EXHIBIT 13
THE SHERWIN-WILLIAMS COMPANY
2004 ANNUAL REPORT
[THE SHERWIN-WILLIAMS COMPANY PICTURE]
FINANCIAL
HIGHLIGHTS
(thousands of dollars except per share data)
2004 2003 2002
---------- ---------- -----------
Net sales $6,113,789 $5,407,764 $5,184,788
---------- ---------- ----------
Income before cumulative effect of change in accounting principle $ 393,254 $ 332,058 $ 310,701
Cumulative effect of change in accounting principle - net of
income taxes of $ 64,476 (183,136)
---------- ---------- ----------
Net income $ 393,254 $ 332,058 $ 127,565
========== ========== ==========
Per common share:
Fully-diluted:
Income before cumulative effect of change in accounting principle $ 2.72 $ 2.26 $ 2.04
Cumulative effect of change in accounting principle - net of income taxes (1.20)
---------- ---------- ----------
Net income $ 2.72 $ 2.26 $ .84
Basic:
Income before cumulative effect of change in accounting principle $ 2.79 $ 2.29 $ 2.07
Cumulative effect of change in accounting principle - net of income taxes (1.22)
---------- ---------- ----------
Net income $ 2.79 $ 2.29 $ .85
Cash dividends $ .68 $ .62 $ .60
Book value $ 11.70 $ 10.17 $ 9.01
========== ========== ==========
Average common shares outstanding (thousands) 140,802 144,847 150,438
Return on sales (1) 6.4% 6.1% 6.0%
Return on net operating assets employed (RONAE) (2) 40.5% 37.3% 35.7%
Return on beginning shareholders' equity (1) 27.0% 24.7% 20.9%
Total debt to capitalization 30.9% 26.0% 28.0%
Interest coverage (3) 15.5x 14.5x 13.3x
Current ratio 1.2 1.5 1.4
Total technical expenditures (4) $ 91,310 $ 88,369 $ 88,721
NET SALES
(millions of dollars)
[BAR CHART]
2002 5,185
2003 5,408
2004 6,114
INCOME - (1)
(millions of dollars)
[BAR CHART]
2002 311
2003 332
2004 393
INCOME PER
SHARE - DILUTED(1)
[BAR CHART]
2002 2.04
2003 2.26
2004 2.72
(1) Based on income before cumulative effect of change in accounting
principle. See Note 3, page 51 of this report.
(2) Based on income before income taxes, minority interest 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, minority interest, cumulative effect
of change in accounting principle and interest expense to interest
expense.
(4) See Note 1, page 48 of this report, for a description of technical
expenditures.
ON THE COVER: First switched on in 1933, this neon "Cover The Earth" sign
beckoned customers to Sherwin-Williams in San Francisco for 57 years. This
vintage sign is among the many historic artifacts given a permanent home at the
new Sherwin-Williams Center of Excellence at company headquarters in Cleveland.
[SWP PICTURE]
TABLE OF CONTENTS
Letter to Shareholders 2
Company Overview 6
Center of Excellence 14
Shareholder Return 16
Stores Map 18
Financial Performance 19
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.
1
[PHOTO OF CHRISTOPHER M. CONNOR] [PHOTO OF JOSEPH M. SCAMINACE]
Chairman and Chief Executive Officer President and Chief Operating Officer
THE SHERWIN-WILLIAMS COMPANY HAD ANOTHER SUCCESSFUL YEAR IN 2004, ACHIEVING
DOUBLE-DIGIT GROWTH IN REVENUE AND VOLUME AND SURPASSING $6 BILLION IN SALES FOR
THE FIRST TIME IN COMPANY HISTORY.
Consolidated net income rose to $393.3 million, representing an increase
of 18.4 percent over the previous year. Diluted net income per common share
increased more than 20 percent to a record $2.72 per share.
We generated nearly $545 million in net operating cash, which enabled us
to complete three strategically important acquisitions, pay record dividends of
$0.68 per share, invest $106.8 million in capital expenditures and repurchase
over six-and-a-half million shares of our stock. Total annual return to our
shareholders in 2004, assuming dividend reinvestment, was 30.4 percent.
Last year marked our 26th consecutive year of dividend increases. On
February 2, 2005 we declared a 20 percent increase in our quarterly dividend
from $0.17 per common share to $0.205 per common share, payable on March 14,
2005 to shareholders of record on February 28, 2005. This represents the first
step toward our 27th consecutive year of increased dividends.
These results are particularly gratifying in light of the stiff headwind
we faced from rapidly rising raw material costs. In 2004, annualized
year-over-year raw material costs for the industry increased more dramatically
than any time in the last decade. This environment has put pressure on our
consolidated gross margin, and we anticipate this pressure will continue in the
foreseeable future. We will be diligent in our efforts to offset raw material
cost increases through manufacturing efficiencies, higher fixed cost absorption,
alternative technologies, tight expense control and measured price increases.
2
LETTER TO SHAREHOLDERS
In 2004, we opened The Sherwin-Williams Center of Excellence at our
headquarters in Cleveland, Ohio. The Center is a living archive which celebrates
our storied past and serves as an inspiration to all of the hard-working men and
women of Sherwin-Williams who are creating our future.
Included among the vast collection of photographs, product samples and
artifacts spanning more than 138 years is a special gift given to
Sherwin-Williams by its second Chairman and CEO, Walter Cottingham. His "Code of
Principles" is a document that speaks of loyalty, consideration, politeness,
winning by merit, and growth in character as well as size. In short, these are
the very principles of honesty, integrity and morality, which still guide us
today.
PAINT STORES SEGMENT
Net sales for our Paint Stores Segment increased by 14.6 percent to $3.98
billion from $3.47 billion in 2003. Comparable store sales improved by 10.1
percent over the prior year. Operating profit from the Segment finished at
$480.2 million, an increase of 19.0 percent compared to 2003. The positive
effects of strong sales volume and aggressive cost control throughout the year
was partially offset by rapidly rising raw material costs.
We remain focused on the professional user of coatings products. The
services of professional painting contractors continue to be in high demand, and
these customers shop our paint stores for the quality products and services to
make their businesses more successful.
In September of 2004, we completed the acquisition of Duron, Inc., one of
the nation's top five operators of specialty paint stores in the eastern and
southeastern United States. The customers served by Duron's company-operated
stores include professional painting contractors, builders and do-it-yourself
homeowners. The acquisition of Duron, Inc. added approximately 3.5 percent to
the Paint Stores Segment's full year net sales and was slightly accretive to
earnings for the year.
In 2004, we added a total of 295 new stores through organic expansion and
acquisition, ending the year with 2,983 stores in operation in North America
compared to 2,688 stores at the end of last year. We organically opened 71 new
stores and closed 5, resulting in a net increase of 66 stores for the year. The
acquisition of Duron, Inc. added 229 stores, all in the United States. We also
completed our Store Refresh Program, a three year project to re-merchandise and
refresh the shopping environment in our stores.
The introduction of new and innovative products designed to improve
performance and productivity continues to be a store strength. We introduced the
ProXP(TM) Eg-Shel which provides two-coat performance in a one-coat application;
DeckScapes(TM), a complete line of deck care products; and E-Barrier(TM), an
energy-efficient reflective coating for attics.
We continued to introduce new products for our industrial maintenance
customers under the ExpressTech(R) product line. This technologically advanced
line of coatings offers significant labor savings and productivity improvements
that allow property and equipment to be returned to service in minimal time.
We capitalized on the growing momentum in manufacturing activity in North
America and Asia. During the past year we successfully introduced numerous new
products for use on wood, plastic and metal substrates, several of which feature
low-VOC, low-HAPS formulations. Manufacturing at our new facility in Shanghai,
China began in 2004, and has helped align us with our domestic OEM customers who
have relocated their operations to the Far East.
CONSUMER SEGMENT
External net sales in the Consumer Segment increased 9.0 percent to $1.3
billion in 2004 versus the prior year. Acquisitions accounted for 7.2 percent
and the balance was largely due to the introduction of new product programs
throughout the year.
[THE SHERWIN-WILLIAMS COMPANY SURPASSED THE $6 BILLION MARK IN SALES].
Operating profit for the year declined $11.3 million, or 5.7 percent, to
$187.7 million. In 2004, operating profit was adversely impacted by a charge for
the impairment of certain assets totaling $12.5 million and by sharply rising
raw material costs that could not be fully offset by operating profit from
acquisitions and favorable manufacturing absorption. The price increases
announced during the year were not implemented in time to offset rising raw
material costs.
The focus of our Consumer Segment remains on building market share,
expanding distribution and growing category demand through product innovation
and brand strength. For example, our new Ready to
3
Roll(TM) paint container joins the Twist & Pour(TM) container as another
revolutionary packaging breakthrough for the Dutch Boy(R) brand. This new
concept in paint packaging features a project-sized container with a built-in
roller tray and an easy open/close lid. The Ready to Roll(TM) paint container
continues our string of innovations brought to the market under the Dutch Boy(R)
brand.
[26 CONSECUTIVE YEARS OF DIVIDEND GROWTH].
Two of our leading brands in the Consumer Segment - Minwax(R) and
Thompson's(R) WaterSeal(R) - celebrated major milestones with their 100th and
75th anniversaries, respectively. In September of 2004, Sherwin-Williams
acquired Paint Sundry Brands Corporation, a leading marketer and manufacturer of
high quality paintbrushes and rollers for professional contractors and
do-it-yourself users. Their respected brands of Purdy(R) and Bestt Liebco(R)
will join established brands like Krylon(R) and Dupli-Color(R) in our diverse
portfolio.
AUTOMOTIVE FINISHES SEGMENT
Our Automotive Finishes Segment posted a 12.6 percent net sales increase
to $514.3 million for the year. This strong performance was helped by
improvements in international sales, new product line introductions and the
acquisition of a majority interest in an automotive coatings company in China,
now known as Sherwin-Williams Kinlita Co., Ltd.
[NAMED AS ONE OF THE 100 BEST COMPANIES TO WORK FOR BY FORTUNE MAGAZINE].
Operating profit for the Segment increased 10.8 percent to $58.1 million
for the year as a result of higher sales volume, sales of higher margin products
and the profit contribution from Sherwin-Williams Kinlita.
In 2004, the Segment added six new branches in North America, bringing the
total number to 200 company-operated branches in the U.S., Canada, Jamaica,
Chile and Peru. During the year, we continued to introduce the highest quality
clearcoat and primer products designed to help our OEM and shop customers reduce
time, labor and materials use. Customers throughout the world are currently
viewing approximately 200,000 color formulas each month through our recently
introduced Internet Scale system.
INTERNATIONAL COATINGS SEGMENT
Net sales in our International Coatings Segment increased 11.7 percent to
$318.6 million in 2004. Segment sales for the year benefited from favorable
currency exchange and sales in local currency that continued to build during
each quarter of 2004. During 2003, a change in fiscal year to a calendar year
basis by South American subsidiaries added one month sales to last year's
results. The net impact of favorable currency exchange in 2004 more than offset
the additional month sales in 2003 due to the fiscal year change, increasing net
sales $9.9 million, or 3.5 percent, for the year.
The Segment realized an operating profit of $18.0 million in 2004 compared
to $8.4 million in 2003. This was primarily the result of higher sales volumes,
operating efficiencies resulting from manufacturing volume increases, tight
expense control and favorable currency exchange fluctuations. The change in
fiscal year had no significant effect on operating profit for the Segment.
We continue to be encouraged by the improving economic conditions in South
America. In Argentina, we strengthened our market position by launching The
Concept Store, based on the Sherwin-Williams paint store model of merchandising
paint, but adapted to fit the local market. We celebrated our 60th anniversary
of production in Brazil, and we again received numerous awards for product
performance and innovation. In the United Kingdom, our Ronseal(TM) wood care
brand remains the market leader and continues to improve its position through
new product offerings and market expansion. Our Ronseal subsidiary successfully
launched a comprehensive range of Specialist Paint products for use in a variety
of applications and saw growth in Ireland with its core wood care and deck
products.
MANAGEMENT CHANGES
In 2004, we continued our long-standing practice of promoting talent from
within the company with two important management appointments.
4
In September, Blair LaCour was appointed to the position of President &
General Manager of the Automotive Division. Blair brings strong leadership and a
wealth of experience to this assignment having spent the past 12 years as
President & General Manager of the Mid Western Division of our Paint Stores
Segment. Under Blair's leadership, the Mid Western Division consistently
produced record sales and profits, made significant market share gains and
successfully integrated a number of important acquisitions. Blair has also
served as Vice President of Sales for the Western Division and Midcentral
Division, and as Vice President of Marketing and Director of Sales for our
Automotive Division.
Drew McCandless was appointed to succeed Blair as President & General
Manager of the Mid Western Division of the Paint Stores Segment. Drew joined
Sherwin-Williams in 1981 as a sales representative and has excelled in a wide
range of Division and Corporate level assignments since then. He served as
Corporate Auditor, Financial Analyst and Treasury Manager before moving to the
Southeastern Division of the Paint Stores Segment where he served as Financial
Manager, Controller and Vice President of Sales. Prior to his new role, Drew
served as Vice President and Controller for the Consumer Division and Senior
Vice President, Operations/Supply Chain Management for the Consumer Division.
OUTLOOK FOR 2005
Taken in total, we are pleased with the performance of your company in
2004. Thanks to the commitment and dedicated efforts of more than 28,000
Sherwin-Williams employees, we surpassed $6 billion in sales for the first time
in company history. Three out of our four operating segments grew their sales
and operating profits at double-digit rates, and we continued our track record
of regular dividend growth and steady profitability.
We expect that the domestic and international economies will continue to
strengthen in 2005 and have a favorable impact on sales volume in all of our
segments. We will continue to add stores organically and expect to open our
3,000th store some time in the first half of 2005. Our ability to generate
significant net operating cash will enable us to continue to invest in product
innovation, new technology and capacity to strengthen our position of industry
leadership.
We believe that our industry leadership and sustained success are linked
to a strong foundation and spirit of innovation that reaches back to the day
when our cofounder, Henry Sherwin, introduced the first ready-mix paint product.
This same commitment to quality and technology has resulted in our company being
issued more than 600 patents over the years - each advancement driven by our
fundamental desire to meet the needs and exceed the expectations of our
customers.
[3,000TH STORE OPENING IN FIRST HALF OF 2005].
We recognize that the primary responsibility for the integrity of our
financial reporting rests with management and we will continue to observe the
highest financial reporting ethical standards. Our management team has conducted
an evaluation of the effectiveness of the company's internal control over
financial reporting and concluded that our controls are effective and contain no
material weaknesses. An independent audit of our assessment is complete and the
auditors have issued an unqualified opinion concurring with management's
conclusion that our controls are effective.
Finally, Fortune Magazine recently named Sherwin- Williams as one of the
100 best companies to work for. We will continue to embrace the ideals and
principles that helped us gain such recognition, and acknowledge and value the
hard work and innovative thinking of the men and women of Sherwin-Williams.
Together, we offer our thanks and appreciation to our customers, suppliers and
shareholders for their confidence and trust.
/s/ Christopher M. Connor
- -------------------------
CHRISTOPHER M. CONNOR
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
/s/ Joseph M. Scaminace
- -----------------------
JOSEPH M. SCAMINACE
PRESIDENT AND CHIEF OPERATING OFFICER
5
[SHERWIN-WILLIAMS PICTURE]
REPRESENTING MORE THAN 65 PERCENT OF TOTAL
company sales, the Paint Stores Segment was instrumental in helping
Sherwin-Williams surpass the $6 billion sales mark in 2004. We delivered strong
comparable store performance, introduced an impressive array of new products,
completed a significant acquisition and are on the verge of opening our 3,000th
store.
Sherwin-Williams paint stores market and sell Sherwin-Williams(R) branded
architectural and industrial paints, stains and related products. Our diverse
customer base includes architectural and industrial painting contractors,
residential and commercial builders, property owners and managers, OEM product
finishers and do-it-yourself homeowners.
Operating our own stores gives us the ability to interact directly with
the end users of our products to better understand their specific needs. Local
store personnel and field
[PICTURES]
6
PAINT STORES SEGMENT
representatives are able to form true partnerships with their customers. Our
recently implemented Trademark Customer Service program and Sales Excellence
initiative are both designed to promote stronger customer relationships. Store
personnel and sales representatives receive extensive training and the tools
they need to ensure they meet our high standards for customer service and
salesmanship. Individual performance is continuously measured against these
standards.
We continue to introduce innovative new Sherwin-Williams(R) branded paint
products through our Paint Stores Segment designed for specific market
applications. To improve contractor productivity and efficiency, we launched
ProXP(TM) Eg-Shel, a one-coat product with two-coat performance characteristics.
Our new DeckScapes(TM) product line features an entire deck-care system that
allows for pretreatment, stain and protection all in one day. Residential and
commercial structures can benefit from E-Barrier (TM), our new energy-efficient
reflective coating for use in attics. We completed the SuperPaint(R) Machine
Finish product line designed for use in the growing prefinished wood siding
market. To capitalize on the popularity of faux finishing, we introduced a new,
in-store Illusions(R) Faux Finishing display that not only provides the tools
and instructions needed to apply these finishes, but also an assortment of color
combinations to eliminate some of the guesswork associated with color selection.
In 2004, we acquired Duron, Inc., one of the most respected names in our
industry. Duron services the professional painting contractor and builder
markets through a chain of 229 company-operated stores located primarily in the
eastern and southeastern United States. The acquisition of Duron, in addition to
the 66 net new stores we opened organically, brings the Paint Stores Segment
store count total in North America to 2,983.
INDUSTRIAL MAINTENANCE AND MARINE coatings from Sherwin-Williams are
formulated to protect steel and masonry infrastructures in highly corrosive,
harsh environments. A network of more than 140 dedicated Industrial and Marine
sales representatives and a staff of corrosion specification specialists support
our heavy-duty coatings customers. In 2004, we introduced several new products
under our ExpressTech(R) product line. These coatings feature proprietary
technology that offers tremendous labor savings and productivity gains through
rapid project completion and return to service. Superior product technology and
an unparalleled sales and service organization will help us to capitalize on the
improving market demand for industrial and marine protective coatings.
CHEMICAL COATINGS had a strong performance in 2004 and is well positioned
for continued growth in North America and Asia. In Asia, we began manufacturing
at our new plant in Shanghai, China. Having a manufacturing presence in this
part of the world enables us to better serve our OEM customers who have moved
their operations there. Our continuous advancements in technology enabled us to
make several significant environmentally friendly product introductions. These
"green" technologies are used in our Sher-Wood(R), UltraCure(R) and Kem Aqua(R)
product lines.
[PICTURES]
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,
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) and Duron(R)
OUTLETS: 2,983 Sherwin-Williams stores in the United States, Canada, Mexico,
Puerto Rico and the Virgin Islands
7
[PICTURE]
OUR CONSUMER SEGMENT IS KNOWN FOR THE STRENGTH
of its brands, and for good reason. Household names like Dutch Boy(R),
Krylon(R), Minwax(R), Purdy(R), Pratt & Lambert(R) and Thompson's(R)
WaterSeal(R) come together to form the strongest collection of brands in the
paint and coatings industry.
These brands are more than just well known. Each one promises our
customers a unique and compelling experience. Whether it's the Dutch Boy(R)
brand's promise of Simple Innovations(TM) for better results with less effort,
or the Minwax(R) brand's promise to Make and Keep Wood Beautiful(TM), customers
trust our brands and the products they represent. We are pleased with the
improving sales performance of our Consumer Segment, and we believe that these
positive results stem from our ability to keep our brands vital and relevant for
consumers through continuous improvement and constant innovation.
CONSUMER BRANDS - Three years ago, we simplified the painting experience
with our easy to open, easy to pour, easy to close Dutch Boy(R) Twist & Pour(TM)
paint container. In 2004, we did it again with the introduction of our new Dutch
Boy(R) Ready to Roll(TM) project sized
[PICTURES]
8
CONSUMER SEGMENT
paint container. This revolutionary new package holds 2.5 gallons of paint that
can be tinted to any shade in the Dutch Boy(R) palette. It features a built-in
roller tray, an easy-carry handle and a lid that's a snap to open and close. The
Ready to Roll(TM) container represents another break-through for our Dutch
Boy(R) product line and continues to provide Dutch Boy(R) paint retailers with
the most compelling, consumer-friendly, easy-to-use innovations in the paint
category.
The Pratt & Lambert(R) brand also attracted attention in 2004 with the
relaunch of the Accolade (R) product line and the introduction of our Never
Compromise(TM) Color Center. Accolade(R) is a family of 100% acrylic paints
formulated for superior adhesion, excellent hiding, and out-standing durability.
The new Accolade(R) tagline, The Crown Jewel of Paints(TM), communicates the
outstanding performance consumers and professional painters can expect from this
premium line. Our Never Compromise(TM) Color Center makes finding the right
colors and inspirational materials easier than ever. The color palette is
organized in both clean and muted tones that are presented on punch-out color
chips to help in color coordination. The Color Center also includes the
Williamsburg Color(R) Collection, which captures the traditional colors and
uniquely American style of Colonial Williamsburg.
WOOD CARE PRODUCTS - Both our Minwax(R) and Thompson's(R) WaterSeal(R)
brands reached significant milestones in 2004. Minwax(R) marked its 100th
anniversary and Thompson's(R) WaterSeal(R) celebrated its 75th anniversary. In
observance of these milestones, our Minwax(R) manufacturing site in Flora,
Illinois was featured on the popular PBS TV series This Old House with Norm
Abram, while Thompson's(R) WaterSeal(R) was featured in an affiliate museum of
the Smithsonian Institution. Both brands have been market leaders throughout
their rich history and continue to develop products that deliver long lasting
beauty, protection and convenience.
