Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(dollars in millions, except as noted and per share data)

Company Background

The Sherwin-Williams Company, founded in 1866, and its consolidated wholly owned subsidiaries (collectively, the Company) are engaged in the development, manufacture, distribution and sale of paint, coatings and related products to professional, industrial, commercial and retail customers primarily in North and South America with additional operations in the Caribbean region and throughout Europe, Asia and Australia.

The Company is structured into three reportable segments – The Americas Group, Consumer Brands Group and Performance Coatings Group (collectively, the Reportable Segments) – and an Administrative segment in the same way it is internally organized for assessing performance and making decisions regarding allocation of resources. See Notes 3 and 21 to the Consolidated Financial Statements in Item 8 for additional information regarding the Valspar acquisition and the Company's Reportable Segments, respectively.

RESULTS OF OPERATIONS

The following discussion and analysis addresses comparisons of material changes in the consolidated financial statements for the years ended December 31, 2019 and 2018. For comparisons of the years ended December 31, 2018 and 2017, see Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2018 filed on February 22, 2019.

	Year Ended December 31,
	2019				2018				% Change
Net Sales:
The Americas Group	$	10,171.9			$	9,625.1			5.7	%
Consumer Brands Group	2,676.8				2,739.1				(2.3	)%
Performance Coatings Group	5,049.2				5,166.4				(2.3	)%
Administrative	2.9				3.9				(25.6	)%
Total	$	17,900.8			$	17,534.5			2.1	%

Consolidated net sales for 2019 increased due primarily to higher paint sales volume in The Americas Group and selling price increases. Currency translation rate changes decreased 2019 consolidated net sales by 1.4%. Net sales of all consolidated foreign subsidiaries decreased 8.7% to $3.679 billion for 2019 versus $4.028 billion for 2018 due primarily to industrial market softness and macroeconomic pressures in China and Australia. Net sales of all operations other than consolidated foreign subsidiaries increased 5.3% to $14.222 billion for 2019 versus $13.507 billion for 2018.

Net sales in The Americas Group increased due primarily to higher paint sales volume across most end market segments and selling price increases. Net sales from stores in U.S. and Canada open for more than twelve calendar months increased 5.3% in the year over last year's comparable period. Currency translation rate changes reduced net sales by 0.9% compared to 2018. During 2019, The Americas Group opened 94 new stores and closed 32 redundant locations for a net increase of 62 stores, increasing the total number of stores in operation at December 31, 2019 to 4,758 in the United States, Canada, Latin America and the Caribbean. The Americas Group’s objective is to expand its store base an average of 2% each year, primarily through internal growth. Sales of products other than paint increased approximately 5.9% over last year. A discussion of changes in volume versus pricing for sales of products other than paint is not pertinent due to the wide assortment of general merchandise sold.

Net sales of the Consumer Brands Group decreased in 2019 primarily due to the divestiture of the Guardsman insurance business and lower sales outside of North America in some end markets, partially offset by selling price increases and higher volume sales to some of the group's retail customers. In 2020, the Consumer Brands Group plans to continue promotions of new and existing products and expand its customer base and product assortment at existing customers.

The Performance Coatings Group’s net sales in 2019 decreased due primarily to softer sales outside of North America and unfavorable currency translation rate changes, partially offset by selling price increases. Currency translation rate changes decreased net sales 2.3% compared to 2018. In 2019, the Performance Coatings Group opened 3 new branches and closed 4 locations decreasing the total from 282 to 281 branches open in the United States, Canada, Mexico, South America, Europe and Asia at

year-end. In 2020, the Performance Coatings Group plans to continue expanding its worldwide presence and improving its customer base.

Net sales in the Administrative segment, which primarily consists of external leasing revenue of excess headquarters space and leasing of facilities no longer used by the Company in its primary business, decreased by an insignificant amount in 2019.

Consolidated gross profit increased $617.5 million in 2019 compared to the same period in 2018. Consolidated gross profit as a percent to consolidated net sales increased to 44.9% in 2019 from 42.3% in 2018. Consolidated gross profit dollars and percent improved as a result of higher paint sales volume in North American stores, selling price increases, improved supply chain efficiencies, moderating raw material costs, and lower acquisition-related amortization expense, partially offset by unfavorable currency translation rate changes. The Americas Group’s gross profit for 2019 increased $384.2 million compared to the same period in 2018. The Americas Group's gross profit dollars and margin improved as a result of higher paint sales volume, selling price increases and moderating raw material costs. The Consumer Brands Group’s gross profit increased $125.5 million in 2019 compared to the same period in 2018. The Consumer Brands Group's gross profit dollars and margin improved due primarily to improved supply chain efficiencies, synergies, moderating raw material costs, and lower acquisition-related depreciation expense, partially offset by lower paint sales volume. The Performance Coatings Group’s gross profit for 2019 increased $51.3 million compared to the same period in 2018. The Performance Coatings Group's gross profit dollars and margin improved due primarily to selling price increases and moderating raw material costs, partially offset by unfavorable currency translation rate changes.

Consolidated SG&A increased by $241.1 million due primarily to increased expenses to support higher sales levels and net new store openings, partially offset by good cost control. SG&A increased as a percent of sales to 29.5% in 2019 from 28.7% in 2018 as a result of softer sales outside of North America. The Americas Group's SG&A increased $196.7 million for the year due primarily to increased spending due to the number of new store openings and general comparable store expenses to support higher sales levels. The Consumer Brands Group’s SG&A increased by $12.7 million for the year primarily due to increased expenses to support new customer programs. The Performance Coatings Group’s SG&A decreased by $0.9 million for the year related to softer sales outside of North America. The Administrative segment’s SG&A increased $32.6 million primarily due to increased investments in information systems and increased compensation, including stock-based compensation.

