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SHERWIN WILLIAMS CO - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
[April 23, 2014]

SHERWIN WILLIAMS CO - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND


(Edgar Glimpses Via Acquire Media NewsEdge) RESULTS OF OPERATIONS SUMMARY The Sherwin-Williams Company, founded in 1866, and its consolidated wholly owned subsidiaries (collectively, the "Company") are engaged in the development, manufacture, distribution and sale of paint, coatings and related products to professional, industrial, commercial and retail customers primarily in North and South America with additional operations in the Caribbean region, Europe and Asia. The Company is structured into four reportable segments-Paint Stores Group, Consumer Group, Global Finishes Group and Latin America Coatings Group (collectively, the "Reportable Segments")-and an Administrative segment in the same way it is internally organized for assessing performance and making decisions regarding allocation of resources. See pages 6 through 15 and Note 18, on pages 73 through 75, in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 for more information concerning the Reportable Segments.



The Company's financial condition, liquidity and cash flow continued to be strong through the first three months of 2014 primarily due to improved operating results in our Paint Stores and Global Finishes Groups. Net working capital decreased $789.3 million at March 31, 2014 compared to the end of the first quarter of 2013 due to a significant increase in current liabilities and a decrease in current assets. Current portion of long-term debt increased $498.8 million resulting from the 3.125% Senior Notes becoming due in 2014 while cash and cash equivalents decreased $247.5 million resulting primarily from treasury stock purchases. The Company has been able to arrange sufficient short-term borrowing capacity at reasonable rates, and the Company has sufficient total available borrowing capacity to fund its current operating needs. Net operating cash improved $8.0 million in the first three months of 2014 to a cash usage of $83.1 million from a cash usage of $91.1 million in 2013 primarily due to improved working capital management in the core business partially offset by impact on working capital from acquisitions.

Consolidated net sales increased 9.2 percent in the first quarter of 2014 to $2.367 billion from $2.167 billion in the first quarter of 2013 due primarily to higher paint sales volume in our Paint Stores Group. Consolidated gross profit as a percent of consolidated net sales increased in the first quarter to 45.0 percent from 44.4 percent in 2013 due primarily to increased paint volume, improved operating efficiency and selling price increases. Selling, general and administrative expenses (SG&A) increased as a percent of consolidated net sales to 37.4 percent from 35.9 percent in the first quarter of 2013 primarily due to timing of net new store openings in the quarter and acquisitions. Interest expense increased $1.1 million in the first quarter of 2014. The effective income tax rate for the first quarter of 2014 was 30.5 percent compared to 31.0 percent in 2013. Diluted net income per common share increased to $1.14 per share, including a $.12 per share loss from acquisitions, for the first quarter of 2014 from $1.11 per share a year ago.


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

A comprehensive discussion of the Company's critical accounting policies and management estimates and significant accounting policies followed in the preparation of the financial statements is included in Management's Discussion and Analysis of Financial Condition and Results of Operations and in Note 1, on pages 48 through 51, in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. There have been no significant changes in critical accounting policies, management estimates or accounting policies followed since the year ended December 31, 2013.

17 -------------------------------------------------------------------------------- FINANCIAL CONDITION, LIQUIDITY AND CASH FLOW Overview The Company's financial condition, liquidity and cash flow continued to be strong through the first three months of 2014 primarily due to improved operating results in our Paint Stores and Global Finishes Groups. Net working capital decreased $789.3 million at March 31, 2014 compared to the end of the first quarter of 2013 due to a significant increase in current liabilities and a decrease in current assets. Cash and cash equivalents decreased $247.5 million primarily due to treasury stock purchases, accounts receivable increased $43.2 million, inventories increased $83.1 million and all other current assets increased $1.9 million. Short-term borrowings increased $19.1 million, while accounts payable increased $107.1 million, current portion of long-term debt increased $498.8 million resulting from the 3.125% Senior Notes becoming due in 2014, and all other current liabilities increased $45.1 million from March 31, 2013. Net working capital decreases were partially offset by net increases from acquisitions. 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. In the first three months of 2014, accounts receivable increased $76.4 million when normal seasonal trends typically require significant growth in this category, and inventories increased $126.0 million primarily from acquisitions partially offset by lower core business inventories. Accounts payable increased $131.9 million primarily due to the seasonal increase in need for working capital along with increases from acquisitions, while short-term borrowings decreased $9.2 million and all other current liabilities decreased $198.6 million primarily due to timing of accrued taxes and other accrued expense payments. The Company's current ratio was 1.21 at March 31, 2014 compared to 1.73 at March 31, 2013 and 1.25 at December 31, 2013. Total debt at March 31, 2014 increased $8.1 million to $1.712 billion from $1.704 billion at March 31, 2013 and increased as a percentage of total capitalization to 50.9 percent from 48.4 percent at the end of the first quarter last year. Total debt decreased $9.9 million from December 31, 2013 and increased as a percentage of total capitalization from 49.2 percent. At March 31, 2014, the Company had remaining borrowing ability of $2.275 billion. Net operating cash improved $8.0 million in the first three months of 2014 to a cash usage of $83.1 million from a cash usage of $91.1 million in 2013. In the twelve month period from April 1, 2013 through March 31, 2014, the Company generated net operating cash of $1.092 billion, used $335.4 million in investing activities, and used $1.000 billion in financing activities. In that same period, the Company invested $164.8 million in capital additions and improvements, invested $79.9 million in acquisitions, had net proceeds from total debt of $11.2 million, purchased $944.2 million in treasury stock and paid $208.3 million in cash dividends to its shareholders of common stock.