In 2004, we introduced new Minwax(R) Clear Brushing Lacquer designed to
provide a traditional, time-honored finish with the ease of brush application
and no sanding between fast drying coats. Our new Thompson's(R) WaterSeal(R)
Concrete Care line offers a full line of products to beautify and protect
walkways, driveways and patios. And, our new Thompson's(R) WaterSeal(R) Deck
Stripper restores wood's natural color and beauty. For floors, the new
DuraSeal(TM) QuickCoat Stain features 2-hour dry time in a palette that includes
existing DuraSeal(TM) and certified Minwax(R) colors.
DIVERSIFIED BRANDS - In 2004, we made significant additions to our already
strong brand portfolio and introduced a wide range of new and distinctive
products. To capitalize on the momentum created by our recent introduction of
Krylon(R) Fusion for Plastic(TM), the first aerosol paint that bonds to plastic,
we added satin colors and an assortment of specialty finishes to the line. We
also expanded our offering of Krylon(R) branded brush-on paints with the
introduction of Color Creations(R), a line of unique mix-in-can faux finishes
and effects that make advanced painting techniques easy to achieve with no mess
and no fuss.
Through our acquisition of Paint Sundry Brands Corporation, we added the
Purdy(R) and Bestt Liebco(R) brands of paintbrushes and rollers to our
applicator business. The wellknown quality associated with these two brands
makes them favorites among professional painting contractors and experienced
do-it-yourself customers alike. Symphony(TM), another brand of Paint Sundry
Brands Corporation, is a leader in the growing category of faux finishing tools
and applicators.
[PICTURES]
PRODUCTS SOLD: Branded, private label and licensed brand paints, stains,
varnishes, industrial products, wood finishing products, wood preservatives,
applicators, corrosion inhibitors, aerosols and related products
MARKETS SERVED: Do-It-Yourselfers, professional painting contractors,
industrial maintenance and flooring contractors
MAJOR BRANDS SOLD: Dutch Boy(R), Krylon(R), Minwax(R), Cuprinol(R),
Thompson's(R) WaterSeal(R), Formby's(R), Pratt & Lambert(R), Martin Senour(R),
H&C(R), White Lightning(R), Dupli-Color(R), Rubberset(R), Purdy(R), Bestt
Liebco(R) and Accurate Dispersions(TM)
OUTLETS: Leading mass merchandisers, home centers, independent paint dealers,
hardware stores, automotive retailers and industrial distributors in the United
States, Canada and Mexico
9
[PICTURE]
OUR 200 COMPANY-OPERATED BRANCHES IN THE U.S.,
Canada, the Caribbean and South America, is the largest such network in the
automotive finishes industry. Combined with thousands of independent
distributors, automotive jobbers, and our foreign licensing agreements and
subsidiaries, we have a distribution platform that is comprehensive and
convenient for our customers.
The diverse automotive finishing categories we serve include passenger car,
commercial vehicle and aircraft. A fundamental objective for all of our
customers is their desire to maximize quality, productivity and efficiency. In
2004, we introduced several innovative products designed to help our customers
save time, material and labor. Our Squeegee Prime(TM) primer application,
developed from the new NP75 Ultra-Fill(R) HS
[PICTURES]
10
AUTOMOTIVE FINISHES SEGMENT
DTM Primer, eliminates the need for masking, quickens repair work and improves
shop productivity. For OEM truck body, bus and fleet applications, our
innovative Element Shield(TM) primer protects primed units for up to nine months
from harsh, outdoor elements without the need for sanding. Another example of
our ability to develop custom solutions for specialty markets is our Ultra
7000(R) Motorcoach Basecoat, the first MATC compliant paint in the RV industry
formulated to withstand the rigors of severe weather and road conditions.
Our FormulaExpress(TM) Internet Scale continues to re-invent the method of
color formula selection in the industry. With more than 800 scales in place and
more than 200,000 formulas viewed each month, Sherwin- Williams customers
worldwide are accessing color information in real time from the data base at our
World Automotive Center - a 350,000-square-foot office and laboratory complex
located in Warrensville Heights, Ohio dedicated to Automotive Finishes.
We grew our international presence significantly over this past year. Our
acquisition of a majority interest in a successful local Chinese automotive
paint company resulted in the formation of Sherwin-Williams Kinlita Co. Ltd.
This accelerate our growth in the Chinese Automotive Refinish and OEM markets.
In Venezuela, we opened our wholly-owned subisdiary, Sherwin-Williams Pinturas
de Venezuela, capturing a significant market share in our first year of
operation. We expanded our sales and distribution platforms in Asia; as well as
in Bolivia, Paraguay and Uruguay through our newly-created export sales office
in Brazil, and we began supplying automotive interior and exterior plastic
coatings to Brazilian OEM customers. A number of our new, OEM-approved
clearcoats and primers were introduced into the European market as well.
For many of today's most recognized NASCAR teams and drivers, Sherwin-
Williams(R) brand automotive paints continue to be the paint of choice. In fact,
in cooperation with Dale Earnhardt, Inc., we released 8 Tonz(TM), eight special
effect custom color basecoats for use in glamour and racecar applications.
Our efforts in Automotive Finishes did not go unnoticed or unrewarded in
2004. In addition to posting double-digit sales gains, we were re-certified for
OEM approved warranty repairs at authorized General Motors, Ford and Daimler
Chrysler dealerships. For the second year in a row, as part of Toyota's Global
Body and Paint Service Cooperation program, we earned the position of National
Training Partner. We were again included as a member of the Honda Body shop
recognition program.
[PICTURES]
PRODUCTS SOLD: High performance interior and exterior coatings for the
automotive, aviation, 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, aviation 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: 200 company-operated branches in the United States, Canada, Jamaica,
Chile and Peru, and other operations throughout North and South America, the
Caribbean Islands, Europe and China
11
[PICTURE]
IT WAS A STRONG YEAR FOR OUR INTERNATIONAL
Coatings Segment, posting gains in both sales and profits. We increased
manufacturing output, expanded distribution, strengthened the position of our
brands across all channels and grew market share. The Segment also benefited
from favorable currency exchange rates and a steadily improving economy in South
America.
The Sherwin-Williams(R) brand, along with a variety of widely accepted
regional brands, is distributed in 20 countries. We operate through wholly-owned
subsidiaries, joint ventures, licensing agreements and independent distributors.
In 2004, we added 10 new stores bringing our total to 71 company-operated
stores.
BRAZIL - We celebrated our 60th anniversary of production in Brazil, our
largest foreign subsidiary. Our commitment to this market has been unwavering,
and over the
[PICTURES]
12
INTERNATIONAL COATINGS SEGMENT
years we have improved our market position in architectural coatings.
Our products are broadly distributed in home centers, mass retailers and
hardware stores. In 2004, we participated in two national trade shows where we
introduced several innovative new products in our market-leading Colorgin(R)
aerosol brand and our Metalatex(R) product line. Colorgin(R) Plasticos, the
Brazilian version of our revolutionary domestic product line Krylon(R) Fusion
for Plastic(TM) aerosol paint, was launched in March. In the construction
segment, we had an April launch of Metalatex(R) Litoral, which offers superior
protection for coastline paint projects. We continued to grow our sales
organically in the industrial maintenance category, and further expanded the
national presence of our Sumare(R) brand by opening seven new stores in 2004.
CHILE - An established distribution platform that benefits from strong
relationships with leading retailers, along with our own direct retail and
wholesale operations, continues to fuel growth in this area. We compete in all
major paint markets from architectural and aerosol to chemical coatings,
industrial and marine and wood. We are the leader in aerosols with our
Marson(TM) brand.
Growth in the industrial maintenance category remains steady, particularly
in marine markets and steel fabrication where shared domestic technologies
continue to provide us with a competitive edge. The integration of the Minwax(R)
brand has resulted in market share gains in wood, and the introduction of
General Polymers(R) products has improved our floor care business. The
completion of our new Color Studio located in the heart of Santiago has been
successful in attracting architects, designers, specifiers and other decorating
professionals to improve our architectural market participation.
ARGENTINA - Seeking to capitalize on the success of our paint store model
in the United States, Sherwin-Williams Argentina created The Concept Store, a
program designed to change the method of displaying and selling paint in this
country. Rather than the traditional closed store counter with product stored in
the back room, these new points of sale, owned and operated by our dealers,
display product on the sales floor, offering customers a more hands-on shopping
experience. In addition, we are strengthening our relationship with our home
center customers through exclusive product offerings and merchandising.
UNITED KINGDOM - As the pre-eminent wood care coatings brand in the U.K.,
Ronseal again exerted its market strength in 2004. In Ireland, Ronseal
successfully introduced several new products in its core wood care category and
the growing deck category. In the U.K., a wide range of Specialist Paint
products were launched. These paints are formulated for specific applications
like Appliance, Radiator, Tile, Patio, Floor and UPVC, to name a few. These are
one-coat products that require no priming. The Specialist Paint product launch
was heavily supported by television advertising and media placements.
[PICTURES]
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(R), Ronseal(TM),
Pulverlack(TM), Colorgin(R), Andina(TM), Tri-Flow(R), Thompson's(R)
WaterSeal(R), Marson(TM), Metalatex(R) and Novacor(R)
OUTLETS: Distribution in 20 countries through wholly-owned subsidiaries, joint
ventures and licensees of technology, trademarks and tradenames, including 71
company-operated architectural and industrial stores in Chile, Brazil, Uruguay
and Argentina
13
[PHOTO OF STACEY GUINN]
Coordinator, Center of Excellence
THE SHERWIN-WILLIAMS CENTER OF EXCELLENCE
opened to the public in 2004. The Center is a living archive of
our company, a celebration of our past and an inspiration for
future generations.
A 40-foot timeline tells the Sherwin-Williams story in the context of
significant events in Cleveland...and the world.
[PICTURE]
At the heart of the Center of Excellence, a display kiosk lists our operating
segments and offers visitors a video greeting from our leadership team.
[PICTURE]
From sponsoring Metropolitan Opera radio auditions, to Cleveland Indians TV
games, Sherwin-Williams has pioneered new media since the 1930s.
[PICTURE]
14
[PICTURE] CENTER OF EXCELLENCE
We are responsible for numerous industry firsts. Between the first resealable
paint can patented in 1877 and the debut of the Twist & Pour(TM) container,
Sherwin-Williams material and chemical inventions have revolutionized the
coatings industry.
[PICTURE]
The original fireplace mantle from Henry Sherwin's office, all of the individual
tiles from the hearth and the chameleon lamp that sat on Henry Sherwin's desk in
the 1880s, are proudly displayed.
[PICTURE]
Sherwin-Williams has been granted more than 600 patents over the years - the
numbers of each are etched in plexiglass display panels.
[PICTURE]
15
1980
[DUTCH BOY LOGO]
1984
[DUPLI-COLOR LOGO]
1988
[WESTERN AUTOMOTIVE FINISHES LOGO]
1990
[KRYLON LOGO]
1995
[WHITE LIGHTNING LOGO]
[H&C LOGO]
[SHERWIN WILLIAMS CALIDAD EN PINTURAS LOGO]
1996
[LAZZURIL LOGO]
[EXCELO LOGO]
[P&L LOGO]
[GLOBO LOGO]
THE SHERWIN-WILLIAMS COMPANY HAS CONSISTENTLY
demonstrated its ability to generate significant operating cash. For the fourth
year in a row,our company has generated in excess of $540 million in net
operating cash.We protect and reward our shareholders by being good stewards of
the cash we generate and returning a portion of the cash directly.
We are thankful for the confidence you have placed in us and pledge our
continued diligence in strengthening our company through wise and appropriate
applications of the cash we generate.
STRATEGIC ACQUISITIONS
In addition to the organic growth we achieve through new store openings and new
product innovations, acquisitions play an important role in growing our sales
and profits and expanding our presence in the market. Over the past 25 years, we
have made many additions to the Sherwin-Williams family of brands and products,
many of which are referenced on the timeline above. These acquisitions have
flourished, become integral parts of our company and made us stronger.
DIVIDENDS PER COMMON SHARE
(after adjustment for all common stock splits)
[BAR CHART]
1979 .01
1980 .04
1981 .05
1982 .06
1983 .08
1984 .10
1985 .12
1986 .13
1987 .14
1988 .16
1989 .18
1990 .19
1991 .21
1992 .22
1993 .25
1994 .28
1995 .32
1996 .35
1997 .40
1998 .45
1999 .48
2000 .54
2001 .58
2002 .60
2003 .62
2004 .68
16
SHAREHOLDER RETURN
1997
[THOMPSON'S WATERSEAL LOGO]
[MINWAX LOGO]
[TINTAS SUMARE LOGO]
2000
[GENERAL POLYMERS LOGO]
1996 (continued)
[SEAGUARD LOGO]
[COLORGIN LOGO]
[BACO PINTURAS STIERLING LOGO]
2001
[MAUTZ LOGO]
2002
[FLEX BON PAINTS LOGO]
2004
[DURON LOGO]
[PSB LOGO]
[LOGO]
Selected branded acquisitions 1980-2004
DIVIDEND GROWTH
In 2004, we completed our 26th consecutive year of increased cash
dividends on common stock paid to our shareholders. It remains our policy to pay
30% of trailing earnings in the form of a cash dividend to shareholders. In
short, we reward shareholders of Sherwin-Williams stock by returning to them a
portion of the cash we are able to generate. Cash dividend payments in 2004
totaled $96.9 million.
STOCK PURCHASE
During 2004, we purchased 6.6 million shares of our common stock in the
open market for the treasury. As we have done in years past, we intend to
continue purchasing shares opportunistically on the open market, as we believe
Sherwin-Williams stock is a good investment. This practice serves to increase
shareholder value by preventing ownership dilution due to the grant and exercise
of stock options.
CAPITAL EXPENDITURES
Our capital expenditures in 2004 exceeded $100 million dollars and helped
us sustain our position of industry and market leadership. We added capacity,
improved systems, enhanced productivity and invested in technology.
DEBT
As a result of short-term borrowing to fund acquisitions, our total debt
to capitalization rose to 30.9 percent in 2004. At this level, the Company still
has ample debt capacity to fund viable acquisitions in the future. Barring any
large acquisitions, we will use a portion of our net operating cash to reduce
debt and expect our total debt to capitalization to decline to the mid twenty
percent range in the coming year.
COMMON STOCK PURCHASE
(millions of shares)
[BAR CHART]
2000 6.80
2001 6.70
2002 6.70
2003 7.98
2004 6.60
CAPITAL EXPENDITURES
(millions of dollars)
[BAR CHART]
2000 132.8
2001 82.6
2002 126.5
2003 116.5
2004 106.8
TOTAL DEBT TO CAPITALIZATION
(percent)
[BAR CHART]
2000 33.5
2001 29.3
2002 28.0
2003 26.0
2004 30.9
17
STORES MAP/SUBSIDIARIES
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.
Pulverlack Nordeste Ltda.
Quetzal Pinturas, S.A. de C.V.
Ronseal (Ireland) Limited
Ronseal Limited
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 France S.r.l.
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 Japan Co., Ltd.
Sherwin-Williams Kinlita Co., Ltd.
Sherwin-Williams Paints (Dongguan) Company Limited
Sherwin-Williams Pinturas de Venezuela S.R.L.
Sherwin-Williams (Shanghai) Paints Company Limited
Sherwin-Williams Uruguay S.A.
The Sherwin-Williams Company Resources Limited
DOMESTIC
Contract Transportation Systems Co.
Omega Testing and Weathering Services LLC
Sherwin-Williams Automotive Finishes Corp.
Sherwin-Williams Realty Holdings, Inc.
SWIMC, Inc.
The Sherwin-Williams Acceptance Corporation
Thompson Minwax International Corp.
[MAP]
Today, Sherwin-Williams has 3,254 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.
18
FINANCIAL PERFORMANCE
[COVER THE EARTH PICTURE]
FINANCIAL TABLE OF CONTENTS
Cautionary Statement Regarding Forward-Looking Information
20
Financial Summary
21
Management's Discussion and Analysis of Financial Condition and Results of
Operations
22
Reports of Management
37
Reports of the Independent Registered Public Accounting Firm
39
Consolidated Financial Statements and Notes
42
Shareholder Information
71
Corporate Officers and Operating Presidents
72
19
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, including the acquisitions of Duron,
Inc. and Paint Sundry Brands Corporation; (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
forwardlooking statement, whether as a result of new information, future events
or otherwise.
20
FINANCIAL SUMMARY
(millions of dollars except as noted and per common share data)
2004 2003 2002 2001 2000
--------- --------- --------- --------- ---------
OPERATIONS
Net sales ......................................... $ 6,114 $ 5,408 $ 5,185 $ 5,066 $ 5,212
Cost of goods sold ................................ 3,412 2,952 2,846 2,846 2,904
Selling, general and administrative expenses ...... 2,069 1,882 1,785 1,730 1,740
Impairment of other assets ........................ 352
Interest expense .................................. 40 39 40 55 62
Income before income taxes, minority interest and
cumulative effect of change in accounting
principle........................................ 580 523 497 424 143
Income before cumulative effect of change in
accounting principle ............................ 393 332 311 263 16
Net income ........................................ 393 332 128 263 16
FINANCIAL POSITION
Inventories ....................................... $ 773 $ 638 $ 625 $ 633 $ 704
Accounts receivable - net ......................... 724 544 494 523 594
Working capital - net ............................. 262 561 422 366 436
Property, plant and equipment - net ............... 720 650 665 673 722
Total assets ...................................... 4,274 3,683 3,432 3,628 3,751
Long-term debt .................................... 488 503 507 504 621
Total debt ........................................ 738 514 522 615 740
Shareholders' equity .............................. 1,647 1,459 1,342 1,488 1,472
PER COMMON SHARE INFORMATION
Average shares outstanding (thousands) ............ 140,802 144,847 150,438 155,557 161,912
Book value ........................................ $ 11.70 $ 10.17 $ 9.01 $ 9.66 $ 9.22
Income before cumulative effect of change in
accounting principle - diluted .................. 2.72 2.26 2.04 1.68 .10
Income before cumulative effect of change in
accounting principle - basic .................... 2.79 2.29 2.07 1.69 .10
Net income - diluted .............................. 2.72 2.26 .84 1.68 .10
Net income - basic ................................ 2.79 2.29 .85 1.69 .10
Cash dividends .................................... .68 .62 .60 .58 .54
FINANCIAL RATIOS
Return on sales (1) ............................... 6.4% 6.1% 6.0% 5.2% .3%
Asset turnover .................................... 1.4x 1.5x 1.5x 1.4x 1.4x
Return on assets (1) .............................. 9.2% 9.0% 9.1% 7.3% .4%
Return on equity (2) .............................. 27.0% 24.7% 20.9% 17.9% .9%
Dividend payout ratio (1) ......................... 24.6% 27.3% 29.3% 34.6% 549.9%
Total debt to capitalization ...................... 30.9% 26.0% 28.0% 29.3% 33.5%
Current ratio ..................................... 1.2 1.5 1.4 1.3 1.4
Interest coverage (3) ............................. 15.5x 14.5x 13.3x 8.8x 3.3x
Working capital to sales .......................... 4.3% 10.4% 8.1% 7.2% 8.4%
Effective income tax rate (4) ..................... 32.0% 36.5% 37.5% 38.0% 88.9%
GENERAL
Capital expenditures .............................. $ 107 $ 117 $ 127 $ 83 $ 133
Total technical expenditures (5) .................. 91 88 89 86 84
Advertising expenditures .......................... 240 239 222 236 276
Repairs and maintenance ........................... 55 52 52 48 48
Depreciation ...................................... 109 105 104 109 109
Amortization of intangible assets ................. 17 12 12 39 51
Shareholders of record (total count) .............. 11,056 11,472 11,936 12,687 13,137
Number of employees (total count) ................. 28,690 25,777 25,752 25,789 26,095
Sales per employee (thousands of dollars) ......... $ 213 $ 210 $ 201 $ 196 $ 200
Sales per dollar of assets ........................ 1.43 1.47 1.51 1.40 1.39
(1) Based on income before cumulative effect of change in accounting
principle. See Note 3, page 51 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, minority interest, cumulative effect
of change in accounting principle and interest expense to interest
expense.
(4) Based on income before income taxes, minority interest and cumulative
effect of change in accounting principle.
(5) See Note 1, page 48 of this report, for a description of technical
expenditures.
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
The Sherwin-Williams Company, founded in 1866, and its consolidated
subsidiaries (collectively, the "Company") are 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 pages 8 through 15 of this report and
Note 18, on pages 68 through 70 of this report, for more information concerning
the Company's reportable segments.
The Company's financial condition remained strong in 2004 despite a
decrease of $256.9 million in cash and cash equivalents from the end of 2003
primarily as a result of acquisitions made in 2004. The Company's current ratio
decreased to 1.17 at December 31, 2004 from 1.49 at the end of 2003. Total debt
increased to $738.3 million at December 31, 2004 from $513.6 million at the end
of last year and increased as a percentage of total capitalization to 30.9
percent from 26.0 percent at the end of 2003. The lower current ratio and
increased total debt also related primarily to the 2004 acquisitions. Net
operating cash decreased to $544.7 million in 2004 versus $558.9 million in
2003. The primary factor reducing net operating cash was increased working
capital requirements to support new sales programs. Excess cash from 2003 and
net operating cash and increased short-term borrowings in 2004 provided the
funds necessary to support current year acquisitions of $554.5 million,
extinguishment of acquired debt of $67.1 million, capital expenditures of $106.8
million, purchases of treasury stock for $267.4 million and payments of $96.9
million in cash dividends.
Consolidated net sales increased 13.1 percent in 2004 to $6.11 billion
from $5.41 billion in 2003. Net income for 2004 increased 18.4 percent to $393.3
million from $332.1 million last year. Diluted net income per common share
increased 20.4 percent to $2.72 per share for 2004 from $2.26 per share a year
ago. During 2004, sales volume increases came from continuing strong domestic
architectural paint sales, improving sales and market conditions in domestic
industrial maintenance and product finishes and the acquisitions of Duron, Inc.
