(dollars in millions, except as noted and per share data) Company BackgroundThe Sherwin-Williams Company , founded in 1866, and its consolidated wholly owned subsidiaries (collectively, the Company) are engaged in the development, manufacture, distribution and sale of paint, coatings and related products to professional, industrial, commercial and retail customers primarily inNorth and South America with additional operations in theCaribbean region and throughoutEurope ,Asia andAustralia . The Company is structured into three reportable segments -The Americas Group ,Consumer Brands Group andPerformance Coatings Group (collectively, the Reportable Segments) - and an Administrative segment in the same way it is internally organized for assessing performance and making decisions regarding allocation of resources. See Note 21 to the Consolidated Financial Statements in Item 8 for additional information on the Company's Reportable Segments. Outlook Beginning in early 2020, extraordinary and wide-ranging actions have been taken by international, federal, state, and local public health and governmental authorities to contain and combat the outbreak and spread of a novel strain of coronavirus (COVID-19). These actions have included, and continue to include, quarantines, physical distancing, face coverings, restrictions on public gatherings and other health and safety protocols, stay-at-home orders, travel restrictions, mandatory business closures, and other mandates that have substantially restricted individuals' daily activities and curtailed or ceased many businesses' normal operations. We have worked with government and health authorities to continue to operate our business during this crisis, including our company-operated stores, manufacturing plants and other facilities, due to the essential nature of our products. We have endeavored to follow recommended actions of government authorities and health officials in order to protect the health and well-being of our employees, customers and their families worldwide by implementing online and phone ordering of products, using curb side pickup or delivery, and implementing remote, alternate and flexible work arrangements where possible. We will continue to work with government authorities and health officials in implementing appropriate safety measures, adapting as recommendations and safety protocols evolve so that we may maintain our operations, keep our stores open and continue to return employees who work in office environments. The COVID-19 pandemic did not have a material adverse effect on our consolidated financial results for 2020. We have a strong liquidity position, with$226.6 million in cash and$3.500 billion of unused capacity under our credit facilities atDecember 31, 2020 . The Company is in compliance with bank covenants and expects to remain in compliance. During the first half of the year, we took actions to preserve liquidity and generate cash flow during the crisis. As the circumstances around the COVID-19 pandemic remain fluid, we continue to actively monitor the pandemic's impact to the Company worldwide, including our financial position, liquidity, results of operations and cash flow, while managing our response to the crisis through collaboration with employees, customers, suppliers, government authorities, health officials and other business partners. Please see Item 1A "Risk Factors" in Part I of this Annual Report on Form 10-K for further information regarding the current and potential impact of the COVID-19 pandemic on the Company. 26 -------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS The following discussion and analysis addresses comparisons of material changes in the consolidated financial statements for the years endedDecember 31, 2020 and 2019. For comparisons of the years endedDecember 31, 2019 and 2018, 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 endedDecember 31, 2019 filed onFebruary 21, 2020 .Net Sales Year Ended December 31, 2020 2019 $ Change % Change Net Sales: The Americas Group$ 10,383.2 $ 10,171.9 $ 211.3 2.1 %
Consumer Brands Group 3,053.4 2,676.8
376.6 14.1 %