Other general expense - net decreased $150.0 million in 2019 compared to 2018. The decrease was mainly caused by a decrease of $147.6 million in the Administrative segment, which was primarily attributable to a decrease in expense recognized related to provisions for environmental matters. The expense recognized related to environmental provisions decreased $153.3 million from the prior year. This decrease was the result of the Company reaching a series of agreements in 2018 with the Environmental Protection Agency for remediation plans with cost estimates at one of the Company's four major sites which required significant environmental provisions to be recorded. See Notes 10 and 18 to the Consolidated Financial Statements in Item 8 for additional information concerning environmental matters and Other general expense - net, respectively.

As required by the Goodwill and Other Intangibles Topic of the ASC, management performed an annual impairment test of goodwill and indefinite-lived intangible assets as of October 1, 2019. During the fourth quarter of 2019, the Company recognized non-cash pre-tax impairment charges totaling $122.1 million related to recently acquired trademarks. These charges included impairments totaling $117.0 million in the Performance Coatings Group and $5.1 million in the Consumer Brands Group. In the Performance Coatings Group, $75.6 million related to trademarks in North America directly associated with strategic decisions made to rebrand industrial products to the Sherwin-Williams® brand name, $25.7 million related to trademarks in the Asia Pacific region as a direct result of recent performance which reduced the long-term forecasted net sales and $15.7 million related to other recently acquired trademarks in various regions. The impairment tests in 2018 did not result in any impairment. See Note 6 to the Consolidated Financial Statements in Item 8 for additional information.

Interest expense decreased $17.4 million in 2019 primarily due to lower average debt levels. Interest and net investment income increased $20.7 million in 2019 including an $18.8 million gain recognized during the fourth quarter of 2019 after the Company received a favorable court decision in Brazil related to the recovery of certain indirect taxes previously paid over gross sales. See Note 18 to the Consolidated Financial Statements in Item 8 for additional information on the Brazil indirect tax matter.

During 2019, the Company recognized a $34.7 million benefit from the resolution of the California public nuisance litigation as a result of the final court approved agreement issued during the third quarter of 2019. During the third quarter of 2018, the Company recognized expense of $136.3 million related to the California litigation. See Note 11 to the Consolidated Financial Statements in Item 8 for additional information related to the litigation.

Other expense (income) - net decreased by $3.4 million in 2019 compared to 2018. This change was primarily attributable to a $38.7 million gain related to the recognition of indirect tax credits partially offset by $14.8 million in losses related to the extinguishment of the 2.25% and 2.75% Senior Notes recorded in the Administrative segment and an increase of $13.6 million related to pension plan settlement and other miscellaneous pension expenses. In addition, foreign currency related transaction losses increased $12.2 million in 2019, primarily in The Americas Group and Performance Coatings Group, which were offset by

other miscellaneous sources of income, including dividend and royalty income. There were no other items within Other income or Other expense that were individually significant at December 31, 2019. See Notes 7, 8 and 18 to the Consolidated Financial Statements in Item 8 for additional information related to debt, pensions and Other expense (income) - net, respectively.

	Year Ended December 31,
	2019				2018				% Change
Income Before Income Taxes:
The Americas Group	$	2,056.5			$	1,898.4			8.3	%
Consumer Brands Group	373.2				261.1				42.9	%
Performance Coatings Group	379.1				452.1				(16.1	)%
Administrative	(827.0		)		(1,251.9		)		33.9	%
Total	$	1,981.8			$	1,359.7			45.8	%

Consolidated Income before income taxes in 2019 increased $622.1 million to $1.982 billion, or 11.1% of net sales, compared to $1.360 billion, or 7.8% of net sales in 2018. Income before income taxes increased $158.1 million and $112.1 million in The Americas Group and Consumer Brands Group, and decreased $73.0 million in the Performance Coatings Group when compared to 2018. In 2019, the Administrative segment expenses favorably impacted Income before income taxes by $424.9 million when compared to 2018 primarily due to lower expense recognized related to environmental matters, benefits from the resolution of the California litigation as well as a Brazil indirect tax credit, and decreased acquisition-related expenses.

The effective income tax rate for 2019 was 22.2% compared to 18.5% in 2018. The increase in the effective rate in 2019 was primarily due to a $74.3 million tax credit investment loss recognized during the second quarter of 2019 related to the reversal of net tax benefits recognized in previous tax years from federal renewable energy tax credit funds. This loss negatively impacted the 2019 effective tax rate by 370 basis points. See Note 19 to the Consolidated Financial Statements in Item 8 for additional information.

Diluted net income per share for 2019 increased to $16.49 per share from $11.67 per share for 2018. Diluted net income per share in 2019 included charges for acquisition-related costs of $3.21 per share and other adjustments totaling $1.42 per share. Acquisition-related costs include integration costs (which primarily consist of professional service expenses, salaries and other employee-related expenses dedicated directly to the integration effort, and severance expenses all of which are included in Selling, general and administrative and other expenses and Cost of goods sold) and amortization of intangible assets recognized in the June 2017 acquisition of Valspar (included in Amortization). Total other adjustments included charges of $1.00 per share for non-cash trademark impairment charges, a tax credit investment loss of $0.79 per share and pension plan settlement expense of $0.27 per share, partially offset by a Brazil indirect tax credit of $0.36 per share and a benefit from the resolution of the California litigation of $0.28 per share. Currency translation rate changes decreased diluted net income per share in the year by $0.18 per share. Diluted net income per share in 2018 included charges for acquisition-related costs of $4.15 per share and other adjustments totaling $2.71 per share. Total other adjustments in 2018 included charges of $1.32 per share for environmental expense provisions, $1.09 per share for California litigation expense and $0.30 per share for pension settlement expense.