(Duron), Paint Sundry Brands Corporation (PSB) and a majority interest in
Shanghai Kinlita Chemical Co., Ltd., that was renamed Sherwin-Williams Kinlita
Co., Ltd. (Kinlita). The domestic and international automotive refinish
businesses improved during the year while stronger economic conditions and
favorable foreign currency exchange rates in most South American countries
contributed to improved International Coatings Segment sales. For the full year
2004, gross profit as a percent of sales declined primarily due to increasing
raw material costs. The impacts on net sales and gross profit relating to a
change in product mix and an impairment charge to reduce the carrying amount of
a customer sales incentive program were negligible. Selling, general and
administrative expenses decreased as a percent of sales in 2004 as compared to
2003.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation and fair presentation of the consolidated financial
statements, accompanying notes and related financial information included in
this report are the responsibility of management and have been prepared in
accordance with accounting principles generally accepted in the United States.
The consolidated financial statements, notes and related information include
amounts that were based upon management's best estimates and judgments which
they believe were reasonable under the circumstances. Management used
assumptions based on historical results and other assumptions to form the basis
for determining appropriate carrying values of assets and liabilities that were
not readily available from other sources. Actual results could differ from those
estimates. Also, materially different amounts may result under materially
different conditions 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 significant accounting policies that were followed in the
preparation of the consolidated financial statements are disclosed in Note 1, on
pages 46 through 50 of this report. The following procedures and assumptions
utilized by management directly impacted many of the reported amounts in the
consolidated financial statements.
The Company's revenue was generated from the sale of its products. All
revenues were recognized when products were shipped and title had passed to
unaffiliated customers. Discounts were recorded as a reduction of
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
net sales in the same period as the sale. Our standard sales terms are final and
returns or exchanges are not permitted unless expressly stated; provisions for
returns or exchanges were established in cases where the right of return
existed. The Company offered a variety of programs, primarily to its retail
customers, designed to promote sales of its products. Such programs required
periodic payments and allowances based on estimated results of specific programs
and were recorded as a reduction to net sales. The Company accrued the estimated
total payments and allowances associated with each transaction at the time of
sale. Additionally, the Company offered programs directly to consumers to
promote the sale of its products. Promotions which reduced the ultimate consumer
sale prices were recorded as a reduction of net sales at the time the
promotional offer was made, generally using estimated redemption and
participation levels. The Company continually assesses the adequacy of accruals
for customer and consumer promotional program costs not yet paid. To the extent
total program payments differ from estimates, adjustments may be necessary.
Historically, these total program payments and adjustments have not been
material.
Management recorded accounts receivable net of provisions for sales
returns and allowances, and net of provisions for doubtful collection of
accounts included in Selling, general and administrative expenses. Estimated
sales returns and allowances were accrued based on management's assessment of
accounts receivable. Judgment was required in order to make this assessment
including an analysis of historical bad debts, a review of the aging of accounts
receivable and a review of the current creditworthiness of customers. Management
recorded allowances for receivables which were believed to be uncollectible,
including amounts for the resolution of potential credit and other collection
issues such as disputed invoices, customer satisfaction claims and pricing
discrepancies. However, depending on how such potential issues are resolved, or
if the financial condition of any of our customers were to deteriorate and their
ability to make required payments became impaired, increases in these allowances
may be required. As of December 31, 2004, 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 method. Inventory quantities
were adjusted during the fourth quarter of 2004 as a result of annual physical
inventory counts taken in all locations. Management recorded the best estimate
of net realizable value for obsolete and discontinued inventories based on
historical experience and current trends through reductions to inventory cost by
recording a provision included in Cost of goods sold. Where management
determined that future demand was lower than current inventory levels, a
reduction in inventory cost to estimated net realizable value was made.
Management's business and technical judgment was used in determining which
intangible assets have indefinite lives and in determining the useful lives of
finitelived 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
indefinitelived intangible assets during the fourth quarters of 2004, 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 3 and 4, pages 51 through 53 of this
report, for a discussion of the reductions in carrying value of goodwill and
indefinite-lived intangible assets recorded in accordance with SFAS No. 142.
Property, plant and equipment was stated on the basis of cost and
depreciated principally on a straightline 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 indicated that the carrying value of
long-lived assets may not be recoverable or the useful life had changed,
impairment tests were performed. Undiscounted future cash flows were used to
calculate the fair value of long-lived assets to determine if such assets were
impaired. Where impairment was identified, management determined fair values for
assets using a discounted cash flow valuation model, incorporating discount
rates commensurate with the risks involved for each group of assets. Growth
models were
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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 Note 4, pages 52 and 53 of this report, for a discussion of
the reductions in carrying value of long-lived assets 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. 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 2005
expense recognition, the Company will use a discount rate of 5.75 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 net pension credit in 2005 that is expected to remain
approximately the same as 2004. See Note 7, pages 55 through 59 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 medical and disability 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 estimated
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 accrued for environmental remediation-related
activities for which commitments or clean-up plans have been developed and for
which costs could be reasonably estimated based on industry standards and
historical experience. All accrued amounts were recorded on an undiscounted
basis. Accrued environmental remediation-related expenses included direct costs
of investigation and remediation and indirect costs such as compensation and
benefits for employees directly involved in the investigation and remediation
activities and fees paid to outside engineering, consulting and law firms. See
Note 9, on pages 60 and 61 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 29 and 30 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 and may adopt an exit or disposal plan for
facilities that no longer meet those strategic goals. Effective January 1, 2003,
the Company recognizes liabilities associated with exit or disposal activities
as incurred in accordance with SFAS No. 146, "Accounting for Costs from Exit or
Disposal Activities." Qualified exit costs primarily include post-closure rent
expenses, incremental post-closure costs and costs of employee terminations.
Adjustments may be made to liabilities accrued for qualified exit costs if
information becomes available upon which more accurate amounts can be reasonably
estimated. Concurrently, long-lived assets are tested for impairment in
accordance with SFAS No. 144 and, 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. Additional
impairment may be recorded for subsequent revisions in estimated fair value.
During 2004, a leased distribution facility in the Automotive Finishes Segment
was exited. During 2003, a formal plan was approved to close and dispose of a
manufacturing facility in the Consumer Segment. The useful lives of the
long-lived assets were reduced at that time in accordance with SFAS No. 144.
Manufacturing ceased at the facility during 2004. In accordance with SFAS No.
146, non-cancelable rent, post-closure severance and other qualified exit costs
were accrued at the time of ceasing
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
operations at these two sites. No formal shutdown plans were approved during
2002. See Note 6, pages 54 and 55 of this report, for information concerning
accrued qualified exit costs and impairments of long-lived assets.
The Company used the purchase method to allocate costs of the acquired
businesses to the assets acquired and liabilities assumed based on their
estimated fair values at the dates of acquisition. The excess costs of the
acquired businesses over the fair values of the assets acquired and liabilities
assumed were recognized as goodwill. The valuations of the acquired assets and
liabilities will impact the determination of future operating results. The
Company used a variety of information sources to determine the values of
acquired assets and liabilities including: third-party appraisers for the value
and lives of identifiable intangible assets and property, plant and equipment;
outside actuaries for defined benefit retirement plans; and legal counsel or
other experts to assess the obligations associated with legal, environmental and
other contingent liabilities.
The Company estimated income taxes in each jurisdiction that it operated.
This involved estimating taxable earnings, specific taxable and deductible
items, the likelihood of generating sufficient future taxable income to utilize
deferred tax assets and possible exposures related to future tax audits. To the
extent these estimates change, adjustments to income taxes will be made in the
period in which the changes occur.
The Company was invested in the United States 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 did not consolidate the operations of the investments. The
carrying amounts of these non-traded investments, which approximate market
value, were determined based on cost less related income tax credits determined
by the effective yield method. See Note 1, on page 46 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 31 of this report.
FINANCIAL CONDITION - 2004
The Company's financial condition remained strong in 2004 due primarily to
improved profitability. The Company ended the year with $45.9 million in cash
and cash equivalents - a decrease of $256.9 million over the end of 2003
primarily as a result of acquisitions made in 2004. The Company's current ratio
decreased to 1.17 at December 31, 2004 from 1.49 at the end of 2003. Total debt
increased to $738.3 million at December 31, 2004 from $513.6 million at the end
of last year and increased as a percentage of total capitalization to 30.9
percent from 26.0 percent at the end of 2003. The lower current ratio and
increased total debt also related primarily to the 2004 acquisitions. Net
operating cash decreased in 2004 to $544.7 million compared to $558.9 million in
2003. The primary factor reducing net operating cash was increased working
capital requirements to support new sales programs. Excess cash from 2003 and
net operating cash and increased short-term borrowings in 2004 provided the
funds necessary to support current year acquisitions of $554.5 million, the
extinguishment of acquired debt of $67.1 million, capital expenditures of $106.8
million, purchases of treasury stock for $267.4 million and payments of $96.9
million in cash dividends. The Consolidated Balance Sheets and Statements of
Consolidated Cash Flows, on pages 42 and 44 of this report, provide more
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 determining a discretionary portion 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 44 of this report. Free Cash Flow as defined
and used by management is determined as follows:
25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(thousands of dollars)
2004 2003 2002
---------- ---------- ----------
NET OPERATING CASH
(PAGE 44) ....................................... $ 544,681 $ 558,929 $ 558,917
CAPITAL EXPENDITURES
(PAGE 44) ....................................... (106,822) (116,507) (126,530)
PAYMENTS OF CASH
DIVIDENDS (PAGE 44) ............................ (96,915) (90,689) (91,007)
--------- --------- ---------
FREE CASH FLOW .................................. $ 340,944 $ 351,733 $ 341,380
========= ========= =========
Goodwill, which represents the excess of cost over the fair value of net
assets acquired in purchase business combinations, increased by a net $336.9
million and intangible assets increased a net $120.7 million in 2004. Increases
in goodwill and intangible assets resulted from acquisitions completed in 2004.
Decreases in intangible assets from adjusting the carrying values of certain
intangibles for impairment as required by SFAS No. 142 and SFAS No. 144,
partially offset the value of acquired intangibles. Foreign currency adjustments
and amortization of intangible assets with finite lives further reduced the net
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 4, pages 52 and 53 of this
report, for a description of the asset impairments recorded in accordance with
SFAS No. 142 and SFAS No. 144 during 2004 and a tabular summary of the carrying
values of goodwill and intangible assets.
Deferred pension assets recognized in the Consolidated Balance Sheets of
$430.2 million at December 31, 2004 represented the recognized portion of the
excess of the fair market value of assets in the Company's defined benefit
pension plans over the actuarially-determined projected benefit obligations. The
2004 increase in deferred pension assets of $10.1 million represented primarily
the recognition of the current year net pension credit of $6.0 million. The net
pension credit increased $3.9 million in 2004 due primarily to a portion of the
actual return on defined benefit pension plan assets in 2003 that exceeded the
expected return on plan assets. A remaining unrecognized actuarial loss in the
Company's defined benefit pension plans at December 31, 2004 related primarily
to past years' lower actual returns on defined benefit pension plan assets,
primarily equity investments, compared to the expected returns and the effects
of changes in assumptions. The expected long-term rate of return on assets
remained at 7.5 percent in 2004 and 2003. The assumed discount rate used to
compute the actuarial present value of projected benefit obligations was
decreased from 6.0 percent to 5.75 percent at December 31, 2004 due to reduced
rates of high-quality, long-term investments. The net pension credit is expected
to remain approximately the same in 2005 due to the net impact of decreasing the
assumed discount rate offset by defined benefit pension plan asset returns that
exceeded the expected return on plan assets in 2004. See Note 7, on pages 55
through 57 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 increased $70.1 million to $720.4
million at December 31, 2004. The increase was due to capital expenditures of
$106.8 million, acquisitions of $67.2 million and favorable foreign currency
translation rates, which were partially offset by depreciation expense of $109.1
million. Capital expenditures during 2004 in the Paint Stores Segment were
primarily attributable to the opening of new paint stores, the purchase of new
automated color matching equipment, the relocation of certain stores and the
normal replacement and upgrading of store equipment. In the Consumer, Automotive
Finishes and International Coatings Segments, capital expenditures during 2004
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 2005, the Company expects to spend
approximately 40 percent more for capital expenditures than in 2004. The
predominant share of the capital expenditures will be due to the planned
construction of a new emulsion plant in the western United States, various
capacity and productivity improvement projects at existing manufacturing and
distribution facilities, new store openings, completion of the rollout of
automated color matching equipment, additional point-of-sale devices 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.
At December 31, 2004, borrowings outstanding under the commercial paper
program totaled $231.2 million due primarily to the current year acquisitions.
The weighted-average interest rate related to these
26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
borrowings was 2.3 percent at December 31, 2004. There were no borrowings
outstanding under the Company's commercial paper program at December 31, 2003 or
2002. Effective July 19, 2004, the Company entered into a new five-year
revolving credit agreement which replaced the prior agreement and which limits
the commercial paper program to a maximum borrowing capability of $650.0
million. The Company uses the revolving credit agreement to satisfy its
commercial paper program's dollar for dollar liquidity requirement. 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 continue to borrow under the commercial paper program during 2005.
Long-term debt, including the current portion, decreased $14.1 million
during 2004 due primarily to the payment of various promissory notes and other
obligations during the year. See Note 8, on pages 59 and 60 of this report, for
a detailed description of the Company's long-term debt outstanding and other
available financing programs.
The Company's long-term liability for postretirement benefits other than
pensions increased $5.1 million to $222.0 million from $216.9 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
6.0 percent to 5.75 percent at December 31, 2004 due to the reduced rates of
high-quality, long-term investments. The assumed health care cost trend rates
for 2005 through 2014 reflect health care cost increase assumptions established
in 2003. Separate assumptions are utilized for health care costs of participants
of pre-65 age and those of 65 and older age. The assumed rates used for 2004
were 9.5 percent for pre-65 age participants and 11.0 percent for those
participants 65 or older, decreasing gradually to 5.0 percent in 2013. See Note
7, on pages 58 and 59 of this report, for further information on the Company's
obligation for postretirement benefits other than pensions.
Other long-term liabilities increased $43.1 million during 2004 due
primarily to current year acquisition-related non-compete liabilities of $22.0
million, increased long-term deferred taxes and taxes payable of $18.6 million
and other obligations. See Note 9, on pages 60 and 61 of this report, for
further information on the Company's long-term liabilities.
Shareholders' equity increased $188.4 million during 2004 to $1,647.2
million at December 31, 2004 from $1,458.9 million last year. The increase in
shareholders' equity resulted from increased retained earnings, increased
capital accounts related primarily to stock option exercises and the reduction
of cumulative other comprehensive loss. Partially offsetting these increases was
the purchase of treasury stock. Retained earnings increased $296.3 million
during 2004 due to net income of $393.2 million partially offset by $96.9
million in cash dividends paid. Net increases in common stock and other capital
of $130.8 million were due primarily to stock option exercises and the tax
impact of certain ESOP transactions. The Company purchased 6.6 million shares of
its common stock during 2004 for treasury at a cost of $267.4 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, 2004 to
purchase 10.4 million shares of its common stock. See the Statements of
Consolidated Shareholders' Equity and Comprehensive Income, on page 45 of this
report, and Notes 10, 11 and 12, on pages 61 through 64 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 $17.8 million in
2004 and $31.8 million in 2003 was attributable to the strengthening in most
foreign operations' functional currencies versus the U.S. dollar except the
Mexican peso. The foreign currency translation loss of $48.3 million in 2002 was
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
27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
decrease in 2002. 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 4, on
pages 52 and 53 of this report, for more information concerning the reduction in
carrying value of long-lived assets.
The Company's cash dividend per common share payout target is 30.0 percent
of the prior year's diluted net income per common share. The 2004 annual cash
dividend of $.68 per common share represented 30.1 percent of 2003 diluted net
income per common share. The 2004 annual dividend represented the twenty-sixth
consecutive year of dividend payments since the dividend was suspended in 1978.
At a meeting held on February 2, 2005, the Board of Directors increased the
quarterly cash dividend to $.205 per common share. This quarterly dividend, if
approved in each of the remaining quarters of 2005, would result in an annual
dividend for 2005 of $.82 per common share or a 30.1 percent payout of 2004
diluted net income per common share.
Management believes that it properly valued the Company's assets and
recorded all known liabilities that existed as of the balance sheet date for
which a value was available or an amount could 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 is also a defendant in legal proceedings arising from the
manufacture and sale of non-lead-based paints which seek recovery based upon
various legal theories, including the failure to adequately warn of potential
exposure to lead during surface preparation when using non-lead-based paint on
surfaces previously painted with lead-based paint. The Company believes that the
litigation 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 and
has requested that the new trial consider all issues, including liability and
damages. A trial has been tentatively scheduled for September 2005. The Company
believes it is possible that additional legal proceedings could be scheduled for
trial in 2005 and in subsequent years in other jurisdictions.
Litigation is inherently subject to many uncertainties. Adverse court
rulings or determinations of liability, among other factors, could affect the
lead pigment and lead-based paint litigation against the Company and encourage
an increase in the number and nature of future claims and proceedings. In
addition, from time to time, various legislation and administrative regulations
have been enacted or proposed to impose obligations on present and former
manufacturers of lead pigments and lead-based paints respecting asserted health
concerns associated with such products and to overturn court decisions in which
the Company and other manufacturers have been successful. Due to the
uncertainties
28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 were included in the normal operating expenses
of conducting business. The Company's capital expenditures, depreciation and
other expenses related to ongoing environmental compliance measures were not
material to the Company's financial condition, liquidity, cash flow or results
of operations during 2004. 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 2005.
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,
2004, 2003 and 2002, the Company had accruals for environmental-related
activities of $141.5 million, $133.4 million and $128.7 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
$117.1 million higher than the accruals at December 31, 2004.
Four of the Company's current and former manufacturing sites, described
below, accounted for the majority of the accruals for environmental-related
activities and the unaccrued maximum of the estimated range of possible outcomes
at December 31, 2004. Included in the accruals of $141.5 million at December 31,
2004 was $92.4 million related directly to these four sites. Of the aggregate
unaccrued exposure of $117.1 million at December 31, 2004, $64.4 million related
to the four
29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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.
The first of the four 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.
Two additional sites relate to a current manufacturing facility located in
Illinois and a contiguous property. The environmental issues at these sites have
been determined to be associated with historical operations of the Company.
While the majority of the investigative work has been completed at these sites
and some remedial actions taken, agreement on a proposed remedial action plan
has not been obtained from the appropriate governmental agency.
The fourth site is a current manufacturing facility in California. Similar
to the Illinois sites 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 four 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. 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. During 2004, the Company
unwound these interest rate swap contracts and paid $1.1 million to the bank for
discontinuation of the contracts. The net payment decreased the carrying amount
of the 6.85% Notes and is being amortized to expense over the remaining maturity
of the Notes. The Company also entered into foreign currency option and forward
contracts to hedge against value changes in foreign currency (see Note 13, on
page 65 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 consolidated leverage covenant. At December
31, 2004, the Company was in compliance with the covenant. The Company's Notes,
Debentures and revolving credit agreement (see Note 8, on pages 59 and 60 of
this report) contain various
30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 commitments to make future
payments under contractual obligations and commercial commitments. The following
table summarizes such obligations and commitments as of December 31, 2004:
(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...................... $ 499,453 $ 11,214 $ 198,005 $ 146 $ 290,088
Operating leases.................... 661,931 155,973 244,915 143,219 117,824
Short-term borrowings............... 238,815 238,815
Purchase obligations (1)............ 177,447 177,447
Other contractual obligations (2)... 43,596 16,518 25,600 1,478
---------- ---------- ---------- ---------- ----------
Total contractual cash obligations.. $1,621,242 $ 599,967 $ 468,520 $ 144,843 $ 407,912
========== ========== ========== ========== ==========
(1) Relates to open purchase orders for raw materials at December 31, 2004.
(2) Other contractual obligations primarily represent the Company's estimated
future capital commitments to its investments in U.S. affordable housing
and historic renovation real estate partnerships, non-compete agreements,
information technology maintenance contracts and various other contractual
obligations.
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 ...... $15,633 $15,633
Surety bonds ................... 27,205 27,205
Other commercial commitments.... 16,921 15,692 $ 476 $ 266 $ 487
------- ------- ------- ------- -------
Total commercial commitments ... $59,759 $58,530 $ 476 $ 266 $ 487
======= ======= ======= ======= =======
The Company offers product warranties for certain products. The specific
terms and conditions of such warranties vary depending on the product or
customer contract requirements. Management estimated and accrued the costs of
unsettled product warranty claims at December 31, 2004, 2003 and 2002 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 2004, 2003 and 2002,
which included customer satisfaction settlements, were as follows:
(thousands of dollars)
2004 2003 2002
-------- -------- --------
Balance at January 1 ..... $ 16,555 $ 15,510 $ 14,074
Charges to expense ....... 32,541 28,745 25,023
Settlements .............. (30,998) (27,700) (23,587)
-------- -------- --------
Balance at December 31.... $ 18,098 $ 16,555 $ 15,510
======== ======== ========
RESULTS OF OPERATIONS - 2004 VS. 2003
Shown below are net sales and the percentage change for the current period
by reportable segment for 2004 and 2003:
(thousands of dollars)
2004 Change 2003
---------- ------ ----------
Paint Stores ............. $3,976,979 14.6% $3,468,857
Consumer ................. 1,296,251 9.0% 1,189,666
Automotive Finishes ...... 514,304 12.6% 456,739
International Coatings.... 318,627 11.7% 285,282
Administrative ........... 7,628 5.7% 7,220
---------- ---- ----------
$6,113,789 13.1% $5,407,764
========== ==== ==========
Consolidated net sales for 2004 increased due primarily to volume
increases from continuing strong domestic architectural paint sales to
contractor and do-it-yourself (DIY) customers, improving sales and market
conditions in domestic industrial maintenance and product finishes and improved
international sales. Consolidated net sales include the operations of five
acquisitions completed at various times after November 2003 including the
operations of two larger acquisitions, Duron and PSB, beginning with the month
of September 2004. The acquisitions increased consolidated net sales $222.6
million, or 4.1 percent, in 2004.
