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Sherwin-Williams Company 10-Q 2005
The Sherwin-Williams Co. 10-Q
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One)
     
þ   Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the Period Ended September 30, 2005
or
     
o   Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the transition period from                    to                    
Commission file number 1-04851
THE SHERWIN-WILLIAMS COMPANY
(Exact name of registrant as specified in its charter)
     
OHIO   34-0526850
     
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     
101 Prospect Avenue, N.W., Cleveland, Ohio   44115-1075
     
(Address of principal executive offices)   (Zip Code)
     
(216) 566-2000
 
(Registrant’s telephone number including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.
Common Stock, $1.00 Par Value – 136,906,023 shares as of September 30, 2005.
 
 

 


TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
Item. 1. Financial Statements
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 4. CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Securities and Use of Proceeds
Item 6. Exhibits
SIGNATURES
INDEX TO EXHIBITS
EX-10(A) Schedule of Certain Executive Officers who are Parties to the Severance Pay Agreements
EX-10(B) Schedule of Certain Executive Officers who are Parties to the Individual Grantor Trust Participation Agreements
EX-31(A) Certification
EX-31(B) Certification
EX-32(A) Section 1350 Certification
EX-32(B) Section 1350 Certification


Table of Contents

PART I. FINANCIAL INFORMATION
Item. 1. Financial Statements
THE SHERWIN-WILLIAMS COMPANY AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME (UNAUDITED)
Thousands of dollars, except per share data
                                 
    Three months ended September 30,     Nine months ended September 30,  
    2005     2004     2005     2004  
Net sales
  $ 1,976,728     $ 1,677,130     $ 5,480,631     $ 4,614,606  
Cost of goods sold
    1,136,983       933,585       3,141,946       2,578,017  
Gross profit
    839,745       743,545       2,338,685       2,036,589  
Percent to net sales
    42.5 %     44.3 %     42.7 %     44.1 %
Selling, general and administrative expenses
    602,517       527,124       1,737,177       1,526,073  
Percent to net sales
    30.5 %     31.4 %     31.7 %     33.1 %
Interest expense
    12,092       10,235       37,612       28,987  
Interest and net investment income
    (1,329 )     (1,734 )     (3,090 )     (4,274 )
Other expense — net
    7,471       3,116       20,781       6,643  
 
                       
 
                               
Income before income taxes and minority interest
    218,994       204,804       546,205       479,160  
Income taxes
    66,970       71,681       156,726       167,706  
Minority interest
    416       260       1,356       685  
 
                       
 
                               
Net income
  $ 151,608     $ 132,863     $ 388,123     $ 310,769  
 
                       
 
                               
Net income per share:
                               
Basic
  $ 1.11     $ 0.95     $ 2.82     $ 2.20  
 
                               
Diluted
  $ 1.07     $ 0.92     $ 2.73     $ 2.14  
See notes to condensed consolidated financial statements.

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Table of Contents

THE SHERWIN-WILLIAMS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Thousands of dollars
                         
    September 30,     December 31,     September 30,  
    2005     2004     2004  
ASSETS
                       
Current assets:
                       
Cash and cash equivalents
  $ 29,836     $ 45,932     $ 97,222  
Accounts receivable, less allowance
    956,109       724,385       839,657  
Inventories:
                       
Finished goods
    711,330       651,095       646,908  
Work in process and raw materials
    110,307       121,757       90,525  
 
                 
 
    821,637       772,852       737,433  
Deferred income taxes
    90,269       88,985       86,732  
Other current assets
    150,564       149,774       168,151  
 
                 
Total current assets
    2,048,415       1,781,928       1,929,195  
 
                       
Goodwill
    908,411       900,444       897,547  
Intangible assets
    295,539       307,900       324,118  
Deferred pension assets
    434,745       430,238       430,011  
Other assets
    150,561       133,281       157,596  
 
                       
Property, plant and equipment
    1,849,384       1,751,628       1,728,466  
Less allowances for depreciation
    1,111,613       1,031,268       1,009,824  
 
                 
 
    737,771       720,360       718,642  
 
                 
 
                       
Total assets
  $ 4,575,442     $ 4,274,151     $ 4,457,109  
 
                 
 
                       
LIABILITIES AND SHAREHOLDERS’ EQUITY
                       
Current liabilities:
                       
Short-term borrowings
  $ 282,629     $ 238,815     $ 367,953  
Accounts payable
    722,251       650,977       711,794  
Compensation and taxes withheld
    178,376       195,739       179,566  
Accrued taxes
    138,909       95,558       193,670  
Current portion of long-term debt
    10,493       11,214       11,178  
Other accruals
    374,662       327,834       337,601  
 
                 
Total current liabilities
    1,707,320       1,520,137       1,801,762  
 
                       
Long-term debt
    487,313       488,239       498,423  
Postretirement benefits other than pensions
    226,163       221,975       218,748  
Other long-term liabilities
    401,577       392,849       364,530  
Minority interest
            3,705       3,112  
 
                       
Shareholders’ equity:
                       
Common stock — $1.00 par value:
                       
136,906,023, 140,777,115 and 141,346,784 shares outstanding at September 30, 2005, December 31, 2004 and September 30, 2004, respectively
    218,647       216,396       215,513  
Preferred stock — convertible, participating, no par value:
                       
64,394, 171,819 and 201,714 shares outstanding at September 30, 2005, December 31, 2004 and September 30, 2004, respectively
    64,394       171,819       201,714  
Unearned ESOP compensation
    (64,394 )     (171,819 )     (201,714 )
Other capital
    528,388       474,594       410,485  
Retained earnings
    2,997,602       2,695,193       2,636,752  
Treasury stock, at cost
    (1,801,517 )     (1,529,355 )     (1,465,218 )
Cumulative other comprehensive loss
    (190,051 )     (209,582 )     (226,998 )
 
                 
Total shareholders’ equity
    1,753,069       1,647,246       1,570,534  
 
                 
 
                       
Total liabilities and shareholders’ equity
  $ 4,575,442     $ 4,274,151     $ 4,457,109  
 
                 
See notes to condensed consolidated financial statements.

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THE SHERWIN-WILLIAMS COMPANY AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS (UNAUDITED)
Thousands of dollars
                 
    Nine months ended September 30,  
    2005     2004  
OPERATING ACTIVITIES
               
Net income
  $ 388,123     $ 310,769  
Adjustments to reconcile net income to net operating cash:
               
Depreciation
    89,531       78,765  
Amortization of intangibles and other assets
    17,422       10,447  
Provisions for qualified exit costs
    671       2,700  
Provisions for environmental-related matters
    12,279       4,150  
Defined benefit pension plans net credit
    (3,674 )     (4,822 )
Net increase in postretirement liability
    4,188       1,895  
(Gain) loss on disposition of assets
    (2,146 )     41  
Loss on disposition of investment
    7,858          
Other
    6,344       10,345  
Change in working capital accounts — net
    (150,430 )     (43,960 )
Costs incurred for environmental - related matters
    (4,635 )     (6,593 )
Costs incurred for qualified exit costs
    (582 )     (828 )
Other
    (1,579 )     (5,130 )
 
           
 
               
Net operating cash
    363,370       357,779  
 
               
INVESTING ACTIVITIES
               
Capital expenditures
    (103,023 )     (76,401 )
Acquisitions of businesses
    (23,267 )     (552,065 )
Increase in other investments
    (19,787 )     (17,281 )
Proceeds from disposition of assets and investment
    10,876       1,896  
Other
    (1,701 )     (6,392 )
 
           
 
               
Net investing cash
    (136,902 )     (650,243 )
 
               
FINANCING ACTIVITIES
               
Net increase in short-term borrowings
    46,527       367,953  
Payments of long-term debt
    (1,505 )     (71,081 )
Payments of cash dividends
    (85,714 )     (72,871 )
Proceeds from stock options exercised
    50,748       66,614  
Treasury stock purchased
    (268,051 )     (203,372 )
Other
    15,254       (1,732 )
 
           
 
               
Net financing cash
    (242,741 )     85,511  
 
               
Effect of exchange rate changes on cash
    177       1,362  
 
               
Net decrease in cash and cash equivalents
    (16,096 )     (205,591 )
Cash and cash equivalents at beginning of year
    45,932       302,813  
 
           
 
               
Cash and cash equivalents at end of period
  $ 29,836     $ 97,222  
 
           
 
               
Income taxes paid
  $ 112,956     $ 52,878  
Interest paid
  $ 46,012     $ 37,376  
See notes to condensed consolidated financial statements.

