# Letter to
Shareholders

_Source: `DeepSeekOCR_Ardian_pruned_1k/basic-materials-specialty-chemicals/NYSE_SHW_2018/NYSE_SHW_2018.mmd` · pages 4-10_

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Letter to
Shareholders

We are pleased to report that Sherwin-Williams delivered record performance across many measures in 2018, including sales, earnings before interest, taxes, depreciation and amortization (EBITDA), and net operating cash. Our success stems from our continued focus on innovative products and services to help our customers improve their productivity, profitability and projects.

We posted these outstanding results while also making tremendous progress on the integration of Valspar, the largest acquisition in our history. Integration synergies in 2018 exceeded the target we set at the beginning of the year. We also faced significant and persistent raw

material inflation for the second year in a row, which we responded to with selling price increases, some of which were still flowing in as we entered 2019. Tariffs, global trade uncertainty, interest rate hikes and other headwinds also impacted the operating environment. Still, Sherwin-Williams employees delivered. Specific financial highlights from 2018 \( ^{*} \)  include:

- Sales increased \(2.55 billion, or 17%, to a record \)17.53 billion. Keeping in mind that the Valspar transaction closed on June 1, 2017, incremental Valspar sales from January through May 2018 increased consolidated sales by 12.4% for the year. Organic growth for the full year was 4.7%.

• EBITDA – or "Earnings Before Interest, Taxes, Depreciation and Amortization" – increased 4.4% to a record $2.32 billion.

- GAAP diluted net income per share for 2018 decreased to \(11.67 per share from \)18.20 per share in 2017. The \(11.67 per share includes non-operating expenses of \)2.71 per share and acquisition-related expenses of \(4.15 per share. The \)18.20 per share includes a charge of \(0.44 related to discontinued operations, acquisition-related expenses of \)3.47 per share and a one-time benefit of $7.04 per share from Deferred Income Tax Reductions.

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John G. Morikis, Chairman, President and Chief Executive Officer, and Allen J. Mistsyyn, Senior Vice President – Finance and Chief Financial Officer

• We believe investors gain a more meaningful view of our underlying performance by excluding non-operating and acquisition-related items from results in both years. On this adjusted basis, 2018 diluted earnings per share from continuing operations increased 23.0% to \(18.53 from \)15.07 per share in 2017.

Organic growth increased 4.7% and adjusted diluted net income per share from continuing operations increased 23% compared to the prior year.

• Net operating cash for the year increased \(60 million to a record \)1.94 billion. This cash generation enabled us to continue investing in growth and return capital directly to our shareholders. During the year, we invested \(251 million in our business through capital expenditures, paid \)323 million in cash dividends, invested $613 million to return 1.525 million shares of common stock to treasury and retired $1.1 billion in debt. Net debt to adjusted EBITDA at the end of the year was approximately 3.3 times.

• Our acquisition integration effort is on track. We delivered approximately \(180 million in synergy benefits to the income statement in 2018, about \)30 million above the midpoint of our expectations at the start of the year. We exited the year with an annual synergy run rate of approximately \(360 million. To date, we have completed 437 value-capture projects. An additional 157 projects are currently in progress with 53 more under evaluation.

Amid these highlights, we did receive some disappointing news during the year, as the United States Supreme Court declined to hear our appeal of a lower court decision related to California lead paint abatement. This resulted in a pre-tax charge of $136.3 million, or one-third of the amount of an abatement fund as recalculated by the trial court. We continue to believe the California verdict is wrong on the facts and law, and we will vigorously defend any potential future litigation as we have in the past.

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The Americas Group introduced 25 new architectural products in North America, the eighth consecutive year of double-digit product introductions in the region.

## The Americas Group

Sales for The Americas Group increased \(507.9 million in 2018, or 5.6% compared to 2017, to \)9.63 billion. This growth comes on top of a strong prior year during which sales grew 8.8%. Currency translation rate changes reduced 2018 sales by 1%. Comparable-store sales in the U.S., Canada and the Caribbean – that is, sales by stores open more than 12 calendar months – increased 5.1% in the year. Full-year segment profit increased 7.3% to $1.90 billion, and segment operating margin increased 30 basis points to 19.7% from 19.4% last year.

