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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR QUARTER ENDED SEPTEMBER 30, 2002. COMMISSION FILE NUMBER 1-5794
MASCO CORPORATION
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 38-1794485
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
21001 VAN BORN ROAD, TAYLOR, MICHIGAN 48180
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(313) 274-7400
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(TELEPHONE NUMBER)
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 AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR
THE PAST 90 DAYS.
YES X NO
----- -----
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF
COMMON STOCK, AS OF THE LATEST PRACTICAL DATE.
SHARES OUTSTANDING AT
CLASS NOVEMBER 1, 2002
------------------------------------ ---------------------
COMMON STOCK, PAR VALUE $1 PER SHARE 492,000,000
MASCO CORPORATION
INDEX
PAGE NO.
--------
Part I. Financial Information
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Balance Sheet -
September 30, 2002 and December 31, 2001 1
Condensed Consolidated Statement of
Operations for the Three Months and Nine
Months Ended September 30, 2002 and 2001 2
Condensed Consolidated Statement of
Cash Flows for the Nine Months Ended
September 30, 2002 and 2001 3
Notes to Condensed Consolidated
Financial Statements 4-15
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations 16-24
Item 4. Disclosure Controls and Procedures 25
Part II. Other Information and Signature 26-27
Disclosure Control Certifications 28-29
MASCO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2002 AND DECEMBER 31, 2001 (UNAUDITED)
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------ ------------
ASSETS
Current assets:
Cash and cash investments $ 600,090 $ 311,990
Accounts and notes receivable, net 1,715,130 1,204,210
Prepaid expenses and other 187,770 197,620
Inventories:
Raw material 391,600 392,820
Finished goods 454,000 356,360
Work in process 148,980 163,920
------------ ------------
994,580 913,100
------------ ------------
Total current assets 3,497,570 2,626,920
Equity investments 95,810 82,290
Securities of Furnishings International Inc. -- 132,550
Property and equipment, net 2,120,600 2,016,730
Acquired goodwill, net 4,138,240 3,234,000
Other intangible assets, net 354,830 309,890
Other assets 1,226,940 780,950
------------ ------------
Total assets $ 11,433,990 $ 9,183,330
============ ============
LIABILITIES
Current liabilities:
Notes payable $ 311,650 $ 129,860
Accounts payable 565,030 322,280
Accrued liabilities 1,010,580 784,420
------------ ------------
Total current liabilities 1,887,260 1,236,560
Long-term debt 3,964,340 3,627,630
Deferred income taxes and other 246,760 199,310
------------ ------------
Total liabilities 6,098,360 5,063,500
------------ ------------
Commitments and contingencies
SHAREHOLDERS' EQUITY
Preferred shares, par value $1 per share
Authorized shares: 1,000,000; issued:
2002 - 20,000; 2001 - 20,000 20 20
Common shares, par value $1 per share
Authorized shares: 1,400,000,000; issued:
2002 - 493,240,000; 2001 - 459,050,000 493,240 459,050
Paid-in capital 2,281,320 1,380,820
Retained earnings 2,659,460 2,468,230
Accumulated other comprehensive income (loss) (98,410) (188,290)
------------ ------------
Total shareholders' equity 5,335,630 4,119,830
------------ ------------
Total liabilities and
shareholders' equity $ 11,433,990 $ 9,183,330
============ ============
See notes to condensed consolidated financial statements.
