XNYS:SHW Sherwin-Williams Co Quarterly Report 10-Q Filing - 6/30/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the Period Ended June 30, 2012

or

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the transition period from              to             

Commission file number 1-04851

 

 

THE SHERWIN-WILLIAMS COMPANY

(Exact name of registrant as specified in its charter)

 

 

 

OHIO   34-0526850

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

101 West Prospect Avenue,

Cleveland, Ohio

  44115-1075
(Address of principal executive offices)   (Zip Code)

(216) 566-2000

(Registrant’s telephone number including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one:)

 

  Large accelerated filer    x      Accelerated filer   ¨
  Non-accelerated filer    ¨    (Do not check if a smaller reporting company)   Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

Common Stock, $1.00 Par Value – 102,632,285 shares as of June 30, 2012.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION

  
  

Item 1. Financial Statements

     2   
  

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     23   
  

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     42   
  

Item 4. Controls and Procedures

     43   

PART II. OTHER INFORMATION

  
  

Item 1. Legal Proceedings

     44   
  

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     45   
  

Item 5. Other Information

     46   
  

Item 6. Exhibits

     47   

SIGNATURES

     48   

INDEX TO EXHIBITS

     49   

EX-4(a)

  

EX-4(b)

  

EX-4(c)

  

EX-4(d)

  

EX-4(e)

  

EX-10(a)

  

EX-10(b)

  

EX-31(a)

  

EX-31(b)

  

EX-32(a)

  

EX-32(b)

  

EX-101 INSTANCE DOCUMENT

  

EX-101 SCHEMA DOCUMENT

  

EX-101 CALCULATION LINKBASE DOCUMENT

  

EX-101 LABEL LINKBASE DOCUMENT

  

EX-101 PRESENTATION LINKBASE DOCUMENT

  

EX-101 DEFINITION LINKBASE DOCUMENT

  


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

THE SHERWIN-WILLIAMS COMPANY AND SUBSIDIARIES

STATEMENTS OF CONSOLIDATED INCOME (UNAUDITED)

Thousands of dollars, except per share data

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Net sales

   $ 2,573,022     $ 2,354,751     $ 4,709,366     $ 4,210,337  

Cost of goods sold

     1,422,425       1,331,996       2,648,930       2,390,174  

Gross profit

     1,150,597       1,022,755       2,060,436       1,820,163  

Percent to net sales

     44.7 %      43.4 %      43.8 %      43.2

Selling, general and administrative expenses

     810,207       755,555       1,567,886       1,446,678  

Percent to net sales

     31.5 %      32.1 %      33.3 %      34.4 % 

Other general expense (income)—net

     3,086       (698     8,123       474  

Interest expense

     10,230       11,747       20,567       22,422  

Interest and net investment income

     (625     (808     (1,167     (1,131

Other income—net

     (104     (57     (5,091     (9
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     327,803       257,016       470,118       351,729  

Income taxes

     99,990       77,901       142,089       104,298  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 227,813     $ 179,115     $ 328,029     $ 247,431  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per common share:

        

Basic

   $ 2.23     $ 1.69     $ 3.20     $ 2.33  

Diluted

   $ 2.17     $ 1.66     $ 3.13     $ 2.29  

Average shares outstanding—basic

     101,446,643       104,676,477       101,758,496       104,833,745  
  

 

 

   

 

 

   

 

 

   

 

 

 

Average shares and equivalents outstanding—diluted

     104,003,128       106,876,461       104,100,046       107,104,025  
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 214,846     $ 191,507     $ 346,619     $ 280,596  
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

 

2


Table of Contents

THE SHERWIN-WILLIAMS COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

Thousands of dollars

 

     June 30,
2012
    December 31,
2011
    June 30,
2011
 

Assets

      

Current assets:

      

Cash and cash equivalents

   $ 46,616     $ 32,696     $ 71,563  

Accounts receivable, less allowance

     1,237,832       989,873       1,183,825  

Inventories:

      

Finished goods

     851,827       730,727       853,715  

Work in process and raw materials

     179,651       196,082       213,296  
  

 

 

   

 

 

   

 

 

 
     1,031,478       926,809       1,067,011  

Deferred income taxes

     148,685       149,207       128,492  

Other current assets

     159,391       163,008       187,291  
  

 

 

   

 

 

   

 

 

 

Total current assets

     2,624,002       2,261,593       2,638,182  

Goodwill

     1,122,274       1,108,008       1,113,721  

Intangible assets

     314,913       305,873       319,751  

Deferred pension assets

     232,591       228,350       253,117  

Other assets

     394,200       368,898       350,692  

Property, plant and equipment:

      

Land

     101,336       105,010       107,110  

Buildings

     665,162       668,802       684,881  

Machinery and equipment

     1,702,849       1,657,874       1,658,432  

Construction in progress

     47,588       41,264       39,732  
  

 

 

   

 

 

   

 

 

 
     2,516,935       2,472,950       2,490,155  

Less allowances for depreciation

     1,578,540       1,516,420       1,531,849  
  

 

 

   

 

 

   

 

 

 
     938,395       956,530       958,306  
  

 

 

   

 

 

   

 

 

 

Total Assets

   $ 5,626,375     $ 5,229,252     $ 5,633,769  
  

 

 

   

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

      

Current liabilities:

      

Short-term borrowings

   $ 604,985     $ 346,313     $ 571,130  

Accounts payable

     1,102,148       965,149       1,019,310  

Compensation and taxes withheld

     231,828       251,060       227,509  

Accrued taxes

     126,556       120,555       120,867  

Current portion of long-term debt

     4,246       7,823       9,507  

Other accruals

     462,040       471,761       441,489  
  

 

 

   

 

 

   

 

 

 

Total current liabilities

     2,531,803       2,162,661       2,389,812  

Long-term debt

     635,589       639,231       644,255  

Postretirement benefits other than pensions

     298,798       297,528       296,778  

Other long-term liabilities

     620,932       612,913       556,112  

Shareholders’ equity:

      

Common stock—$1.00 par value:

      

102,632,285, 103,854,234 and 106,278,767 shares outstanding at June 30, 2012, December 31, 2011 and June 30, 2011, respectively

     109,682       107,454       106,779  

Preferred stock—convertible, no par value:

      

128,390, 160,273 and 194,275 shares outstanding at June 30, 2012, December 31, 2011 and June 30, 2011, respectively

     128,390       160,273       194,275  

Unearned ESOP compensation

     (128,390     (160,273     (194,275

Other capital

     1,429,209       1,297,625       1,289,455  

Retained earnings

     1,003,693       756,372       637,434  

Treasury stock, at cost

     (654,043     (276,654     (41,700

Cumulative other comprehensive loss

     (349,288     (367,878     (245,156
  

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

     1,539,253       1,516,919       1,746,812  
  

 

 

   

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 5,626,375     $ 5,229,252     $ 5,633,769  
  

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

THE SHERWIN-WILLIAMS COMPANY AND SUBSIDIARIES

CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS (UNAUDITED)

Thousands of dollars

 

     Six Months Ended  
     June 30,
2012
    June 30,
2011
 

OPERATING ACTIVITIES

    

Net income

   $ 328,029     $ 247,431  

Adjustments to reconcile net income to net operating cash:

    

Depreciation

     75,507       74,807  

Amortization of intangible assets

     12,963       13,127  

Stock-based compensation expense

     21,945       21,433  

Provisions for qualified exit costs

     1,582       936  

Provisions for environmental-related matters

     9,093       4,650  

Defined benefit pension plans net cost

     9,855       7,928  

Net increase in postretirement liability

     1,800       1,800  

Other

     494       (4,859

Change in working capital accounts—net

     (220,890     (245,139

Costs incurred for environmental-related matters

     (20,165     (8,180

Costs incurred for qualified exit costs

     (1,907     (3,929

Other

     (16,194     (1,839
  

 

 

   

 

 

 

Net operating cash

     202,112       108,166  

INVESTING ACTIVITIES

    

Capital expenditures

     (69,972     (68,929

Acquisitions of businesses, net of cash acquired

     (43,993     (2,612

Proceeds from sale of assets

     8,979       6,613  

Decrease (increase) in other investments

     14,848       (20,463
  

 

 

   

 

 

 

Net investing cash

     (90,138     (85,391

FINANCING ACTIVITIES

    

Net increase in short-term borrowings

     260,193       168,465  

Proceeds from long-term debt

     1,846       30,625  

Payments of long-term debt

     (12,164     (33,430

Payments of cash dividends

     (80,438     (77,849

Proceeds from stock options exercised

     88,182       38,183  

Income tax effect of stock-based compensation exercises and vesting

     36,612       8,030  

Treasury stock purchased

     (362,623     (132,734

Other

     (27,546     127  
  

 

 

   

 

 

 

Net financing cash

     (95,938     1,417  
  

 

 

   

 

 

 

Effect of exchange rate changes on cash

     (2,116     (11,214
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     13,920       12,978  

Cash and cash equivalents at beginning of year

     32,696       58,585  
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 46,616     $ 71,563  
  

 

 

   

 

 

 

Income taxes paid

   $ 97,709     $ 42,952  

Interest paid

     20,899       11,944  

See notes to condensed consolidated financial statements.

 

 

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Table of Contents

THE SHERWIN-WILLIAMS COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Periods ended June 30, 2012 and 2011

NOTE 1—BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

There have been no significant changes in critical accounting policies since December 31, 2011. Accounting estimates were revised as necessary during the first six months of 2012 based on new information and changes in facts and circumstances. Certain amounts in the 2011 condensed consolidated financial statements have been reclassified to conform to the 2012 presentation.

The Company primarily uses the last-in, first-out (LIFO) method of valuing inventory. An actual valuation of inventory under the LIFO method can be made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations are based on management’s estimates of expected year-end inventory levels and costs are subject to the final year-end LIFO inventory valuation. In addition, interim inventory levels include management’s estimates of annual inventory losses due to shrinkage and other factors. The final year-end valuation of inventory is based on an annual physical inventory count performed during the fourth quarter. For further information on inventory valuations and other matters, refer to the consolidated financial statements and footnotes thereto included in the Company’s Form 10-K for the year ended December 31, 2011.

The consolidated results for the three and six months ended June 30, 2012 are not necessarily indicative of the results to be expected for the year ending December 31, 2012.

NOTE 2—IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

Effective January 1, 2012, the Company adopted Accounting Standards Update (ASU) No. 2011-5 and 2011-12, which amend the Comprehensive Income Topic of the Accounting Standards Codification (ASC). The updated guidance requires the components of income and other comprehensive income to be presented in a single continuous statement or two consecutive statements in annual periods. In interim periods, total comprehensive income must be presented in either a single continuous statement or two consecutive statements.

During the six months ended June 30, 2012, there were no other new accounting pronouncements or updates to recently issued accounting pronouncements disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 that affect the Company’s results of operations, financial condition, liquidity or disclosures.

 

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Table of Contents

NOTE 3—DIVIDENDS

Dividends paid on common stock during each of the first two quarters of 2012 and 2011 were $.390 per common share and $.365 per common share, respectively.

NOTE 4—COMPREHENSIVE INCOME

Comprehensive income is summarized as follows:

 

(Thousands of dollars)    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
   2012      2011     2012     2011  

Net income

   $ 227,813     $ 179,115     $ 328,029     $ 247,431  

Foreign currency translation adjustments

     (16,259     9,384       11,921       26,889  

Amortization of net prior service costs and net actuarial losses, net of taxes (1)

     3,388       3,435       6,784       6,684  

Adjustments of marketable equity securities, net of taxes (2)

     (96     (427     (115     (408
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 214,846     $ 191,507     $ 346,619     $ 280,596  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

The tax effect of amortization of net prior service costs and net actuarial losses was $(3,017) and $(6,037) for the three and six months ended June 30, 2012 and $(2,873) and $(5,961) for the three and six months ended June 30, 2011.

(2) 

The tax effect of adjustments of marketable equity securities was $61 and $74 for the three and six months ended June 30, 2012 and $273 and $261 for the three and six months ended June 30, 2011.

 

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NOTE 5—PRODUCT WARRANTIES

Changes in the Company’s accrual for product warranty claims during the first six months of 2012 and 2011, including customer satisfaction settlements, were as follows:

 

(Thousands of dollars)    2012     2011  

Balance at January 1

   $ 22,071     $ 23,103  

Charges to expense

     11,710       14,445  

Settlements

     (10,842     (12,746
  

 

 

   

 

 

 

Balance at June 30

   $ 22,939     $ 24,802  
  

 

 

   

 

 

 

For further details on the Company’s accrual for product warranty claims, see Note 1 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

NOTE 6—EXIT OR DISPOSAL ACTIVITIES

Liabilities associated with exit or disposal activities are recognized as incurred in accordance with the Exit or Disposal Cost Obligations Topic of the ASC. Qualified exit costs primarily include post-closure rent expenses, incremental post-closure costs and costs of employee terminations. Adjustments may be made to liabilities accrued for qualified exit costs if information becomes available upon which more accurate amounts can be reasonably estimated. Concurrently, property, plant and equipment is tested for impairment in accordance with the Property, Plant and Equipment Topic of the ASC, and if impairment exists, the carrying value of the related assets is reduced to estimated fair value. Additional impairment may be recorded for subsequent revisions in estimated fair value.

