1
EXHIBIT 13
PORTIONS OF ANNUAL REPORT TO SHAREHOLDERS (PAGES 10 - 17, 20 - 33, 35)
NOTES TO FINANCIAL TABLE
Operating profit is total revenue, including realized profit on
intersegment transfers less operating costs and expenses. Corporate expenses
include interest which is unrelated to real estate leasing activities, certain
provisions for disposition and termination of operations and environmental
remediation which are not directly associated with any operating segment, and
other adjustments.
Identifiable assets are those directly identified with each segment's
operations. Corporate assets consist primarily of cash, investments, deferred
pension assets and headquarters property, plant and equipment.
The operating margin for each segment is based upon total external
sales and intersegment transfers. Intersegment transfers are accounted for at
values comparable to normal unaffiliated customer sales.
Net external sales and operating profits of consolidated foreign
subsidiaries were $521 million and $47 million, and $523 million and $55
million, respectively, for 1998 and 1997. Domestic operations account for the
remaining net sales and operating profits. Long-lived assets consist of net
property, plant and equipment, goodwill, and intangibles. Long-lived assets of
consolidated foreign subsidiaries totaled $312 million and $320 million,
respectively, at December 31, 1998 and 1997. The consolidated total of
long-lived assets for the Company was $2,134 million and $2,164 million at
December 31, 1998 and 1997, respectively. Corporate expenses do not include any
significant foreign operations. No single geographic area outside the United
States was significant relative to consolidated net external sales or operating
profits. Consolidated foreign operations were not material for any year prior to
1997.
Export sales and sales to any individual customer were each less than
10 percent of consolidated sales to unaffiliated customers during all years
presented.
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================================================================================
(Millions of Dollars)
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
NET EXTERNAL SALES
Paint Stores $ 2,786 $ 2,605 $ 2,410 $ 2,131 $ 1,986
Coatings 2,135 2,264 1,709 1,129 1,100
Other 13 12 14 14 14
------- ------- ------- ------- -------
Segment totals $ 4,934 $ 4,881 $ 4,133 $ 3,274 $ 3,100
OPERATING PROFITS
Paint Stores $ 249 $ 225 $ 206 $ 158 $ 141
Coatings 322 345 260 202 201
Other 14 12 13 13 8
Corporate expenses-net (145) (155) (104) (55) (51)
------- ------- ------- ------- -------
Income before income taxes $ 440 $ 427 $ 375 $ 318 $ 299
IDENTIFIABLE ASSETS
Paint Stores $ 725 $ 689 $ 634 $ 550 $ 517
Coatings 2,699 2,711 1,764 846 757
Other 76 73 45 45 44
Corporate 565 563 552 700 644
------- ------- ------- ------- -------
Consolidated totals $ 4,065 $ 4,036 $ 2,995 $ 2,141 $ 1,962
CAPITAL EXPENDITURES
Paint Stores $ 40 $ 27 $ 40 $ 29 $ 26
Coatings 84 114 68 68 46
Other 4 9 3 4 1
Corporate 18 14 12 7 6
------- ------- ------- ------- -------
Consolidated totals $ 146 $ 164 $ 123 $ 108 $ 79
DEPRECIATION
Paint Stores $ 29 $ 28 $ 26 $ 24 $ 23
Coatings 58 52 40 31 30
Other 4 3 3 2 3
Corporate 7 7 7 6 5
------- ------- ------- ------- -------
Consolidated totals $ 98 $ 90 $ 76 $ 63 $ 61
OPERATING MARGINS
Paint Stores 8.9% $ 8.7% 8.6% 7.4% 7.1%
Coatings 9.9% 10.5% 9.9% 10.5% 11.1%
Other 38.9% 37.1% 38.4% 39.1% 26.2%
------- ------- ------- ------- -------
Segment totals 9.6% 9.9% 9.4% 9.1% 9.1%
INTERSEGMENT TRANSFERS
Coatings $ 1,125 $ 1,015 $ 924 $ 801 $ 720
Other 24 21 21 19 18
------- ------- ------- ------- -------
Segment totals $ 1,149 $ 1,036 $ 945 $ 820 $ 738
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION - 1998
Net operating cash flow generated by the Company during 1998 was $478.5
million. This cash flow provided the funds to invest in property, plant and
equipment, reduce total debt, acquire treasury stock, and increase the annual
dividend. The Company's current ratio increased to 1.39 at December 31, 1998
from 1.37 at the end of 1997. The Company's Consolidated Balance Sheets and
Statements of Consolidated Cash Flows, on pages 21 and 22 of this report,
provide more detailed information on the Company's financial position and cash
flows.
There were no short-term borrowings outstanding at December 31, 1998.
Short-term borrowings outstanding at December 31, 1997 of $106.9 million,
primarily related to the Company's commercial paper program, were paid in 1998.
The commercial paper program had unused borrowing availability of $1.0 billion
at December 31, 1998. Borrowings under the commercial paper program are fully
backed by and limited to the borrowing availability under the Company's
revolving credit agreements which aggregated $760.0 million effective January 1,
1999.
The increase in the current portion of long-term debt was due primarily
to the reclassification of debt securities of $50.0 million, due October 15,
2027, which allow the holders to exercise a put option beginning on October 15,
1999. Inventories decreased $39.1 million due to planned reductions associated
with the Coatings Segment's sales decline in 1998. Increases in other components
of net working capital, which occurred during 1998, were primarily due to
timing.
Deferred pension assets of $304.0 million at December 31, 1998
represent the excess of the fair market value of the assets in the Company's
defined benefit pension plans over the actuarially-determined projected benefit
obligations. The 1998 increase in deferred pension assets of $27.9 million
represents primarily the recognition of the current year net pension credit,
described in Note 6 on pages 27 and 28 of this report, and the recording of a
settlement of a portion of the accumulated benefit obligations in two of its
defined benefit pension plans. The assumed discount rate used to compute the
actuarial present value of benefit obligations was lowered to 6.75 percent at
December 31, 1998 due to decreased rates of high-quality, long-term investments,
thereby increasing the benefit obligations and decreasing the unrecognized net
gain of the plans. The increase in the actual return on plan assets during 1998
over the assumed return of 8.5 percent was primarily the result of favorable
returns on equity investments. A portion of the increase was deferred which
caused an offsetting increase to the cumulative unrecognized net gain of the
plans. The net effect of these deferred items, combined with an increased asset
base, will increase the pension credit in 1999.
Goodwill, which represents the excess of cost over the fair value of
net assets acquired in purchase business combinations, decreased $38.0 million,
and intangible assets, which represent items such as trademarks and patents,
decreased $18.5 million from 1997. These decreases related primarily to
amortization expense of $50.1 million. Balance sheet reclassifications and other
adjustments to the value of assets acquired during 1997 of $6.4 million further
reduced goodwill and intangible assets. The increase in other assets of $16.6
million was primarily due to the capitalization of costs incurred related to
designing, developing, obtaining, and implementing internal use software in
accordance with Statement of Position 98-1, "Accounting for the Cost of Computer
Software Developed or Obtained for Internal Use". Increases in other
investments, partially offset by the sale of the Company's joint venture
interest in American Standox, Inc., accounted for the remaining change in other
assets.
Net property, plant and equipment increased $26.6 million to $718.9
million at December 31, 1998 due to capital expenditures of $146.1 million,
offset by depreciation expense of $97.8 million and provisions for disposition
or retirement of certain assets. Capital expenditures in 1998 represented
primarily the costs of installing or upgrading customer service hardware in the
paint stores, upgrading and installing other computer hardware, and the
construction, capacity expansion or upgrade of manufacturing and distribution
centers. The increase in capital expenditures during 1998 in the Paint Stores
Segment was primarily attributable to increased new store openings and the
purchase and installation of state-of-the-art satellite and communication
systems used to improve customer service and merchandise management. The
Coatings Segment's decrease in capital expenditures during 1998 primarily
related to the volume of construction costs incurred in 1997 for three powder
coatings facilities, a manufacturing facility in Brazil, and a distribution
center in Nevada. These facilities were completed and placed in service in 1998.
Capital expenditures in the Other Segment decreased due to reduced property
refurbishing spending. In 1999, the Company expects that its most significant
capital expenditures will relate to construction or acquisition of a new
research and development technical lab facility, various capacity and
productivity improvement projects at manufacturing facilities, and new or
upgraded information systems equipment. The Company does not anticipate the need
for any specific long-term external financing to support these capital programs.
Long-term debt decreased $113.6 million during the year to $730.3
million at December 31, 1998, resulting primarily from principal payments and
current maturities. The Company filed a new universal shelf registration
statement to issue debt securities, common stock, and warrants of up to $1.5
billion. No securities have been issued pursuant to this shelf registration. The
Company expects to remain in a borrowing position throughout 1999.
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The increase in the Company's long-term postretirement benefit
liability occurred due to the excess of the net postretirement benefit expense
over the costs for benefit claims incurred. The current portion of the accrued
postretirement liability, amounting to $10.0 million at December 31, 1998, is
included in other accruals. The assumed discount rate used to calculate the
actuarial present value of the postretirement benefit obligations was lowered to
6.75 percent at December 31, 1998 due to decreased rates of high-quality,
long-term investments, thereby increasing the cumulative unrecognized net loss
for the postretirement plans. The effect of this change on the net
postretirement benefit expense for 1999 will be minimal as the cumulative
unrecognized net loss is below the threshold for required amortization. See Note
6, on pages 27 and 28 of this report, for further information on the Company's
postretirement benefit obligations.
Other long-term liabilities include accruals for environmental-related
liabilities and other non-current items. The increase of $18.3 million in other
long-term liabilities during 1998 primarily related to additional tax
liabilities partially offset by decreased accruals for environmental-related
liabilities. See Note 9, on page 29 of this report, for additional information
concerning the Company's other long-term liabilities.
The Company and certain other companies are defendants in a number of
lawsuits arising from the manufacture and sale of lead pigments and lead paints.
It is possible that additional lawsuits may be filed against the Company in the
future. The various existing lawsuits seek damages for personal injuries and
property damages, along with costs involving the abatement of lead related paint
from buildings and medical monitoring costs. The Company believes that such
lawsuits are without merit and is vigorously defending them. The Company does
not believe that any potential liability ultimately determined to be
attributable to the Company arising out of such lawsuits will have a material
adverse effect on the Company's business or financial condition.