Net Working Capital, Debt and Other Long-Term Assets and Liabilities Cash and cash equivalents decreased $378.4 million during the first three months of 2014. Cash and cash equivalents on hand funded cash requirements for increased sales and normal seasonal increases in working capital, capital expenditures of $29.4 million, payments of cash dividends of $55.1 million, treasury stock purchases of $256.4 million and net payments made on long-term debt of $0.7 million. At March 31, 2014, the Company's current ratio was 1.21 compared to 1.25 at December 31, 2013 and 1.73 a year ago. The decrease resulted from the increase in current portion of long-term debt and decrease in cash and cash equivalents.

Goodwill and intangible assets decreased $4.9 million from December 31, 2013 and decreased $8.5 million from March 31, 2013. The net decrease during the first three months of 2014 was due primarily to amortization of $7.6 million. The net decrease over the twelve month period from March 31, 2013 resulted from amortization of $28.9 million partially offset by capitalization of software of $14.8 million and acquisitions of $5.6 million. See Note 4, on pages 52 to 53, in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 for more information concerning goodwill and intangible assets.

Deferred pension assets increased $0.6 million during the first three months of 2014 and increased $52.7 million from March 31, 2013. The increase in the last twelve months was due primarily to increases in the fair market value of equity securities held by the Company's defined benefit pension plans. See Note 6, on pages 56 through 61, in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 for more information concerning the Company's benefit plan assets.

Other assets at March 31, 2014 increased $19.3 million in the first three months of 2014 and increased $48.7 million from a year ago. Both increases were due primarily to increased investments in affordable housing and historic renovation real estate properties along with increases in various other investments.

Net property, plant and equipment decreased $17.0 million in the first three months of 2014 and increased $49.5 million in the twelve months since March 31, 2013. The decrease in the first three months was primarily due to depreciation expense of $41.4 million and changes in currency translation rates of $8.2 million partially offset by capital expenditures of $29.4 million, acquisitions of $2.7 million and sale or disposition of fixed assets of $0.5 million. Since March 31, 2013, capital expenditures 18 -------------------------------------------------------------------------------- of $164.8 million and acquisitions of $56.2 million were partially offset by depreciation expense of $161.3 million, changes in currency translation rates of $6.9 million and dispositions or sale of assets with remaining net book value of $3.3 million. Capital expenditures during the first three months of 2014 primarily represented expenditures associated with improvements and normal equipment replacement in manufacturing and distribution facilities in the Consumer Group and normal equipment replacement in the Paint Stores and Global Finishes Groups.

There were no borrowings under the Company's domestic commercial paper program outstanding nor certain other short-term revolving and letter of credit agreements at March 31, 2014. Short-term borrowings outstanding under various foreign programs at March 31, 2014 were $87.4 million with a weighted average interest rate of 7.9 percent. The Company had unused capacity of $1.050 billion at March 31, 2014 under the commercial paper program that is backed by the Company's revolving credit agreement. There were no significant changes in long-term debt during the first quarter of 2014. See Note 7, on pages 61 to 62, in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 for more information concerning the Company's debt.