Performance Coatings Group 4,922.4 5,049.2 (126.8) (2.5) % Administrative 2.7 2.9 (0.2) (6.9) % Total$ 18,361.7 $ 17,900.8 $ 460.9 2.6 % Consolidated net sales for 2020 increased due primarily to higher sales to most of theConsumer Brands Group's retail customers in theU.S. andEurope , and higher sales in residential repaint, DIY and new residential in theU.S. andCanada paint stores inThe Americas Group , partially offset by the impacts of COVID-19 on some end markets primarily served by thePerformance Coatings Group . Currency translation rate changes decreased 2020 consolidated net sales by 1.1%. Net sales of all consolidated foreign subsidiaries decreased 2.7% to$3.581 billion for 2020 versus$3.679 billion for 2019 due primarily to demand softness in certain industrial end markets globally and changes inThe Americas Group's store footprint outside of theU.S. andCanada . Net sales of all operations other than consolidated foreign subsidiaries increased 3.9% to$14.781 billion for 2020 versus$14.222 billion for 2019. Net sales inThe Americas Group increased due primarily to higher residential repaint, DIY and new residential paint sales in theU.S. andCanada , partially offset by the impacts of COVID-19 on demand in some end markets served. Net sales from stores inU.S. andCanada open for more than twelve calendar months increased 2.7% in the year over last year's comparable period. Currency translation rate changes reduced net sales by 1.1% compared to 2019. During 2020,The Americas Group opened 56 new stores and closed 40 redundant locations for a net increase of 16 stores, with a net increase of 38 new stores in theU.S. andCanada . The total number of stores in operation atDecember 31, 2020 was 4,774 inthe United States ,Canada ,Latin America and theCaribbean .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 decreased approximately 2.0% 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 theConsumer Brands Group increased in 2020 primarily due to higher volume sales to most of the group's North American and European retail customers from strong DIY demand. In 2021, theConsumer Brands Group plans to expand its customer base and product assortment at existing customers.The Performance Coatings Group's net sales in 2020 decreased due primarily to softer end market demand in most businesses, mostly due to the impacts of COVID-19, and unfavorable currency translation rate changes, partially offset by increased sales in the packaging and coil divisions in all regions. Currency translation rate changes decreased net sales 1.6% compared to 2019. In 2020, thePerformance Coatings Group opened 1 new location, increasing the total to 282 branches open inthe United States ,Canada ,Mexico ,South America ,Europe andAsia atDecember 31, 2020 . In 2021, thePerformance Coatings Group plans to continue expanding its worldwide presence, including improving its customer base and product offering. 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 2020. 27 -------------------------------------------------------------------------------- Table of Contents Income Before Income Taxes The following tables presents the components of income before income taxes as a percentage of net sales: (millions of dollars, except % of sales data) Year Ended December 31, 2020 2019 % of Net Sales % of Net Sales Gross profit$ 8,682.6 47.3 %$ 8,036.1 44.9 % Selling, general, and administrative expenses 5,477.9 29.8 % 5,274.9 29.5 % Other general expense - net 27.7 0.2 % 39.1 0.2 % Amortization 313.4 1.7 % 312.8 1.7 % Impairment of trademarks 2.3 - % 122.1 0.7 % Interest expense 340.4 1.9 % 349.3 2.0 % Interest and net investment income (3.6) - % (25.9) (0.1) % California litigation expense - - % (34.7) (0.2) % Other expense - net 5.3 - % 16.7 - % Income before income taxes$ 2,519.2 13.7 %$ 1,981.8 11.1 % Consolidated gross profit increased$646.5 million in 2020 compared to the same period in 2019. Consolidated gross profit as a percent to consolidated net sales increased to 47.3% in 2020 from 44.9% in 2019. Consolidated gross profit dollars and percent improved as a result of favorable customer and product mix and moderating raw material costs, partially offset by unfavorable currency translation rate changes.The Americas Group's gross profit for 2020 increased$388.2 million compared to the same period in 2019.The Americas Group's gross profit dollars and margin improved as a result of favorable customer and product mix and moderating raw material costs.The Consumer Brands Group's gross profit increased$221.0 million in 2020 compared to the same period in 2019.The Consumer Brands Group's gross profit dollars and margin improved due primarily to higher volume sales, product portfolio improvements and international cost reductions.The Performance Coatings Group's gross profit for 2020 increased$21.1 million compared to the same period in 2019.The Performance Coatings Group's gross profit dollars and margin improved due primarily to moderating raw material costs, partially offset by unfavorable currency translation rate changes. Consolidated SG&A increased by$203.0 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 29.8% in 2020 from 29.5% in 2019 as a result of higher costs to support our higher sales levels and investments in future growth initiatives.The Americas Group's SG&A