MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW CRITICAL ACCOUNTING POLICIES AND ESTIMATES 22 The Sherwin-Williams Company, founded in 1866, and its consolidated subsidiaries (collectively, the “Com- pany”) are engaged in the manufacture, distribution and sale of paints, coatings and related products to profes- sional, industrial, commercial and retail customers pri- marily in North and South America. The Company is structured into five reportable segments – Paint Stores, Consumer, Automotive Finishes, International Coatings (collectively, the “Operating Segments”) and Adminis- trative – in the same way that management internally organizes its business for assessing performance and making decisions regarding allocation of resources. See pages 8 through 15 of this report and Note 18, on pages 68 through 70 of this report, for more information con- cerning the Company’s reportable segments. The Company’s financial condition remained strong in 2004 despite a decrease of $256.9 million in cash and cash equivalents from the end of 2003 primarily as a result of acquisitions made in 2004. The Company’s current ratio decreased to 1.17 at December 31, 2004 from 1.49 at the end of 2003. Total debt increased to $738.3 million at December 31, 2004 from $513.6 mil- lion at the end of last year and increased as a percentage of total capitalization to 30.9 percent from 26.0 percent at the end of 2003. The lower current ratio and increased total debt also related primarily to the 2004 acquisitions. Net operating cash decreased to $544.7 million in 2004 versus $558.9 million in 2003. The pri- mary factor reducing net operating cash was increased working capital requirements to support new sales pro- grams. Excess cash from 2003 and net operating cash and increased short-term borrowings in 2004 provided the funds necessary to support current year acquisitions of $554.5 million, extinguishment of acquired debt of $67.1 million, capital expenditures of $106.8 million, purchases of treasury stock for $267.4 million and pay- ments of $96.9 million in cash dividends. Consolidated net sales increased 13.1 percent in 2004 to $6.11 billion from $5.41 billion in 2003. Net income for 2004 increased 18.4 percent to $393.3 mil- lion from $332.1 million last year. Diluted net income per common share increased 20.4 percent to $2.72 per share for 2004 from $2.26 per share a year ago. During 2004, sales volume increases came from continuing strong domestic architectural paint sales, improving sales and market conditions in domestic industrial main- tenance and product finishes and the acquisitions of Duron, Inc. (Duron), Paint Sundry Brands Corporation All of the significant accounting policies that were followed in the preparation of the consolidated finan- cial statements are disclosed in Note 1, on pages 46 through 50 of this report. The following procedures and assumptions utilized by management directly impacted many of the reported amounts in the consoli- dated financial statements. The Company’s revenue was generated from the sale of its products. All revenues were recognized when products were shipped and title had passed to unaffiliat- ed customers. Discounts were recorded as a reduction of The preparation and fair presentation of the consoli- dated financial statements, accompanying notes and related financial information included in this report are the responsibility of management and have been pre- pared in accordance with accounting principles general- ly accepted in the United States. The consolidated financial statements, notes and related information include amounts that were based upon management’s best estimates and judgments which they believe were reasonable under the circumstances. Management used assumptions based on historical results and other assumptions to form the basis for determining appropri- ate carrying values of assets and liabilities that were not readily available from other sources. Actual results could differ from those estimates. Also, materially dif- ferent amounts may result under materially different conditions or from using materially different assump- tions. However, management believes that any material- ly different amounts resulting from materially different conditions or material changes in facts or circumstances are unlikely. (PSB) and a majority interest in Shanghai Kinlita Chemi- cal Co., Ltd., that was renamed Sherwin-Williams Kinli- ta Co., Ltd. (Kinlita). The domestic and international automotive refinish businesses improved during the year while stronger economic conditions and favorable for- eign currency exchange rates in most South American countries contributed to improved International Coat- ings Segment sales. For the full year 2004, gross profit as a percent of sales declined primarily due to increasing raw material costs. The impacts on net sales and gross profit relating to a change in product mix and an impairment charge to reduce the carrying amount of a customer sales incentive program were negligible. Sell- ing, general and administrative expenses decreased as a percent of sales in 2004 as compared to 2003.