1
MASCO CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)
FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
----------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
---------------------------- ----------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Net sales $ 2,518,000 $ 2,227,000 $ 6,932,000 $ 6,187,000
Cost of sales 1,717,040 1,548,270 4,720,740 4,325,110
------------ ------------ ------------ ------------
Gross profit 800,960 678,730 2,211,260 1,861,890
Selling, general and administrative
expenses 379,460 341,900 1,104,060 994,040
Charge for litigation settlement 166,000 -- 166,000 --
Amortization of acquired goodwill -- 23,900 -- 70,000
------------ ------------ ------------ ------------
Operating profit 255,500 312,930 941,200 797,850
------------ ------------ ------------ ------------
Other income (expense), net:
Interest expense (61,000) (61,600) (170,300) (179,300)
Impairment charge for:
Securities of Furnishings
International Inc. -- (460,000) -- (460,000)
Other non-operating assets -- (70,000) -- (70,000)
Other, net (15,300) (3,130) (39,400) 20,650
------------ ------------ ------------ ------------
(76,300) (594,730) (209,700) (688,650)
------------ ------------ ------------ ------------
Income (loss) before income taxes
and cumulative effect of
accounting change, net 179,200 (281,800) 731,500 109,200
Income taxes (credit) 56,400 (98,800) 244,200 38,200
------------ ------------ ------------ ------------
Income (loss) before cumulative
effect of accounting change, net 122,800 (183,000) 487,300 71,000
------------ ------------ ------------ ------------
Cumulative effect of accounting change
(net of income tax credit of $24,400) -- -- 92,400 --
------------ ------------ ------------ ------------
Net income (loss) $ 122,800 $ (183,000) $ 394,900 $ 71,000
============ ============ ============ ============
Earnings (loss) per common share:
Basic:
Income (loss) before cumulative
effect of accounting change $ .25 $ (.39) $ 1.01 $ .16
Cumulative effect of accounting change -- -- (.19) --
------------ ------------ ------------ ------------
Net income (loss) $ .25 $ (.39) $ .82 $ .16
============ ============ ============ ============
Diluted:
Income (loss) before cumulative
effect of accounting change $ .24 $ (.39) $ .96 $ .15
Cumulative effect of accounting change -- -- (.18) --
------------ ------------ ------------ ------------
Net income (loss) $ .24 $ (.39) $ .78 $ .15
============ ============ ============ ============
Cash dividends per common share:
Declared $ .14 $ -- $ .41 $ .26
============ ============ ============ ============
Paid $ .135 $ .13 $ .405 $ .39
============ ============ ============ ============
SUPPLEMENTAL DISCLOSURE:
Net income (loss) as reported $ (183,000) $ 71,000
Goodwill amortization, net of tax 20,000 58,700
------------ ------------
Net income (loss) as adjusted $ (163,000) $ 129,700
============ ============
Earnings (loss) per common share:
Basic as reported $ (.39) $ .16
Goodwill amortization, net of tax .04 .13
------------ ------------
Basic as adjusted $ (.35) $ .29
============ ============
Diluted as reported $ (.39) $ .15
Goodwill amortization, net of tax .04 .12
------------ ------------
Diluted as adjusted $ (.35) $ .27
============ ============
See notes to condensed consolidated financial statements.
2
MASCO CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(DOLLARS IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30
----------------------------
2002 2001
------------ ------------
CASH FLOWS FROM (FOR) OPERATING ACTIVITIES:
Cash provided by operations $ 828,940 $ 707,070
Increase in receivables (352,690) (164,740)
Increase in inventories (7,200) (26,140)
Increase in accounts payable and
accrued liabilities, net 221,780 36,870
------------ ------------
Total cash from operating activities 690,830 553,060
------------ ------------
CASH FLOWS FROM (FOR) FINANCING ACTIVITIES:
Issuance of notes 1,082,090 1,300,000
Issuance of Company common stock 598,340 --
Issuance of Zero Coupon Convertible Senior Notes -- 750,000
Increase in principally bank debt 90,440 412,340
Payment of principally bank debt (807,620) (2,015,020)
Purchase of Company common stock for:
Retirement (60,540) (69,180)
Long-term stock incentive award plan (31,260) (30,440)
Cash dividends paid (196,500) (179,540)
------------ ------------
Total cash from financing activities 674,950 168,160
------------ ------------
CASH FLOWS FROM (FOR) INVESTING ACTIVITIES:
Acquisition of companies, net of cash acquired (660,790) (581,760)
Capital expenditures (175,450) (200,590)
Purchases of marketable securities (457,270) (335,820)
Proceeds from disposition of:
Marketable securities 195,370 226,290
Business 15,430 189,630
Purchases of other investments, net (42,410) (12,220)
Other, net 47,440 (29,870)
------------ ------------
Total cash (for) investing activities (1,077,680) (744,340)
------------ ------------
CASH AND CASH INVESTMENTS:
Increase (decrease) for the period 288,100 (23,120)
At January 1 311,990 169,430
------------ ------------
At September 30 $ 600,090 $ 146,310
============ ============
See notes to condensed consolidated financial statements.
3
MASCO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
A. In the opinion of the Company, the accompanying unaudited condensed
consolidated financial statements contain all adjustments, of a normal
recurring nature, necessary to present fairly its financial position as at
September 30, 2002 and the results of operations for the three months and
nine months ended September 30, 2002 and 2001 and changes in cash flows for
the nine months ended September 30, 2002 and 2001. The condensed
consolidated balance sheet at December 31, 2001 was derived from audited
financial statements.