increased$159.3 million for the year due primarily to increased spending from new store openings, additional sales reps and COVID-19 costs, partially offset by currency translation rate changes.The Consumer Brands Group's SG&A increased by$28.3 million for the year primarily to support higher sales levels.The Performance Coatings Group's SG&A increased by$8.7 million for the year primarily due to investments in information technology systems and expenses related to COVID-19, partially offset by currency translation rate changes. The Administrative segment's SG&A increased$6.7 million primarily due to higher compensation, including incentive and stock-based compensation. Other general expense - net decreased$11.4 million in 2020 compared to 2019. The decrease was primarily attributable to a$25.5 million increase in gains from the sale and disposition of fixed assets, partially offset by a$14.1 million increase in provisions for environmental matters in the Administrative segment. See Notes 9 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 theGoodwill and Other Intangibles Topic of the ASC, management performed an annual impairment test of goodwill and indefinite-lived intangible assets as ofOctober 1, 2020 . During the fourth quarter of 2020, the Company recognized non-cash pre-tax impairment charges totaling$2.3 million related to recently acquired trademarks in thePerformance Coatings Group as a direct result of recent performance which reduced the long-term forecasted net sales in theAsia Pacific region. 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 thePerformance Coatings Group and$5.1 million in theConsumer Brands Group . In thePerformance Coatings Group ,$75.6 million related to trademarks inNorth America directly associated with strategic decisions made to rebrand industrial products to the Sherwin-Williams® brand name,$25.7 million related to trademarks in theAsia Pacific region as a direct result of recent 28 -------------------------------------------------------------------------------- Table of Contents performance which reduced the long-term forecasted net sales and$15.7 million related to other recently acquired trademarks in various regions. See Note 5 to the Consolidated Financial Statements in Item 8 for additional information. Interest expense decreased$8.9 million in 2020 primarily due to lower average debt levels. Interest and net investment income decreased$22.3 million in 2020 to$3.6 million . The decrease is primarily due to the recognition of an$18.8 million gain during the fourth quarter of 2019 after the Company received a favorable court decision inBrazil 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 theBrazil indirect tax matter. During the third quarter of 2019, the Company recognized a benefit of$34.7 million related to theCalifornia litigation. See Note 10 to the Consolidated Financial Statements in Item 8 for additional information related to the litigation. Other expense - net decreased by$11.4 million in 2020 compared to 2019 primarily due to a decrease in foreign currency transaction related losses primarily in thePerformance Coatings Group . In 2020, the Administrative segment recognized a$21.3 million loss related to the extinguishment of the 2.75% Senior Notes due 2022. In 2019, the Administrative segment recognized a$32.4 million charge for a domestic pension plan settlement and$14.8 million in losses related to the extinguishment of the 2.25% Senior Notes due 2020 and 2.75% Senior Notes due 2022, partially offset by a$38.7 million gain related to the recognition of indirect tax credits. There were no other items within Other income or Other expense that were individually significant atDecember 31, 2020 or 2019. See Notes 6, 7 and 18 to the Consolidated Financial Statements in Item 8 for additional information related to debt, pensions and Other expense - net, respectively. The following tables presents income before income taxes by segment and as a percentage of net sales by segment: Year Ended December 31, 2020 2019 $ Change % Change Income Before Income Taxes: The Americas Group $ 2,294.1$ 2,056.5 $ 237.6 11.6 % Consumer Brands Group 579.6 373.2 206.4 55.3 % Performance Coatings Group 500.1 379.1 121.0 31.9 % Administrative (854.6) (827.0) (27.6) (3.3) % Total $ 2,519.2$ 1,981.8 $ 537.4 27.1 % Income Before Income Taxes as a % ofNet Sales : The Americas Group 22.1 % 20.2 % Consumer Brands Group 19.0 % 13.9 % Performance Coatings Group 10.2 % 7.5 % Administrative nm nm Total 13.7 % 11.1 % nm - not meaningful Income Tax Expense The effective income tax rate for 2020 was 19.4% compared to 22.2% in 2019. The decrease in the effective rate was primarily due to the recognition of a$74.3 million tax credit investment loss in 2019 related to the reversal of certain partnership tax credits, partially offset by a reduction in research and development credits. The tax credit investment 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. Net Income Per Share Diluted net income per share for 2020 increased to$22.08 per share from$16.49 per share for 2019. Diluted net income per share in 2020 included charges for acquisition-related amortization expense of$2.50 per share. Currency translation rate changes decreased diluted net income per share in the year by$0.07 per share. 