(dollars in millions, except as noted and per share data) BACKGROUNDThe Sherwin-Williams Company , founded in 1866, and its consolidated wholly owned subsidiaries (collectively, the "Company") are engaged in the development, manufacture, distribution and sale of paint, coatings and related products to professional, industrial, commercial and retail customers primarily inNorth and South America with additional operations in theCaribbean region and throughoutEurope ,Asia andAustralia . The Company is structured into three reportable segments-The Americas Group ,Consumer Brands Group andPerformance Coatings Group (collectively, the "Reportable Segments")-and an Administrative segment in the same way it is internally organized for assessing performance and making decisions regarding allocation of resources. See Note 17 of Item 1 for additional information on the Company's Reportable Segments. SUMMARY •Consolidated net sales decreased 5.6% in the quarter to$4.604 billion •Diluted net income per share increased to$6.48 per share in the quarter compared to$5.03 per share in the second quarter 2019 •Second quarter 2020 included charges of$0.62 per share for acquisition-related amortization expense; second quarter 2019 included charges of$0.63 per share for acquisition-related amortization expense,$0.12 per share for integration costs and$0.79 per share for a tax credit investment loss. •Net operating cash increased 42% year-to-date to$1.07 billion , or 12.3% of sales OUTLOOK OnMarch 11, 2020 , theWorld Health Organization declared the outbreak of the novel coronavirus (COVID-19) to be a global pandemic and recommended containment and mitigation measures worldwide. While the response to the outbreak continues to evolve, it has led to stay-at-home orders and physical distancing guidelines, among other mandates, that have substantially disrupted normal activities in most segments of the global economy. We have worked with government and health authorities to continue to operate our business during this crisis, including our company-operated stores, manufacturing plants and other facilities, due to the essential nature of our products. In late March, we began adopting appropriately enhanced risk mitigation and safety practices, such as temporarily reducing store hours and closing sales floors to the general public in our company-operated stores, requiring our customers to order product online or by phone and to access products via curbside pickup or delivery, and implementing remote, alternate and flexible work arrangements where possible. We have endeavored to follow recommended actions of government authorities and health officials in order to protect the health and well-being of our employees, customers and their families worldwide. In May, we began the process of reinstituting regular store hours and re-opening the sales floors in our stores with appropriate health and safety protocols, which has resulted in all of our stores in theU.S. andCanada being fully re-opened. We plan to continue to work with government authorities and health officials in implementing appropriate safety measures so that we may continue our operations, keep our stores open and return employeeswho work in office environments. While the COVID-19 pandemic did not have a material adverse effect on our consolidated financial results for the first or second quarters, we anticipate the impact of the deterioration of theU.S and global economies will most likely continue and could have an adverse impact on our business through the remainder of the year. The extent to which our operations will be impacted by the outbreak in the remaining quarters of 2020 depends largely on future developments, including the duration, severity and scope of the pandemic, all of which remain uncertain. We have a strong liquidity position, with$188.1 million in cash and$2.96 billion of unused capacity under our credit facilities atJune 30, 2020 . The Company is in compliance with bank covenants and expects to remain in compliance. We will continue to evaluate and take action to preserve liquidity and generate cash flow during the crisis, including by limiting capital expenditures as much as possible, temporarily suspending share repurchases, reducing discretionary spending and reducing payroll costs. As the circumstances around the COVID-19 pandemic remain fluid, we continue to actively monitor the pandemic's impact to the Company worldwide, including our financial position, liquidity, results of operations and cash flows, while managing our response to the crisis through collaboration with employees, customers, suppliers, government authorities, health officials and other business partners. 24 -------------------------------------------------------------------------------- Please see Item 1A "Risk Factors" in Part II of this Quarterly Report on Form 10-Q for further information regarding the current and potential impact of the COVID-19 pandemic on the Company. RESULTS OF OPERATIONS The Company has historically experienced, and expects to continue to experience, variability in quarterly results. The results of operations for the three and six months endedJune 30, 2020 are not indicative of the results to be expected for the full year as business is seasonal in nature with the majority of Net sales for the Reportable Segments traditionally occurring during the second and third quarters. However, periods of economic downturn can alter the Company's seasonal patterns. The following discussion and analysis addresses comparisons of material changes in the consolidated financial statements for the three and six months endedJune 30, 2020 and 2019. Net Sales (millions of dollars) Three Months Ended June 30, Six Months Ended June 30, 2020 2019 $ Change % Change 2020 2019 $ Change % Change The Americas Group$ 2,523.7 $ 