# Letter to
Shareholders

_Source: `DeepSeekOCR_Ardian_pruned_1k/basic-materials-specialty-chemicals/NYSE_SHW_2017/NYSE_SHW_2017.mmd` · pages 4-10_

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Letter to
Shareholders

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

## The Sherwin-Williams Company described in the pages of this annual report differs in many meaningful ways from the company we reported on just one year ago.

With the completion of the Valspar acquisition on June 1, 2017, we are a larger, more diversified and more global enterprise. We are also a more complex and disparate company with higher balance sheet leverage. I have heard from many institutional investors over the past year that large-scale acquisitions often fail to create significant shareholder value. Based on our experience thus far, I believe our acquisition of Valspar will prove to be a convincing exception to this rule.

The successful integration of Valspar will create a faster-growing, more profitable company. Since closing the acquisition, we have invested considerable effort and energy in fortifying our customer relationships, defining the right organizational structure and building momentum in every line of business. We detail our integration progress in a special section on page 7 and throughout this annual report, and we are delighted to welcome the talented employees of Valspar to the Sherwin-Williams family.

2017 was also a year of many financial milestones, including record sales for the seventh consecutive year and record earnings for the sixth straight year. Consolidated sales increased 26.4 percent to \(14.98 billion, EBITDA – or "Earnings Before Interest, Taxes, Depreciation and Amortization" – increased 17.3 percent to \)2.28 billion, net income from continuing operations increased 60.1 percent to \(1.81 billion, and diluted earnings per share from continuing operations increased 59.4 percent to \)19.11. Cash flow from operations increased 44.0 percent to \(1.88 billion. Total shareholder return for the year was 54.1 percent compared to 21.8 percent for the S&P 500 and 31.6 percent for our peer group. These full-year results include seven months of Valspar-related sales and earnings, purchase accounting adjustments, and

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transaction and integration costs. Our reported results also include a one-time benefit from deferred income tax liabilities related to the Tax Cuts and Jobs Act enacted in December 2017 and Valspar subsidiary mergers (Deferred income tax reductions).

Strength in the core Sherwin-Williams business underpins these consolidated results. If you exclude the impacts from Valspar and the Deferred income tax reductions:

• Consolidated sales for the year increased 5.6 percent to $12.5 billion,

• Operating Profit improved 6 percent to $1.92 billion,

• Profit Before Tax grew 6.5 percent to $1.84 billion,

• EBITDA increased 5.8 percent to $2.12 billion,

• Comparable diluted Earnings Per Share increased 11.1 percent to $14.27 per share.

Record cash generation during the year enabled us to invest in growth, increase our annual dividend for the 39 \( ^{th} \)  consecutive year, and pay down debt at a rapid pace. The Americas Group opened 101 net new stores, finishing the year with 4,620 stores in operation. We also paid 319.0 million in cash dividends and retired over 1 billion in debt. Given these priorities, we made no open market purchases of our common stock for treasury in 2017.

With the distractions inherent in integrating two large organizations into one, it was vital to keep our teams focused on delivering the value to our customers that will drive sustained growth and profitability over the long term. Each of our three reportable segments contributed to our success in 2017.

## THE AMERICAS GROUP

The Americas Group segment teams in the United States, Canada, Caribbean and all of Latin America have been focused on collaboration and sharing resources and expertise. We strongly believe these efforts will result in accelerated growth across the region.

In the U.S., Canada and the Caribbean, we remain the largest operator of specialty paint stores, servicing the needs of architectural and industrial painting contractors and do-it-yourself homeowners. In Latin America, we sell a variety of branded architectural paint, coatings and related products through company-operated specialty paint stores and third party retailers, dealers, licensees and other distributors.

