ========== ==========
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
The net expense (income) of financing and investing activities includes
the net realized gains or losses from disposing of fixed assets, the net gain or
loss relating to the change in the Company's investment in certain long-term
asset funds and certain foreign entities, the net pre-tax expense associated
with the Company's investment in broad-based corporate owned life insurance and
fees related to debt issuance and financing services.
Foreign currency exchange losses - net include foreign currency
transaction gains and losses and realized and unrealized gains and losses from
foreign currency option and forward contracts. All foreign currency option and
forward contracts outstanding at December 31, 2003 have maturity dates of less
than twelve months and are undesignated hedges with changes in fair value being
recognized in earnings in accordance with SFAS No. 133. These derivative
instrument values are included in either Other current assets or Other accruals
and were immaterial at December 31, 2003, 2002 and 2001.
Other income includes items of revenue and other gains that are
unrelated to the primary business purpose of the Company. Each individual item
of other income is immaterial; no single category of items exceeded $1,000.
Other expense includes expense items and losses that are unrelated to
revenues associated with the primary business purpose of the Company. Each
individual item of other expense is immaterial. The only components of other
expense that exceed $1,000 relate to joint venture losses of $1,500 in 2001 and
a loss of $3,500 associated with long-term non-trade receivables in 2001.
NOTE 13 -- INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes using the
enacted tax rates and laws that are currently in effect. Significant components
of the Company's deferred tax assets and liabilities as of December 31, 2003,
2002 and 2001 are as follows:
2003 2002 2001
---------- ---------- ----------
DEFERRED TAX ASSETS:
DISPOSITIONS, ENVIRON-
MENTAL AND OTHER
SIMILAR ITEMS ........... $ 47,941 $ 48,452 $ 54,856
OTHER ITEMS (EACH
LESS THAN 5 PERCENT
OF TOTAL ASSETS) ........ 105,660 138,515 107,726
---------- ---------- ----------
TOTAL DEFERRED
TAX ASSETS ......... $ 153,601 $ 186,967 $ 162,582
========== ========== ==========
DEFERRED TAX LIABILITIES:
DEPRECIATION AND
AMORTIZATION ............ $ 49,634 $ 29,082 $ 49,164
DEFERRED EMPLOYEE
BENEFIT ITEMS ........... 61,981 63,165 58,535
---------- ---------- ----------
TOTAL DEFERRED TAX
LIABILITIES ........ $ 111,615 $ 92,247 $ 107,699
========== ========== ==========
Significant components of the provisions for income taxes are as
follows:
2003 2002 2001
---------- ---------- ----------
CURRENT:
FEDERAL ........................ $ 129,146 $ 138,541 $ 118,882
FOREIGN ........................ 5,719 9,549 9,893
STATE AND LOCAL ................ 16,131 16,410 16,839
---------- ---------- ----------
TOTAL CURRENT ............. 150,996 164,500 145,614
DEFERRED:
FEDERAL ........................ 32,299 20,770 15,374
FOREIGN ........................ 3,554 (1,498) (2,458)
STATE AND LOCAL ................ 4,019 2,691 2,761
---------- ---------- ----------
TOTAL DEFERRED ............ 39,872 21,963 15,677
---------- ---------- ----------
TOTAL PROVISIONS FOR
INCOME TAXES ................. $ 190,868 $ 186,463 $ 161,291
========== ========== ==========
Significant components of income before income taxes and cumulative
effect of change in accounting principle as used for income tax purposes, are as
follows:
2003 2002 2001
---------- ---------- ----------
DOMESTIC .......................... $ 492,592 $ 458,535 $ 393,200
FOREIGN ........................... 30,334 38,629 31,249
---------- ---------- ----------
$ 522,926 $ 497,164 $ 424,449
========== ========== ==========
A reconciliation of the statutory federal income tax rate to the
effective tax rate follows:
2003 2002 2001
---- ---- ----
STATUTORY FEDERAL
INCOME TAX RATE ................ 35.0% 35.0% 35.0%
EFFECT OF:
STATE AND LOCAL
INCOME TAXES .............. 2.5 2.5 3.0
INVESTMENT VEHICLES .......... (0.6) 0.8 1.3
OTHER - NET .................. (0.4) (0.8) (1.3)
---- ---- ----
EFFECTIVE TAX RATE ................ 36.5% 37.5% 38.0%
==== ==== ====
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
A portion of the transitional impairment charge recorded in the first
quarter of 2002 (see Note 2) related to goodwill that was not deductible for tax
purposes. This is not reflected in the statutory federal income tax rate
reconciliation above because the transitional impairment charge was recorded as
a cumulative effect of change in accounting principle. The remaining portion of
the impairment charge created federal, state, foreign and local deferred tax
benefits in the amount of $64,476 due to the temporary differences between the
carrying amounts for financial statement purposes and amounts used for tax
purposes.