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 29 -------------------------------------------------------------------------------- Table of Contents 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 theJune 2017 acquisition ofValspar (included in Amortization). Total other adjustments in 2019 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 aBrazil indirect tax credit of$0.36 per share and a benefit from the resolution of theCalifornia litigation of$0.28 per share. FINANCIAL CONDITION, LIQUIDITY AND CASH FLOW Overview The Company's financial condition, liquidity and cash flow continued to be strong in 2020 as net operating cash increased to a record$3.409 billion primarily due to improved operating results as consolidated income before income taxes increased to$2.519 billion or 13.7% of net sales. Strong net operating cash provided the funds necessary for the Company to invest$303.8 million in capital expenditures, reduce total debt by$410.3 million and return$2.934 billion to shareholders in the form of cash dividends and share buybacks during the year. During 2020, the Company generated EBITDA of$3.441 billion . See the Non-GAAP Financial Measures section in Item 6 for definition and calculation of EBITDA. As ofDecember 31, 2020 , the Company had Cash and cash equivalents of$226.6 million and total debt outstanding of$8.292 billion . Total debt, net of Cash and cash equivalents, was$8.066 billion and was 2.4 times the Company's EBITDA in 2020. Net Working Capital Total current assets less Total current liabilities (net working capital) decreased$112.8 million to a deficit of$3.0 million atDecember 31, 2020 from a surplus of$109.8 million atDecember 31, 2019 . The net working capital decrease is due to both a decrease in current assets and an increase in current liabilities. Accounts receivable decreased$10.8 million , Inventories decreased$85.5 million , and Other current assets decreased$8.8 million primarily related to refundable income taxes. Current liabilities excluding Short-term borrowings and the Current portion of long-term debt increased$681.8 million primarily due to the timing of payments and higher incentive compensation, partially offset by a$609.3 million decrease in Short-term borrowings and the Current portion of long-term debt. As a result of the net effect of these changes, the Company's current ratio decreased to 1.00 atDecember 31, 2020 from 1.02 atDecember 31, 2019 . Accounts receivable as a percent of net sales decreased to 11.3% in 2020 from 11.7% in 2019. Accounts receivable days outstanding decreased to 57 days in 2020 from 61 days in 2019. In 2020, provisions for allowance for doubtful collection of accounts increased$17.0 million , or 46.6%. Inventories as a percent of net sales decreased to 9.8% in 2020 from 10.6% in 2019. Inventory days outstanding decreased to 74 days in 2020 from 81 days in 2019. The Company has sufficient total available borrowing capacity to fund its current operating needs. Property, Plant and Equipment Net property, plant and equipment decreased$0.7 million to$1.835 billion atDecember 31, 2020 due primarily to depreciation expense of$268.0 million and sale or disposition of assets with remaining net book value of$46.9 million , partially offset by capital expenditures of$303.8 million and currency translation and other adjustments of$10.4 million . Capital expenditures during 2020 inThe Americas Group were primarily attributable to the opening of new paint stores and renovation and improvements in existing stores. In theConsumer Brands Group and thePerformance Coatings Group , capital expenditures during 2020 were primarily attributable to improvements and normal equipment replacements in manufacturing and distribution facilities. The Administrative segment incurred capital expenditures primarily to acquire the land for the new global headquarters (new headquarters) in downtownCleveland, Ohio and a new research and development (R&D) center in theCleveland suburb ofBrecksville . The Company expects 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 expected to commence in 2021, with completion in 2024 at the earliest. The Company has not made any decisions regarding the disposition of the Company's currentCleveland -area headquarters and R&D centers, which are all owned by the Company. In 2021, the Company expects to spend more than 2020 for capital expenditures. The predominant share of the capital expenditures in 2021 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 inOhio . The Company does not anticipate the need for any specific long-term external financing to support these capital expenditures. 