In 2017, The Americas Group net sales increased 8.8 percent compared to the prior year to \(9.12 billion. The growth was driven by higher architectural paint sales volume across all segments and selling price increases. Full-year net sales by stores in the U.S., Canada and the Caribbean, open more than 12 calendar months, increased 6.3 percent, and net sales in the Latin America region increased 4.5 percent, both as compared to the prior year. Segment profit increased 10.2 percent to \)1.77 billion, and segment operating margin increased 30 basis points to 19.4 percent compared to the prior year.
By our estimate, our company-operated stores in the U.S. grew architectural paint sales volumes at a rate of approximately two times the rate of U.S. market growth, and our protective and marine coatings business reversed a two-year negative sales trend. During the year, we opened 87 net new stores in the U.S., Canada and the Caribbean, bringing total store count in the region to 4,267. Our customers responded favorably to multiple new product introductions, including Extreme Cover \( ^{™} \)  Interior Stain Blocking Paint and Primer in One, Emerald \( ^{®} \)  Interior/Exterior Water-Based Urethane Trim Enamel, and ProMar \( ^{®} \)  200HP Zero VOC Interior Acrylic. J.D. Power recognized us for "Highest in Customer Satisfaction among Interior Paints."*

In Latin America, selling price increases enabled us to grow revenues in the full year, though underlying economic conditions in the region remained challenging. We continued to position ourselves for long-term growth, adding 14 new company-operated stores in the region, bringing our total to 353. We also added 65 new dedicated dealers, bringing our total to more than 700. We are adopting some best practices from our U.S. stores in Latin America, with initial emphasis on customer segmentation and new account development. Some high-potential new products introduced in the region during the year were ProCraft \( ^{®} \)  flat interior paint, ProCraft \( ^{®} \)  ceiling paint, and Krylon \( ^{®} \)  Super Maxx premium fast-drying aerosol, all based on successful product platforms in the U.S. and Canada. We also released our ColorSnap \( ^{®} \)  App in Spanish and Portuguese to assist consumers with the challenging process of color selection and coordination.

## CONSUMER BRANDS GROUP

The Consumer Brands Group sells a broad portfolio of branded product lines through a variety of independent retail outlets in the United States, Canada, United Kingdom, China, Australia and New Zealand. In 2017, the Consumer Brands Group net sales increased 41.1 percent compared to the prior year to \(2.15 billion, but segment profit decreased 25.0 percent year-over-year to \)226.0 million and segment operating margin decreased 920 basis points to 10.5 percent compared to 2016. Segment profit and operating margin in the year include acquisition purchase accounting charges of \(107.6 million that were partially offset by Valspar profit from operations of \)71.7 million. Excluding the impact of Valspar, core sales for the Group decreased 8.4 percent, core segment profit decreased 13.0 percent, and core operating margin decreased 100 basis points, all compared to the prior year.

The results for our core Consumer Brands Group business in 2017 were disappointing. Demand was soft across most product categories, retail channels and geographies throughout the year. This weakness was particularly acute in Europe and in smaller retail accounts across the U.S. and Canada. Many retailers responded to slower sales of architectural paint to Do-It-Yourself customers.

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by scaling back inventory. The impact of weak sales volumes on segment profit was exacerbated by rising raw material costs throughout the year.

Although the Consumer Brands Group results fell short of expectations in 2017, we remain confident in the future prospects for this Group for many reasons. The combined portfolio of brands managed by this talented team is second to none in the paint and coatings category in terms of appeal to retailers and end users. Brands such as Valspar \( ^{®} \)  and HGTV HOME \( ^{®} \)  by Sherwin-Williams paints, Minwax \( ^{®} \)  stains and varnishes, Purdy \( ^{®} \)  applicator tools, Cabot \( ^{®} \)  stains, Krylon \( ^{®} \)  aerosol paint and Thompson's \( ^{®} \)  WaterSeal \( ^{®} \)  waterproofing products, to name a few, rank among the best-known, most sought-after brands in their respective categories.

Above all, we are excited about the category expertise and strong customer relationships the Valspar acquisition brings to this segment. The integration of Valspar sales and marketing teams is, for the most part, complete with little or no customer disruption. We are addressing the persistent raw material inflation by implementing price increases across all retail channels and customers, which we expect will benefit results for the Group in 2018.