The provisions for income taxes include estimated taxes payable on that
portion of retained earnings of foreign subsidiaries expected to be received by
the Company. A provision was not made with respect to $13,810 of retained
earnings at December 31, 2003 that have been invested by foreign subsidiaries.
It is not practicable to estimate the amount of unrecognized deferred tax
liability for undistributed foreign earnings.
Netted against the Company's other deferred tax assets are valuation
reserves of $17,643, $14,459 and $10,200 at December 31, 2003, 2002, and 2001,
respectively, resulting from the uncertainty as to the realization of the tax
benefits from certain foreign net operating losses and certain other foreign
assets.
NOTE 14--NET INCOME PER SHARE
2003 2002 2001
------------ ------------ ------------
Income before cumulative effect of change
in accounting principle................... $ 332,058 $ 310,701 $ 263,158
Cumulative effect of change in accounting
principle - net of income taxes
of $64,476 ............................... (183,136)
------------ ------------ ------------
Net income .................................. $ 332,058 $ 127,565 $ 263,158
============ ============ ============
BASIC
Average common shares outstanding ........ 144,846,933 150,437,900 155,557,085
Per common share:
Income before cumulative effect of
change in accounting principle ......... $ 2.29 $ 2.07 $ 1.69
Cumulative effect of change in
accounting principle ................ (1.22)
------------ ------------ ------------
Net income ............................. $ 2.29 $ .85 $ 1.69
============ ============ ============
DILUTED
Average common shares outstanding ........ 144,846,933 150,437,900 155,557,085
Non-vested restricted stock grants ....... 614,458 318,433 321,500
Stock options -- treasury stock method ... 1,543,885 1,678,977 1,014,950
------------ ------------ ------------
Average shares assuming dilution ......... 147,005,276 152,435,310 156,893,535
=========== =========== ===========
Per common share:
Income before cumulative effect of
change in accounting principle ......... $ 2.26 $ 2.04 $ 1.68
Cumulative effect of change in
accounting principle ................... (1.20)
------------ ------------ ------------
Net income ............................. $ 2.26 $ .84 $ 1.68
============ ============ ============
NOTE 15 -- SUMMARY OF QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
2003
-------------------------------------------------------------------
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER FULL YEAR
----------- ----------- ----------- ----------- -----------
NET SALES ......................... $ 1,148,461 $ 1,471,678 $ 1,503,086 $ 1,284,539 $ 5,407,764
GROSS PROFIT ...................... $ 501,764 $ 665,752 $ 678,646 $ 609,133 $ 2,455,295
NET INCOME ........................ $ 30,802 $ 110,130 $ 120,297 $ 70,829 $ 332,058
NET INCOME PER SHARE - BASIC ...... $ .21 $ .76 $ .83 $ .49 $ 2.29
NET INCOME PER SHARE - DILUTED .... $ .21 $ .75 $ .82 $ .48 $ 2.26
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
Net income in the fourth quarter was increased by $1,714 ($.01 per
share) due to certain year-end adjustments. Gross profit increased by $12,409
primarily as a result of physical inventory adjustments of $9,108. Selling,
general and administrative expenses decreased $328 due to various year-end
adjustments. Other expense - net increased $10,100 due primarily to provisions
for environmental matters of $10,237.
