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MarketScreener Homepage  >  Equities  >  Nyse  >  The Sherwin-Williams Company    SHW

THE SHERWIN-WILLIAMS COMPANY

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

10/27/2020 | 01:28pm EST
(dollars in millions, except as noted and per share data)
BACKGROUND
The Sherwin-Williams Company, founded in 1866, and its consolidated wholly owned
subsidiaries (collectively, the "Company") are engaged in the development,
manufacture, distribution and sale of paint, coatings and related products to
professional, industrial, commercial and retail customers primarily in North and
South America with additional operations in the Caribbean region and throughout
Europe, Asia and Australia.
The Company is structured into three reportable segments-The Americas Group,
Consumer Brands Group and Performance Coatings Group (collectively, the
"Reportable Segments")-and an Administrative segment in the same way it is
internally organized for assessing performance and making decisions regarding
allocation of resources. See Note 17 of Item 1 for additional information on the
Company's Reportable Segments.
SUMMARY
•Consolidated net sales increased 5.2% in the quarter to $5.122 billion
•Net sales from stores in U.S. and Canada open more than twelve calendar months
increased 3.1% in the quarter
•Diluted net income per share increased to $7.66 per share in the quarter
compared to $6.16 per share in the third quarter 2019
•Third quarter 2020 included charges of $0.63 per share for acquisition-related
amortization expense; third quarter 2019 included charges of $0.63 per share for
acquisition-related amortization expense and $0.14 per share for integration
costs, partially offset by a $0.28 per share benefit from the resolution of the
California litigation
•Net operating cash increased 54% year-to-date to $2.56 billion, or 18.5% of
sales
OUTLOOK
On March 11, 2020, the World Health Organization declared the outbreak of the
novel coronavirus (COVID-19) to be a global pandemic and recommended containment
and mitigation measures worldwide. While the response to the outbreak continues
to evolve, it has led to stay-at-home orders and physical distancing guidelines,
among other mandates, that have substantially disrupted normal activities in
most segments of the global economy. We have worked with government and health
authorities to continue to operate our business during this crisis, including
our company-operated stores, manufacturing plants and other facilities, due to
the essential nature of our products. 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.
While the COVID-19 pandemic did not have a material adverse effect on our
consolidated financial results for the first three quarters, we anticipate the
impact of the deterioration of the U.S and global economies may continue and
could have an adverse impact on our business in future periods. The extent to
which our operations will be impacted by the outbreak depends largely on future
developments, including the duration, severity and scope of the pandemic, all of
which remain uncertain.
We have a strong liquidity position, with $619.9 million in cash and $3.50
billion of unused capacity under our credit facilities at September 30, 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 flows, 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 II of this Quarterly Report on Form
10-Q for further information regarding the current and potential impact of the
COVID-19 pandemic on the Company.
                                       25
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RESULTS OF OPERATIONS
The Company has historically experienced, and expects to continue to experience,
variability in quarterly results. The results of operations for the three and
nine months ended September 30, 2020 are not indicative of the results to be
expected for the full year as business is seasonal in nature with the majority
of Net sales for the Reportable Segments traditionally occurring during the
second and third quarters. However, periods of economic downturn can alter the
Company's seasonal patterns.
The following discussion and analysis addresses comparisons of material changes
in the consolidated financial statements for the three and nine months ended
September 30, 2020 and 2019.
Net Sales
(millions of dollars)                                 Three Months Ended September 30,                                                                                           Nine Months Ended September 30,
                                       2020                   2019            $ Change            % Change               2020                2019              $ Change             % Change
The Americas Group             $    2,978.3$ 2,898.2$   80.1                   2.8  %       $  7,807.5$  7,809.1$    (1.6)                     -  %
Consumer Brands Group                 838.1                   678.4             159.7                  23.5  %          2,440.6             2,137.4              303.2                   14.2  %
Performance Coatings Group          1,305.3                 1,290.2              15.1                   1.2  %          3,622.7             3,838.0             (215.3)                  (5.6) %
Administrative                          0.5                     0.9              (0.4)                (44.4) %              2.1                 1.9                0.2                   10.5  %
Total                          $    5,122.2$ 4,867.7$  254.5                   5.2  %       $ 13,872.9$ 13,786.4$    86.5                    0.6  %


Three Months Ended September 30, 2020
Consolidated net sales increased in the third quarter of 2020 due primarily to
higher sales to most of the Consumer Brands Group's retail customers in all
regions, continued strong sales in residential repaint and DIY in North American
stores, and a return to growth in Performance Coatings Group. Currency
translation rate changes decreased net sales by 0.9% in the third quarter of
2020. Net sales of all consolidated foreign subsidiaries were up 5.3% to $967.6
million in the third quarter compared to $918.8 million in the same period last
year. The increase in net sales for all consolidated foreign subsidiaries in the
third quarter was due primarily to higher volume sales to most of the Consumer
Brands Group's retail customers. Net sales of all operations other than
consolidated foreign subsidiaries were up 5.2% to $4.155 billion in the third
quarter compared to $3.949 billion in the same period last year.