FINANCIAL CONDITION, LIQUIDITY AND CASH FLOW

Overview

The Company’s financial condition, liquidity and cash flow continued to be strong in 2019 as net operating cash increased to a record $2.321 billion primarily due to improved operating results as consolidated income from continuing operations before income taxes increased to $1.982 billion or 11.1% of net sales. Strong net operating cash provided the funds necessary for the Company to invest $406.2 million in capital expenditures and acquisitions of businesses, reduce total debt by $665.8 million and return $1.200 billion to shareholders in the form of cash dividends and share buybacks during the year.

During 2019, the Company generated EBITDA from continuing operations of $2.906 billion. See the Non-GAAP Financial Measures section in Item 6 for definition and calculation of EBITDA. As of December 31, 2019, the Company had cash and cash equivalents of $161.8 million and total debt outstanding of $8.685 billion. Total debt, net of cash and cash equivalents, was $8.523 billion and was less than 3x the Company’s EBITDA in 2019.

Net Working Capital

Total current assets less Total current liabilities (net working capital) increased $63.0 million to a surplus of $109.8 million at December 31, 2019 from a surplus of $46.8 million at December 31, 2018. The net working capital increase is due to an increase in current assets, partially offset by an increase in current liabilities primarily attributable to the recognition of operating lease

liabilities upon the adoption of the Leases Topic of the ASC (ASU 2016-02) as of January 1, 2019. Accounts receivable increased $70.1 million, inventories increased $74.3 million primarily due to intentional inventory build to better service customers, other current assets increased $136.5 million primarily related to refundable income taxes and the surplus assets transferred from the Company's terminated domestic defined benefit pension plan as discussed in the deferred pension and other assets section below. In addition to the increase in liabilities as a result of adopting ASU 2016-02, Accounts payable increased $76.9 million, partially offset by a decrease in the California litigation accrual of $124.3 million as a result of the terms of the settlement discussed in Note 11 of Item 8 and a decrease in Other accruals of $152.0 million due to timing of payments.

As a result of the net effect of these changes, the Company’s current ratio improved to 1.02 at December 31, 2019 from 1.01 at December 31, 2018. Accounts receivable as a percent of Net sales increased to 11.7% in 2019 from 11.5% in 2018. Accounts receivable days outstanding remained unchanged from 2018 at 61 days in 2019. In 2019, provisions for allowance for doubtful collection of accounts decreased $9.4 million, or 20.5%. Inventories as a percent of Net sales increased to 10.6% in 2019 from 10.4% in 2018 primarily to support future growth. Inventory days outstanding remained unchanged from 2018 at 81 days in 2019. The Company has sufficient total available borrowing capacity to fund its current operating needs.

Goodwill and Intangible Assets

Goodwill, which represents the excess of cost over the fair value of net assets acquired in purchase business combinations, increased $48.1 million in 2019 primarily due to incremental goodwill recognized in 2019 acquisitions of $14.2 million and foreign currency translation rate fluctuations of $33.9 million. Intangible assets decreased $467.1 million in 2019 primarily due to amortization of finite-lived intangible assets of $312.8 million, impairment of indefinite-lived trademarks of $122.1 million, and foreign currency translation rate fluctuations of $70.4 million, partially offset by finite-lived intangible assets recognized in 2019 acquisitions of $34.9 million. See Note 6 to the Consolidated Financial Statements in Item 8 for a description of goodwill, identifiable intangible assets and asset impairments recognized in accordance with the Goodwill and Other Intangibles Topic of the ASC and summaries of the remaining carrying values of goodwill and intangible assets.

Deferred Pension and Other Assets

Deferred pension assets of $43.0 million at December 31, 2019 represent the excess of the fair value of assets over the actuarially determined projected benefit obligations. The decrease in Deferred pension assets during 2019 of $227.7 million from $270.7 million last year was primarily due to the termination of the Company's domestic defined benefit pension plan. See Note 8 to the Consolidated Financial Statements in Item 8 and the Defined Benefit Pension and Other Postretirement Benefit Plans section below.

Other assets decreased $22.6 million to $561.4 million at December 31, 2019 due primarily to a decrease in deferred tax assets.

Property, Plant and Equipment

Net property, plant and equipment increased $58.4 million to $1.835 billion at December 31, 2019 due primarily to capital expenditures of $328.9 million and assets acquired through business combinations of $16.8 million, partially offset by depreciation expense of $262.1 million and sale or disposition of assets with remaining net book value of $37.5 million. The remaining change of $12.3 million is attributable to currency translation and other adjustments. Capital expenditures during 2019 in The Americas Group were primarily attributable to the opening of new paint stores and renovation and improvements in existing stores. In the Consumer Brands Group and the Performance Coatings Group, capital expenditures during 2019 were primarily attributable to improvements and normal equipment replacements in manufacturing and distribution facilities. The Administrative segment incurred capital expenditures primarily for information systems hardware. On February 6, 2020, the Company announced that it is finalizing plans to build and occupy a new global headquarters (new headquarters) in downtown Cleveland, Ohio and a new research and development (R&D) center in the Cleveland suburb of Brecksville. Preliminary plans require the Company to invest a minimum of $600 million of capital expenditures to build both the new headquarters and R&D center. Construction on the new headquarters and R&D center is not expected to commence before mid-2020, with completion in 2023 at the earliest. The plans are contingent upon completion of standard due diligence, approvals of economic development incentives and other matters at the state, county and city levels, and resolution of business and legal matters that accompany such major real estate investment projects. The Company has not made any decisions regarding the disposition of the Company’s current Cleveland-area headquarters and R&D centers, which are all owned by the Company. Due to the remaining contingencies and uncertainties listed above, an estimate of the impact on the financial statements cannot be made at this time. In 2020, the Company expects to spend more than 2019 for capital expenditures. The predominant share of the capital expenditures in 2020 is expected to be for various productivity improvement and maintenance projects at existing manufacturing, distribution and research and development facilities, new store openings, new or upgraded information systems hardware and the new global headquarters and R&D center in Ohio. The Company does not anticipate the need for any specific long-term external financing to support these capital expenditures.