31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net sales in the Paint Stores Segment in 2004 increased due primarily to
continuing strong domestic architectural paint sales to contractor and DIY
customers. Continued improvement of industrial maintenance and product finishes
sales and market conditions also contributed to this Segment's net sales
increase. The acquisition of Duron added 229 stores to this Segment, increased
full year net sales approximately 3.5 percent and was slightly accretive to
operating profit. Net sales from stores opened more than twelve calendar months
increased 10.1 percent for the full year. During 2004, the Paint Stores Segment
opened 67 net new stores, remodeled 10, relocated 35 and transferred 1 store to
the Automotive Finishes Segment. At the end of 2004, this Segment had 2,983
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, primarily by internal growth. In 2004,
the Paint Stores Segment completed its three-year project to remerchandise and
refresh the interior design of 2,265 outdated existing stores. The cost of the
refresh project was charged to current operations and was accomplished primarily
by in-store personnel resulting in a high-impact, low-cost method of enhancing
the shopping environment in the stores.
Consumer Segment net sales increased due primarily to sales from
acquisitions that increased net sales 7.2 percent and new product programs.
Partially offsetting these increases was the elimination of a paint program at
one of the Segment's retail customers and a charge against net sales of $9.8
million due to the impairment of a customer sales incentive program. In 2005,
this Segment plans to continue its aggressive promotions of new and existing
products and expanding its customer base.
The Automotive Finishes Segment's net sales increase for the year resulted
primarily from new product line introductions, improving international sales and
the April 2004 acquisition of a majority interest in Kinlita. Currency exchange
fluctuations relative to last year had a negligible impact on net sales of this
Segment in 2004. There were 200 automotive branches open at the end of 2004 in
the United States, Canada, Chile, Jamaica and Peru. In 2005, this Segment
expects to continue opening new branches, increasing sales in improving
international markets and improving its customer base in a soft domestic market.
Net sales in the International Coatings Segment increased due primarily to
favorable currency exchange fluctuations and sales in local currency that
continued to build during each quarter of 2004 by improving sales trends in
South America and the United Kingdom. During 2003, a change in fiscal year to a
calendar year basis by South American subsidiaries, added an additional month
sales to last year's results. The net impact of favorable currency exchange
fluctuations in 2004 more than offset the additional month sales in 2003 due to
the fiscal year change increasing net sales of this Segment by $9.9 million, or
3.5 percent.
Shown below are operating profit and the percent change for the current
period by reportable segment:
(thousands of dollars)
2004 Change 2003
---------- ------- ----------
Paint Stores ............. $ 480,213 19.0% $ 403,379
Consumer ................. 187,717 (5.7%) 198,984
Automotive Finishes ...... 58,056 10.8% 52,375
International Coatings.... 18,041 115.5% 8,370
Administrative ........... (163,832) (16.9%) (140,182)
--------- ----- ---------
$ 580,195 11.0% $ 522,926
========= ===== =========
Consolidated operating profit in 2004 increased primarily due to increased
sales volume generating an increase in gross profit of $246.1 million that more
than offset increased selling, general and administrative expenses of $187.3
million. The increased gross profit was adversely affected by rapidly rising raw
material prices. As a percent of sales, consolidated gross profit decreased to
44.2 percent from 45.4 percent in 2003. The decrease in gross profit as a
percent of sales was due primarily to raw material cost increases and $12.3
million in impairment charges that included a $9.8 million charge for a customer
sales incentive program.
The Paint Stores Segment's gross profit for 2004 increased $238.8 million
due primarily to increased sales volume and the acquisition of Duron. In the
Consumer Segment, gross profit for 2004 decreased due primarily to the
year-over-year impact of a $12.3 million impairment charge in 2004 for certain
intangible assets and a customer sales incentive program and sharply increasing
raw material costs. The Automotive Finishes Segment's gross profit improved over
2003 due to domestic and foreign sales volume increases, sales of higher margin
new products and profits of the Kinlita acquisition. The International Coatings
Segment's gross profit increased due to the net sales gain and operating
efficiencies related to additional manufacturing volume.
Consolidated selling, general and administrative expenses (SG&A),
increased $187.3 million due primarily to expenses associated with additional
investment in
32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
our businesses but decreased as a percent of sales to 33.8 percent in 2004 from
34.8 percent in 2003. In the Paint Stores Segment, SG&A increased $162.0 million
due primarily to incremental expenses associated with increased sales volume,
continued investments in new stores and acquisitions. The Consumer Segment's
SG&A decreased and the percentage of sales ratio was favorable to last year due
primarily to continued cost control. In the Automotive Segment, SG&A as a
percent of sales remained flat with last year. Lower expenses associated with
the Kinlita acquisition were offset by incremental expenses associated with the
opening of new branches in this Segment. In the International Coatings Segment,
SG&A decreased in U.S. dollar spending and declined as a percentage of sales due
primarily to increased sales levels, favorable currency exchange fluctuations
and tight expense control. In addition to an impairment charge of $2.1 million
for a reduction in the carrying value of certain capitalized software, the
Administrative Segment's SG&A increased in 2004 due to higher interest expense,
more environmental-related provisions, increased expenses of results-related
employee benefits and incentive compensation programs and normal increases in
administrative spending.
The annual impairment review performed as of October 1, 2004 in accordance
with SFAS No. 142, resulted in reductions in the carrying value of certain
trademarks with indefinite lives of $2.5 million, which was charged to Cost of
goods sold in the Consumer Segment. The impairment of trademarks with indefinite
lives was due to a reduction in estimated discounted cash flows for certain
product lines. In addition, the Company also recorded impairments due to change
in circumstances in accordance with SFAS No. 144 for capitalized software of
$2.1 million, which was charged to the Administrative Segment's SG&A, and a
customer sales incentive program of $9.8 million, which was charged to Net sales
in the Consumer Segment. In 2003, an impairment charge was recorded in SG&A of
the Consumer Segment for $1.0 million due to the reduction in fair values of
indefinite-lived intangible assets. An impairment charge of $11.4 million for
capitalized software was also recorded in 2003 and charged to SG&A in the
Consumer and Administrative Segments. See Note 4, on pages 52 and 53 of this
report, for more information concerning the impairment of goodwill, intangible
assets and long-lived assets in accordance with SFAS No. 142 and SFAS No. 144.
Interest expense increased $1.2 million in 2004 versus 2003 due to
increased short-term borrowing and rates that were 125 average basis points
higher in 2004 than in 2003.
Other expense - net decreased $.8 million in 2004 compared to 2003. A
decrease in net expense of financing and investing activities and an increase in
other miscellaneous income items more than offset a $3.7 million increase in
provisions for environmental-related matters. See Note 13, on page 65 of this
report, for more information concerning the Other expense - net caption.
Income before income taxes, minority interest and cumulative effect of
change in accounting principle increased $57.3 million primarily as a result of
increased gross profit exceeding SG&A by $58.9 million. Net income increased
$61.2 million in 2004 due primarily to the increased sales volume, the accretion
to net income by acquisitions of $4.7 million and the favorable effect of a
reduction in the effective tax rate to 32.0 percent in 2004 from 36.5 percent
last year. The reduction in the effective tax rate was due to better performance
in our foreign operations which are taxed at lower rates, favorable changes in
the tax laws, increases in the favorable effect of tax credit investments and an
increase in deductible dividends under the Company's ESOP. For the year, diluted
net income per common share increased to $2.72 per share from $2.26 per share in
2003.
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
33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Statements of Consolidated Cash Flows, on pages 43 and 44 of this report. EBITDA
as used by management is calculated as follows:
(thousands of dollars)
2004 2003 2002
-------- --------- ---------
Net income (Page 43) ..... $393,254 $ 332,058 $ 127,565
Cumulative effect of
change in accounting
principle (Page 43) .... 183,136
Interest expense
(Page 43) .............. 39,948 38,742 40,475
Income taxes (Page 43).... 185,662 190,868 186,463
Depreciation (Page 44) ... 109,058 104,803 103,659
Amortization (Page 44) ... 16,584 11,761 11,989
-------- --------- ---------
EBITDA ................... $744,506 $ 678,232 $ 653,287
======== ========= =========
RESULTS OF OPERATIONS - 2003 VS. 2002
Shown below are net sales and the percentage change for the current period
by reportable segment for 2003 and 2002:
(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 2003 with some improvement in the
last quarter. The domestic automotive refinish market was sluggish in 2003 and
could not maintain sales at the same level as 2002. 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 2003 in most South American currencies improved slightly during
the last half of 2003. A change in the fiscal year of the South American
subsidiaries to a calendar year basis increased consolidated net 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 2003. 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 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. During 2003, a total of 495 stores were remerchandised
and their interior design refreshed bringing the total completed over the
two-year life of the project to 1,335 stores by the end of 2003. 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 2003 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.
The Automotive Finishes Segment's external net sales increase for 2003
resulted primarily from sales improvement in the international operating units
of the Segment that more than offset soft domestic sales. The sales increase for
2003 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 2003. There were 194 automotive branches
open at the end of 2003 in the United States, Canada, Chile, Jamaica and Peru.
External net sales in the International Coatings Segment increased in 2003
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. The change to a calendar year and currency exchange fluctuations
increased net sales for the Segment by $9.7 million for 2003. Sales volume
accounted for the majority of the sales improvement over 2002 as the South
American
34
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 during 2003 continued to be strong compared to
2002. Selective price increases throughout the Segment and some reversal of the
shift to lower priced products during 2002 also helped improve sales in 2003.
Shown below are 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
========= ===== =========
Consolidated gross profit in 2003 increased $116.7 over 2002 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 2003. 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 in 2003 were lower than 2002 due to economic and
competitive pressures and the higher cost of dollar-denominated raw materials.
Consolidated SG&A for 2003 increased $97.1 million, or 5.4 percent, to
$1.88 billion versus $1.78 billion in 2002. As a percent of sales, SG&A
increased to 34.8 percent from 34.4 percent in 2002. Higher SG&A in 2003 was 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 increased $88.3 million in 2003 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 decreased $11.8
million in 2003 and the percentage of sales ratio was favorable to 2002 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 as a percent of sales increased in 2003 over 2002 due primarily to the
sales short 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 increased $7.2 million in U.S. dollar spending during 2003 but
declined as a percentage of sales due primarily to increased sales levels and
tight expense control. The Administrative Segment's SG&A increased $7.5 million
in 2003 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 ($2,495) for the impairment of fair values
of long-lived assets of the Argentine subsidiary in accordance with SFAS No.
144. In accordance with SFAS No. 142, an annual impairment review was conducted
as of October 1, 2002 resulting in an impairment of goodwill and
indefinite-lived intangible assets of $3,607 that was recorded and charged to
Cost of Goods Sold ($801) and SG&A ($2,806). In 2003, an impairment was charged
to SG&A 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 2003 and charged to SG&A for $11,441. See Notes 3 and 4, on pages 51 through
53 of this report, for more information concerning the impairment of goodwill,
intangible assets and long-lived assets in accordance with SFAS No. 142 and SFAS
No. 144.
Paint Stores Segment operating profit for 2003 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 in 2003 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
35
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
in 2003. The operating profit improvement for the Consumer Segment in 2003
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 in 2003 resulted primarily from low sales
volume, related unfavorable manufacturing absorption and a reduction of $1.8
million in the net pension credit compared to 2002. There was no significant
impact on operating profit in this Segment during 2003 from the fiscal year
change or foreign currency fluctuations. The International Segment's 2003
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.
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-related matters that
increased $1.6 million and a reduction in dividend and royalty income of $.5
million. Decreases in foreign currency exchange losses during 2003 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 in 2003 were due primarily to charges
incurred relating to the Company's foreign operations. See Note 13 on page 65 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.
Income before income taxes, minority interest and cumulative effect of
change in accounting principle increased $25.8 million in 2003 primarily as a
result of increased gross profit exceeding SG&A 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 in 2002. For the
full year 2003, 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.
36
REPORT OF MANAGEMENT ON THE
CONSOLIDATED FINANCIAL STATEMENTS
Shareholders
The Sherwin-Williams Company
We are responsible for the preparation and fair presentation of the
consolidated financial statements, accompanying notes and related financial
information included in this report of The Sherwin-Williams Company and its
consolidated subsidiaries (collectively, the "Company") as of December 31, 2004,
2003 and 2002 and for the years then ended in accordance with accounting
principles generally accepted in the United States. The consolidated financial
information included in this report contains certain amounts that were based
upon our best estimates, judgments and assumptions that we believe were
reasonable under the circumstances.
We have conducted an assessment of the effectiveness of internal control
over financial reporting based on criteria established in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. As discussed in the Report of Management on Internal
Control Over Financial Reporting, we concluded that the Company's internal
control over financial reporting was effective as of December 31, 2004.
The Board of Directors pursues its responsibility for the oversight of the
Company's accounting policies and procedures, financial statement preparation
and internal control over financial reporting through the Audit Committee,
comprised exclusively of independent directors. The Audit Committee is
responsible for the appointment and compensation of the independent registered
public accounting firm. The Audit Committee meets at least quarterly with
financial management, internal auditors and the independent registered public
accounting firm to review the adequacy of financial controls, the effectiveness
of the Company's internal control over financial reporting and the nature,
extent and results of the audit effort. Both the internal auditors and the
independent registered public accounting firm have private and confidential
access to the Audit Committee at all times.
We believe that the consolidated financial statements, accompanying notes
and related financial information included in this report fairly reflect the
form and substance of all material financial transactions and fairly present, in
all material respects, the consolidated financial position, results of
operations and cash flows as of and for the periods presented.
/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
37
REPORT OF MANAGEMENT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
Shareholders
The Sherwin-Williams Company
We are responsible for establishing and maintaining accounting and control
systems over financial reporting which are designed to provide reasonable
assurance that the Company has the ability to record, process, summarize and
report reliable financial information. We recognize that internal control over
financial reporting cannot provide absolute assurance of achieving financial
reporting objectives because of its inherent limitations. Internal control over
financial reporting is a process that involves human diligence and is subject to
the possibility of human error or the circumvention or the overriding of
internal control. Therefore, there is a risk that material misstatements may not
be prevented or detected on a timely basis by internal control over financial
reporting. However, we believe we have designed into the process safeguards to
reduce, though not eliminate, this risk. Projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In order to ensure that the Company's internal control over financial
reporting was effective as of December 31, 2004, we conducted an assessment of
its effectiveness under the supervision and with the participation of our
management group. This assessment was based on criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. However, we did not have sufficient
time to conduct an assessment of the effectiveness of internal control over
financial reporting at Duron, Inc. and Paint Sundry Brands Corporation in the
period between the September 1, 2004, acquisition date and December 31, 2004.
The acquired businesses constituted approximately five percent of total and net
assets (excluding goodwill and intangible assets) as of December 31, 2004, and
less than three percent and one percent of revenues and net income,
respectively, for the year then ended. These acquired businesses are excluded
from this report on the effectiveness of internal control over financial
reporting.
Based on our assessment of internal control over financial reporting under
the criteria established in Internal Control - Integrated Framework, we have
concluded that, as of December 31, 2004, the Company's internal control over
financial reporting was effective to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with accounting principles generally
accepted in the United States. Our assessment of the effectiveness of the
Company's internal control over financial reporting as of December 31, 2004 has
been audited by Ernst & Young LLP, an independent registered public accounting
firm, and their report on our assessment is included on pages 39 and 40 of this
report.
/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 THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Shareholders and Board of Directors
The Sherwin-Williams Company
Cleveland, Ohio
We have audited management's assessment, included in the accompanying
Report of Management On Internal Control Over Financial Reporting, that The
Sherwin-Williams Company maintained effective internal control over financial
reporting as of December 31, 2004, based on criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). The
Sherwin-Williams Company's management is responsible for maintaining effective
internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility
is to express an opinion on management's assessment and an opinion on the
effectiveness of the company's internal control over financial reporting based
on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
39
REPORT OF THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING (CONTINUED)
As indicated in the accompanying Report of Management On Internal Control
Over Financial Reporting, management's assessment of and conclusion on the
effectiveness of internal control over financial reporting did not include an
assessment of the effectiveness of internal controls over financial reporting of
Duron, Inc. and Paint Sundry Brands Corporation (the companies). The companies
were acquired September 1, 2004, and have been included in the consolidated
financial statements of The Sherwin-Williams Company since that date. The
companies constituted approximately five percent of total and net assets
(excluding goodwill and intangible assets) as of December 31, 2004, and less
than three percent and one percent of revenues and net income, respectively, for
the year then ended. Our audit of internal control over financial reporting of
The Sherwin-Williams Company also did not include an evaluation of the internal
controls over financial reporting of the companies.
In our opinion, management's assessment that The Sherwin-Williams Company
maintained effective internal control over financial reporting as of December
31, 2004, is fairly stated, in all material respects, based on the COSO
criteria. Also, in our opinion, The Sherwin-Williams Company maintained, in all
material respects, effective internal control over financial reporting as of
December 31, 2004, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheets of The Sherwin-Williams Company as of December 31, 2004, 2003, and 2002,
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, 2004, and our report dated February 10, 2005, expressed an
unqualified opinion thereon.
ERNST & YOUNG LLP
Cleveland, Ohio
February 10, 2005
40
REPORT OF THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM ON THE CONSOLIDATED FINANCIAL STATEMENTS
Shareholders and Board of Directors
The Sherwin-Williams Company
Cleveland, Ohio
We have audited the accompanying consolidated balance sheets of The
Sherwin-Williams Company as of December 31, 2004, 2003 and 2002, 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, 2004. 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 standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
The Sherwin-Williams Company at December 31, 2004, 2003 and 2002, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2004, in conformity with U.S.
generally accepted accounting principles.
As disclosed in Note 3 to the consolidated financial statements, in 2002
the Company changed its method of accounting for goodwill and indefinite-lived
intangible assets.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the effectiveness of The
Sherwin-Williams Company's internal control over financial reporting as of
December 31, 2004, based on criteria established in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission and our report dated February 10, 2005, expressed an
unqualified opinion thereon.
ERNST & YOUNG LLP
Cleveland, Ohio
February 10, 2005
41
CONSOLIDATED BALANCE SHEETS
(thousands of dollars)
December 31,
-------------------------------------------
2004 2003 2002
----------- ----------- -----------
ASSETS
CURRENT ASSETS:
CASH AND CASH EQUIVALENTS ..................................... $ 45,932 $ 302,813 $ 164,012
ACCOUNTS RECEIVABLE, LESS ALLOWANCE ........................... 724,385 544,070 493,935
INVENTORIES:
FINISHED GOODS .............................................. 651,095 552,657 534,984
WORK IN PROCESS AND RAW MATERIALS ........................... 121,757 85,580 89,666
----------- ----------- -----------
772,852 638,237 624,650
DEFERRED INCOME TAXES ......................................... 88,985 86,616 116,228
OTHER CURRENT ASSETS .......................................... 149,774 143,408 107,168
----------- ----------- -----------
TOTAL CURRENT ASSETS ........................................ 1,781,928 1,715,144 1,505,993
GOODWILL ........................................................ 900,444 563,531 552,207
INTANGIBLE ASSETS ............................................... 307,900 187,202 186,039
DEFERRED PENSION ASSETS ......................................... 430,238 420,133 414,589
OTHER ASSETS .................................................... 133,281 146,348 108,884
PROPERTY, PLANT AND EQUIPMENT:
LAND .......................................................... 70,231 58,514 62,069
BUILDINGS ..................................................... 462,964 425,712 436,214
MACHINERY AND EQUIPMENT ....................................... 1,185,420 1,091,215 1,034,286
CONSTRUCTION IN PROGRESS ...................................... 33,013 36,353 44,936
----------- ----------- -----------
1,751,628 1,611,794 1,577,505
LESS ALLOWANCES FOR DEPRECIATION .............................. 1,031,268 961,544 912,905
----------- ----------- -----------
720,360 650,250 664,600
----------- ----------- -----------
TOTAL ASSETS .................................................... $ 4,274,151 $ 3,682,608 $ 3,432,312
=========== =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
SHORT-TERM BORROWINGS ......................................... $ 238,815
ACCOUNTS PAYABLE .............................................. 650,977 $ 587,935 $ 522,339
COMPENSATION AND TAXES WITHHELD ............................... 195,739 168,758 146,987
ACCRUED TAXES ................................................. 95,558 89,081 101,178
CURRENT PORTION OF LONG-TERM DEBT ............................. 11,214 10,596 15,001
OTHER ACCRUALS ................................................ 327,834 297,800 297,991
----------- ----------- -----------
TOTAL CURRENT LIABILITIES ................................... 1,520,137 1,154,170 1,083,496
LONG-TERM DEBT .................................................. 488,239 502,992 506,682
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS ..................... 221,975 216,853 213,749
OTHER LONG-TERM LIABILITIES ..................................... 392,849 349,736 286,495
MINORITY INTEREST ............................................... 3,705
SHAREHOLDERS' EQUITY:
COMMON STOCK - $1.00 PAR VALUE: 140,777,115,
143,406,707 AND 148,910,487 SHARES OUTSTANDING AT
DECEMBER 31, 2004, DECEMBER 31, 2003 AND
DECEMBER 31, 2002, RESPECTIVELY ............................. 216,396 212,409 209,836
PREFERRED STOCK - CONVERTIBLE, PARTICIPATING, NO PAR VALUE:....