Net sales in The Americas Group increased in the third quarter of 2020 due
primarily to higher residential repaint, DIY and new residential paint sales in
the U.S. and Canada, partially offset by the impacts of COVID-19 on demand in
some end market segments served. Net sales from stores open for more than twelve
calendar months in the U.S. and Canada increased 3.1% in the third quarter
compared to last year's comparable period. Sales of non-paint products increased
0.2% compared to last year's third quarter. A discussion of changes in volume
versus pricing for sales of products other than paint is not pertinent due to
the wide assortment of general merchandise sold.
Net sales of the Consumer Brands Group increased in the third quarter due
primarily to higher volume sales to most of the group's retail customers in all
regions.
Net sales in the Performance Coatings Group stated in U.S. dollars increased in
the third quarter primarily due to higher sales volume and improving demand in
most businesses and regions, led by our Packaging and Industrial Wood divisions.
Currency translation rate changes decreased the Performance Coatings Group's net
sales by 1.4% in the third quarter.
Nine Months Ended September 30, 2020
Consolidated net sales increased slightly in the first nine months of 2020 due
primarily to higher sales to most of the Consumer Brands Group's retail
customers in all regions, mostly offset by demand softness in some end markets
in The Americas Group and the Performance Coatings Group caused by the impacts
of COVID-19 and unfavorable currency translation rate changes. Currency
translation rate changes decreased net sales by 1.3% in the first nine months of
2020. Net sales of all consolidated foreign subsidiaries were down 7.1% to
$2.572 billion in the first nine months compared to $2.768 billion in the same
period last year. The decrease in net sales for all consolidated foreign
subsidiaries in the first nine months was due primarily to demand softness in
some end markets from the impacts of COVID-19, and unfavorable currency
translation rate changes. Net sales of all operations other than consolidated
foreign subsidiaries were up 2.6% to $11.301 billion in the first nine months
compared to $11.019 billion in the same period last year.
Net sales in The Americas Group were essentially flat in the first nine months
of 2020 due primarily to the impacts of COVID-19 on demand in most end market
segments served during the second quarter. Net sales from stores open for more
than twelve calendar months in the U.S. and Canada increased 0.7% in the first
nine months compared to last year's comparable
                                       26
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period. Sales of non-paint products decreased 4.3% over last year's first nine
months. A discussion of changes in volume versus pricing for sales of products
other than paint is not pertinent due to the wide assortment of general
merchandise sold.
Net sales of the Consumer Brands Group increased in the first nine months due
primarily to higher volume sales to most of the group's North American and
European retail customers.
Net sales in the Performance Coatings Group stated in U.S. dollars decreased in
the first nine months primarily due 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
the Performance Coatings Group's net sales by 2.2% in the first nine months of
2020.
Income Before Income Taxes
The following table presents the components of income before income taxes as a
percentage of net sales:
(millions of dollars, except %
of sales data)                                       Three Months Ended September 30,                                                                                                  Nine Months Ended September 30,
                                                 2020                                                  2019                                                                     2020                             2019
                                                           % of Net                             % of Net                                         % of Net
                                                             Sales                                Sales                                            Sales                             % of Net Sales
Gross profit                     $       2,455.3              47.9  %       $ 2,225.6              45.7  %                   $ 6,553.9              47.2  %       $ 6,142.1                 44.6  %
Selling, general and
administrative expenses                  1,406.8              27.5  %         1,345.2              27.6  %                     4,005.7              28.9  %         3,920.5                 28.4  %
Other general expense - net                 10.5               0.2  %            12.0               0.2  %                        13.1               0.1  %            18.7                  0.2  %
Amortization                                78.7               1.5  %            77.5               1.6  %                       234.2               1.7  %           234.4                  1.7  %

Interest expense                            83.3               1.6  %            85.3               1.8  %                       257.6               1.8  %           265.5                  1.9  %
Interest and net investment
income                                      (1.4)                -  %            (0.6)                -  %                        (2.6)                -  %            (1.6)                   -  %
California litigation expense                  -                 -  %           (34.7)             (0.7) %                           -                 -  %           (34.7)                (0.2) %
Other expense - net                          1.8                 -  %            31.1               0.6  %                        30.6               0.2  %            54.9                  0.4  %
Income before income taxes       $         875.6              17.1  %       $   709.8              14.6  %                   $ 2,015.3              14.5  %       $ 1,684.4                 12.2  %


Three Months Ended September 30, 2020
Consolidated gross profit increased $229.7 million in the third quarter of 2020
compared to the same period in 2019. Consolidated gross profit as a percent of
consolidated net sales increased in the third quarter of 2020 to 47.9%, compared
to 45.7% during the same period in 2019. Consolidated gross profit dollars and
percent improved as a result of favorable customer and product mix and
moderating raw material costs.