The operations of the Company, like those of other companies in its
industry, are subject to various federal, state and local environmental laws and
regulations. These laws and regulations not only govern its current operations
and products, but also impose liability on the Company for past operations which
were conducted utilizing practices and procedures considered acceptable under
the laws and regulations existing at that time. The Company expects
environmental laws and regulations to impose increasingly stringent requirements
upon the Company and its industry in the future. The Company believes it
conducts its operations in compliance with applicable environmental laws and
regulations and has implemented various programs to protect the environment and
promote continued compliance.
Capital expenditures and other expenses related to ongoing
environmental compliance measures are included in the normal operating expenses
of conducting business. The Company's capital expenditures and other expenses
related to ongoing environmental compliance measures were not material to the
Company's financial condition or net income during 1998, and the Company does
not expect such capital expenditures and other expenses to be material to the
Company's financial condition or net income in the future.
The Company is involved with environmental compliance and remediation
activities at some of its current and former sites (including former sites which
were previously owned and/or operated by businesses acquired by the Company).
The Company, together with other parties, has also been designated a potentially
responsible party under federal and state environmental protection laws for the
remediation of 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 certain environmental remediation-related
activities relating to its past operations and third-party sites, including
Superfund sites, for which commitments or clean-up plans have been developed or
for which costs or minimum costs can be reasonably estimated. The Company
continuously assesses its potential liability for 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 which require changing the estimated costs or
the procedure utilized in estimating such costs. 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 attributable 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.
Pursuant to a Consent Decree entered into with the United States of
America, on behalf of the Environmental Protection Agency, filed in the United
States District Court for the Northern District of Illinois, the Company has
agreed, in part, to (i) conduct an investigation at its southeast Chicago,
Illinois facility to determine the nature, extent and potential impact, if any,
of environmental contamination at the facility and (ii) implement remedial
action measures, if required, to address any environmental contamination
identified pursuant to the investigation. The Company is currently conducting
its investigation of the site.
The Company is a defendant in a lawsuit brought by PMC, Inc. regarding
the Company's former Chemical Division's manufacturing facility which was sold
to PMC, Inc. in 1985 and is located adjacent to the Company's southeast Chicago,
Illinois facility. PMC, Inc. is seeking an undisclosed amount for environmental
remediation costs and other damages based upon contractual and tort theories and
under various environmental laws. The United States District Court for the
Northern District of Illinois conducted a trial on the environmental law and
state law theories and generally held, in part,
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that the Company was responsible for all future remediation costs at the
facility pursuant to Section 113(f) of CERCLA. The above determination was
affirmed on appeal in July 1998 by the United States Court of Appeals for the
Seventh Circuit. The Company continues to vigorously defend the remaining
contractual and tort theories in this lawsuit.
With respect to the Company's southeast Chicago, Illinois facility and
its former Chemical Division's manufacturing facility adjacent thereto, the
Company has evaluated its potential liability and, based upon its preliminary
evaluation, has accrued an appropriate amount. However, due to the uncertainties
surrounding these facilities, the Company's ultimate liability may result in
costs that are significantly higher than currently accrued. In such event, the
recording of the liability may result in a significant impact on net income for
the annual or interim period during which the additional costs are accrued.
The Company 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, cash
flow or, except as set forth in the preceding paragraph, net income. See Note 9,
on page 29 of this report, for discussion of the environmental-related accruals
included in the Company's consolidated balance sheets.
Shareholders' equity increased more than $123.8 million during 1998 due
primarily to the excess of current year net income over dividends paid to
shareholders, partially offset by the repurchase of 3,000,000 shares of treasury
stock at a cost of $85.0 million and other comprehensive losses related to
foreign currency translations. The Company acquires its own stock for general
corporate purposes and, depending on its future cash position and market
conditions, it may acquire additional shares in the future. In April 1997, the
Board of Directors authorized the Company to purchase, in the aggregate,
10,000,000 shares of common stock. At December 31, 1998, authorization remained
to acquire 7,000,000 shares.
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income", which
requires reporting comprehensive income on both an accumulated and period basis.
Prior to the adoption of SFAS No. 130, a company was required to report only the
accumulated balances of comprehensive income. Comprehensive income is comprised
of net income and the components of other comprehensive income, which include
foreign currency translation, minimum pension liability adjustments and
unrealized gains and losses on certain investments in debt and equity
securities. See Note 16, on page 33 of this report. The decrease of $11.4
million in accumulated other comprehensive income occurred due primarily to the
strengthening of the U.S. dollar over the functional currencies of the Company's
international subsidiaries.
The Company's Mexican subsidiaries were the only foreign subsidiaries
accounted for under highly inflationary accounting rules during 1998. As of
January 1, 1999, the Mexican economy is not considered highly inflationary. As
of that date, the Mexican Peso became the functional currency for all Mexican
operations and any resulting translation adjustments will be included in Other
Comprehensive Income. In January 1999, the Brazilian Central Bank eliminated its
governmental policy of supporting and tightly managing the trading band of its
currency, the Real, and allowed it to trade freely in the open market against
other currencies. Shortly after this announcement the Real weakened
significantly in trading with the U.S. dollar and other foreign currencies. As a
result of the floating Real exchange rate, the Company may experience increased
losses in Other Comprehensive Income from foreign currency translation of its
Brazilian operations. Any such increases in losses from translation will be in
addition to the weakening of any other foreign currencies in countries where we
have operations. The ultimate amount of any increased losses from the floating
of the Real will not be known until certain policy decisions made by the
Brazilian government help stabilize the currency and improve the Brazilian
economy. However, the Company does not expect the devaluation of the Brazilian
Real, combined with other currency translation losses, to have a material
adverse effect on operating results, financial condition or cash flows for the
Company as a whole.
The Company is exposed to market risk through various financial
instruments, including fixed rate debt instruments and interest rate swaps. The
Company does not believe that any potential loss related to these financial
instruments will have a material adverse effect on the Company's financial
condition or results of operations.
Beginning in the fourth quarter of 1997, the Company commenced
multi-year information technology projects to enhance portions of the Company's
computer systems. The projects will provide efficiencies and further integration
of operations within the Coatings Segment. The Company expects that full
implementation of the projects will involve significant capital expenditures
over the next several years, although capital expenditures in 1998 related to
such projects were not material. Costs and expenses related to these projects,
including amortization costs, charged to operations in 1998 were not material.
Costs and expenses to be charged to operations in the future are not expected to
have a material adverse effect on the Company's annual results of operations.
Expenditures associated with these projects slightly impacted cash flows from
operations in 1998 and will have slightly more of an impact on cash flows from
operations in 1999. However, anticipated benefits beginning in 2000 are expected
to reduce the impact on cash flows.
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At a meeting held February 3, 1999, the Board of Directors increased
the quarterly dividend to $.12 per share. This represents the twentieth
consecutive annual increase and a compounded annual rate of increase of 26.0
percent since the dividend was reinstated in the fourth quarter of 1979. The
1998 annual dividend of $.45 per share marked the nineteenth consecutive year
that the dividend approximated our payout ratio target of 30.0 percent of the
prior year's earnings.
YEAR 2000 READINESS
The Company is engaged in a company-wide project to prepare its
business for the change in date from the year 1999 to 2000. The Company has
assembled a Year 2000 project team consisting of Company employees and third
party consultants. The goal of the Year 2000 project is to assure that there are
no major interruptions in the Company's business operations relating to the
transition to the year 2000. The scope of the Company's Year 2000 project
includes (i) identifying and taking appropriate corrective action to remedy the
Company's software, hardware and embedded technology, (ii) working with certain
key financial institutions, customers, suppliers and service providers, with
which the Company does business electronically, to help protect such business
from being adversely affected by the Year 2000, and (iii) contacting key vendors
and service providers and requesting assurances that such third parties will be
Year 2000 compliant. The status of the Year 2000 project is reported regularly
to senior management and the Board of Directors.
The Year 2000 project team has implemented a compliance process to
address Year 2000 issues in the Company's software and hardware systems and
embedded technology consisting of the following nine steps: (1) inventory, (2)
risk assessment, (3) prioritization, (4) impact analysis, (5) remediation, (6)
testing, (7) certification, (8) deployment, and (9) approval. The Company's
mission critical systems have been the project team's top priority. The
Company's mission critical systems include systems, which are the most essential
to the Company to continue its operations without interruption. The Company
believes it has completed its compliance process beyond the impact analysis
phase for approximately 84 percent of its mission critical software and hardware
systems, with approximately 62 percent of its mission critical software and
hardware systems having been remediated and 22 percent currently being
remediated. With regard to embedded technology, the Company has completed the
remediation and testing phases for 39 percent of its facilities. The Company's
target for completing its compliance process for all of its mission critical
systems is mid-1999. The Company's target for completing its compliance process
for its non-mission critical systems is the end of 1999.
The Company is in contact with certain key financial institutions,
customers, suppliers and service providers, with which the Company does business
electronically, to address potential Year 2000 issues. The Company is directly
working with certain key third parties to remediate and test affected systems
where practicable. The Company sent surveys to key vendors and service providers
requesting information regarding the status of their Year 2000 readiness. The
Company is also in the process of reviewing the public Year 2000 disclosures of
key customers. Based upon this information, the Company is in the process of
identifying potential critical Year 2000 issues involving key third parties, if
any, and either resolving those issues or developing contingency plans to the
extent practicable.
All costs and expenses incurred to address the Year 2000 issue are
charged against income on a current basis. The total cost of the project is
expected to be approximately $35 million, of which about $15 million has been
spent since the beginning of the project through December 31, 1998. These costs
include costs of internal employees and third-party consultants involved in the
project and the costs of software and hardware. The Company does not expect
these costs and expenses to have a material adverse effect on the Company's
financial condition.
While the Company continues to focus on solutions for Year 2000 issues,
and expects to complete its Year 2000 project in a timely manner, the Company is
in the process of identifying potential major business interruptions that could
reasonably likely result from Year 2000 issues and will develop contingency
plans designed to address such potential interruptions. The Company may also
develop contingency plans designed to generally help protect the Company from
unanticipated Year 2000 business interruptions. Contingency plans are
anticipated to include, for example, the identification of alternate suppliers
or service providers, increases in safety levels of raw material and finished
goods inventories, and the development of alternate procedures. The Company's
contingency plans will be developed and modified over time as it receives better
information regarding the Year 2000 status of its systems and embedded
technology and third party readiness.