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Table of Contents

THE SHERWIN-WILLIAMS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Periods ended September 30, 2005 and 2004
Note A—BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Form 10-K for the fiscal year ended December 31, 2004. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The consolidated results for the third quarter and nine months ended September 30, 2005 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2005.
Minority interest reflects the minority shareholder’s interest in the net income and equity of Sherwin-Williams Kinlita Co., Ltd (Kinlita). On September 30, 2005 the Company sold its majority interest in Kinlita (see Note C).
Note B—STOCK BASED COMPENSATION
At September 30, 2005, the Company had two stock-based compensation plans accounted for under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, as more fully described in Note 1 and Note 12 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. Pro-forma information regarding the impact of stock-based compensation on net income and earnings per share is required by Statement of Financial Accounting Standard (SFAS) No. 123, “Accounting for Stock-Based Compensation.” Such pro-forma information, determined as if the Company had accounted for its employee stock options under the fair value method of that Statement, is illustrated in the following table:
                                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
(Thousands of dollars except per share data)   2005     2004     2005     2004  
Net income, as reported
  $ 151,608     $ 132,863     $ 388,123     $ 310,769  
Add: Total stock-based compensation expense included in the determination of net income as reported, net of related tax effects
    1,042       1,773       3,631       5,705  
Less: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects
    (3,246 )     (3,738 )     (8,661 )     (10,805 )
 
                       
 
                               
Pro forma net income
  $ 149,404     $ 130,898     $ 383,093     $ 305,669  
 
                       
 
                               
Net income per share:
                               
Basic — as reported
  $ 1.11     $ .95     $ 2.82     $ 2.20  
Basic — pro-forma
  $ 1.09     $ .93     $ 2.78     $ 2.17  
Diluted — as reported
  $ 1.07     $ .92     $ 2.73     $ 2.14  
Diluted — pro-forma
  $ 1.06     $ .90     $ 2.71     $ 2.10  

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Table of Contents

Note C—ACQUISITIONS
During the first quarter of 2005, the Company acquired substantially all of the assets and business of KST Coatings Manufacturing, Inc., KST Coatings LLC and Uniflex LLC (collectively, “KST”) for $23.1 million paid in cash. KST, included in the Consumer Segment, provides roof coatings and roof, deck and wall sealants to professional paint contractors and do-it-yourself users in the United States under the Kool Seal® and the Snow Roof Systems® brands. The acquisition was accounted for as a purchase, with results of operations included in the consolidated financial statements beginning with the month of January 2005. The KST acquisition resulted in the recognition of goodwill of $13.5 million and identifiable intangible assets of $2.8 million and was completed primarily to assist with the implementation of the Company’s growth strategy of supplying high quality products and services to professional paint contractors and do-it-yourself users through various channels of distribution.
During the third quarter of 2004, the Company completed its acquisitions of 100% of the stock of Duron, Inc. (Duron) and Paint Sundry Brands Corporation (PSB) for an aggregate consideration of $640.0 million, and the assumption of certain financial obligations. Both acquisitions were financed through the use of cash, liquidated short-term investments and $350.0 million in proceeds from the sale of commercial paper under the Company’s existing commercial paper program. Both acquisitions were accounted for as purchases, with results of operations included in the consolidated financial statements beginning with the month of September 2004.
During the second quarter of 2004, the Company acquired a majority interest in Kinlita for $7.0 million paid in cash. Kinlita, included in the Automotive Finishes Segment, supplies coatings to original equipment truck and bus manufacturers in the Peoples Republic of China. The acquisition was accounted for as a purchase, with results of operations included in the consolidated financial statements beginning with the month of April 2004. On September 30, 2005, the Company realized a loss of $7.9 million on the disposition of its majority interest in Kinlita.
The following unaudited pro-forma summary presents consolidated financial information as if KST, Kinlita, Duron and PSB had been acquired at the beginning of each period presented. The pro-forma consolidated financial information does not necessarily reflect the actual results that would have occurred had the acquisitions taken place on January 1, 2004 or of future results of operations of the combined companies under ownership and operation of the Company.
                                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
(Thousands of dollars except per share data)   2005     2004     2005     2004  
Net sales
  $ 1,976,728     $ 1,779,822     $ 5,480,631     $ 4,979,812  
Net income (1)
    151,608       106,939       388,123       300,217  
 
                               
Net income per common share:
                               
Basic (1)
  $ 1.11     $ 0.76       2.82     $ 2.13  
Diluted (1)
  $ 1.07     $ 0.74       2.73     $ 2.07  
 
(1)   Included in the 2004 reported pro-forma net income are material charges of $30.5 million paid by Duron for settlement of certain compensation arrangements incurred prior to closing and $4.8 million paid by PSB for loan origination fees written off prior to closing.
For further details on the Company’s 2004 acquisitions, see Note 2 and Note 4 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.
Note D—DIVIDENDS
Dividends paid on common stock during each of the first three quarters of 2005 and 2004 were $.205 per common share and $.17 per common share, respectively.

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Note E—OTHER EXPENSE — NET
Items included in Other expense — net are as follows:
                                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
(Thousands of dollars)   2005     2004     2005     2004  
Dividend and royalty income
  $ (860 )   $ (680 )   $ (2,402 )   $ (1,890 )
Net expense from financing and investing activities
    1,510       945       4,310       2,737  
(Gain) loss on disposition of assets
    (1,193 )     231       (2,146 )     41  
Loss on disposition of investment
    7,858               7,858          
Foreign currency related losses
    492       618       1,363       2,101  
Provisions for environmental matters
            2,150       12,279       4,150  
Other income
    (875 )     (1,052 )     (3,001 )     (2,765 )
Other expense
    539       904       2,520       2,269  
 
                       
 
  $ 7,471     $ 3,116     $ 20,781     $ 6,643  
 
                       
The net expense from financing and investing activities represents the net gain or loss relating to the change in the Company’s investment in certain long-term asset funds and financing fees.
The (gain) loss on disposition of assets represents the realized gains or losses associated with the disposal of fixed assets.
The loss on disposition of investment is the Company’s majority ownership in Kinlita.
The provisions for environmental matters recorded during the nine months of both years were for clean-up plans at several of the Company’s sites. See Note L for further details on the Company’s environmental-related activities.
Other income and other expense include miscellaneous items that are not related to the primary business purpose of the Company.
Note F—EXIT OR DISPOSAL ACTIVITIES
The Company recognizes liabilities associated with exit or disposal activities as incurred in accordance with SFAS No. 146, “Accounting for Costs Asssociated with Exit or Disposal Activities.” Qualifying exit costs primarily include post-closure rent expenses, incremental post-closure costs and costs of employee terminations. Adjustments may be made to prior provisions for qualified exit costs if information becomes available upon which more accurate amounts can be reasonably estimated. Concurrently, property, plant and equipment is tested for impairment in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” and, if impairment exists, the carrying value of the related assets is reduced to estimated fair value. Additional impairment may be recorded for subsequent revisions in estimated fair value. No significant revisions occurred during the first three quarters of 2005.