Goodwill and Other Intangible Assets
On January 1, 2002, Statement of Financial Accounting Standards ("SFAS")
No. 142, "Goodwill and Other Intangible Assets," became effective. In
accordance with SFAS No. 142, the Company is no longer recording
amortization expense related to goodwill and other indefinite-lived
intangible assets. The Company has provided a supplemental disclosure of
adjusted net income and basic and diluted earnings per common share for the
three months and nine months ended September 30, 2001 on the condensed
consolidated statement of operations to exclude goodwill amortization
expense. The Company will test the impairment of goodwill and other
indefinite-lived intangible assets on an annual basis utilizing a
discounted cash flow model in the fourth quarter of each year. Intangible
assets with finite useful lives will be amortized over their useful lives.
The Company will evaluate the remaining useful life of amortizable
intangible assets for each reporting period to determine whether events and
circumstances warrant a revision to the remaining periods of amortization.
The Company completed the two-step transitional goodwill impairment testing
in the second quarter of 2002. The first step of the test was to perform an
assessment of whether there is an indication that goodwill is impaired. To
the extent that an indication of impairment existed, the Company performed
a second test to measure the amount of the impairment. The Company tested
for impairment of its reporting units by comparing fair value to carrying
value. Fair value was determined using a discounted cash flow method. This
evaluation indicated that goodwill recorded for certain of the Company's
business units, principally in Europe, were impaired. Certain of the
Company's European businesses have been affected by continued weak market
and economic conditions. On adoption of SFAS No. 142, a non-cash impairment
charge of $92.4 million, net of income tax benefit of $24.4 million, was
recognized as a cumulative effect of change in accounting principle in the
first half of 2002, effective January 1, 2002. Impairment adjustments, if
any, recorded in the future, are required to be recorded as operating
expenses.
4
MASCO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
Note A - continued:
The changes in the carrying amount of goodwill for the nine months ended
September 30, 2002, by segment, are as follows, in thousands:
Pre-tax
Balance Impairment Balance
Dec. 31, 2001 Additions(A) Loss Other(B) Sept. 30, 2002
------------- ------------ ---------- ---------- --------------
Cabinets and Related
Products $ 553,060 $ 23,770 $ (18,800) $ 36,800 $ 594,830
Plumbing Products 175,930 122,340 (7,500) 17,680 308,450
Installation and Other
Services 957,920 702,290 -- -- 1,660,210
Decorative Architectural
Products 454,240 4,760 (31,200) 8,530 436,330
Other Specialty Products 1,092,850 80,040 (59,300) 24,830 1,138,420
---------- ---------- ---------- ---------- ----------
Total $3,234,000 $ 933,200 $ (116,800) $ 87,840 $4,138,240
========== ========== ========== ========== ==========
(A) Additions to the carrying amount of goodwill include acquisitions and other
purchase price adjustments. For the nine months ended September 30, 2002,
additions principally include acquisitions of $890 million, the payment of
approximately $38 million of additional contingent consideration for prior
years' acquisitions and other adjustments related to the finalization of
certain purchase price allocations.
(B) Other changes to the carrying amount of goodwill principally include
foreign currency translation adjustments.
Other indefinite-lived intangible assets include registered trademarks of
$220 million at September 30, 2002. The carrying value of the Company's
definite-lived intangible assets is $134.8 million at September 30, 2002
(net of accumulated amortization of $38.6 million) and principally includes
customer relationships and non-compete agreements, with a weighted average
amortization period of 9 years. Amortization expense related to the
definite-lived intangible assets was approximately $17 million for the nine
months ended September 30, 2002.
Recently Issued Accounting Standards
On January 1, 2002, SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" became effective. This statement addresses
financial accounting and reporting for the impairment or disposal of
long-lived assets. The adoption of SFAS No. 144 did not have a material
effect on the Company's consolidated financial statements.
Emerging Issues Task Force ("EITF") Issue No. 01-9, "Accounting for
Consideration Given by a Vendor to a Customer," became effective for the
Company in the first quarter of 2002. EITF No. 01-9 requires that certain
expenses, including co-operative advertising expenses and other
customer-related incentives, be recorded as a reduction in sales unless
certain conditions are met. The adoption of EITF No. 01-9 resulted in the
reclassification of $20 million and $56 million of co-operative advertising
expenses from selling expense to a reduction in sales for the three months
and nine months ended September 30, 2001, respectively. This
reclassification did not result in a change in net income (loss) or
earnings (loss) per common share.