The most reasonably likely worst case scenario which could result from
the failure of the Company or its customers, vendors or other key third parties
to adequately address Year 2000 issues would include a temporary interruption or
curtailment in the Company's manufacturing or distribution operations at one or
more of its facilities. Such failures could also cause a delay or curtailment in
the processing of orders and invoices and the collection of revenues, as well as
the inability to maintain accurate accounting records, and lead to increased
costs and loss of sales. If these failures would occur, depending upon their
duration and severity, they could have a material adverse effect on the
Company's business, results of operations and financial condition.
Management's estimates regarding expected completion dates and costs
involved in the Company's Year 2000 project are based upon various assumptions
regarding future events, including the availability of resources, the success of
third parties in addressing their Year 2000 issues, and other factors. While
management believes the Company is addressing the Year 2000 issue, there is no
guarantee that these estimated completion dates and costs will be achieved. In
the event that the estimated completion dates and costs differ materially from
the actual completion dates and costs, such could have a materially adverse
effect on the Company's financial condition and results of
15
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operations. In addition, the Company cannot reasonably estimate the impact of
Year 2000 on the Company if key third parties, including financial institutions,
suppliers, customers, service providers, public utilities and governments, are
unsuccessful in completing their Year 2000 efforts.
RESULTS OF OPERATIONS - 1998 VS 1997
Consolidated net sales increased 1.1 percent over 1997 to $4.93 billion
in 1998, due to increased Paint Stores and Other Segment sales, partially offset
by decreased Coatings Segment sales.
The Paint Stores Segment's sales during 1998 increased 6.9 percent due
primarily to increased paint gallons sold to both retail and wholesale
customers, combined with sales gains in each of the remaining major product
lines (wallcoverings, floorcoverings, spray equipment and associated products).
Comparable-store sales were up 4.9% in 1998. The Company plans to increase the
number of paint store openings in 1999 and expects sales growth in the Paint
Stores Segment to continue.
External sales in the Coatings Segment decreased 5.7 percent during
1998 due primarily to weak do-it-yourself coatings sales, poor market conditions
in South America, and the continuing effects of the 1997 loss of certain
coatings, aerosol and detergent business. The Company expects that sales from
new product introductions and expansion of its presence at several retailers
will result in sales growth in 1999. Reduced gallons sold to national accounts
and home center customers, due to the weak do-it-yourself sales, accounted for a
significant portion of the sales decline in this Segment. Reduced sales to some
customers in the cleaning solutions businesses affected Coatings Segment sales
of related products. External sales in the Coatings Segment's consolidated
foreign subsidiaries decreased slightly during 1998 and represented 10.6 percent
of the Company's consolidated net sales. Revenue generated by real estate
operations in the Other Segment was higher than last year as vacated space was
leased to new tenants.
Consolidated gross profit as a percent of sales increased to 43.2
percent from 43.0 percent in 1997. The Paint Stores Segment's 1998 gross profit
margin was slightly higher than last year due primarily to a favorable product
mix. Gross profit margin in the Coatings Segment was slightly higher than last
year due to selective selling price increases and the favorable effects of
replacing lower margin business with more profitable sales. Provision for plant
closings included in cost of goods sold and lower fixed and overhead cost
absorption resulting from decreased sales volume partially offset the gross
profit margin gains.
Consolidated selling, general and administrative expenses as a percent
of sales increased to 32.4 percent from 32.2 percent in 1997 primarily as a
result of increased expenses related to Year 2000 compliance efforts. The Paint
Stores Segment's SG&A expenses as a percent of sales improved slightly over last
year due to effective cost containment. A slightly favorable SG&A ratio in the
Coatings Segment for 1998 compared to 1997 was primarily a result of reduced
promotional expenses.
Consolidated operating profits increased 3.0 percent in 1998. Operating
profits of the Paint Stores Segment increased 10.4 percent, due primarily to
increased sales volume and gross profit, partially offset by higher selling,
general and administrative expenses. The Coatings Segment's operating profits
were 6.7 percent lower than last year due primarily to decreased sales volume
and gross profit, partially offset by lower selling, general and administrative
expenses. Operating profits of the Coatings Segment's consolidated foreign
subsidiaries declined approximately $8.0 million in 1998 and represented 10.7
percent of the Company's consolidated operating profits. There are certain risks
in transacting business internationally, such as changes in applicable laws and
regulatory requirements, political instability, general economic and labor
conditions, fluctuations in currency exchange rates and expatriation
restrictions, which could adversely affect the financial condition or results of
operation of the Company's consolidated foreign subsidiaries. The operating
profits of the Other Segment increased in 1998 due primarily to the leasing of
office space which was vacant in 1997. Corporate expenses decreased in 1998 due
primarily to decreased interest expense and net losses relating to translation
of certain foreign investments which are not directly associated with any
individual operating segment. Refer to pages 5 through 11 of this report for
additional reportable segment information.
Interest expense decreased in 1998 due primarily to lower average
outstanding debt balances. As a result, interest coverage increased to 7.1 times
from 6.3 times in 1997. Fixed charge coverage, which is calculated using
interest and rent expense, increased to 3.3 times from 3.2 times in 1997.
Net interest and investment income decreased in 1998 due primarily to
lower average cash and short-term investment balances and lower average yields.
See Note 4, on page 26 of this report, for further detail on other costs and
expenses. As shown in Note 13, on page 32 of this report, the effective income
tax rate in 1998 decreased to 38%, from 39% in 1997, due to the effects of
changes in tax credits from investment vehicles and other, net items.
Net income increased 4.7 percent in 1998 to $272.9 million from $260.6
million in 1997. Net income per common share-diluted, calculated in accordance
with SFAS No. 128, increased 4.7 percent to $1.57 from $1.50. See Note 15, on
page 33 of this report for detailed computations.
Although the costs and expenses of the Company's Year 2000 project and
the expenses associated with the information technology project will impact
operating profits and net income in 1999, the Company doesn't expect that it
will have a material adverse effect on operating results, financial condition or
cash flows for the Company as a whole.
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RESULTS OF OPERATIONS - 1997 VS 1996
Consolidated net sales increased 18.1 percent over 1996 to $4.88
billion in 1997. Excluding incremental sales from Thompson Minwax Holding Corp.
and other smaller domestic and foreign acquisitions (collectively, the 1997
Acquisitions) which occurred at various times since December 31, 1996, net sales
for 1997 increased 3.7 percent.
The Paint Stores Segment's sales during 1997 increased 8.1 percent, or
6.6 percent excluding the 1997 Acquisitions, due primarily to increased paint
gallons sold to wholesale customers combined with wholesale volume increases in
the remaining major product lines. Although volume sales to retail customers
were soft in the second half of the year, overall retail sales increased in 1997
compared to 1996, thereby contributing to the sales improvement in the Paint
Stores Segment.
External sales in the Coatings Segment increased 32.5 percent during
1997 due primarily to incremental sales from the 1997 Acquisitions. Excluding
the 1997 Acquisitions, sales declined 0.5 percent. Sales were affected by the
loss of certain business due to the Company's unwillingness to match or exceed
the low prices offered by our competition. Reduced gallons sold to national
accounts and home center customers, which resulted from poor out-the-door sales
and the loss of certain product lines at one of its customers, accounted for a
slight sales decline in this Segment's consumer products after excluding the
1997 Acquisitions. Coatings Segment's automotive product sales were higher than
1996, on both an as-reported basis and excluding the 1997 Acquisitions, due
primarily to sales gains in its automotive branches and at original equipment
manufacturers combined with foreign sales gains resulting from increased market
penetration in those areas. Coatings Segment's product sales gains in the
industrial and applicator product lines were offset by reduced sales to some
customers in the retail national (formerly hardware) and cleaning solutions
businesses, leading to slightly lower sales excluding the 1997 Acquisitions as
compared to last year. External sales in the Coatings Segment's consolidated
foreign subsidiaries increased significantly during 1997 and represented 11.3
percent of the Company's consolidated net sales due primarily to the Company's
acquisition activity. Revenue generated by real estate operations in the Other
Segment was lower than 1996 due to the loss of a large tenant in one of its
office buildings at the end of 1996.
Consolidated gross profit as a percent of sales increased to 43.0
percent from 41.8 percent in 1996 due in part to the effects of the 1997
Acquisitions, although improved gross profit margins were also obtained
excluding the 1997 Acquisitions. The Paint Stores Segment's 1997 gross margin
excluding the 1997 Acquisitions was higher than 1996 due primarily to sales
gains in its higher-margin paint and paint-related product lines. Margins in the
Coatings Segment were higher than 1996 due to above-average margins realized
from some of the 1997 Acquisitions' businesses combined with a favorable sales
mix and favorable factory operations.
Consolidated selling, general and administrative expenses as a percent
of sales increased to 32.2 percent from 31.7 percent in 1996. Excluding the 1997
Acquisitions, SG&A expenses as a percent of sales were even with last year. The
Paint Stores Segment's SG&A expenses as a percent of sales were favorable to
1996 on both an as-reported basis and excluding the 1997 Acquisitions due to
cost containment combined with the sales gains achieved. Increased merchandising
and administrative costs related to new products, new customers and improved
service levels led to an unfavorable SG&A ratio in the Coatings Segment for 1997
compared to 1996.
Consolidated operating profits increased 21.6 percent in 1997, or 7.2
percent excluding the 1997 Acquisitions. Operating profits of the Paint Stores
Segment increased 9.3 percent, or 8.9 percent excluding the 1997 Acquisitions,
due primarily to increased paint volume combined with containment of selling,
general and administrative expenses. The Coatings Segment's operating profits
excluding the 1997 Acquisitions were 6.6 percent higher than last year due
primarily to the realization of manufacturing efficiencies in certain business
units. Operating profits of the Coatings Segment's consolidated foreign
subsidiaries represented 12.6 percent of the Company's consolidated operating
profits due primarily to profits from the Company's acquisitions. The operating
profits of the Other Segment decreased in 1997 due primarily to vacant lease
space during part of the year related to the loss of a large tenant in one of
its office buildings. Corporate expenses increased in 1997 due primarily to
increased interest expense and net losses relating to translation of certain
foreign investments which are not directly associated with or allocable to any
individual operating segment.