In the six months ended June 30, 2012, five stores in the Paint Stores Group, two branches and one facility in the Global Finishes Group and four stores in the Latin America Coatings Group were closed due to lower demand or redundancy.

 

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The following table summarizes the activity and remaining liabilities associated with qualified exit costs at June 30, 2012:

 

 

(Thousands of dollars)

 

Exit Plan

   Balance at
December 31,
2011
     Provisions in
Cost of  goods
sold or SG&A
     Actual
expenditures
charged to
accrual
    Adjustments to
prior  provisions
in Other general
expense—net
    Balance at
June 30,
2012
 

Global Finishes Group facility shutdown in 2012:

            

Severance and related costs

      $ 1,617          $ 1,617  

Consumer Group manufacturing facilities shutdown in 2011:

            

Severance and related costs

   $ 197         $ (133       64  

Paint Stores Group stores shutdown in 2011:

            

Other qualified exit costs

     156           (141   $ (7     8  

Global Finishes Group branches shutdown in 2011:

            

Severance and related costs

     129           (129    

Other qualified exit costs

     470           (95       375  

Global Finishes Group branches shutdown in 2010:

            

Other qualified exit costs

     955           (70       885  

Other qualified exit costs for facilities shutdown prior to 2010

     8,493           (1,339     (28     7,126  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Totals

   $ 10,400      $ 1,617      $ (1,907   $ (35   $ 10,075  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

For further details on the Company’s exit or disposal activities, see Note 6 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

 

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NOTE 7HEALTH CARE, PENSION AND OTHER BENEFITS

Shown below are the components of the Company’s net periodic benefit cost for domestic defined benefit pension plans, foreign defined benefit pension plans and postretirement benefits other than pensions:

 

(Thousands of dollars)    Domestic Defined
Benefit Pension Plans
    Foreign Defined
Benefit Pension Plans
    Postretirement
Benefits Other than
Pensions
 
     2012     2011     2012     2011     2012     2011  

Three Months Ended June 30:

            

Net periodic benefit cost:

            

Service cost

   $ 4,732     $ 4,007     $ 893     $ 961     $ 736     $ 874  

Interest cost

     4,331       4,707       1,724       1,094       3,380       3,895  

Expected return on assets

     (11,211     (11,611     (1,677     (681    

Amortization of:

            

Prior service cost (credit)

     398       409           (164     (164

Actuarial loss

     5,485       4,877       252       220       428       626  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic benefit cost

   $ 3,735     $ 2,389     $ 1,192     $ 1,594     $ 4,380     $ 5,231  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six Months Ended June 30:

            

Net periodic benefit cost:

            

Service cost

   $ 9,464     $ 8,014     $ 1,785     $ 1,896     $ 1,472     $ 1,748  

Interest cost

     8,662       9,414       3,449       2,164       6,760       7,790  

Expected return on assets

     (22,421     (23,221     (3,354     (1,346    

Amortization of:

            

Prior service cost (credit)

     796       818           (328     (328

Actuarial loss

     10,971       9,754       503       435       857       1,252  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic benefit cost

   $ 7,472     $ 4,779     $ 2,383     $ 3,149     $ 8,761     $ 10,462  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For further details on the Company’s health care, pension and other benefits, see Note 7 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

NOTE 8—OTHER LONG-TERM LIABILITIES

The Company initially provides for estimated costs of environmental-related activities relating to its past operations and third-party sites for which commitments or clean-up plans have been developed and when such costs can be reasonably estimated based on industry standards and professional judgment. These estimated costs are determined based on currently available facts regarding each site. If the best estimate of costs can only be identified as a range and no specific amount within that range can be determined more likely than any other amount within the range, the minimum of the range is provided. At June 30, 2012, the unaccrued maximum of the estimated range of possible outcomes is $97.7 million higher than the minimum.

The Company continuously assesses its potential liability for investigation and remediation-related activities and adjusts its environmental-related accruals as information becomes available

 

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upon which more accurate costs can be reasonably estimated and as additional accounting guidelines are issued. Actual costs incurred may vary from these estimates due to the inherent uncertainties involved including, among others, the number and financial condition of parties involved with respect to any given site, the volumetric contribution which may be attributed to the Company relative to that attributed to other parties, the nature and magnitude of the wastes involved, the various technologies that can be used for remediation and the determination of acceptable remediation with respect to a particular site.

Included in Other long-term liabilities at June 30, 2012 and 2011 were accruals for extended environmental-related activities of $83.9 million and $87.5 million, respectively. Estimated costs of current investigation and remediation activities of $42.9 million and $60.0 million are included in Other accruals at June 30, 2012 and 2011, respectively.

Four of the Company’s currently and formerly owned manufacturing sites account for the majority of the accrual for environmental-related activities and the unaccrued maximum of the estimated range of possible outcomes at June 30, 2012. At June 30, 2012, $84.6 million, or 66.7 percent of the total accrual, related directly to these four sites. In the aggregate unaccrued maximum of $97.7 million at June 30, 2012, $66.2 million, or 67.8 percent, related to the four manufacturing sites. While environmental investigations and remedial actions are in different stages at these sites, additional investigations, remedial actions and monitoring will likely be required at each site.

Management cannot presently estimate the ultimate potential loss contingencies related to these sites or other less significant sites until such time as a substantial portion of the investigation at the sites is completed and remedial action plans are developed. In the event any future loss contingency significantly exceeds the current amount accrued, the recording of the ultimate liability may result in a material impact on net income for the annual or interim period during which the additional costs are accrued. Management does not believe that any potential liability ultimately attributed to the Company for its environmental-related matters will have a material adverse effect on the Company’s financial condition, liquidity, or cash flow due to the extended period of time during which environmental investigation and remediation takes place. An estimate of the potential impact on the Company’s operations cannot be made due to the aforementioned uncertainties.

Management expects these contingent environmental-related liabilities to be resolved over an extended period of time. Management is unable to provide a more specific time frame due to the indefinite amount of time to conduct investigation activities at any site, the indefinite amount of time to obtain environmental agency approval, as necessary, with respect to investigation and remediation activities, and the indefinite amount of time necessary to conduct remediation activities.

For further details on the Company’s Other long-term liabilities, see Note 9 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

 

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NOTE 9—LITIGATION

In the course of its business, the Company is subject to a variety of claims and lawsuits, including, but not limited to, litigation relating to product liability and warranty, personal injury, environmental, intellectual property, commercial, contractual and antitrust claims that are inherently subject to many uncertainties regarding the possibility of a loss to the Company. These uncertainties will ultimately be resolved when one or more future events occur or fail to occur confirming the incurrence of a liability or the reduction of a liability. In accordance with the Contingencies Topic of the ASC, the Company accrues for these contingencies by a charge to income when it is both probable that one or more future events will occur confirming the fact of a loss and the amount of the loss can be reasonably estimated. In the event that the Company’s loss contingency is ultimately determined to be significantly higher than currently accrued, the recording of the additional liability may result in a material impact on the Company’s results of operations, liquidity or financial condition for the annual or interim period during which such additional liability is accrued. In those cases where no accrual is recorded because it is not probable that a liability has been incurred and cannot be reasonably estimated, any potential liability ultimately determined to be attributable to the Company may result in a material impact on the Company’s results of operations, liquidity or financial condition for the annual or interim period during which such liability is accrued. In those cases where no accrual is recorded or exposure to loss exists in excess of the amount accrued, the Contingencies Topic of the ASC requires disclosure of the contingency when there is a reasonable possibility that a loss or additional loss may have been incurred.

Lead pigment and lead-based paint litigation. The Company’s past operations included the manufacture and sale of lead pigments and lead-based paints. The Company, along with other companies, is and has been a defendant in a number of legal proceedings, including individual personal injury actions, purported class actions, and actions brought by various counties, cities, school districts and other government-related entities, arising from the manufacture and sale of lead pigments and lead-based paints. The plaintiffs’ claims have been based upon various legal theories, including negligence, strict liability, breach of warranty, negligent misrepresentations and omissions, fraudulent misrepresentations and omissions, concert of action, civil conspiracy, violations of unfair trade practice and consumer protection laws, enterprise liability, market share liability, public nuisance, unjust enrichment and other theories. The plaintiffs seek various damages and relief, including personal injury and property damage, costs relating to the detection and abatement of lead-based paint from buildings, costs associated with a public education campaign, medical monitoring costs and others. The Company is also a defendant in legal proceedings arising from the manufacture and sale of non-lead-based paints that seek recovery based upon various legal theories, including the failure to adequately warn of potential exposure to lead during surface preparation when using non-lead-based paint on surfaces previously painted with lead-based paint. The Company believes that the litigation brought to date is without merit or subject to meritorious defenses and is vigorously defending such litigation. The Company has not settled any lead pigment or lead-based paint litigation. The Company expects that additional lead pigment and lead-based paint litigation may be filed against the Company in the future asserting similar or different legal theories and seeking similar or different types of damages and relief.

 

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Notwithstanding the Company’s views on the merits, litigation is inherently subject to many uncertainties, and the Company ultimately may not prevail. Adverse court rulings or determinations of liability, among other factors, could affect the lead pigment and lead-based paint litigation against the Company and encourage an increase in the number and nature of future claims and proceedings. In addition, from time to time, various legislation and administrative regulations have been enacted, promulgated or proposed to impose obligations on present and former manufacturers of lead pigments and lead-based paints respecting asserted health concerns associated with such products or to overturn the effect of court decisions in which the Company and other manufacturers have been successful.

Due to the uncertainties involved, management is unable to predict the outcome of the lead pigment and lead-based paint litigation, the number or nature of possible future claims and proceedings, or the effect that any legislation and/or administrative regulations may have on the litigation or against the Company. In addition, management cannot reasonably determine the scope or amount of the potential costs and liabilities related to such litigation, or resulting from any such legislation and regulations. The Company has not accrued any amounts for such litigation. With respect to such litigation, including the public nuisance litigation, the Company does not believe that it is probable that a loss has occurred, and it is not possible to estimate the range of potential losses as there is no prior history of a loss of this nature and there is no substantive information upon which an estimate could be based. In addition, any potential liability that may result from any changes to legislation and regulations cannot reasonably be estimated. In the event any significant liability is determined to be attributable to the Company relating to such litigation, the recording of the liability may result in a material impact on net income for the annual or interim period during which such liability is accrued. Additionally, due to the uncertainties associated with the amount of any such liability and/or the nature of any other remedy which may be imposed in such litigation, any potential liability determined to be attributable to the Company arising out of such litigation may have a material adverse effect on the Company’s results of operations, liquidity or financial condition. An estimate of the potential impact on the Company’s results of operations, liquidity or financial condition cannot be made due to the aforementioned uncertainties.

Public nuisance claim litigation. The Company and other companies are or were defendants in legal proceedings seeking recovery based on public nuisance liability theories, among other theories, brought by the State of Rhode Island, the City of St. Louis, Missouri, various cities and counties in the State of New Jersey, various cities in the State of Ohio and the State of Ohio, the City of Chicago, Illinois, the City of Milwaukee, Wisconsin and the County of Santa Clara, California and other public entities in the State of California. Except for the Santa Clara County, California proceeding, all of these legal proceedings have been concluded in favor of the Company and other defendants at various stages in the proceedings.

The proceedings initiated by the State of Rhode Island included two jury trials. At the conclusion of the second trial, the jury returned a verdict finding that (i) the cumulative presence of lead pigment in paints and coatings on buildings in the State of Rhode Island constitutes a public nuisance, (ii) the Company, along with two other defendants, caused or substantially contributed to the creation of the public nuisance, and (iii) the Company and two other defendants should be ordered to abate the public nuisance. The Company and two other defendants appealed and, on

 

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July 1, 2008, the Rhode Island Supreme Court, among other determinations, reversed the judgment of abatement with respect to the Company and two other defendants. The Rhode Island Supreme Court’s decision reversed the public nuisance liability judgment against the Company on the basis that the complaint failed to state a public nuisance claim as a matter of law.

The Santa Clara County, California proceeding was initiated in March 2000 in the Superior Court of the State of California, County of Santa Clara. In the original complaint, the plaintiffs asserted various claims including fraud and concealment, strict product liability/failure to warn, strict product liability/design defect, negligence, negligent breach of a special duty, public nuisance, private nuisance, and violations of California’s Business and Professions Code. A number of the asserted claims were resolved in favor of the defendants through pre-trial proceedings. The named plaintiffs in the Fourth Amended Complaint, filed on March 16, 2011, are the Counties of Santa Clara, Alameda, Los Angeles, Monterey, San Mateo, Solano and Ventura, and the Cities of Oakland, San Diego and San Francisco. The Fourth Amended Complaint asserts a sole claim for public nuisance, alleging that the presence of lead products for use in paint and coatings in, on and around buildings in the plaintiffs’ jurisdictions constitutes a public nuisance. The plaintiffs seek the abatement of the alleged public nuisance that exists within the plaintiffs’ jurisdictions.