The Americas Group's gross profit in the third quarter of 2020 was higher than
last year by $107.2 million due primarily to favorable customer and product mix
and moderating raw material costs, partially offset by unfavorable currency
translation rate changes. The Americas Group's gross profit as a percent of
sales increased in the third quarter of 2020 compared to the same period in 2019
for these same reasons. The Consumer Brands Group's gross profit increased by
$90.3 million in the third quarter compared to the same period last year due
primarily to higher sales volume to most of the group's retail customers and
moderating raw material costs. The Consumer Brands Group's gross profit as a
percent of sales increased in the third quarter compared to the same period last
year due to higher sales volume, moderating raw material costs and actions taken
over the past year to improve international operating margins. The Performance
Coatings Group's gross profit increased $31.2 in the third quarter compared to
the same period last year, when stated in U.S. dollars, primarily due to
moderating raw material costs and higher sales volume. The Performance Coatings
Group's gross profit as a percent of sales increased in the third quarter
compared to the same period last year for these same reasons.
Consolidated selling, general and administrative expenses (SG&A) increased $61.6
million in the third quarter of 2020 versus the same period last year due
primarily to increased spending from new store openings, and to support higher
DIY sales levels with our retail customers. As a percent of sales, consolidated
SG&A remained relatively flat at 27.5% in the third quarter of 2020, from 27.6%
in the same period last year.
The Americas Group's SG&A increased $36.5 million in the third quarter of 2020
compared to the same period last year due primarily to increased spending from
new store openings and additional sales reps. The Consumer Brands Group's SG&A
increased $8.3 million in the third quarter compared to the same period last
year to support higher sales levels. The Performance Coatings Group's SG&A
increased $9.1 million in the third quarter compared to the same period last
year to
                                       27
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support higher sales levels and investments in information technology systems.
The Administrative segment's SG&A increased $7.7 million in the third quarter
compared to the same period last year due primarily to investments in
information technology systems, partially offset by lower integration costs.
In the third quarter of 2020, amortization of acquired intangibles was $50.5
million and $21.7 million for the Performance Coatings and Consumer Brands
Groups, respectively. In the third quarter of 2019, amortization of acquired
intangibles was $50.5 million and $21.4 million for the Performance Coatings and
Consumer Brands Groups, respectively.
Other expense - net improved $29.3 million in the third quarter of 2020 compared
to the same period in 2019 primarily due to a decrease in foreign currency
transaction related losses and the recognition of a $14.8 million loss on
extinguishment of debt in the prior year.
Nine Months Ended September 30, 2020
Consolidated gross profit increased $411.8 million in the first nine months of
2020 compared to the same period in 2019. Consolidated gross profit as a percent
of consolidated net sales increased in the first nine months of 2020 to 47.2%,
compared to 44.6% during the same period in 2019. Consolidated gross profit
dollars and percent improved as a result of favorable customer and product mix
and moderating raw material costs.
The Americas Group's gross profit in the first nine months of 2020 was higher
than last year by $236.6 million due to moderating raw material costs and
favorable customer and product mix, partially offset by unfavorable currency
translation rate changes. The Americas Group's gross profit as a percent of
sales increased in the first nine months of 2020 compared to the same period in
2019 for the same reasons. The Consumer Brands Group's gross profit increased by
$178.7 million in the first nine months compared to the same period last year
due primarily to higher sales volume to most of the group's North American and
European retail customers and moderating raw material costs. The Consumer Brands
Group's gross profit as a percent of sales increased in the first nine months
compared to the same period last year for these same reasons. The Performance
Coatings Group's gross profit decreased $15.5 million in the first nine months
compared to the same period last year, when stated in U.S. dollars, primarily
due to unfavorable currency translation rate changes, partially offset by
moderating raw material costs. The Performance Coatings Group's gross profit as
a percent of sales increased in the first nine months compared to the same
period last year due to moderating raw material costs.
Consolidated SG&A increased $85.2 million in the first nine months of 2020
versus the same period last year due primarily to increased expenses in The
Americas Group, partially offset by reduced or deferred corporate costs related
to COVID-19. As a percent of sales, consolidated SG&A in the first nine months
compared to the same period last year increased due to these same reasons.
The Americas Group's SG&A increased $108.0 million in the first nine months of
2020 due primarily to increased spending from new store openings, additional
sales reps and COVID-19 costs primarily in the second quarter. The Consumer
Brands Group's SG&A increased $3.1 million in the first nine months compared to
the same period last year primarily to support higher sales levels, partially
offset by currency translation rate changes. The Performance Coatings Group's
SG&A increased $2.1 million in the first nine months compared to the same period
last 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 decreased $28.0 million in the first
nine months compared to the same period last year due primarily to lower
investments in information technology systems.
Other general expense - net decreased $5.6 million in the first nine months of
2020 compared to the same period in 2019 primarily due to increased gains from
the sale and disposition of fixed assets in the current year.