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The following table summarizes the remaining liabilities associated with qualified exit costs at September 30, 2005 and the activity for the nine month period then ended:
(Thousands of dollars)
                                 
            Provisions for     Actual        
    Balance at     Closure of     expenditures     Balance at  
    December 31,     Acquired     charged to     September 30,  
Exit Plan   2004     Facilities     accrual     2005  
Consumer Group manufacturing facility:
                               
Severence and related costs
          $ 671     $ (222 )   $ 449  
Automotive Finishes distribution facility:
                               
Other qualified exit costs
  $ 316             (265 )     51  
Qualified exit costs initiated prior to 2004
    13,819               (95 )     13,724  
 
                       
Totals
  $ 14,135     $ 671     $ (582 )   $ 14,224  
 
                       
For further details on the Company’s exit or disposal activities, see Note 6 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.
Note G—PRODUCT WARRANTIES
Changes in the Company’s accrual for product warranty claims during the first nine months of 2005 and 2004, including customer satisfaction settlements during the year, were as follows:
                 
(Thousands of dollars)   2005     2004  
Balance at January 1
  $ 18,098     $ 16,555  
Charges to expense
    22,654       25,282  
Settlements
    (20,408 )     (21,362 )
 
           
Balance at September 30
  $ 20,344     $ 20,475  
 
           
For further details on the Company’s accrual for product warranty claims, see Note 1 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.
Note H—COMPREHENSIVE INCOME
Comprehensive income is summarized as follows:
                                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
(Thousands of dollars)   2005     2004     2005     2004  
Net income
  $ 151,608     $ 132,863     $ 388,123     $ 310,769  
Foreign currency translation adjustments
    10,941       10,759       19,375       2,270  
Marketable equity securities adjustments
    165               156          
 
                       
Comprehensive income
  $ 162,714     $ 143,622     $ 407,654     $ 313,039  
 
                       

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Note I—INCOME PER COMMON SHARE
                                 
    Three months ended September 30,     Nine months ended September 30,  
(Thousands of dollars except per share data)   2005     2004     2005     2004  
Basic
                               
Average common shares outstanding
    136,911,347       140,197,680       137,618,594       141,179,049  
 
                       
 
                               
Net income
  $ 151,608     $ 132,863     $ 388,123     $ 310,769  
 
                       
 
                               
Net income per common share
  $ 1.11     $ 0.95     $ 2.82     $ 2.20  
 
                       
 
                               
Diluted
                               
Average common shares outstanding
    136,911,347       140,197,680       137,618,594       141,179,049  
Non-vested restricted stock grants
    886,225       897,000       971,700       864,333  
Stock options and other contingently issuable shares
    3,429,896       3,570,333       3,382,033       3,059,831  
 
                       
Average common shares assuming dilution
    141,227,468       144,665,013       141,972,327       145,103,213  
 
                       
 
                               
Net income
  $ 151,608     $ 132,863     $ 388,123     $ 310,769  
 
                       
Net income per common share
  $ 1.07     $ 0.92     $ 2.73     $ 2.14  
 
                       

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Note J—REPORTABLE SEGMENT INFORMATION
The Company reports segment information in the same way that management internally organizes its business for assessing performance and making decisions regarding allocation of resources in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.”

Net External Sales/ Operating Profit


                                 
    2005     2004  
    Net     Segment     Net     Segment  
    External     Operating     External     Operating  
(Thousands of dollars)   Sales     Profit     Sales     Profit  
Three months ended September 30:
                               
Paint Stores
  $ 1,366,601     $ 185,113     $ 1,118,001     $ 168,536  
Consumer
    361,176       52,951       345,762       54,344  
Automotive Finishes
    145,520       9,593       130,785       14,835  
International Coatings
    101,542       8,428       80,681       4,471  
Administrative
    1,889       (37,091 )     1,901       (37,382 )
 
                       
Consolidated totals
  $ 1,976,728     $ 218,994     $ 1,677,130     $ 204,804  
 
                       
 
                               
Nine months ended September 30:
                               
Paint Stores
  $ 3,664,959     $ 450,740     $ 2,958,424     $ 364,871  
Consumer
    1,104,837       168,979       1,034,711       173,483  
Automotive Finishes
    419,010       42,072       382,597       43,055  
International Coatings
    286,214       15,714       233,164       10,475  
Administrative
    5,611       (131,300 )     5,710       (112,724 )
 
                       
Consolidated totals
  $ 5,480,631     $ 546,205     $ 4,614,606     $ 479,160  
 
                       

Intersegment Transfers
                                 
    Three months ended September 30,     Nine months ended September 30,  
(Thousands of dollars)   2005     2004     2005     2004  
Paint Stores
  $ 251     $ 177     $ 643     $ 510  
Consumer
    442,923       320,215       1,149,597       866,499  
Automotive Finishes
    19,263       17,541       51,129       44,138  
International Coatings
    323       343       600       1,131  
Administrative
    1,264       1,172       3,910       3,493  
 
                       
Segment totals
  $ 464,024     $ 339,448     $ 1,205,879     $ 915,771  
 
                       
Segment operating profit is total revenue, including intersegment transfers, less operating costs and expenses. Domestic intersegment transfers are accounted for at the approximate fully absorbed manufactured cost plus distribution costs. International intersegment transfers are accounted for at values comparable to normal unaffiliated customer sales. The Administrative Segment’s expenses include interest which is unrelated to certain financing activities of the Operating Segments, certain foreign currency transaction losses related to dollar-denominated debt and other financing activities, and other adjustments.
Net external sales and operating profits of all consolidated foreign subsidiaries were $203.8 million and $11.1 million, respectively, for the third quarter of 2005, and $160.4 million and $9.3 million, respectively, for the third quarter of 2004. Net external sales and operating profits of these subsidiaries were $555.8 million and $27.9 million, respectively, for the first nine months of 2005, and $463.7 million and $22.5 million, respectively, for the first nine months of 2004. Long-lived assets of these subsidiaries totaled $123.2 million and $121.7 million at September 30, 2005 and 2004, respectively. Domestic operations account for the remaining net external sales, operating profits and long-lived assets. The Administrative Segment’s expenses do not include any significant foreign operations. No single geographic area outside the United States was significant relative to consolidated net external sales or consolidated long-lived assets.
Export sales and sales to any individual customer were each less than 10% of consolidated sales to unaffiliated customers during all periods presented.