Interest expense increased significantly in 1997 due to the increases
in long-term debt related to the financing of the 1997 Acquisitions. As a
result, interest coverage decreased to 6.3 times from 16.3 times in 1996. Our
fixed charge coverage, which is calculated using interest and rent expense,
declined to 3.2 times from 3.9 times in 1996.
Net interest and investment income increased in 1997 due primarily to
higher average cash and short-term investment balances and higher average
yields. See Note 4, on page 26 of this report, for further detail on other costs
and expenses. The effective income tax rate in 1997 remained unchanged from the
1996 rate.
Net income increased 13.7 percent in 1997 to $260.6 million from $229.2
million in 1996. Excluding the 1997 Acquisitions, net income increased 14.9
percent. Net income per common share-diluted, calculated in accordance with SFAS
No. 128 adopted during the fourth quarter ended December 31, 1997, increased
12.8 percent to $1.50 from $1.33 (as restated to conform to SFAS No. 128). See
Note 1, on page 24 of this report, for additional discussion on the Company's
adoption of SFAS No. 128 and Note 15, on page 33 of this report, for detailed
computations.
17
9
STATEMENTS OF CONSOLIDATED INCOME
================================================================================
(Thousands of Dollars Except Per Share Data)
Year ended December 31,
-----------------------------------------------
1998 1997 1996
----------- ----------- -----------
Net sales $ 4,934,430 $ 4,881,103 $ 4,132,879
Costs and expenses:
Cost of goods sold 2,804,459 2,784,392 2,405,178
Selling, general and administrative expenses 1,598,333 1,573,510 1,309,086
Interest expense 71,971 80,837 24,537
Interest and net investment income (6,482) (8,278) (6,819)
Other 26,046 23,365 25,520
----------- ----------- -----------
4,494,327 4,453,826 3,757,502
----------- ----------- -----------
Income before income taxes 440,103 427,277 375,377
Income taxes 167,239 166,663 146,220
----------- ----------- -----------
Net income $ 272,864 $ 260,614 $ 229,157
=========== =========== ===========
Net income per common share:
Basic $ 1.58 $ 1.51 $ 1.34
=========== =========== ===========
Diluted $ 1.57 $ 1.50 $ 1.33
=========== =========== ===========
See notes to consolidated financial statements.
20
10
CONSOLIDATED BALANCE SHEETS
================================================================================
(Thousands of Dollars)
December 31,
-----------------------------------------------
1998 1997 1996
----------- ----------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 19,133 $ 3,530 $ 1,880
Accounts receivable, less allowance 604,516 546,314 452,421
Inventories:
Finished goods 568,328 587,680 529,148
Work in process and raw materials 114,195 133,988 113,539
----------- ----------- -----------
682,523 721,668 642,687
Deferred income taxes 117,720 124,669 105,065
Other current assets 123,398 136,072 214,134
----------- ----------- -----------
Total current assets 1,547,290 1,532,253 1,416,187
Goodwill 1,123,128 1,161,129 546,461
Intangible assets 291,715 310,221 104,206
Deferred pension assets 304,006 276,086 254,376
Other assets 80,466 63,854 123,969
Property, plant and equipment:
Land 67,567 64,367 53,705
Buildings 422,902 383,485 312,954
Machinery and equipment 906,501 841,343 716,015
Construction in progress 43,274 68,649 51,258
----------- ----------- -----------
1,440,244 1,357,844 1,133,932
Less allowances for depreciation 721,387 665,586 584,541
----------- ----------- -----------
718,857 692,258 549,391
----------- ----------- -----------
Total Assets $ 4,065,462 $ 4,035,801 $ 2,994,590
=========== =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term borrowings $ 106,913 $ 168,001
Accounts payable $ 408,144 424,184 385,928
Compensation and taxes withheld 125,698 118,709 103,353
Current portion of long-term debt 118,178 53,926 2,133
Other accruals 383,149 367,392 325,635
Accrued taxes 76,804 44,539 65,957
----------- ----------- -----------
Total current liabilities 1,111,973 1,115,663 1,051,007
Long-term debt 730,283 843,919 142,679
Postretirement benefits other than pensions 204,763 199,839 184,551
Other long-term liabilities 302,503 284,200 215,121
Shareholders' equity:
Common stock - $1.00 par value: 171,033,231, 172,907,418
and 171,831,178 shares outstanding at December 31, 1998,
1997 and 1996, respectively 205,701 204,538 101,650
Other capital 143,686 119,695 203,223
Retained earnings 1,797,945 1,602,882 1,411,295
Treasury stock, at cost (386,465) (301,418) (295,954)
Cumulative other comprehensive loss (44,927) (33,517) (18,982)
----------- ----------- -----------
Total shareholders' equity 1,715,940 1,592,180 1,401,232
----------- ----------- -----------
Total Liabilities and Shareholders' Equity $ 4,065,462 $ 4,035,801 $ 2,994,590
=========== =========== ===========
See notes to consolidated financial statements.
21
11
STATEMENTS OF CONSOLIDATED CASH FLOWS
================================================================================
(Thousands of Dollars)
Year Ended December 31,
-----------------------------------------------
1998 1997 1996
----------- ----------- -----------
OPERATIONS
Net income $ 272,864 $ 260,614 $ 229,157
Adjustments to reconcile net income to net operating cash:
Depreciation 97,821 90,202 76,176
Deferred income tax expense 30,557 59,247 (13,798)
Provisions for disposition of operations 23,557 4,152 17,366
Provisions for environmental-related matters 4,295 7,607 15,494
Amortization of intangible assets 50,067 49,044 27,447
Defined benefit pension plans net credit (30,851) (20,173) (15,298)
Net increase in postretirement liability 5,424 5,452 3,258
Other 14,753 15,133 8,408
Change in current items-net:
Increase in accounts receivable (58,202) (22,190) (20,338)
Decrease (increase) in inventories 39,145 (30,940) (85,911)
(Decrease) increase in accounts payable (16,040) 6,841 60,410
Increase (decrease) in accrued taxes 32,778 (24,671) 33,147
Other current items 33,211 4,398 11,869
Proceeds of insurance settlement 53,900
Increase in long-term accrued taxes 8,211 12,174 4,735
Costs incurred for environmental-related matters (14,275) (18,052) (9,400)
Costs incurred for disposition of operations (14,571) (17,585) (6,993)
Other (245) 4,377 3,586
----------- ----------- -----------
Net operating cash 478,499 439,530 339,315
----------- ----------- -----------
INVESTING
Capital expenditures (146,129) (163,955) (122,720)
Decrease in short-term investments 20,000
Acquisitions of assets (884,525) (670,755)
(Increase) decrease in other investments (19,281) (5,633) 37,829
Other (3,264) (6,375) 9,148
----------- ----------- -----------
Net investing cash (168,674) (1,060,488) (726,498)
----------- ----------- -----------
FINANCING
Net (decrease) increase in short-term borrowings (106,913) (61,692) 134,654
Increase in long-term debt 4,559 750,653 101,792
Payments of long-term debt (54,673) (2,194) (72,426)
Payments of cash dividends (77,801) (69,027) (60,029)
Proceeds from stock options exercised 16,818 14,760 12,800
Treasury stock acquired (85,047) (8,437) (3,149)
Other financing of acquisitions 4,542 22,000
Debt issue costs (6,050)
Other 8,835 53 3,937
----------- ----------- -----------
Net financing cash (294,222) 622,608 139,579
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 15,603 1,650 (247,604)
Cash and cash equivalents at beginning of year 3,530 1,880 249,484
----------- ----------- -----------
Cash and cash equivalents at end of year $ 19,133 $ 3,530 $ 1,880
=========== =========== ===========
Taxes paid on income $ 85,746 $ 115,801 $ 141,821
Interest paid on debt 71,970 59,572 22,950
See notes to consolidated financial statements.
22
12
STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY
================================================================================
(Thousands of Dollars Except Per Share Data)
Cumulative
Other
Common Other Retained Treasury Comprehensive
Stock Capital Earnings Stock Loss Total
---------- ---------- ------------ ---------- ---------- ------------
Balance at January 1, 1996 $ 101,110 $ 182,311 $ 1,242,167 $(292,805) $ (20,657) $ 1,212,126
Comprehensive income:
Net income 229,157 229,157
Other comprehensive income 1,675 1,675
------------
Comprehensive income 230,832
Stock issued 540 20,912 (3,149) 18,303
Cash dividends -- $.35 per share (60,029) (60,029)
---------- ---------- ------------ ---------- ---------- ------------
Balance at December 31, 1996 101,650 203,223 1,411,295 (295,954) (18,982) 1,401,232
Comprehensive income:
Net income 260,614 260,614
Other comprehensive loss (14,535) (14,535)
------------
Comprehensive income 246,079
Two-for-one stock split 101,876 (101,876)
Stock issued 1,012 21,321 (5,464) 16,869
Stock acquired for trust (2,973) (2,973)
Cash dividends -- $.40 per share (69,027) (69,027)
---------- ---------- ------------ ---------- ---------- ------------
Balance at December 31, 1997 204,538 119,695 1,602,882 (301,418) (33,517) 1,592,180
Comprehensive income:
Net income 272,864 272,864
Other comprehensive loss (11,410) (11,410)
------------
Comprehensive income 261,454
Stock issued 1,163 25,231 (85,047) (58,653)
Stock acquired for trust (1,240) (1,240)
Cash dividends -- $.45 per share (77,801) (77,801)
---------- ---------- ------------ ---------- ---------- ------------
Balance at December 31, 1998 $ 205,701 $ 143,686 $ 1,797,945 $(386,465) $ (44,927) $ 1,715,940
========== ========== ============ ========== ========== ============
See notes to consolidated financial statements.
23
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
(Thousands of Dollars Unless Otherwise Indicated)
NOTE 1--SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION. The consolidated financial statements include all controlled
subsidiaries. Inter-company accounts and transactions have been eliminated.
REPORTABLE SEGMENTS. Reportable segment information appears on pages 5 through
11 of this report.
FOREIGN CURRENCY TRANSLATION. All consolidated non-highly inflationary foreign
operations use the local currency of the country of operation as the functional
currency and translate the local currency asset and liability accounts at
year-end exchange rates while income and expense accounts are translated at
average exchange rates. The resulting translation adjustments are included in
"Cumulative other comprehensive income", a component of Shareholders' Equity.
All consolidated highly inflationary foreign operations use the Company's
currency as the functional currency.