In the first nine months of 2020, amortization of acquired intangibles was
$150.6 million and $64.5 million for the Performance Coatings and Consumer
Brands Groups, respectively. In the first nine months of 2019, amortization of
acquired intangibles was $152.1 million and $64.1 million for the Performance
Coatings and Consumer Brands Groups, respectively.
Other expense - net improved $24.3 million in the first nine months of 2020
compared to the same period in 2019 primarily due to a $$32.4 million charge
recognized in 2019 for the settlement of a domestic pension plan, partially
offset by a $6.5 million increase in losses recognized upon extinguishment of
debt.
The following table presents income before income taxes by segment and as a
percentage of net sales by segment:
                                       28
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                                              Three Months Ended                                                             Nine Months Ended
                                                 September 30,                                       %                         September 30,                       %
                                             2020              2019             Change              2020                  2019                 Change
Income Before Income Taxes:
The Americas Group                       $   747.4$ 663.6               12.6  %       $ 1,735.4$       1,607.1                8.0  %
Consumer Brands Group                        198.3            114.9               72.6  %           519.2                    343.5               51.1  %
Performance Coatings Group                   155.3            137.5               12.9  %           366.4                    386.5               (5.2) %
Administrative                              (225.4)          (206.2)              (9.3) %          (605.7)                  (652.7)               7.2  %
Total                                    $   875.6$ 709.8               23.4  %       $ 2,015.3$       1,684.4               19.6  %

Income Before Income Taxes
as a % of Net Sales:
The Americas Group                            25.1  %          22.9  %                               22.2  %                  20.6  %
Consumer Brands Group                         23.7  %          16.9  %                               21.3  %                  16.1  %
Performance Coatings Group                    11.9  %          10.7  %                               10.1  %                  10.1  %
Administrative                                     nm               nm                                    nm                       nm
Total                                         17.1  %          14.6  %                               14.5  %                  12.2  %

nm - not meaningful


Income Tax Expense
The effective tax rate was 19.4% for the third quarter of 2020 compared to 18.8%
for the third quarter of 2019 and 19.4% for the first nine months of 2020
compared to 23.3% for the first nine months of 2019. The decrease in the
effective tax rate in the current year compared to prior year was primarily due
to a $74.3 million tax provision recorded in the first nine months of 2019
related to the reversal of previously recognized net tax benefits from federal
renewable energy tax credit funds. The effective tax rate was also favorably
impacted by tax benefits related to employee share based payments during 2020
and 2019. The other significant components of the Company's tax rate were
consistent year over year. See Note 15 of Item 1 for additional information.
Net Income Per Share
Diluted net income per share in the third quarter of 2020 increased to $7.66 per
share compared to $6.16 per share in the third quarter of 2019. Diluted net
income per share for the third quarter of 2020 included a $0.63 per share charge
for acquisition-related amortization expense. The third quarter of 2019 included
charges of $0.63 per share for acquisition-related amortization expense and
$0.14 per share for integration costs, partially offset by a benefit of $0.28
per share from the resolution of the California litigation. Currency translation
rate changes had a negligible impact on diluted net income per share in the
third quarter.
Diluted net income per share in the first nine months of 2020 increased to
$17.60 per share compared to $13.82 per share in the first nine months of 2019.
Diluted net income per share for the first nine months of 2020 included a $1.87
per share charge for acquisition-related amortization expense. The first nine
months of 2019 included charges of $1.90 per share for acquisition-related
amortization expense, $0.33 per share for integration costs, $0.79 per share for
a tax credit investment loss and $0.27 per share for pension plan settlement
expense, partially offset by a benefit of $0.28 per share from the resolution of
the California litigation. Currency translation rate changes decreased diluted
net income per share in the first nine months by $0.09 per share.
FINANCIAL CONDITION, LIQUIDITY AND CASH FLOW
Overview
The Company's financial condition, liquidity and cash flow continued to be
strong during the first nine months of 2020 as net operating cash was $2.564
billion, an improvement of $902.4 million from the prior year comparable period,
primarily due to improved operating results as consolidated income before income
taxes increased $330.9 million to $2.015 billion in the current year or 14.5% of
net sales.
Cash and cash equivalents increased $458.1 million during the first nine months
of 2020. Cash flow from operations funded normal seasonal working capital
increases, allowed the Company to return $1.663 billion to shareholders in the
form of share
                                       29
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buybacks and cash dividends and repay $205.7 million in long-term debt (net of
proceeds from issuances) during the first nine months of 2020. At September 30,
2020, the Company's cash and cash equivalents were $619.9 million compared to
$161.8 million and $189.6 million at December 31, 2019 and September 30, 2019,
respectively.