Litigation seeking damages from alleged personal injury. The Company and other companies are defendants in a number of legal proceedings seeking monetary damages and other relief from alleged personal injuries. These proceedings include claims by children allegedly injured from ingestion of lead pigment or lead-containing paint, claims for damages allegedly incurred by the children’s parents or guardians, and claims for damages allegedly incurred by professional painting contractors. These proceedings generally seek compensatory and punitive damages, and seek other relief including medical monitoring costs. These proceedings include purported claims by individuals, groups of individuals and class actions.

The plaintiff in Thomas v. Lead Industries Association, et al., initiated an action in state court against the Company, other alleged former lead pigment manufacturers and the Lead Industries Association in September 1999. The claims against the Company and the other defendants include strict liability, negligence, negligent misrepresentation and omissions, fraudulent misrepresentation and omissions, concert of action, civil conspiracy and enterprise liability. Implicit within these claims is the theory of “risk contribution” liability (Wisconsin’s theory which is similar to market share liability) due to the plaintiff’s inability to identify the manufacturer of any product that allegedly injured the plaintiff. The case ultimately proceeded to trial and, on November 5, 2007, the jury returned a defense verdict, finding that the plaintiff had ingested white lead carbonate, but was not brain damaged or injured as a result. The plaintiff appealed and, on December 16, 2010, the Wisconsin Court of Appeals affirmed the final judgment in favor of the Company and other defendants.

Wisconsin is the only jurisdiction to date to apply a theory of liability with respect to alleged personal injury (i.e., risk contribution/market share liability) that does not require the plaintiff to identify the manufacturer of the product that allegedly injured the plaintiff in the lead pigment and lead-based paint litigation. Although the risk contribution liability theory was applied during the Thomas trial, the constitutionality of this theory as applied to the lead pigment cases has not

 

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been judicially determined by the Wisconsin state courts. However, in an unrelated action filed in the United States District Court for the Eastern District of Wisconsin, Gibson v. American Cyanamid, et al., on November 15, 2010, the District Court held that Wisconsin’s risk contribution theory as applied in that case violated the defendants’ right to substantive due process and is unconstitutionally retroactive. The District Court’s decision in Gibson v. American Cyanamid, et al., has been appealed by the plaintiff.

Insurance coverage litigation. The Company and its liability insurers, including certain Underwriters at Lloyd’s of London, initiated legal proceedings against each other to primarily determine, among other things, whether the costs and liabilities associated with the abatement of lead pigment are covered under certain insurance policies issued to the Company. The Company’s action, filed on March 3, 2006 in the Common Pleas Court, Cuyahoga County, Ohio, is currently stayed. The liability insurers’ action, which was filed on February 23, 2006 in the Supreme Court of the State of New York, County of New York, has been dismissed. An ultimate loss in the insurance coverage litigation would mean that insurance proceeds could be unavailable under the policies at issue to mitigate any ultimate abatement related costs and liabilities. The Company has not recorded any assets related to these insurance policies or otherwise assumed that proceeds from these insurance policies would be received in estimating any contingent liability accrual. Therefore, an ultimate loss in the insurance coverage litigation without a determination of liability against the Company in the lead pigment or lead-based paint litigation will have no impact on the Company’s results of operation, liquidity or financial condition. As previously stated, however, the Company has not accrued any amounts for the lead pigment or lead-based paint litigation and any significant liability ultimately determined to be attributable to the Company relating to such litigation may result in a material impact on the Company’s results of operations, liquidity or financial condition for the annual or interim period during which such liability is accrued.

Department of Labor (DOL) Leveraged ESOP Investigation. As previously disclosed, the DOL’s investigation of transactions related to the Company’s ESOP (the “Leveraged ESOP Transactions”) remains open. On April 19, 2012, the Employee Benefits Security Administration of the DOL notified the Company, certain current and former directors and the ESOP trustee of potential enforcement claims asserting breaches of fiduciary obligations. The DOL is seeking compensatory and equitable remedies, including monetary damages to the ESOP for alleged losses to the ESOP. The Company believes that the DOL’s claims are subject to meritorious defenses and will vigorously defend any proceedings initiated by the DOL. The Company has not accrued any amounts for such claims.

NOTE 10—OTHER

Other general expense (income)—net

Included in Other general expense (income)—net were the following:

 

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(Thousands of dollars)    Three Months Ended
June  30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Provisions for environmental matters—net

   $ 3,988     $ (702   $ 9,093     $ 4,650  

(Gain) loss on disposition of assets

     (814     10       (935     (4,399

Adjustments to prior provisions for qualified exit costs

     (88     (6     (35     223  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 3,086     $ (698   $ 8,123     $ 474  
  

 

 

   

 

 

   

 

 

   

 

 

 

Provisions for environmental matters–net represent site-specific increases or decreases to environmental-related accruals as information becomes available upon which more accurate costs can be reasonably estimated and as additional accounting guidelines are issued. Environmental-related accruals are not recorded net of insurance proceeds in accordance with the Offsetting Subtopic of the Balance Sheet Topic of the ASC. See Note 8 for further details on the Company’s environmental-related activities.

The (gain) loss on disposition of assets represents net realized (gains) losses associated with the disposal of fixed assets previously used in the conduct of the primary business of the Company.

The adjustments to prior provisions for qualified exit costs represent site specific increases or decreases to accrued qualified exit costs as adjustments for costs of employee terminations are required or as information becomes available upon which more accurate amounts can be reasonably estimated. See Note 6 for further details on the Company’s exit or disposal activities.

Other income—net

Included in Other income—net were the following:

 

(Thousands of dollars)    Three Months Ended
June  30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Dividend and royalty income

   $ (851   $ (1,660   $ (2,101   $ (2,985

Net expense from financing activities

     1,041       1,826       4,021       3,949  

Foreign currency related losses (gains)

     1,374       1,605       (3,704     2,919  

Other income

     (5,229     (5,019     (8,480     (8,336

Other expense

     3,561       3,191       5,173       4,444  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ (104   $ (57   $ (5,091   $ (9
  

 

 

   

 

 

   

 

 

   

 

 

 

The net expense from financing activities includes the net expense relating to the change in the Company’s financing fees.

Foreign currency related losses (gains) included foreign currency transaction gains and losses and realized and unrealized net gains from foreign currency option and forward contracts. The Company had foreign currency option and forward contracts outstanding at June 30, 2011. All of the outstanding contracts had maturity dates of less than twelve months and were undesignated hedges with changes in fair value being recognized in earnings in accordance with the Derivatives and Hedging Topic of the ASC. These derivative instrument values were included in either Other current assets or Other accruals and were insignificant at June 30, 2011. There were no foreign currency option and forward contracts outstanding at June 30, 2012.

 

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Other income and Other expense included items of revenue, gains, expenses and losses that were unrelated to the primary business purpose of the Company. There were no items within the other income or other expense caption that were individually significant.

NOTE 11—INCOME TAXES

The effective tax rate was 30.5 percent and 30.2 percent for the second quarter and first six months of 2012, respectively, compared to 30.3 percent and 29.7 percent for the second quarter and first six months of 2011, respectively.

At December 31, 2011, the Company had $29.7 million in unrecognized tax benefits, the recognition of which would have an effect of $25.6 million on the current provision for income taxes. At June 30, 2012, the amounts were reduced to $24.6 million and $21.2 million, respectively. Included in the balance of unrecognized tax benefits at December 31, 2011, was $7.8 million related to tax positions for which it is reasonably possible that the total amounts could significantly change during the next twelve months. At June 30, 2012, this amount was reduced to $4.3 million. The above reductions in unrecognized tax benefits during the first six months of 2012 were primarily due to the expiration of the statutes related to the 2006 and 2007 federal income tax years as well as the recognition of the related state income tax benefits. The above recognition of income tax benefits had a favorable impact on the Company’s effective tax rate for the second quarter and first six months of 2012.

The Company classifies all income tax related interest and penalties as income tax expense. At December 31, 2011, the Company had accrued $8.1 million for the potential payment of income tax interest and penalties. This amount was reduced to $6.8 million at June 30, 2012 primarily due to the expiration of the 2006 and 2007 federal statutes noted above.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. As disclosed in Note 15 in the Company’s 2011 Annual Report on Form 10-K, the Company has fully resolved all IRS issues for the 2003 through 2009 tax years relating to the matters challenging the ESOP related federal income tax deductions claimed by the Company. With the exception of $2.0 million of interest related to the 2008 tax year, all ESOP related settlement payments have been made to the IRS. The Department of Labor’s investigation of the Leveraged ESOP Transactions remains open. Refer to Note 9 for more information. The IRS commenced an examination of the Company’s U.S. income tax returns for the 2008 and 2009 tax years in the third quarter of 2011. Field work is expected to be completed during 2012. At this time, the Company has determined that an insignificant refund is due for issues under review during this audit period.

As of June 30, 2012, the Company is subject to non-U.S. income tax examinations for the tax years of 2004 through 2011. In addition, the Company is subject to state and local income tax examinations for the tax years 2002 through 2011.

 

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NOTE 12—NET INCOME PER COMMON SHARE

 

(Thousands of dollars except per share data)    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
   2012     2011     2012     2011  

Basic

        

Average common shares outstanding

     101,446,643       104,676,477       101,758,496       104,833,745  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 227,813     $ 179,115     $ 328,029     $ 247,431  

Less net income allocated to unvested restricted shares

     (1,908     (2,039     (2,689     (2,709
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income allocated to common shares

   $ 225,905     $ 177,076     $ 325,340     $ 244,722  
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic net income per common share

   $ 2.23     $ 1.69     $ 3.20     $ 2.33  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

        

Average common shares outstanding

     101,446,643       104,676,477       101,758,496       104,833,745  

Stock options and other contingently issuable shares (1)

     2,556,485       2,199,984       2,341,550       2,270,280  
  

 

 

   

 

 

   

 

 

   

 

 

 

Average common shares outstanding assuming dilution

     104,003,128       106,876,461       104,100,046       107,104,025  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 227,813     $ 179,115     $ 328,029     $ 247,431  

Less net income allocated to unvested restricted shares assuming dilution

     (1,865     (2,004     (2,633     (2,666
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income allocated to common shares assuming dilution

   $ 225,948     $ 177,111     $ 325,396     $ 244,765  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted net income per common share

   $ 2.17     $ 1.66     $ 3.13     $ 2.29  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Stock options and other contingently issuable shares excluded 54,675 shares for the three and six months ended June 30, 2011 due to their anti-dilutive effect. There were no options excluded due to their anti-dilutive effect for the three and six months ended June 30, 2012.

The Company has two classes of participating securities: common shares and restricted shares, representing 99% and 1% of outstanding shares, respectively. The restricted shares are shares of unvested restricted stock granted under the Company’s restricted stock award program. Unvested restricted shares granted prior to April 21, 2010 received non-forfeitable dividends. Accordingly, the shares are considered a participating security and the two-class method of calculating basic and diluted earnings per share is required. Effective April 21, 2010, the restricted stock award program was revised and dividends on performance-based restricted shares granted after this date are deferred and payment is contingent upon the awards vesting. Only the time-based restricted shares, which continue to receive non-forfeitable dividends, are considered a participating security. Basic and diluted earnings per share are calculated using the two-class method in accordance with the Earnings Per Share Topic of the ASC.

 

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NOTE 13—REPORTABLE SEGMENT INFORMATION

The Company reports segment information in the same way that management internally organizes its business for assessing performance and making decisions regarding allocation of resources in accordance with the Segment Disclosures Topic of the ASC. The Company has determined that it has four reportable segments: Paint Stores Group, Consumer Group, Global Finishes Group and Latin America Coatings Group (collectively, the “Reportable Segments”).