2002
-------------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Full Year
----------- ----------- ----------- ----------- -----------
Net sales ........................................ $ 1,149,178 $ 1,453,198 $ 1,426,266 $ 1,156,146 $ 5,184,788
Gross profit ..................................... $ 492,104 $ 651,810 $ 645,293 $ 549,380 $ 2,338,587
Income before cumulative effect
of change in accounting principle ............. $ 34,785 $ 107,525 $ 111,333 $ 57,058 $ 310,701
Cumulative effect of change in accounting
principle - net of income taxes of $64,476 .... (183,136) (183,136)
----------- ----------- ----------- ----------- -----------
Net income (loss) ................................ $ (148,351) $ 107,525 $ 111,333 $ 57,058 $ 127,565
=========== =========== =========== =========== ===========
Income per share:
Basic:
Before cumulative effect of
change in accounting principle ........... $ .23 $ .71 $ .74 $ .38 $ 2.07
Cumulative effect of change in
accounting principle - net of income
taxes .................................... (1.21) (1.22)
----------- ----------- ----------- ----------- -----------
Net income (loss) ........................... $ (.98) $ .71 $ .74 $ .38 $ .85
=========== =========== =========== =========== ===========
Diluted:
Before cumulative effect of
change in accounting principle ........... $ .23 $ .70 $ .73 $ .38 $ 2.04
Cumulative effect of change in
accounting principle - net of income
taxes .................................... (1.21) (1.20)
----------- ----------- ----------- ----------- -----------
Net income (loss) ........................... $ (.98) $ .70 $ .73 $ .38 $ .84
=========== =========== =========== =========== ===========
Net income (loss) in the fourth quarter was increased by $1,829 ($.01
per share) due to certain year-end adjustments. Gross profit increased by
$11,733 primarily as a result of physical inventory adjustments of $10,390.
Selling, general and administrative expenses decreased $667 due to various
year-end adjustments. Other expense - net increased $9,586 due primarily to
provisions for environmental matters of $8,609.
NOTE 16 -- OPERATING LEASES
The Company leases certain stores, warehouses, manufacturing
facilities, office space and equipment. Renewal options are available on the
majority of leases and, under certain conditions, options exist to purchase
certain properties. Rental expense for operating leases was $155,268, $151,555
and $141,072 for 2003, 2002 and 2001, respectively. Certain store leases require
the payment of contingent rentals based on sales in excess of specified
minimums. Contingent rentals included in rent expense were $12,933, $15,752 and
$13,479 in 2003, 2002, and 2001, respectively. Rental income, as lessor, from
real estate leasing activities and sublease rental income for all years
presented was not significant.
During the fourth quarter of 2003, the Company completed sale-leaseback
transactions involving two of its warehouses. The warehouses were sold at fair
market value resulting in a pretax gain of $2,701, which was deferred and is
being amortized to offset rent expense over the life of the new operating
leases. The Company does not have any retained or contingent interest in the
warehouses. The operating leases that resulted in these transactions are
included in the table below.
Following is a schedule, by year and in the aggregate, of future
minimum lease payments under noncancellable operating leases having initial or
remaining terms in excess of one year at December 31, 2003:
2004.................................... $ 127,539
2005.................................... 109,953
2006.................................... 88,816
2007.................................... 67,677
2008.................................... 44,706
Later years............................. 99,880
---------
Total minimum lease payments............ $ 538,571
=========
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
NOTE 17 -- REPORTABLE SEGMENT INFORMATION
The Company reports its segment information in five reportable segments
- - Paint Stores, Consumer, Automotive Finishes, International Coatings
(collectively, the "Operating Segments") and Administrative in accordance with
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information." SFAS No. 131 requires an enterprise to report segment information
in the same way that management internally organizes its business for assessing
performance and making decisions regarding allocation of resources. See pages 4,
5 and 10 through 17 of this report for more information about the Operating
Segments.
The Company's chief operating decision maker has been identified as the
Chief Executive Officer because he has final authority over performance
assessment and resource allocation decisions. Because of the global, diverse
operations of the Company, the chief operating decision maker regularly receives
discrete financial information about each reportable segment as well as a
significant amount of additional financial information about certain aggregated
divisions, business units and subsidiaries of the Company. The chief operating
decision maker uses all such financial information for performance assessment
and resource allocation decisions. Factors considered in determining the five
reportable segments of the Company include the nature of the business
activities, existence of managers responsible for the operating and
administrative activities and information presented to the Board of Directors.
The chief operating decision maker evaluates the performance of the Operating
Segments and allocates resources based on profit or loss and cash generated from
operations before income taxes, excluding corporate expenses and financing
gains and losses. The accounting policies of the reportable segments are the
same as those described in Note 1.