## With the completion of the Valspar acquisition on June 1, 2017, we are a larger, more diversified and more global enterprise.

In 2017, the Valspar paint brand was recognized by J.D. Power as the "Highest in Customer Satisfaction among Exterior Paints."* The power of the Valspar brand and the caliber of the Valspar sales team have strengthened our relationship with key retailers and provided additional tools and expertise to help convert more shoppers into buyers. Valspar also enhances our global scale, bringing us platforms to build upon with Huarun™, a leading Chinese domestic paint brand, and Wattyl®, a leading product brand and a chain of company-operated outlets in Australia and New Zealand.

The success of our reportable segments is supported by a highly efficient global supply chain and research & development organization, all managed within our Consumer Brands Group segment. Innovation remains a core competency of this organization, validated by the introduction of more than 20 new architectural products in 2017. With the addition of Valspar's supply chain assets, we now operate 84 manufacturing and distribution facilities worldwide. While this added capacity will reduce the need for future capital investments, we see meaningful opportunities to further optimize our global footprint in support of profitable growth. In 2017, we exited three non-essential facilities and announced our intention to consolidate five others. We opened a new distribution center in Waco, Texas, and a new manufacturing site in Nantong, China, to help us capitalize on our rapid growth in both regions.

Our commercial transportation fleet covered a record 74 million miles in 2017 – 7.3 percent more than in 2016 – and was awarded a SmartWay Excellence Award for superior environmental performance and reduction of freight emissions through collaborative and operational practices. Our fleet also earned the National Private Truck Council (NPTC) 2017 Fleet of the Year Safety Award. Safety and quality remain top priorities throughout the organization, and many of our facilities have experienced no recordable injuries for multiple years. At the end of 2017, we had 28 VPP Star sites, 12 OHSAS 18001 sites in the U.S. and 44 ISO 14001 sites globally – more certifications than any other paint and coatings manufacturer.

## PERFORMANCE COATINGS GROUP

In 2017, net sales by our Performance Coatings Group increased 90.4 percent compared to the prior year to \(3.71 billion. Segment profit increased 16.1 percent to \)298.5 million, but segment profit margin decreased 510 basis points to 8.1 percent compared to 2016. Segment profit and operating margin for the year include Valspar profit from operations of \(231.1 million partially offset by acquisition purchase accounting charges of \)183.1 million. Excluding the impact of Valspar, core sales for the Group increased 3.0 percent, core segment profit decreased 2.6 percent, and core operating margin decreased 72 basis points, all compared to the prior year.

The Performance Coatings Group provides differentiated product technology and value-added services to a diverse group of industrial coatings customers. We made impressive progress on the integration of Valspar operations during the year, organizing this new segment into industry-specific business units to enhance focus and competitiveness. There are significant opportunities to further optimize this structure as we aggressively pursue our value capture targets.

The addition of Valspar's coatings business significantly increases our operating scale outside North America and broadens our technology offering, both of which will enable us to create new opportunities. Geographically, Valspar adds sales volume and large-scale manufacturing and distribution to our operations in Europe and Asia, enabling us to serve more customers more profitably. The combination also results in a more complete product offering and diverse service model. For example, combining Sherwin-Williams' local-market, small-batch blending capability with Valspar's expertise in supplying highly customized coatings solutions to large original equipment manufacturers

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(OEMs) makes us a compelling single-source coatings provider for OEMs and their tier supplier networks. Valspar also brings us two entirely new profitable growth opportunities in packaging coatings – coating liners for food and beverage packaging – and coil & extrusion coatings – coatings used in the manufacture of appliances, HVAC equipment, metal building products and more.