CASH FLOWS. The Company considers all highly liquid investments with a maturity
of three months or less when purchased to be cash equivalents.
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.
USE OF ESTIMATES. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
ENVIRONMENTAL MATTERS. Capital expenditures for ongoing environmental compliance
measures are recorded in the consolidated balance sheets and related expenses
are included in the normal operating expenses of conducting business. The
Company is involved with environmental compliance and remediation activities at
some of its current and former sites and at a number of third-party sites. The
Company accrues for certain environmental remediation-related activities for
which commitments or clean-up plans have been developed or for which costs can
be reasonably estimated. All accrued amounts are recorded on an undiscounted
basis. Accrued environmental remediation-related expenses include direct costs
of remediation and indirect costs related to the remediation effort, such as
compensation and benefits for employees directly involved in the remediation
activities and fees paid to outside engineering, consulting and law firms. See
Note 4 and Note 9 for discussions of the environmental remediation-related
expense and accruals included in the financial statements.
STOCK-BASED COMPENSATION. The Company uses the intrinsic value method of
accounting for stock-based compensation in accordance with Accounting Principles
Board Opinion No. 25. See Note 12 for pro forma disclosure of net income and
earnings per share under the fair value method of accounting for stock-based
compensation as proscribed by SFAS No. 123, "Accounting for Stock-Based
Compensation".
PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment is stated on the
basis of cost. Depreciation is provided principally by the straight-line method.
The major classes of assets and ranges of depreciation rates are as follows:
Buildings 2% - 6-2/3%
Machinery and equipment 4% - 20%
Furniture and fixtures 5% - 20%
Automobiles and trucks 10% - 33-1/3%
INVESTMENT IN LIFE INSURANCE. The Company invests in broad-based corporate owned
life insurance. The cash surrender values of the policies, net of policy loans,
are included in Other Assets. The net expense associated with such investment is
included in Other Costs and Expenses. Such expense is immaterial to income
before income taxes.
GOODWILL. Goodwill represents the cost in excess of fair value of net assets
acquired in business combinations accounted for by the purchase method and is
amortized on a straight-line basis over periods not exceeding 40 years. The
Company evaluates the recoverability of goodwill at each balance sheet date and
would record an impairment if necessary. Accumulated amortization of goodwill
was $78,983, $48,596 and $18,186 at December 31, 1998, 1997 and 1996,
respectively.
INTANGIBLES. Accumulated amortization of intangible assets was $102,359, $85,242
and $74,450 at December 31, 1998, 1997 and 1996, respectively. These assets are
amortized by the straight-line method over the expected period of benefit. The
Company reviews such assets for impairment at each balance sheet date and
revises the related estimated remaining lives if necessary.
TECHNICAL EXPENDITURES. Total technical expenditures include research and
development costs, quality control, product formulation expenditures and other
similar items. Research and development costs included in technical expenditures
were $20,430, $24,748 and $18,661 for 1998, 1997 and l996, respectively.
ADVERTISING EXPENSES. The cost of advertising is expensed as incurred. The
Company incurred $282,817, $295,942 and $212,448 in advertising costs during
1998, 1997 and 1996, respectively.
EARNINGS PER SHARE. The Company adopted SFAS No. 128, "Earnings Per Share"
during the quarter ended December 31, 1997. Accordingly, basic net income per
share is computed based on the weighted-average number of common shares
outstanding during the year, and diluted net income per share is computed based
on the weighted-average number of common shares outstanding plus all potentially
dilutive securities outstanding during the year. All per share amounts shown for
periods prior to adoption have been restated to conform to the provisions of
SFAS No. 128. See Note 15 for computation.
24
14
LETTERS OF CREDIT. The Company occasionally enters into standby letter of credit
agreements to guarantee various operating activities. These agreements, which
expire in 1999, provide credit availability to the various beneficiaries if
certain contractual events occur. Amounts outstanding under these agreements
totaled $15,042, $18,844 and $17,092 at December 31, 1998, 1997 and 1996,
respectively.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The following methods and assumptions were
used by the Company in estimating its fair value disclosures for financial
instruments:
CASH AND CASH EQUIVALENTS: The carrying amounts reported in the
consolidated balance sheets for cash and cash equivalents approximate
fair value.
SHORT-TERM INVESTMENTS: The carrying amounts reported in the
consolidated balance sheets for marketable debt and equity securities
are based on quoted market prices and approximate fair value.
INVESTMENTS IN SECURITIES: The Company maintains certain long-term
investments, classified as available for sale securities, in a fund to
provide for payment of health care benefits of certain qualified
employees. The estimated fair values of these securities, included in
other assets, of $25,523, $28,751 and $31,785 at December 31, 1998,
1997 and 1996, respectively, are based on quoted market prices.
LONG-TERM DEBT (INCLUDING CURRENT PORTION): The fair values of the
Company's publicly traded debentures, 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.
December 31,
-----------------------------------------------------------------------------------------
1998 1997 1996
----------------------------- -------------------------- --------------------------
CARRYING FAIR Carrying Fair Carrying Fair
AMOUNT VALUE Amount Value Amount Value
------------- ------------ ------------ ----------- ------------ -----------
Publicly traded debt $764,806 $825,989 $764,725 $826,400 $ 15,900 $ 18,670
Non-traded debt 83,559 80,929 133,012 122,354 130,460 110,295
INTEREST RATE SWAPS: The Company occasionally enters into interest rate
swaps primarily to hedge against interest rate risks. These agreements
generally involve the exchange of fixed and floating rate interest
payment obligations without the exchange of the underlying principal
amounts. Counterparties to these agreements are major financial
institutions. Management believes the risk of incurring losses related
to credit risk is remote.
The fair values for the Company's off-balance-sheet instruments, shown
below, are based on pricing models or formulas using current
assumptions for comparable instruments.
December 31,
-----------------------------------------------------------
1998 1997 1996
------------- ------------- ------------
Carrying amount $ (808)
Fair value $ 17 $ 443 770
Notional amount 50,000 100,000 109,669
Number of agreements outstanding 1 2 3
NON-TRADED INVESTMENTS: It was not practicable to estimate the fair
value of the Company's investment in certain non-traded investments
because of the lack of quoted market prices and the inability to
estimate fair values without incurring excessive costs. The carrying
amounts, included in other assets, of $20,034, $17,587 and $100,797 at
December 31, 1998, 1997 and 1996, respectively, represent the Company's
best estimate of current economic values of these investments.
RECLASSIFICATION. Certain amounts in the 1997 and 1996 financial statements have
been reclassified to conform with the 1998 presentation.
NOTE 2--ACQUISITION AND MERGER
Effective January 7, 1997, the Company, through a wholly-owned
subsidiary, acquired all shares outstanding of Thompson Minwax Holding Corp.
(Thompson Minwax). The total amount of funds required to acquire the shares and
pay off certain indebtedness of Thompson Minwax was approximately $830,000. The
excess purchase price over the fair value of the net assets acquired is being
amortized over 40 years using the straight-line method. For financial statement
purposes, the acquisition was accounted for under the purchase method of
accounting. Accordingly, the results of operations of Thompson Minwax since the
date of acquisition are included in the Company's statements of consolidated
income.
Effective January 10, 1996, the Company, through a wholly-owned
subsidiary, acquired all shares outstanding of Pratt & Lambert United, Inc.
(Pratt & Lambert) for a total cash purchase price of approximately $400,000. The
excess purchase price over the fair value of the net assets acquired is being
amortized over 40 years using the straight-line method. For financial statement
purposes, the acquisition was accounted for under the purchase method of
accounting. Accordingly, the results of operations of Pratt & Lambert since the
date of acquisition are included in the Company's statements of consolidated
income.
In addition, during the three-year period ended December 31, 1998, the
Company purchased various domestic automotive and retail paint distributors,
coatings manufacturers, and aerosol and liquid filling businesses. Various
foreign architectural and automotive paint manufacturing and aerosol filling
businesses located in South America were also acquired during the three-year
period.
25
15
NOTE 3--INVENTORIES
Inventories are stated at the lower of cost or market. Cost is
determined principally on the last-in, first-out (LIFO) method which provides a
better matching of current costs and revenues. The following presents the effect
on inventories, net income and net income per basic share had the Company used
the first-in, first-out (FIFO) and average cost methods of inventory valuation
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.
1998 1997 1996
-------------- --------------- ---------------
Percentage of total inventories on LIFO 91% 93% 96%
Excess of FIFO and average cost over LIFO $ 96,235 $104,637 $ 94,138
Increase (decrease) in net income due to LIFO 4,685 (3,604) 4,698
Increase (decrease) in net income per basic share due to LIFO .03 (.02) .03
NOTE 4 -- OTHER COSTS AND EXPENSES
A summary of significant items included in Other Costs and Expenses is
as follows:
1998 1997 1996
-------- -------- --------
Dividend and royalty income $ (3,069) $ (3,361) $ (5,127)
Net expense of financing and investing activities 122 3,688 8,429
Provisions for environmental matters - net (see Note 9) 695 107 15,494
Provisions for disposition and termination of operations
(see Note 5) 12,290 4,152 5,506
Foreign exchange losses 11,773 15,580 3,335
Miscellaneous 4,235 3,199 (2,117)
-------- -------- --------
$ 26,046 $ 23,365 $ 25,520
======== ======== ========
The net expense of financing and investing activities represents the
net realized gains and losses from disposing of fixed assets, the net gain or
loss associated with the investment of certain long-term asset funds, the net
pre-tax expense associated with the Company's investment in broad-based
corporate owned life insurance, and in 1998, the net gain related to the sale of
the Company's joint venture interest in American Standox, Inc.
The provisions for environmental matters reflect the increased
estimated costs of environmental remediation at current, former and third-party
sites which were partially offset by settlements with certain insurance carriers
pertaining to environmental-related matters totaling $3,600, $7,500 and $56,000
during 1998, 1997 and 1996, respectively.
The provisions for disposition and termination of operations reduce
property, plant and equipment at closed facilities to its estimated net
realizable value and adjust all previous provisions to current estimates as
closure or disposition occurs. The increase in 1998 is primarily due to
provisions recorded for closing four manufacturing facilities.
NOTE 5--DISPOSITION AND TERMINATION OF OPERATIONS
The Company is continually re-evaluating its operating facilities with
regard to the long-term strategic goals established by management and the board
of directors. Operating facilities which are not expected to sufficiently
contribute to the Company's future plans are closed or sold.