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Note K HEALTH CARE, PENSION AND OTHER BENEFITS
Shown below are the components of the Company’s net periodic benefit (credit) cost for domestic defined benefit pension plans, foreign defined benefit pension plans and postretirement benefits other than pensions:
                                                 
(thousands of dollars)   Domestic Defined     Foreign Defined     Postretirement Benefits  
    Benefit Pension Plans     Benefit Pension Plans     Other than Pensions  
    2005     2004     2005     2004     2005     2004  
Three months ended September 30:
                                               
Net periodic benefit (credit) cost:
                                               
Service cost
  $ 4,316     $ 1,924     $ 587     $ 388     $ 1,111     $ 1,071  
Interest cost
    3,406       2,920       673       586       4,345       3,860  
Expected return on assets
    (11,003 )     (10,066 )     (503 )     (477 )                
Recognition of:
                                               
Unrecognized prior service cost
    154       197       15       17       (1,112 )     (1,114 )
Unrecognized actuarial loss
    781       1,272       303       265       1,265       454  
 
                                   
Net periodic benefit (credit) cost
  $ (2,346 )   $ (3,753 )   $ 1,075     $ 779     $ 5,609     $ 4,271  
 
                                   
 
                                               
Nine months ended September 30:
                                               
Net periodic benefit (credit) cost:
                                               
Service cost
  $ 12,946     $ 7,796     $ 1,836     $ 1,268     $ 3,333     $ 3,255  
Interest cost
    10,220       9,275       2,097       1,849       13,035       12,548  
Expected return on assets
    (33,009 )     (29,517 )     (1,554 )     (1,488 )                
Recognition of:
                                               
Unrecognized prior service cost
    464       591       53       67       (3,336 )     (3,338 )
Unrecognized actuarial loss
    2,345       4,535       928       802       3,795       2,678  
 
                                   
Net periodic benefit (credit) cost
  $ (7,034 )   $ (7,320 )   $ 3,360     $ 2,498     $ 16,827     $ 15,143  
 
                                   
For further details on the Company’s health care, pension and other benefits, see Note 7 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.
NOTE L—OTHER LONG-TERM LIABILITIES
The Company initially provides for estimated costs of environmental-related activities relating to its past operations and third-party sites for which commitments or clean-up plans have been developed and when such costs can be reasonably estimated based on industry standards and historical experience. These estimated costs are determined based on currently available facts regarding each site. If the best estimate of costs can only be identified as a range and no specific amount within that range can be determined more likely than any other amount within the range, the minimum of the range is provided. The unaccrued maximum of the estimated range of possible outcomes is $134.4 million higher than the accrued amount at September 30, 2005. The Company continuously assesses its potential liability for investigation and remediation-related activities and adjusts its environmental-related accruals as information becomes available upon which more accurate costs can be reasonably estimated and as additional accounting guidelines are issued. Actual costs incurred may vary from these estimates due to the inherent uncertainties involved including, among others, the number and financial condition of parties involved with respect to any given site, the volumetric contribution which may be attributed to the Company relative to that attributed to other parties, the nature and magnitude of the wastes involved, the various technologies that can be used for remediation and the determination of acceptable remediation with respect to a particular site.
Included in Other long-term liabilities at September 30, 2005 and 2004 were accruals for extended environmental-related activities of $124.2 million and $107.8 million, respectively. Estimated costs of current investigation and remediation activities of $24.9 million and $25.7 million are included in Other accruals at September 30, 2005 and 2004, respectively.
Four of the Company’s current and former manufacturing sites account for the majority of the accrual for environmental-related activities and the unaccrued maximum of the estimated range of possible outcomes at September 30, 2005. Included in the accruals of $149.1 million at September 30, 2005 is $96.1 million related directly to these four sites. Of the aggregate unaccrued exposure of $134.4 million at September 30, 2005, $75.4 million relates to the four manufacturing sites. While environmental

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investigations and remedial actions are in different stages at these sites, additional investigations, remedial actions and monitoring will likely be required at each site.
Management cannot presently estimate the potential loss contingencies related to these four sites or other less significant sites until such time as a substantial portion of the investigation at the sites is completed and remedial action plans are developed. In the event any future loss contingency significantly exceeds the current amount accrued, the recording of the ultimate liability may result in a material impact on net income for the annual or interim period during which the additional costs are accrued. Management does not believe that any potential liability ultimately attributed to the Company for its environmental-related matters will have a material adverse effect on the Company’s financial condition, liquidity, or cash flow due to the extended period of time during which environmental investigation and remediation takes place. An estimate of the potential impact on the Company’s operations cannot be made due to the aforementioned uncertainties.
Management expects these contingent environmental-related liabilities to be resolved over an extended period of time. Management is unable to provide a more specific time frame due to the indefinite amount of time to conduct investigation activities at any site, the indefinite amount of time to obtain governmental agency approval, as necessary, with respect to investigation and remediation activities, and the indefinite amount of time necessary to conduct remediation activities.
For further details on the Company’s Other long-term liabilities, see Note 9 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.
Note M IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123R, “Share-Based Payment,” that addresses the accounting transactions in which a company exchanges its equity instruments for goods or services. It also addresses transactions in which a company incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. SFAS No. 123R eliminates the ability to account for share-based compensation transactions using Accounting Principles Board (APB) Opinion No. 25 and requires instead that such transactions be accounted for using a fair-value-based method. SFAS No. 123R requires the tax benefit associated with these share based payments to be classified as financing activities in the statement of cash flows. In April 2005, the Securities and Exchange Commission adopted a rule that amends the compliance date of SFAS No. 123R to fiscal years beginning after June 15, 2005. The Company will adopt this statement as required, and management is currently assessing the effect SFAS No. 123R will have on the Company’s results of operations, financial condition or liquidity.
In December 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4,” which requires that abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) be recognized as current-period charges. In addition, the statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005. The Company will adopt this statement as required, and management does not believe the adoption will have a material effect on the Company’s results of operations, financial condition or liquidity.
In December 2004, the FASB issued FSP FAS No. 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, for the Tax Deduction Provided to U.S. Based Manufacturers by the American Jobs Creation Act of 2004.” This statement requires the qualified production activities deduction as defined in the American Jobs Creation Act of 2004 (the Jobs Act) to be accounted for as a special deduction in accordance with SFAS No. 109, “Accounting for Income Taxes.” The statement also requires that the special deduction should be considered in measuring deferred taxes when graduated tax rates are a significant factor and when assessing whether a valuation allowance is necessary. FSP FAS No. 109-1 was effective upon issuance. Management has determined that this statement will have a slightly favorable effect on the Company’s 2005 annual effective tax rate.
In March 2005, the FASB issued Interpretation No. 47 (“FIN 47”), “Accounting for Conditional Asset Retirement Obligations – an interpretation of FASB Statement No. 143.” FIN 47 requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated. FIN 47 states that a conditional asset retirement obligation is a legal obligation to perform an asset retirement activity in which the timing or method of settlement are conditional upon a future event that may or may not be within control of the entity. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. Retrospective application for the interim financial information is permitted but

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not required. Early adoption of FIN 47 is encouraged. The Company will adopt this statement as required, and management is currently assessing the effect FIN 47 will have on the Company’s results of operations, financial condition or liquidity.
Note N — INCOME TAXES
The effective tax rates were 30.6 percent and 28.7 percent for the third quarter and first nine months of 2005, respectively, and 35.0 percent for both the third quarter and first nine months of 2004. The reduction in the tax rate in 2005 was due to various favorable factors including the impact of the settlement of federal and state audit issues and tax benefits related to foreign operations.
Note O — RECLASSIFICATION
Certain amounts in the 2004 financial statements have been reclassified to conform with the 2005 presentation.