We've also begun to leverage our combined technology portfolio, which is significantly enhanced by Valspar's waterborne formulations and resin development capabilities. Recently released examples of industrial coatings innovation include AquaGuard \( ^{®} \)  low-VOC coatings for general industrial applications, the Sayerlock \( ^{®} \)  HydroPlus \( ^{™} \)  family of low-VOC high-performance wood coatings, dynamic clearcoat CC200 premium coatings, DeBeer \( ^{®} \)  waterborne coatings, and ValPure \( ^{®} \)  V70 non-BPA epoxy coating for can coating.

## BOARD AND MANAGEMENT CHANGES

In April, Michael Thaman was elected to our Board of Directors and appointed to the Compensation and Management Development Committee. Mike currently serves as Chairman, President and Chief Executive Officer of Owens Corning, a Toledo, Ohio-based world leader in composite solutions and building materials systems and a market-leading innovator of glass fiber technology. He has demonstrated strong leadership in a variety of roles at Owens Corning for 25 years, and his broad financial and international experience will serve the Board and our shareholders well. We look forward to his contributions to Sherwin-Williams for many years.

In December, Sean Hennessy announced his retirement after 33 years of dedicated service to the Company, including 15 years as the Company's Senior Vice President – Finance and Chief Financial Officer. Over the last year, Sean served in the role of Senior Vice President – Corporate Planning, Development and Administration, supporting AI Mistsyn in his successful transition to Senior Vice President – Finance and Chief Financial Officer and assisting in the acquisition and integration of Valspar. Sean will be missed, and we wish him a very happy and healthy retirement.

Our continued focus on internal talent development resulted in several leadership appointments during the year. Mary Garceau was promoted to Senior Vice President, General Counsel and Secretary. Mary joined Sherwin-Williams in 2014 as Associate General Counsel for our Paint Stores Group and previously served as Vice President, General Counsel and Corporate Secretary for Bob Evans Farms, Inc. and Thirty-One Gifts, LLC. Dennis Karnstein was named President & General Manager of Industrial Wood Coatings Division, Performance Coatings Group. Dennis joined Sherwin-Williams in 1989 as a Management Trainee in our Paint Stores Group. After working his way up through the ranks in our paint stores organization, Dennis joined our Global Finishes Group as Senior Vice President & General Manager for Product Finishes Europe and President & General Manager, Product Finishes Division of Global Finishes Group. Most recently, Dennis served as Senior Vice President of Global Integration for the Valspar acquisition. Bruce Irussi was promoted to the position of President & General Manager of General Industrial Coatings Division, Performance Coatings Group. Bruce joined Sherwin-Williams in 1984 as a Professional Coatings Representative, and worked his way up as Branch Manager, Sales Manager, Product Finishes Division Area Sales Manager, District Manager and Regional Facility Manager and Senior Vice President of Sales, Product Finishes Division – North America. Most recently, Bruce was President & General Manager of the Product Finishes Division of our Global Finishes Group. Robert Lynch was promoted to President & General Manager of the North America Division of our Consumer Brands Group. Rob joined the Company in 2000 and most recently served as Senior Vice President of Sales within our Performance Coatings Group. Lee Diamond was promoted to President & General Manager of Canada Division, The Americas Group. Lee joined the Company in 1991 and most recently served as Vice President of Sales for the Southeastern Division of The Americas Group.

Continued growth in residential and commercial construction and remodeling across North America should benefit The Americas Group and our Consumer Brands Group, and positive momentum in many industrial end segments worldwide should benefit our Performance Coatings Group.

Diana Strongosky was promoted to Senior Vice President Operations North America. Diana joined the Company in 1988 and most recently served as Senior Vice President of R&D within our Global Supply Chain organization. Kathleen Szczesniak was promoted to Senior Vice President of R&D within our Global Supply Chain organization. Kathleen joined the Company in 1998 and most recently served as Vice President for R&D within our Performance Coatings Group.