Debt

Total debt including short-term borrowings decreased by $658.5 million to $8.685 billion in 2019. This was primarily attributable to the Company repurchasing $1.071 billion of its 2.25% Senior Notes due May 2020 and $490.0 million of its 2.75% Senior Notes due June 2022, partially offset by the Company issuing $800.0 million of 2.95% Senior Notes due 2029 and $550.0 million of 3.80% Senior Notes due 2049 (collectively the "New Notes") in a public offering during the third quarter of 2019. The net proceeds from the issuance of the New Notes will be used for general corporate purposes. The repurchases of Senior Notes above resulted in a loss of $14.8 million recorded in other expense (income) - net. See Note 18 to the Consolidated Financial Statements in Item 8 for additional information.

On May 9, 2019, the Company entered into a U.S. Dollar to Euro cross currency swap contract with a total notional amount of $400.0 million to hedge the Company's net investment in its European operations. This contract has been designated as a net investment hedge and will mature on January 15, 2022. During the term of the contract, the Company will pay fixed-rate interest in Euros and receive fixed-rate interest in U.S. Dollars, thereby effectively converting a portion of the Company's U.S. Dollar denominated fixed-rate debt to Euro denominated fixed-rate debt. The fair value of the contract is included in Other assets on the balance sheet. The changes in fair value are recognized in the foreign currency translation adjustments component of Accumulated other comprehensive loss. For the year ended December 31, 2019, an unrealized gain of $1.1 million, net of tax, was recognized in Accumulated other comprehensive loss.

On July 19, 2018, the Company and three of its wholly-owned subsidiaries, Sherwin-Williams Canada, Inc., Sherwin-Williams Luxembourg S.à r.l and Sherwin-Williams UK Holding Limited (all together with the Company, the Borrowers), entered into a new five-year $2.000 billion credit agreement. This credit agreement may be used for general corporate purposes, including the financing of working capital requirements, and replaced a credit agreement dated July 16, 2015, as amended, which was terminated. This credit agreement allows the Company to extend the maturity of the facility with two one-year extension options and the Borrowers to increase the aggregate amount of the facility to $2.750 billion, both of which are subject to the discretion of each lender. In addition, the Borrowers may request letters of credit in an amount of up to $250.0 million. On October 8, 2019, the Company amended this agreement to, among other things, extend the maturity date to October 8, 2024. At December 31, 2019 and 2018, there were no short-term borrowings under this credit agreement.

In September 2017, the Company entered into a five-year letter of credit agreement, subsequently amended on multiple dates, with an aggregate availability of $625.0 million at December 31, 2019. On May 6, 2016, the Company entered into a five-year credit agreement, subsequently amended on multiple dates. 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 $875.0 million at December 31, 2019. Both of these credit agreements are being used for general corporate purposes. At December 31, 2019 and 2018, there were no short-term borrowings outstanding under these credit agreements.

Borrowing outstanding under the Company’s domestic commercial paper program as of December 31, 2019 and 2018 were $191.9 million and $291.4 million, respectively, with a weighted average interest rate of 2.1% and 3.0%, respectively. Borrowings outstanding under various other foreign programs were $12.8 million and $37.0 million at December 31, 2019 and 2018, respectively, with a weighted average interest rate of 4.3% and 9.3%, respectively.

See Note 7 to the Consolidated Financial Statements in Item 8 for a detailed description and summary of the Company’s outstanding debt and other available financing programs.

Defined Benefit Pension and Other Postretirement Benefit Plans

In 2018, the Company terminated its domestic defined benefit pension plan for salaried employees (Terminated Plan) and the participants were moved to a qualified replacement plan (Qualified Replacement Plan), which is the Company's domestic defined contribution plan. The Company settled the liabilities of the Terminated Plan through a combination of (i) lump sum payments to eligible participants who elected to receive them and (ii) the purchase of annuity contracts for participants who either did not elect lump sums or were already receiving benefit payments. The lump sum payments were paid in December 2018 and resulted in a settlement charge of $37.6 million in 2018. During the first quarter of 2019, the Company purchased annuity contracts to settle the remaining liabilities of the Terminated Plan. The annuity contract purchase resulted in a settlement charge of $32.4 million in the first quarter of 2019. The remaining surplus of the Terminated Plan is being used, as prescribed in the applicable regulations, to fund Company contributions to the Qualified Replacement Plan. During 2019, the Company transferred the remaining surplus of $242.2 million to a suspense account held within a trust for the Qualified Replacement Plan. This amount included $131.8 million of Company common stock (300,000 shares). The shares are treated as treasury stock in accordance with ASC 715. The Company's domestic defined benefit pension plan for hourly employees continues to operate.

In accordance with the accounting prescribed by the Retirement Benefits Topic of the ASC, the Company’s total liability for unfunded or underfunded defined benefit pension plans increased $12.0 million to $92.7 million primarily due to changes in the

actuarial assumptions. Postretirement benefits other than pensions increased $5.9 million to $280.5 million at December 31, 2019 due primarily to changes in the actuarial assumptions.