 

(Thousands of dollars)    Three Months Ended June 30, 2012  
     Paint Stores
Group
     Consumer
Group
    Global
Finishes
Group
     Latin America
Coatings
Group
     Administrative     Consolidated
Totals
 

Net external sales

   $ 1,488,109      $ 397,749      $ 498,693      $ 187,281      $ 1,190     $ 2,573,022  

Intersegment transfers

        655,276        1,935        11,649        (668,860  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total net sales and intersegment transfers

   $ 1,488,109      $ 1,053,025      $ 500,628      $ 198,930      $ (667,670   $ 2,573,022  

Segment profit

   $ 266,982      $ 80,757   $ 48,032      $ 9,281        $ 405,052  

Interest expense

              $ (10,230     (10,230

Administrative expenses and other

                (67,019     (67,019
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Income before income taxes

   $ 266,982      $ 80,757      $ 48,032      $ 9,281      $ (77,249   $ 327,803  
     Three Months Ended June 30, 2011  
     Paint Stores
Group
     Consumer
Group
    Global
Finishes
Group
     Latin America
Coatings
Group
     Administrative     Consolidated
Totals
 

Net external sales

   $ 1,299,047      $ 375,634      $ 482,695      $ 196,176      $ 1,199     $ 2,354,751  

Intersegment transfers

        576,422        2,072        9,537        (588,031  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total net sales and intersegment transfers

   $ 1,299,047      $ 952,056      $ 484,767      $ 205,713      $ (586,832   $ 2,354,751  

Segment profit

   $ 206,631      $ 61,371   $ 30,249      $ 15,821        $ 314,072  

Interest expense

              $ (11,747     (11,747

Administrative expenses and other

                (45,309     (45,309
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Income before income taxes

   $ 206,631      $ 61,371      $ 30,249      $ 15,821      $ (57,056   $ 257,016  

 

* Segment profit includes $7,968 and $6,861 of mark-up on intersegment transfers realized as a result of external sales by the Paint Stores Group during the second quarter of 2012 and 2011, respectively.

 

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     Six Months Ended June 30, 2012  
     Paint Stores
Group
     Consumer
Group
    Global
Finishes
Group
     Latin America
Coatings Group
     Administrative     Consolidated
Totals
 

Net external sales

   $ 2,611,187      $ 718,122      $ 981,768      $ 395,874      $ 2,415     $ 4,709,366  

Intersegment transfers

        1,158,776        4,265        22,624        (1,185,665  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total net sales and intersegment transfers

   $ 2,611,187      $ 1,876,898      $ 986,033      $ 418,498      $ (1,183,250   $ 4,709,366  

Segment profit

   $ 379,694      $ 136,063 **    $ 76,669      $ 29,168        $ 621,594  

Interest expense

              $ (20,567     (20,567

Administrative expenses and other

                (130,909     (130,909
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Income before income taxes

   $ 379,694      $ 136,063      $ 76,669      $ 29,168      $ (151,476   $ 470,118  
     Six Months Ended June 30, 2011  
     Paint Stores
Group
     Consumer
Group
    Global
Finishes
Group
     Latin America
Coatings Group
     Administrative     Consolidated
Totals
 

Net external sales

   $ 2,228,314      $ 670,564      $ 918,012      $ 391,025      $ 2,422     $ 4,210,337  

Intersegment transfers

        994,570        3,370        17,977        (1,015,917  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total net sales and intersegment transfers

   $ 2,228,314      $ 1,665,134      $ 921,382      $ 409,002      $ (1,013,495   $ 4,210,337  

Segment profit

   $ 275,488      $ 102,462 **    $ 49,687      $ 33,193        $ 460,830  

Interest expense

              $ (22,422     (22,422

Administrative expenses and other

                (86,679     (86,679
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Income before income taxes

   $ 275,488      $ 102,462      $ 49,687      $ 33,193      $ (109,101   $ 351,729  

 

** Segment profit includes $14,644 and $11,809 of mark-up on intersegment transfers realized as a result of external sales by the Paint Stores Group during the first six months of 2012 and 2011, respectively.

In the reportable segment financial information, Segment profit was total net sales and intersegment transfers less operating costs and expenses. Domestic intersegment transfers were accounted for at the approximate fully absorbed manufactured cost, based on normal capacity volumes, plus customary distribution costs. International intersegment transfers were accounted for at values comparable to normal unaffiliated customer sales. The Administrative segment includes the administrative expenses of the Company’s corporate headquarters site. Also included in the Administrative segment was interest expense, interest and investment income, certain expenses related to closed facilities and environmental-related matters, and other expenses which were not directly associated with the Reportable Segments. The Administrative segment did not include any significant foreign operations. Also included in the Administrative segment was a real estate management unit that is responsible for the ownership, management and leasing of non-retail properties held primarily for use by the Company, including the Company’s headquarters site, and disposal of idle facilities. Sales of this segment represented external leasing revenue of excess headquarters space or leasing of facilities no longer used by the Company in its primary businesses. Gains and losses from the sale of property were not a significant operating factor in determining the performance of the Administrative segment.

Net external sales and segment profit of all consolidated foreign subsidiaries were $491.9 million and $32.5 million, respectively, for the second quarter of 2012, and $507.1 million and $34.4 million, respectively, for the second quarter of 2011. Net external sales and segment profit of

 

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these subsidiaries were $993.8 million and $67.3 million, respectively, for the first six months of 2012, and $977.1 million and $61.8 million, respectively, for the first six months of 2011. Long-lived assets of these subsidiaries totaled $637.7 million and $671.1 million at June 30, 2012 and June 30, 2011, respectively. Domestic operations accounted for the remaining net external sales, segment profits and long-lived assets. No single geographic area outside the United States was significant relative to consolidated net external sales, income before taxes, or consolidated long-lived assets.

Export sales and sales to any individual customer were each less than 10 percent of consolidated sales to unaffiliated customers during all periods presented.

NOTE 14ACQUISITIONS

Effective June 1, 2012, the Company acquired Geocel Corporation. Geocel manufactures innovative caulks, sealants, and adhesives specially designed for tough construction and repair applications in commercial, residential, industrial and transport non-automotive markets. Geocel has operations in both the United States and United Kingdom. The acquisition strengthens the Consumer Group’s sealant and adhesive market position. The acquisition resulted in the recognition of goodwill and intangible assets.

The Company acquired a controlling interest in Leighs Paints in July 2011 and the remaining interest in December 2011. Headquartered in Bolton, United Kingdom, Leighs Paints is one of the leading industrial fire protection coatings manufacturers in the world, with a growing global platform driven by technology innovation and quality products. The acquisition strengthens the Global Finishes Group’s growing global platform. The aggregate consideration paid for Leighs Paints was $41.8 million, net of cash acquired. The acquisition resulted in the recognition of goodwill and intangible assets.

The following unaudited pro-forma summary presents consolidated financial information as if Geocel and Leighs Paints had been acquired as of the beginning of each period presented. The pro-forma consolidated financial information does not necessarily reflect the actual results that would have occurred had the acquisitions taken place on January 1, 2011 or of future results of operations of Geocel and Leighs Paints under ownership and operation of the Company.

 

(Thousands of dollars except per share data)    Three Months Ended June 30,      Six Months Ended June 30,  
     2012      2011      2012      2011  

Net sales

   $ 2,582,156      $ 2,387,005      $ 4,736,462      $ 4,272,819  

Net income

     228,799        179,570        330,422        248,667  

Net income per common share:

           

Basic

   $ 2.24      $ 1.70      $ 3.22      $ 2.35  

Diluted

   $ 2.18      $ 1.66      $ 3.15      $ 2.30  

 

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NOTE 15FAIR VALUE MEASUREMENTS

The Fair Value Measurements and Disclosures Topic of the ASC applies to the Company’s financial and non-financial assets and liabilities. The guidance applies when other standards require or permit the fair value measurement of assets and liabilities. It does not expand the use of fair value measurements. The Company did not have any fair value measurements for its non-financial assets and liabilities during the second quarter. The following table presents the Company’s financial assets and liabilities that are measured at fair value on a recurring basis, categorized using the fair value hierarchy:

 

(Thousands of dollars)    Fair Value at
June 30,
2012
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)

Assets:

           

Deferred compensation plan asset (1)

   $ 19,094      $ 14,466      $ 4,628     
  

 

 

    

 

 

    

 

 

    

Liabilities:

           

Deferred compensation plan liability (2)

   $ 28,012      $ 28,012        
  

 

 

    

 

 

       

 

(1) 

The deferred compensation plan asset consists of the investment funds maintained for the future payments under the Company’s executive deferred compensation plan, which is structured as a rabbi trust. The investments are marketable securities accounted for under the Debt and Equity Securities Topic of the ASC. The level 1 investments are valued using quoted market prices multiplied by the number of shares. The level 2 investments are valued based on vendor or broker models. The cost basis of the investment funds is $19,086.

(2) 

The deferred compensation plan liability is the Company’s liability under its executive deferred compensation plan. The liability represents the fair value of the participant shadow accounts, and the value is based on quoted market prices.

NOTE 16FINANCIAL INSTRUMENTS

The table below summarizes the carrying amount and fair value of the Company’s publicly traded debt and non-publicly traded debt in accordance with the Fair Value Measurements and Disclosures Topic of the ASC. The fair values of the Company’s publicly traded debt are based on quoted market prices. The fair values of the Company’s non-traded debt are estimated using discounted cash flow analyses, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. The Company’s publicly traded debt and non-traded debt are classified as level 1 and level 2, respectively, in the fair value hierarchy.

 

(Thousands of dollars)    June 30, 2012      June 30, 2011  
     Carrying
Amount
     Fair Value      Carrying
Amount
     Fair Value  

Publicly traded debt

   $ 632,448      $ 694,626      $ 632,400      $ 676,031  

Non-traded debt

     7,387        7,120        21,362        20,309  

On January 30, 2012, the Company entered into a five-year credit agreement, which was amended on February 6, 2012, February 13, 2012 and February 27, 2012. This credit agreement gives the Company the right to borrow and to obtain the issuance, renewal, extension and increase of a letter of credit of up to an aggregate availability of $500 million.

 

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On April 23, 2012, the Company entered into a new five-year credit agreement, which was amended on April 25, 2012 and May 7, 2012. This credit agreement gives the Company the right to borrow and to obtain the issuance, renewal, extension and increase of a letter of credit up to an aggregate availability of $250 million.

On June 29, 2012, Sherwin-Williams Canada, Inc., a wholly owned subsidiary of the Company, entered into a CAD 75 million five-year revolving credit facility. The credit facility replaced the existing three-year credit facility, and will be used for general corporate purposes, including refinancing indebtedness and for acquisitions.

NOTE 17NON-TRADED INVESTMENTS

The Company has invested in the U.S. affordable housing and historic renovation real estate markets. These non-traded investments have been identified as variable interest entities. However, because the Company does not have the power to direct the day-to-day operations of the investments and the risk of loss is limited to the amount of contributed capital, the Company is not considered the primary beneficiary. In accordance with the Consolidation Topic of the ASC, the investments are not consolidated. The Company uses the effective yield method to determine the carrying value of the investments. Under the effective yield method, the initial cost of the investments is amortized over the period that the tax credits are recognized. The carrying amount of the investments, included in Other assets, was $250.5 million and $215.8 million at June 30, 2012 and 2011, respectively. The liability for estimated future capital contributions to the investments was $233.7 million and $190.0 million at June 30, 2012 and 2011, respectively.

NOTE 18CAPITAL STOCK

On March 31, 2011, the Company retired all of its 125.4 million shares of common stock held in treasury at that date, which decreased Treasury stock, Common stock and Retained earnings by $4.5 billion, $0.1 billion and $4.4 billion, respectively.

 

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Item 2. MANAGEMENT’S DISCUSSION AND

ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

SUMMARY

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, Europe and Asia. The Company is structured into four reportable segments—Paint Stores Group, Consumer Group, Global Finishes Group and Latin America 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 pages 6 through 15 and Note 19, on pages 76 through 79, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 for more information concerning the Reportable Segments.

The Company’s financial condition, liquidity and cash flow were strong in the second quarter of 2012 primarily due to improving domestic architectural paint demand. Net working capital decreased $156.2 million at June 30, 2012 compared to the end of the second quarter of 2011 due to an increase in current liabilities and a slight decrease in current assets. The Company has been able to arrange sufficient short-term borrowing capacity at reasonable rates even as credit markets remain tight, and the Company has sufficient total available borrowing capacity to fund its current operating needs. Net operating cash increased $93.9 million in the first six months of 2012, including a payment to the IRS for the 2011 ESOP settlement of $59.1 million in the first quarter of 2012, to a cash source of $202.1 million from a cash source of $108.2 million in 2011. In the twelve month period from July 1, 2011 through June 30, 2012, the Company generated net operating cash of $829.8 million, including two payments to the IRS for the 2011 ESOP settlement totaling $119.1 million.

Consolidated net sales increased 9.3 percent in the second quarter to $2.573 billion from $2.355 billion in the second quarter of 2011, and increased 11.9 percent in the first six months of 2012 to $4.709 billion from $4.210 billion in the first six months of 2011 due primarily to higher paint sales volume and selling price increases. Consolidated gross profit as a percent of consolidated net sales increased in the second quarter to 44.7 percent from 43.4 percent in 2011 and increased to 43.8 percent from 43.2 percent in the first six months due primarily to selling price increases and increased paint volume. Selling, general and administrative expenses (SG&A) decreased as a percent of consolidated net sales to 31.5 percent from 32.1 percent in the second quarter of 2011 and decreased to 33.3 percent from 34.4 percent in the first six months due primarily to increased sales and good expense control across all Reportable Segments. Interest expense decreased $1.5 million in the second quarter and decreased $1.9 million in the first six months of 2012. The effective income tax rate for second quarter of 2012 was 30.5 percent compared to 30.3 percent in 2011, and the rate for the first six months of 2012 was 30.2 percent compared to 29.7 percent in 2011. Diluted net income per common share increased to $2.17 per share for the second quarter of 2012 from $1.66 per share a year ago and increased to $3.13 per share from $2.29 per share in the first six months.