5
MASCO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
Note A - concluded:
In June 2002, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 146, "Accounting for Costs from Exit or Disposal Activities" which
requires, among other things, that a liability for costs associated with an
exit or disposal activity be recognized when the liability is incurred. The
adoption of SFAS No. 146 is effective for all exit or disposal activities
subsequent to December 31, 2002. The Company is currently evaluating the
impact that SFAS No. 146 will have on its consolidated financial
statements.
Certain prior-year amounts have been reclassified to conform to the 2002
presentation in the condensed consolidated financial statements.
B. Depreciation and amortization expense was $164 million and $204 million for
the nine months ended September 30, 2002 and 2001, respectively.
C. The Company has investments principally in U.S. marketable equity
securities and bond funds (approximately $141 million) at September 30,
2002. The combined investments, included in other assets, at September 30,
2002 and December 31, 2001 were as follows, in thousands:
Unrealized Unrealized Recorded
Cost Basis Gains Losses Basis
---------- ---------- ---------- ----------
September 30, 2002 $ 482,320 $ 1,310 $ (86,310) $ 397,320
December 31, 2001 $ 126,350 $ 2,510 $ (22,800) $ 106,060
Investments in private equity funds and other investments were $375 million
and $322 million at September 30, 2002 and December 31, 2001, respectively.
D. In the first nine months of 2002, the Company completed the acquisition of
several home improvement products companies including Newport Brass and
Bristan Limited (Plumbing Products segment), Cambrian Windows Limited,
Duraflex Limited and Premier Manufacturing Limited (Other Specialty
Products segment), SCE Unlimited, IDI Group and several relatively small
installation service companies (Installation and Other Services segment),
and Diversified Cabinet Distributors (Cabinets and Related Products
segment). The results of these acquisitions are included in the
consolidated financial statements from the respective dates of acquisition.
Newport Brass is a U.S. company headquartered in California and is a
manufacturer of premium price-point plumbing products, plumbing specialties
and bath accessories. Bristan Limited is a provider of kitchen and bath
faucets, showers and bath accessories. Cambrian Windows Limited is a
manufacturer of vinyl window frames and Duraflex Limited is an extruder of
vinyl window frame components. Premier Manufacturing Limited is a
manufacturer of vinyl window frames, doorframes and sunrooms. Bristan
Limited, Cambrian Windows Limited, Duraflex Limited and Premier
Manufacturing Limited are headquartered in the United Kingdom. SCE
Unlimited and IDI Group are installers of insulation and other products and
are located in the U.S. Diversified Cabinet Distributors is a distributor
of cabinets and countertops and is located in Georgia. The aggregate net
purchase price of these acquisitions was $325 million, including cash of
$220 million, 1.7 million shares of Company common stock valued at $45
million (the market value of Company common stock at the date of
acquisition) and assumed debt of $60 million.
6
MASCO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
Note D - concluded:
In the third quarter of 2002, the Company also acquired Service Partners
LLC, a distributor and installer of insulation and other building products
(Installation and Other Services segment). The aggregate net purchase price
was approximately $735 million, including $411 million of cash, 11.6
million shares of Company common stock valued at $320 million
(approximately $27.52 per common share, the guaranteed share price) and
assumed debt of $4 million. The acquisition of Service Partners allows the
Company to accelerate its growth in the Installation and Other Services
segment by adding to the Company's strategy of offering value-added
services to major customers, particularly homebuilders, and to expand sales
of certain of the Company's existing products through Service Partners'
distribution network.
The results of Service Partners are included in the condensed consolidated
financial statements from the date of acquisition. Had Service Partners
been acquired effective January 1, 2001, pro forma unaudited consolidated
net sales, income (loss) before cumulative effect of accounting change, net
income and diluted earnings (loss) per common share would have been as
follows, dollars in thousands, except per share data:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net sales $2,610,000 $2,350,000 $7,280,000 $6,560,000
Income (loss) before
cumulative effect of
accounting change, net $ 127,640 $ (176,790) $ 504,180 $ 89,640
Net income (loss) $ 127,640 $ (176,790) $ 411,780 $ 89,640
Diluted earnings (loss)
per common share $ 0.24 $ (.37) $ 0.80 $ 0.18
The purchase price allocations for all of these acquisitions are
preliminary, and as such could change upon the completion of asset
valuations, which are on-going as of the date of this filing.