Total debt at September 30, 2020 was $8.291 billion or 66.3% as a percentage of
total capitalization compared to $8.685 billion or 67.8% at December 31, 2019
and $8.908 billion or 68.9% at September 30, 2019. At September 30, 2020, the
Company had remaining short-term borrowing ability of $3.500 billion. The
Company continues to maintain sufficient short-term borrowing capacity at
reasonable rates, and the Company has sufficient cash on hand and total
available borrowing capacity to fund its current operating needs.
Net Working Capital
Net working capital, defined as total current assets less total current
liabilities, increased $775.4 million to a surplus of $817.3 million at
September 30, 2020 compared to a surplus of $41.9 million at September 30, 2019.
The net working capital increase is primarily due to cash generated from
operations, a reduction in short-term borrowings and the current portion of
long-term debt, partially offset by decreases in accounts receivable and
inventory.
Comparing current asset balances at September 30, 2020 to September 30, 2019,
cash and cash equivalents increased $430.3 million, accounts receivable
decreased $24.5 million, inventories decreased $152.2 million due to increased
DIY paint demand, and other current assets increased $14.3 million primarily
related to prepaid expenses. Current liability balances decreased at
September 30, 2020 compared to September 30, 2019 primarily due to a $435.5
million decrease in short-term borrowings, a $405.5 million decrease in the
current portion of long-term debt, partially offset by increases in accrued
expenses and accounts payable. At September 30, 2020, the Company's current
ratio was 1.19 compared to 1.02 and 1.01 at December 31, 2019 and September 30,
2019, respectively.
Goodwill and Intangible Assets
Goodwill and intangible assets decreased $235.0 million from December 31, 2019
and decreased $343.7 million from September 30, 2019. The net decrease during
the first nine months of 2020 was primarily due to amortization of $234.2
million and foreign currency translation of $1.6 million. The net decrease over
the twelve month period from September 30, 2019 was primarily due to
amortization of $312.6 million, impairment of indefinite-lived trademarks during
the fourth quarter of 2019 of $122.1 million and foreign currency translation of
$86.6 million, partially offset by acquisitions of $3.6 million. The fair value
of the Company's acquired intangible assets may be impacted by the Company's
ongoing integration efforts.
During the first nine months of 2020, the Company considered the current and
expected future economic and market conditions surrounding the COVID-19 pandemic
when evaluating whether an interim impairment trigger had occurred related to
the Company's recognized goodwill and intangible assets. While the Company
determined no impairment trigger occurred during the first nine months of 2020
and believes its assumptions and estimates of fair value related to reporting
units and indefinite-lived trademarks are reasonable, actual financial results
could differ from those estimates due to the inherent uncertainty involved in
making such estimates. Changes in assumptions concerning future financial
results (including sales projections related to trademarks impaired during the
fourth quarter of 2019) or other underlying assumptions could have a significant
impact and future impairment charges could be required.
See Note 6 in the Company's Annual Report on Form 10-K for the year ended
December 31, 2019 for more information concerning the Company's goodwill and
intangible assets, including impairment testing of these assets.
Other Assets
Other assets at September 30, 2020 increased $6.8 million in the first nine
months of 2020 and decreased $40.1 million from a year ago. The increase in the
first nine months was primarily due to an increase in other investments,
partially offset by a decrease in deposits. The decrease from September 30, 2019
was primarily due to decreases in deferred tax assets and other investments.
Property, Plant and Equipment
Net property, plant and equipment decreased $55.2 million in the first nine
months of 2020 and decreased $18.3 million in the twelve months since
September 30, 2019. The decrease in the first nine months was primarily due to
depreciation expense of $200.0 million, unfavorable changes in currency
translation rates of $14.6 million and sale or disposition of fixed assets of
$34.4 million, partially offset by capital expenditures of $193.8 million. Since
September 30, 2019, the decrease was primarily due to depreciation expense of
$267.1 million, sale or disposition of fixed assets of $54.1 million, and
unfavorable changes in currency translation rates of $11.8 million, partially
offset by capital expenditures of $297.9 million and acquisitions of $16.8
million. Capital expenditures primarily represented expenditures associated with
improvements and normal equipment
                                       30
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replacement in manufacturing and distribution facilities in the Consumer Brands
Group, normal equipment replacement in The Americas and Performance Coatings
Groups, and aviation transportation and information systems hardware in the
Administrative segment.
Debt
In March 2020, the Company issued $500.0 million of 2.30% Senior Notes due May
2030 and $500.0 million of 3.30% Senior Notes due May 2050 (collectively the
"New Notes") in a public offering. The net proceeds from the issuance of the New
Notes were used to repurchase a portion of the 2.75% Senior Notes due 2022 and
redeem the 2.25% Senior Notes due May 2020. The repurchase of the 2.75% Senior
Notes due 2022 during the first quarter of 2020 resulted in a loss of $21.3
million recorded in Other expense - net.
On September 14, 2020, the Company amended its five-year credit agreement
entered into on May 6, 2016. The primary purpose of the amendment was to extend
the maturity of $75.0 million of the commitments available for borrowing and
obtaining the issuance, renewal, extension and increase of a revolving letter of
credit from June 20, 2021 to June 20, 2025.