2,756.0 $ (232.3) (8.4) %$ 4,829.2 $ 4,910.9 $ (81.7) (1.7) % Consumer Brands Group 980.2 804.5 175.7 21.8 % 1,602.5 1,459.0 143.5 9.8 % Performance Coatings Group 1,099.8 1,317.0 (217.2) (16.5) % 2,317.4 2,547.8 (230.4) (9.0) % Administrative 0.3 0.3 - - % 1.6 1.0 0.6 60.0 % Total$ 4,604.0 $ 4,877.8 $ (273.8) (5.6) %$ 8,750.7 $ 8,918.7 $ (168.0) (1.9) % Three Months EndedJune 30, 2020 Consolidated net sales decreased in the second quarter of 2020 due primarily to the impacts of COVID-19, which caused demand softness in some end markets inThe Americas Group and thePerformance Coatings Group , and unfavorable currency translation rate changes, partially offset by higher sales to most of theConsumer Brands Group's retail customers. Currency translation rate changes decreased net sales by 1.5% in the second quarter of 2020. Net sales of all consolidated foreign subsidiaries were down 19.4% to$776.2 million in the second quarter compared to$963.1 million in the same period last year. The decrease in net sales for all consolidated foreign subsidiaries in the second quarter was due primarily to continued demand softness in most end markets from the impacts of COVID-19 and unfavorable currency translation rate changes. Net sales of all operations other than consolidated foreign subsidiaries were down 2.2% to$3.828 billion in the second quarter compared to$3.915 billion in the same period last year. Net sales inThe Americas Group decreased in the second quarter of 2020 due primarily to the impacts of COVID-19 on demand in most end market segments served, partially offset by higher DIY paint sales in theU.S. andCanada . Net sales from stores open for more than twelve calendar months in theU.S. andCanada decreased 6.9% in the second quarter compared to last year's comparable period. Sales of non-paint products decreased 17.0% compared to last year's second quarter. A discussion of changes in volume versus pricing for sales of products other than paint is not pertinent due to the wide assortment of general merchandise sold. Net sales of theConsumer Brands Group increased in the second quarter due primarily to higher volume sales to most of the group's North American and European retail customers, partially offset by softer sales inAsia Pacific . Net sales in thePerformance Coatings Group stated inU.S. dollars decreased in the second quarter primarily due to softer end market demand in most businesses, partially due to the impacts of COVID-19, and unfavorable currency translation rate changes, partially offset by increased sales in the packaging division within ourPerformance Coatings Group in all regions. Currency translation rate changes decreased thePerformance Coatings Group's net sales by 3.0% in the second quarter. Six Months EndedJune 30, 2020 Consolidated net sales decreased in the first six months of 2020 due primarily to the impacts of COVID-19, which caused demand softness in some end markets inThe Americas Group and thePerformance Coatings Group , and unfavorable currency translation rate changes, partially offset by higher sales to most of theConsumer Brands Group's retail customers. Currency translation rate changes decreased net sales by 1.4% in the first six months of 2020. Net sales of all consolidated foreign subsidiaries were down 13.3% to$1.604 billion in the first six months compared to$1.849 billion in the same period last year. The decrease in net sales for all consolidated foreign subsidiaries in the first six months was due primarily to continued demand softness in some end markets from the impacts of COVID-19, and unfavorable currency translation rate changes. Net sales of 25 -------------------------------------------------------------------------------- all operations other than consolidated foreign subsidiaries were up 1.1% to$7.147 billion in the first six months compared to$7.070 billion in the same period last year. Net sales inThe Americas Group decreased in the first six months of 2020 due primarily to the impacts of COVID-19 on demand in most end market segments served, partially offset by higher DIY paint sales in theU.S. andCanada . Net sales from stores open for more than twelve calendar months in theU.S. andCanada decreased 0.7% in the first six months compared to last year's comparable period. Sales of non-paint products decreased 6.9% over last year's first six months. A discussion of changes in volume versus pricing for sales of products other than paint is not pertinent due to the wide assortment of general merchandise sold. Net sales of theConsumer Brands Group increased in the first six months due primarily to higher volume sales to most of the group's North American and European retail customers, partially offset by softer sales inAsia Pacific . Net sales in thePerformance Coatings Group stated inU.S. dollars decreased in the first six months primarily due to softer end market demand in most businesses, partially due to the impacts of COVID-19, and unfavorable currency translation rate changes, partially offset by increased sales in the packaging and coil divisions within ourPerformance Coatings Group in all regions. Currency translation rate changes decreased thePerformance Coatings Group's net sales by 2.6% in the first six months of 2020. Income Before Income Taxes The following table presents the components of income before income taxes as a percentage of net sales: (millions of dollars, except % of sales data) Three Months EndedJune 30 , Six Months EndedJune 30, 2020 2019 2020 2019 % of net % of net % of net % of net sales sales sales sales Gross profit$ 2,208.9 48.0 %$ 2,181.4 44.7 %$ 4,098.6 46.8 %$ 3,916.5 43.9 % Selling, general and administrative expenses 1,291.3 28.0 % 1,331.3 27.3 % 2,598.9 29.7 % 2,575.3 28.9 % Other general (income) expense - net (1.1) - % 7.2 0.1 % 2.6 - % 6.7 0.1 % Amortization 77.4 