E. The following are reconciliations of the numerators and denominators used
in the computations of basic and diluted earnings (loss) per common share,
in thousands:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Numerator:
Income (loss) before
cumulative effect of
accounting change, net $ 122,800 $ (183,000) $ 487,300 $ 71,000
Cumulative effect of
accounting change, net -- -- 92,400 --
---------- ---------- ---------- ----------
Net income (loss) $ 122,800 $ (183,000) $ 394,900 $ 71,000
========== ========== ========== ==========
Denominator:
Basic common shares (based
on weighted average) 494,700 468,100 480,400 456,900
Add:
Contingent common shares 25,300 -- 24,300 14,500
Stock option dilution 1,900 -- 2,800 2,800
---------- ---------- ---------- ----------
Diluted common shares 521,900 468,100 507,500 474,200
========== ========== ========== ==========
7
MASCO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
Note E - concluded:
Income (loss) per common share amounts for the first three quarters of 2002
and 2001 do not total to the per common share amounts for the nine months
ended September 30, 2002 and 2001 due to the timing of capital stock
issuances and the effect of contingently issuable shares.
The outstanding preferred stock, which is convertible into Company common
stock and carries substantially the same attributes as Company common
stock, has been treated as if converted in the computation of basic and
diluted common shares.
Approximately 24 million common shares for both the three months and nine
months ended September 30, 2002 and 19.4 million and 6.5 million weighted
average common shares for the three months and nine months ended September
30, 2001, respectively, related to the Zero Coupon Convertible Senior Notes
due 2031 were not included in the computation of diluted earnings per
common share since, at September 30, 2002 and 2001, they were not
convertible according to their terms. Additionally, for the three months
and nine months ended September 30, 2002, 3.5 million and 3.3 million
common shares, respectively, and 2.4 million common shares for both the
three months and nine months ended September 30, 2001 related to stock
options were excluded from the computation of diluted earnings per common
share due to their anti-dilutive effect since the exercise price was
greater than the stock price at September 30.
For the three months ended September 30, 2001, 20.8 million contingent
common shares and 2.5 million stock option common shares were not included
in diluted shares due to their anti-dilutive effect since the Company
recorded a net (loss) in the third quarter of 2001.
F. In December 2000, the Company adopted a plan to dispose of several
businesses that the Company believed were not core to its long-term growth
strategies. In the first quarter of 2002, the Company sold its subsidiary,
StarMark Cabinetry, Inc., for approximate book value. StarMark was included
in the Cabinets and Related Products segment and had annual sales of
approximately $50 million.
G. As disclosed in the Company's 2001 Form 10-K, the carrying value of the
Company's investment in Furnishings International Inc. ("FII") was adjusted
in 2001 to the estimated fair value of proceeds expected to be received
from the liquidation of FII in satisfaction of amounts due to the Company
for its investment in pay-in-kind junior subordinated debt securities of
FII and certain advances to FII (collectively "FII debt").
During the second quarter of 2002, FII completed the disposition of its
operations. The fair value of the remaining net assets of FII represents
proceeds for the Company's investment in FII debt. The assets and
liabilities are primarily comprised of notes receivable, 4 million shares
of Furniture Brands International common stock and pension obligations of
approximately $75 million. Certain non-Masco shareholders of FII have
contributed their FII shares back to FII resulting in Masco becoming the
majority shareholder. Accordingly, the assets and liabilities of FII have
been recorded in the Company's condensed consolidated financial statements.
8
MASCO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
H. In the third quarter of 2001, the Company recorded an aggregate $530
million pre-tax, non-cash charge for the write-down of certain investments,
including the Company's investments in FII and other non-operating assets.
The furniture industry in general and FII in particular had been adversely
affected by the ongoing economic weakness in its markets, the bankruptcies
of a number of major retailers and import competition. In light of these
factors, the Company reevaluated the carrying value of its investment in
FII and recorded a $460 million pre-tax, non-cash charge to write down this
investment to its estimated current fair value. The Company also recorded a
$70 million pre-tax, non-cash charge for an other-than-temporary decline in
the fair value of certain of the Company's, principally technology-related,
investments.
