THE SHERWIN-WILLIAMS

SHW
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SHERWIN WILLIAMS : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-Q)

07/28/2020 | 02:02pm


(dollars in millions, except as noted and per share data)
BACKGROUND
The Sherwin-Williams Company, founded in 1866, and its consolidated wholly owned
subsidiaries (collectively, the "Company") are engaged in the development,
manufacture, distribution and sale of paint, coatings and related products to
professional, industrial, commercial and retail customers primarily in North and
South America
with additional operations in the Caribbean region and throughout
Europe, Asia and Australia.
The Company is structured into three reportable segments-The Americas Group,
Consumer Brands Group and Performance Coatings Group (collectively, the
"Reportable Segments")-and an Administrative segment in the same way it is
internally organized for assessing performance and making decisions regarding
allocation of resources. See 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
On March 11, 2020, the World 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 the U.S. and Canada 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 employees who 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 the U.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 at June 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.
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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 ended June 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 ended
June 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 Ended June 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 in The
Americas Group
and the Performance Coatings Group, and unfavorable currency
translation rate changes, partially offset by higher sales to most of the
Consumer 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 in The 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 the U.S. and Canada. Net
sales from stores open for more than twelve calendar months in the U.S. and
Canada 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 the Consumer 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 in Asia Pacific.
Net sales in the Performance Coatings Group stated in U.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 our Performance Coatings Group in all regions. Currency translation rate
changes decreased the Performance Coatings Group's net sales by 3.0% in the
second quarter.
Six Months Ended June 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 in
The Americas Group and the Performance Coatings Group, and unfavorable currency
translation rate changes, partially offset by higher sales to most of the
Consumer 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
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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 in The 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 the U.S. and Canada. Net
sales from stores open for more than twelve calendar months in the U.S. and
Canada 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 the Consumer 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 in Asia Pacific.
Net sales in the Performance Coatings Group stated in U.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 our Performance Coatings Group in all regions.
Currency translation rate changes decreased the Performance 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 Ended June 30, Six Months Ended June 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 Ended June 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 in U.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.
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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 Ended June 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 in U.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 in The 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.
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Other expense - net increased $5.0 million in the first six months of 2020
compared to the same period in 2019 primarily due to an increase in foreign
currency transaction related losses.
The following table presents income before income taxes by segment and as a
percentage of net sales by segment:



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.
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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. At June 30, 2020, the Company's cash and cash equivalents were
$188.1 million compared to $161.8 million and $145.6 million at December 31,
2019
and June 30, 2019, respectively.
Total debt at June 30, 2020 was $8.850 billion or 69.6% as a percentage of total
capitalization compared to $8.685 billion or 67.8% at December 31, 2019 and
$9.456 billion or 71.6% at June 30, 2019. At June 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 at June 30,
2020
compared to a deficit of $1.253 billion at June 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 at June 30, 2020 to June 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 at June 30, 2020 compared to June 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. At June 30, 2020, the Company's current ratio was 1.09 compared to 1.02
and 0.80 at December 31, 2019 and June 30, 2019, respectively.
Goodwill and Intangible Assets
Goodwill and intangible assets decreased $228.8 million from December 31, 2019
and decreased $495.0 million from June 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 from June 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 ended
December 31, 2019 for more information concerning the Company's goodwill and
intangible assets, including impairment testing of these assets.
Other Assets
Other assets at June 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
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deferred tax assets and deposits. The decrease from June 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 since June 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. Since June 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 the
Consumer Brands Group, normal equipment replacement in The Americas and
Performance Coatings Groups, and aviation transportation and information systems
hardware in the Administrative segment.
Debt
In March 2020, the Company issued $500.0 million of 2.30% Senior Notes due May
2030
and $500.0 million of 3.30% Senior Notes due May 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 due May 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.
At June 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, at June 30, 2020. The Company
had unused capacity under its various credit agreements of $2.962 billion at
June 30, 2020.
Defined Benefit Pension and Other Postretirement Benefit Plans
Long-term liabilities for postretirement benefits other than pensions did not
change significantly from December 31, 2019 and June 30, 2019. See Note 8 in the
Company's Annual Report on Form 10-K for the year ended December 31, 2019 for
more information concerning the Company's benefit plan obligations.
Deferred Income Taxes
Deferred income taxes at June 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.
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Contractual Obligations, Commercial Commitments and Warranties
Short-term borrowings increased $354.8 million to $559.5 million at June 30,
2020
from $204.7 million at December 31, 2019. Total long-term debt decreased
$190.4 million to $8.290 billion at June 30, 2020 from $8.481 billion at
December 31, 2019, and decreased $357.2 million from $8.647 billion at June 30,
2019
.
The California litigation accrual decreased $59.6 million to $76.7 million
($12.0 million current and $64.7 million long-term) at June 30, 2020 from $136.3
million
at June 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 in September 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
ended December 31, 2019.
Litigation
See Note 9 for information concerning litigation.
Shareholders' Equity
Shareholders' equity decreased $253.4 million to $3.870 billion at June 30, 2020
from $4.123 billion at December 31, 2019 and increased $122.4 million from
$3.748 billion at June 30, 2019.
The decrease in Shareholders' equity for the first six months of 2020 resulted
from $871.5 million of Treasury 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 since June 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 of Treasury 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 at June 30, 2020 to purchase
6.75 million shares of its common stock.
In February 2020, the Company's Board of Directors increased the quarterly cash
dividend from $1.13 per common share to $1.34 per common share. In April 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
In February 2020, the Company settled its $400.0 million U.S. Dollar to Euro
cross currency swap contract entered into in May 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.
In February 2020, the Company entered into two 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 on June 1, 2024 and November 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 in U.S. Dollars, thereby
effectively converting a portion of the Company's U.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 in U.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 ended
June 30, 2020, an unrealized loss of $10.7 million, net of tax, was recognized
in AOCI.
31
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Cash Flow
Net operating cash for the six months ended June 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 in
Ohio.
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 from July 1, 2019 through June 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. At June 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 ended December 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 with
U.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.
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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 with U.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 ended December 31, 2019. There
have been no significant changes in critical accounting policies, management
estimates or accounting policies followed since the year ended December 31,
2019
.
33
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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
in Asia, 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 as Asia, Europe and South
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 the Securities 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.

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