1.7 % 78.1 1.6 % 155.5 1.8 % 156.9 1.8 % Interest expense 88.1 1.9 % 89.2 1.8 % 174.3 2.0 % 180.2 2.0 % Interest and net investment income (0.6) - % (0.6) - % (1.2) - % (1.0) - % Other expense - net 6.4 0.1 % 0.5 - % 28.8 0.3 % 23.8 0.3 % Income before income taxes$ 747.4 16.2 %$ 675.7 13.9 %$ 1,139.7 13.0 %$ 974.6 10.9 % Three Months EndedJune 30, 2020 Consolidated gross profit increased$27.5 million in the second quarter of 2020 compared to the same period in 2019. Consolidated gross profit as a percent of consolidated net sales increased in the second quarter of 2020 to 48.0%, compared to 44.7% during the same period in 2019. Consolidated gross profit dollars and percent improved as a result of favorable customer and product mix and moderating raw material costs.The Americas Group's gross profit in the second quarter of 2020 was lower than last year by$13.0 million due to lower paint sales volume and unfavorable currency translation rate changes, partially offset by moderating raw material costs and favorable customer and product mix.The Americas Group's gross profit as a percent of sales increased in the second quarter of 2020 compared to the same period in 2019 for these same reasons.The Consumer Brands Group's gross profit increased by$90.8 million in the second quarter compared to the same period last year due primarily to higher sales volume to most of the group's retail customers and moderating raw material costs.The Consumer Brands Group's gross profit as a percent of sales increased in the second quarter compared to the same period last year due to higher sales volume and moderating raw material costs.The Performance Coatings Group's gross profit decreased$57.9 in the second quarter compared to the same period last year, when stated inU.S. dollars, primarily due to lower sales volume and unfavorable currency translation rate changes, partially offset by moderating raw material costs.The Performance Coatings Group's gross profit as a percent of sales increased in the second quarter compared to the same period last year due to moderating raw material costs, partially offset by lower sales volume. 26 -------------------------------------------------------------------------------- Consolidated selling, general and administrative expenses (SG&A) decreased$40.0 million in the second quarter of 2020 versus the same period last year due primarily to good cost control and reduced or deferred costs related to travel, marketing, and information technology improvements, partially offset by direct expenses for personal protective equipment and employee costs related to COVID-19.The Americas Group's SG&A decreased$5.8 million in the second quarter of 2020 compared to the same period last year. The SG&A of the Consumer Brands and Performance Coatings Groups decreased$4.4 million and$7.8 million , respectively, in the second quarter compared to the same period last year. Each group's decrease in the quarter was primarily due to good cost control, partially offset by additional costs related to COVID-19. The Administrative segment's SG&A decreased$22.0 million in the second quarter compared to the same period last year due primarily to decreased travel and investments in information technology systems as a result of COVID-19. Other general (income) expense - net decreased$8.3 million in the second quarter of 2020 compared to the same period in 2019 primarily due to gains from the sale and disposition of fixed assets in the current quarter. In the second quarter of 2020, amortization of acquired intangibles was$49.9 million and$21.4 million for the Performance Coatings and Consumer Brands Groups, respectively. In the second quarter of 2019, amortization of acquired intangibles was$50.7 million and$21.3 million for the Performance Coatings and Consumer Brands Groups, respectively. Other expense - net increased$5.9 million in the second quarter of 2020 compared to the same period in 2019 primarily due to an increase in foreign currency transaction related losses. Six Months EndedJune 30, 2020 Consolidated gross profit increased$182.1 million in the first six months of 2020 compared to the same period in 2019. Consolidated gross profit as a percent of consolidated net sales increased in the first six months of 2020 to 46.8%, compared to 43.9% during the same period in 2019. Consolidated gross profit dollars and percent improved as a result of favorable customer and product mix and moderating raw material costs.The Americas Group's gross profit in the first six months of 2020 was higher than last year by$129.4 million due to increased moderating raw material costs and favorable customer and product mix, partially offset by unfavorable currency translation rate changes.The Americas Group's gross profit as a percent of sales increased in the first six months of 2020 compared to the same period in 2019 for the same reasons.The Consumer Brands Group's gross profit increased by$88.4 million in the first six months compared to the same period last year due primarily to higher sales volume to most of the group's retail customers and moderating raw material costs.The Consumer Brands Group's gross profit as a percent of sales increased in the first six months compared to the same period last year for these same reasons.The Performance Coatings Group's gross profit decreased$46.7 million in the first six months compared to the same period last year, when stated inU.S. dollars, primarily due to lower sales volume and unfavorable currency translation rate changes, partially offset by moderating raw material costs.The Performance Coatings Group's gross profit as a percent of sales increased in the first six months compared to the same period last year due to moderating raw material costs, partially offset by lower sales volume. Consolidated SG&A increased$23.6 million in