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Item 2. MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Consolidated net sales increased 17.9 percent to $2.0 billion in the third quarter of 2005 and 18.8 percent to $5.50 billion in the first nine months of 2005 versus 2004. Diluted net income per common share increased 16.3 percent in the third quarter to $1.07 per share from $.92 per share in 2004 and 27.6 percent in the first nine months of 2005 to $2.73 per share from $2.14 per share a year ago.
Consolidated net sales increased in both the quarter and first nine months of 2005 due primarily to strong sales performances by stores open for more than twelve calendar months, acquisitions in the Paint Stores and Consumer Segments and improvement in the Automotive Finishes and International Coatings Segments. Acquisitions, including Duron, Inc. and Paint Sundry Brands Corporation acquired in September 2004, added $102.1 million, or 6.1 percent, to net sales in the third quarter and $367.1 million, or 8.0 percent, to net sales in the first nine months of 2005.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The consolidated financial statements and accompanying footnotes included in this report have been prepared in accordance with accounting principles generally accepted in the United States with certain amounts based on management’s best estimates and judgments. To determine appropriate carrying values of assets and liabilities that are not readily available from other sources, management uses assumptions based on historical results and other factors that they believe are reasonable. Actual results could differ from those estimates. Also, materially different amounts may result under materially different conditions or from using materially different assumptions. However, management currently believes that any materially different amounts resulting from materially different conditions or material changes in facts or circumstances are unlikely.
There have been no significant changes in critical accounting policies or management estimates since the year ended December 31, 2004. The Company’s accruals for environmental remediation-related activities as of September 30, 2005 are disclosed in Note L. Changes in the Company’s accruals for qualified exit or disposal costs since the year ended December 31, 2004 are disclosed in Note F. A comprehensive discussion of the Company’s critical accounting policies and management estimates 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, 2004.
FINANCIAL CONDITION
Cash and cash equivalents decreased $16.1 million during the first nine months of 2005 related primarily to treasury stock purchases of $268.1 million, cash dividends of $85.7 million and capital expenditures of $103.0 million, which were offset by net cash from operations and an increase in short-term borrowings of $46.5 million. Short-term borrowings related to the

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Company’s commercial paper program outstanding at September 30, 2005 were $267.1 million. The Company had unused maximum borrowing availability of $642.9 million at September 30, 2005 under the commercial paper program that is backed by the Company’s revolving credit agreement. At September 30, 2005, the Company’s current ratio was 1.20, a slight increase from 1.17 at December 31, 2004.
Since September 30, 2004, a cash balance of $97.2 million and cash generated by operations of $550.3 million were used primarily to purchase treasury stock of $332.0 million, for capital expenditures of $133.4 million, for dividends paid of $109.7 million and to reduce short-term borrowings by $82.7 million.
Capital expenditures during the first nine months of 2005 primarily represented expenditures associated with 57 net new store openings and normal equipment replacement in the Paint Stores Segment and capacity and service improvements in the Consumer Segment.
During the third quarter of 2005, the Company purchased 2,325,629 shares of its common stock for treasury purposes through open market purchases, which brings the total number of shares purchased in 2005 to 6,025,729. The Company acquires shares of its common stock for general corporate purposes and, depending upon its cash position and market conditions, the Company may acquire additional shares of its common stock in the future. The Company had remaining authorization at September 30, 2005 to purchase 4,397,271 shares of its common stock.
Management believes that it properly valued the Company’s assets and recorded all known liabilities that existed as of the balance sheet date for which a value was available or an amount could be reasonably estimated in accordance with all present accounting principles generally accepted in the United States. In addition, the Company may be subject to potential liabilities, as described in the following, which cannot be reasonably estimated due to the uncertainties involved.
The Company’s past operations included the manufacture and sale of lead pigments and lead-based paints. The Company, along with other companies, is a defendant in a number of legal proceedings, including purported class actions, separate actions brought by the State of Rhode Island, 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 are seeking recovery 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 practices and consumer protection laws, enterprise liability, market share liability, nuisance, unjust enrichment and other theories. The plaintiffs seek various damages and relief, including personal injury and property damage, costs relating to the detection and abatement of lead-based paint from buildings, costs associated with a public education campaign, medical monitoring costs and others. The Company is also a defendant in legal proceedings arising from the manufacture and sale of non-lead-based paints which 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 is without merit and is vigorously defending such litigation. The Company expects that additional lead pigment and lead-based paint litigation may

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be filed against the Company in the future asserting similar or different legal theories and seeking similar or different types of damages and relief.
During September 2002, a jury trial commenced in the first phase of the action brought by the State of Rhode Island against the Company and the other defendants. The sole issue before the court in this first phase was whether lead pigment in paint constituted a public nuisance under Rhode Island law. This first phase did not consider the issues of liability or damages, if any, related to the public nuisance claim. In October 2002, the court declared a mistrial as the jury, which was split four to two in favor of the defendants, was unable to reach a unanimous decision. This was the first legal proceeding against the Company to go to trial relating to the Company’s lead pigment and lead-based paint litigation. The State of Rhode Island decided to retry the case and the new trial will decide all issues, including liability and damages. The trial commenced on November 1, 2005. The Company believes it is possible that additional legal proceedings could be scheduled for trial in subsequent years in other jurisdictions.
Litigation is inherently subject to many uncertainties. 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 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 and to overturn 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 affect 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 any such legislation and regulations. The Company has not accrued any amounts for such litigation. Any potential liability that may result from such litigation or such legislation and regulations cannot reasonably be estimated. Based upon, among other things, the outcome of such litigation to date, management believes that the Company will ultimately be successful on the merits of such litigation. However, 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.
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

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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 2005. 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 2005.
The Company is involved with environmental investigation and remediation activities at some of its current and former 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 current, former 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 September 30, 2005 and 2004, the Company had accruals for environmental-related activities of $149.1 million and $133.5 million, respectively.
Due to the uncertainties surrounding environmental investigation and remediation activities, the Company’s 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 $134.4 million higher than the accruals at September 30, 2005.
Four of the Company’s current and former manufacturing sites, described below, accounted for the majority of the accruals for environmental-related activities and the unaccrued maximum of the estimated range of possible outcomes at September 30, 2005. Included in the accruals of $149.1 million at September 30, 2005 was $96.1 million related directly to these four sites. Of

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the aggregate unaccrued exposure of $134.4 million at September 30, 2005, $75.4 million related to the four manufacturing sites. While environmental investigations and remedial actions are in different stages at these sites, additional investigations, remedial actions and monitoring will likely be required at each site.
The first of the four sites is a former manufacturing facility in New Jersey that is in the early investigative stage of the environmental-related process. Although contamination exists at the site and adjacent areas, the extent and magnitude of the contamination has not yet been fully quantified. Due to the uncertainties of the scope and magnitude of contamination and the degree of remediation that may be necessary relating to this site, it is reasonably likely that further extensive investigation may be required and that extensive remedial actions may be necessary not only at the former manufacturing site but along an adjacent waterway. Depending on the extent of the additional investigation and remedial actions necessary, the ultimate liability for this site may exceed the amount currently accrued and the maximum of the range of reasonably possible outcomes currently estimated by management.
Two additional sites relate to a current manufacturing facility located in Illinois and a contiguous property. The environmental issues at these sites have been determined to be associated with historical operations of the Company. While the majority of the investigative work has been completed at these sites and some remedial actions taken, agreement on a proposed remedial action plan has not been obtained from the appropriate governmental agency.
The fourth site is a current manufacturing facility in California. Similar to the Illinois sites noted above, the environmental issues at this site have been determined to be associated with historical operations. The majority of the investigative activities have been completed at this site, some remedial actions have been taken and a proposed remedial action plan has been formulated but currently no clean up goals have been approved by the lead governmental agency. In both the Illinois and California sites, the potential liabilities relate to clean-up goals that have not yet been established and the degree of remedial actions that may be necessary to achieve these goals.
Management cannot presently estimate the potential loss contingencies that may exceed the amounts accrued related to these four sites or other less significant sites until such time as a substantial portion of the investigation at the sites is completed and remedial action plans are developed. In the event any future loss contingency significantly exceeds the current amount accrued, the recording of the ultimate liability may result in a material impact on net income for the annual or interim period during which the additional costs are accrued. Management does not believe that any potential liability ultimately attributed to the Company for its environmental-related matters will have a material adverse effect on the Company’s financial condition, liquidity, or cash flow due to the extended period of time during which environmental investigation and remediation takes place. An estimate of the potential impact on the Company’s operations cannot be made due to the aforementioned uncertainties.
Management expects these contingent environmental-related liabilities to be resolved over an extended period of time. Management is unable to provide a more specific time frame due to the indefinite amount of time to conduct investigation activities at any site, the indefinite amount of time to obtain governmental agency approval, as necessary, with respect to investigation and