171,819, 284,657 AND 41,806 SHARES OUTSTANDING AT
DECEMBER 31, 2004, DECEMBER 31, 2003 AND
DECEMBER 31, 2002, RESPECTIVELY ............................. 171,819 284,657 41,806
UNEARNED ESOP COMPENSATION .................................... (171,819) (284,657) (41,806)
OTHER CAPITAL ................................................. 474,594 347,779 265,635
RETAINED EARNINGS ............................................. 2,695,193 2,398,854 2,157,485
TREASURY STOCK, AT COST ....................................... (1,529,355) (1,270,917) (1,029,894)
CUMULATIVE OTHER COMPREHENSIVE LOSS ........................... (209,582) (229,268) (261,172)
----------- ----------- -----------
TOTAL SHAREHOLDERS' EQUITY .................................. 1,647,246 1,458,857 1,341,890
----------- ----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ...................... $ 4,274,151 $ 3,682,608 $ 3,432,312
=========== =========== ===========
See notes to consolidated financial statements.
42
STATEMENTS OF CONSOLIDATED INCOME
(thousands of dollars except per common share data)
Year ended December 31,
---------------------------------------------
2004 2003 2002
----------- ----------- -----------
NET SALES ............................................... $ 6,113,789 $ 5,407,764 $ 5,184,788
COST OF GOODS SOLD ...................................... 3,412,378 2,952,469 2,846,201
GROSS PROFIT ............................................ 2,701,411 2,455,295 2,338,587
PERCENT TO NET SALES .................................. 44.2% 45.4% 45.1%
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ............ 2,068,936 1,881,664 1,784,527
PERCENT TO NET SALES .................................. 33.8% 34.8% 34.4%
INTEREST EXPENSE ........................................ 39,948 38,742 40,475
INTEREST AND NET INVESTMENT INCOME ...................... (5,533) (6,668) (5,050)
OTHER EXPENSE - NET ..................................... 17,865 18,631 21,471
----------- ----------- -----------
INCOME BEFORE INCOME TAXES, MINORITY INTEREST AND
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE ... 580,195 522,926 497,164
INCOME TAXES ............................................ 185,662 190,868 186,463
MINORITY INTEREST ....................................... 1,279
----------- ----------- -----------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE ............................... 393,254 332,058 310,701
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE -....
NET OF INCOME TAXES OF $64,476 ........................ (183,136)
----------- ----------- -----------
NET INCOME .............................................. $ 393,254 $ 332,058 $ 127,565
=========== =========== ===========
INCOME PER COMMON SHARE:
BASIC:
BEFORE CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE ............................. $ 2.79 $ 2.29 $ 2.07
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE - NET OF INCOME TAXES ..................... (1.22)
----------- ----------- -----------
NET INCOME ............................................ $ 2.79 $ 2.29 $ 0.85
=========== =========== ===========
DILUTED:
BEFORE CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE ............................. $ 2.72 $ 2.26 $ 2.04
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE - NET OF INCOME TAXES ..................... (1.20)
----------- ----------- -----------
NET INCOME ............................................ $ 2.72 $ 2.26 $ 0.84
=========== =========== ===========
See notes to consolidated financial statements.
43
STATEMENTS OF CONSOLIDATED CASH FLOWS
(thousands of dollars)
Year Ended December 31,
-------------------------------------
2004 2003 2002
--------- --------- ---------
OPERATING ACTIVITIES
NET INCOME ...................................................... $ 393,254 $ 332,058 $ 127,565
ADJUSTMENTS TO RECONCILE NET INCOME TO NET OPERATING CASH:
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE ........... 183,136
DEPRECIATION .................................................. 109,058 104,803 103,659
AMORTIZATION OF INTANGIBLE ASSETS ............................. 16,584 11,761 11,989
IMPAIRMENT OF LONG-LIVED ASSETS ............................... 14,556 12,454 19,948
PROVISIONS FOR QUALIFIED EXIT COSTS ........................... 2,737 14 262
PROVISIONS FOR ENVIRONMENTAL-RELATED MATTERS .................. 13,953 10,237 8,609
DEFERRED INCOME TAXES ......................................... 17,227 39,872 19,747
DEFINED BENEFIT PENSION PLANS NET CREDIT ...................... (5,992) (2,072) (23,013)
INCOME TAX EFFECT OF ESOP ON OTHER CAPITAL .................... 19,304 24,665 22,380
AMORTIZATION OF RESTRICTED STOCK EXPENSE ...................... 11,642 5,641 3,097
INCOME TAX EFFECT OF NON-QUALIFIED STOCK OPTION EXERCISES ..... 20,932 6,944 5,776
NET INCREASE IN POSTRETIREMENT LIABILITY ...................... 5,122 3,904 4,086
FOREIGN CURRENCY RELATED LOSSES ............................... 1,699 1,460 8,435
DECREASE IN NON-TRADED INVESTMENTS ............................ 24,331 20,276 9,278
OTHER ......................................................... 959 (2,069) 2,787
CHANGE IN WORKING CAPITAL ACCOUNTS:
(INCREASE) DECREASE IN ACCOUNTS RECEIVABLE .................... (89,039) (39,361) 3,588
INCREASE IN INVENTORIES ....................................... (62,702) (153) (229)
INCREASE IN ACCOUNTS PAYABLE .................................. 33,419 60,149 81,733
INCREASE (DECREASE) IN ACCRUED TAXES .......................... 6,135 (12,117) (5,483)
OTHER ......................................................... 21,779 (4,027) 4,778
COSTS INCURRED FOR ENVIRONMENTAL - RELATED MATTERS .............. (8,712) (7,005) (12,036)
COSTS INCURRED FOR QUALIFIED EXIT COSTS ......................... (3,514) (1,580) (3,663)
OTHER ........................................................... 1,949 (6,925) (17,512)
--------- --------- ---------
NET OPERATING CASH ............................................ 544,681 558,929 558,917
INVESTING ACTIVITIES
CAPITAL EXPENDITURES ............................................ (106,822) (116,507) (126,530)
ACQUISITIONS OF BUSINESSES ...................................... (554,478) (48,374) (26,649)
INCREASE IN OTHER INVESTMENTS ................................... (12,739) (27,875) (16,144)
PROCEEDS FROM SALE OF ASSETS .................................... 605 47,847 11,778
OTHER ........................................................... (8,447) 8,856 (15,016)
--------- --------- ---------
NET INVESTING CASH ............................................ (681,881) (136,053) (172,561)
FINANCING ACTIVITIES
NET INCREASE IN SHORT-TERM BORROWINGS ........................... 238,815
PAYMENTS OF LONG-TERM DEBT ...................................... (14,135) (8,095) (95,305)
PAYMENTS OF ACQUIRED DEBT ....................................... (67,131)
PAYMENTS OF CASH DIVIDENDS ...................................... (96,915) (90,689) (91,007)
PROCEEDS FROM STOCK OPTIONS EXERCISED ........................... 88,489 47,468 37,516
TREASURY STOCK PURCHASED ........................................ (267,358) (238,148) (190,320)
OTHER ........................................................... (5,157) (1,310) (4,727)
--------- --------- ---------
NET FINANCING CASH ............................................ (123,392) (290,774) (343,843)
EFFECT OF EXCHANGE RATE CHANGES ON CASH ......................... 3,711 6,699 2,685
--------- --------- ---------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS ............ (256,881) 138,801 45,198
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR .................. 302,813 164,012 118,814
--------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR ........................ $ 45,932 $ 302,813 $ 164,012
========= ========= =========
TAXES PAID ON INCOME ............................................ $ 114,908 $ 106,950 $ 103,447
INTEREST PAID ON DEBT ........................................... 39,731 39,029 42,041
See notes to consolidated financial statements.
44
STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(thousands of dollars except per common share data)
Unearned
ESOP
Common Preferred Compen- Other Retained Treasury
Stock Stock sation Capital Earnings Stock
-------- --------- -------- ------- -------- --------
BALANCE AT JANUARY 1, 2002 .............. $208,031 $ 168,305 $(168,305) $ 200,643 $2,120,927 $ (837,284)
COMPREHENSIVE INCOME:
NET INCOME ............................ 127,565
FOREIGN CURRENCY TRANSLATION ..........
MINIMUM PENSION LIABILITY,
NET OF TAXES OF $3,572 ..............
COMPREHENSIVE INCOME ................
TREASURY STOCK PURCHASED ................ (3,040) (187,280)
REDEMPTION OF PREFERRED STOCK ........... (126,499) 126,499
INCOME TAX EFFECT OF ESOP ............... 22,380
STOCK ISSUED (TENDERED) FOR
EXERCISE OF OPTIONS ................... 1,792 41,498 (4,562)
STOCK TENDERED IN CONNECTION
WITH RESTRICTED STOCK GRANTS .......... (768)
RESTRICTED STOCK GRANTS (NET ACTIVITY) .. 13 3,082
STOCK ACQUIRED FOR TRUST ................ (76)
REVOCABLE TRUST STOCK SOLD -
INCLUDING REALIZED GAIN ............... 1,148
CASH DIVIDENDS--$.60 PER COMMON SHARE.... (91,007)
-------- --------- --------- ---------- ---------- -----------
BALANCE AT DECEMBER 31, 2002 ............ 209,836 41,806 (41,806) 265,635 2,157,485 (1,029,894)
COMPREHENSIVE INCOME:
NET INCOME ............................ 332,058
FOREIGN CURRENCY TRANSLATION ..........
MINIMUM PENSION LIABILITY,
NET OF TAXES OF ($35) ...............
COMPREHENSIVE INCOME ................
TREASURY STOCK PURCHASED ................ (238,148)
ISSUANCE OF PREFERRED STOCK
TO PRE-FUND ESOP ...................... 350,000 (350,000)
REDEMPTION OF PREFERRED STOCK ........... (107,149) 107,149
INCOME TAX EFFECT OF ESOP ............... 24,665
STOCK ISSUED (TENDERED) FOR
EXERCISE OF OPTIONS ................... 2,172 52,239 (743)
STOCK TENDERED IN CONNECTION
WITH RESTRICTED STOCK GRANTS .......... (2,132)
RESTRICTED STOCK GRANTS (NET ACTIVITY) .. 401 5,240
CASH DIVIDENDS--$.62 PER COMMON SHARE.... (90,689)
-------- --------- --------- ---------- ---------- -----------
BALANCE AT DECEMBER 31, 2003 ............ 212,409 284,657 (284,657) 347,779 2,398,854 (1,270,917)
COMPREHENSIVE INCOME:
NET INCOME ............................ 393,254
FOREIGN CURRENCY TRANSLATION ..........
MINIMUM PENSION LIABILITY,
NET OF TAXES OF ($597) ..............
UNREALIZED GAIN ON MARKETABLE EQUITY
SECURITIES, NET OF TAXES OF ($328) ..
COMPREHENSIVE INCOME ................
TREASURY STOCK PURCHASED ................ (9,565) (257,793)
REDEMPTION OF PREFERRED STOCK ........... (112,838) 112,838
INCOME TAX EFFECT OF ESOP ............... 19,304
STOCK ISSUED (TENDERED) FOR
EXERCISE OF OPTIONS ................... 3,702 105,719 (645)
RESTRICTED STOCK GRANTS (NET ACTIVITY) .. 285 11,357
CASH DIVIDENDS--$.68 PER COMMON SHARE.... (96,915)
-------- --------- --------- ---------- ---------- -----------
BALANCE AT DECEMBER 31, 2004 ............ $216,396 $ 171,819 $(171,819) $ 474,594 $2,695,193 $(1,529,355)
======== ========= ========= ========== ========== ===========
Cumulative
Other
Comprehensive
Income
(Loss) Total
------------- -----
BALANCE AT JANUARY 1, 2002 .............. $ (204,553) $1,487,764
COMPREHENSIVE INCOME:
NET INCOME ............................ 127,565
FOREIGN CURRENCY TRANSLATION .......... (48,285) (48,285)
MINIMUM PENSION LIABILITY,
NET OF TAXES OF $3,572 .............. (8,334) (8,334)
----------
COMPREHENSIVE INCOME ................ 70,946
TREASURY STOCK PURCHASED ................ (190,320)
REDEMPTION OF PREFERRED STOCK ...........
INCOME TAX EFFECT OF ESOP ............... 22,380
STOCK ISSUED (TENDERED) FOR
EXERCISE OF OPTIONS ................... 38,728
STOCK TENDERED IN CONNECTION
WITH RESTRICTED STOCK GRANTS .......... (768)
RESTRICTED STOCK GRANTS (NET ACTIVITY) .. 3,095
STOCK ACQUIRED FOR TRUST ................ (76)
REVOCABLE TRUST STOCK SOLD -
INCLUDING REALIZED GAIN ............... 1,148
CASH DIVIDENDS--$.60 PER COMMON SHARE.... (91,007)
---------- ----------
BALANCE AT DECEMBER 31, 2002 ............ (261,172) 1,341,890
COMPREHENSIVE INCOME:
NET INCOME ............................ 332,058
FOREIGN CURRENCY TRANSLATION .......... 31,822 31,822
MINIMUM PENSION LIABILITY,
NET OF TAXES OF ($35) ............... 82 82
----------
COMPREHENSIVE INCOME ................ 363,962
TREASURY STOCK PURCHASED ................ (238,148)
ISSUANCE OF PREFERRED STOCK
TO PRE-FUND ESOP ......................
REDEMPTION OF PREFERRED STOCK ...........
INCOME TAX EFFECT OF ESOP ............... 24,665
STOCK ISSUED (TENDERED) FOR
EXERCISE OF OPTIONS ................... 53,668
STOCK TENDERED IN CONNECTION
WITH RESTRICTED STOCK GRANTS .......... (2,132)
RESTRICTED STOCK GRANTS (NET ACTIVITY) .. 5,641
CASH DIVIDENDS--$.62 PER COMMON SHARE.... (90,689)
---------- ----------
BALANCE AT DECEMBER 31, 2003 ............ (229,268) 1,458,857
COMPREHENSIVE INCOME:
NET INCOME ............................ 393,254
FOREIGN CURRENCY TRANSLATION .......... 17,782 17,782
MINIMUM PENSION LIABILITY,
NET OF TAXES OF ($597) .............. 1,394 1,394
UNREALIZED GAIN ON MARKETABLE EQUITY
SECURITIES, NET OF TAXES OF ($328) .. 510 510
----------
COMPREHENSIVE INCOME ................ 412,940
TREASURY STOCK PURCHASED ................ (267,358)
REDEMPTION OF PREFERRED STOCK ...........
INCOME TAX EFFECT OF ESOP ............... 19,304
STOCK ISSUED (TENDERED) FOR
EXERCISE OF OPTIONS ................... 108,776
RESTRICTED STOCK GRANTS (NET ACTIVITY) .. 11,642
CASH DIVIDENDS--$.68 PER COMMON SHARE.... (96,915)
---------- ----------
BALANCE AT DECEMBER 31, 2004 ............ $ (209,582) $1,647,246
========== ==========
See notes to consolidated financial statements.
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
NOTE 1--SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION. The consolidated financial statements include the accounts
of The Sherwin-Williams Company, 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, judgments and assumptions that affect the
amounts reported in the consolidated financial statements and accompanying
notes. Actual results could differ from those amounts.
NATURE OF OPERATIONS. The Company is engaged in the 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 18.
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 to estimate 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: Two separate funds maintained for payment
of certain employee benefits include investments that are classified as
available for sale securities. The fair values of such investments, based
on quoted market prices, included in a health care benefits fund reported
in Other current assets were $3, $827 and $4,092 at December 31, 2004,
2003 and 2002, respectively. The fair values of such investments, based on
quoted market prices, included in a nonqualified benefits fund reported in
Other assets were $9,853 and $20,643 at December 31, 2004 and 2003,
respectively. There were no available for sale investments in this fund at
December 31, 2002. The fair values of other investments, based on quoted
market prices, included in a non-qualified benefits fund reported in Other
assets were $6,568, $1,910 and $18,560 at December 31, 2004, 2003 and
2002.
NON-TRADED INVESTMENTS: The Company has invested 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 Financial Accounting
Standards Board (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 $24,356, $20,695 and $11,117 at December 31, 2004, 2003 and
2002, 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.
SHORT-TERM BORROWINGS: The carrying amounts reported in the
consolidated balance sheets for short-term borrowings approximate fair
value.
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 8.
DECEMBER 31,
----------------------------------------------------------
2004 2003 2002
------------------ ------------------ ------------------
CARRYING FAIR Carrying Fair Carrying Fair
AMOUNT VALUE Amount Value Amount Value
-------- ----- -------- ----- -------- -----
PUBLICLY TRADED DEBT... $489,609 $557,798 $505,621 $574,106 $508,134 $543,971
NON-TRADED DEBT........ 9,844 8,553 8,786 8,068 13,549 12,390
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
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 and 2002 primarily
to hedge against interest rate risks. See Note 8. The Company also entered
into option and forward currency exchange contracts in 2004, 2003 and 2002
primarily to hedge against foreign currency risk exposure. See Note 13.
The Company does not use derivative instruments for speculative or trading
purposes.
GOODWILL. Goodwill represents the cost in excess of fair value of net
assets acquired in business combinations accounted for by the purchase method.
Effective January 1, 2002, the Company adopted SFAS No. 142 that discontinued
amortization of goodwill and requires goodwill to be tested periodically for
impairment. See Note 4.
INTANGIBLE ASSETS. Intangible assets include trademarks, non-compete
covenants and certain intangible property rights. Pursuant to the adoption of
SFAS No. 142, trademarks have been classified as indefinite-lived assets and
amortization was discontinued effective January 1, 2002. The cost of non-compete
covenants and certain intangible property rights are amortized on a
straight-line basis over the expected period of benefit as follows:
Useful Life
-----------
Non-compete covenants .................. 2 - 7 years
Certain intangible property rights ..... 3 - 20 years
Accumulated amortization of intangible assets was $130,865, $114,833 and
$106,868 at December 31, 2004, 2003 and 2002, respectively. See Note 4.
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 during 2003 and 2002 was included in Other
expense - net. Such expense was immaterial to Income before income taxes,
minority interest and cumulative effect of change in accounting principle. A
receivable of $325 and $9,841 for the remaining amounts due under the program
was included in Other assets at December 31, 2004 and 2003, respectively.
IMPAIRMENT OF LONG-LIVED ASSETS. In accordance with Statement of Financial
Accounting Standards (SFAS) No. 144, management evaluates the recoverability and
estimated remaining lives of long-lived assets whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable or the
useful life has changed. See Note 4.
PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment is stated on
the basis of cost. Depreciation is provided by the straight-line method. The
major classes of assets and ranges of annual 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 2005, provide credit availability to the various beneficiaries
if certain contractual events occur. Amounts outstanding under these agreements
totaled $15,633, $13,282 and $13,273 at December 31, 2004, 2003 and 2002,
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 translated the local currency asset and liability
accounts at year-end exchange rates while income and expense accounts were
translated at average exchange rates. The resulting translation adjustments were
included in Cumulative other comprehensive loss, a component of Shareholders'
equity.
COMPREHENSIVE INCOME. At December 31, 2004, 2003 and 2002, the ending
accumulated balance of Cumulative other comprehensive loss included adjustments
for foreign currency translation of $203,234, $221,016 and $252,838,
respectively, a minimum pension liability of $6,858, $8,252 and $8,334,
respectively, and at December 31, 2004 only, an adjustment for unrealized gains
on marketable equity securities of $510.
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
REVENUE RECOGNITION. All revenues were recognized when products were
shipped and title had passed to unaffiliated customers.
CUSTOMER AND VENDOR CONSIDERATIONS. The Company offered certain customers
rebate and sales incentive programs which were classified as reductions in Net
sales. Such programs were in the form of volume rebates, rebates that
constituted a percentage of sales or rebates for attaining certain sales goals.
The Company received consideration from certain suppliers of raw materials in
the form of volume rebates or rebates that constituted a percentage of
purchases. These rebates were recognized on an accrual basis by the Company as a
reduction of the purchase price of the raw materials and a subsequent reduction
of Cost of goods sold when the related product was sold.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. The Company has recorded an allowance for
doubtful accounts to reduce accounts receivable to their net realizable value.
The allowance was based upon an analysis of historical bad debts, a review of
the aging of accounts receivable and the current creditworthiness of customers.
SHIPPING AND HANDLING COSTS. All costs the Company incurred to ship
products were included in Cost of goods sold in the Statements of Consolidated
Income.
TECHNICAL EXPENDITURES. Total technical expenditures included research and
development costs, quality control, product formulation expenditures and other
similar items. Research and development costs included in technical expenditures
were $34,313, $34,391 and $36,019 for 2004, 2003 and 2002, respectively.
ADVERTISING EXPENSES. The cost of advertising was expensed as incurred.
The Company incurred $239,953, $238,754 and $221,572 in advertising costs during
2004, 2003 and 2002, respectively.
MINORITY INTEREST. Minority interest reflects the minority shareholders'
interest in the net income and equity of Sherwin-Williams Kinlita Co., Ltd.
(Kinlita).
ENVIRONMENTAL MATTERS. Capital expenditures for ongoing environmental
compliance measures were recorded in the Consolidated Balance Sheets, and
related expenses were included in the normal operating expenses of conducting
business. The Company is involved with environmental investigation and
remediation activities at some of its current and former sites and at a number
of third-party sites. The Company accrued for environmental remediation-related
activities for which commitments or clean-up plans have been developed and for
which costs could be reasonably estimated based on industry standards and
historical experience. All accrued amounts were recorded on an undiscounted
basis. Accrued environmental remediation-related expenses included direct costs
of investigation and remediation and indirect costs such as compensation and
benefits for employees directly involved in the investigation and remediation
activities and fees paid to outside engineering, consulting and law firms. See
Notes 9 and 13.
EMPLOYEE STOCK PURCHASE AND SAVINGS PLAN AND PREFERRED STOCK. The Company
accounts for the employee stock purchase and savings plan (ESOP) in accordance
with Statement of Position (SOP) No. 93-6, "Employers' Accounting for Employee
Stock Ownership Plans." The Company recognized compensation expense for amounts
contributed to the ESOP and the ESOP used dividends on unallocated preferred
shares to service debt. Unallocated preferred shares held by the ESOP were not
considered outstanding in calculating earnings per share of the Company. See
Note 11.