At September 30, 2020, the Company's outstanding debt was primarily comprised of
$8.291 billion of long-term debt primarily associated with senior notes. There
were no borrowings outstanding on its revolving lines of credit or under its
commercial paper program. The Company had unused capacity under its various
credit agreements of $3.500 billion at September 30, 2020.
Defined Benefit Pension and Other Postretirement Benefit Plans
Long-term liabilities for postretirement benefits other than pensions did not
change significantly from December 31, 2019 and September 30, 2019. See Note 8
in the Company's Annual Report on Form 10-K for the year ended December 31, 2019
for more information concerning the Company's benefit plan obligations.
Deferred Income Taxes
Deferred income taxes at September 30, 2020 decreased $13.2 million in the first
nine months of 2020, and decreased $140.2 million from a year ago, primarily due
to amortization of acquisition-related intangible assets.
Other Long-Term Liabilities
Environmental-Related Liabilities
The operations of the Company, like those of other companies in the same
industry, are subject to various federal, state and local environmental laws and
regulations. These laws and regulations not only govern current operations and
products, but also impose potential liability on the Company for past
operations. Management expects environmental laws and regulations to impose
increasingly stringent requirements upon the Company and the industry in the
future. Management believes that the Company conducts its operations in
compliance with applicable environmental laws and regulations and has
implemented various programs designed to protect the environment and promote
continued compliance.
Depreciation of capital expenditures and other expenses related to ongoing
environmental compliance measures were included in the normal operating expenses
of conducting business. The Company's capital expenditures, depreciation and
other expenses related to ongoing environmental compliance measures were not
material to the Company's financial condition, liquidity, cash flow or results
of operations during the first nine months of 2020. Management does not expect
that such capital expenditures, depreciation and other expenses will be material
to the Company's financial condition, liquidity, cash flow or results of
operations in 2020. See Note 8 for further information on environmental-related
long-term liabilities.
Contractual Obligations, Commercial Commitments and Warranties
Short-term borrowings decreased $204.5 million to $0.2 million at September 30,
2020 from $204.7 million at December 31, 2019. Total long-term debt decreased
$189.5 million to $8.291 billion at September 30, 2020 from $8.481 billion at
December 31, 2019, and decreased $181.6 million from $8.473 billion at
September 30, 2019.
The California litigation accrual decreased $12.0 million to $64.7 million
($12.0 million current and $52.7 million long-term) at September 30, 2020 from
$76.7 million at September 30, 2019 as a result of the Company remitting its
annual payment in September in accordance with the final court approved
agreement to resolve the litigation. See Note 9 for additional information.
There have been no other significant changes to the Company's contractual
obligations and commercial commitments in the third quarter of 2020 as
summarized in Management's Discussion and Analysis of Financial Condition and
Results of Operations in the Company's Annual Report on Form 10-K for the year
ended December 31, 2019.
                                       31
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Litigation

See Note 9 for information concerning litigation.
Shareholders' Equity
Shareholders' equity increased $84.0 million to $4.207 billion at September 30,
2020 from $4.123 billion at December 31, 2019 and increased $184.4 million from
$4.023 billion at September 30, 2019.
The increase in Shareholders' equity for the first nine months of 2020 resulted
from net income of $1.623 billion and an increase in other capital of $220.3
million primarily associated with stock-based compensation expense and stock
option exercises, partially offset by $1.277 billion of Treasury stock activity
primarily attributable to treasury stock repurchases, cash dividends paid on
common stock of $367.8 million and an increase in Accumulated other
comprehensive loss of $112.8 million.
The increase in Shareholders' equity since September 30, 2019 resulted from net
income of $1.872 billion and an increase in other capital of $294.0 million
primarily associated with stock-based compensation expense and stock option
exercises, partially offset by $1.481 billion of Treasury stock activity
primarily attributable to treasury stock repurchases, cash dividends paid on
common stock of $473.7 million and an increase in Accumulated other
comprehensive loss of $25.2 million.
During the first nine months of 2020, the Company purchased 2,300,000 shares of
its common stock for treasury purposes through open market purchases. The
Company acquires its common stock for general corporate purposes, and depending
on its cash position and market conditions, it may acquire additional shares in
the future. The Company had remaining authorization at September 30, 2020 to
purchase 6.15 million shares of its common stock.
In February 2020, the Company's Board of Directors increased the quarterly cash
dividend from $1.13 per share to $1.34 per share. This quarterly dividend will
result in an annual dividend for 2020 of $5.36 per share or a 32.5% payout of
2019 diluted net income per share.
Net Investment Hedges
In February 2020, the Company settled its $400.0 millionU.S. Dollar to Euro
cross currency swap contract entered into in May 2019 to hedge the Company's net
investment in its European operations. At the time of the settlement, an
unrealized gain of $11.8 million, net of tax, was recognized in AOCI. For the
three and nine months ended September 30, 2019, an unrealized gain of
$13.9 million and $8.9 million, respectively, net of tax, was recognized in
AOCI.