The Paint Stores Segment consists of 2,688 company-operated specialty
paint stores in the United States, Canada, Virgin Islands, Puerto Rico and
Mexico. Each division of the Segment is engaged in the related business activity
of selling the Company's own manufactured coatings and related products to
end-use customers. During 2003, this Segment opened 45 net new stores, remodeled
14 and relocated 29. The net new stores consisted of 41 stores in the United
States, 3 in Canada and 1 in Mexico. In 2002, there were 70 net new stores
opened or acquired (62 in the United States). In 2001, there were 85 net new
stores opened or acquired (83 in the United States). This Segment manufactures
OEM product finishes sold through certain shared or dedicated paint stores (72,
69 and 65 at December 31, 2003, 2002 and 2001, respectively) and by direct
outside sales representatives. In addition to stores, operations in Mexico
include outside selling functions to dealers and other distributors.
The Paint Stores Segment is the exclusive North American marketer and
seller of Sherwin-Williams(R) branded architectural coatings, industrial and
marine products, OEM product finishes and related items produced by its product
finishes manufacturing and by the Consumer Segment including that Segment's
Mexico manufacturing facility. The loss of any single customer would not have a
material adverse effect on the business of this Segment. A map on page 20 of
this report shows the number of paint stores and their geographical location.
The Consumer Segment develops, manufactures and distributes a variety
of paint, coatings and related products to third party customers and the Paint
Stores Segment. Approximately 46 percent of the total sales of the Consumer
Segment in 2003, including inter-segment transfers, represented products sold
through the Paint Stores Segment. Sales and marketing of certain control-branded
and private labeled products is performed by a direct sales staff. The products
distributed through third party customers are intended for resale to the
ultimate end-user of the product. The Consumer Segment has sales to certain
customers that, individually, may be a significant portion of the sales of the
Segment. However, the loss of any single customer would not have a material
adverse effect on the overall profitability of the Segment. This Segment incurs
most of the Company's capital expenditures related to ongoing environmental
compliance measures.
The Automotive Finishes Segment develops, manufactures and distributes
a variety of motor vehicle finish, refinish and touch-up products primarily
throughout North and South America, the Caribbean Islands, and Europe. This
Segment also licenses certain technology and trade names worldwide.
Sherwin-Williams(R) branded automotive finish and refinish products are
distributed throughout North America solely through this Segment's network of
142 company-operated automotive branches in the United States and 16 in Canada.
Additional automotive branches in Jamaica (15), Chile (20) and Peru (1) complete
this Segment's worldwide network. At December 31, 2003, this Segment included
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
consolidated operations in 9 foreign countries and realized income from
licensing agreements in 14 foreign countries. A map on page 20 of this report
shows the number of branches and their geographical location.
The International Coatings Segment develops, licenses, manufactures and
distributes a variety of paint, coatings and related products worldwide. The
majority of the sales from licensees and subsidiaries occur in South America,
the Segment's most important international market. This Segment sells its
products through 28 company-operated specialty paint stores in Chile, 27 in
Brazil, 5 in Uruguay and 1 in Argentina and by outside selling functions to
dealers and other distributors. At December 31, 2003, this Segment included
consolidated operations in 7 foreign countries, 4 foreign joint ventures and
income from licensing agreements in 15 foreign countries.
The Administrative Segment includes the administrative expenses of the
Company's corporate headquarters site. This Segment also includes interest
expense which is unrelated to retail real estate leasing activities, investment
income, certain foreign currency transaction losses related to
dollar-denominated debt and foreign currency option and forward contracts,
certain expenses related to closed facilities and environmental-related matters,
and other expenses which are not directly associated with any Operating Segment.
Administrative expenses do not include any significant foreign operations. Also
included in the Administrative Segment is a real estate management unit that is
responsible for the ownership, management, leasing of non-retail properties held
primarily for use by the Company, including the Company's headquarters site, and
disposal of idle facilities. Sales of the Administrative Segment represent
external leasing revenue of excess headquarters space or leasing of facilities
no longer used by the Company in its operations. Gains and losses from the sale
of property are not a significant operating factor in determining the
performance of this Segment.