STOCK-BASED COMPENSATION. At December 31, 2004, the Company had two
stock-based compensation plans, as more fully described in Note 12, 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. Pro-forma information regarding the impact of
stock-based compensation on net income and income 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:
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
2004 2003 2002
---- ---- ----
NET INCOME, AS REPORTED ..... $393,254 $332,058 $127,565
ADD: TOTAL STOCK-BASED
COMPENSATION EXPENSE
INCLUDED IN THE
DETERMINATION OF NET
INCOME AS REPORTED, NET
OF RELATED TAX EFFECTS .... 7,778 3,667 2,013
LESS: TOTAL STOCK-BASED
COMPENSATION EXPENSE
DETERMINED UNDER FAIR
VALUE BASED METHOD FOR
ALL AWARDS, NET OF
RELATED TAX EFFECTS ....... (14,576) (12,138) (11,455)
-------- -------- --------
PRO-FORMA NET INCOME ........ $386,456 $323,587 $118,123
======== ======== ========
INCOME PER SHARE:
BASIC - AS REPORTED ....... $ 2.79 $ 2.29 $ .85
BASIC - PRO-FORMA ......... $ 2.74 $ 2.23 $ .79
DILUTED - AS REPORTED ..... $ 2.72 $ 2.26 $ .84
DILUTED - PRO-FORMA ....... $ 2.67 $ 2.20 $ .78
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:
2004 2003 2002
---- ---- ----
RISK-FREE INTEREST RATE ............... 2.87% 2.24% 2.15%
EXPECTED LIFE OF OPTION ............... 3 YEARS 3 years 3 years
EXPECTED DIVIDEND YIELD OF STOCK ...... 2.28% 2.28% 2.18%
EXPECTED VOLATILITY OF STOCK .......... .225 .290 .333
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 11) and common stock held in a revocable trust
(see Note 10) were 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 were computed based on the
weighted-average number of common shares outstanding during the year. Diluted
income per common share amounts were computed based on the weighted-average
number of common shares outstanding plus all dilutive securities potentially
outstanding during the year. See Note 15. 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 estimated and accrued
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 2004,
2003 and 2002, including customer satisfaction settlements during the year, were
as follows:
2004 2003 2002
---- ---- ----
Balance at January 1 ........ $ 16,555 $ 15,510 $ 14,074
Charges to expense .......... 32,541 28,745 25,023
Settlements ................. (30,998) (27,700) (23,587)
-------- -------- --------
Balance at December 31 ...... $ 18,098 $ 16,555 $ 15,510
======== ======== ========
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS. In April 2004, the
Emerging Issues Task Force (EITF) issued EITF No. 03-6, "Participating
Securities and the Two-Class Method Under FASB Statement No. 128, Earnings Per
Share." EITF No. 03-6 addresses a number of questions regarding the computation
of earnings per share by companies that have issued securities other than common
stock that contractually entitle the holder to participate in dividends and
earnings of the company when, and if, it declares dividends on its common stock.
The pronouncement also provides further guidance in applying the two-class
method of calculating earnings per share, clarifying what constitutes a
participating security and how to apply the two-class method of computing
earnings per share once it is determined that a security is participating,
including how to allocate undistributed earnings to such a security. EITF No.
03-6 is effective for fiscal periods beginning after March 31, 2004. Adoption of
this pronouncement had no significant effect on the Company's reported
earnings per share.
In May 2004, the FASB issued FASB Staff Position (FSP) Financial
Accounting Standard (FAS) No. 106-2
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003." FSP FAS No. 106-2 is effective
for interim or annual periods beginning after June 15, 2004. See Note 7 for the
effect of FSP FAS No. 106-2.
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment,"
that addresses the accounting transactions in which a company exchanges its
equity instruments for goods or services. It also addresses transactions in
which a company incurs liabilities in exchange for goods or services that are
based on the fair value of the entity's equity instruments or that may be
settled by the issuance of those equity instruments. SFAS No. 123R eliminates
the ability to account for share-based compensation transactions using APBO No.
25 and requires instead that such transactions be accounted for using a
fair-value-based method. SFAS No. 123R requires the tax benefit associated with
these share based payments to be classified as financing activities in the
statement of cash flows. Adoption of SFAS No. 123R is effective for periods
beginning after June 15, 2005. The Company will adopt this statement as
required, and management is currently assessing the effect SFAS No. 123R will
have on the Company's results of operations, financial condition or liquidity.
In December 2004, the FASB issued SFAS No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4," which requires that abnormal amounts of
idle facility expense, freight, handling costs and wasted material (spoilage) be
recognized as current-period charges. In addition, the statement requires that
allocation of fixed production overheads to the costs of conversion be based on
the normal capacity of the production facilities. SFAS No. 151 is effective for
fiscal years beginning after June 15, 2005. The Company will adopt this
statement as required, and management does not believe the adoption will have a
material effect on the Company's results of operations, financial condition or
liquidity.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29," which eliminates the exception for
nonmonetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of nonmonetary assets that do not have
commercial substance. The statement defines a nonmonetary exchange with
commercial substance as one in which the future cash flows of an entity are
expected to change significantly as a result of the exchange. SFAS No. 153 is
effective for fiscal years beginning after June 15, 2005. The Company will adopt
this statement as required, and management does not believe the adoption will
have a material effect on the Company's results of operations, financial
condition or liquidity.
In December 2004, the FASB issued FSP FAS No. 109-1, "Application of FASB
Statement No. 109, Accounting for Income Taxes, for the Tax Deduction Provided
to U.S. Based Manufacturers by the American Jobs Creation Act of 2004." This
statement requires the qualified production activities deduction as defined in
the American Jobs Creation Act of 2004 (the Jobs Act) to be accounted for as a
special deduction in accordance with SFAS No. 109, "Accounting for Income
Taxes." The statement also requires that the special deduction should be
considered in measuring deferred taxes when graduated tax rates are a
significant factor and when assessing whether a valuation allowance is
necessary. FSP FAS No. 109-1 was effective upon issuance. In accordance with the
Jobs Act, determination of the qualified production activities deduction is not
required until 2005. Management is currently assessing the effect this statement
will have on the Company's results of operations, financial condition and
liquidity.
In December 2004, the FASB issued FSP FAS No. 109-2, "Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision within the
American Jobs Creation Act of 2004." This statement allows additional time
beyond the financial reporting period of enactment to evaluate the effect of the
Jobs Act on the Company's plan for reinvestment or repatriation of foreign
earnings for purposes of applying SFAS No. 109. FSP FAS No. 109-2 was effective
upon issuance. After the issuance of FSP FAS No. 109-2 and prior to December 31,
2004, the Company completed its plan for repatriation of foreign earnings under
the Jobs Act. See Note 14 for discussion of the effect the Jobs Act had on the
Company's plan for repatriation of foreign earnings.
RECLASSIFICATION. Certain amounts in the 2003 and 2002 consolidated
financial statements have been reclassified to conform with the 2004
presentation.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
NOTE 2--ACQUISITIONS
During the second quarter of 2004, the Company acquired a majority
interest in Kinlita for $6,982 paid in cash. Kinlita, included in the Automotive
Finishes Segment, supplies coatings to original equipment truck and bus
manufacturers in the Peoples Republic of China. The acquisition was accounted
for as a purchase, with results of operations included in the consolidated
financial statements beginning with the month of April 2004. The Kinlita
acquisition resulted in the recognition of goodwill and was completed primarily
to participate in the growing Chinese automotive coatings market. See Note 4 for
discussion of goodwill acquired with the acquisition of Kinlita.
During the third quarter of 2004, the Company completed its acquisitions
of 100% of the stock of Duron, Inc. (Duron) and Paint Sundry Brands Corporation
(PSB) for an aggregate consideration of $640,625, and the assumption of certain
financial obligations. Both acquisitions were financed through the use of cash,
liquidated short-term investments and $350,000 in proceeds from the sale of
commercial paper under the Company's existing commercial paper program. Both
acquisitions were accounted for as purchases, with results of operations
included in the consolidated financial statements beginning with the month of
September 2004.
Duron, included in the Paint Stores Segment, is a leading coatings company
in the eastern and southeastern portion of the United States servicing the
professional painting contractor, builder and do-it-yourself markets through 229
company-operated stores. PSB, included in the Consumer Segment, provides high
quality paint applicators to professional paint contractors and do-it-yourself
users in the United States, Canada and the United Kingdom under the Purdy(R),
Bestt Liebco(R) and other brands. The Duron and PSB acquisitions resulted in the
recognition of goodwill and were completed primarily to assist with the
continued implementation of the Company's growth strategy of supplying high
quality products and services to professional paint contractors and
do-it-yourself users through various channels of distribution. See Note 4 for
discussion of goodwill and intangible assets acquired with the acquisitions of
Duron and PSB.
The following unaudited pro-forma summary presents consolidated financial
information as if Kinlita, Duron and PSB had been acquired at the beginning of
each period presented. The pro-forma consolidated financial information does not
necessarily reflect the actual results that would have occurred had the
acquisitions taken place on January 1, 2002 or of future results of operations
of the combined companies under ownership and operation of the Company.
2004 2003 2002
----------- ----------- -----------
Net sales ............ $ 6,450,573 $ 5,878,713 $ 5,632,754
Net income (1) ....... 379,597 363,411 152,024
Net income per
common share:
Basic (1)........... 2.70 2.51 1.01
Diluted (1) ........ 2.62 2.47 1.00
(1) Included in the reported pro-forma net income for 2004 are material charges
of $30,500 paid by Duron for settlement of certain compensation arrangements
incurred prior to closing and $4,781 paid by PSB for loan origination fees
written off prior to closing.
NOTE 3--CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE
Effective January 1, 2002, the Company adopted SFAS No. 142. 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 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.
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
NOTE 4--GOODWILL, INTANGIBLE AND
LONG-LIVED ASSETS
During 2004, the Company recognized goodwill in the acquisitions of Duron,
PSB and Kinlita of $116,208, $212,082 and $4,944, respectively. Identifiable
intangible assets valued in the acquisitions were trademarks of $41,300, a
covenant not to compete of $33,000 and a customer list of $10,600 for Duron and
trademarks of $44,300, a customer list of $8,800 and a patent of $1,550 for PSB.
Acquired intangible assets subject to amortization are being amortized over
weighted-average periods of 3 years for the non-compete covenant, 11 years for
the customer lists and 13.5 years for the patent. No significant residual value
was estimated for these assets.
During 2003, the Company recorded additions of $19,555 in intangible
assets, primarily related to $17,540 of technology-based assets of Accurate
Dispersions. Acquired intangible assets subject to amortization are being
amortized over weighted-average periods of 7 years for software and 17 years for
all other intangible assets. No significant residual value was estimated for
these assets.
In accordance with SFAS No. 144, whenever events or changes in
circumstances indicated that the carrying value of long-lived assets may not be
recoverable or the useful life had changed, impairment tests were performed.
Undiscounted cash flows were used to calculate the fair value of long-lived
assets to determine if such assets were impaired. Where impairment was
identified, a discounted cash flow valuation model, incorporating discount rates
commensurate with the risks involved for each group of assets, was used to
determine the fair value for the assets.
During 2004, an impairment test was performed for capitalized software
costs due to the replacement and significant changes in the utilization of
certain software. A reduction in the carrying value of capitalized software
costs of $2,085 was charged to Selling, general and administrative expenses in
the Administrative Segment. Assets related to a customer sales incentive program
were tested for impairment due to lower than anticipated sales performance,
resulting in a reduction in carrying value and a charge of $9,790 to Net sales
in the Consumer Segment. A reduction in the carrying value of certain
manufacturing equipment in the Consumer Segment of $133 was charged to Cost of
goods sold.
During 2003, an impairment test was performed for capitalized software
costs 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 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.
Also during 2002, an impairment of other long-lived assets in the Consumer
Segment was deemed probable relating to capitalized software costs 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.
Goodwill and trademarks with indefinite lives are required by SFAS No. 142
to be periodically tested for impairment. October 1 has been established for the
annual impairment review. Fair values are estimated separately for goodwill and
trademarks with indefinite lives 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, 2004 resulted
in reductions in the carrying value of certain trademarks with indefinite lives
of $2,548, which was charged to Cost of goods sold in the Consumer Segment. The
impairment of trademarks with indefinite lives related to reduction in estimated
discounted cash flows.
The annual impairment review performed as of October 1, 2003 resulted in
reductions in the carrying value of certain trademarks with indefinite lives of
$1,013, which was charged to Selling, general and administrative expenses in the
Consumer Segment. The impairment of trademarks with indefinite lives related to
lower-than-anticipated sales of certain acquired domestic brands.
The annual impairment review performed as of October 1, 2002 resulted in
reductions in the carrying values of goodwill of $2,401 and trademarks with
indefinite lives of $1,206. The total of $3,607 was charged to Cost of goods
sold ($801) and Selling, general and
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
administrative expenses ($2,806). 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 trademarks with
indefinite lives related to lower-than-anticipated sales of certain acquired
domestic and international brands.
Amortization of finite-lived intangible assets is as follows for the next
five years: $23,200 in 2005, $21,500 in 2006, $17,000 in 2007, $8,300 in 2008
and $7,300 in 2009.
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, 2002 ............ $ 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
ACQUISITIONS ........................ 116,208 215,362 4,944 336,514
CURRENCY AND OTHER ADJUSTMENTS ...... 3 18 378 399
--------- --------- --------- ----------
BALANCE AT DECEMBER 31, 2004 .......... $ 206,014 $ 661,506 $ 32,924 $ 900,444
========= ========= ========= ==========
A summary of changes in 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, 2004
- ---------------------------------------
WEIGHTED-AVERAGE AMORTIZATION PERIOD .. 10 YEARS 9 YEARS 10 YEARS
GROSS ................................. $ 61,405 $ 141,192 $ 202,597 $ 236,168 $ 438,765
ACCUMULATED AMORTIZATION .............. (22,468) (70,009) (92,477) (38,388) (130,865)
---------- ---------- ---------- --------- ----------
NET VALUE ........................... $ 38,937 $ 71,183 $ 110,120 $ 197,780 $ 307,900
========== ========== ========== ========= ==========
December 31, 2003
- ---------------------------------------
Weighted-average amortization period .. 11 years 15 years 12 years
Gross ................................. $ 60,820 $ 90,318 $ 151,138 $ 150,897 $ 302,035
Accumulated amortization .............. (17,960) (59,295) (77,255) (37,578) (114,833)
---------- ---------- ---------- --------- ----------
Net value ........................... $ 42,860 $ 31,023 $ 73,883 $ 113,319 $ 187,202
========== ========== ========== ========= ==========
December 31, 2002
- ---------------------------------------
Weighted-average amortization period .. 12 years 14 years 12 years
Gross ................................. $ 72,501 $ 70,200 $ 142,701 $ 150,206 $ 292,907
Accumulated amortization .............. (15,973) (54,311) (70,104) (36,764) (106,868)
---------- ---------- ---------- --------- ----------
Net value ........................... $ 56,708 $ 15,889 $ 72,597 $ 113,442 $ 186,039
========== ========== ========== ========= ==========
NOTE 5--INVENTORIES
Inventories were 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 common 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.
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
2004 2003 2002
--------- --------- ---------
Percentage of total
inventories on LIFO .......... 81% 88% 87%
Excess of FIFO over
LIFO ......................... $125,212 $ 96,591 $ 100,226
(Decrease) increase in
net income due to
LIFO ......................... (18,580) 2,213 8,088
(Decrease) increase in
net income per
common share due
to LIFO ...................... (.13) .02 .05
NOTE 6--EXIT OR DISPOSAL ACTIVITIES
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. Qualified exit
costs primarily include post-closure rent expenses, incremental post-closure
costs and costs of employee terminations. Adjustments may be made to liabilities
accrued for qualified exit costs if information becomes available upon which
more accurate amounts can be reasonably estimated. Concurrently, property, plant
and equipment is tested for impairment in accordance with SFAS No. 144 and, if
impairment exists, the carrying value of the related assets is reduced to
estimated fair value. Additional impairment may be recorded for subsequent
revisions in estimated fair value. No significant revisions occurred during
2004, 2003 or 2002.
The following table summarizes the activity and remaining liabilities
associated with qualified exit costs:
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 2003 sold accrual expense - net 2004
- ------------------------------------- ----------- ------------- ------------ ---------------- ------------
AUTOMOTIVE FINISHES DISTRIBUTION
FACILITY SHUTDOWN IN 2004:
SEVERANCE AND RELATED COSTS ....... $ 297 $ (185) $ (112)
OTHER QUALIFIED EXIT COSTS ........ 903 (683) 96 $ 316
CONSUMER MANUFACTURING FACILITY
SHUTDOWN IN 2004:
OTHER QUALIFIED EXIT COSTS ........ 1,500 (1,810) 310
CONSUMER MANUFACTURING FACILITY
SHUTDOWN IN 2001:
OTHER QUALIFIED EXIT COSTS ........ $ 2,058 (186) (25) 1,847
OTHER QUALIFIED EXIT COSTS FOR
FACILITIES SHUTDOWN PRIOR TO 2001.. 12,854 (650) (232) 11,972
-------- ---------- --------- -------- --------
TOTALS .............................. $ 14,912 $ 2,700 $ (3,514) $ 37 $ 14,135
======== ========== ========= ======== ========
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
shutdown in 2001:
Severance and related costs ....... $ 133 $ (133)
Other qualified exit costs ........ 2,790 (641) $ (91) $ 2,058
Paint Stores manufacturing facility
shutdown in 2001:
Other qualified exit costs ........ 333 (105) (228)
Other qualified exit costs for
facilities shutdown prior to 2001.. 13,221 (700) 333 12,854
-------- --------- -------- --------
Totals .............................. $ 16,477 $ (1,579) $ 14 $ 14,912
======== ========= ======== ========
54
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 2001 sold accrual expense - net 2002
- ------------------------------------- ----------- ------------- ------------ ---------------- ------------
Consumer manufacturing facility
shutdown in 2001:
Severance and related costs ....... $ 1,454 $ (1,321) $ 133
Other qualified exit costs ........ 1,946 (256) $ 1,100 2,790
Paint Stores manufacturing facility
shutdown in 2001:
Severance and related costs ....... 710 (667) (43)
Other qualified exit costs ........ 290 43 333
Other qualified exit costs for
facilities shutdown prior to 2001.. 15,479 (1,420) (838) 13,221
-------- --------- -------- --------
Totals .............................. $ 19,879 $ (3,664) $ 262 $ 16,477
======== ========= ======== ========
During 2004, a formal plan was approved to close a leased distribution
facility in the Automotive Finishes Segment. During 2003, a formal plan was
approved to close a manufacturing facility in the Consumer Segment and the
useful lives of the assets were reduced in accordance with SFAS No. 144. Both
facilities were closed during 2004. In accordance with SFAS No. 146,
non-cancelable rent, post-closure severance and other qualified exit costs were
accrued at the time of closing. No formal shutdown plans were approved during
2002.
Less than 7 percent of the ending accrual for qualified exit costs at
December 31, 2004 related to facilities shutdown prior to 2002 that are expected
to be incurred by the end of 2005. The remaining portion of the ending accrual
primarily represented 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 7--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 16,725, 16,286 and 16,301 active employees entitled
to receive benefits under these plans as of December 31, 2004, 2003 and 2002,
respectively. The cost of these benefits for active employees, which includes
claims incurred and claims incurred but not reported, amounted to $82,980,
$80,888 and $70,169 for 2004, 2003 and 2002, 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
$4,273, $8,542 and $8,134 in 2004, 2003 and 2002, respectively. In connection
with the acquisitions of Duron and PSB, the Company acquired certain health care
benefit plans for employees who met certain eligibility requirements. The
Company operated the acquired plans independently from the date of acquisition
until December 31, 2004. Beginning January 1, 2005, the participants of these
acquired plans became participants in the Company's health care benefit plan.
The Company provides pension benefits to substantially all employees
through noncontributory defined 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 $41,040, $41,531 and $41,569 for 2004, 2003 and 2002,
respectively. 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 did 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 $1,049, $1,236 and $1,260 for 2004, 2003 and
2002, respectively. Assets in employee accounts of the foreign defined
contribution pension plans are invested in various mutual funds. These mutual
funds did not own a significant number of shares of the Company's common stock.
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
In connection with the acquisition of Duron, the Company acquired a
domestic defined benefit pension plan (Duron Plan). The Duron Plan covered all
employees who met certain eligibility requirements based primarily on age,
length of service and hours worked per year. The Company operated the Duron Plan
independently from the date of acquisition until December 31, 2004, at which
time it was frozen and merged into the Company's domestic salaried defined
benefit pension plan. The decision to freeze the Duron Plan and merge it with
the Company's domestic salaried defined benefit pension plan effective December
31, 2004 was made at the acquisition date. Accrued benefits and vesting service
under the Duron Plan were credited under the Company's domestic salaried defined
benefit pension plan. At December 31, 2004, the Duron Plan was under-funded by
$2,574 with a projected benefit obligation and an accumulated benefit obligation
of $18,307 and a fair value of plan assets of $15,733. The Company made
contributions of $1,175 to the Duron Plan in 2004.
Effective January 1, 2002, the domestic salaried defined benefit pension
plan, which was frozen since 1984, was re-opened to 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, 2004, defined benefit pension plan assets were
invested as follows:
Domestic Foreign
Plans Plans
-------- ------
Equity investments 67% 66%
Fixed income investments 30% 30%
Cash and other investments 3% 4%
Included as equity investments in the domestic defined benefit pension
plan at December 31, 2004 were 1,255,000 shares of the Company's common stock
with a market value of $56,011, which was 9.4 percent of total domestic defined
benefit pension plan assets. During 2004, 345,000 shares of the Company's common
stock were sold and dividends received on the Company's common stock were $995.