Other, net in other income (expense), net included the following, in
thousands:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
-------------------- --------------------
2002 2001 2002 2001
-------- -------- -------- --------
Other, net:
Equity earnings from affiliates $ 5,700 $ 3,000 $ 13,000 $ 3,700
Income from cash and
cash investments 2,100 1,900 4,000 4,700
Other interest income 1,900 100 3,400 33,500
Income from financial investments:
Realized gains from marketable
securities 3,440 6,970 9,380 30,380
Realized (losses) from
marketable securities (1,850) (10,130) (36,580) (30,620)
Dividend income from marketable
securities 1,540 690 2,830 1,900
Termination of interest
ratelock (13,840) -- (13,840) --
Gain (loss) from other
investments (1,300) 3,240 1,660 6,020
Dividend income from other
investments 3,590 1,760 5,060 3,690
Other, net (16,580) (10,660) (28,310) (32,620)
-------- -------- -------- --------
Total Other, net $(15,300) $ (3,130) $(39,400) $ 20,650
======== ======== ======== ========
Other interest income for the nine months ended September 30, 2001 included
$30.3 million of interest income from indebtedness of Furnishings
International Inc. ("FII"). No such interest income was recorded for the
three months ended September 30, 2001. The recording of such interest
income was discontinued effective July 1, 2001 due to the impairment of the
Company's investment in FII.
In the third quarter of 2002, the Company incurred $13.8 million of losses
related to interest ratelock transactions entered into in anticipation of
the Company issuing fixed rate debt in the third quarter of 2002. There
were no interest ratelock agreements outstanding at September 30, 2002.
9
MASCO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
I. In May 2002, the Company sold 22 million shares of Company common stock in
a public offering, resulting in net proceeds to the Company of $598.3
million (net of issuance costs of $14.4 million). On June 24, 2002, the
Company issued $500 million of 5-7/8% notes due 2012, resulting in net
proceeds of $490.8 million. On August 20, 2002, the Company issued $300
million of 4-5/8% notes due 2007, resulting in net proceeds of $296.7
million. On August 20, 2002, the Company also issued $300 million of 6-1/2%
notes due 2032, resulting in net proceeds of $294.6 million. These proceeds
are net of aggregate debt issuance costs of $17.9 million, which are being
amortized over the issue lives of the related notes. The Company used the
proceeds from the equity and debt issuances to reduce bank indebtedness
and for other general corporate purposes, including investments in
marketable securities and other investments.
At September 30, 2002, the maturities of short-term and long-term debt
during each of the next five years were approximately as follows: 2003 -
$312 million; 2004 - $525 million; 2005 - $10 million; 2006 - $808 million;
and 2007 - $303 million.
On July 19, 2002, the Company announced that it amended the terms of its
Zero Coupon Convertible Senior Notes ("Notes") due July 20, 2031 to permit
an additional date, April 20, 2004, on which holders, at their option, can
cause the Company to repurchase the Notes, at the then accreted value of
$429.57 per Note, payable by the Company in cash on April 26, 2004. Under
the original terms of the Notes, holders of $26.4 million of Notes required
the Company to repurchase, for $10.7 million cash, the accreted value of
such Notes on July 23, 2002.
Subsequent Event: On October 16, 2002, the Company issued $350 million of
5-7/8% notes due 2012, resulting in net proceeds of $356 million, including
a premium of $8.3 million and debt issuance costs of $2.3 million, which
are being amortized through 2012. The Company subsequently filed
Registration Statements with the Securities and Exchange Commission,
pending effectiveness, to increase the unallocated shelf registration
pursuant to which the Company is able to issue up to a combined $2 billion
of debt and equity securities and 50 million shares of Company common
stock.
10
MASCO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
J. The following table presents information about the Company by segment and
geographic area, in millions.
THREE MONTHS ENDED SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30
-------------------------------------------- --------------------------------------------
2002 2001 2002 2001 2002 2001 2002 2001
-------------------------------------------- --------------------------------------------
Net Sales(1) Operating Profit(2) Net Sales(1) Operating Profit(2)
-------------------------------------------- --------------------------------------------
The Company's operations by
segment were(3):
Cabinets and Related Products $ 738 $ 684 $ 114 $ 60 $ 2,076 $ 1,906 $ 281 $ 200
Plumbing Products 535 455 83 71 1,508 1,317 242 180
Installation and Other Services 489 417 82 65 1,277 1,292 217 181
Decorative Architectural Products 439 389 97 81 1,238 1,128 275 223
Other Specialty Products 317 282 70 60 833 544 165 86
-------- -------- -------- -------- -------- -------- -------- --------
Total $ 2,518 $ 2,227 $ 446 $ 337 $ 6,932 $ 6,187 $ 1,180 $ 870
======== ======== ======== ======== ======== ======== ======== ========
The Company's operations by
geographic area were:
North America $ 2,114 $ 1,884 $ 390 $ 302 $ 5,882 $ 5,252 $ 1,040 $ 774
International, principally Europe 404 343 56 35 1,050 935 140 96
-------- -------- -------- -------- -------- -------- -------- --------
Total, as above $ 2,518 $ 2,227 446 337 $ 6,932 $ 6,187 1,180 870
======== ======== ======== ========
General corporate expense, net (25) (24) (73) (72)
Charge for litigation settlement(4) (166) -- (166) --
-------- -------- -------- --------
Operating profit, after general
corporate expense and charge for
litigation settlement 255 313 941 798
Other (expense), net (76) (595) (210) (689)
-------- -------- -------- --------
Income (loss) before income taxes and
cumulative effect of accounting change,
net $ 179 $ (282) $ 731 $ 109
======== ======== ======== ========
(1) Intra-company sales among segments were not material.