Sales to residential repaint contractors remained our strongest customer end market in the year, with sales increasing by a double-digit percentage. All other customer categories were also positive for the year. We continued to serve these customers by investing in innovation. We introduced 25 new products in North America in 2018 – our eighth consecutive year of double-digit product introductions in the region – and 30 more in Latin America. Particularly well-received products include Loxon \( ^{\circledR} \)  Self-Cleaning Exterior Acrylic Coating, SuperDeck \( ^{\circledR} \)  Solid Color Stain with new Cool Feel \( ^{\circledR} \)  Color Technology, Extreme Block \( ^{\circledR} \)  Primer/Sealer and Duration Home \( ^{\circledR} \)  Interior Paint with Moisture Resistant Technology.

Our value proposition rests on combining innovative products with premium service. We believe our company-operated stores offer professional painting contractors and DIYers the best service experience available. We further invested in this model in 2018, opening 76 net new stores, including 87 in North America, which was partially offset by some store consolidation in Latin America. Total store count at year-end was 4,696. Our service model also includes our e-business platform, which we enhanced in 2018 and which enables pro customers to better manage their businesses with 24/7 access to ordering, pricing, purchase history and more.

## Consumer Brands Group

2018 sales for the Consumer Brands Group increased \(584.3 million, or 27.1% compared to 2017, to \)2.74 billion. Incremental Valspar sales from the five months ended May 2018 increased Group sales 26.9% in the year. Segment profit increased 28.7% to \(261.1 million due to incremental Valspar operations profit for the first five months of \)75.8 million, increased selling prices and reduced impacts of a voluntary inventory accounting change, partially offset by increased raw material costs and lower sales to some of the Group's customers. Reported segment operating margin increased to 9.5% in 2018 from 9.4% last year. Excluding purchase accounting expense in both years and the voluntary inventory accounting change adjustment to 2017, adjusted segment operating margin decreased to 13.6% in 2018 from 15.5% in 2017. The margin decrease was driven mainly by incremental expenses related to the launch of our new partnership with Lowe's and raw material inflation, not all of which were anticipated.

Since the acquisition of Valspar in June 2017, the Consumer Brands Group has integrated two distinct teams into one. Evidence of the value provided by this combination came early in 2018, as we announced an expanded partnership with Lowe's. The partnership positions Lowe's as the only national home center in the United States to offer our Valspar \( ^{\circledR} \)  brand paints and stains, HGTV HOMETM by Sherwin-Williams paints, Minwax \( ^{\circledR} \) , Cabot \( ^{\circledR} \)  and Thompson's \( ^{\circledR} \)  Water Seal \( ^{\circledR} \)  stains, Krylon \( ^{\circledR} \)  aerosols and Purdy \( ^{\circledR} \)  applicators. We executed six major product category resets and trained 20,000 Lowe's associates during the year, providing Lowe's customers with an improved experience throughout the paint department. We began to see the benefits of this expanded partnership in 2018, and our expectations for longer-term success remain high.

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We partner with other premier retailers as well, such as Menards, Ace, Orgill, Do-It-Best and others. The Valspar acquisition also provides us with the opportunity to grow outside of North America through the Valspar \( ^{®} \) , Huarun \( ^{®} \)  and Wattyl \( ^{®} \)  brands in Europe, China and Australia/New Zealand, respectively.

The success of each of our reportable segments is supported by a highly efficient global supply chain and research and development organization, all managed within the Consumer Brands Group. This team performed admirably in 2018, keeping pace with the incremental load-in demand of the new Lowe's program while also supporting what is traditionally the peak period of architectural paint sales volume in North America. This effort resulted in approximately $20 million in incremental costs that were not included in our earnings outlook for the full year. Deep thanks goes to the many members of our global supply chain for their efforts in putting our customers first. Their dedication is a great source of pride to all of us.