At the time of the decision to close or sell a facility, a provision is
made and the expense included in Other Costs and Expenses to reduce property,
plant and equipment to its estimated net realizable value. Similarly, provisions
are made which reduce all other assets to their estimated net realizable values
and provide for all qualified exit costs such as lease cancellation penalties,
post-closure rent expenses, incremental post-closure expenses, and the estimated
costs of employee termination benefits if management has approved a termination
plan and communicated such plan to the affected employees. The expenses
associated with the provisions for all other assets and for such exit costs and
termination benefits are included in Cost of Goods Sold. Adjustments to all
previous accruals, as closure or disposition occurs, are included in Other Costs
and Expenses.
The provisions made during 1998 provided for the reduction to net
realizable value of certain assets and for the exit costs related to four
redundant manufacturing facilities within the reorganized Consumer Group. There
were no new provisions made in 1997. The provisions made during 1996 provided
for the reduction to net realizable value of certain assets and exit costs
related to one manufacturing facility and consolidations of certain redundant
distribution and administrative facilities.
A summary of the financial data related to the closing or sale of the
facilities is as follows:
1998 1997 1996
-------- -------- ----------
Beginning accruals -- January 1 $ 47,111 $ 60,544 $ 27,545
Provisions included in cost of goods sold 11,267 11,860
Provisions and adjustments to prior accruals
included in costs and expenses - other 12,290 4,152 5,506
-------- -------- ----------
Total charges 23,557 4,152 17,366
Accruals related to acquired sites 22,626
Actual expenditures (14,571) (17,585) (6,993)
-------- -------- ----------
Ending accruals - December 31 $ 56,097 $ 47,111 $ 60,544
======== ======== ========
Net after-tax charges to current operations $ 15,312 $ 2,699 $ 11,288
Net after-tax charges per basic share $ .09 $ .02 $ .07
26
16
NOTE 6 -- PENSION AND OTHER BENEFITS
The Company provides pension benefits to substantially all employees through
noncontributory defined benefit or defined contribution plans. In addition,
certain health care and life insurance benefits are provided by
company-sponsored plans for certain active and retired employees. Effective
December 31, 1998, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits". The disclosures required by SFAS No. 132 supersede
previous disclosure requirements without affecting measurement or recognition
criteria. Accordingly, all disclosures for prior periods shown below have been
restated to conform to the disclosure requirements of SFAS No. 132.
Defined Benefit Pension Plans Other Postretirement Benefits
---------------------------------- -------------------------------------
1998 1997 1996 1998 1997 1996
---------- ---------- ---------- ----------- ----------- -----------
BENEFIT OBLIGATION:
Balance at beginning of year $ 175,204 $ 158,876 $ 128,335 $ 206,007 $ 183,179 $ 171,910
Service cost 2,564 2,570 3,516 3,877 3,720 3,327
Interest cost 11,942 11,859 10,933 13,909 13,708 12,483
Actuarial (gain) loss 1,702 402 95 3,184 15,366 (2,235)
Plan amendments 2,003 201 1,037
Acquisitions 19,644 26,149 5,701
Benefits paid (24,316) (18,348) (11,189) (9,350) (9,966) (8,007)
---------- ---------- ---------- ----------- ----------- -----------
Balance at end of year 169,099 175,204 158,876 217,627 206,007 183,179
PLAN ASSETS:
Balance at beginning of year 446,271 391,865 323,216
Actual return on plan assets 71,188 60,143 49,923
Acquisitions 10,574 30,778
Other, net (759) 2,037 (863)
Benefits paid (24,316) (18,348) (11,189)
---------- ---------- ----------
Balance at end of year 492,384 446,271 391,865
EXCESS (DEFICIENT) PLAN ASSETS 323,285 271,067 232,989 (217,627) (206,007) (183,179)
Unrecognized net asset (2,792) (4,304) (6,943)
Unrecognized actuarial (gain) loss (20,348) 3,195 27,472 20,171 16,784 11,288
Unrecognized prior service cost (credit) 2,330 808 858 (17,307) (20,116) (21,570)
---------- ---------- ---------- ----------- ----------- -----------
NET ASSET (LIABILITY) RECOGNIZED IN THE
CONSOLIDATED BALANCE SHEETS $ 302,475 $ 270,766 $ 254,376 $ (214,763) $ (209,339) $ (193,461)
========== ========== ========== =========== =========== ===========
NET ASSET (LIABILITY) RECOGNIZED IN THE
CONSOLIDATED BALANCE SHEETS CONSIST OF:
Prepaid benefit cost $ 304,006 $ 276,086 $ 254,376
Accrued benefit liability (1,136) $ (204,763) $ (199,839) $ (184,551)
Amount included in current liabilities (1,531) (4,612) (10,000) (9,500) (8,910)
Accumulated other comprehensive
income, net of tax 428
---------- ---------- ---------- ----------- ----------- -----------
$ 302,475 $ 270,766 $ 254,376 $ (214,763) $ (209,339) $ (193,461)
========== ========== ========== =========== =========== ===========
WEIGHTED-AVERAGE ASSUMPTIONS AS
OF DECEMBER 31:
Discount rate 6.75% 7.00% 7.25% 6.75% 7.00% 7.25%
Expected long-term rate of return on assets 8.50% 8.50% 8.50%
Rate of compensation increase 5.00% 5.00% 5.00%
Health care cost trend rate 6.70% 7.20% 7.75%
NET PERIODIC BENEFIT (CREDIT) COST:
Service and interest cost $ 14,506 $ 14,429 $ 14,449 $ 17,786 $ 17,428 $ 15,810
Net amortization and deferral (2,524) (1,008) (145) (2,809) (2,689) (2,696)
Expected return on assets (37,531) (33,594) (29,602)
Settlement gain (5,302)
---------- ---------- ---------- ----------- ----------- -----------
Net periodic benefit (credit) cost $ (30,851) $ (20,173) $ (15,298) $ 14,977 $ 14,739 $ 13,114
========== ========== ========== =========== =========== ===========
27
17
Plan assets include 1,938,800 shares of the Company's common stock at December
31, 1998. The ending market value and dividends received during the year for
those shares was $56,952 and $872, respectively.
The projected benefit obligation, accumulated benefit obligation, and fair value
of plan assets for the pension plans with accumulated benefit obligations in
excess of plan assets were $15,612, $15,573 and $11,541, respectively, as of
December 31, 1997.
The Company's annual contribution for its defined contribution pension plans,
which is based on a level percentage of compensation for covered employees, was
$27,004 for 1998, $28,255 for 1997, and $24,730 for 1996.
The health care plans are contributory and contain cost-sharing features such as
deductibles and coinsurance. There were 15,894, 16,049, and 16,935 active
employees entitled to receive benefits under these plans as of December 31,
1998, 1997 and 1996, respectively. The cost of these benefits for active
employees is recognized as claims are incurred and amounted to $47,563, $47,484,
and $44,221 for 1998, 1997, and 1996, respectively. The Company has a fund, to
which it no longer intends to contribute, that provides for payment of health
care benefits of certain qualified employees. Distributions from the fund
amounted to $4,928 in 1998, $5,025 in 1997, and $4,618 in 1996.
Employees of the Company who were hired prior to January 1, 1993 and who
are not members of a collective bargaining unit, and certain groups of employees
added through acquisitions, are eligible for certain health care and life
insurance benefits upon retirement from active service, subject to the terms,
conditions and limitations of the applicable plans. There were 4,800, 4,229, and
4,152 retired employees entitled to receive benefits as of December 31, 1998,
1997 and 1996, respectively. The plans are unfunded.
The health care cost trend rate is assumed to decrease gradually to 5.5 percent
for 2003 and thereafter. Assumed health care cost trend rates have a significant
effect on the amounts reported for the health care plan. A one-percentage-point
change in assumed health care cost trend rates would have the following effects
as of December 31, 1998:
ONE-PERCENTAGE-POINT
----------------------
INCREASE DECREASE
-------- --------
Effect on total of service and interest
cost components $ 1,300 $ 1,290
Effect on the postretirement benefit
obligation $16,040 $14,870
NOTE 7--LONG-TERM DEBT
Amount Outstanding
---------------------------------------------------
Due Date 1998 1997 1996
------------------ --------------- ---------------- ---------------
6.85% Notes 2007 $ 199,742 $ 199,710
7.375% Debentures 2027 149,903 149,900
7.45% Debentures 2097 149,396 149,390
6.5% Notes 2002 99,966 99,955
6.25% Notes 2000 99,974 99,948
Floating Rate Notes 50,000 $ 100,000
5.5% Notes 2027 49,922
9.875% Debentures 2007 to 2016 15,900 15,900 15,900
6% to 9% Promissory Notes Through 2004 10,623 23,791 22,618
8% to 12% Promissory Notes partially secured by
certain land and buildings and other Through 2005 3,884 4,495 3,242
4.75% Promissory Note 2000 800 800 800
Other Obligations 95 108 119
--------------- ---------------- ---------------
$ 730,283 $843,919 $ 142,679
=============== ================ ===============
Maturities of long-term debt are as follows for the next five years:
$118,178 in 1999; $105,958 in 2000; $4,141 in 2001; $102,960 in 2002; and $1,542
in 2003.
Interest expense on long-term debt amounted to $59,137, $52,351 and
$8,602 for 1998, 1997 and 1996, respectively. There were no interest charges
capitalized during the periods presented.
Effective January 3, 1997, the Company entered into new revolving
credit agreements aggregating a maximum borrowing amount of $1,450,000.
Amendments in 1997 and 1998 reduced the aggregate maximum borrowing amount under
these agreements to $1,080,000 and $1,064,000, respectively. Effective January
1, 1999, the agreements were further amended to reflect the following: 1) a
364-day agreement aggregating $147,200; and 2) a five-year agreement aggregating
$612,800, with $104,000 expiring January 3, 2003 and $508,800 expiring January
3, 2004. There were no outstanding borrowings under any revolving credit
agreement for all periods presented.