(2) Operating profit excluding goodwill amortization expense for the three
months and nine months ended September 30, 2001, respectively, was as
follows: Cabinets and Related Products - $64 million and $211 million,
Plumbing Products - $73 million and $185 million, Installation and Other
Services - $77 million and $215 million, Decorative Architectural Products
- $84 million and $232 million and Other Specialty Products - $63 million
and $97 million.
(3) Significant increases in assets of certain segments in the first nine
months of 2002 was as follows: Installation and Other Services - $940
million, primarily related to acquisitions.
(4) The charge for litigation settlement relates to litigation discussed in
Footnote M regarding the Company's subsidiary, Behr Process Corporation,
which is included in the Decorative Architectural Products segment.
11
MASCO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
K. The Company's total comprehensive income (loss) was as follows, in
thousands:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------------ ------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net income (loss) $ 122,800 $ (183,000) $ 394,900 $ 71,000
Other comprehensive income
(loss):
Cumulative translation
adjustments (11,210) 56,560 130,640 (18,820)
Unrealized gain (loss) on
marketable securities, net
of income tax effect (46,050) 17,450 (40,760) 15,550
---------- ---------- ---------- ----------
Total comprehensive
income (loss) $ 65,540 $ (108,990) $ 484,780 $ 67,730
========== ========== ========== ==========
The unrealized gain (loss) on marketable securities is net of income tax
(credit) of $(27.0) million and $(23.9) million for the three months and
nine months ended September 30, 2002, respectively, and $10.3 million and
$9.1 million for the three months and nine months ended September 30, 2001,
respectively.
The components of accumulated other comprehensive income, net of tax, at
September 30, 2002 and December 31, 2001 was as follows, in thousands:
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------ ------------
Unrealized losses on available
for sale securities $ (53,550) $ (12,790)
Foreign currency translation adjustment (44,860) (175,500)
---------- ----------
Accumulated other comprehensive (loss) $ (98,410) $ (188,290)
========== ==========
L. Excluding goodwill amortization expense, the Company's adjusted net income
and basic and diluted earnings per common share for the years ended
December 31, 2001, 2000 and 1999 were, in thousands except per share data:
YEAR ENDED DECEMBER 31
-----------------------------------
2001 2000 1999
---------- ---------- ----------
Net income as reported $ 198,500 $ 591,700 $ 569,600
Goodwill amortization, net of tax 78,200 55,680 39,320
---------- ---------- ----------
Net income as adjusted $ 276,700 $ 647,380 $ 608,920
========== ========== ==========
Earnings per common share:
Basic as reported $ .43 $ 1.34 $ 1.31
Goodwill amortization, net of tax .17 .13 .09
---------- ---------- ----------
Basic as adjusted $ .60 $ 1.47 $ 1.40
========== ========== ==========
Diluted as reported $ .42 $ 1.31 $ 1.28
Goodwill amortization, net of tax .16 .12 .09
---------- ---------- ----------
Diluted as adjusted $ .58 $ 1.43 $ 1.37
========== ========== ==========
12
MASCO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
M. The Company is subject to lawsuits and claims pending or asserted with
respect to matters arising in the ordinary course of business.