Long-term liabilities for postretirement benefits other than pensions did not change significantly from December 31, 2013 and decreased $49.7 million from March 31, 2013. The decrease in the liability was due to the decrease in the actuarially determined postretirement benefit obligation resulting from changes in actuarial assumptions and favorable claims experience. See Note 6, on pages 56 to 61, in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 for more information concerning the Company's benefit plan obligations.

Other long-term liabilities at March 31, 2014 increased $2.5 million in the first three months of 2014 and increased $72.4 million from a year ago primarily due to an increase in non-current deferred tax liabilities.

Environmental-Related Liabilities The operations of the Company, like those of other companies in the same industry, are subject to various federal, state and local environmental laws and regulations. These laws and regulations not only govern current operations and products, but also impose potential liability on the Company for past operations. Management expects environmental laws and regulations to impose increasingly stringent requirements upon the Company and the industry in the future. Management believes that the Company conducts its operations in compliance with applicable environmental laws and regulations and has implemented various programs designed to protect the environment and promote continued compliance.

Depreciation of capital expenditures and other expenses related to ongoing environmental compliance measures were included in the normal operating expenses of conducting business. The Company's capital expenditures, depreciation and other expenses related to ongoing environmental compliance measures were not material to the Company's financial condition, liquidity, cash flow or results of operations during the first three months of 2014. 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 2014.

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

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

These estimated costs are based on currently available facts regarding each site. The Company accrues a specific estimated amount when such an amount and a time frame in which the costs will be incurred can be reasonably determined. If the best estimate of costs can only be identified as a range and no specific amount within that range can be determined more likely than any other amount within the range, the minimum of the range is accrued by the Company in accordance with applicable accounting rules and interpretations. The Company continuously assesses its potential liability for investigation and remediation activities and adjusts its environmental-related accruals as information becomes available upon which more accurate costs can be reasonably estimated. At March 31, 2014 and 2013, the Company had accruals for environmental-related activities of $98.7 million and $110.6 million, respectively.

Due to the uncertainties of the scope and magnitude of contamination and the degree of investigation and remediation activities that may be necessary at certain currently or formerly owned sites and third party sites, it is reasonably likely that further extensive investigations may be required and that extensive remedial actions may be necessary not only on such sites but on adjacent properties. Depending on the extent of the additional investigations and remedial actions necessary, the Company's 19 -------------------------------------------------------------------------------- ultimate liability may result in costs that are significantly higher than currently accrued. If the Company's future loss contingency is ultimately determined to be at the maximum of the range of possible outcomes for every site for which costs can be reasonably estimated, the Company's aggregate accruals for environmental-related activities would be $86.6 million higher than the accruals at March 31, 2014.

Two of the Company's currently and formerly owned sites accounted for the majority of the accruals for environmental-related activities and the unaccrued maximum of the estimated range of possible outcomes at March 31, 2014. At March 31, 2014, $56.2 million, or 57.0 percent, related directly to these two sites. Of the aggregate unaccrued exposure at March 31, 2014, $59.3 million, or 68.5 percent, related to the two sites. While environmental investigations and remedial actions are in different stages at these sites, additional investigations, remedial actions and/or monitoring will likely be required at each site. A comprehensive description of the two currently and formerly owned sites that account for the majority of the accruals for environmental-related activities is included in Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. There have been no significant changes in the investigative or remedial status of the two sites since December 31, 2013.

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

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

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

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

Contractual Obligations, Commercial Commitments and Warranties Short-term borrowings decreased $9.2 million to $87.4 million at March 31, 2014 from $96.6 million at December 31, 2013. Total long-term debt decreased $0.7 million to $1.625 billion at March 31, 2014 from $1.625 billion at December 31, 2013 and decreased $11.0 million from $1.636 billion at March 31, 2013. See the Financial Condition, Liquidity and Cash Flow section of this report for more information. There have been no other significant changes to the Company's contractual obligations and commercial commitments in the first quarter of 2014 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, 2013.

Changes to the Company's accrual for product warranty claims in the first three months of 2014 are disclosed in Note 5.