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remediation activities, and the indefinite amount of time necessary to conduct remediation activities.
On October 26, 2005, a wholly-owned subsidiary of the Company acquired a 25% interest in Life Shield Engineered Systems, LLC (Life Shield) and became obligated to acquire an additional 24% interest in Life Shield on October 26, 2007. Life Shield is a start-up company that develops and manufactures blast and fragment mitigating systems and ballistic resistant systems. The blast and fragment mitigating systems and ballistic resistant systems create a potentially higher level of product liability for the Company (as an owner of and raw material supplier to Life Shield and as the exclusive distributor of Life Shield’s systems) than is normally associated with coatings and related products currently manufactured, distributed and sold by the Company.
Certain of Life Shield’s technology has been designated as Qualified Anti-Terrorism Technology and has been granted a Designation under the Support Anti-terrorism by Fostering Effective Technologies Act of 2002 (SAFETY Act) and the regulations adopted pursuant to the SAFETY Act. Under the SAFETY Act, the potentially higher level of possible product liability for Life Shield relating to the technology granted the Designation is limited to $6.0 million per occurrence in the event any such liability arises from an Act of Terrorism (as defined in the SAFETY Act). The limitation of liability provided for under the SAFETY Act does not apply to any technology not granted a designation or certification as a Qualified Anti-Terrorism Technology, nor in the event that any such liability arises from an act or event other than an Act of Terrorism. Life Shield is expected to obtain commercially available insurance for liabilities up to the $6.0 million per occurrence limitation caused by failure of its products in the event of an Act of Terrorism. This commercial insurance is also expected to cover product liability claims asserted against the Company as the distributor of Life Shield’s systems. The Company expects to seek Designation and Certification under the SAFETY Act for certain products supplied by the Company to Life Shield.
Management of the Company has reviewed the potential increased liabilities associated with Life Shield’s systems and determined that potential liabilities arising from an Act of Terrorism that could ultimately affect the Company will be appropriately insured or limited by current regulations. However, due to the uncertainties involved in the future development, usage and application of Life Shield’s systems, the number or nature of possible future claims and legal proceedings, or the affect that any change in legislation and/or administrative regulations may have on the limitations of potential liabilities, management cannot reasonably determine the scope or amount of any potential costs and liabilities for the Company related to Life Shield or to Life Shield’s systems. Any potential liability for the Company that may result from Life Shield or Life Shield’s systems cannot reasonably be estimated. However, based upon, among other things, the limitation of liability under the SAFETY Act in the event of an Act of Terrorism, management does not currently believe that the costs or potential liability ultimately determined to be attributable to the Company through its ownership of Life Shield, as a supplier to Life Shield or as a distributor of Life Shield’s systems arising from the use of Life Shield’s systems will have a material adverse effect on the Company’s results of operations, liquidity or financial condition.
There have been no significant changes to the Company’s contractual obligations and commercial commitments in the first nine months of 2005 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, 2004.
Changes to the Company’s accrual for product warranty claims in the first nine months of 2005 are disclosed in Note G.
RESULTS OF OPERATIONS
Shown below are net sales and the percentage change for the third quarter and first nine months by reportable segment for 2005 and 2004:
                         
(thousands of dollars)   2005     Change     2004  
Three months ended September 30:
                       
Paint Stores
  $ 1,366,601       22.2 %   $ 1,118,001  
Consumer
    361,176       4.5 %     345,762  
Automotive Finishes
    145,520       11.3 %     130,785  
International Coatings
    101,542       25.9 %     80,681  
Administrative
    1,889       -0.6 %     1,901  
 
                   
 
  $ 1,976,728       17.9 %   $ 1,677,130  
 
                   
 
                       
Nine months ended September 30:
                       
Paint Stores
  $ 3,664,959       23.9 %   $ 2,958,424  
Consumer
    1,104,837       6.8 %     1,034,711  
Automotive Finishes
    419,010       9.5 %     382,597  
International Coatings
    286,214       22.8 %     233,164  
Administrative
    5,611       -1.7 %     5,710  
 
                   
 
 
  $ 5,480,631       18.8 %   $ 4,614,606  
 
                   
Consolidated net sales increased in both the quarter and first nine months of 2005 due primarily to strong sales performances by stores open for more than twelve calendar months, acquisitions in the Paint Stores and Consumer Segments and improvement in the Automotive Finishes and International Coatings Segments. Acquisitions, including Duron, Inc. and Paint Sundry Brands Corporation acquired in September 2004, added $102.1 million, or 6.1 percent, to net sales in the third quarter and $367.1 million, or 8.0 percent, to net sales in the first nine months of 2005. In the Paint Stores Segment, the acquisition of Duron, Inc. added approximately 6.6% to this Segment’s net sales in the quarter and 9.0% in the first nine months. Net sales from stores open for more than twelve calendar months increased 14.0% in the quarter and 13.2% in the first nine months over last year. Net sales of the Consumer Segment increased in the quarter and the first nine months compared to last year due primarily to acquisitions that added approximately 8.0

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percent to net sales in the quarter and approximately 9.1 percent to net sales in the first nine months. In addition, sales increases associated with new product introductions, increased paint sales volume and selling price increases were more than offset by the elimination of a paint program with a customer, lower sales to certain major retail customers of this Segment as they continue to drive up inventory turns and sluggish retail sales at some of the Segment’s other customers.
The Automotive Finishes Segment’s net sales in the third quarter and first nine months increased due primarily to the impact of favorable currency exchange rates and selling price increases. The impact of favorable currency exchange rates increased net sales of this Segment by 3.8 percent in the quarter and 2.8 percent in the first nine months. The April 2004 acquisition of a majority interest in an automotive coatings company in China added 1.5 percent to net sales in the first nine months. On September 30, 2005, the Company disposed of its majority interest in this joint venture and realized a loss of $7.9 million. In the International Coatings Segment, net sales increases in local currencies of 9.9 percent in the quarter and 11.1 percent in the first nine months were enhanced by the impact of favorable currency exchange rates that further increased sales in U.S. dollars. The sales increases in local currencies were due primarily to volume gains and selling price increases in South America.
Shown below are operating profit and the percent change for the third quarter and first nine months by reportable segment for 2005 and 2004:
                         
(thousands of dollars)   2005     Change     2004  
Three months ended September 30:
                       
Paint Stores
  $ 185,113       9.8 %   $ 168,536  
Consumer
    52,951       -2.6 %     54,344  
Automotive Finishes
    9,593       -35.3 %     14,835  
International Coatings
    8,428       88.5 %     4,471  
Administrative
    (37,091 )     0.8 %     (37,382 )
 
                   
 
 
  $ 218,994       6.9 %   $ 204,804  
 
                   
 
Nine months ended September 30:
                       
Paint Stores
  $ 450,740       23.5 %   $ 364,871  
Consumer
    168,979       -2.6 %     173,483  
Automotive Finishes
    42,072       -2.3 %     43,055  
International Coatings
    15,714       50.0 %     10,475  
Administrative
    (131,300 )     -16.5 %     (112,724 )
 
                   
 
  $ 546,205       14.0 %   $ 479,160  
 
                   
Consolidated operating profit increased due to the change in gross profit, which increased $96.2 million and $302.1 million in the third quarter and first nine months of 2005, respectively. Consolidated gross profit as a percent to net sales declined to 42.5 percent in the quarter from 44.3 percent in the third quarter of 2004 and to 42.7 percent from 44.1 percent in the first nine months of 2004 due primarily to raw material cost increases partially offset by selling price increases and better factory utilization resulting from higher volume.