Net external sales of all consolidated foreign subsidiaries were
$546,472, $488,280 and $503,861 for 2003, 2002, and 2001, respectively.
Operating profits of all consolidated foreign subsidiaries were $14,340, $17,953
and $16,797 for 2003, 2002, and 2001, respectively. Domestic operations account
for the remaining net sales and operating profits. Long-lived assets consist of
net property, plant and equipment, goodwill and intangibles. Long-lived assets
of consolidated foreign subsidiaries totaled $114,247, $97,741 and $211,381 at
December 31, 2003, 2002, and 2001, respectively. The consolidated total of
long-lived assets for the Company was $1,400,983, $1,402,846 and $1,649,591 at
December 31, 2003, 2002, and 2001, respectively. During 2002, the reduction in
the carrying value of long-lived assets of consolidated foreign subsidiaries
resulted primarily from a devaluation of the Argentine peso, other foreign
currency translation rate declines and an impairment of long-lived assets of the
Argentina subsidiary. Total assets of consolidated foreign subsidiaries at
December 31, 2003 were $366,605, which represents 9.96 percent of the Company's
total assets. No single geographic area outside the United States was
significant relative to consolidated net external sales or operating profits.
Export sales and sales to any individual customer were each less than 10 percent
of consolidated sales to unaffiliated customers during all years presented.
In the reportable segment financial information that follows, operating
profit is total revenue, including inter-segment transfers, less operating costs
and expenses. Identifiable assets are those directly identified with each
reportable segment. Administrative Segment assets consist primarily of cash and
cash equivalents, investments, deferred pension assets, and headquarters
property, plant and equipment. The operating margin for each Operating Segment
is based upon total external sales and inter-segment transfers. Domestic
inter-segment transfers are accounted for at the approximate fully absorbed
manufactured cost plus distribution costs. International inter-segment transfers
are accounted for at values comparable to normal unaffiliated customer sales.
The reportable segment financial information has been restated for 2001 and 2000
to reflect certain reorganizations between segments effective January 1, 2002.
Reportable segment information for 1999 has not been restated due to the
insignificant effect of the reorganizations and the prohibitive cost to
assimilate all the required information.
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
NET EXTERNAL SALES
Paint Stores ..................................... $ 3,469 $ 3,302 $ 3,185 $ 3,166 $ 3,002
Consumer ......................................... 1,190 1,178 1,142 1,251 1,224
Automotive Finishes .............................. 457 454 464 493 471
International Coatings ........................... 285 244 268 294 299
Administrative ................................... 7 7 7 8 8
-------- -------- -------- -------- --------
Consolidated totals .............................. $ 5,408 $ 5,185 $ 5,066 $ 5,212 $ 5,004
OPERATING PROFITS
Paint Stores ..................................... $ 403 $ 399 $ 388 $ 410 $ 377
Consumer ......................................... 199 193 110** (208)* 155
Automotive Finishes .............................. 52 54 51 61 67
International Coatings ........................... 8 (6) 5 17 34
Administrative:
Interest expense .............................. (38) (40) (54) (60) (59)
Corporate expenses and other .................. (101) (103) (76) (77) (84)
-------- -------- -------- -------- --------
Income before income taxes and cumulative
effect of change in accounting principle ...... $ 523 $ 497 $ 424** $ 143* $ 490
IDENTIFIABLE ASSETS
Paint Stores ..................................... $ 1,000 $ 967 $ 954 $ 1,014 $ 930