 

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation and fair presentation of the consolidated unaudited interim financial statements and accompanying notes included in this report are the responsibility of management. The financial statements and footnotes have been prepared in accordance with U.S. generally accepted accounting principles for interim financial statements and contain certain amounts that were based upon management’s best estimates, judgments and assumptions that were believed to be reasonable under the circumstances. Management considered the impact of the uncertain economic environment and utilized certain outside sources of economic information when developing the basis for their estimates and assumptions. The impact of the global economic conditions on the estimates and assumptions used by management was believed to be reasonable under the circumstances. Management used assumptions based on historical results, considering the current economic trends, and other assumptions to form the basis for determining appropriate carrying values of assets and liabilities that were not readily available from other sources. Actual results could differ from those estimates. Also, materially different amounts may result under materially different conditions, materially different economic trends or from using materially different assumptions. However, management believes that any materially different amounts resulting from materially different conditions or material changes in facts or circumstances are unlikely to significantly impact the current valuation of assets and liabilities that were not readily available from other sources.

A comprehensive discussion of the Company’s critical accounting policies and 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 in Note 1, on pages 48 through 52, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. There have been no significant changes in critical accounting policies, management estimates or accounting policies followed since the year ended December 31, 2011.

FINANCIAL CONDITION, LIQUIDITY AND CASH FLOW

Overview

The Company’s financial condition, liquidity and cash flow were strong in the first six months of 2012 primarily due to improving domestic architectural paint demand. Net working capital decreased $156.2 million at June 30, 2012 compared to the end of the second quarter of 2011 due to an increase in current liabilities and a slight decrease in current assets. Accounts receivable increased $54.0 million while inventories decreased $35.5 million and all other current assets decreased $32.7 million. Accounts payable increased $82.8 million while all other current liabilities increased $59.2 million from June 30, 2011. Net working capital increases were impacted primarily by increased sales and higher raw material costs. The Company has been able to arrange sufficient short-term borrowing capacity at reasonable rates even as credit markets remain tight, and the Company has sufficient total available borrowing capacity to fund its current operating needs. In the first six months of 2012, short-term borrowings increased $258.7 million and accounts payable increased $137.0 million from December 31, 2011 primarily due to

 

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the seasonal increase in need for working capital and higher raw material costs, and all other current liabilities decreased $26.5 million primarily due to timing of tax payments. Accounts receivable and inventories increased $352.6 million from December 31, 2011 to June 30, 2012 when normal seasonal trends typically require significant growth in these categories. The Company’s current ratio was 1.04 at June 30, 2012 compared to 1.10 at June 30, 2011 and 1.05 at December 31, 2011. Total debt at June 30, 2012 increased $19.9 million to $1.245 billion from $1.225 billion at June 30, 2011 and increased as a percentage of total capitalization to 44.7 percent from 41.2 percent at the end of the second quarter last year. Total debt increased $251.5 million and increased from 39.6 percent of total capitalization at December 31, 2011. At June 30, 2012, the Company had remaining borrowing ability of $1.643 billion. Net operating cash increased $93.9 million in the first six months of 2012 to a cash source of $202.1 million from a cash source of $108.2 million in 2011 primarily due to an increase in net income of $80.6 million and improved working capital management partially offset by a payment to the IRS for the 2011 ESOP settlement of $59.1 million in the first quarter of 2012. Net investing cash usage increased $4.7 million in the first six months of 2012 to a usage of $90.1 million from a usage of $85.4 million in 2011 primarily due to increased cash used to acquire businesses partially offset by changes in other investments. Net financing cash usage increased $97.3 million to a usage of $95.9 million in the first six months of 2012 from a source of $1.4 million in 2011 primarily due to increases in treasury stock purchases of $229.9 million in the first six months of 2012 partially offset by net increases in short-term borrowings of $91.7 million. In the twelve month period from July 1, 2011 through June 30, 2012, the Company generated net operating cash of $829.8 million, including two payments to the IRS for the 2011 ESOP settlement totaling $119.1 million, used $282.5 million in investing activities, and used $572.6 million in financing activities. In that same period, the Company invested $154.8 million in capital additions and improvements, invested $85.8 million in acquisitions, received net proceeds from total debt of $31.8 million, purchased $597.3 million in treasury stock and paid $156.1 million in cash dividends to its shareholders of common stock.

Net Working Capital, Debt and Other Long-Term Assets and Liabilities

Cash and cash equivalents increased $13.9 million during the first six months of 2012. Cash requirements for increased sales and normal seasonal increases in working capital, a payment to the IRS for the 2011 ESOP settlement of $59.1 million in the first quarter of 2012, capital expenditures of $70.0 million, net payments made on long-term debt of $10.3 million, payments of cash dividends of $80.4 million and treasury stock purchases of $362.6 million were funded primarily by net cash from operations and net increase in short-term borrowings of $258.7 million. At June 30, 2012, the Company’s current ratio was 1.04 compared to 1.05 at December 31, 2011 and 1.10 a year ago. The decrease from a year ago was due primarily to the year-over-year increase in accounts payable and short-term borrowings more than offsetting increases in accounts receivable.

Goodwill and intangible assets increased $23.3 million from December 31, 2011 and increased $3.7 million from June 30, 2011. The net increase during the first six months of 2012 was due primarily to acquisitions of $34.5 million, capitalization of software of $1.4 million and foreign currency translation of $0.4 million partially offset by amortization of $13.0 million. The net increase over the twelve-month period from June 30, 2011 resulted from acquisitions of $58.8 million and capitalization of software of $4.8 million partially offset by amortization of $29.5

 

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million, foreign currency translation of $24.9 million and impairments of $5.5 million. See Note 5, on pages 53 to 54, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 for more information concerning goodwill and intangible assets.

Deferred pension assets increased $4.2 million during the first six months of 2012 and decreased $20.5 million from June 30, 2011. The decrease in the last twelve months was due primarily to decreases in the fair market value of equity securities held by the Company’s defined benefit pension plans. See Note 7, on pages 58 to 64, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 for more information concerning the Company’s benefit plan assets.

Other assets at June 30, 2012 increased $25.3 million in the first six months of 2012 and $43.5 million from a year ago due primarily to increased investments in affordable housing and historic renovation real estate properties along with increases in various other investments during both time periods.

Net property, plant and equipment decreased $18.1 million in the first six months of 2012 and decreased $19.9 million in the twelve months since June 30, 2011. The decrease in the first six months was primarily due to depreciation expense of $75.5 million, sale or disposition of fixed assets of $8.0 million and changes in currency translation rates of $9.6 million partially offset by capital expenditures of $70.0 million and acquisitions of $5.1 million. Since June 30, 2011, depreciation expense of $151.9 million, dispositions or sale of assets with remaining net book value of $13.9 million and changes in currency translation rates of $30.0 million were partially offset by capital expenditures of $154.8 million and acquisitions of $21.0 million. Capital expenditures during the first six months of 2012 primarily represented expenditures associated with improvements and normal equipment replacement in manufacturing and distribution facilities in the Consumer Group and normal equipment replacement in the Paint Stores and Global Finishes Groups.

Short-term borrowings related to the Company’s domestic commercial paper program outstanding were $543.9 million at an average rate of 0.27 percent at June 30, 2012. There were no borrowings under certain other short-term revolving and letter of credit agreements at June 30, 2012. Short-term borrowings outstanding under various foreign programs at June 30, 2012 were $61.3 million with a weighted average interest rate of 3.1 percent. The Company had unused capacity of $506.1 million at June 30, 2012 under the commercial paper program that is backed by the Company’s revolving credit agreement. On January 30, 2012, the Company entered into a five-year credit agreement, which was amended on February 6, 2012, February 13, 2012 and February 27, 2012. This credit agreement gives the Company the right to borrow and to obtain the issuance, renewal, extension and increase of a letter of credit of up to an aggregate availability of $500 million. On April 23, 2012, the Company entered into a new five-year credit agreement, which was amended on April 25, 2012 and May 7, 2012. This credit agreement gives the Company the right to borrow and to obtain the issuance, renewal, extension and increase of a letter of credit up to an aggregate availability of $250 million. On June 29, 2012, Sherwin-Williams Canada, Inc., a wholly owned subsidiary of the Company, entered into a CAD 75 million five-year revolving credit facility. The credit facility replaced the existing three-year credit facility, and will be used for general corporate purposes, including refinancing

 

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indebtedness and for acquisitions. See Note 8, on pages 64 through 65, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 for more information concerning the Company’s debt.

Long-term liabilities for postretirement benefits other than pensions did not change significantly from December 31, 2011 and increased $2.0 million from June 30, 2011. The slight increase in the liability was due to the increase in the actuarially determined postretirement benefit obligation resulting from changes in actuarial assumptions and unfavorable claims experience. See Note 7, on pages 58 to 64, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 for more information concerning the Company’s benefit plan obligations.

Other long-term liabilities at June 30, 2012 increased $8.0 million in the first six months of 2012. The increase of $64.8 million from a year ago was due primarily to an increase in non-current deferred tax 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 2012. 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 2012.

The Company is involved with environmental investigation and remediation activities at some of its currently and formerly owned sites (including sites which were previously owned and/or operated by businesses acquired by the Company). In addition, the Company, together with other parties, has been designated a potentially responsible party under federal and state environmental protection laws for the investigation and remediation of environmental contamination and hazardous waste at a number of third-party sites, primarily Superfund sites. The Company may be similarly designated with respect to additional third-party sites in the future.

The Company accrues for estimated costs of investigation and remediation activities at its currently and formerly owned sites and third party sites for which commitments or clean-up plans have been developed and when such costs can be reasonably estimated based on industry standards and professional judgment. These estimated costs are based on currently available facts

 

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regarding each site. The Company accrues a specific estimated amount when such an amount and a time frame in which the costs will be incurred can be reasonably determined. If the best estimate of costs can only be identified as a range and no specific amount within that range can be determined more likely than any other amount within the range, the minimum of the range is accrued by the Company in accordance with applicable accounting rules and interpretations. The Company continuously assesses its potential liability for investigation and remediation activities and adjusts its environmental-related accruals as information becomes available upon which more accurate costs can be reasonably estimated. At June 30, 2012 and 2011, the Company had accruals for environmental-related activities of $126.8 million and $147.5 million, respectively.

Due to the uncertainties of the scope and magnitude of contamination and the degree of investigation and remediation activities that may be necessary at certain currently or formerly owned sites and third party sites, it is reasonably likely that further extensive investigations may be required and that extensive remedial actions may be necessary not only on such sites but on adjacent properties. Depending on the extent of the additional investigations and remedial actions necessary, the Company’s ultimate liability may result in costs that are significantly higher than currently accrued. If the Company’s future loss contingency is ultimately determined to be at the maximum of the range of possible outcomes for every site for which costs can be reasonably estimated, the Company’s aggregate accruals for environmental-related activities would be $97.7 million higher than the accruals at June 30, 2012.

Four of the Company’s currently and formerly owned sites accounted for the majority of the accruals for environmental-related activities and the unaccrued maximum of the estimated range of possible outcomes at June 30, 2012. At June 30, 2012, $84.6 million, or 66.7 percent, related directly to these four sites. Of the aggregate unaccrued exposure at June 30, 2012, $66.2 million, or 67.8 percent, related to the four sites. While environmental investigations and remedial actions are in different stages at these sites, additional investigations, remedial actions and/or monitoring will likely be required at each site. A comprehensive description of the four currently and formerly owned sites that account for the majority of the accruals for environmental-related activities is included 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, 2011. There have been no significant changes in the investigative or remedial status of the four sites since December 31, 2011.

Management cannot presently estimate the ultimate potential loss contingencies related to these four sites or other less significant sites until such time as a substantial portion of the investigative activities at each site is completed and remedial action plans are developed.

In accordance with the Asset Retirement Obligations Topic of the ASC, the Company has identified certain conditional asset retirement obligations at various current manufacturing, distribution and store facilities. These obligations relate primarily to asbestos abatement and closures of hazardous waste containment devices. Using investigative, remediation and disposal methods that are currently available to the Company, the estimated cost of these obligations is not significant.

 

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In the event any future loss contingency significantly exceeds the current amount accrued, the recording of the ultimate liability may result in a material impact on net income for the annual or interim period during which the additional costs are accrued. Management does not believe that any potential liability ultimately attributed to the Company for its environmental-related matters or conditional asset retirement obligations will have a material adverse effect on the Company’s financial condition, liquidity, or cash flow due to the extended period of time during which environmental investigation and remediation takes place. An estimate of the potential impact on the Company’s operations cannot be made due to the aforementioned uncertainties.