I have often said the acquisition of Valspar represents the greatest one-time infusion of talent in Sherwin-Williams' history. Shortly after closing the transaction, we announced several appointments of Valspar personnel to our senior leadership team. Aaron Erter was named President of Consumer Brands Group. Aaron joined Valspar's consumer business in 2011 after serving 15 years with Black & Decker Corporation, where he held leadership positions in sales, global marketing, product

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development and new business development. Bryan Young was named Vice President - Corporate Strategy & Development. Bryan joined Valspar as Vice President of Corporate Development in 2015 and previously held similar positions at Agrium and Rockwell Automation. Karl Jorgenrud was named President & General Manager of Protective & Marine Division, Performance Coatings Group. Karl joined Valspar in 1994 and most recently served as Vice President & General Manager of Valspar's Global Functional Coatings. Sam Shoemaker was named President & General Manager of Global Packaging, Coil, and Coatings Resins & Colorants Division, Performance Coatings Group. Sam joined Valspar in 2012 and most recently served as Valspar's Senior Vice President of Global Packaging. He previously worked for The Dow Chemical Company. Mike Bourdeau was named President & General Manager of Coil & Extrusion, Performance Coatings Group. Mike joined Valspar in 1986 and most recently served as Vice President, Global Coil & Extrusion. Colin Davie was named President & General Manager, Global Coating Resins & Colorants, Performance Coatings Group. Colin joined Valspar in 2012 and most recently served as Valspar's Vice President, Global EPS/CCA. He previously worked for DuPont and Ciba Specialty Chemicals plc. Finally, J.R. Benites was named Regional President & General Manager of Latin America, Performance Coatings. J.R. joined Valspar in 1997 and most recently served as Senior Vice President and President of Valspar's Latin America Region with executive responsibility for Global Coil.

## OUTLOOK FOR 2018

We begin 2018 with expectations for another strong year in most of our businesses. Continued growth in residential and commercial construction and remodeling across North America should benefit The Americas Group and our Consumer Brands Group, and positive momentum in many industrial end segments worldwide should benefit our Performance Coatings Group. It is our intention to reinvest a portion of the savings from recent U.S. tax reform into growth initiatives, particularly in The Americas Group, and our expanded global footprint and technical capabilities will provide greater exposure to many new growth opportunities in emerging markets.

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From a profitability standpoint, we should continue to benefit from operating expense control and volume growth, both domestic and abroad, but rising raw material costs are likely to constrain gross margins, especially early in the year. Raw materials represent roughly 85 percent of the cost of goods sold for most paint and coatings products, and we anticipate inflation across the raw material basket in 2018 to average in the mid-single digits in percentage terms – perhaps higher in the first half of the year. This inflation will likely be broad-based across petrochemical feedstocks, pigments and packaging. We will continue to closely monitor the raw materials markets and are prepared to implement additional price increases if conditions so warrant.

On a final note, the longer-term financial targets we presented at our Financial Community Presentation on October 3, 2017, will serve as a gauge to measure our success in managing the complexities of a large-scale integration process while maintaining a steadfast focus on the reason we are here – to help our customers be more successful. Using combined Sherwin-Williams and Valspar pro-forma 2016 results as a baseline, and 2020 as a target date, we expect to grow net sales at a compound annual rate of 4 to 6 percent, expand EBITDA margin to a range of 18.8 to 21 percent from 16.6 percent, increase adjusted free cash flow – net operating cash less capital expenditures – to a range of 10 to 10.5 percent of net sales from 8.9 percent, and grow core diluted net earnings per common share \( ^{(1)} \)  at a compounded annual growth rate of 9 to 12 percent. By 2020, we expect to achieve at least 1 billion in cumulative savings from the integration of Valspar.

To all employees of the new Sherwin-Williams, I offer my heartfelt thanks for all of your hard work, skill and commitment this past year; I truly believe we have the best team in the business, and that is integral to our success. On behalf of the approximately 60,000 Sherwin-Williams employees around the world, we offer our thanks and appreciation to our customers, suppliers and shareholders for your continued trust and confidence.

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John G. Morikis
Chairman, President and Chief Executive Officer