Consumer ......................................... 1,218 1,162 1,272 1,347* 1,778
Automotive Finishes .............................. 278 274 329 349 279
International Coatings ........................... 156 130 285 315 320
Administrative ................................... 1,031 899 788 726 726
-------- -------- -------- -------- --------
Consolidated totals .............................. $ 3,683 $ 3,432 $ 3,628 $ 3,751* $ 4,033
CAPITAL EXPENDITURES
Paint Stores ..................................... $ 54 $ 56 $ 36 $ 48 $ 49
Consumer ......................................... 36 37 18 40 40
Automotive Finishes .............................. 8 3 11 29 10
International Coatings ........................... 5 10 7 6 11
Administrative ................................... 14 21 11 10 24
-------- -------- -------- -------- --------
Consolidated totals .............................. $ 117 $ 127 $ 83 $ 133 $ 134
DEPRECIATION
Paint Stores ..................................... $ 44 $ 44 $ 47 $ 45 $ 42
Consumer ......................................... 33 33 31 28 29
Automotive Finishes .............................. 9 9 9 9 8
International Coatings ........................... 5 4 6 6 6
Administrative ................................... 14 14 16 21 20
-------- -------- -------- -------- --------
Consolidated totals .............................. $ 105 $ 104 $ 109 $ 109 $ 105
OPERATING SEGMENT MARGINS
Paint Stores ..................................... 11.6% 12.1% 12.2% 12.9% 12.5%
Consumer ......................................... 9.0% 8.9% 5.3%** (9.5%)* 7.6%
Automotive Finishes .............................. 10.5% 11.1% 10.2% 11.5% 13.3%
International Coatings ........................... 2.8% (2.4%) 1.9% 5.8% 11.4%
-------- -------- -------- -------- --------
Operating segment totals ......................... 10.2% 10.3% 9.2%** 4.5%* 10.8%
INTERSEGMENT TRANSFERS
Paint Stores ..................................... $ 1 $ 1 $ 1 $ 2 $ 8
Consumer ......................................... 1,024 989 929 929 817
Automotive Finishes .............................. 40 34 34 36 31
International Coatings ........................... 1 1
Administrative ................................... 4 4 9 11 12
-------- -------- -------- -------- --------
Segment totals ................................... $ 1,070 $ 1,029 $ 973 $ 978 $ 868
* Includes charge and reduction in asset value of $352 in 2000 for
impairment of other assets.
** Includes amortization expense of $21 in the Consumer Segment and $29 in
income before income taxes and cumulative effect of change in
accounting principle for goodwill and intangible assets that are no
longer amortized as of January 1, 2002 in accordance with SFAS No. 142.
The effect on any other segment was not significant. Due to the
impairment of other assets in 2000, disclosure of the effect of
amortization expense on segment operating profit prior to 2001 is not
meaningful.
66
SHAREHOLDER INFORMATION
ANNUAL MEETING
The annual meeting of shareholders will be held in the Landmark
Conference Center, 927 Midland Building, 101 Prospect Avenue, N.W., Cleveland,
Ohio on Wednesday, April 28, 2004 at 9:00 A.M., local time.
INVESTOR RELATIONS
Conway G. Ivy
The Sherwin-Williams Company
101 Prospect Avenue, N.W.
Cleveland, Ohio 44115-1075
Internet: www.sherwin.com
FORM 10-K
The Company's Annual Report on Form 10-K, filed with the Securities and
Exchange Commission, is available without charge. To obtain a copy, contact the
Investor Relations Office.
DIVIDEND REINVESTMENT PROGRAM
A dividend reinvestment program is available to shareholders of common
stock. For information, contact our transfer agent, The Bank of New York.
HEADQUARTERS
The Sherwin-Williams Company
101 Prospect Avenue, N.W.
Cleveland, Ohio 44115-1075
(216) 566-2000
INDEPENDENT AUDITORS
Ernst & Young LLP
Cleveland, Ohio
STOCK TRADING
Sherwin-Williams Common Stock-Symbol, SHW, is traded on the New York Stock
Exchange.