Litigation In the course of its business, the Company is subject to a variety of claims and lawsuits, including, but not limited to, litigation relating to product liability and warranty, personal injury, environmental, intellectual property, commercial, contractual and antitrust claims that are inherently subject to many uncertainties regarding the possibility of a loss to the Company. These uncertainties will ultimately be resolved when one or more future events occur or fail to occur confirming the incurrence of a liability or the reduction of a liability. In accordance with the Contingencies Topic of the ASC, the Company accrues for these contingencies by a charge to income when it is both probable that one or more future events will occur confirming the fact of a loss and the amount of the loss can be reasonably estimated. In the event that the Company's loss contingency is ultimately determined to be significantly higher than currently accrued, the recording of the additional liability may result in a material impact on the Company's results of operations, liquidity or financial condition for the annual or interim period during which such additional liability is accrued. In those cases where no accrual is recorded because it is not probable that a liability has been incurred and the amount of any such loss cannot be reasonably estimated, any potential liability ultimately determined to 20 -------------------------------------------------------------------------------- be attributable to the Company may result in a material impact on the Company's results of operations, liquidity or financial condition for the annual or interim period during which such liability is accrued. In those cases where no accrual is recorded or exposure to loss exists in excess of the amount accrued, the Contingencies Topic of the ASC requires disclosure of the contingency when there is a reasonable possibility that a loss or additional loss may have been incurred.

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

Notwithstanding the Company's views on the merits, litigation is inherently subject to many uncertainties, and the Company ultimately may not prevail.

Adverse court rulings or determinations of liability, among other factors, could affect the lead pigment and lead-based paint litigation against the Company and encourage an increase in the number and nature of future claims and proceedings.

In addition, from time to time, various legislation and administrative regulations have been enacted, promulgated or proposed to impose obligations on present and former manufacturers of lead pigments and lead-based paints respecting asserted health concerns associated with such products or to overturn the effect of court decisions in which the Company and other manufacturers have been successful.

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

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

The proceedings initiated by the State of Rhode Island included two jury trials.

At the conclusion of the second trial, the jury returned a verdict finding that (i) the cumulative presence of lead pigment in paints and coatings on buildings in the State of Rhode Island constitutes a public nuisance, (ii) the Company, along with two other defendants, caused or substantially contributed to the creation of the public nuisance and (iii) the Company and two other defendants should be ordered to abate the public nuisance. The Company and two other defendants appealed and, on July 1, 2008, the Rhode Island Supreme Court, among other determinations, reversed the judgment of abatement with respect to the Company and two other defendants. The 21 -------------------------------------------------------------------------------- Rhode Island Supreme Court's decision reversed the public nuisance liability judgment against the Company on the basis that the complaint failed to state a public nuisance claim as a matter of law.

The Santa Clara County, California proceeding was initiated in March 2000 in the Superior Court of the State of California, County of Santa Clara. In the original complaint, the plaintiffs asserted various claims including fraud and concealment, strict product liability/failure to warn, strict product liability/design defect, negligence, negligent breach of a special duty, public nuisance, private nuisance, and violations of California's Business and Professions Code. A number of the asserted claims were resolved in favor of the defendants through pre-trial proceedings. The named plaintiffs in the Fourth Amended Complaint, filed on March 16, 2011, are the Counties of Santa Clara, Alameda, Los Angeles, Monterey, San Mateo, Solano and Ventura, the Cities of Oakland and San Diego and the City and County of San Francisco. The Fourth Amended Complaint asserted a sole claim for public nuisance, alleging that the presence of lead pigments for use in paint and coatings in, on and around residences in the plaintiffs' jurisdictions constitutes a public nuisance. The plaintiffs sought the abatement of the alleged public nuisance that exists within the plaintiffs' jurisdictions. A trial commenced on July 15, 2013 and ended on August 22, 2013. The court entered final judgment on January 27, 2014, finding in favor of the plaintiffs and against the Company and two other defendants (ConAgra Grocery Products Company and NL Industries, Inc.). The final judgment held the Company jointly and severally liable with the other two defendants to pay $1.15 billion into a fund to abate the public nuisance. The Company strongly disagrees with the judgment. On February 18, 2014, the Company filed a motion for new trial and a motion to vacate the judgment. The court denied these motions on March 24, 2014. On March 28, 2014, the Company filed a notice of appeal to the Sixth District Court of Appeal for the State of California. The filing of the notice of appeal effects an automatic stay of the judgment without the requirement to post a bond. The Company believes that the judgment conflicts with established principles of law and is unsupported by the evidence. The Company has had a favorable history with respect to lead pigment and lead-based paint litigation, particularly other public nuisance litigation, and accordingly, the Company believes that it is not probable that a loss has occurred and it is not possible to estimate the range of potential loss with respect to the case.