the first six months of 2020 versus the same period last year due primarily to increased expenses inThe Americas Group , partially offset by good cost control and reduced or deferred costs related to COVID-19. As a percent of sales, consolidated SG&A in the first six months compared to the same period last year increased due to these same reasons.The Americas Group's SG&A increased$71.5 million in the first six months of 2020 due primarily to initial costs related to COVID-19.The Consumer Brands Group's SG&A decreased$5.2 million in the first six months compared to the same period last year primarily due to currency translation rate changes.The Performance Coatings Group's SG&A decreased$7.0 million in the first six months compared to the same period last year primarily due to currency translation rate changes, partially offset by decreased investments in information technology systems. The Administrative segment's SG&A decreased$35.7 million in the first six months compared to the same period last year due primarily to decreased travel and investments in information technology systems as a result of COVID-19. Other general (income) expense - net decreased$4.1 million in the first six months of 2020 compared to the same period in 2019 primarily due to increased gains from the sale and disposition of fixed assets in the current year. In the first six months of 2020, amortization of acquired intangibles was$100.1 million and$42.8 million for the Performance Coatings and Consumer Brands Groups, respectively. In the first six months of 2019, amortization of acquired intangibles was$101.6 million and$42.7 million for the Performance Coatings and Consumer Brands Groups, respectively. 27 --------------------------------------------------------------------------------
Other expense - net increased
Three Months Ended Six Months Ended June 30, % June 30, % 2020 2019 Change 2020 2019 Change Income Before Income Taxes: The Americas Group$ 599.7 $ 612.4 (2.1) %$ 988.0 $ 943.5 4.7 % Consumer Brands Group 237.4 140.7 68.7 % 320.9 228.6 40.4 % Performance Coatings Group 97.4 150.3 (35.2) % 211.1 249.0 (15.2) % Administrative (187.1) (227.7) 17.8 % (380.3) (446.5) 14.8 % Total$ 747.4 $ 675.7 10.6 %$ 1,139.7 $ 974.6 16.9 % Income Before Income Taxes as a % of Net Sales: The Americas Group 23.8 % 22.2 % 20.5 % 19.2 % Consumer Brands Group 24.2 % 17.5 % 20.0 % 15.7 % Performance Coatings Group 8.9 % 11.4 % 9.1 % 9.8 % Administrative nm nm nm nm Total 16.2 % 13.9 % 13.0 % 10.9 % nm - not meaningful Income Tax Expense The effective tax rate was 20.3% for the second quarter of 2020 compared to 30.3% for the second quarter of 2019 and 19.5% for the first six months of 2020 compared to 26.5% for the first six months of 2019. The decrease in the effective tax rate in the current year compared to prior year was primarily due to a$74.3 million tax provision recorded in the first six months of 2019 related to the reversal of previously recognized net tax benefits from federal renewable energy tax credit funds. The effective tax rate was also favorably impacted by tax benefits related to employee share based payments during 2020 and 2019. The other significant components of the Company's tax rate were consistent year over year. See Note 15 of Item 1 for additional information. Net Income Per Share Diluted net income per share in the second quarter of 2020 increased to$6.48 per share compared to$5.03 per share in the second quarter of 2019. Diluted net income per share for the second quarter of 2020 included a$0.62 per share charge for acquisition-related amortization expense. The second quarter of 2019 included a$0.63 per share charge for acquisition-related amortization expense, a$0.12 per share charge for integration costs and a$0.79 per share charge for a tax credit investment loss. Currency translation rate changes decreased diluted net income per share in the second quarter by$0.04 per share. Diluted net income per share in the first six months of 2020 increased to$9.93 per share compared to$7.65 per share in the first six months of 2019. Diluted net income per share for the first six months of 2020 included a$1.24 per share charge for acquisition-related amortization expense. The first six months of 2019 included a$1.27 per share charge for acquisition-related amortization expense, a$0.19 per share charge for integration costs, a$0.79 per share charge for a tax credit investment loss and a$0.27 per share charge for pension plan settlement expense. Currency translation rate changes decreased diluted net income per share in the first six months by$0.08 per share. 28 -------------------------------------------------------------------------------- FINANCIAL CONDITION, LIQUIDITY AND CASH FLOW Overview The Company's financial condition, liquidity and cash flow continued to be strong during the first six months of 2020 as net operating cash was$1.075 billion , an improvement of$316.6 million from the prior year comparable period, primarily due to improved operating results as consolidated income before income taxes increased$165.1 million to$1.140 billion in the current year or 13.0% of net sales. Cash and cash equivalents increased$26.3 million during the first six months of 2020. Cash flow from operations and short-term borrowings funded normal seasonal working capital increases, allowed the Company to return$1.136 billion to shareholders in the form of share buybacks and cash dividends and repay$205.7 million in long-term debt (net of proceeds from issuances) during the first six months of 2020. AtJune 30, 2020 , the Company's cash and cash equivalents were$188.1 million compared to$161.8 million and$145.6 million atDecember 31, 2019 andJune 30, 2019 , respectively. Total debt atJune 30, 2020 was$8.850 billion or 69.6% as a percentage of total capitalization compared to$8.685 