At December 31, 2004, one of the Company's foreign defined benefit pension
plans was under-funded by $7,371 with a projected benefit obligation of $43,247,
an accumulated benefit obligation of $30,607, and a fair value of plan assets of
$23,236. In addition, the Company has one unfunded foreign defined benefit
pension plan with an accumulated benefit obligation of $633. Contributions to
the foreign defined benefit pension plans are expected to be $2,183 in 2005.
The Company expects to make the following benefit payments for all
domestic and foreign defined benefit pension plans: $18,023 in 2005; $17,102 in
2006; $18,529 in 2007; $19,792 in 2008; $21,013 in 2009; and $103,246 in 2010
through 2014.
The following table summarizes the obligations and assets of the defined
benefit pension plans, which are all measured as of December 31:
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
Domestic Foreign
Defined Benefit Pension Plans Defined Benefit Pension Plans
------------------------------------- -------------------------------------
2004 2003 2002 2004 2003 2002
--------- --------- --------- --------- --------- ---------
ACCUMULATED BENEFIT OBLIGATION
AT END OF YEAR ..................... $ 230,912 $ 218,804 $ 186,980 $ 36,437 $ 32,323 $ 23,295
========= ========= ========= ========= ========= =========
PROJECTED BENEFIT OBLIGATION:
BALANCE AT BEGINNING OF YEAR ....... $ 224,265 $ 190,711 $ 186,174 $ 40,182 $ 30,089 $ 17,674
SERVICE COST ....................... 10,992 7,036 4,214 1,520 1,358 968
INTEREST COST ...................... 12,777 12,066 12,016 2,354 1,959 1,383
ACTUARIAL LOSS (GAIN) .............. (2,295) 30,276 218 5,123 (368) 8,313
PLAN AMENDMENTS, MERGER AND OTHER .. 18,026 1,206 487 4,646 235
EFFECT OF FOREIGN EXCHANGE ......... 3,074 3,373 1,838
BENEFITS PAID ...................... (17,126) (15,824) (13,117) (866) (875) (322)
--------- --------- --------- --------- --------- ---------
BALANCE AT END OF YEAR ............. 246,639 224,265 190,711 51,874 40,182 30,089
PLAN ASSETS:
BALANCE AT BEGINNING OF YEAR ....... 533,340 464,110 515,889 23,133 15,732 22,103
ACTUAL RETURN ON PLAN ASSETS ....... 67,612 88,023 (35,282) 2,179 4,765 (9,510)
PLAN MERGER AND OTHER - NET ........ 12,271 (2,969) (3,380) 2,354 1,842 1,242
EFFECT OF FOREIGN EXCHANGE ......... 1,724 1,669 2,219
BENEFITS PAID ...................... (17,126) (15,824) (13,117) (866) (875) (322)
--------- --------- --------- --------- --------- ---------
BALANCE AT END OF YEAR ............. 596,097 533,340 464,110 28,524 23,133 15,732
EXCESS (DEFICIENCY) OF PLAN ASSETS
OVER PROJECTED BENEFIT OBLIGATION:
BALANCE AT END OF YEAR ............ 349,458 309,075 273,399 (23,350) (17,049) (14,357)
UNRECOGNIZED ACTUARIAL LOSS ....... 74,290 108,297 137,690 24,602 18,922 18,368
UNRECOGNIZED PRIOR SERVICE COST ... 1,506 1,726 2,684 328 388
--------- --------- --------- --------- --------- ---------
EXCESS RECOGNIZED IN THE
CONSOLIDATED BALANCE SHEETS ........ $ 425,254 $ 419,098 $ 413,773 $ 1,580 $ 2,261 $ 4,011
========= ========= ========= ========= ========= =========
EXCESS RECOGNIZED IN THE CONSOLIDATED
BALANCE SHEETS CONSISTED OF:
DEFERRED PENSION ASSETS ........... $ 428,714 $ 419,098 $ 413,773 $ 1,524 $ 1,069 $ 816
BENEFIT LIABILITY INCLUDED
IN OTHER ACCRUALS ............... (6,235) (6,982) (7,391)
BENEFIT LIABILITY INCLUDED
IN OTHER LONG-TERM LIABILITIES .. (3,460) (3,507) (3,615) (1,320)
CUMULATIVE OTHER
COMPREHENSIVE LOSS ................ 9,798 11,789 11,906
--------- --------- --------- --------- --------- ---------
$ 425,254 $ 419,098 $ 413,773 $ 1,580 $ 2,261 $ 4,011
========= ========= ========= ========= ========= =========
WEIGHTED-AVERAGE ASSUMPTIONS
USED TO DETERMINE PROJECTED
BENEFIT OBLIGATION:
DISCOUNT RATE ..................... 5.75% 6.00% 6.55% 5.49% 5.73% 5.50%
RATE OF COMPENSATION INCREASE ..... 4.00% 4.00% 4.00% 3.98% 3.67% 3.50%
WEIGHTED-AVERAGE ASSUMPTIONS USED TO
DETERMINE NET PENSION (CREDIT) COST:
DISCOUNT RATE ..................... 5.98% 6.55% 6.75% 5.73% 5.50% 6.00%
EXPECTED LONG-TERM RATE OF RETURN
ON ASSETS ......................... 7.50% 8.00% 8.50% 8.00% 8.00% 8.50%
RATE OF COMPENSATION INCREASE ..... 4.00% 4.00% 4.50% 3.67% 3.50% 3.50%
NET PENSION (CREDIT) COST:
SERVICE COST ....................... $ 10,992 $ 7,036 $ 4,214 $ 1,520 $ 1,358 $ 968
INTEREST COST ...................... 12,777 12,066 12,016 2,354 1,959 1,383
EXPECTED RETURN ON ASSETS .......... (39,695) (36,485) (43,349) (1,934) (1,465) (1,525)
RECOGNITION OF:
UNRECOGNIZED PRIOR SERVICE COST ... 788 958 867 59 294
UNRECOGNIZED ACTUARIAL LOSS ....... 6,047 11,100 1,935 1,100 1,107 478
--------- --------- --------- --------- --------- ---------
NET PENSION (CREDIT) COST .......... $ (9,091) $ (5,325) $ (24,317) $ 3,099 $ 3,253 $ 1,304
========= ========= ========= ========= ========= =========
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
Employees of the Company hired prior to January 1, 1993 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, subject to the terms of the unfunded plans. There were 4,658,
4,727 and 4,719 retired employees entitled to receive benefits as of December
31, 2004, 2003 and 2002, respectively.
The assumed health care cost trend rates to be used to determine the net
periodic benefit cost for 2005 are 9.5 percent and 11.0 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 2013. 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 had the following
effects as of December 31, 2004:
One-Percentage-Point
---------------------
Increase (Decrease)
--------- ----------
Effect on total of service and
interest cost components ...... $ 601 $ (582)
Effect on the postretirement
benefit obligation ............ $ 9,459 $ (9,080)
A summary of the obligation for postretirement health care and life
insurance benefits is as follows:
Postretirement Benefits Other than Pensions
-------------------------------------------
2004 2003 2002
--------- --------- ---------
BENEFIT OBLIGATION:
BALANCE AT BEGINNING OF YEAR ................................ $ 302,449 $ 261,807 $ 267,118
SERVICE COST ................................................ 4,339 4,334 3,898
INTEREST COST ............................................... 16,725 16,787 16,567
ACTUARIAL LOSS (GAIN) ....................................... 8,745 35,495 (3,806)
PLAN AMENDMENTS ............................................. (4,787) (6,778)
BENEFITS PAID ............................................... (15,677) (15,974) (15,192)
--------- --------- ---------
BALANCE AT END OF YEAR ...................................... 311,794 302,449 261,807
UNFUNDED BENEFIT OBLIGATION RECOGNIZED IN
THE CONSOLIDATED BALANCE SHEETS:
UNFUNDED BENEFIT OBLIGATION AT END OF YEAR ................. (311,794) (302,449) (261,807)
UNRECOGNIZED ACTUARIAL LOSS ................................ 83,720 78,559 45,706
UNRECOGNIZED PRIOR SERVICE CREDIT .......................... (9,301) (8,963) (12,848)
--------- --------- ---------
UNFUNDED BENEFIT OBLIGATION RECOGNIZED IN
THE CONSOLIDATED BALANCE SHEETS: ............................ $(237,375) $(232,853) $(228,949)
========= ========= =========
UNFUNDED BENEFIT OBLIGATION RECOGNIZED IN THE
CONSOLIDATED BALANCE SHEETS CONSISTED OF:
BENEFIT LIABILITY INCLUDED IN OTHER LONG-TERM LIABILITIES .. $(221,975) $(216,853) $(213,749)
BENEFIT LIABILITY INCLUDED IN OTHER ACCRUALS ............... (15,400) (16,000) (15,200)
--------- --------- ---------
$(237,375) $(232,853) $(228,949)
========= ========= =========
WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE
BENEFIT OBLIGATION:
DISCOUNT RATE .............................................. 5.75% 6.00% 6.55%
HEALTH CARE COST TREND RATE - PRE-65 ....................... 9.50% 10.00% 8.90%
HEALTH CARE COST TREND RATE - POST-65 ...................... 11.00% 12.00% 8.90%
WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE
NET PERIODIC BENEFIT COST:
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%
NET PERIODIC BENEFIT COST:
SERVICE COST ................................................ $ 4,339 $ 4,334 $ 3,898
INTEREST COST ............................................... 16,725 16,787 16,567
RECOGNITION OF:
UNRECOGNIZED PRIOR SERVICE CREDIT .......................... (4,448) (3,885) (3,885)
UNRECOGNIZED ACTUARIAL LOSS ................................ 3,568 2,546 2,341
--------- --------- ---------
NET PERIODIC BENEFIT COST ................................... $ 20,184 $ 19,782 $ 18,921
========= ========= =========
58
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 Medicare Act) was signed into law. The Medicare
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. 106-2, the effects of the federal subsidy resulted in a
$21,400 reduction of the accumulated postretirement benefit obligation for
benefits attributed to past service, which is being recognized prospectively
beginning July 1, 2004. During the last half of 2004, this recognition resulted
in a $1,550 reduction of the net periodic postretirement benefit cost, which
consisted of $880 amortization of the actuarial experience gain, a $640
reduction in interest cost and a $30 reduction in service cost.
The Company expects to make gross postretirement benefit cash payments and
to receive Medicare Part D prescription cash reimbursements as follows:
Postretirement Medicare
Benefits Other Prescription
than Pensions Reimbursement
-------------- -------------
2005 ................... $ 20,950
2006 ................... 23,310 $ (2,970)
2007 ................... 25,240 (3,220)
2008 ................... 26,690 (3,450)
2009 ................... 27,810 (3,690)
2010 through 2014 ...... 144,570 (18,460)
------------ ------------
Total expected benefit
cash payments ......... $ 268,570 $ (31,790)
============ ============
NOTE 8--LONG-TERM DEBT
Due Date 2004 2003 2002
------------ ---------- ------------ -----------
6.85% Notes......................... 2007 $ 198,143 $ 203,173 $ 204,202
7.375% Debentures................... 2027 139,929 149,921 149,917
7.45% Debentures.................... 2097 146,942 147,932 149,420
5% to 8.5% Promissory Notes......... Through 2007 1,725 1,285 1,643
9.875% Debentures................... 2016 1,500 1,500 1,500
---------- ------------ -----------
Long-term debt before SFAS
No. 133 adjustments............... 488,239 503,811 506,682
Fair value adjustments to 6.85%
Notes in accordance with
SFAS No. 133..................... (819)
---------- ------------ -----------
$ 488,239 $ 502,992 $ 506,682
========== ============ ===========
Maturities of long-term debt are as follows for the next five years:
$11,214 in 2005; $962 in 2006; $197,043 in 2007; $73 in 2008, and $73 in 2009.
Interest expense on long-term debt was $37,315, $37,460 and $37,029 for
2004, 2003 and 2002, respectively.
Among other restrictions, the Company's Notes, Debentures and revolving
credit agreement contain certain covenants relating to liens, ratings changes,
merger and sale of assets, consolidated leverage 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 was in compliance with all covenants for all
years presented.
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 varied 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. During 2004, the Company unwound all of the interest rate swap contracts
and paid $1,084 to the bank for discontinuation of the contracts. The net
payment decreased the carrying amount of the 6.85% Notes and is being amortized
to expense over the remaining maturity of the Notes. At December 31, 2003, the
fair value of the two separate interest rate swap contracts represented
unrealized losses of $819, which was included in Other long term liabilities.
The weighted average interest rate on these contracts was 5.35 percent at
December 31, 2003.
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
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 varied 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. During 2002, the Company unwound all six 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.
There were no interest rate swap agreements outstanding at December 31, 2004 and
2002.
The Company has a five-year senior unsecured revolving credit agreement.
The current agreement, aggregating $650,000, was effective July 19, 2004 and
expires July 20, 2009. There were no borrowings outstanding under the revolving
credit agreement during all years presented.
At December 31, 2004, borrowings outstanding under the commercial paper
program totaled $231,203 and were included in Short-term borrowings on the
balance sheet. The weighted-average interest rate related to these borrowings
was 2.3% at December 31, 2004. There were no borrowings outstanding under the
Company's commercial paper program at December 31, 2003 and 2002, respectively.
The Company uses the revolving credit agreement to satisfy its commercial paper
program's dollar for dollar liquidity requirement. Effective July 19, 2004, the
aggregate maximum borrowing capacity under the revolving credit agreement limits
the commercial paper program to a maximum borrowing capability of $650,000.
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. Prior to
2002, individual debt security holders exercised put options requiring the
Company to repay $46,905 of these debt securities. The remaining balance of
these debt securities of $3,095 was included in Current portion of long-term
debt on the balance sheets at December 31, 2004, 2003 and 2002.
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, 2004, 2003 and 2002.
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 or issuance of common
stock or warrants under this registration at December 31, 2004, 2003 and 2002.
NOTE 9--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
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
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 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
$117,135 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, 2004, 2003, and
2002 were accruals for extended environmental-related activities of $116,537,
$107,688 and $105,207, respectively. Estimated costs of current investigation
and remediation activities of $24,953, $25,697 and $23,499 were included in
Other accruals at December 31, 2004, 2003 and 2002, respectively.
Four of the Company's current and former manufacturing sites accounted for
the majority of the accrual for environmental-related activities and the
unaccrued maximum of the estimated range of possible outcomes at December 31,
2004. Included in the total accrual of $141,490 at December 31, 2004 was $92,384
related directly to these four sites. In the aggregate unaccrued exposure of
$117,135 at December 31, 2004, $64,436 related to the four manufacturing sites.
While environmental investigations and remedial actions are in different stages
at these sites, additional investigations, remedial actions and monitoring will
likely be required at each site.
Management cannot presently estimate the potential loss contingencies
related to these sites or other less significant sites until such time as a
substantial portion of the investigation at the sites is completed and remedial
action plans are developed. In the event any future loss contingency
significantly exceeds the current amount accrued, the recording of the ultimate
liability may result in a material impact on net income for the annual or
interim period during which the additional costs are accrued. Management does
not believe that any potential liability ultimately attributed to the Company
for its environmental-related matters will have a material adverse effect on the
Company's financial condition, liquidity, or cash flow due to the extended
period of time during which environmental investigation and remediation takes
place. An estimate of the potential impact on the Company's operations cannot be
made due to the aforementioned uncertainties.
Management expects these contingent environmental-related liabilities to
be resolved over an extended period of time. Management is unable to provide a
more specific time frame due to the indefinite amount of time to conduct
investigation activities at any site, the indefinite amount of time to obtain
environmental agency approval, as necessary, with respect to investigation and
remediation activities, and the indefinite amount of time necessary to conduct
remediation activities.
NOTE 10--CAPITAL STOCK
At December 31, 2004, 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 are 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 571,819 shares are designated as convertible
participating serial preferred stock (see Note 11). An aggregate of 18,355,814,
22,386,580 and 16,411,277 shares of common stock at December 31, 2004, 2003 and
2002, respectively, were reserved for future grants of restricted stock and the
exercise and future grants of stock options (see Note 12). Common shares
outstanding shown in the following table included 475,628 shares of common stock
held in a revocable trust at December 31, 2004, 2003 and 2002, respectively. The
revocable trust is used
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
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.
Common shares Common shares
in Treasury Outstanding
------------- -------------
Balance at January 1, 2002 .................................... 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
SHARES TENDERED AS PAYMENT FOR OPTIONS EXERCISED ............ 17,219 (17,219)
SHARES ISSUED FOR EXERCISE OF STOCK OPTIONS ................. 3,702,377
NET SHARES ISSUED UNDER RESTRICTED STOCK GRANTS ............. 285,250
TREASURY STOCK PURCHASED .................................... 6,600,000 (6,600,000)
---------- -----------
BALANCE AT DECEMBER 31, 2004 .................................. 75,619,150 140,777,115
========== ===========
NOTE 11--STOCK PURCHASE PLAN AND PREFERRED STOCK
As of December 31, 2004, 15,577 employees contributed to the Company's
ESOP, a voluntary defined contribution plan available to all eligible salaried
employees. Participants are allowed to contribute, on a pretax basis only, up to
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 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.
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 $46,524, $40,662 and $38,921 in 2004, 2003
and 2002, respectively. The Company's matching contributions to the ESOP charged
to operations were $35,573, $31,331 and $27,916 for 2004, 2003 and 2002,
respectively.
At December 31, 2004, there were 23,406,467 shares of the Company's common
stock being held by the ESOP, representing 16.6 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 August 27, 2003, the Company issued 350,000 shares of convertible
participating serial preferred stock, no par value with cumulative quarterly
dividends of ten dollars per share (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
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
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, 2004 and 2003, there were no allocated or
committed-to-be-released shares of Preferred stock outstanding. The ESOP
redeemed 112,838 shares and 65,343 shares of the 2003 issuance of Preferred
stock for cash in 2004 and 2003, respectively.
On April 18, 2001, the Company issued 250,000 shares of 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
compensation expense related to the Company's contributions was earned at which
time contributions were credited to the members' accounts. At December 31, 2002,
there were no allocated or committed-to-be-released shares of Preferred stock
outstanding. In 2002, the ESOP redeemed 126,499 shares of Preferred stock for
cash. The ESOP redeemed the remaining 41,806 shares of the 2001 issuance of
Preferred stock for cash in 2003.
NOTE 12--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 the 1994 Stock
Plan, all rights granted under the plan remains. 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. No
shares of restricted stock vested during 2004 or 2002. During 2003, 199,500
shares of restricted stock vested and were delivered to certain officers and key
employees. There were 873,250 shares of restricted stock granted to certain
officers and key employees outstanding at December 31, 2004. Unamortized
deferred compensation expense with respect to restricted stock granted to
eligible employees amounted to $19,606, $12,853 and $3,267 at December 31, 2004,
2003, and 2002, respectively, and is being amortized over the four-year vesting
period. Deferred compensation expense aggregated $11,272, $5,641 and $3,097 in
2004, 2003 and 2002, respectively.
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. Grants of
restricted stock generally vest and are received without restriction to the
extent of one-third of the granted shares for each full year of service as a
Director following the date of grant. There were 15,000 shares of restricted
stock granted to nonemployee Directors during 2004 and all shares were
outstanding at December 31, 2004. As of December 31, 2004, there were 201,667
shares available for grant under the 1997 Stock Plan.
A summary of restricted stock granted to certain officers, key employees
and nonemployee Directors during 2004, 2003, and 2002 is as follows:
2004 2003 2002
-------- -------- --------
SHARES GRANTED ............... 328,250 401,000 13,500
WEIGHTED-AVERAGE FAIR VALUE
OF RESTRICTED SHARES
GRANTED DURING YEAR ........ $ 33.59 $ 27.37 $ 26.22
Grants of non-qualified and incentive stock options have been awarded to
certain officers, key employees and nonemployee Directors under various stock
plans at prices not less than fair market value of the shares, as defined by the
plans, at the date of grant. The options
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
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.
A summary of the Company's non-qualified and incentive stock option activity
and related information for the years ended December 31, 2004, 2003 and 2002 is
shown in the following table:
2004 2003 2002
----------------------- ----------------------- ----------------------
WEIGHTED- Weighted- Weighted-
AVERAGE Average Average
OPTIONED EXERCISE Optioned Exercise Optioned Exercise
SHARES PRICE Shares Price Shares Price
---------- --------- ---------- --------- ---------- ---------
Outstanding beginning of year .. 15,099,131 $ 25.27 15,178,222 $ 23.90 14,129,176 $ 23.19
Granted ........................ 2,065,900 41.40 2,431,500 30.96 3,064,900 25.47
Exercised ...................... (3,702,377) 23.90 (2,171,839) 21.86 (1,791,675) 20.94
Forfeited ...................... (155,237) 27.25 (127,604) 24.50 (111,901) 22.07
Expired ........................ (20,584) 24.01 (211,148) 27.50 (112,278) 26.98
----------- -------- ----------- -------- ----------- --------
Outstanding end of year ........ 13,286,833 $ 28.14 15,099,131 $ 25.27 15,178,222 $ 23.90
=========== ======== =========== ======== =========== ========
Exercisable at end of year ..... 8,691,851 $ 24.78 9,716,381 $ 23.91 9,258,221 $ 23.69
Weighted-average fair value of
options granted during year .. $ 6.24 $ 5.76 $ 5.48
Reserved for future grants ..... 4,867,314 7,070,782 979,055
Exercise prices for optioned shares outstanding as of December 31, 2004
ranged from $16.34 to $41.73. 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
- --------------- --------- -------------- ------------ --------- --------------
$16.34 - $24.50 .... 4,135,516 $21.98 5.7 4,102,475 $21.96
$25.06 - $35.34 .... 7,145,717 27.92 6.6 4,589,376 27.29
$38.53 - $41.73 .... 2,005,600 41.64 9.8
---------- ------ --- --------- ------
13,286,833 $28.14 6.8 8,691,851 $24.78
========== ====== === ========= ======
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
NOTE 13--OTHER EXPENSE--NET
Included in the Other expense - net caption of the Statements of
Consolidated Income are the following:
2004 2003 2002
-------- -------- --------
DIVIDEND AND ROYALTY
INCOME ................... $ (2,498) $ (2,877) $ (3,341)
NET EXPENSE OF FINANCING
AND INVESTING ACTIVITIES.. 7,140 9,071 7,284
PROVISIONS FOR ENVIRONMENTAL
MATTERS (SEE NOTE 9) ..... 13,953 10,237 8,609
NET EXPENSE OF EXIT OR
DISPOSAL ACTIVITIES
(SEE NOTE 6) ............. 37 14 262
FOREIGN CURRENCY EXCHANGE
LOSSES - NET ............. 1,699 1,460 8,435
OTHER INCOME ................ (4,458) (1,429) (4,154)
OTHER EXPENSE ............... 1,992 2,155 4,376
-------- -------- --------
$ 17,865 $ 18,631 $ 21,471
======== ======== ========
The net expense of financing and investing activities included 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, fees related to debt issuance and financing
services and in 2003 and 2002, the net pretax expense associated with the
Company's investment in broad-based corporate owned life insurance.