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The Paint Stores Segment’s gross profit for the third quarter and first nine months of 2005 increased $85.8 million and $284.5 million, respectively, due primarily to increased sales volume from strong domestic architectural paint sales, increased sales to do-it-yourself customers and improved industrial maintenance and product finishes sales that partially offset increased raw material costs. The Consumer Segment’s gross profit for the third quarter and nine months of 2005 was essentially flat with last year due to selling price increases, better factory utilization resulting from higher volume through the Paint Stores Segment and the acquisition of Paint Sundry Brands offsetting continued significant raw material cost increases. The Automotive Finishes Segment’s gross profit percentage decreased during the quarter and first nine months of 2005 due to significant increases in raw material costs that could not be entirely offset by the favorable net sales gains. The International Coatings Segment’s gross profit for the third quarter and first nine months of 2005 increased by $5.6 million and $11.6 million, respectively, as a result of increased sales, favorable currency exchange rates and improved operating efficiencies related to additional manufacturing volume which were partially offset by continued significant cost increases of many raw materials.
Selling, general and administrative expenses decreased as a percent of sales to 30.5 percent in the third quarter of 2005 from 31.4 percent in the third quarter of 2004 and decreased to 31.7 percent in the first nine months of 2005 from 33.1 percent in the nine months of 2004. In the Paint Stores Segment, the SG&A ratio decreased in both the third quarter and first nine months of 2005 due to increased sales volume and effective SG&A expense control. The Consumer Segment’s SG&A ratio was favorable as a percent of sales and spending was only slightly over last year in the third quarter and first nine months of 2005 due primarily to ongoing tight expense control. The Automotive Finishes and International Coatings Segment’s SG&A expense as a percent of sales decreased for both the third quarter and first nine months of 2005 due to increased sales volumes and effective expense control.
The effective tax rates were 30.6 percent and 28.7 percent for the third quarter and first nine months of 2005, respectively, and 35.0 percent for both the third quarter and first nine months of 2004. The reduction in the tax rate in 2005 was due to various favorable factors including the impact of the settlement of federal and state audit issues and tax benefits related to foreign operations.
Net income increased $18.7 million, or 14.1 percent, in the third quarter of 2005 and increased $77.4 million, or 24.9 percent, for the first nine months of 2005. The increase in diluted net income per common share of $.15 per share in the quarter and $.59 per share in nine months resulted primarily from improved operating performance and profit contributions of acquisitions of $.12 per share and $.41 per share respectively and from lower effective tax rates of approximately $.06 per share in the third quarter and $.23 per share year-to-date.
Management considers a measurement that is not in accordance with accounting principles generally accepted in the United States 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

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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 accounting principles generally accepted in the United States disclosed in the Statements of Consolidated Income and Statements of Consolidated Cash Flows. EBITDA as used by management is calculated as follows:
                                 
    Three months ended September 30,     Nine months ended September 30,  
(thousands of dollars)   2005     2004     2005     2004  
Net income
  $ 151,608     $ 132,863     $ 388,123     $ 310,769  
Interest expense
    12,092       10,235       37,612       28,987  
Income taxes
    66,970       71,681       156,726       167,706  
Depreciation
    30,597       27,891       89,531       78,765  
Amortization
    5,296       3,916       17,422       10,447  
 
                       
EBITDA
  $ 266,563     $ 246,586     $ 689,414     $ 596,674  
 
                       

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are based upon management’s current expectations, estimates, assumptions and beliefs concerning future events and conditions and may discuss, among other things, anticipated future performance (including sales and earnings), expected growth, future business plans and the costs and potential liability for environmental-related matters and the lead pigment and lead-based paint litigation. Any statement that is not historical in nature is a forward-looking statement and may be identified by the use of words and phrases such as “expects,” “anticipates,” “believes,” “will,” “will likely result,” “will continue,” “plans to” and similar expressions.
Readers are cautioned not to place undue reliance on any forward-looking statements. Forward-looking statements are necessarily subject to risks, uncertainties and other factors, many of which are outside the control of the Company, that could cause actual results to differ materially from such statements and from the Company’s historical results and experience. These risks, uncertainties and other factors include such things as: (a) 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 availability and pricing; (d) changes in the Company’s relationships with customers and suppliers; (e) the ability of the Company to attain cost savings from productivity initiatives; (f) the ability of the Company to successfully integrate past and future acquisitions into its existing operations, as well as the performance of the businesses acquired, including the acquisitions of Duron, Inc. and Paint Sundry Brands Corporation; (g) changes in general domestic economic conditions such as inflation rates, interest rates and tax rates; (h) risks and uncertainties associated with the Company’s expansion into and its operations in China, South America and other foreign markets, including inflation rates, recessions, foreign currency exchange rates, foreign investment and repatriation restrictions, unrest and other external economic and political factors; (i) the achievement of growth in developing markets, such as China, Mexico and South America; (j) increasingly stringent domestic and foreign governmental regulations including those affecting the environment; (k) inherent uncertainties involved in assessing the Company’s potential liability for environmental remediation-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 affect 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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Item 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk associated with interest rates and value changes in foreign currencies. The Company 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 has partially hedged risks associated with fixed interest rate debt by entering into various interest rate swap agreements. The Company does not believe that any potential loss related to interest rate exposure would have a material adverse effect on the Company’s financial condition, results of operations or cash flows. The Company enters into foreign currency option and forward contracts to hedge against value changes in foreign currency. The Company believes it may experience continuing losses from foreign currency translation. However, the Company does not expect currency translation, transaction or hedging contract losses to have a material adverse effect on the Company’s financial condition, results of operations or cash flows. There were no material changes in the Company’s exposure to market risk since the disclosure included in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

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Item 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our Chairman, President and Chief Executive Officer and our Senior Vice President — Finance and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 and Rule 15d-15 of the Securities Exchange Act of 1934, as amended. Based upon that evaluation, our Chairman, President and Chief Executive Officer and our Senior Vice President — Finance and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be disclosed by us in our periodic SEC reports. There were no changes in our internal control over financial reporting identified in connection with the evaluation that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Securities and Use of Proceeds
A summary of the repurchase activity for the Company’s third quarter is as follows:
                                 
                    Total Number     Maximum  
    Total             of Shares     Number of Shares  
    Number of     Average     Purchased as     That May Yet Be  
    Shares     Price Paid     Part of Publicly     Purchased Under  
Period   Purchased     Per Share     Announced Plan     the Plan  
July 1 - July 31
                               
Share repurchase program (1)
                            6,722,900  
Employee transactions (2)
    3,648     $ 47.61               N/A  
August 1 - August 31
                               
Share repurchase program (1)
    299,900     $ 46.46       299,900       6,423,000  
Employee transactions (2)
                            N/A  
September 1 - September 30
                               
Share repurchase program (1)
    2,025,729     $ 43.87       2,025,729       4,397,271  
Employee transactions (2)
    3,861     $ 43.76               N/A  
 
                       
 
                               
Total
                               
Share repurchase program (1)
    2,325,629     $ 44.20       2,325,629       4,397,271  
Employee transactions (2)
    7,509     $ 45.63               N/A  
 
(1)   All shares were purchased through the Company’s 20.0 million share repurchase program publicly announced on October 24, 2003. On October 21, 2005, the Company rescinded the October 24, 2003 share repurchase program and announced a new 20.0 million share repurchase program. There is no expiration date specified for the new program. The Company intends to repurchase stock under the new program in the future.
 