30 -------------------------------------------------------------------------------- Table of ContentsGoodwill and Intangible AssetsGoodwill , which represents the excess of cost over the fair value of net assets acquired in purchase business combinations, increased$44.3 million in 2020 due to foreign currency translation rate fluctuations. Intangible assets decreased$263.3 million in 2020 primarily due to amortization of finite-lived intangible assets of$313.4 million , impairment of indefinite-lived trademarks of$2.3 million , partially offset by foreign currency translation rate fluctuations of$51.5 million . See Note 5 to the Consolidated Financial Statements in Item 8 for a description of goodwill, identifiable intangible assets and asset impairments recognized in accordance with theGoodwill 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$53.1 million atDecember 31, 2020 represent the excess of the fair value of assets over the actuarially determined projected benefit obligations. See Note 7 to the Consolidated Financial Statements in Item 8 and the Defined Benefit Pension and Other Postretirement Benefit Plans section below. Other assets increased$79.8 million to$641.2 million atDecember 31, 2020 . The increase was primarily due to incremental securities purchased with the proceeds generated from the sale of treasury shares to fund future contributions to the Company's Qualified Replacement Plan. See Notes 7 and 11 to the Consolidated Financial Statements in Item 8 for additional information related to the Qualified Replacement Plan and the sale of treasury stock, respectively. Debt Total debt including Short-term borrowings decreased by$393.1 million to$8.292 billion in 2020. This was primarily attributable to the repayment of Short-term borrowings and a net reduction in Long-term debt. InMarch 2020 , the Company issued$500.0 million of 2.30% Senior Notes dueMay 2030 and$500.0 million of 3.30% Senior Notes dueMay 2050 in a public offering. The net proceeds from the issuance of these notes were used to repurchase a portion of the 2.75% Senior Notes due 2022 and redeem the 2.25% Senior Notes dueMay 2020 . The repurchase of the 2.75% Senior Notes due 2022 during the first quarter of 2020 resulted in a loss of$21.3 million recorded in Other expense - net. OnJuly 19, 2018 , the Company 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. 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 . OnOctober 8, 2019 , the Company amended this credit agreement to, among other things, extend the maturity date toOctober 8, 2024 . AtDecember 31, 2020 and 2019, there were no short-term borrowings under this credit agreement. OnMay 6, 2016 , the Company entered into a five-year credit agreement, subsequently amended on multiple dates to extend the maturity of the agreement. 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 atDecember 31, 2020 . InSeptember 2017 , the Company entered into an additional five-year letter of credit agreement, subsequently amended on multiple dates to extend the maturity of the agreement, with an aggregate availability of$625.0 million atDecember 31, 2020 . Both of these credit agreements are being used for general corporate purposes. AtDecember 31, 2020 and 2019, there were no borrowings outstanding under these credit agreements. There were no borrowings outstanding under the Company's domestic commercial paper program atDecember 31, 2020 . Borrowings outstanding under the Company's domestic commercial paper program atDecember 31, 2019 were$191.9 million with a weighted average interest rate of 2.1%. Borrowings outstanding under various foreign programs were$0.1 million and$12.8 million atDecember 31, 2020 and 2019, respectively with a weighted average interest rate of 0.2% and 4.3%, respectively. AtDecember 31, 2020 , the Company had unused capacity under its various credit agreements of$3.500 billion . See Note 6 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 surplus assets of the Terminated Plan are 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 31 -------------------------------------------------------------------------------- Table of Contents included$131.8 million of Company common stock (300,000 shares). The shares are treated as treasury stock in accordance with ASC 715. During 2020, the Company sold 275,000 treasury shares from the trust in the Company's Qualified Replacement Plan. The proceeds generated from the sale of the treasury shares were used to fund the Company's 2020 contribution to the Qualified Replacement Plan and purchase securities held in a suspense account to fund future contributions to the Company's Qualified Replacement Plan. 