The assumed discount rate used to determine the projected benefit obligation for domestic defined benefit pension plans was 3.4% at December 31, 2019 and 3.6% at December 31, 2018 and 2017. The assumed discount rate used to determine the projected benefit obligation for foreign defined benefit pension plans decreased to 2.2% at December 31, 2019 from 3.0% at December 31, 2018. The decrease in the discount rates for both the domestic and foreign defined benefit pension plans was primarily due to lower interest rates. The assumed discount rate used to determine the projected benefit obligation for other postretirement benefit obligations decreased to 3.2% at December 31, 2019 from 4.2% at December 31, 2018 for the same reason. The rate of compensation increases used to determine the projected benefit obligations at December 31, 2019 was 3.0% for the domestic pension plan and 3.1% for foreign pension plans, which was comparable to the rates used in the prior year. In deciding on the rate of compensation increases, management considered historical Company increases as well as expectations for future increases. The expected long-term rate of return on assets remained 5.0% at December 31, 2019 for the domestic pension plan and was slightly lower for most foreign plans. In establishing the expected long-term rate of return on plan assets for 2019, management considered the historical rates of return, the nature of investments and an expectation for future investment strategies. The assumed health care cost trend rates used to determine the net periodic benefit cost of postretirement benefits other than pensions for 2019 were 4.9% and 9.8%, respectively, for medical and prescription drug cost increases, both decreasing gradually to 4.5% in 2026. In developing the assumed health care cost trend rates, management considered industry data, historical Company experience and expectations for future health care costs.

For 2020 Net pension cost for the ongoing domestic pension plan, the Company will use a discount rate of 3.4%, an expected long-term rate of return on assets of 5.0% and a rate of compensation increase of 3.0%. Lower discount rates and expected long-term rates of return on plan assets will be used for most foreign plans. For 2020, Net periodic benefit costs for postretirement benefits other than pensions, the Company will use a discount rate of 3.2%. Net pension cost in 2020 for the ongoing domestic pension plan is expected to be approximately $2.8 million. Net periodic benefit costs for postretirement benefits other than pensions in 2020 is expected to be approximately $10.0 million. See Note 8 to the Consolidated Financial Statements in Item 8 for more information on the Company’s obligations and funded status of its defined benefit pension plans and postretirement benefits other than pensions.

Deferred Income Taxes

Deferred income taxes at December 31, 2019 decreased $161.0 million from the prior year primarily due to the change in deferred taxes as a result of the amortization of intangible assets and settlement of the domestic defined benefit pension plan in the current year. See Note 19 to the Consolidated Financial Statements in Item 8 for more information on deferred taxes.

Other Long-Term Liabilities

Other long-term liabilities increased $187.4 million during 2019 due primarily to the final court approved agreement to resolve the California public nuisance litigation, which impacted the timing and amount of expected payments, and an increase related to the reversal of net tax benefits recognized in previous tax years from federal renewable energy tax credit funds. See Notes 10 and 11, and 19 to the Consolidated Financial Statements in Item 8 for additional information on litigation and income tax matters, respectively.

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 2019. Management does not expect that such capital expenditures, depreciation and other expenses will be material to the Company’s financial condition, liquidity, cash flow or results of operations in 2020. See Note 10 to the Consolidated Financial Statements in Item 8 for further information on environmental-related long-term liabilities.

Contractual Obligations and Commercial Commitments

The Company has certain obligations and commitments to make future payments under contractual obligations and commercial commitments. The following tables summarize such obligations and commitments as of December 31, 2019.

		Payments Due by Period
Contractual Obligations		Total				Less Than 1 Year				1–3 Years				3–5 Years				More Than 5 Years
Long-term debt		$	8,539.2			$	430.1			$	1,435.6			$	500.4			$	6,173.1
Interest on Long-term debt		3,416.8				244.3				462.4				411.7				2,298.4
Operating leases		1,961.1				430.3				692.5				436.4				401.9
Short-term borrowings		204.7				204.7
California litigation accrual		76.7				12.0				24.0				24.0				16.7
Real estate financing transactions		218.4				14.0				28.1				30.2				146.1
Purchase obligations (1)		88.0				88.0
Other contractual obligations (2)		222.1				132.6				50.0				18.0				21.5
Total contractual cash obligations		$	14,727.0			$	1,556.0			$	2,692.6			$	1,420.7			$	9,057.7

(1)	Relate to open purchase orders for raw materials at December 31, 2019.

(2)	Relate primarily to estimated future capital contributions to investments in the U.S. affordable housing and historic renovation real estate partnerships and various other contractual obligations.

		Amount of Commitment Expiration Per Period
Commercial Commitments		Total				Less Than 1 Year				1–3 Years				3–5 Years				More Than 5 Years
Standby letters of credit		$	61.3			$	61.3
Surety bonds		105.1				105.1
Total commercial commitments		$	166.4			$	166.4			$	—			$	—			$	—

Warranties

The Company offers product warranties for certain products. The specific terms and conditions of such warranties vary depending on the product or customer contract requirements. Management estimated the costs of unsettled product warranty claims based on historical results and experience and included an amount in Other accruals. Management periodically assesses the adequacy of the accrual for product warranty claims and adjusts the accrual as necessary. Changes in the Company’s accrual for product warranty claims during 2019, 2018 and 2017, including customer satisfaction settlements during the year, were as follows:

	2019				2018				2017
Balance at January 1	$	57.1			$	151.4			$	34.4
Charges to expense	32.5				31.7				39.7
Settlements	(47.3		)		(57.8		)		(53.1		)
Acquisition, divestiture and other adjustments					(68.2		)		130.4
Balance at December 31	$	42.3			$	57.1			$	151.4

Warranty accruals acquired in connection with the Valspar acquisition in 2017 include warranties for certain products under extended furniture protection plans. The decrease in the accrual in 2018 was primarily due to the divestiture of the furniture protection plan business during the third quarter of 2018 for an immaterial amount that approximated net book value.