Management expects these contingent environmental-related liabilities and conditional asset retirement obligations to be resolved over an extended period of time. Management is unable to provide a more specific time frame due to the indefinite amount of time to conduct investigation activities at any site, the indefinite amount of time to obtain governmental agency approval, as necessary, with respect to investigation and remediation activities, and the indefinite amount of time necessary to conduct remediation activities.

Contractual Obligations, Commercial Commitments and Warranties

Short-term borrowings increased $258.7 million to $605.0 million at June 30, 2012 from $346.3 million at December 31, 2011. Total long-term debt decreased $7.2 million to $639.8 million at June 30, 2012 from $647.1 million at December 31, 2011 and $653.8 million at June 30, 2011. See the Financial Condition, Liquidity and Cash Flow section of this report for more information. There have been no other significant changes to the Company’s contractual obligations and commercial commitments in the second quarter or the first six months of 2012 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, 2011.

Changes to the Company’s accrual for product warranty claims in the first six months of 2012 are disclosed in Note 5.

Contingent Liabilities

Life Shield Engineered Systems, LLC (Life Shield) is a wholly-owned subsidiary of the Company. Life Shield develops and manufactures blast and fragment mitigating systems. The blast and fragment mitigating systems create a potentially higher level of product liability for the Company (as an owner of and supplier to Life Shield) than is normally associated with coatings and related products currently manufactured, distributed and sold by the Company.

Certain of Life Shield’s technology has been designated as Qualified Anti-Terrorism Technology and granted a Designation under the Support Anti-Terrorism by Fostering Effective Technologies Act of 2002 (SAFETY Act) and the regulations adopted pursuant to the SAFETY Act. Under the SAFETY Act, the potentially higher level of possible product liability for Life Shield relating to the technology granted the Designation is limited to $6.0 million per occurrence in the event any such liability arises from an Act of Terrorism (as defined in the SAFETY Act). The limitation of liability provided for under the SAFETY Act does not apply to any technology not granted a designation or certification as a Qualified Anti-Terrorism Technology, nor in the event that any such liability arises from an act or event other than an Act of Terrorism. Life Shield maintains insurance for liabilities up to the $6.0 million per occurrence limitation caused by failure of its products in the event of an Act of Terrorism.

 

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Management of the Company has reviewed the potential increased liabilities associated with Life Shield’s systems and determined that potential liabilities arising from an Act of Terrorism that could ultimately affect the Company will be appropriately insured or limited by current regulations. However, due to the uncertainties involved in the future development, usage and application of Life Shield’s systems, the number or nature of possible future claims and legal proceedings, or the effect that any change in legislation and/or administrative regulations may have on the limitations of potential liabilities, management cannot reasonably determine the scope or amount of any potential costs and liabilities for the Company related to Life Shield or to Life Shield’s systems. Any potential liability for the Company that may result from Life Shield or Life Shield’s systems cannot reasonably be estimated. However, based upon, among other things, the limitation of liability under the SAFETY Act in the event of an Act of Terrorism, management does not currently believe that the costs or potential liability ultimately determined to be attributable to the Company through its ownership of Life Shield, or as a supplier to Life Shield arising from the use of Life Shield’s systems will have a material adverse effect on the Company’s results of operations, liquidity or financial conditions.

Litigation

In the course of its business, the Company is subject to a variety of claims and lawsuits, including, but not limited to, litigation relating to product liability and warranty, personal injury, environmental, intellectual property, commercial, contractual and antitrust claims that are inherently subject to many uncertainties regarding the possibility of a loss to the Company. These uncertainties will ultimately be resolved when one or more future events occur or fail to occur confirming the incurrence of a liability or the reduction of a liability. In accordance with the Contingencies Topic of the ASC, the Company accrues for these contingencies by a charge to income when it is both probable that one or more future events will occur confirming the fact of a loss and the amount of the loss can be reasonably estimated. In the event that the Company’s loss contingency is ultimately determined to be significantly higher than currently accrued, the recording of the additional liability may result in a material impact on the Company’s results of operations, liquidity or financial condition for the annual or interim period during which such additional liability is accrued. In those cases where no accrual is recorded because it is not probable that a liability has been incurred and cannot be reasonably estimated, any potential liability ultimately determined to be attributable to the Company may result in a material impact on the Company’s results of operations, liquidity or financial condition for the annual or interim period during which such liability is accrued. In those cases where no accrual is recorded or exposure to loss exists in excess of the amount accrued, the Contingencies Topic of the ASC requires disclosure of the contingency when there is a reasonable possibility that a loss or additional loss may have been incurred.

Lead pigment and lead-based paint litigation. The Company’s past operations included the manufacture and sale of lead pigments and lead-based paints. The Company, along with other companies, is and has been a defendant in a number of legal proceedings, including individual personal injury actions, purported class actions, and actions brought by various counties, cities,

 

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school districts and other government-related entities, arising from the manufacture and sale of lead pigments and lead-based paints. The plaintiffs’ claims have been based upon various legal theories, including negligence, strict liability, breach of warranty, negligent misrepresentations and omissions, fraudulent misrepresentations and omissions, concert of action, civil conspiracy, violations of unfair trade practice and consumer protection laws, enterprise liability, market share liability, public nuisance, unjust enrichment and other theories. The plaintiffs seek various damages and relief, including personal injury and property damage, costs relating to the detection and abatement of lead-based paint from buildings, costs associated with a public education campaign, medical monitoring costs and others. The Company is also a defendant in legal proceedings arising from the manufacture and sale of non-lead-based paints that seek recovery based upon various legal theories, including the failure to adequately warn of potential exposure to lead during surface preparation when using non-lead-based paint on surfaces previously painted with lead-based paint. The Company believes that the litigation brought to date is without merit or subject to meritorious defenses and is vigorously defending such litigation. The Company has not settled any lead pigment or lead-based paint litigation. The Company expects that additional lead pigment and lead-based paint litigation may be filed against the Company in the future asserting similar or different legal theories and seeking similar or different types of damages and relief.

Notwithstanding the Company’s views on the merits, litigation is inherently subject to many uncertainties, and the Company ultimately may not prevail. Adverse court rulings or determinations of liability, among other factors, could affect the lead pigment and lead-based paint litigation against the Company and encourage an increase in the number and nature of future claims and proceedings. In addition, from time to time, various legislation and administrative regulations have been enacted, promulgated or proposed to impose obligations on present and former manufacturers of lead pigments and lead-based paints respecting asserted health concerns associated with such products or to overturn the effect of court decisions in which the Company and other manufacturers have been successful.

Due to the uncertainties involved, management is unable to predict the outcome of the lead pigment and lead-based paint litigation, the number or nature of possible future claims and proceedings, or the effect that any legislation and/or administrative regulations may have on the litigation or against the Company. In addition, management cannot reasonably determine the scope or amount of the potential costs and liabilities related to such litigation, or resulting from any such legislation and regulations. The Company has not accrued any amounts for such litigation. With respect to such litigation, including the public nuisance litigation, the Company does not believe that it is probable that a loss has occurred, and it is not possible to estimate the range of potential losses as there is no prior history of a loss of this nature and there is no substantive information upon which an estimate could be based. In addition, any potential liability that may result from any changes to legislation and regulations cannot reasonably be estimated. In the event any significant liability is determined to be attributable to the Company relating to such litigation, the recording of the liability may result in a material impact on net income for the annual or interim period during which such liability is accrued. Additionally, due to the uncertainties associated with the amount of any such liability and/or the nature of any other remedy which may be imposed in such litigation, any potential liability determined to be attributable to the Company arising out of such litigation may have a material adverse effect on

 

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the Company’s results of operations, liquidity or financial condition. An estimate of the potential impact on the Company’s results of operations, liquidity or financial condition cannot be made due to the aforementioned uncertainties.

Public nuisance claim litigation. The Company and other companies are or were defendants in legal proceedings seeking recovery based on public nuisance liability theories, among other theories, brought by the State of Rhode Island, the City of St. Louis, Missouri, various cities and counties in the State of New Jersey, various cities in the State of Ohio and the State of Ohio, the City of Chicago, Illinois, the City of Milwaukee, Wisconsin and the County of Santa Clara, California and other public entities in the State of California. Except for the Santa Clara County, California proceeding, all of these legal proceedings have been concluded in favor of the Company and other defendants at various stages in the proceedings.

The proceedings initiated by the State of Rhode Island included two jury trials. At the conclusion of the second trial, the jury returned a verdict finding that (i) the cumulative presence of lead pigment in paints and coatings on buildings in the State of Rhode Island constitutes a public nuisance, (ii) the Company, along with two other defendants, caused or substantially contributed to the creation of the public nuisance, and (iii) the Company and two other defendants should be ordered to abate the public nuisance. The Company and two other defendants appealed and, on July 1, 2008, the Rhode Island Supreme Court, among other determinations, reversed the judgment of abatement with respect to the Company and two other defendants. The Rhode Island Supreme Court’s decision reversed the public nuisance liability judgment against the Company on the basis that the complaint failed to state a public nuisance claim as a matter of law.

The Santa Clara County, California proceeding was initiated in March 2000 in the Superior Court of the State of California, County of Santa Clara. In the original complaint, the plaintiffs asserted various claims including fraud and concealment, strict product liability/failure to warn, strict product liability/design defect, negligence, negligent breach of a special duty, public nuisance, private nuisance, and violations of California’s Business and Professions Code. A number of the asserted claims were resolved in favor of the defendants through pre-trial proceedings. The named plaintiffs in the Fourth Amended Complaint, filed on March 16, 2011, are the Counties of Santa Clara, Alameda, Los Angeles, Monterey, San Mateo, Solano and Ventura, and the Cities of Oakland, San Diego and San Francisco. The Fourth Amended Complaint asserts a sole claim for public nuisance, alleging that the presence of lead products for use in paint and coatings in, on and around buildings in the plaintiffs’ jurisdictions constitutes a public nuisance. The plaintiffs seek the abatement of the alleged public nuisance that exists within the plaintiffs’ jurisdictions.

Litigation seeking damages from alleged personal injury. The Company and other companies are defendants in a number of legal proceedings seeking monetary damages and other relief from alleged personal injuries. These proceedings include claims by children allegedly injured from ingestion of lead pigment or lead-containing paint, claims for damages allegedly incurred by the children’s parents or guardians, and claims for damages allegedly incurred by professional painting contractors. These proceedings generally seek compensatory and punitive damages, and seek other relief including medical monitoring costs. These proceedings include purported claims by individuals, groups of individuals and class actions.

 

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The plaintiff in Thomas v. Lead Industries Association, et al., initiated an action in state court against the Company, other alleged former lead pigment manufacturers and the Lead Industries Association in September 1999. The claims against the Company and the other defendants include strict liability, negligence, negligent misrepresentation and omissions, fraudulent misrepresentation and omissions, concert of action, civil conspiracy and enterprise liability. Implicit within these claims is the theory of “risk contribution” liability (Wisconsin’s theory which is similar to market share liability) due to the plaintiff’s inability to identify the manufacturer of any product that allegedly injured the plaintiff. The case ultimately proceeded to trial and, on November 5, 2007, the jury returned a defense verdict, finding that the plaintiff had ingested white lead carbonate, but was not brain damaged or injured as a result. The plaintiff appealed and, on December 16, 2010, the Wisconsin Court of Appeals affirmed the final judgment in favor of the Company and other defendants.

Wisconsin is the only jurisdiction to date to apply a theory of liability with respect to alleged personal injury (i.e., risk contribution/market share liability) that does not require the plaintiff to identify the manufacturer of the product that allegedly injured the plaintiff in the lead pigment and lead-based paint litigation. Although the risk contribution liability theory was applied during the Thomas trial, the constitutionality of this theory as applied to the lead pigment cases has not been judicially determined by the Wisconsin state courts. However, in an unrelated action filed in the United States District Court for the Eastern District of Wisconsin, Gibson v. American Cyanamid, et al., on November 15, 2010, the District Court held that Wisconsin’s risk contribution theory as applied in that case violated the defendants’ right to substantive due process and is unconstitutionally retroactive. The District Court’s decision in Gibson v. American Cyanamid, et al., has been appealed by the plaintiff.

Insurance coverage litigation. The Company and its liability insurers, including certain Underwriters at Lloyd’s of London, initiated legal proceedings against each other to primarily determine, among other things, whether the costs and liabilities associated with the abatement of lead pigment are covered under certain insurance policies issued to the Company. The Company’s action, filed on March 3, 2006 in the Common Pleas Court, Cuyahoga County, Ohio, is currently stayed. The liability insurers’ action, which was filed on February 23, 2006 in the Supreme Court of the State of New York, County of New York, has been dismissed. An ultimate loss in the insurance coverage litigation would mean that insurance proceeds could be unavailable under the policies at issue to mitigate any ultimate abatement related costs and liabilities. The Company has not recorded any assets related to these insurance policies or otherwise assumed that proceeds from these insurance policies would be received in estimating any contingent liability accrual. Therefore, an ultimate loss in the insurance coverage litigation without a determination of liability against the Company in the lead pigment or lead-based paint litigation will have no impact on the Company’s results of operation, liquidity or financial condition. As previously stated, however, the Company has not accrued any amounts for the lead pigment or lead-based paint litigation and any significant liability ultimately determined to be attributable to the Company relating to such litigation may result in a material impact on the Company’s results of operations, liquidity or financial condition for the annual or interim period during which such liability is accrued.