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$17.5 million to$110.3 million primarily due to changes in the actuarial assumptions. The Company's liability for other postretirement benefits increased$11.1 million to$291.6 million atDecember 31, 2020 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 2.9% atDecember 31, 2020 and 3.4% atDecember 31, 2019 . The assumed discount rate used to determine the projected benefit obligation for foreign defined benefit pension plans decreased to 1.6% atDecember 31, 2020 from 2.2% atDecember 31, 2019 . 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 2.5% atDecember 31, 2020 from 3.2% atDecember 31, 2019 for the same reason. The rate of compensation increases used to determine the projected benefit obligations atDecember 31, 2020 was 3.0% for the domestic pension plan and 2.9% 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% atDecember 31, 2020 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 2020, 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 other postretirement benefits for 2020 were 5.3% and 9.0%, respectively, for medical and prescription drug cost increases, both decreasing gradually to 4.5% in 2027. In developing the assumed health care cost trend rates, management considered industry data, historical Company experience and expectations for future health care costs. For 2021 net pension cost for the ongoing domestic pension plan, the Company will use a discount rate of 2.9%, 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 2021 net periodic benefit costs for other postretirement benefits, the Company will use a discount rate of 2.5%. Net pension cost in 2021 for the ongoing domestic pension plan is expected to be approximately$1.7 million . Net periodic benefit costs for other postretirement benefits in 2021 is expected to be approximately$11.3 million . See Note 7 to the Consolidated Financial Statements in Item 8 for additional information on the Company's obligations and funded status of its defined benefit pension plans and other postretirement benefits. Deferred Income Taxes Deferred income taxes atDecember 31, 2020 decreased$123.8 million from the prior year primarily due to the change in deferred taxes as a result of the amortization of intangible assets in the current year. See Note 19 to the Consolidated Financial Statements in Item 8 for additional information on deferred taxes. Other Long-Term Liabilities Other long-term liabilities increased$177.0 million during 2020 due primarily to legislatively authorized tax payment deferral mechanisms available primarily forU.S. federal payroll withholding taxes until 2021 and 2022 and the net investment hedges being in a net loss position atDecember 31, 2020 . See Note 15 to the Consolidated Financial Statements in Item 8 for additional information on the net investment hedges. 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 32 -------------------------------------------------------------------------------- Table of Contents related to ongoing environmental compliance measures were not material to the Company's financial condition, liquidity, cash flow or results of operations during 2020. Management does not expect that such capital expenditures, depreciation and other expenses will be material to the Company's financial condition, liquidity, cash flow or results of operations in 2021. See Note 9 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 ofDecember 31, 2020 . Payments Due by Period Less Than More Than Contractual Obligations Total 1 Year 1-3 Years 3-5 Years 5 Years Long-term debt$ 8,359.8 $ 25.1 $ 661.3 $ 1,150.3 $ 6,523.1 Interest on Long-term debt 4,580.4 306.5 576.6 537.0 3,160.3 Operating leases 2,017.7 441.3 711.3 455.9 409.2 Short-term borrowings 0.1 0.1 California litigation accrual 64.7 12.0 24.0 28.7 Real estate financing transactions 204.4 14.0 29.0 30.5 130.9 Purchase obligations (1) 364.3 364.3 Other contractual obligations (2) 228.2 99.1 44.8 30.4 53.9 Total contractual cash obligations$ 15,819.6 $ 1,262.4
(1)Relate to open purchase orders for raw materials atDecember 31, 2020 . (2)Relate primarily to estimated future capital contributions to investments in theU.S. affordable housing and historic renovation real estate partnerships and various other contractual obligations.