Shareholders’ Equity

Shareholders’ equity increased $392.6 million to $4.123 billion at December 31, 2019 from $3.731 billion last year primarily due to an increase in retained earnings of $1.120 billion and an increase in Other capital of $256.6 million, partially offset by purchases of Treasury stock and Treasury stock received from stock option exercises totaling $935.8 million and an increase in Accumulated other comprehensive loss of $49.6 million. Retained earnings increased $1.120 billion during 2019 due to net income of $1.541 billion, partially offset by $420.8 million in cash dividends paid. The increase in Other capital of $256.6 million was due primarily to the recognition of stock-based compensation expense and stock option exercises. The increase in Accumulated other comprehensive loss of $49.6 million was due primarily to unfavorable foreign currency translation effects of $49.8 million. See the Statements of Consolidated Shareholders Equity and Statements of Consolidated Comprehensive Income in Item 8 for additional information.

The Company purchased 1.675 million shares of its common stock for treasury during 2019. The Company acquires its common stock for general corporate purposes, and depending on its cash position and market conditions, it may acquire shares in the future. The Company had remaining authorization from its Board of Directors at December 31, 2019 to purchase 8.45 million shares of its common stock.

The Company's 2019 annual cash dividend of $4.52 per share represented 38.7% of 2018 diluted net income per share. The 2019 annual dividend represented the 41st consecutive year of increased dividend payments since the dividend was suspended in 1978. At a meeting held on February 19, 2020, the Board of Directors increased the quarterly cash dividend to $1.34 per share. This quarterly dividend, if approved in each of the remaining quarters of 2020, would result in an annual dividend for 2020 of $5.36 per share or a 32.5% payout of 2019 diluted net income per share. See the Statements of Consolidated Shareholders’ Equity in Item 8 for more information concerning Shareholders’ equity.

Cash Flow

Net operating cash increased $377.6 million in 2019 to a cash source of $2.321 billion from a cash source of $1.944 billion in 2018 due primarily to an increase in net income and favorable changes in non-cash items, partially offset by changes in working capital when compared to 2018. Net operating cash increased as a percent to sales to 13.0% in 2019 compared to 11.1% in 2018. During 2019, strong net operating cash continued to provide the funds necessary to pay down total net debt, invest in new stores and manufacturing and distribution facilities, and return cash to shareholders through treasury stock purchases and dividends paid.

Net investing cash usage increased $211.0 million to a usage of $462.6 million in 2019 from a usage of $251.6 million in 2018 due primarily to increased capital expenditures, cash used to fund the acquisition of a domestic packaging company and two European coatings companies as disclosed in Note 3 to the Consolidated Financial Statements in Item 8, and decreased proceeds from the sale of assets.

Net financing cash usage increased $99.7 million to a usage of $1.846 billion in 2019 from a usage of $1.747 billion in 2018 due primarily to increased payments of long-term debt, treasury stock purchases, cash dividends and activity related to other accruals, partially offset by the issuance of new long-term debt and a decrease in net payments on short-term borrowings.

Litigation

See Note 11 to the Consolidated Financial Statements in Item 8 for information concerning litigation.

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 entered into foreign currency forward contracts with maturity dates of less than twelve months in 2019, 2018 and 2017, primarily to hedge against value changes in foreign currency. There were no material foreign currency forward contracts outstanding at December 31, 2019, 2018 and 2017. In May 2019, the Company entered into a U.S. Dollar to Euro cross currency swap contract with a total notional amount of $400.0 million to hedge the Company's net investment in its European operations. This contract has been designated as a net investment hedge and will mature on January 15, 2022. During the term of the contract, the Company will pay fixed-rate interest in Euros and receive fixed-rate interest in U.S. Dollars, thereby effectively converting a portion of the Company's U.S. Dollar denominated fixed-rate debt to Euro denominated fixed-rate debt. 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. See Notes 1 and 18 to the Consolidated Financial Statements in Item 8.

Financial Covenant

Certain borrowings contain a consolidated leverage covenant. The covenant states the Company’s leverage ratio is not to exceed 3.75 to 1.00. The leverage ratio is defined as the ratio of total indebtedness (the sum of Short-term borrowings, Current portion of long-term debt and Long-term debt) at the reporting date to consolidated “Earnings Before Interest, Taxes, Depreciation and Amortization” (EBITDA) for the 12-month period ended on the same date. Refer to the “Results of Operations” caption in Item 7 for a reconciliation of EBITDA to Net income. At December 31, 2019, the Company was in compliance with the covenant. The Company’s Notes, Debentures and revolving credit agreement contain various default and cross-default provisions. In the event of default under any one of these arrangements, acceleration of the maturity of any one or more of these borrowings may result. See Note 7 to the Consolidated Financial Statements in Item 8 for additional information.