 

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Department of Labor (DOL) Leveraged ESOP Investigation. As previously disclosed, the DOL’s investigation of transactions related to the Company’s ESOP (the “Leveraged ESOP Transactions”) remains open. On April 19, 2012, the Employee Benefits Security Administration of the DOL notified the Company, certain current and former directors and the ESOP trustee of potential enforcement claims asserting breaches of fiduciary obligations. The DOL is seeking compensatory and equitable remedies, including monetary damages to the ESOP for alleged losses to the ESOP. The Company believes that the DOL’s claims are subject to meritorious defenses and will vigorously defend any proceedings initiated by the DOL. The Company has not accrued any amounts for such claims.

Shareholders’ Equity

Shareholders’ equity increased $22.3 million to $1.539 billion at June 30, 2012 from $1.517 billion at December 31, 2011 and decreased $207.6 million from $1.747 billion at June 30, 2011. Effective March 31, 2011, the Company retired all of its 125.4 million shares of common stock held in treasury, which resulted in decreases in treasury stock, common stock and retained earnings of $4.357 billion, $0.125 billion and $4.482 billion, respectively. The increase in Shareholders’ equity for the first six months of 2012 resulted primarily from net income of $328.0 million, an increase in Other capital of $131.6 million, resulting primarily from stock option exercises, and a decrease in Cumulative other comprehensive loss of $18.6 million partially offset by purchases of treasury stock of $362.6 million and cash dividends paid on common stock of $80.4 million. Since June 30, 2011, purchases of treasury stock for $597.3 million cash dividends paid on common stock of $156.1 million and an increase in Cumulative other comprehensive loss of $104.1 million in twelve months, due primarily to unfavorable foreign currency translation effects, more than offset net income of $522.5 million and an increase in Other capital of $139.8 million. During the first six months of 2012, the Company purchased 3.30 million shares of its common stock for treasury purposes through open market purchases. The Company purchased 6.40 million shares of its common stock since June 30, 2011 for treasury. 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, 2012 to purchase 17.75 million shares of its common stock. At a meeting held on July 18, 2012, the Board of Directors increased the quarterly cash dividend from $.365 per common share to $.39 per common share. This quarterly dividend, if approved in each of the remaining quarters of 2012, would result in an annual dividend for 2012 of $1.56 per common share or a 37.7 percent payout of 2011 diluted net income per common share.

Cash Flow

Net operating cash increased $93.9 million in the first six months of 2012 to a cash source of $202.1 million from a cash source of $108.2 million in 2011 primarily due to an increase in net income of $80.6 million and improved working capital management partially offset by a payment to the IRS for the 2011 ESOP settlement of $59.1 million in the first quarter of 2012. Net investing cash usage increased $4.7 million in the first six months of 2012 to a usage of $90.1 million from a usage of $85.4 million in 2011 primarily due to increased cash used to acquire businesses partially offset by changes in other investments. Net financing cash usage increased $97.3 million to a usage of $95.9 million in the first six months of 2012 from a source of $1.4 million in 2011 primarily due to increases in treasury stock purchases of $229.9 million

 

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in the first six months of 2012 partially offset by net increases in short-term borrowings of $91.7 million. In the twelve month period from July 1, 2011 through June 30, 2012, the Company generated net operating cash of $829.8 million, including two payments to the IRS for the 2011 ESOP settlement totaling $119.1 million, used $282.5 million in investing activities, and used $572.6 million in financing activities. In that same period, the Company invested $154.8 million in capital additions and improvements, invested $85.8 million in acquisitions, received net proceeds from total debt $31.8 million, purchased $597.3 million in treasury stock and paid $156.1 million in cash dividends to its shareholders of common stock.

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. In the first six months of 2012, the Company entered into forward currency exchange contracts with maturity dates of less than twelve months to hedge against value changes in foreign currency. 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 the Company’s leverage ratio is not to exceed 3.00 to 1.00. In connection with the new credit facility entered into on July 8, 2011, the leverage ratio for that facility was increased to 3.25 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) for the 12-month period ended on the same date. Refer to the “Results of Operations” caption below for a reconciliation of EBITDA to Net income. At June 30, 2012, the Company was in compliance with the covenant. 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 8, on page 64 and 65, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 for more information concerning the Company’s debt and related covenant.

RESULTS OF OPERATIONS

Shown below are net sales and income before taxes by segment for the second quarter and first six months:

 

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(thousands of dollars)    Three Months Ended
June 30,
           Six Months Ended
June 30,
        
     2012      2011      Change     2012      2011      Change  

Net Sales:

                

Paint Stores Group

   $ 1,488,109      $ 1,299,047        14.6   $ 2,611,187      $ 2,228,314        17.2

Consumer Group

     397,749        375,634        5.9     718,122        670,564        7.1

Global Finishes Group

     498,693        482,695        3.3     981,768        918,012        6.9

Latin America Coatings Group

     187,281        196,176        -4.5     395,874        391,025        1.2

Administrative

     1,190        1,199        -0.8     2,415        2,422        -0.3
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 2,573,022      $ 2,354,751        9.3   $ 4,709,366      $ 4,210,337        11.9
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

     Three Months Ended
June 30,
          Six Months Ended
June  30,
       
     2012     2011     Change     2012     2011     Change  

Income Before Income Taxes:

            

Paint Stores Group

   $ 266,982     $ 206,631       29.2   $ 379,694     $ 275,488       37.8

Consumer Group

     80,757       61,371       31.6     136,063       102,462       32.8

Global Finishes Group

     48,032       30,249       58.8     76,669       49,687       54.3

Latin America Coatings Group

     9,281       15,821       -41.3     29,168       33,193       -12.1

Administrative

     (77,249     (57,056     -35.4     (151,476     (109,101     38.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 327,803     $ 257,016       27.5   $ 470,118     $ 351,729       33.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated net sales increased in the second quarter and first six months of 2012 due primarily to higher paint sales volume and selling price increases.

Net sales of all consolidated foreign subsidiaries were down 3.0 percent to $491.9 million in the quarter and up 1.7 percent to $993.8 million in the first six months versus $507.1 million and $977.1 million in the same periods last year. The decrease in net sales for all consolidated foreign subsidiaries in the quarter was due primarily to a 10.8 percent negative impact of foreign currency translation rate changes partially offset by acquisitions, which increased net sales 4.6 percent in the quarter, and selling price increases. The increase in the first six months was due primarily to higher paint sales volume, selling price increases and acquisitions, which increased net sales 4.1 percent in the first six months, partially offset by a 7.8 percent negative impact of foreign currency translation rate changes in the first six months. Net sales of all operations other than consolidated foreign subsidiaries were up 12.6 percent to $2.081 billion in the quarter and up 14.9 percent to $3.716 billion in the first six months as compared to $1.848 billion and $3.233 billion in the same periods last year.

Net sales in the Paint Stores Group increased due primarily to higher paint sales volume and selling price increases. Net sales from stores open for more than twelve calendar months increased 13.9 percent in the quarter and increased 16.6 percent in the first six months compared to last year’s comparable periods. Total paint sales volume percentage increases were in the high single digits for the quarter and first six months as compared to last year’s comparable periods. Sales of non-paint products increased by 9.4 percent over last year’s second quarter and increased by 12.4 percent over last year’s first six months. A discussion of changes in volume

 

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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 Group increased in the second quarter and first six months due primarily to selling price increases. Net sales in the Global Finishes Group stated in U.S. dollars increased in the second quarter and first six months primarily due to selling price increases, acquisitions and higher paint sales volume partially offset by unfavorable currency translation rate changes. Acquisitions increased sales by 3.7 percent and 3.8 percent for the second quarter and the first six months, respectively. Currency translation rate changes decreased sales 5.4 percent in the quarter and 3.9 percent in the first six months. Net sales in the Latin America Coatings Group stated in US dollars decreased in the second quarter, which can primarily be attributed to unfavorable currency translation rate changes partially offset by selling price increases and higher paint sales volume. Net sales in the Latin America Coatings Group stated in US dollars increased in the first six months primarily due to selling price increases and higher paint sales volume partially offset by unfavorable currency translation rate changes. Currency translation rate changes decreased net sales by 14.5 percent in the quarter and 10.1 percent in the first six months. Net sales in the Administrative segment, which primarily consist of external leasing revenue of excess headquarters space and leasing of facilities no longer used by the Company in its primary business, was essentially flat in the second quarter and first six months.

Consolidated gross profit increased $127.8 million in the second quarter and increased $240.3 million in the first six months of 2012 compared to the same periods in 2011. As a percent of sales, consolidated gross profit increased to 44.7 percent in the quarter from 43.4 percent in the second quarter of 2011 and improved to 43.8 percent in the first six months of 2012 from 43.2 percent last year. The percent to sales and dollar increases for both periods were primarily due to increased paint sales volume and selling price increases partially offset by higher raw material costs.

The Paint Stores Group’s gross profit was higher than last year by $100.3 million in the second quarter and was higher than last year by $180.2 in the first six months due to increased paint sales volume and higher selling prices partially offset by increased raw material costs. The Paint Stores Group’s gross profit margins were higher in the quarter and were lower in the first six months compared to the same periods last year. The Consumer Group’s gross profit increased by $27.5 million in the quarter and increased by $43.1 million in the first six months due primarily to selling price increases partially offset by increased raw material costs. The Consumer Group’s gross profit margins increased as a percent of sales for the second quarter and the first six months compared to the same periods last year primarily due to selling price increases partially offset by increased raw material costs. The Global Finishes Group’s gross profit increased $11.3 million in the second quarter and increased $21.6 million in the first six months compared to the same periods last year, when stated in U.S. dollars, due primarily to selling price increases, acquisitions and higher paint sales volume partially offset by increased raw material costs and unfavorable currency translation rate changes. The Global Finishes Group’s gross profit margins were up as a percent of sales in the quarter, due to selling price increases and higher sales volume partially offset by increased raw material costs, and flat in the first six months compared to last year. The Latin America Coatings Group’s gross profit decreased by $4.5 million in the second quarter and its gross profit decreased by $1.0 million in the first six months from the same periods in the prior year, when stated in U.S. dollars, primarily due to unfavorable currency

 

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translation rate changes. The Latin America Coatings Group’s gross profit margins were down as a percent of sales for the second quarter and the first six months as compared to the same periods last year primarily due to unfavorable currency translation rate changes and increased raw material costs partially offset by selling price increases and higher paint sales volume. The Administrative segment’s gross profit decreased by an insignificant amount in the second quarter and in the first six months compared to the same periods last year.

Selling, general and administrative expenses (SG&A) increased $54.7 million in the second quarter and increased $121.2 million in the first six months of 2012 versus last year due primarily to increased expenses to support higher sales levels and net new store openings. As a percent of sales, consolidated SG&A decreased to 31.5 percent in the quarter and decreased to 33.3 percent in the first six months from 32.1 percent in the second quarter and 34.4 percent in the first six months of 2011 due to higher sales.

The Paint Stores Group’s SG&A increased $40.5 million in the second quarter and increased $77.0 million in the first six months due primarily to net new store openings and general comparable store expenses to support higher sales levels. The Consumer Group’s SG&A was up $7.8 million in the quarter and $8.6 million in the first six months of 2012 compared to the same periods last year. The Global Finishes Group’s SG&A decreased $2.0 million in the quarter and increased $5.1 million in the first six months. The Latin America Coatings Group’s SG&A decreased $1.1 million in the second quarter and increased $1.4 million in the first six months. The Administrative segment’s SG&A increased by $9.4 million in the second quarter and increased by $29.1 million in the first six months due primarily to an increase in incentive compensation expense, including stock-based compensation, and information systems costs to integrate the previous acquisitions.

Other general expense—net increased $3.8 million in the second quarter and increased by $7.6 million in the first six months. The increase in the quarter was primarily due to increased provisions for environmental expenses in the Administrative segment. The increase in the first six months was primarily due to increased provisions for environmental expenses partially offset by decreased gain on the sale of assets.

Other income—net was flat in the second quarter and increased $5.1 million in the first six months primarily due to increased foreign currency gains primarily impacting the Global Finishes and Latin America Coatings Groups.

Consolidated income before income taxes increased $70.8 million in the second quarter and increased $118.4 million in the first six months of 2012 due to higher segment profits in Paint Stores, Consumer and Global Finishes Groups partially offset by decreased profits in Latin America Coatings Group and increased expenses in the Administrative segment.

The effective income tax rate of 30.5 percent for the second quarter of 2012 was higher than the 30.3 percent effective income tax rate for the second quarter of 2011 due primarily to the timing of discrete items. The effective income tax rate of 30.2 percent for the first six months of 2012 was higher than the 29.7 percent effective income tax rate for the first six months of 2011 due primarily to the timing of discrete items.