In February 2020, the Company entered into two U.S. Dollar to Euro cross
currency swap contracts to hedge the Company's net investment in its European
operations. The contracts have a notional value of $500.0 million and $244.0
million, respectively, and mature on June 1, 2024 and November 15, 2021,
respectively. During the term of the $500.0 million contract, the Company will
pay fixed-rate interest in Euros and receive fixed-rate interest in U.S.
Dollars, thereby effectively converting a portion of the Company's U.S. Dollar
denominated fixed-rate debt to Euro denominated fixed-rate debt. During the term
of the $244.0 million contract, the Company will pay floating-rate interest in
Euros and receive floating-rate interest in U.S. Dollars. The fair value of the
contracts are included in Other liabilities on the balance sheet. See Note 13.
The changes in fair value are recognized in the foreign currency translation
adjustments component of AOCI. For the three and nine months ended September 30,
2020, an unrealized loss of $26.4 million and $37.1 million, respectively, net
of tax, was recognized in AOCI.
Cash Flow
Net operating cash for the nine months ended September 30, 2020 was a cash
source of $2.564 billion compared to a cash source of $1.661 billion for the
same period in 2019. The improvement in net operating cash was primarily due to
an increase in net income and improved working capital management, partially
offset by an increase in cash requirements for long-term items.
Net investing cash usage decreased $111.9 million in the first nine months of
2020 to a usage of $176.6 million from a usage of $288.5 million in 2019
primarily due to a decrease in cash used for acquisitions and an increase in
proceeds from sale of assets.
Net financing cash usage increased $574.5 million to a usage of $1.916 billion
in the first nine months of 2020 from a usage of $1.342 billion for the same
period in 2019 primarily due to an increase in treasury stock purchases,
repayments of short-term borrowings and cash dividends, partially offset by a
decrease in long-term debt repayments and issuances, as well as the issuance of
100,000 shares of treasury stock (which were associated with the domestic
defined benefit plan terminated in 2018).
In the twelve month period from October 1, 2019 through September 30, 2020, the
Company generated net operating cash of $3.224 billion, used $350.7 million in
investing activities and used $2.421 billion in financing activities.
                                       32
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Market Risk
The Company is exposed to market risk associated with interest rate, foreign
currency and commodity fluctuations. The Company occasionally utilizes
derivative instruments as part of its overall financial risk management policy,
but does not use derivative instruments for speculative or trading purposes. The
Company believes it may be exposed to continuing market risk from foreign
currency exchange rate and commodity price fluctuations. However, the Company
does not expect that foreign currency exchange rate and commodity price
fluctuations or hedging contract losses will have a material adverse effect on
the Company's financial condition, results of operations or cash flows.
Financial Covenant
Certain borrowings contain a consolidated leverage covenant. The covenant states
that the Company's leverage ratio is not to exceed 3.75 to 1.00. The leverage
ratio is defined as the ratio of total indebtedness (the sum of Short-term
borrowings, Current portion of long-term debt and Long-term debt) at the
reporting date to consolidated "Earnings Before Interest, Taxes, Depreciation,
and Amortization" (EBITDA), as defined in the credit agreement, for the 12-month
period ended on the same date. Refer to the "Non-GAAP Financial Measures"
section below for a reconciliation of EBITDA to Net income. At September 30,
2020, the Company was in compliance with the covenant and expects to remain in
compliance. The Company's notes, debentures and revolving credit agreements
contain various default and cross-default provisions. In the event of default
under any one of these arrangements, acceleration of the maturity of any one or
more of these borrowings may result. See Note 7 in the Company's Annual Report
on Form 10-K for the year ended December 31, 2019 for more information
concerning the Company's debt and related covenant.
Non-GAAP Financial Measures
Management utilizes certain financial measures that are not in accordance with
U.S. generally accepted accounting principles (US GAAP) to analyze and manage
the performance of the business. The required disclosures for these non-GAAP
measures are shown below. The Company provides such non-GAAP information in
reporting its financial results to give investors additional data to evaluate
the Company's operations. Management does not, nor does it suggest investors
should, consider such non-GAAP measures in isolation from, or in substitution
for, financial information prepared in accordance with US GAAP.
EBITDA
EBITDA is a non-GAAP financial measure defined as net income from continuing
operations before income taxes and interest, depreciation and amortization.
Management considers EBITDA useful in understanding the operating performance of
the Company. The reader is cautioned that the Company's EBITDA should not be
compared to other entities unknowingly. Further, EBITDA should not be considered
alternatives to Net income or Net operating cash as an indicator of operating
performance or as a measure of liquidity. The reader should refer to the
determination of Net income and Net operating cash in accordance with US GAAP
disclosed in the Statements of Consolidated Income and Statements of
Consolidated Cash Flows in Item 1.