Employee Stock Ownership Plan

Participants in the Company’s Employee Stock Purchase and Savings Plan (ESOP) are allowed to contribute up to the lesser of 20% of their annual compensation and the maximum dollar amount allowed under the Internal Revenue Code. The Company

matches 6% of eligible employee contributions. The Company’s matching contributions to the ESOP charged to operations were $111.9 million in 2019 compared to $104.7 million in 2018. At December 31, 2019, there were 8,433,722 shares of the Company’s common stock being held by the ESOP, representing 9.2% of the total number of voting shares outstanding. See Note 13 to the Consolidated Financial Statements in Item 8 for more information concerning the Company’s ESOP.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (US GAAP) requires management to make estimates and assumptions that affect amounts reported in the accompanying consolidated financial statements. These determinations were made based upon management’s best estimates, judgments and assumptions that were believed to be reasonable under the circumstances, giving due consideration to materiality. We do not believe there is a great likelihood that materially different amounts would be reported under different conditions or using different assumptions related to the accounting policies described below. However, application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates.

All of the significant accounting policies that were followed in the preparation of the consolidated financial statements are disclosed in Note 1 to the Consolidated Financial Statements in Item 8. Management believes that the following critical accounting policies and estimates have a significant impact on our consolidated financial statements.

Inventories

Inventories were stated at the lower of cost or net realizable value with cost determined principally on the last-in, first-out (LIFO) method based on inventory quantities and costs determined during the fourth quarter. Inventory quantities were adjusted during the fourth quarter as a result of annual physical inventory counts taken at all locations. If inventories accounted for on the LIFO method are reduced on a year-over-year basis, then liquidation of certain quantities carried at costs prevailing in prior years occurs. Management recorded the best estimate of net realizable value for obsolete and discontinued inventories based on historical experience and current trends through reductions to inventory cost by recording a provision included in Cost of goods sold. If management estimates that the reasonable market value is below cost or determines that future demand was lower than current inventory levels, based on historical experience, current and projected market demand, current and projected volume trends and other relevant current and projected factors associated with the current economic conditions, a reduction in inventory cost to estimated net realizable value is provided for in the reserve for obsolescence. See Note 5 to the Consolidated Financial Statements in Item 8 for more information regarding the impact of the LIFO inventory valuation and the reserve for obsolescence.

Goodwill and Intangible Assets

In accordance with the Goodwill and Other Intangibles Topic of the ASC, management performs impairment tests of goodwill and indefinite-lived intangible assets on an annual basis, as well as whenever an event occurs or circumstances change that indicate impairment has more likely than not occurred. An optional qualitative assessment allows companies to skip the annual quantitative test if it is not more likely than not that impairment has occurred based on monitoring key Company financial performance metrics and macroeconomic conditions. The qualitative assessment is performed when deemed appropriate.

In accordance with the Goodwill and Other Intangibles Topic of the ASC, management tests goodwill for impairment at the reporting unit level. A reporting unit is an operating segment per the Segment Reporting Topic of the ASC or one level below the operating segment (component level) as determined by the availability of discrete financial information that is regularly reviewed by operating segment management or an aggregate of component levels of an operating segment having similar economic characteristics. At the time of goodwill impairment testing (if performing a quantitative assessment), management determines fair value through the use of a discounted cash flow valuation model incorporating discount rates commensurate with the risks involved for each reporting unit. If the calculated fair value is less than the current carrying value, then impairment of the reporting unit exists. The use of a discounted cash flow valuation model to determine estimated fair value is common practice in impairment testing. The key assumptions used in the discounted cash flow valuation model for impairment testing include discount rates, growth rates, cash flow projections and terminal value rates. Discount rates are set by using the Weighted Average Cost of Capital (“WACC”) methodology. The WACC methodology considers market and industry data as well as Company-specific risk factors for each reporting unit in determining the appropriate discount rates to be used. The discount rate utilized for each reporting unit is indicative of the return an investor would expect to receive for investing in such a business. Operational management, considering industry and Company-specific historical and projected data, develops growth rates, sales projections and cash flow projections for each reporting unit. Terminal value rate determination follows common methodology of capturing the present value of perpetual cash flow estimates beyond the last projected period assuming a constant WACC and low long-term growth rates. As an indicator that each reporting unit has been valued appropriately through the use of the discounted cash flow valuation model, the aggregate of all reporting units' fair value is reconciled to the total market capitalization of the Company.

The Company had seven components, some of which are aggregated due to similar economic characteristics, to form three reporting units (also the operating segments) with goodwill as of October 1, 2019, the date of the annual impairment test. The annual impairment review performed as of October 1, 2019 did not result in any of the reporting units having impairment or deemed at risk for impairment.

In accordance with the Goodwill and Other Intangibles Topic of the ASC, management tests indefinite-lived intangible assets for impairment at the asset level, as determined by appropriate asset valuations at acquisition. Management utilizes the royalty savings method and valuation model to determine the estimated fair value for each indefinite-lived intangible asset or trademark. In this method, management estimates the royalty savings arising from the ownership of the intangible asset. The key assumptions used in estimating the royalty savings for impairment testing include discount rates, royalty rates, growth rates, sales projections, terminal value rates and, to a lesser extent, tax rates. Discount rates used are similar to the rates developed by the WACC methodology considering any differences in Company-specific risk factors between reporting units and trademarks. Royalty rates are established by management and valuation experts and periodically substantiated by valuation experts. Operational management, considering industry and Company-specific historical and projected data, develops growth rates and sales projections for each significant trademark. Terminal value rate determination follows common methodology of capturing the present value of perpetual sales estimates beyond the last projected period assuming a constant WACC and low long-term growth rates. The royalty savings valuation methodology and calculations used in 2019 impairment testing are consistent with prior years. The annual impairment review performed as of October 1, 2019 resulted in the Company recognizing non-cash pre-tax impairment charges totaling $122.1 million related to certain recently acquired indefinite-lived trademarks.