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

These proceedings include purported claims by individuals, groups of individuals and class actions.

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

Wisconsin is the only jurisdiction to date to apply a theory of liability with respect to alleged personal injury (i.e., risk contribution/market share liability) that does not require the plaintiff to identify the manufacturer of the product that allegedly injured the plaintiff in the lead pigment and lead-based paint litigation. Although the risk contribution liability theory was applied during the Thomas trial, the constitutionality of this theory as applied to the lead pigment cases has not been judicially determined by the Wisconsin state courts. However, in an unrelated action filed in the United States District Court for the Eastern District of Wisconsin, Gibson v. American Cyanamid, et al., on November 15, 2010, the District Court held that Wisconsin's risk contribution theory as applied in that case violated the defendants' right to substantive due process and is unconstitutionally retroactive. The District Court's decision in Gibson v. American Cyanamid, et al., has been appealed by the plaintiff and is awaiting a decision by the United States Court of Appeals for the Seventh Circuit. Also, in Yasmine Clark v. The Sherwin-Williams Company, et al., the Wisconsin Circuit Court, Milwaukee County, on March 25, 2014, held that the application to a pending case of Section 895.046 of the Wisconsin Statutes (which clarifies the application of the risk contribution theory) is unconstitutional as a violation of the plaintiffs' right to due process of law under the Wisconsin Constitution. Defendants intend to file a petition requesting the Wisconsin Court of Appeal to hear the issue as an interlocutory appeal.

Insurance coverage litigation. The Company and its liability insurers, including certain underwriters at Lloyd's of London, initiated legal proceedings against each other to primarily determine, among other things, whether the costs and liabilities associated with the abatement of lead pigment are covered under certain insurance policies issued to the Company. The 22 -------------------------------------------------------------------------------- Company's action, filed on March 3, 2006 in the Common Pleas Court, Cuyahoga County, Ohio, is currently stayed and inactive. The liability insurers' action, which was filed on February 23, 2006 in the Supreme Court of the State of New York, County of New York, has been dismissed. An ultimate loss in the insurance coverage litigation would mean that insurance proceeds could be unavailable under the policies at issue to mitigate any ultimate abatement related costs and liabilities. The Company has not recorded any assets related to these insurance policies or otherwise assumed that proceeds from these insurance policies would be received in estimating any contingent liability accrual. Therefore, an ultimate loss in the insurance coverage litigation without a determination of liability against the Company in the lead pigment or lead-based paint litigation will have no impact on the Company's results of operation, liquidity or financial condition. As previously stated, however, the Company has not accrued any amounts for the lead pigment or lead-based paint litigation and any significant liability ultimately determined to be attributable to the Company relating to such litigation may result in a material impact on the Company's results of operations, liquidity or financial condition for the annual or interim period during which such liability is accrued.

Government tax assessment settlements related to Brazilian operations. Charges totaling $28.7 million and $2.9 million were recorded to Cost of goods sold and SG&A, respectively, during the second and third quarters of 2013. The charges were primarily related to import duty taxes paid to the Brazilian government related to the handling of import duties on products brought into the country for the years 2006 through 2012. The Company elected to pay the taxes through an existing voluntary amnesty program offered by the government to resolve these issues rather than contest them in court. The after-tax charges were $21.9 million for the full year 2013. The Company's import duty process in Brazil was changed to reach a final resolution of this matter with the Brazilian government.

Shareholders' Equity Shareholders' equity decreased $121.5 million to $1.653 billion at March 31, 2014 from $1.775 billion at December 31, 2013 and decreased $159.9 million from $1.813 billion at March 31, 2013. The decrease in Shareholders' equity for the first three months of 2014 resulted primarily from purchases of treasury stock of $256.4 million, cash dividends paid on common stock of $55.1 million and an increase in Cumulative other comprehensive loss of $8.2 million partially offset by net income of $115.5 million and an increase in Other capital of $103.3 million, resulting primarily from stock option exercises. Since March 31, 2013, purchases of treasury stock for $944.2 million and cash dividends paid on common stock of $208.3 million more than offset increases from net income of $751.8 million, an increase in Other capital of $221.7 million and a decrease in Cumulative other comprehensive loss of $39.7 million in twelve months. During the first three months of 2014, the Company purchased 1.30 million shares of its common stock for treasury purposes through open market purchases. The Company purchased 5.10 million shares of its common stock since March 31, 2013 for treasury. The Company acquires its common stock for general corporate purposes, and depending on its cash position and market conditions, it may acquire additional shares in the future. The Company had remaining authorization at March 31, 2014 to purchase 10.85 million shares of its common stock. At a meeting held on February 19, 2014, the Board of Directors increased the quarterly cash dividend from $.50 per common share to $.55 per common share.