This team also remained crucial to our acquisition value-capture efforts in 2018, especially in the area of optimizing our manufacturing and distribution footprint. We consolidated four manufacturing plants and three distribution centers in 2018 while completing seven capacity expansion projects to support global growth. We also began to more fully realize the benefits of our new distribution center in Waco, Texas, and new manufacturing facility in Nantong, China, both of which opened in 2017. Health and safety remained priorities for us as well, and we had 31 U.S. VPP Star sites and 12 OHSAS 18001 and 45 ISO 14001 sites globally at the end of 2018.

This team also operates our commercial transportation fleet, which was honored again in 2018 with the SmartWay Excellence Award. This annual award honors top shipping and logistics company partners for superior environmental performance and additional actions to reduce freight emissions through effective collaboration and operational practices. The fleet also earned 2 \( ^{nd} \)  Place for the National Private Truck Council's Fleet of the Year Safety Award.

## Performance Coatings Group

2018 sales for the Performance Coating Group increased $1.46 billion, or 39.4% compared to 2017, to $5.17 billion. Incremental Valspar sales from the five months ended May 2018 increased Group sales 34.3% in the year. Segment profit increased 72.0% to $452.1 million due to incremental Valspar operations profit for the first five months of $97.6 million,

## We continued to innovate in the area of coatings that reduce impacts to the environment.

selling price increases and reduced impacts of a voluntary inventory accounting change, partially offset by increased raw material costs and increased purchase accounting impacts. Reported segment operating margin increased to 8.8% in 2018 from 7.1% last year. Excluding purchase accounting expense in both years and a voluntary inventory accounting change adjustment to 2017, adjusted segment operating margin was essentially flat at 12.9% in 2018 compared to 13.0% in 2017. Given the level of raw material inflation this segment experienced in 2018, flat operating margin year over year is evidence that our pricing actions have had success.

Like the Consumer Brands Group, this segment has integrated distinct Sherwin-Williams and Valspar teams into a single global organization with a common purpose: delivering value to customers through differentiated products and solutions that focus on both application performance and enhancing productivity. This starts with innovation, especially in the area of coatings that reduce impacts to the environment,

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where the Performance Coatings Group continues to make advancements in next-generation waterborne technology, low-cure powder coatings, renewable bio-based raw materials, and non-isocyanate and non-formaldehyde formulated coatings. We're also maximizing our large-batch/small-batch capabilities to serve a broader range of customer needs.

All product categories managed by this Group generated growth in the year, led by General Industrial and Packaging, which were both up by double-digit percentages. General Industrial's Color Express \( ^{™} \)  program is reducing the time it takes for powder finishers to match, receive and apply powder. And in Packaging, our ValPure \( ^{®} \)  V70 Series of non-BPA epoxy coatings has emerged as a top choice among can coaters.

Industrial Wood customers are benefiting from our latest flooring coatings, including Ultra-Cure \( ^{®} \)  MarGuard \( ^{™} \)  Clear Topcoat, which provides resistance to stains, scratches and abrasion. In Automotive Finishes, our Ultra 9KT \( ^{™} \)  Waterborne System is a great example of synergy, combining basecoat technologies from Valspar with primer and clearcoats from Sherwin-Williams to deliver a truly differentiated offering.

For Coil & Extrusion customers, we continued to deliver value with our Fluropon \( ^{®} \)  70% Polyvinylidene Fluoride (PVDF) coatings for metal architecture.

In the Protective and Marine space, our patented Firetex \( ^{®} \)  FX6002 is an ultrafast-drying intumescent coating for structural steel surfaces that provides fire resistance for up to 2 hours.

## Leadership Announcements

Our continued focus on internal talent development resulted in several leadership appointments during the year. Pete Ippolito was promoted to President of The Americas Group, succeeding Jay Davisson, who retired after 31 years of service to the Company. Pete took on leadership of our largest operating segment early in 2018, with his 32 years of experience at Sherwin-Williams preparing him extremely well for the role. After joining the Company as a management trainee, Pete progressed through a variety of leadership roles, most recently as President & General Manager of the Mid Western Division of The Americas Group.