 

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Net income for the quarter increased $48.7 million to $227.8 million from $179.1 million in the second quarter of 2011 and increased $80.6 million to $328.0 million from $247.4 million in the first six months of 2011. Diluted net income per common share increased 30.7 percent from $1.66 per share in the second quarter of 2011 to $2.17 per share in the second quarter of 2012. Diluted net income per common share increased 36.7 percent from $2.29 in the first six months of 2011 to $3.13 in the first six months of 2012.

Management considers a measurement that is not in accordance with U.S. generally accepted accounting principles a useful measurement of the operational profitability of the Company. Some investment professionals also utilize such a measurement as an indicator of the value of profits and cash that are generated strictly from operating activities, putting aside working capital and certain other balance sheet changes. For this measurement, management increases net income for significant non-operating and non-cash expense items to arrive at an amount known as “Earnings Before Interest, Taxes, Depreciation and Amortization” (EBITDA). The reader is cautioned that the following value for EBITDA should not be compared to other entities unknowingly. EBITDA should not be considered an alternative to net income or cash flows from operating activities as an indicator of operating performance or as a measure of liquidity. The reader should refer to the determination of net income and cash flows from operating activities in accordance with U. S. generally accepted accounting principles disclosed in the Statements of Consolidated Income and Statements of Consolidated Cash Flows. EBITDA as used by management is calculated as follows:

 

     Three Months
Ended June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  

(thousands of dollars)

           

Net income

   $ 227,813      $ 179,115      $ 328,029      $ 247,431  

Interest expense

     10,230        11,747        20,567        22,422  

Income taxes

     99,990        77,901        142,089        104,298  

Depreciation

     37,623        37,475        75,507        74,807  

Amortization

     6,364        6,733        12,963        13,127  
  

 

 

    

 

 

    

 

 

    

 

 

 

EBITDA

   $ 382,020      $ 312,971      $ 579,155      $ 462,085  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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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 Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are based upon management’s current expectations, estimates, assumptions and beliefs concerning future events and conditions and may discuss, among other things, anticipated future performance (including sales and earnings), expected growth, future business plans and the costs and potential liability for environmental-related matters and the lead pigment and lead-based paint litigation. Any statement that is not historical in nature is a forward-looking statement and may be identified by the use of words and phrases such as “expects,” “anticipates,” “believes,” “will,” “will likely result,” “will continue,” “plans to” and similar expressions.

Readers are cautioned not to place undue reliance on any forward-looking statements. Forward-looking statements are necessarily subject to risks, uncertainties and other factors, many of which are outside the control of the Company, that could cause actual results to differ materially from such statements and from the Company’s historical results and experience. These risks, uncertainties and other factors include such things as: (a) the duration and severity of the current negative global economic and financial conditions; (b) general business conditions, strengths of retail and manufacturing economies and the growth in the coatings industry; (c) competitive factors, including pricing pressures and product innovation and quality; (d) changes in raw material and energy supplies and pricing; (e) changes in the Company’s relationships with customers and suppliers; (f) the Company’s ability to attain cost savings from productivity initiatives; (g) the Company’s ability to successfully integrate past and future acquisitions into its existing operations, including the recent acquisitions of Becker Acroma Industrial Wood Coatings, Sayerlack Industrial Wood Coatings, Pinturas Condor, Leighs Paints and Geocel, as well as the performance of the businesses acquired; (h) risks and uncertainties associated with the Company’s ownership of Life Shield Engineered Systems LLC; (i) changes in general domestic economic conditions such as inflation rates, interest rates, tax rates, unemployment rates, higher labor and healthcare costs, recessions, and changing governmental policies, laws and regulations; (j) risks and uncertainties associated with the Company’s expansion into and its operations in Asia, Europe, Mexico, 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; (k) the achievement of growth in foreign markets, such as Asia, Europe, Mexico and South America; (l) increasingly stringent domestic and foreign governmental regulations including those affecting health, safety and the environment; (m) inherent uncertainties involved in assessing the Company’s potential liability for environmental-related activities; (n) other changes in governmental policies, laws and regulations, including changes in accounting policies and standards and taxation requirements (such as new tax laws and new or revised tax law interpretations); (o) 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; and (p) unusual weather conditions.

 

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Readers are cautioned that it is not possible to predict or identify all of the risks, uncertainties and other factors that may affect future results and that the above list should not be considered to be a complete list. Any forward-looking statement speaks only as of the date on which such statement is made, and the Company undertakes no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

 

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT 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 enters into option and forward currency exchange contracts and commodity swaps to hedge against value changes in foreign currency and commodities. The Company believes it may experience continuing losses from foreign currency translation and commodity price fluctuations. However, the Company does not expect currency translation, transaction, commodity price fluctuations or hedging contract losses to have a material adverse effect on the Company’s financial condition, results of operations or cash flows. There were no material changes in the Company’s exposure to market risk since the disclosure included 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, 2011.

 

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Item 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our Chairman and Chief Executive Officer and our Senior Vice President—Finance and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 and Rule 15d-15 of the Securities Exchange Act of 1934, as amended (“Exchange Act”). Based upon that evaluation, our Chairman and Chief Executive Officer and our Senior Vice President—Finance and Chief Financial Officer concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and accumulated and communicated to our management including our Chairman and Chief Executive Officer and our Senior Vice President—Finance and Chief Financial Officer, to allow timely decisions regarding required disclosure.

There were no changes in our internal control over financial reporting identified in connection with the evaluation that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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Table of Contents

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

For information with respect to certain environmental-related matters and legal proceedings, see the information included under the captions entitled “Environmental-Related Liabilities” and “Litigation” of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Notes 8 and 9 of the “Notes to Condensed Consolidated Financial Statements,” which is incorporated herein by reference.

 

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Table of Contents
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

A summary of the repurchase activity for the Company’s second quarter is as follows:

 

Period

   Total
Number of
Shares
Purchased
     Average
Price
Paid Per
Share
     Number of
Shares
Purchased as
Part of a
Publicly
Announced
Plan
     Number of
Shares That
May Yet Be
Purchased
Under the
Plan
 
           

April 1 - April 30

           

Share repurchase program (1)

     150,000      $ 120.71        150,000        19,100,000  
           

May 1 - May 31

           

Share repurchase program (1)

     1,350,000      $ 121.28        1,350,000        17,750,000  

Employee transactions (2)

     3,653        123.03           NA   

June 1 - June 30

           

Share repurchase program (1)

              17,750,000  
           
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

           

Share repurchase program (1)

     1,500,000      $ 121.22        1,500,000        17,750,000  

Employee transactions (2)

     3,653        123.03           NA   

 

(1)

All shares were purchased through the Company’s publicly announced share repurchase program. On October 20, 2011, the Board of Directors of the Company authorized the Company to purchase an additional 20,000,000 shares of its common stock. The Company had remaining authorization at June 30, 2012 to purchase 17,750,000 shares. There is no expiration date specified for the program. The Company intends to repurchase stock under the program in the future.

(2)

All shares were delivered to satisfy the exercise price and/or tax withholding obligations by employees who exercised stock options or had shares of restricted stock vest.

 

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Table of Contents
Item 5. Other Information.

During the fiscal quarter ended June 30, 2012, the Audit Committee of the Board of Directors of the Company approved permitted non-audit services to be performed by Ernst & Young LLP, the Company’s independent registered public accounting firm. These non-audit services were approved within categories related to domestic advisory tax and tax compliance services and international tax compliance.

 

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Table of Contents
Item 6.  

Exhibits.

4(a)   Five Year Credit Agreement, dated as of April 23, 2012, by and among the Company, Citicorp USA, Inc., as administrative agent and issuing bank, and the Lenders party thereto filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K dated April 23, 2012, and incorporated herein by reference.
4(b)   Agreement for Letter of Credit, dated as of April 23, 2012, by and between the Company and Citibank, N.A. filed as Exhibit 4.2 to the Company’s Current Report on Form 8-K dated April 23, 2012, and incorporated herein by reference.
4(c)   Five Year Credit Agreement Amendment No. 1, dated as of April 25, 2012, by and among the Company, Citicorp USA, Inc., as administrative agent and issuing bank, and the Lenders party thereto filed as Exhibit 4 to the Company’s Current Report on Form 8-K dated April 25, 2012, and incorporated herein by reference.
4(d)   Five Year Credit Agreement Amendment No. 2, dated as of May 7, 2012, by and among the Company, Citicorp USA, Inc., as administrative agent and issuing bank, and the Lenders party thereto filed as Exhibit 4 to the Company’s Current Report on Form 8-K dated May 7, 2012, and incorporated herein by reference.
4(e)   Credit Agreement, dated as of June 29, 2012, among Sherwin-Williams Canada Inc., as borrower, the Company, as guarantor, the Lenders party thereto, KeyBank National Association, as joint lead arranger, sole bookrunner and administrative agent, and PNC Bank, National Association, as joint lead arranger and syndication agent filed as Exhibit 4 to the Company’s Current Report on Form 8-K dated June 29, 2012, and incorporated herein by reference.
10(a)   The Sherwin-Williams Company 2007 Executive Performance Bonus Plan (As Amended and Restated Effective January 1, 2012) filed as Exhibit 10(a) to the Company’s Current Report on Form 8-K dated April 18, 2012, and incorporated herein by reference.
10(b)   Forms of Stock Option Award under The Sherwin-Williams Company 2006 Equity and Performance Incentive Plan (Amended and Restated as of April 21, 2010) (filed herewith).
31(a)   Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer (filed herewith).
31(b)   Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer (filed herewith).
32(a)   Section 1350 Certification of Chief Executive Officer (filed herewith).
32(b)   Section 1350 Certification of Chief Financial Officer (filed herewith).
101.INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema Document
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document

 

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Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    THE SHERWIN-WILLIAMS COMPANY
July 25, 2012   By:  

/s/ A.J. Mistysyn

                A.J. Mistysyn
                Vice President-Corporate Controller
July 25, 2012   By:  

/s/ L.E. Stellato

                L.E. Stellato
                Senior Vice President, General
                Counsel and Secretary

 

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Table of Contents

INDEX TO EXHIBITS

 

Exhibit No.

 

Exhibit Description

4(a)   Five Year Credit Agreement, dated as of April 23, 2012, by and among the Company, Citicorp USA, Inc., as administrative agent and issuing bank, and the Lenders party thereto filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K dated April 23, 2012, and incorporated herein by reference.
4(b)   Agreement for Letter of Credit, dated as of April 23, 2012, by and between the Company and Citibank, N.A. filed as Exhibit 4.2 to the Company’s Current Report on Form 8-K dated April 23, 2012, and incorporated herein by reference.
4(c)   Five Year Credit Agreement Amendment No. 1, dated as of April 25, 2012, by and among the Company, Citicorp USA, Inc., as administrative agent and issuing bank, and the Lenders party thereto filed as Exhibit 4 to the Company’s Current Report on Form 8-K dated April 25, 2012, and incorporated herein by reference.
4(d)   Five Year Credit Agreement Amendment No. 2, dated as of May 7, 2012, by and among the Company, Citicorp USA, Inc., as administrative agent and issuing bank, and the Lenders party thereto filed as Exhibit 4 to the Company’s Current Report on Form 8-K dated May 7, 2012, and incorporated herein by reference.
4(e)   Credit Agreement, dated as of June 29, 2012, among Sherwin-Williams Canada Inc., as borrower, the Company, as guarantor, the Lenders party thereto, KeyBank National Association, as joint lead arranger, sole bookrunner and administrative agent, and PNC Bank, National Association, as joint lead arranger and syndication agent filed as Exhibit 4 to the Company’s Current Report on Form 8-K dated June 29, 2012, and incorporated herein by reference.
10(a)   The Sherwin-Williams Company 2007 Executive Performance Bonus Plan (As Amended and Restated Effective January 1, 2012) filed as Exhibit 10(a) to the Company’s Current Report on Form 8-K dated April 18, 2012, and incorporated herein by reference.
10(b)   Forms of Stock Option Award under The Sherwin-Williams Company 2006 Equity and Performance Incentive Plan (Amended and Restated as of April 21, 2010) (filed herewith).
31(a)   Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer (filed herewith).
31(b)   Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer (filed herewith).
32(a)   Section 1350 Certification of Chief Executive Officer (filed herewith).
32(b)   Section 1350 Certification of Chief Financial Officer (filed herewith).
101.INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema Document
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document

 

49

XNYS:SHW Sherwin-Williams Co Quarterly Report 10-Q Filling

Sherwin-Williams Co XNYS:SHW Stock - Get Quarterly Report SEC Filing of Sherwin-Williams Co XNYS:SHW stocks, including company profile, shares outstanding, strategy, business segments, operations, officers, consolidated financial statements, financial notes and ownership information.

XNYS:SHW Sherwin-Williams Co Quarterly Report 10-Q Filing - 6/30/2012
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