This quarterly dividend, if approved in each of the remaining quarters of 2014, will result in an annual dividend for 2014 of $2.20 per common share or a 30.3 percent payout of 2013 diluted net income per common share.

Cash Flow Net operating cash improved $8.0 million in the first three months of 2014 to a cash usage of $83.1 million from a cash usage of $91.1 million in 2013 primarily due to improved working capital management and a payment to the ESOP for the 2012 DOL settlement of $80.0 million in the first quarter of 2013, partially offset by increases in working capital from acquisitions and a decrease in net income of $0.7 million. Net investing cash usage decreased $2.9 million in the first three months of 2014 to a usage of $45.1 million from a usage of $48.0 million in 2013 primarily due to slightly lower capital expenditures. Net financing cash usage increased $146.9 million to a usage of $254.3 million in the first three months of 2014 from a usage of $107.4 million in 2013 primarily due to increases in treasury stock purchases of $175.0 million and net decreases in short-term borrowings of $9.6 million in the first three months of 2014 partially offset by increased proceeds from stock options exercised of $27.9 million. In the twelve month period from April 1, 2013 through March 31, 2014, the Company generated net operating cash of $1.092 billion, used $335.4 million in investing activities and used $1.000 billion in financing activities. In that same period, the Company invested $164.8 million in capital additions and improvements and $79.9 million in acquisitions, received net proceeds from total debt of $11.2 million, purchased $944.2 million in treasury stock and paid $208.3 million in cash dividends to its shareholders of common stock.

23 -------------------------------------------------------------------------------- Market Risk The Company is exposed to market risk associated with interest rate, foreign currency and commodity fluctuations. The Company occasionally utilizes derivative instruments as part of its overall financial risk management policy, but does not use derivative instruments for speculative or trading purposes. In the first three months of 2014, the Company entered into forward currency exchange contracts with maturity dates of less than twelve months to hedge against value changes in foreign currency. The Company believes it may be exposed to continuing market risk from foreign currency exchange rate and commodity price fluctuations. However, the Company does not expect that foreign currency exchange rate and commodity price fluctuations or hedging contract losses will have a material adverse effect on the Company's financial condition, results of operations or cash flows.

Financial Covenant Certain borrowings contain a consolidated leverage covenant. The covenant states the Company's leverage ratio is not to exceed 3.25 to 1.00. The leverage ratio is defined as the ratio of total indebtedness (the sum of Short-term borrowings, Current portion of long-term debt and Long-term debt) at the reporting date to consolidated "Earnings Before Interest, Taxes, Depreciation, and Amortization" (EBITDA) for the twelve month period ended on the same date. Refer to the "Results of Operations" caption below for a reconciliation of EBITDA to Net income. At March 31, 2014, the Company was in compliance with the covenant. The Company's Notes, Debentures and revolving credit agreements contain various default and cross-default provisions. In the event of default under any one of these arrangements, acceleration of the maturity of any one or more of these borrowings may result. See Note 7, on pages 61 to 62, in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 for more information concerning the Company's debt and related covenant.

RESULTS OF OPERATIONS Shown below are net sales and income before taxes by segment for the first quarter: (Thousands of dollars) Three Months Ended March 31, 2014 2013 Change Net Sales: Paint Stores Group $ 1,360,003 $ 1,167,937 16.4 % Consumer Group 325,299 308,580 5.4 % Global Finishes Group 497,639 486,818 2.2 % Latin America Coatings Group 182,388 202,636 -10.0 % Administrative 1,227 1,197 2.5 % Total $ 2,366,556 $ 2,167,168 9.2 % (Thousands of dollars) Three Months Ended March 31, 2014 2013 Change Income Before Income Taxes: Paint Stores Group $ 146,265 $ 129,713 12.8 % Consumer Group 51,088 53,972 -5.3 % Global Finishes Group 46,477 33,931 37.0 % Latin America Coatings Group 9,987 20,839 -52.1 % Administrative (87,740 ) (70,071 ) -25.2 % Total $ 166,077 $ 168,384 -1.4 % Consolidated net sales increased in the first quarter of 2014 due primarily to higher paint sales volume in our Paint Stores Group and acquisitions.