(2)   All shares were delivered to satisfy the exercise price and/or tax withholding obligations by employees who exercised stock options.
Item 6. Exhibits.
  (a)   Exhibits.
             
 
    (4 )(a)   Amendment and Restatement Agreement, dated as of July 20, 2005, in respect of the Five-Year Competitive Advance and Revolving Credit Facility Agreement, dated July 19, 2004, among The Sherwin-Williams Company; the Lenders party thereto; JPMorgan Chase Bank, N.A., as Administrative Agent; and Wachovia Bank, National Association, as Syndication Agent, filed

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          as Exhibit 4(a) to Sherwin-Williams’ Current Report on Form 8-K dated July 20, 2005, and incorporated herein by reference.
 
           
 
    (10 )(a)   Schedule of Certain Executive Officers who are Parties to the Severance Pay Agreements in the forms attached as Exhibit 10(b) to Sherwin-Williams’ Quarterly Report on Form 10-Q for the period ended June 30, 1997 (filed herewith).
 
           
 
    (10 )(b)   Schedule of Certain Executive Officers who are Parties to the Individual Grantor Trust Participation Agreements in the form attached as Exhibit 10(a) to Sherwin-Williams’ Quarterly Report on Form 10-Q for the period ended September 30, 2003 (filed herewith).
 
           
 
    (10 )(c)   2004-2 Amendment to The Sherwin-Williams Company Deferred Compensation Savings and Pension Equalization Plan filed as Exhibit 10(b) to Sherwin-Williams’ Current Report on Form 8-K dated July 20, 2005, and incorporated herein by reference.
 
           
 
    (10 )(d)   2004-1 Amendment to The Sherwin-Williams Company Revised Key Management Deferred Compensation Plan filed as Exhibit 10(c) to Sherwin-Williams’ Current Report on Form 8-K dated July 20, 2005, and incorporated herein by reference.
 
           
 
    (10 )(e)   2004-1 Amendment to The Sherwin-Williams Company Director Deferred Fee Plan (1997 Amendment and Restatement) filed as Exhibit 10(d) to Sherwin-Williams’ Current Report on Form 8-K dated July 20, 2005, and incorporated herein by reference.
 
           
 
    (10 )(f)   The Sherwin-Williams Company 2005 Deferred Compensation Savings and Pension Equalization Plan filed as Exhibit 10(e) to Sherwin-Williams’ Current Report on Form 8-K dated July 20, 2005, and incorporated herein by reference.
 
           
 
    (10 )(g)   The Sherwin-Williams Company 2005 Key Management Deferred Compensation Plan filed as Exhibit 10(f) to Sherwin-Williams’ Current Report on Form 8-K dated July 20, 2005, and incorporated herein by reference.
 
           
 
    (10 )(h)   The Sherwin-Williams Company 2005 Director Deferred Fee Plan filed as Exhibit 10(g) to Sherwin-Williams’ Current Report on Form 8-K dated July 20, 2005, and incorporated herein by reference.
 
           
 
    (31 )(a)   Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer (filed herewith).

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    (31 )(b)   Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer (filed herewith).
 
           
 
    (32 )(a)   Section 1350 Certification of Chief Executive Officer (filed herewith).
 
           
 
    (32 )(b)   Section 1350 Certification of Chief Financial Officer (filed herewith).
SIGNATURES
     Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  THE SHERWIN-WILLIAMS COMPANY
 
 
November 9, 2005  By:   /s/ J. L. Ault    
    J. L. Ault   
    Vice President-Corporate Controller
 
 
 
         
     
November 9, 2005  By:   /s/ L. E. Stellato    
    L. E. Stellato   
    Vice President, General Counsel and
Secretary 
 
 
INDEX TO EXHIBITS
     
EXHIBIT NO.   EXHIBIT
(4)(a)
  Amendment and Restatement Agreement, dated as of July 20, 2005, in respect of the Five-Year Competitive Advance and Revolving Credit Facility Agreement, dated July 19, 2004, among The Sherwin-Williams Company; the Lenders party thereto; JPMorgan Chase Bank, N.A., as Administrative Agent; and Wachovia Bank, National Association, as Syndication Agent, filed as Exhibit 4(a) to Sherwin-Williams’ Current Report on Form 8-K dated July 20, 2005, and incorporated herein by reference.
 
   
(10)(a)
  Schedule of Certain Executive Officers who are Parties to the Severance Pay Agreements in the forms attached as Exhibit 10(b) to Sherwin-Williams’ Quarterly Report on Form 10-Q for the period ended June 30, 1997 (filed herewith).

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(10)(b)
  Schedule of Certain Executive Officers who are Parties to the Individual Grantor Trust Participation Agreements in the form attached as Exhibit 10(a) to Sherwin-Williams’ Quarterly Report on Form 10-Q for the period ended September 30, 2003 (filed herewith).
 
   
(10)(c)
  2004-2 Amendment to The Sherwin-Williams Company Deferred Compensation Savings and Pension Equalization Plan filed as Exhibit 10(b) to Sherwin-Williams’ Current Report on Form 8-K dated July 20, 2005, and incorporated herein by reference.
 
   
(10)(d)
  2004-1 Amendment to The Sherwin-Williams Company Revised Key Management Deferred Compensation Plan filed as Exhibit 10(c) to Sherwin-Williams’ Current Report on Form 8-K dated July 20, 2005, and incorporated herein by reference.
 
   
(10)(e)
  2004-1 Amendment to The Sherwin-Williams Company Director Deferred Fee Plan (1997 Amendment and Restatement) filed as Exhibit 10(d) to Sherwin-Williams’ Current Report on Form 8-K dated July 20, 2005, and incorporated herein by reference.
 
   
(10)(f)
  The Sherwin-Williams Company 2005 Deferred Compensation Savings and Pension Equalization Plan filed as Exhibit 10(e) to Sherwin-Williams’ Current Report on Form 8-K dated July 20, 2005, and incorporated herein by reference.
 
   
(10)(g)
  The Sherwin-Williams Company 2005 Key Management Deferred Compensation Plan filed as Exhibit 10(f) to Sherwin-Williams’ Current Report on Form 8-K dated July 20, 2005, and incorporated herein by reference.
 
   
(10)(h)
  The Sherwin-Williams Company 2005 Director Deferred Fee Plan filed as Exhibit 10(g) to Sherwin-Williams’ Current Report on Form 8-K dated July 20, 2005, and incorporated herein by reference.
 
   
(31)(a)
  Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer (filed herewith).
 
   
(31)(b)
  Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer (filed herewith).
 
   
(32)(a)
  Section 1350 Certification of Chief Executive Officer (filed herewith).
 
   
(32)(b)
  Section 1350 Certification of Chief Financial Officer (filed herewith).

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