Amount of Commitment Expiration Per Period
Less Than More Than Commercial Commitments Total 1 Year 1-3 Years 3-5 Years 5 Years Standby letters of credit$ 51.3 $ 51.3 Surety bonds 110.0 110.0 Total commercial commitments$ 161.3 $ 161.3 $ - $ - $ - 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 2020, 2019 and 2018, including customer satisfaction settlements during the year, were as follows: 2020 2019 2018 Balance at January 1$ 42.3 $ 57.1 $ 151.4 Charges to expense 38.1 32.5 31.7 Settlements (37.1) (47.3) (57.8) Divestiture and other adjustments (68.2) Balance at December 31$ 43.3 $ 42.3 $ 57.1 Warranty accruals acquired in connection with theValspar 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. 33 -------------------------------------------------------------------------------- Table of Contents Shareholders' Equity Shareholders' equity decreased$512.5 million to$3.611 billion atDecember 31, 2020 from$4.123 billion last year. The decrease was primarily attributable to the Company repurchasing$2.446 billion inTreasury stock and declaring$488.0 million in cash dividends, partially offset by$2.030 billion of net income, an increase of$250.8 million associated with the recognition of stock-based compensation expense and stock option exercises, and an increase of$182.4 million from the issuance of treasury stock during the year. During the fourth quarter of 2020, the Company retired 30.6 million common stock shares held in treasury, which resulted in decreases of Common stock, Retained earnings andTreasury stock of$30.6 million ,$8.062 billion , and$8.092 billion , respectively. See the Statements of Consolidated Shareholders' Equity and Statements of Consolidated Comprehensive Income in Item 8 for additional information. The Company purchased 3.9 million shares of its common stock for treasury purposes through open market purchases during 2020. 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 atDecember 31, 2020 to purchase 4.55 million shares of its common stock. OnFebruary 17, 2021 , the Board of Directors authorized the Company to purchase an additional 15.0 million shares of the Company's stock for treasury purposes. The Company's 2020 annual cash dividend of$5.36 per share represented 32.5% of 2019 diluted net income per share. The 2020 annual dividend represented the 42nd consecutive year of increased dividend payments since the dividend was suspended in 1978. OnFebruary 17, 2021 , the Board of Directors increased the quarterly cash dividend to$1.65 per share. This quarterly dividend, if approved in each of the remaining quarters of 2021, would result in an annual dividend for 2021 of$6.60 per share or a 30% payout of 2020 diluted net income per share. OnFebruary 3, 2021 , the Board of Directors approved and declared a three-for-one stock split in the form of a stock dividend. Each shareholder of record at the close of business onMarch 23, 2021 will receive two additional common shares for each then-held common share, to be distributed after close of trading onMarch 31, 2021 . Net Investment Hedges InFebruary 2020 , the Company settled its$400.0 million U.S. Dollar to Euro cross currency swap contract entered into inMay 2019 to hedge the Company's net investment in its European operations. At the time of the settlement, an unrealized gain of$11.8 million , net of tax, was recognized in Accumulated other comprehensive income (loss) (AOCI), a component of Shareholders' equity. InFebruary 2020 , the Company also entered intotwo U.S. Dollar to Euro cross currency swap contracts to hedge the Company's net investment in its European operations. The contracts, which were designated as net investment hedges, have a notional value of$500.0 million and$244.0 million , respectively, and mature onJune 1, 2024 andNovember 15, 2021 , respectively. During the term of the$500.0 million contract, the Company will pay fixed-rate interest in Euros and receive fixed-rate interest inU.S. Dollars, thereby effectively converting a portion of the Company'sU.S. Dollar denominated fixed-rate debt to Euro denominated fixed-rate debt. During the term of the$244.0 million contract, the Company will pay floating-rate interest in Euros and receive floating-rate interest inU.S. Dollars. As ofDecember 31, 2020 , the outstanding cross currency swap contracts were in a net loss position of$85.8 million with$31.0 million included in Other accruals and$54.8 million included in Other liabilities, respectively, on the consolidated balance sheet. As ofDecember 31, 2019 , the outstanding cross currency swap contract was in a net gain position of$1.5 million . See Note 15 to the Consolidated Financial Statements in Item 8 for additional information. Cash Flow Net operating cash increased$1.087 billion in 2020 to a cash source of$3.409 billion from$2.321 billion in 2019 due primarily to an increase in net income and improved working capital management, partially offset by unfavorable changes in non-cash items when compared to 2019. Net operating cash increased as a percent to sales to 18.6% in 2020 compared to 13.0% in 2019. During 2020, 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 