billion or 67.8% atDecember 31, 2019 and$9.456 billion or 71.6% atJune 30, 2019 . AtJune 30, 2020 , the Company had remaining short-term borrowing ability of$2.962 billion . The Company continues to maintain sufficient short-term borrowing capacity at reasonable rates, and the Company has sufficient cash on hand and total available borrowing capacity to fund its current operating needs.Net Working Capital Net working capital, defined as total current assets less total current liabilities, increased$1.676 billion to a surplus of$423.6 million atJune 30, 2020 compared to a deficit of$1.253 billion atJune 30, 2019 . The net working capital increase is primarily due to a reduction in the current portion of long-term debt, short-term borrowings and accounts payable, partially offset by decreases in accounts receivable and inventory. Comparing current asset balances atJune 30, 2020 toJune 30, 2019 , cash and cash equivalents increased$42.5 million , accounts receivable decreased$186.6 million due to lower sales volumes from the impacts of COVID-19, inventories decreased$106.3 million due to increased DIY paint demand, and other current assets increased$43.6 million primarily related to prepaid expenses. Current liability balances decreased atJune 30, 2020 compared toJune 30, 2019 primarily due to a$1.437 billion decrease in the current portion of long-term debt, a$249.3 million decrease in short-term borrowings and lower accounts payable. AtJune 30, 2020 , the Company's current ratio was 1.09 compared to 1.02 and 0.80 atDecember 31, 2019 andJune 30, 2019 , respectively.Goodwill and Intangible AssetsGoodwill and intangible assets decreased$228.8 million fromDecember 31, 2019 and decreased$495.0 million fromJune 30, 2019 . The net decrease during the first six months of 2020 was primarily due to foreign currency translation of$73.4 million and amortization of$155.5 million . The net decrease over the twelve month period fromJune 30, 2019 was primarily due to amortization of$311.4 million , impairment of indefinite-lived trademarks during the fourth quarter of 2019 of$122.1 million and foreign currency translation of$110.8 million , partially offset by acquisitions of$49.1 million . The fair value of the Company's acquired intangible assets may be impacted by the Company's ongoing integration efforts. During the first six months of 2020, the Company considered the current and expected future economic and market conditions surrounding the COVID-19 pandemic when evaluating whether an interim impairment trigger had occurred related to the Company's recognized goodwill and intangible assets. While the Company determined no impairment trigger occurred during the first six months of 2020 and believes its assumptions and estimates of fair value related to reporting units and indefinite-lived trademarks are reasonable, actual financial results could differ from those estimates due to the inherent uncertainty involved in making such estimates. Changes in assumptions concerning future financial results (including sales projections related to trademarks impaired during the fourth quarter of 2019) or other underlying assumptions could have a significant impact and future impairment charges could be required. See Note 6 in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 for more information concerning the Company's goodwill and intangible assets, including impairment testing of these assets. Other Assets Other assets atJune 30, 2020 increased$1.2 million in the first six months of 2020 and decreased$43.9 million from a year ago. The increase in the first six months was primarily due to an increase in other investments, partially offset by a decrease in 29 -------------------------------------------------------------------------------- deferred tax assets and deposits. The decrease fromJune 30, 2019 was primarily due to decreases in deferred tax assets and other investments. Property, Plant and Equipment Net property, plant and equipment decreased$36.6 million in the first six months of 2020 and increased$25.0 million in the twelve months sinceJune 30, 2019 . The decrease in the first six months was primarily due to depreciation expense of$132.6 million , unfavorable changes in currency translation rates of$28.8 million and sale or disposition of fixed assets of$17.5 million , partially offset by capital expenditures of$142.3 million . SinceJune 30, 2019 , the increase was primarily due to capital expenditures of$343.3 million and acquisitions of$16.8 million , partially offset by depreciation expense of$265.0 million , sale or disposition of fixed assets of$49.4 million , and changes in currency translation rates of$20.7 million . Capital expenditures primarily represented expenditures associated with improvements and normal equipment replacement in manufacturing and distribution facilities in theConsumer Brands Group , normal equipment replacement in TheAmericas and Performance Coatings Groups, and aviation transportation and information systems hardware in the Administrative segment. Debt InMarch 2020 , the Company issued$500.0 million of 2.30% Senior Notes dueMay 2030 and$500.0 million of 3.30% Senior Notes dueMay 2050 (collectively the "New Notes") in a public offering. The net proceeds from the issuance of the New Notes were used to repurchase a portion of the 2.75% Senior Notes due 2022 and redeem the 2.25% Senior Notes dueMay 2020 . The repurchase of the 2.75% Senior Notes due 2022 during the first quarter of 2020 resulted in a loss of$21.3 million recorded in Other expense - net. AtJune 30, 2020 , the Company's outstanding debt was comprised of$8.290 billion of long-term debt primarily associated with senior notes,$475.0 million of borrowings outstanding on its revolving lines of credit,$63.0 million outstanding under its commercial paper program and$21.5 