The discounted cash flow and royalty savings valuation methodologies require management to make certain assumptions based upon information available at the time the valuations are performed. Actual results could differ from these assumptions. Management believes the assumptions used are reflective of what a market participant would have used in calculating fair value considering the current economic conditions. See Note 6 to the Consolidated Financial Statements in Item 8 for a discussion of goodwill and intangible assets and the impairment tests performed in accordance with the Goodwill and Other Intangibles Topic of the ASC.

Valuation of Long-Lived Assets

In accordance with the Property, Plant and Equipment Topic of the ASC, if events or changes in circumstances indicated that the carrying value of long-lived assets, including Operating lease right-of-use assets, may not be recoverable or the useful life had changed, impairment tests were performed or the useful life was adjusted. Undiscounted cash flows were used to calculate the recoverable value of long-lived assets to determine if such assets were not recoverable. If the carrying value of the assets was deemed to not be recoverable, the impairment to be recognized is the amount by which the carrying value of the assets exceeds the estimated fair value of the assets as determined in accordance with the Fair Value Topic of the ASC. If the usefulness of an asset was determined to be impaired, then management estimated a new useful life based on the period of time for projected uses of the asset. Fair value approaches and changes in useful life required management to make certain assumptions based upon information available at the time the valuation or determination was performed. Actual results could differ from these assumptions. Management believes the assumptions used are reflective of what a market participant would have used in calculating fair value or useful life considering the current economic conditions. All tested long-lived assets or groups of long-lived assets had undiscounted cash flows that were substantially in excess of their carrying value. See Notes 4 and 6 to the Consolidated Financial Statements in Item 8 for a discussion of the reductions in carrying value or useful life of long-lived assets in accordance with the Property, Plant and Equipment Topic of the ASC. See Note 1 to the Consolidated Financial Statements in Item 8 for the Property, Plant and Equipment accounting policy.

Defined Benefit Pension and Other Postretirement Benefit Plans

To determine the Company’s ultimate obligation under its defined benefit pension plans and postretirement benefit plans other than pensions, management must estimate the future cost of benefits and attribute that cost to the time period during which each covered employee works. To determine the obligations of such benefit plans, management uses actuaries to calculate such amounts using key assumptions such as discount rates, inflation, long-term investment returns, mortality, employee turnover, rate of compensation increases and medical and prescription drug costs. Management reviews all of these assumptions on an ongoing basis to ensure that the most current information available is being considered. An increase or decrease in the assumptions or economic events outside management’s control could have a direct impact on the Company’s results of operations or financial condition.

In accordance with the Retirement Benefits Topic of the ASC, the Company recognizes each plan’s funded status as an asset for overfunded plans and as a liability for unfunded or underfunded plans. Actuarial gains and losses and prior service costs are recognized and recorded in Accumulated other comprehensive loss, a component of Shareholders’ equity. The amounts recorded in Accumulated other comprehensive loss will continue to be modified as actuarial assumptions and service costs change, and all such amounts will be amortized to expense over a period of years through the net pension and net periodic benefit costs.

Pension costs for 2020 are expected to decrease significantly due to pension settlement lump sum activity in 2018 and annuity contract purchases in the first quarter of 2019. The annuity contract purchases in 2019 resulted in a settlement charge of $32.4 million. The Company will use any remaining overfunded cash surplus balances, as prescribed in the applicable regulations, to fund future Company contributions to a qualified replacement pension plan, which is the current domestic defined contribution plan (Qualified Replacement Plan). Postretirement benefit plan costs for 2020 are expected to be approximately the same as 2019 due to similar actuarial assumptions being applied. See Note 8 to the Consolidated Financial Statements in Item 8 for information concerning the Company’s defined benefit pension plans and postretirement benefit plans other than pensions.

Environmental Matters

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). 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, which are not discounted, are determined based on currently available facts regarding each site. If the reasonably estimable costs can only be identified as a range and no specific amount within that range can be determined more likely than any other amount within the range, the minimum of the range is provided. The Company continuously assesses its potential liability for investigation and remediation-related activities and adjusts its environmental-related accruals as information becomes available upon which more accurate costs can be reasonably estimated and as additional accounting guidelines are issued. Actual costs incurred may vary from the accrued estimates due to the inherent uncertainties involved. See Note 10 to the Consolidated Financial Statements in Item 8 for information concerning the accrual for extended environmental-related activities and a discussion concerning unaccrued future loss contingencies.

Litigation and Other Contingent Liabilities

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. Management believes that the Company has properly accrued for all known liabilities that existed and those where a loss was deemed probable for which a fair value was available or an amount could be reasonably estimated in accordance with US GAAP. However, because litigation is inherently subject to many uncertainties and the ultimate result of any present or future litigation is unpredictable, the Company’s ultimate liability may result in costs that are significantly higher than currently accrued. In the event that the Company’s loss contingency is ultimately determined to be significantly higher than currently accrued, 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 involved, 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. See Note 11 to the Consolidated Financial Statements in Item 8 for information concerning litigation.

Income Taxes

The Company estimated income taxes in each jurisdiction that it operated. This involved estimating taxable earnings, specific taxable and deductible items, the likelihood of generating sufficient future taxable income to utilize deferred tax assets and possible exposures related to future tax audits. To the extent these estimates change, adjustments to deferred and accrued income taxes will be made in the period in which the changes occur.

We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. These assessments of uncertain tax positions contain judgments related to the interpretation of tax regulations in the jurisdictions in which we transact business. The judgments and estimates made at a point in time may change based on the outcome of tax audits, expiration of statutes of limitations, as well as changes to, or further interpretations of, tax laws and regulations. Income tax expense is adjusted in our Statements of Consolidated Income in the period in which these events occur. See Note 19 to the Consolidated Financial Statements in Item 8 for information concerning income taxes.