Acquisitions increased consolidated net sales 4.5 percent in the quarter, while unfavorable currency translation rate changes decreased consolidated net sales 1.9 percent in the quarter.

Net sales of all consolidated foreign subsidiaries were up 2.4 percent to $529.2 million in the quarter versus $516.8 million in the same period last year. The increase in net sales for all consolidated foreign subsidiaries in the quarter was due primarily to acquisitions, which increased net sales 5.3 percent in the quarter, and selling price increases partially offset by a 7.6 percent 24 -------------------------------------------------------------------------------- negative impact of foreign currency translation rate changes. Net sales of all operations other than consolidated foreign subsidiaries were up 11.3 percent to $1.837 billion in the quarter as compared to $1.650 billion in the same period last year.

Net sales in the Paint Stores Group increased in the first quarter due primarily to higher architectural paint sales volume and acquisitions. Acquisitions increased net sales 7.2 percent in the quarter. Net sales from stores open for more than twelve calendar months increased 7.9 percent in the quarter compared to last year's comparable period. Total paint sales volume percentage increases were in the high single digits for the core business and exceeded 20.0 percent when including acquisitions for the quarter as compared to last year's comparable period. Sales of non-paint products increased by 10.2 percent over last year's first 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 Group increased in the first quarter due primarily to the impact of acquisitions and the timing of seasonal shipments to some customers. Acquisitions increased net sales 3.9 percent in the quarter. Net sales in the Global Finishes Group stated in U.S.

dollars increased in the first quarter due primarily to selling price increases partially offset by lower paint sales volume and unfavorable currency translation rate changes, which decreased net sales by 1.6%. Net sales in the Latin America Coatings Group stated in U.S. dollars decreased in the first quarter, which can primarily be attributed to unfavorable currency translation rate changes and lower paint sales volume partially offset by selling price increases. Currency translation rate changes decreased net sales by 16.5 percent in the quarter. Net sales in the Administrative segment, which primarily consist of external leasing revenue of excess headquarters space and leasing of facilities no longer used by the Company in its primary business, were essentially flat in the first quarter.

Consolidated gross profit increased $103.1 million in the first quarter of 2014 compared to the same period in 2013. As a percent of sales, consolidated gross profit increased to 45.0 percent in the quarter from 44.4 percent in the first quarter of 2013. The percent to sales and dollar increases were primarily due to increased paint sales volume and selling price increases.

The Paint Stores Group's gross profit was higher than last year by $104.7 million in the first quarter due to higher paint sales volume. The Paint Stores Group's gross profit margins were higher in the quarter compared to the same period last year. The Consumer Group's gross profit increased by $1.4 million primarily due to acquisitions. The Consumer Group's gross profit margins declined as a percent of sales for the first quarter compared to the same period last year primarily due to higher distribution costs to maintain customer service due to inclement weather. The Global Finishes Group's gross profit increased $5.6 million in the first quarter compared to the same period last year, when stated in U.S. dollars, and gross profit margins were up as a percent of sales in the quarter compared to the same period last year due primarily to improved operating efficiencies and selling price increases. The Latin America Coatings Group's gross profit decreased by $6.9 million in the first quarter from the same period in the prior year, when stated in U.S. dollars, primarily due to lower volume sales, increasing raw material costs and unfavorable currency translation rate changes, partially offset by selling price increases.

The Latin America Coatings Group's gross profit margins were down as a percent of sales for the first quarter as compared to the same period last year for these same reasons. The Administrative segment's gross profit decreased by $1.8 million in the first quarter compared to the same period last year.

Selling, general and administrative expenses (SG&A) increased $105.4 million in the first quarter of 2014 versus last year due primarily to increased expenses to support higher sales levels and net new store openings as well as the impact from acquisitions. As a percent of sales, consolidated SG&A increased to 37.4 percent in the quarter from 35.9 percent in the first quarter of 2013 primarily due to timing of net new store openings in the quarter and acquisitions.