Todd Stephenson succeeds Pete as President & General Manager of the Mid Western Division. Todd joined Sherwin-Williams in 1992 and most recently served as Senior Vice President of Sales, Protective & Marine Division, Performance Coatings Group. Tom Hablitzel was promoted to Senior Vice President, Enterprise Strategic Accounts, succeeding Mark Henderson, who retired after 36 years of service to the Company. Tom joined the Company in 2005 and most recently served as President of the Automotive Finishes Division, Performance Coatings Group. Justin Binns succeeds Tom as President & General Manager of the Automotive Finishes Division. Justin joined the Company in 2001 and takes on his new role after serving most recently as President & General Manager of the Eastern Division within The Americas Group. Mark Provenson succeeds Justin as President & General Manager of the Eastern Division. Mark joined Sherwin-Williams in 2000 and most recently served as Vice President of Sales, Mid Western Division. Jonathan Reid was promoted to President & General Manager of the South Western Division in The Americas Group, succeeding Monty Griffin, who retired after 33 years of service to the Company. Jon joined Sherwin-Williams in 1993 and most recently served as Vice President of Sales in the South Western Division. These seamless transitions during the year demonstrate our thoughtful approach to succession planning and the depth of our talent pool.

## Outlook

We enter 2019 with confidence in the sustainability of demand across most of our end markets, and we see significant opportunities for profitable growth throughout the business. In The Americas Group, we will continue to invest in our store model and best-in-class products while executing on share of wallet and new account activation initiatives. In the Consumer Brands Group, we are excited by the exclusive national home center relationship and shared commitment to

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growth we have with our largest retail partner, as well as by our strong relationships with other leading retailers. And in the Performance Coatings Group, we are focused on maximizing the combined capabilities of our integrated organization across the various end markets and geographies we serve. We are also confident in our team's ability to execute on the key initiatives that drive our success in the short and long term, and in our ability to continue delivering significant value to customers. We are well positioned and focused on what we can control.

## We expect 2019 sales to increase 4% to 7% compared to 2018.

There are a number of economic, political and social variables that are beyond our control, including government shutdowns, federal interest rate hikes, tariffs, global trade uncertainty, immigration and security, among others. While it is our job to focus on those things we can control, and adapt to those things we cannot, these factors have the potential to affect our business and expand the range of potential outcomes in our results.

Against this backdrop, we expect 2019 net sales to increase 4% to 7% compared to 2018. In terms of profitability, we should continue to benefit from operating expense control, volume growth and acquisition synergies. One key assumption embedded in this outlook is that raw material inflation for 2019 will be in the low single digits compared to 2018. We expect the rate of year-over-year inflation will be highest in the first quarter, and, assuming stable petrochemical feedstocks and no supply disruptions, it should diminish as we go through the second half of 2019.

Over the past two years, we allocated a significant share of capital generated to debt reduction, retiring approximately \(1 billion in both 2017 and 2018. In 2019, we expect to begin moving back toward our more traditional capital allocation philosophy. Capital expenditures will remain modest, at approximately 1.7% of sales. We still expect to reduce debt by \)600 million in 2019, which should reduce our net debt-to-EBITDA ratio to below 3 times by the end of the year. Historically, we have targeted dividends at about 30% of prior-year GAAP earnings. At its February 2019 meeting, our Board of Directors approved a quarterly dividend increase of 31% to \(1.13 per share, up from \)0.86 last year. It is also part of our longstanding philosophy not to hold excess cash on the balance sheet. We expect to use this cash to make open-market purchases of Company stock in 2019 at a level beyond what is necessary to offset dilution from option exercises. On December 31, 2018, we had remaining authorization to acquire approximately 10.13 million shares. We will also continue to evaluate acquisitions that fit our strategy.

Let me close this letter by thanking the more than 60,000 employees of Sherwin-Williams for their hard work and dedication. There is no better team in the industry, and I am continually inspired by your passion for our company and our customers. I also offer my sincere thanks to you, our shareholders, for your continued trust and confidence in us. We expect to deliver strong performance in 2019 and in the years to come.

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John G. Morikis

Chairman, President and Chief Executive Officer