The aggregate principal amount of unsecured short-term notes that may
be issued under the Company's commercial paper program was increased from
$600,000 to $1,450,000 in January 1997 and subsequently decreased to $1,000,000
in May 1997. The Company uses the revolving credit agreements to satisfy this
program's dollar for dollar liquidity requirement. At December 31, 1997 and
1996, outstanding borrowings under this program totaled $106,748 and $166,246,
respectively, and are included in short-term borrowings on the respective
balance sheets. The weighted-average interest rates related to these borrowings
were 5.89% and 5.71% at December 31, 1997 and 1996, respectively. There were no
outstanding borrowings under this program at December 31, 1998. Effective
January 1, 1999, this program will be limited to $760,000, since the revolving
credit agreements' aggregate maximum borrowing limit has fallen below this
program's limit.
28
18
On February 10, 1997, the Company issued $400,000 of debt securities
under its $450,000 shelf registration with the Securities and Exchange
Commission consisting of $100,000 of 6.25% notes due February 1, 2000, $100,000
of 6.5% notes due February 1, 2002 and $200,000 of 6.85% notes due February 1,
2007. In addition, on February 10, 1997, the Company issued $150,000 of 7.375%
debentures due February 1, 2027 and $150,000 of 7.45% debentures due February 1,
2097 in a private offering not registered under the Securities Act of 1933, as
amended (Securities Act). In July 1997, the Company completed offers to exchange
all of its outstanding $300,000 of debentures for an equal principal amount of
newly-issued debentures containing identical terms except that the newly-issued
debentures were registered under the Securities Act. The net proceeds from these
borrowings were used to refinance a portion of the Company's commercial paper
debt.
On October 6, 1997, the Company issued the remaining $50,000 of debt
securities under this shelf registration consisting of 5.5% notes, due October
15, 2027, with provisions that the holders, individually or in the aggregate,
may exercise a put option which would require the Company to repay the
securities at an earlier date. This option is first available to the holders on
October 15, 1999, and then annually on each October 15 thereafter. Accordingly,
these debt securities have been reclassified to current at December 31, 1998.
The net proceeds from this borrowing were used to refinance short-term
commercial paper debt.
On December 24, 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
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
outstanding borrowings under this registration.
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 the amount of $1,500,000. The registration was
effective September 8, 1998. There were no outstanding borrowings under this
registration.
NOTE 8--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 some
properties. Rental expense for operating leases was $117,762, $113,339 and
$104,894 for 1998, 1997 and 1996, 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 $10,329 in 1998, $10,396 in
1997 and $9,877 in 1996. Rental income, as lessor, from real estate leasing
activities and sublease rental income for all years presented was not
significant.
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, 1998:
1999 $ 89,051
2000 75,342
2001 60,610
2002 44,190
2003 27,253
Later years 84,336
-----------
Total minimum lease payments $ 380,782
===========
NOTE 9--OTHER LONG-TERM LIABILITIES
Other long-term liabilities consist of the following:
1998 1997 1996
-------- -------- --------
Environmental-related $127,613 $143,276 $139,057
Other 174,890 140,924 76,064
-------- -------- --------
$302,503 $284,200 $215,121
======== ======== ========
The accrual for environmental-related long-term liabilities represents
the Company's provisions for estimated costs associated with extended
environmental remediation-related activities at some of its current and former
sites. Also, the Company, together with other parties, has been designated a
potentially responsible party under federal and state environmental protection
laws for the remediation of hazardous waste at a number of third-party sites,
primarily Superfund sites. In general, these laws provide that potentially
responsible parties may be held jointly and severally liable for investigation
and remediation costs regardless of fault. The Company provides for, and
includes in long-term liabilities, its estimated potential long-term liability
for investigation and remediation costs with respect to such third-party sites.
The Company initially provides for the estimated cost of certain
environmental-related activities relating to its current, former and third-party
sites when costs can be reasonably estimated. These estimates 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 accrued. Actual costs incurred may vary from these
estimates due to the inherent uncertainties involved. The Company believes that
any additional liability in excess of amounts provided which may result from the
resolution of such matters will not have a material adverse effect on the
financial condition, liquidity or cash flow of the Company.
The decrease in the accrual for environmental-related long-term
liabilities in 1998 represents primarily the excess of current year expenditures
over current year provisions and adjustments to the previous accrual resulting
from the ongoing evaluation of environmental matters at certain current, former
and third-party sites.
In addition to the environmental-related long-term liabilities shown
above, certain current environmental-related liabilities are included in other
accruals on the consolidated balance sheets.
29
19
NOTE 10--STOCK PURCHASE PLAN
As of December 31, 1998, 14,413 employees participated through regular
payroll deductions in the Company's Employee Stock Purchase and Savings Plan.
The Company's contribution charged to operations amounted to $32,679, $33,582
and $29,935 for 1998, 1997 and 1996, respectively. Additionally, the Company
made contributions on behalf of participating employees, which represent salary
reductions for income tax purposes, amounting to $20,250 in 1998, $18,905 in
1997 and $15,282 in 1996.
At December 31, 1998, there were 24,765,710 shares of the Company's
stock being held by this plan, representing 14.5 percent of the total number of
voting shares outstanding. Shares of company stock credited to each member's
account under the plan are voted by the trustee under instructions from each
individual plan member. Shares for which no instructions are received are voted
by the trustee in the same proportion as those for which instructions are
received.
NOTE 11--CAPITAL STOCK
Shares Shares
in Treasury Outstanding
------------ ------------
Balance at January 1, 1996 31,310,828 170,909,626
Stock issued upon:
Exercise of stock options 158,688 918,552
Restricted stock grants 3,000
------------ ------------
Balance at December 31, 1996 31,469,516 171,831,178
Stock issued upon:
Exercise of stock options 160,739 967,040
Restricted stock grants 109,200
------------ ------------
Balance at December 31, 1997 31,630,255 172,907,418
Stock issued upon:
Exercise of stock options 37,663 1,163,813
Restricted stock grants/(cancellations) (38,000)
Treasury stock acquired 3,000,000 (3,000,000)
------------ ------------
Balance at December 31, 1998 34,667,918 171,033,231
============ ============
An aggregate of 20,389,127, 21,594,603, and 8,686,286 shares of stock
at December 31, 1998, 1997 and 1996, respectively, were reserved for future
grants of restricted stock and the exercise and future grants of stock options.
Shares outstanding include 159,800 and 115,000 shares of stock held in a
revocable trust at December 31, 1998 and 1997, respectively. At December 31,
1998, there were 300,000,000 shares of common stock and 30,000,000 shares of
serial preferred stock authorized for issuance (3,000,000 shares of the
authorized serial preferred stock have been designated as cumulative redeemable
serial preferred stock which may be issued pursuant to the Company's
shareholders' rights plan if the Company becomes the target of coercive and
unfair takeover tactics).
NOTE 12--STOCK PLAN
The Company's 1994 Stock Plan permits the granting of stock options,
stock appreciation rights and restricted stock to eligible employees. The 1994
Stock Plan succeeded the 1984 Stock Plan which expired on February 15, 1994.
Although no further grants may be made under the 1984 Stock Plan, all rights
granted under such plan remain. In April 1997, the 1994 Stock Plan was amended
to authorize an additional 14,000,000 shares to the shares then available for
future grants. Non-qualified and incentive stock options have been granted to
certain officers and key employees under the plans at prices not less than fair
market value of the shares, as defined by the plans, at the date of grant. The
options generally become exercisable to the extent of one-third of the optioned
shares for each full year following the date of grant and generally expire ten
years after the date of grant. In April 1997, the 1997 Stock Plan for
Nonemployee Directors was adopted. This plan 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. Grants made pursuant to the 1997 Stock Plan are
authorized by the Board of Directors. The number of options and any period of
service required before the options may be exercised is determined by the Board
of Directors at the time of grant. No options may be exercised more than ten
years from the date of grant.
Restricted stock grants, 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 1994 Stock Plan. The number of shares to be received without
restriction is based on the Company's performance relative to a peer group of
companies. During 1997, 123,200 shares of restricted stock vested and were
delivered to officers and employees. No shares vested during 1998 or 1996. At
December 31, 1998, there were 323,000 shares of restricted stock outstanding.
Unamortized deferred compensation expense with respect to the restricted stock
grants amounted to $2,781, $5,401 and $2,962 at December 31, 1998, 1997 and
1996, respectively, and is being amortized over the four-year vesting period.
Deferred compensation expense aggregated $2,090, $528 and $3,983 in 1998, 1997
and 1996, respectively. No stock appreciation rights have been granted.
A summary of restricted stock granted during 1998, 1997 and 1996 is as
follows:
1998 1997 1996
------ ------ ------
Shares granted 4,000 232,500 3,000
Weighted-average fair value
of restricted shares granted
during year $33.06 $27.91 $20.72
30
20
The Company has elected to follow Accounting Principles Board Opinion
(APBO) No. 25, "Accounting for Stock Issued to Employees", and related
interpretations, in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation", requires use of highly subjective assumptions in
option valuation models. Under APBO No. 25, because the exercise price of the
Company's employee stock options is not less than fair market price of the
shares at the date of grant, no compensation is recognized in the financial
statements. Pro forma information regarding net income and earnings per share,
determined as if the Company had accounted for its employee stock options under
the fair value method of SFAS No. 123, is required by that statement. 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:
1998 1997 1996
------------ -------------- --------------
Risk-free interest rate 5.14% 6.10% 5.99%
Expected life of option 3 YEARS 3 years 3 years
Expected dividend yield of stock 2.00% 2.00% 2.00%
Expected volatility of stock 0.194 0.164 0.201
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.
The amounts below represent the pro forma information calculated
through use of the Black-Scholes model. For purposes of pro forma disclosures,
the estimated fair value of the options is amortized to expense over the
options' vesting period.
1998 1997 1996
--------- --------- ---------
Pro forma net income $ 269,838 $ 257,757 $ 228,126
Pro forma net income per common share:
Basic $ 1.57 $ 1.50 $ 1.33
Diluted $ 1.56 $ 1.49 $ 1.32
Due to the required phase-in provisions, the effects of applying SFAS
No. 123 to arrive at the above pro forma amounts are not representative of the
expected effects on pro forma net income or earnings per share in future years.