The Paint Stores Group's SG&A increased $88.9 million in the first quarter due primarily to net new store openings and general comparable store expenses to support higher sales levels as well as the impact from acquisitions. The Consumer Group's SG&A was up $4.4 million in the quarter compared to the same period last year primarily due to acquisitions. The Global Finishes Group's SG&A decreased $1.6 million in the quarter. The Latin America Coatings Group's SG&A increased $0.7 million in the first quarter due to timing of spending partially offset by currency translation rate changes. The Administrative segment's SG&A increased $13.0 million in the first quarter primarily due to acquisition due diligence efforts and information systems costs.

Other general expense-net decreased $4.5 million in the first quarter. The decrease in the quarter was primarily due to decreased loss on disposal of assets and decreased provisions for environmental expenses both in the Administrative segment.

Other income-net decreased $3.2 million in the first quarter primarily due to decreased miscellaneous income impacting the Global Finishes and Latin America Coatings Groups.

Consolidated income before income taxes decreased $2.3 million, including a loss from acquisitions of $19.2 million, in the first quarter of 2014 due to higher segment profits in Paint Stores and Global Finishes Groups partially offset by lower segment profits in the Consumer and Latin America Coatings Groups and increased expenses in the Administrative segment.

25 -------------------------------------------------------------------------------- The effective income tax rate of 30.5 percent for the first quarter of 2014 was lower than the 31.0 percent effective income tax rate for the first quarter of 2013 due primarily to the timing of discrete items.

Net income for the quarter decreased $0.7 million to $115.5 million from $116.2 million in the first quarter of 2013. Diluted net income per common share increased 2.7 percent from $1.11 per share in the first quarter of 2013 to $1.14 per share, including a $.12 per share loss from acquisitions, in the first quarter of 2014.

Management considers a measurement that is not in accordance with U.S. generally accepted accounting principles a useful measurement of the operational profitability of the Company. Some investment professionals also utilize such a measurement as an indicator of the value of profits and cash that are generated strictly from operating activities, putting aside working capital and certain other balance sheet changes. For this measurement, management increases net income for significant non-operating and non-cash expense items to arrive at an amount known as "Earnings Before Interest, Taxes, Depreciation and Amortization" (EBITDA). The reader is cautioned that the following value for EBITDA should not be compared to other entities unknowingly. EBITDA should not be considered an alternative to net income or cash flows from operating activities as an indicator of operating performance or as a measure of liquidity. The reader should refer to the determination of net income and cash flows from operating activities in accordance with U. S. generally accepted accounting principles disclosed in the Statements of Consolidated Income and Comprehensive Income and Statements of Consolidated Cash Flows. EBITDA as used by management is calculated as follows: (Thousands of dollars) Three Months Ended March 31, 2014 2013 Net income $ 115,457 $ 116,185 Interest expense 16,394 15,311 Income taxes 50,620 52,199 Depreciation 41,408 38,892 Amortization 7,552 7,664 EBITDA $ 231,431 $ 230,251 26-------------------------------------------------------------------------------- CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION Certain statements contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this report constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

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

Readers are cautioned not to place undue reliance on any forward-looking statements. Forward-looking statements are necessarily subject to risks, uncertainties and other factors, many of which are outside the control of the Company, that could cause actual results to differ materially from such statements and from the Company's historical results and experience. These risks, uncertainties and other factors include such things as: (a) general business conditions, strengths of retail and manufacturing economies and the growth in the coatings industry; (b) competitive factors, including pricing pressures and product innovation and quality; (c) changes in raw material and energy supplies and pricing; (d) changes in the Company's relationships with customers and suppliers; (e) the Company's ability to attain cost savings from productivity initiatives; (f) the Company's ability to successfully integrate past and future acquisitions into its existing operations, including the recent acquisitions of the Comex business in the United States and Canada, Geocel Holdings Corporation and Jiangsu Pulanna, as well as the performance of the businesses acquired; (g) changes in general domestic 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; (h) risks and uncertainties associated with the Company's expansion into and its 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; (i) the achievement of growth in foreign markets, such as Asia, Europe and South America; (j) increasingly stringent domestic and foreign governmental regulations, including those affecting health, safety and the environment; (k) inherent uncertainties involved in assessing the Company's potential liability for environmental-related activities; (l) other changes in governmental policies, laws and regulations, including changes in accounting policies and standards and taxation requirements (such as new tax laws and new or revised tax law interpretations); (m) the nature, cost, quantity and outcome of pending and future litigation and other claims, including the lead pigment and lead-based paint litigation, and the effect of any legislation and administrative regulations relating thereto; and (n) unusual weather conditions.

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

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