The following table summarizes EBITDA as calculated by management for the
periods indicated below:
       (millions of dollars)       Three Months Ended                           Nine Months Ended
                                     September 30,                                September 30,
                                   2020           2019          2020                2019
       Net income              $     705.8$ 576.5$ 1,623.4      $          1,292.7
       Interest expense               83.3         85.3          257.6                   265.5
       Income taxes                  169.8        133.3          391.9                   391.7
       Depreciation                   67.4         65.3          200.0                   195.0
       Amortization                   78.7         77.5          234.2                   234.4
       EBITDA                  $   1,105.0$ 937.9$ 2,707.1      $          2,379.3


CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles (US GAAP) requires management to make estimates
and assumptions that affect amounts reported in the accompanying consolidated
unaudited interim financial statements. These determinations were made based
upon management's best estimates, judgments and assumptions that were believed
to be reasonable under the circumstances, giving due consideration to
materiality. We do not believe there is a great likelihood that materially
different amounts would be reported under different conditions or using
different assumptions related to the accounting policies described below.
However, application of these accounting policies
                                       33
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involves the exercise of judgment and use of assumptions as to future
uncertainties and, as a result, actual results could differ from these
estimates.
A comprehensive discussion of the Company's critical accounting policies,
management estimates and significant accounting policies followed in the
preparation of the financial statements is included in Management's Discussion
and Analysis of Financial Condition and Results of Operations and Note 1 in the
Company's Annual Report on Form 10-K for the year ended December 31, 2019. There
have been no significant changes in critical accounting policies, management
estimates or accounting policies followed since the year ended December 31,
2019.
                                       34
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere in this report
constitute "forward-looking statements" within the meaning of the federal
securities laws. These forward-looking statements are based upon management's
current expectations, estimates, assumptions and beliefs concerning future
events and conditions and may discuss, among other things, anticipated future
performance (including sales and earnings), expected growth, future business
plans and the costs and potential liability for environmental-related matters
and the lead pigment and lead-based paint litigation. Any statement that is not
historical in nature is a forward-looking statement and may be identified by the
use of words and phrases such as "believe," "expect," "may," "will," "should,"
"project," "could," "plan," "goal," "potential," "seek," "intend" or
"anticipate" or the negative thereof or comparable terminology.
Readers are cautioned not to place undue reliance on any forward-looking
statements. Forward-looking statements are necessarily subject to risks,
uncertainties and other factors, many of which are outside our control, that
could cause actual results to differ materially from such statements and from
our historical results and experience. These risks, uncertainties and other
factors include such things as:
•general business conditions, strengths of retail and manufacturing economies
and growth in the coatings industry;
•changes in general domestic and international economic conditions such as
inflation rates, interest rates, tax rates, unemployment rates, higher labor and
healthcare costs, recessions, and changing government policies, laws and
regulations;
•changes in raw material and energy supplies and pricing;
•changes in our relationships with customers and suppliers;
•our ability to successfully integrate past and future acquisitions into our
existing operations, as well as the performance of the businesses acquired;
•competitive factors, including pricing pressures and product innovation and
quality;
•our ability to attain cost savings from productivity initiatives;
•risks and uncertainties associated with our expansion into and our operations
in Asia, Europe, South America and other foreign markets, including general
economic conditions, inflation rates, recessions, foreign currency exchange
rates, foreign investment and repatriation restrictions, legal and regulatory
constraints, civil unrest and other external economic and political factors;
•the achievement of growth in foreign markets, such as Asia, Europe and South
America;
•increasingly stringent domestic and foreign governmental regulations, including
those affecting health, safety and the environment;
•inherent uncertainties involved in assessing our potential liability for
environmental-related activities;
•other changes in governmental policies, laws and regulations, including changes
in tariff policies, as well as changes in accounting policies and standards and
taxation requirements (such as new tax laws and new or revised tax law
interpretations);
•the nature, cost, quantity and outcome of pending and future litigation and
other claims, including the lead pigment and lead-based paint litigation, and
the effect of any legislation and administrative regulations relating thereto;
•adverse weather conditions or impacts of climate change, natural disasters and
public health crises, including the COVID-19 pandemic; and
•the duration, severity and scope of the COVID-19 pandemic and the actions
implemented by international, federal, state and local public health and
governmental authorities to contain and combat the outbreak and spread of
COVID-19, which may exacerbate one or more of the aforementioned and/or other
risks, uncertainties and factors more fully described in the Company's reports
filed with the Securities and Exchange Commission.
Readers are cautioned that it is not possible to predict or identify all of the
risks, uncertainties and other factors that may affect future results and that
the above list should not be considered to be a complete list. Any
forward-looking statement speaks only as of the date on which such statement is
made, and we undertake no obligation to update or revise any forward-looking
statement, whether as a result of new information, future events or otherwise,
except as otherwise required by law.

                                       35

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