million outstanding under various other foreign programs. The weighted average interest rates for the borrowings outstanding on the revolving line of credit and the commercial paper program were 1.0% and 0.8%, respectively, atJune 30, 2020 . The Company had unused capacity under its various credit agreements of$2.962 billion atJune 30, 2020 . Defined Benefit Pension and Other Postretirement Benefit Plans Long-term liabilities for postretirement benefits other than pensions did not change significantly fromDecember 31, 2019 andJune 30, 2019 . See Note 8 in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 for more information concerning the Company's benefit plan obligations. Deferred Income Taxes Deferred income taxes atJune 30, 2020 decreased$16.7 million in the first six months of 2020, and decreased$161.5 million from a year ago, primarily due to amortization of acquisition-related intangible assets. Other Long-Term Liabilities Environmental-Related Liabilities The operations of the Company, like those of other companies in the same industry, are subject to various federal, state and local environmental laws and regulations. These laws and regulations not only govern current operations and products, but also impose potential liability on the Company for past operations. Management expects environmental laws and regulations to impose increasingly stringent requirements upon the Company and the industry in the future. Management believes that the Company conducts its operations in compliance with applicable environmental laws and regulations and has implemented various programs designed to protect the environment and promote continued compliance. Depreciation of capital expenditures and other expenses related to ongoing environmental compliance measures were included in the normal operating expenses of conducting business. The Company's capital expenditures, depreciation and other expenses related to ongoing environmental compliance measures were not material to the Company's financial condition, liquidity, cash flow or results of operations during the first six months of 2020. Management does not expect that such capital expenditures, depreciation and other expenses will be material to the Company's financial condition, liquidity, cash flow or results of operations in 2020. See Note 8 for further information on environmental-related long-term liabilities. 30 -------------------------------------------------------------------------------- Contractual Obligations, Commercial Commitments and Warranties Short-term borrowings increased$354.8 million to$559.5 million atJune 30, 2020 from$204.7 million atDecember 31, 2019 . Total long-term debt decreased$190.4 million to$8.290 billion atJune 30, 2020 from$8.481 billion atDecember 31, 2019 , and decreased$357.2 million from$8.647 billion atJune 30, 2019 . TheCalifornia litigation accrual decreased$59.6 million to$76.7 million ($12.0 million current and$64.7 million long-term) atJune 30, 2020 from$136.3 million atJune 30, 2019 as a result of the final court approved agreement to resolve the litigation and the initial payment of$25.0 million to the plaintiffs in accordance with the agreement inSeptember 2019 . See Note 9 for additional information. There have been no other significant changes to the Company's contractual obligations and commercial commitments in the second quarter of 2020 as summarized in Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 . Litigation See Note 9 for information concerning litigation. Shareholders' Equity Shareholders' equity decreased$253.4 million to$3.870 billion atJune 30, 2020 from$4.123 billion atDecember 31, 2019 and increased$122.4 million from$3.748 billion atJune 30, 2019 . The decrease in Shareholders' equity for the first six months of 2020 resulted from$871.5 million ofTreasury stock activity primarily attributable to treasury stock repurchases, cash dividends paid on common stock of$245.6 million and an increase in Accumulated other comprehensive loss of$187.7 million , partially offset by net income of$917.6 million and an increase in other capital of$136.1 million . The increase in Shareholders' equity sinceJune 30, 2019 resulted from net income of$1.743 billion and an increase in other capital of$278.4 million , partially offset by$1.204 billion ofTreasury stock activity primarily attributable to treasury stock repurchases, cash dividends paid on common stock of$456.6 million and an increase in Accumulated other comprehensive loss of$236.4 million . During the first six months of 2020, the Company purchased 1,700,000 shares of its common stock for treasury purposes through open market purchases. The Company acquires its common stock for general corporate purposes, and depending on its cash position and market conditions, it may acquire additional shares in the future. The Company had remaining authorization atJune 30, 2020 to purchase 6.75 million shares of its common stock. InFebruary 2020 , the Company's Board of Directors increased the quarterly cash dividend from$1.13 per common share to$1.34 per common share. InApril 2020 , the Board of Directors approved a quarterly cash dividend of$1.34 per common share. If approved in each of the remaining quarters of 2020, this quarterly cash dividend will result in an annual dividend for 2020 of$5.36 per common share or a 32.5% payout of 2019 diluted net income per common share. Net Investment Hedges InFebruary 2020 , the Company settled its$400.0 million U.S. Dollar to Euro cross currency swap contract entered into inMay 2019 to hedge the Company's net investment in its European operations. At the time of the settlement, an unrealized gain of$11.8 million , net of tax, was recognized in AOCI. InFebruary 2020 , the Company entered intotwo U.S Dollar to Euro cross currency swap contracts to hedge the Company's