Foreign currency exchange losses - net included foreign currency
transaction gains and losses and realized and unrealized gains and losses from
foreign currency option and forward contracts. The Company had no foreign
currency option or forward contracts outstanding at December 31, 2004. All
foreign currency option and forward contracts outstanding at December 31, 2003
and 2002 had maturity dates of less than twelve months and were undesignated
hedges with changes in fair value being recognized in earnings in accordance
with SFAS No. 133. These derivative instrument values were included in either
Other current assets or Other accruals and were immaterial at December 31, 2003
and 2002.
Other income included items of revenue and other gains that were unrelated
to the primary business purpose of the Company. Each individual item of other
income was immaterial; no single category of items exceeded $1,000.
Other expense included expense items and losses that were unrelated to
revenues associated with the primary business purpose of the Company. Each
individual item of other expense was immaterial; no single category of items
exceeded $1,000.
NOTE 14 -- 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, 2004, 2003 and
2002 were as follows:
2004 2003 2002
--------- --------- ---------
Deferred tax assets:
Dispositions,
environmental
and other
similar items ........... $ 51,859 $ 47,941 $ 48,452
Other items (each
less than 5 percent
of total assets) ........ 110,955 105,660 138,515
--------- --------- ---------
Total deferred
tax assets ............ $ 162,814 $ 153,601 $ 186,967
========= ========= =========
Deferred tax liabilities:
Depreciation and
amortization ............ $ 75,573 $ 49,634 $ 29,082
Deferred employee
benefit items ........... 59,892 61,981 63,165
--------- --------- ---------
Total deferred
tax liabilities ....... $ 135,465 $ 111,615 $ 92,247
========= ========= =========
Netted against the Company's other deferred tax assets were valuation
reserves of $14,930, $17,643 and $14,459 at December 31, 2004, 2003 and 2002,
respectively, resulting from the uncertainty as to the realization of the tax
benefits from certain foreign net operating losses and certain other foreign
assets.
Significant components of the provisions for income taxes were as follows:
2004 2003 2002
--------- --------- ---------
Current:
Federal ............. $ 126,199 $ 129,146 $ 138,541
Foreign ............. 17,994 5,719 9,549
State and local ..... 24,242 16,131 16,410
--------- --------- ---------
Total current ..... 168,435 150,996 164,500
Deferred:
Federal ............. 18,001 32,299 20,770
Foreign ............. (3,312) 3,554 (1,498)
State and local ..... 2,538 4,019 2,691
--------- --------- ---------
Total deferred .... 17,227 39,872 21,963
--------- --------- ---------
Total provisions
for income taxes .... $ 185,662 $ 190,868 $ 186,463
========= ========= =========
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
The provisions for income taxes included estimated taxes payable on that
portion of retained earnings of foreign subsidiaries expected to be received by
the Company. The effect of the repatriation provisions of the American Jobs
Creation Act of 2004 and the provisions of APB No. 23, "Accounting for Income
Taxes - Special Areas," was $2,693 in 2004. A provision was not made with
respect to $13,399 of retained earnings at December 31, 2004 that have been
invested by foreign subsidiaries. It was not practicable to estimate the amount
of unrecognized deferred tax liability for undistributed foreign earnings.
Significant components of income before income taxes, minority interest
and cumulative effect of change in accounting principle as used for income tax
purposes, were as follows:
2004 2003 2002
-------- -------- --------
Domestic .. $520,454 $492,592 $458,535
Foreign ... 59,741 30,334 38,629
-------- -------- --------
$580,195 $522,926 $497,164
======== ======== ========
A reconciliation of the statutory federal income tax rate to the effective
tax rate follows:
2004 2003 2002
---- ---- -----
Statutory federal
income tax rate ......... 35.0% 35.0% 35.0%
Effect of:
State and local
income taxes ........ 3.0 2.5 2.5
Investment vehicles.... (1.6) (0.6) 0.8
ESOP dividends ........ (4.2) (1.0) (1.0)
Other - net ........... (0.2) 0.6 0.2
---- ---- ----
Effective tax rate ........ 32.0% 36.5% 37.5%
==== ==== ====
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 increase in the ESOP dividends deduction was the result of
increases to the annual dividend payable for 2004 versus 2003 and changes in
plan design which resulted in an increase in deductible dividends.
NOTE 15 -- NET INCOME PER COMMON SHARE
2004 2003 2002
------------- ------------- -------------
Income before cumulative effect of change in accounting principle... $ 393,254 $ 332,058 $ 310,701
Cumulative effect of change in accounting principle -
net of income taxes of $64,476 ................................... (183,136)
------------- ------------- -------------
Net income ......................................................... $ 393,254 $ 332,058 $ 127,565
============= ============= =============
BASIC
Average common shares outstanding ................................ 140,801,836 144,846,933 150,437,900
============= ============= =============
Per common share:
Income before cumulative effect of change in accounting principle $ 2.79 $ 2.29 $ 2.07
Cumulative effect of change in accounting principle ............. (1.22)
------------- ------------- -------------
Net income ...................................................... $ 2.79 $ 2.29 $ .85
============= ============= =============
DILUTED
Average common shares outstanding ................................. 140,801,836 144,846,933 150,437,900
Non-vested restricted stock grants ................................ 870,313 614,458 318,433
Stock options and other contingently issuable shares .............. 3,063,440 1,543,885 1,678,977
------------- ------------- -------------
Average common shares assuming dilution ........................... 144,735,589 147,005,276 152,435,310
============= ============= =============
Per common share:
Income before cumulative effect of change in accounting principle $ 2.72 $ 2.26 $ 2.04
Cumulative effect of change in accounting principle ............. (1.20)
------------- ------------- -------------
Net income ...................................................... $ 2.72 $ 2.26 $ .84
============= ============= =============
66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
NOTE 16 -- SUMMARY OF QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
2004
-----------------------------------------------------------------------
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER FULL YEAR
----------- ----------- ----------- ----------- ----------
NET SALES ...................... $1,319,522 $1,617,955 $1,677,130 $1,499,182 $6,113,789
GROSS PROFIT ................... $ 571,627 $ 721,417 $ 743,545 $ 664,822 $2,701,411
NET INCOME ..................... $ 51,468 $ 126,438 $ 132,863 $ 82,845 $ 393,254
NET INCOME PER SHARE - BASIC ... $ .36 $ .89 $ .95 $ .59 $ 2.79
NET INCOME PER SHARE - DILUTED.. $ .35 $ .87 $ .92 $ .57 $ 2.72
Net income in the fourth quarter was increased by $6,029 ($.04 per share)
due primarily to physical inventory adjustments. Gross profit was increased by
$13,540 primarily as a result of physical inventory adjustments of $14,877.
Administrative expenses were increased by $4,170 due primarily to increased
incentive compensation accruals.
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
Net income in the fourth quarter of 2003 was increased by $1,714 ($.01 per
share) due to certain year-end adjustments. Gross profit in the fourth quarter
of 2003 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 during the
fourth quarter of 2003.
NOTE 17 -- 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, recognized on a straight-line
basis over the lease term in accordance with FASB Technical Bulletin No. 85-3,
"Accounting for Operating Leases with Scheduled Rent Increases," was $173,491,
$155,268 and $151,555 for 2004, 2003 and 2002, 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 $18,134,
$12,933 and $15,752 in 2004, 2003 and 2002, respectively. Rental income, as
lessor, from real estate leasing activities and sublease rental income for all
years presented was not significant.
During 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 from 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, 2004:
2005................................. $ 155,973
2006................................. 134,826
2007................................. 110,089
2008................................. 83,897
2009................................. 59,322
Later years.......................... 117,824
---------
Total minimum lease payments......... $ 661,931
=========
67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
NOTE 18 - 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 8
through 15 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 consisted of 2,983 company-operated specialty
paint stores in the United States, Canada, Virgin Islands, Puerto Rico and
Mexico at December 31, 2004. 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. The acquisition of Duron was included in
this Segment. During 2004, this Segment opened 67 net new stores, acquired 229,
remodeled 10, relocated 35 and transferred one store to the Automotive Finishes
Segment. The net new and acquired stores consisted of 294 stores in the United
States, 3 in Canada and one closed in Mexico. In 2003, there were 45 net new
stores opened or acquired (41 in the United States). In 2002, there were 70 net
new stores opened or acquired (62 in the United States). This Segment
manufactures OEM product finishes sold through certain shared or dedicated paint
stores (71, 72 and 69 at December 31, 2004, 2003 and 2002, respectively,
included above) and by direct outside sales representatives. The Paint Stores
Segment markets and sells Sherwin-Williams(R) branded architectural coatings,
industrial and marine products, OEM product finishes and related items
throughout North America and the Caribbean. These products are produced by this
Segment's manufacturing facilities and those in the Consumer Segment. The loss
of any single customer would not have a material adverse effect on the business
of this Segment. A map on page 18 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. The acquisition of PSB was included in this Segment.
Approximately 47 percent of the total sales of the Consumer Segment in 2004,
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 had 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 incurred 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
146 company-operated automotive branches in the United States and 19 in Canada.
Additional automotive branches in Jamaica (15), Chile (17) and Peru (3) complete
this Segment's worldwide
68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
network. At December 31, 2004, this Segment included consolidated operations in
11 foreign countries and realized income from licensing agreements in 13 foreign
countries. A map on page 18 of this report shows the number of automotive
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 occurred in South America,
the Segment's most important international market. This Segment sold its
products through 29 company-operated specialty paint stores in Chile, 36 in
Brazil, 5 in Uruguay and 1 in Argentina and by outside selling functions to
dealers and other distributors. At December 31, 2004, this Segment included
consolidated operations in 8 foreign countries, 4 foreign joint ventures and
income from licensing agreements in 12 foreign countries.
The Administrative Segment included the administrative expenses of the
Company's corporate headquarters site. This Segment also included interest
expense which was 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 were not directly associated with any Operating
Segment. Administrative expenses did not include any significant foreign
operations. Also included in the Administrative Segment was a real estate
management unit that is responsible for the ownership, management, 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 represented 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 were not a significant
operating factor in determining the performance of this Segment.
Net external sales of all consolidated foreign subsidiaries were $637,137,
$546,472 and $488,280 for 2004, 2003 and 2002, respectively. Operating profits
of all consolidated foreign subsidiaries were $46,516, $14,340 and $17,953 for
2004, 2003 and 2002, respectively. Domestic operations account for the remaining
net sales and operating profits. Long-lived assets consist of net property,
plant and equipment, goodwill, intangibles, deferred pension assets and other
long-term assets. Long-lived assets of consolidated foreign subsidiaries totaled
$149,037, $130,188 and $108,077 at December 31, 2004, 2003 and 2002,
respectively. The consolidated total of long-lived assets for the Company was
$2,492,223, $1,967,464 and $1,926,319 at December 31, 2004, 2003 and 2002,
respectively. During 2002, the reduction in the carrying value of long-lived
assets of consolidated foreign subsidiaries resulted primarily from an
impairment of long-lived assets of the Argentina subsidiary due to a devaluation
of the Argentine peso and other foreign currency translation rate declines.
Total assets of consolidated foreign subsidiaries at December 31, 2004 were
$458,705, which represented 10.7 percent of the Company's total assets. No
single geographic area outside the United States was significant relative to
consolidated net 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 was total revenue, including inter-segment transfers, less operating
costs and expenses. Identifiable assets were those directly identified with each
reportable segment. Administrative Segment assets consisted primarily of cash
and cash equivalents, investments, deferred pension assets, and headquarters
property, plant and equipment. The operating margin for each Operating Segment
was based upon total net sales and inter-segment transfers. Domestic
inter-segment transfers were accounted for at the approximate fully absorbed
manufactured cost plus distribution costs. International inter-segment transfers
were 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.
69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(thousands of dollars unless otherwise indicated)
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
NET EXTERNAL SALES
Paint Stores ................................... $ 3,977 $ 3,469 $ 3,302 $ 3,185 $ 3,166
Consumer ....................................... 1,296 1,190 1,178 1,142 1,251
Automotive Finishes ............................ 514 457 454 464 493
International Coatings ......................... 319 285 244 268 294
Administrative ................................. 8 7 7 7 8
------- ------- ------- ------- -------
Consolidated totals ............................ $ 6,114 $ 5,408 $ 5,185 $ 5,066 $ 5,212
OPERATING PROFITS
Paint Stores ................................... $ 480 $ 403 $ 399 $ 388 $ 410
Consumer ....................................... 188 199 193 110** (208)*
Automotive Finishes ............................ 58 52 54 51 61
International Coatings ......................... 18 8 (6) 5 17
Administrative:
Interest expense ............................. (40) (38) (40) (54) (60)
Corporate expenses and other ................. (124) (101) (103) (76) (77)
------- ------- ------- ------- -------
Income before income taxes, minority interest
and cumulative effect of change in
accounting principle ......................... $ 580 $ 523 $ 497 $ 424** $ 143*
IDENTIFIABLE ASSETS
Paint Stores ................................... $ 1,400 $ 1,000 $ 967 $ 954 $ 1,014
Consumer ....................................... 1,597 1,218 1,162 1,272 1,347*
Automotive Finishes ............................ 321 278 274 329 349
International Coatings ......................... 193 156 130 285 315
Administrative ................................. 763 1,031 899 788 726
------- ------- ------- ------- -------
Consolidated totals ............................ $ 4,274 $ 3,683 $ 3,432 $ 3,628 $ 3,751*
CAPITAL EXPENDITURES
Paint Stores ................................... $ 55 $ 54 $ 56 $ 36 $ 48
Consumer ....................................... 35 36 37 18 40
Automotive Finishes ............................ 4 8 3 11 29
International Coatings ......................... 5 5 10 7 6
Administrative ................................. 8 14 21 11 10
------- ------- ------- ------- -------
Consolidated totals ............................ $ 107 $ 117 $ 127 $ 83 $ 133
DEPRECIATION
Paint Stores ................................... $ 49 $ 44 $ 44 $ 47 $ 45
Consumer ....................................... 33 33 33 31 28
Automotive Finishes ............................ 9 9 9 9 9
International Coatings ......................... 5 5 4 6 6
Administrative ................................. 13 14 14 16 21
------- ------- ------- ------- -------
Consolidated totals ............................ $ 109 $ 105 $ 104 $ 109 $ 109
OPERATING SEGMENT MARGINS
Paint Stores ................................... 12.1% 11.6% 12.1% 12.2% 12.9%
Consumer ....................................... 7.7% 9.0% 8.9% 5.3%** (9.5%)*
Automotive Finishes ............................ 10.2% 10.5% 11.1% 10.2% 11.5%
International Coatings ......................... 5.6% 2.8% (2.4%) 1.9% 5.8%
------- ------- ------- ------- -------
Operating segment totals ....................... 10.2% 10.2% 10.3% 9.2%** 4.5%*
INTERSEGMENT TRANSFERS
Paint Stores ................................... $ 1 $ 1 $ 1 $ 1 $ 2
Consumer ....................................... 1,138 1,024 989 929 929
Automotive Finishes ............................ 57 40 34 34 36
International Coatings ......................... 1 1 1
Administrative ................................. 5 4 4 9 11
------- ------- ------- ------- -------
Segment totals ................................. $ 1,202 $ 1,070 $ 1,029 $ 973 $ 978
* Included a charge and reduction in asset value of $352 in 2000 for
impairment of other assets.
** Included 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.
70
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 20, 2005 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
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.
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.
CERTIFICATIONS
The Company filed with the Securities and Exchange Commission, as Exhibit 31 to
the Company's Annual Report on Form 10-K for the 2004 fiscal year,
certifications of its Chief Executive Officer and Chief Financial Officer
regarding the quality of the Company's public disclosure. The Company also
submitted to the New York Stock Exchange the previous year's certification of
its Chief Executive Officer certifying that he was not aware of any violation by
the Company of the New York Stock Exchange corporate governance listing
standards.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
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
HEADQUARTERS
The Sherwin-Williams Company
101 Prospect Avenue, N.W.
Cleveland, Ohio 44115-1075
(216) 566-2000
COMMON STOCK TRADING STATISTICS
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
HIGH ....................... $ 45.61 $ 34.77 $ 33.24 $ 28.23 $ 27.625
LOW ........................ 32.95 24.42 21.75 19.73 17.125
CLOSE DECEMBER 31 .......... 44.63 34.74 28.25 27.50 26.313
SHAREHOLDERS OF RECORD ..... 11,056 11,472 11,936 12,687 13,137
SHARES TRADED (THOUSANDS) .. 175,664 143,702 193,256 162,219 158,349
QUARTERLY STOCK PRICES AND DIVIDENDS
2004
- -------------------------------------------
Quarter High Low Dividend
- ------- ------- -------- --------
1ST $ 38.54 $ 32.95 $ .17
2ND 41.63 35.55 .17
3RD 44.11 37.95 .17
4TH 45.61 40.36 .17
2003
- ----------------------------------------
Quarter High Low Dividend
- ------- ------- -------- --------
1st $ 29.25 $ 24.42 $ .155
2nd 28.55 26.16 .155
3rd 30.75 26.47 .155
4th 34.77 29.39 .155
71
CORPORATE OFFICERS AND OPERATING PRESIDENTS
CORPORATE OFFICERS
CHRISTOPHER M. CONNOR, 48*
Chairman and Chief Executive Officer
JOSEPH M. SCAMINACE, 51*
President and Chief Operating Officer
SEAN P. HENNESSY, 47*
Senior Vice President - Finance and
Chief Financial Officer
THOMAS E. HOPKINS, 47*
Senior Vice President -
Human Resources
CONWAY G. IVY, 63*
Senior Vice President - Corporate
Planning and Development
JOHN L. AULT, 59*
Vice President - Corporate Controller
CYNTHIA D. BROGAN, 53
Vice President and Treasurer
MARK J. DVOROZNAK, 46
Vice President - Corporate Audit
and Loss Prevention
JAMES J. SGAMBELLONE, 47
Vice President - Taxes and
Assistant Secretary
LOUIS E. STELLATO, 54*
Vice President, General Counsel
and Secretary
RICHARD M. WEAVER, 50
Vice President - Administration
OPERATING PRESIDENTS
THOMAS S. BRUMMETT, 59
President & General Manager
Chemical Coatings Division
Paint Stores Group
ROBERT J. DAVISSON, 44
President & General Manager
Southeastern Division
Paint Stores Group
TIMOTHY J. DROUILHET, 42
President & General Manager
Eastern Division
Paint Stores Group
TIMOTHY A. KNIGHT, 40
President & General Manager
Diversified Brands Division
BLAIR P. LACOUR, 58*
President & General Manager
Automotive Division
DREW A. MCCANDLESS, 44
President & General Manager
Mid Western Division
Paint Stores Group
JOHN G. MORIKIS, 41*
President
Paint Stores Group
STEVEN J. OBERFELD, 52
President & General Manager
South Western Division
Paint Stores Group
HARVEY P. SASS, 47
President & General Manager
Wood Care Division
THOMAS W. SEITZ, 56*
President & General Manager
Consumer Division
ALEXANDER ZALESKY, 45*
President & General Manager
International Division
* Executive Officer as defined by the Securities Exchange Act of 1934
72
[PICTURE] BOARD OF DIRECTORS
1 SUSAN J. KROPF, 56
President and Chief Operating Officer
Avon Products, Inc.
2 JOHN G. BREEN, 70
Retired, former Chairman, Chief Executive
Officer and President
The Sherwin-Williams Company
3 DANIEL E. EVANS, 68
Retired, former Chairman, Chief Executive
Officer and Secretary
Bob Evans Farms, Inc.
4 CHRISTOPHER M. CONNOR, 48
Chairman and Chief Executive Officer
The Sherwin-Williams Company
5 JOSEPH M. SCAMINACE, 51
President and Chief Operating Officer
The Sherwin-Williams Company
6 RICHARD K. SMUCKER, 56*
President and Co-Chief Executive Officer
The J.M. Smucker Company
7 CURTIS E. MOLL, 65*
Chairman and Chief Executive Officer
MTD Holdings Inc
8 GARY E. MCCULLOUGH, 46*
Senior Vice President,
Abbott Laboratories,
President, Ross Products Division
9 DUANE E. COLLINS, 68
Retired, former Chairman, Chief
Executive Officer and President
Parker-Hannifin Corporation
10 ROBERT W. MAHONEY, 68
Retired, former Chairman, Chief
Executive Officer and President
Diebold, Incorporated
11 JAMES C. BOLAND, 65*
Vice Chairman
Cavaliers/Gund Arena Company
12 A.MALACHI MIXON, III, 64
Chairman and Chief Executive Officer
Invacare Corporation
[GRAPHIC]
* Audit Committee Member
[SHERWIN WILLIAMS LOGO]
The Sherwin-Williams Company
101 Prospect Avenue, N.W.
Cleveland, Ohio 44115-1075
www.sherwin.com