decreased$140.2 million to a usage of$322.4 million in 2020 from a usage of$462.6 million in 2019 due primarily to a decrease in cash used for acquisitions and an increase in proceeds from sale of assets. See Note 3 to the Consolidated Financial Statements in Item 8 for additional information on the acquisitions in 2019. Net financing cash usage increased$1.174 billion to a usage of$3.020 billion in 2020 from a usage of$1.846 billion in 2019 due primarily to an increase in treasury stock purchases, repayments of short-term borrowings and cash dividends paid, partially offset by a decrease in long-term debt repayments and issuances, as well as the issuance of 275,000 shares of treasury stock 34 -------------------------------------------------------------------------------- Table of Contents (which were associated with the domestic defined benefit plan terminated in 2018 as disclosed in Notes 7 and 11 to the Consolidated Financial Statements in Item 8). Litigation See Note 10 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. In 2020 and 2019, the Company entered into foreign currency forward contracts with maturity dates of less than twelve months primarily to hedge against value changes in foreign currency and cross currency swap contracts to hedge its net investment in European operations. See Notes 1, 15 and 18 to the Consolidated Financial Statements in Item 8 for additional information related to the Company's use of derivative instruments. 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 3.75 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 "Non-GAAP Financial Measures" section in Item 6 for a reconciliation of EBITDA to net income. AtDecember 31, 2020 , 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 6 to the Consolidated Financial Statements in Item 8 for additional information. Employee Stock Ownership Plan Participants in the Employee Stock Purchase and Savings Plan, the Company's employee stock ownership plan (ESOP), are allowed to contribute up to the lesser of 50% 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$120.0 million in 2020 compared to$111.9 million in 2019. AtDecember 31, 2020 , there were 7,318,468 shares of the Company's common stock being held by the ESOP, representing 8.2% of the total number of voting shares outstanding. See Note 12 to the Consolidated Financial Statements in Item 8 for additional information concerning the Company's ESOP. 35 -------------------------------------------------------------------------------- Table of Contents CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in conformity withU.S. generally accepted accounting principles (US GAAP) requires management to make estimates and assumptions that affect amounts reported in the accompanying consolidated 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 4 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 theGoodwill 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 theGoodwill 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 ofOctober 1, 2020 , the date of the annual impairment test. The annual impairment review performed as ofOctober 1, 2020 did not result in any of the reporting units having impairment or deemed at risk for impairment. 36 -------------------------------------------------------------------------------- Table of Contents In accordance with theGoodwill 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 2020 impairment testing are consistent with prior years. The annual impairment review performed as ofOctober 1, 2020 resulted in the Company recognizing non-cash pre-tax impairment charges totaling$2.3 million related to lower than anticipated sales of an acquired indefinite-lived trademark. 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 5 to the Consolidated Financial Statements in Item 8 for a discussion of goodwill and intangible assets and the impairment tests performed in accordance with theGoodwill 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 Note 5 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 other postretirement benefit plans , 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 AOCI. The amounts recorded in AOCI 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. In 2021, pension costs are expected to decrease slightly and other postretirement benefit plan costs are expected to increase slightly based on the actuarial assumptions being applied. See Note 7 to the Consolidated Financial Statements in Item 8 for information concerning the Company's defined benefit pension plans and other postretirement benefit plans. 37 -------------------------------------------------------------------------------- Table of Contents 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 mostly undiscounted, 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 9 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 10 to the Consolidated Financial Statements in Item 8 for information concerning litigation. Income Taxes The Company estimated income taxes for each jurisdiction that it operated in. 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. 38
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