net investment in its European operations. The contracts have a notional value of$500.0 million and$244.0 million , respectively, and mature onJune 1, 2024 andNovember 15, 2021 , respectively. During the term of the$500.0 million contract, the Company will pay fixed-rate interest in Euros and receive fixed-rate interest inU.S. Dollars, thereby effectively converting a portion of the Company'sU.S. Dollar denominated fixed-rate debt to Euro denominated fixed-rate debt. During the term of the$244.0 million contract, the Company will pay floating-rate interest in Euros and receive floating-rate interest inU.S. Dollars. The fair value of the contracts are included in Other assets and Other liabilities on the balance sheet. See Note 13. The changes in fair value are recognized in the foreign currency translation adjustments component of AOCI. For the six months endedJune 30, 2020 , an unrealized loss of$10.7 million , net of tax, was recognized in AOCI. 31 -------------------------------------------------------------------------------- Cash Flow Net operating cash for the six months endedJune 30, 2020 was a cash source of$1.075 billion compared to a cash source of$758.0 million for the same period in 2019. The improvement in net operating cash was primarily due to an increase in net income and improved working capital management, partially offset by an increase in cash requirements for long-term items. Net investing cash usage decreased$30.4 million in the first six months of 2020 to a usage of$146.8 million from a usage of$177.2 million in 2019 primarily due to an increase in proceeds from sales of assets, partially offset by an increase in capital expenditures associated with the new global headquarters inOhio . Net financing cash usage increased$301.5 million to a usage of$886.1 million in the first six months of 2020 from a usage of$584.6 million for the same period in 2019 primarily due to repayments of long-term debt, treasury stock purchases and cash dividends, partially offset by the issuance of new long-term debt and the issuance of 100,000 shares of treasury stock (which were associated with the domestic defined benefit plan terminated in 2018). In the twelve month period fromJuly 1, 2019 throughJune 30, 2020 , the Company generated net operating cash of$2.638 billion , used$432.2 million in investing activities and used$2.148 billion in financing activities. Market Risk The Company is exposed to market risk associated with interest rate, foreign currency and commodity fluctuations. The Company occasionally utilizes derivative instruments as part of its overall financial risk management policy, but does not use derivative instruments for speculative or trading purposes. The Company believes it may be exposed to continuing market risk from foreign currency exchange rate and commodity price fluctuations. However, the Company does not expect that foreign currency exchange rate and commodity price fluctuations or hedging contract losses will have a material adverse effect on the Company's financial condition, results of operations or cash flows. Financial Covenant Certain borrowings contain a consolidated leverage covenant. The covenant states that the Company's leverage ratio is not to exceed 3.75 to 1.00. The leverage ratio is defined as the ratio of total indebtedness (the sum of Short-term borrowings, Current portion of long-term debt and Long-term debt) at the reporting date to consolidated "Earnings Before Interest, Taxes, Depreciation, and Amortization" (EBITDA), as defined in the credit agreement, for the 12-month period ended on the same date. Refer to the "Non-GAAP Financial Measures" section below for a reconciliation of EBITDA to Net income. AtJune 30, 2020 , the Company was in compliance with the covenant and expects to remain in compliance. The Company's notes, debentures and revolving credit agreements contain various default and cross-default provisions. In the event of default under any one of these arrangements, acceleration of the maturity of any one or more of these borrowings may result. See Note 7 in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 for more information concerning the Company's debt and related covenant. Non-GAAP Financial Measures Management utilizes certain financial measures that are not in accordance withU.S. generally accepted accounting principles (US GAAP) to analyze and manage the performance of the business. The required disclosures for these non-GAAP measures are shown below. The Company provides such non-GAAP information in reporting its financial results to give investors additional data to evaluate the Company's operations. Management does not, nor does it suggest investors should, consider such non-GAAP measures in isolation from, or in substitution for, financial information prepared in accordance with US GAAP. EBITDA EBITDA is a non-GAAP financial measure defined as net income from continuing operations before income taxes and interest, depreciation and amortization. Management considers EBITDA useful in understanding the operating performance of the Company. The reader is cautioned that the Company's EBITDA should not be compared to other entities unknowingly. Further, EBITDA should not be considered alternatives to Net income or Net operating cash as an indicator of operating performance or as a measure of liquidity. The reader should refer to the determination of Net income and Net operating cash in accordance with US GAAP disclosed in the Statements of Consolidated Income and Statements of Consolidated Cash Flows in Item 1. 32 --------------------------------------------------------------------------------
The following table summarizes EBITDA as calculated by management for the periods indicated below:
(millions of dollars) Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 Net income$ 595.9 $ 471.0 $ 917.6 $ 716.2 Interest expense 88.1 89.2 174.3 180.2 Income taxes 151.5 204.7 222.1 258.4 Depreciation 66.1 65.0 132.6 129.7 Amortization 77.4 78.1 155.5 156.9 EBITDA$ 979.0 $ 908.0 $ 1,602.1 $ 1,441.4 CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in conformity withU.S. generally accepted accounting principles (US GAAP) requires management to make estimates and assumptions that affect amounts reported in the accompanying consolidated unaudited interim financial statements. These determinations were made based upon management's best estimates, judgments and assumptions that were believed to be reasonable under the circumstances, giving due consideration to materiality. We do not believe there is a great likelihood that materially different amounts would be reported under different conditions or using different assumptions related to the accounting policies described below. However, application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. A comprehensive discussion of the Company's critical accounting policies, management estimates and significant accounting policies followed in the preparation of the financial statements is included in Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 1 in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 . There have been no significant changes in critical accounting policies, management estimates or accounting policies followed since the year endedDecember 31, 2019 . 33 -------------------------------------------------------------------------------- CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION Certain statements contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this report constitute "forward-looking statements" within the meaning of the federal securities laws. These forward-looking statements are based upon management's current expectations, estimates, assumptions and beliefs concerning future events and conditions and may discuss, among other things, anticipated future performance (including sales and earnings), expected growth, future business plans and the costs and potential liability for environmental-related matters and the lead pigment and lead-based paint litigation. Any statement that is not historical in nature is a forward-looking statement and may be identified by the use of words and phrases such as "believe," "expect," "may," "will," "should," "project," "could," "plan," "goal," "potential," "seek," "intend" or "anticipate" or the negative thereof or comparable terminology. Readers are cautioned not to place undue reliance on any forward-looking statements. Forward-looking statements are necessarily subject to risks, uncertainties and other factors, many of which are outside our control, that could cause actual results to differ materially from such statements and from our historical results and experience. These risks, uncertainties and other factors include such things as: •general business conditions, strengths of retail and manufacturing economies and growth in the coatings industry; •changes in general domestic and international economic conditions such as inflation rates, interest rates, tax rates, unemployment rates, higher labor and healthcare costs, recessions, and changing government policies, laws and regulations; •changes in raw material and energy supplies and pricing; •changes in our relationships with customers and suppliers; •our ability to successfully integrate past and future acquisitions into our existing operations, as well as the performance of the businesses acquired; •competitive factors, including pricing pressures and product innovation and quality; •our ability to attain cost savings from productivity initiatives; •risks and uncertainties associated with our expansion into and our operations inAsia ,Europe ,South America and other foreign markets, including general economic conditions, inflation rates, recessions, foreign currency exchange rates, foreign investment and repatriation restrictions, legal and regulatory constraints, civil unrest and other external economic and political factors; •the achievement of growth in foreign markets, such asAsia ,Europe andSouth America ; •increasingly stringent domestic and foreign governmental regulations, including those affecting health, safety and the environment; •inherent uncertainties involved in assessing our potential liability for environmental-related activities; •other changes in governmental policies, laws and regulations, including changes in tariff policies, as well as changes in accounting policies and standards and taxation requirements (such as new tax laws and new or revised tax law interpretations); •the nature, cost, quantity and outcome of pending and future litigation and other claims, including the lead pigment and lead-based paint litigation, and the effect of any legislation and administrative regulations relating thereto; •adverse weather conditions or impacts of climate change, natural disasters and public health crises, including the COVID-19 pandemic; and •the duration, severity and scope of the COVID-19 pandemic and the actions implemented by international, federal, state and local public health and governmental authorities to contain and combat the outbreak and spread of COVID-19, which may exacerbate one or more of the aforementioned and/or other risks, uncertainties and factors more fully described in the Company's reports filed with theSecurities and Exchange Commission . Readers are cautioned that it is not possible to predict or identify all of the risks, uncertainties and other factors that may affect future results and that the above list should not be considered to be a complete list. Any forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as otherwise required by law. 34
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