TRANSFER AGENT & REGISTRAR
The Bank of New York
Shareholder Relations
Department-11E
P.O. Box 11258
Church Street Station
New York, NY 10286
1-866-537-8703
E-mail address:
Shareowner-svcs@Email.bony.com
Internet: www.stockbny.com
COMMON STOCK TRADING STATISTICS
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
HIGH .............................. $ 34.77 $ 33.24 $ 28.23 $ 27.625 $ 32.875
LOW ............................... 24.42 21.75 19.73 17.125 18.75
CLOSE DECEMBER 31 ................. 34.74 28.25 27.50 26.313 21.00
SHAREHOLDERS OF RECORD ............ 11,472 11,936 12,687 13,137 13,806
SHARES TRADED (THOUSANDS) ......... 143,702 193,256 162,219 158,349 161,118
QUARTERLY STOCK PRICES AND DIVIDENDS
2003 2002
- ---------------------------------------- ----------------------------------------
QUARTER HIGH LOW DIVIDEND Quarter High Low Dividend
- ------- -------- -------- -------- ------- -------- -------- --------
1ST $ 29.25 $ 24.42 $ .155 1st $ 29.65 $ 23.50 $ .15
2ND 28.55 26.16 .155 2nd 33.24 27.65 .15
3RD 30.75 26.47 .155 3rd 30.46 22.70 .15
4TH 34.77 29.39 .155 4th 29.23 21.75 .15
67
CORPORATE OFFICERS AND OPERATING PRESIDENTS
CORPORATE OFFICERS
CHRISTOPHER M. CONNOR, 47*
Chairman and Chief Executive Officer
JOSEPH M. SCAMINACE, 50*
President and Chief Operating Officer
SEAN P. HENNESSY, 46*
Senior Vice President - Finance and
Chief Financial Officer
THOMAS E. HOPKINS, 46*
Senior Vice President - Human Resources
CONWAY G. IVY, 62*
Senior Vice President - Corporate Planning and
Development
JOHN L. AULT, 58*
Vice President - Corporate Controller
CYNTHIA D. BROGAN, 52
Vice President and Treasurer
MARK J. DVOROZNAK, 45
Vice President - Corporate Audit and Loss Prevention
JAMES J. SGAMBELLONE, 46
Vice President - Taxes and Assistant Secretary
LOUIS E. STELLATO, 53*
Vice President, General Counsel and Secretary
RICHARD M. WEAVER, 49
Vice President - Administration
OPERATING PRESIDENTS
THOMAS S. BRUMMETT, 58
President & General Manager
Chemical Coatings Division
Paint Stores Group
ROBERT J. DAVISSON, 43
President & General Manager
Southeastern Division
Paint Stores Group
TIMOTHY J. DROUILHET, 41
President & General Manager
Eastern Division
Paint Stores Group
TIMOTHY A. KNIGHT, 39
President & General Manager
Diversified Brands Division
BLAIR P. LACOUR, 57
President & General Manager
Mid Western Division
Paint Stores Group
JOHN G. MORIKIS, 40*
President
Paint Stores Group
RONALD P. NANDOR, 44*
President & General Manager
Automotive Division
STEVEN J. OBERFELD, 51
President & General Manager
South Western Division
Paint Stores Group
HARVEY P. SASS, 46
President & General Manager
Wood Care Division
THOMAS W. SEITZ, 55*
President & General Manager
Consumer Division
ALEXANDER ZALESKY, 44*
President & General Manager
International Division
* Executive Officer as defined by the Securities Exchange Act of 1934
68
BOARD OF
DIRECTORS
[PHOTO OF BOARD OF DIRECTORS]
1 SUSAN J. KROPF, 55
President and Chief Operating Officer
Avon Products, Inc.
2 JOHN G. BREEN, 69
Retired, former Chairman, Chief Executive
Officer and President
The Sherwin-Williams Company
3 DANIEL E. EVANS, 67
Retired, former Chairman, Chief Executive
Officer and Secretary
Bob Evans Farms, Inc.
4 CHRISTOPHER M. CONNOR, 47
Chairman and Chief Executive Officer
The Sherwin-Williams Company
5 JOSEPH M. SCAMINACE, 50
President and Chief Operating Officer
The Sherwin-Williams Company
6 RICHARD K. SMUCKER, 55*
President, Co-Chief Executive Officer and
Chief Financial Officer
The J.M. Smucker Company
7 CURTIS E. MOLL, 64*
Chairman and Chief Executive Officer
MTD Holdings Inc
8 GARY E. MCCULLOUGH, 45*
Senior Vice President,
Abbott Laboratories
President, Ross Products Division
9 DUANE E. COLLINS, 67
Chairman
Parker-Hannifin Corporation
10 ROBERT W. MAHONEY, 67
Retired, former Chairman, Chief
Executive Officer and President
Diebold, Incorporated
11 JAMES C. BOLAND, 64*
Vice Chairman
Cavaliers/Gund Arena Company
12 A. MALACHI MIXON, III, 63
Chairman and Chief Executive Officer
Invacare Corporation
* Audit Committee Member
The Sherwin-Williams Company
101 Prospect Avenue, N.W.
Cleveland, Ohio 44115-1075
www.sherwin.com