A summary of the Company's stock option activity, and related
information for the years ended December 31, 1998, 1997 and 1996, is shown in
the following table:
1998 1997 1996
---------------------------- ---------------------------- ---------------------------
WEIGHTED- Weighted- Weighted-
AVERAGE Average Average
OPTIONED EXERCISE Optioned Exercise Optioned Exercise
SHARES PRICE Shares Price Shares Price
-------------- ------------ ------------ -------------- -------------- ------------
Outstanding beginning of year 5,810,471 $18.47 5,434,596 $14.91 4,976,268 $12.35
Granted 1,867,500 29.10 1,746,500 27.93 1,648,500 20.82
Exercised (1,201,476) 14.00 (1,127,779) 12.88 (1,077,240) 11.28
Canceled (216,793) 26.68 (242,846) 22.68 (112,932) 18.36
-------------- ------------ ------------ -------------- -------------- ------------
Outstanding end of year 6,259,702 $22.89 5,810,471 $18.47 5,434,596 $14.91
============== ============ ============ ============== ============== ============
Exercisable at end of year 3,019,873 $17.77 2,924,515 $13.96 3,011,242 $11.99
Weighted-average fair value of
options granted during year $5.12 $4.53 $3.57
Reserved for future grants 14,129,425 15,784,132 3,251,686
A summary by range of exercise prices for optioned shares outstanding as of
December 31, 1998 from $6.47 to $35.34 as follows:
Outstanding Exercisable
------------------------------ ------------------------------ Weighted-
Weighted- Weighted- Average
Average Average Remaining
Range of Optioned Exercise Optioned Exercise Contractual
Exercise Prices Shares Price Shares Price Life (years)
---------------------------- -------------- -------------- -------------- -------------- --------------
less than $12.00 639,175 $ 9.34 639,175 $ 9.34 1.89
$12.00 - $19.99 1,126,701 15.89 1,126,701 15.89 5.25
$20.00 - $26.00 1,276,779 21.17 762,153 20.94 7.28
greater than $26.00 3,217,047 28.72 491,844 27.19 8.82
-------------- -------------- -------------- -------------- --------------
6,259,702 $ 22.89 3,019,873 $ 17.77 7.51
============== ============== ============== ============== ==============
31
21
NOTE 13--INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes".
Under SFAS No. 109, deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that are currently in
effect.
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. Significant
components of the Company's deferred tax liabilities and assets as of December
31, 1998, 1997 and 1996 are as follows:
1998 1997 1996
---------- ---------- ---------
Deferred tax liabilities:
Depreciation $ 51,997 $ 38,605 $ 24,393
Deferred employee benefit items 35,163 26,128 27,873
---------- ---------- ---------
Total deferred tax liabilities $ 87,160 $ 64,733 $ 52,266
========== ========== =========
Deferred tax assets:
Dispositions, environmental and other similar items $ 61,857 $ 61,537 $ 55,143
Other items (each less than 5% of total assets) 88,432 99,120 100,679
---------- ---------- ---------
Total deferred tax assets $ 150,289 $ 160,657 $ 155,822
========== ========== =========
Significant components of the provisions for income taxes are as
follows:
1998 1997 1996
---------- ---------- ---------
Current:
Federal $ 106,538 $ 87,626 $ 124,847
Foreign 6,982 3,472 8,125
State and Local 23,162 16,318 27,046
---------- ---------- ---------
Total Current 136,682 107,416 160,018
Deferred:
Federal 20,946 46,890 (12,169)
Foreign 5,587 2,375 417
State and Local 4,024 9,982 (2,046)
---------- ---------- ---------
Total Deferred 30,557 59,247 (13,798)
---------- ---------- ---------
Total income tax expense $ 167,239 $ 166,663 $ 146,220
========== ========== =========
Significant components of income before income taxes as
used for income tax purposes, are as follows:
1998 1997 1996
---------- ---------- ---------
Domestic $ 382,469 $ 382,325 $ 343,445
Foreign 57,634 44,952 31,932
---------- ---------- ---------
$ 440,103 $ 427,277 $ 375,377
========== ========== =========
A reconciliation of the statutory federal income tax rate and the
effective tax rate follows:
1998 1997 1996
---------- ---------- ---------
Statutory tax rate 35.0% 35.0% 35.0%
Effect of:
State and local taxes 4.0 4.0 4.3
Investment vehicles (2.7) (3.3) (2.9)
Other, net 1.7 3.3 2.6
---------- ---------- ---------
Effective tax rate 38.0% 39.0% 39.0%
========== ========== =========
The provision includes estimated taxes payable on that portion of
retained earnings of foreign subsidiaries expected to be received by the
Company. A provision was not made with respect to $6,862 of retained earnings at
December 31, 1998 that have been invested by foreign subsidiaries. It is not
practicable to estimate the amount of unrecognized deferred tax liability for
undistributed foreign earnings.
Netted against the Company's other deferred tax assets are valuation
reserves of $16,703, $19,836 and $19,158 at December 31, 1998, 1997 and 1996,
respectively, resulting from the uncertainty as to the realization of the tax
benefits resulting from certain foreign net operating losses and other foreign
assets.
NOTE 14--SUMMARY OF QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
1998
- ------------------------------------------------------------------------------------------------------------------------------
NET INCOME PER NET INCOME PER
QUARTER NET SALES GROSS PROFIT NET INCOME SHARE - BASIC SHARE - DILUTED
- -------------- ------------------ ------------------ ------------------ --------------------- ---------------------
1ST $ 1,104,147 $ 454,939 $ 25,198 $.15 $.14
2ND 1,377,785 599,465 99,450 .58 .57
3RD 1,341,431 587,902 100,748 .59 .58
4TH 1,111,067 487,665 47,468 .28 .28
Net income during the fourth quarter was increased by $883 (no per share
effect) due to certain year-end adjustments. Cost of goods sold decreased by
$13,962 ($9,075 after-tax, $.05 per share) as a result of physical inventory
adjustments of $17,411 ($11,317 after-tax, $.06 per share) and other year-end
adjustments of $7,818 ($5,082 after-tax, $.03 per share). These adjustments were
partially offset by provisions for the closing costs associated with certain
operations of $11,267 ($7,324 after-tax, $.04 per share). Administrative
expenses increased $295 ($192 after-tax, no per share effect) due to other
year-end adjustments. Other costs and expenses increased $12,785 ($8,310
after-tax, $.05 per share) due to the provision of $12,290 ($7,988 after-tax,
$.05 per share) for the adjustment to net realizable value of certain net fixed
assets and due to the net provisions for environmental-related matters at
current, former and third-party sites of $495 ($322 after-tax, no per share
effect).
32
22
1997
- ------------------------------------------------------------------------------------------------------------------------------
Net Income per Net Income per
Quarter Net Sales Gross Profit Net Income Share - Basic Share - Diluted
- -------------- ------------------ ------------------ ------------------ --------------------- ---------------------
1st $ 1,069,787 $ 443,614 $ 23,134 $.13 $.13
2nd 1,373,351 597,556 93,203 .54 .54
3rd 1,346,531 583,391 99,211 .58 .57
4th 1,091,434 472,150 45,066 .26 .26
Year-end adjustments during the fourth quarter slightly decreased net
income with no effect on net income per share. Cost of goods sold decreased by a
net of $2,998 ($1,949 after-tax, $.01 per share) as a result of physical
inventory adjustments of $6,967 ($4,529 after-tax, $.03 per share) which were
partially offset by various year end charges of $3,969 ($2,580 after-tax, $.02
per share). Administrative expenses were reduced $2,451 ($1,593 after-tax, $.01
per share) due to other year-end adjustments. Other costs and expenses increased
$5,525 ($3,591 after-tax, $.02 per share) due to provisions for
environmental-related matters at certain current, former and third-party sites
of $493 ($320 after-tax, no per share effect) and increases to prior accruals
for the disposition and termination of operations of $5,032 ($3,271 after-tax,
$.02 per share).
NOTE 15--NET INCOME PER COMMON SHARE
1998 1997 1996
------------ ------------ ------------
BASIC
Average common shares outstanding 172,162,472 172,107,459 171,117,390
============ ============ ============
Net income $ 272,864 $ 260,614 $ 229,157
============ ============ ============
Net income per common share $ 1.58 $ 1.51 $ 1.34
============ ============ ============
DILUTED
Average common shares outstanding 172,162,472 172,107,459 171,117,390
Non-vested restricted stock grants (see Note 12) 235,317 312,988 300,000
Stock options -- treasury stock method 1,137,890 1,611,895 1,408,386
------------ ------------ ------------
Average common shares assuming dilution 173,535,679 174,032,342 172,825,776
============ ============ ============
Net income $ 272,864 $ 260,614 $ 229,157
============ ============ ============
Net income per common share $ 1.57 $ 1.50 $ 1.33
============ ============ ============
Net income per common share has been computed in accordance with Statement of
Financial Accounting Standards (SFAS) No. 128 adopted during the quarter ended
December 31, 1997. Net income per common share amounts shown for 1996 have been
restated to conform to the provisions of SFAS No. 128.
NOTE 16--COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income". SFAS No.
130 establishes new rules for the reporting and display of comprehensive income
and its components; however, the adoption of this statement had no impact on the
Company's net income or shareholders' equity. SFAS No. 130 requires other
comprehensive income to include foreign currency translation adjustments and
minimum pension liability adjustments, which prior to adoption were reported
separately in shareholders' equity. The December 31, 1997 and 1996 financial
statements have been reclassified to conform to the requirements of SFAS No.
130.
Cumulative other comprehensive loss consists of the following
components:
Foreign Minimum Cumulative
Currency Pension Other
Translation Liability Comprehensive
Adjustments Adjustments Loss
----------- ----------- -------------
Balance at January 1, 1996 $ (20,657) $ (20,657)
Other comprehensive income 1,675 1,675
----------- ----------
Balance at December 31, 1996 (18,982) (18,982)
Other comprehensive loss (14,107) $ (428) (14,535)
----------- ------- ----------
Balance at December 31, 1997 (33,089) (428) (33,517)
Other comprehensive loss (11,838) 428 (11,410)
----------- ------- ----------
Balance at December 31, 1998 $ (44,927) $ 0 $ (44,927)
=========== ======= ==========
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23
QUARTERLY STOCK PRICES AND DIVIDENDS
1998 1997
-------------------------------------------- -----------------------------------------
QUARTER HIGH LOW DIVIDEND Quarter High Low Dividend
--------- ---------- -------- --------- --------- --------- --------- ---------
1ST $35.625 $25.750 $.1125 1st $29.125 $25.938 $.10
2ND 37.875 30.063 .1125 2nd 32.375 24.125 .10
3RD 35.000 19.438 .1125 3rd 33.375 27.063 .10
4TH 29.813 20.563 .1125 4th 30.188 25.188 .10
35