In May 1998, a civil suit was filed in the Grays Harbor County, Washington
Superior Court against Behr Process Corporation, a subsidiary of the
Company. The case involves four exterior wood coating products, which
represent a relatively small part of Behr's total sales. The plaintiffs
allege, among other things, that after applying these products, the wood
surfaces suffered excessive mildewing in the very humid climate of western
Washington. The trial court certified the case as a class action, including
all purchasers of the products who reside in nineteen counties in western
Washington. Behr denies the allegations. In May 2000, the court entered a
default against Behr as a discovery sanction. Thereafter, the jury returned
a verdict awarding damages to the named plaintiffs. The damages awarded for
the eight homeowner claims (excluding one award to the owners of a vacation
resort) ranged individually from $14,500 to $38,000. The awards were
calculated using a formula based on the product used, the nature and square
footage of wood surface and certain other allowances. Under the verdict,
the same formula will be used for calculating awards on claims that may be
submitted by the subject purchasers of these products. In addition, the
court granted the plaintiffs' motion for attorneys' fees. Behr appealed the
trial court judgment to the Court of Appeals of Washington. On September
13, 2002, the Court of Appeals issued its opinion, ruling in favor of the
plaintiffs on substantially all issues. The opinion was unexpected in light
of the unprecedented and disproportionate extent of the default sanction
ordered by the trial court and the belief by the Company and its outside
legal counsel that the rulings by the trial court had errors that would be
reversed by the appellate review. Following the trial court judgment in the
Washington case, Behr and the Company were served with 21 complaints filed
by consumers in state courts in Alabama, Alaska, California, Illinois, New
Jersey, New York, Oregon, and Washington, and in British Columbia, Canada
and Ontario, Canada. The complaints allege that certain of Behr's exterior
wood coating products fail to perform as warranted, resulting in damage to
the plaintiffs' wood surfaces. Trial courts in Washington and Illinois
have certified their cases as national class actions. In addition, the
Company has recently been advised that one state is conducting an
investigation into the effectiveness of certain of these products.
13
MASCO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
Note M - continued:
On October 29, 2002, the Company announced settlements to resolve all of
the class actions in the United States. The Company and attorneys
representing class members have reached an agreement in principle to settle
the 19-county Washington lawsuit. The parties are negotiating a definitive
settlement agreement that the Company expects to submit within 30 days for
preliminary approval by the trial court. At that time a fairness hearing
will be scheduled following which the parties will request that the court
grant final approval of the settlement. Under the terms of the settlement,
eligible class members who successfully complete the claims process will
receive a cash award based on the product used, the type and square footage
of wood surface and certain other allowances. The awards will be calculated
using the damage formulas in the judgment entered by the trial court. The
Company will pay cash awards to class members, the costs of notice to the
class, the costs to administer the claims process and certain other
expenses, up to an aggregate maximum of $55 million. In addition, the
Company will pay class counsel fees awarded by the trial court up to a
maximum of $12.5 million. Based upon the sales volume of the related
products during the class period, the damage formulas ordered by trial
court, the expected class size, the estimated number of claims that would
be filed on a timely basis, the estimated average cost per claim, and the
experience of the Company's legal counsel with class action settlements,
the Company estimates that the total cost of the Washington settlement will
approximate the maximum, $67.5 million, excluding amounts that the Company
expects to recover from liability insurers and other third parties.
The Company has also reached a settlement that management expects will
resolve all other class actions pending in the U.S. The settlement has
received preliminary court approval. A fairness hearing has been scheduled
for March 6, 2003, at which time the court will be requested to enter an
order of final approval and judgment. The settlement requires the dismissal
of all other related litigation pending in the United States. Counsel for
plaintiffs in the Illinois case have taken action in the Illinois court to
prevent the Company from proceeding with the settlement. The Company
intends to oppose this effort and any change in the existing terms of the
settlement. The settlement provides that eligible class members who
successfully complete the claims process can elect to receive either a
merchandise certificate for a discount on the purchase of Behr products, or
a cash award based on the product used, the square footage of wood surface,
proof of purchase, the interval of time between product application and the
appearance of mildew, and the extent of mildew damage. The Company will pay
a settlement amount of up to $107.5 million, which will include total cash
payments to eligible class members, the cost of notice to the class, the
cost to administer the claims process, and the face value of merchandise
certificates issued to eligible claimants up to $7.5 million. If the
aggregate face value of merchandise certificates issued exceeds $7.5
million, the excess will not be credited against the $107.5 million
settlement amount but will be settled by issuance of additional merchandise
certificates. The settlement also provides that the Company will pay class
counsel fees awarded by the trial court, up to a maximum of $25 million.
Based upon the sales volume of the related products during the class
period, the expected class size, the estimated number of claims that would
be filed on a timely basis, the estimated size and mix of claims (coupon
versus cash), the estimated average cost per claim and the experience of
the Company's legal counsel with class action settlements, the Company
estimates that the cost of the settlement will range from $96 million to
$136 million (including adjustments due to the $107.5 million limit),
excluding amounts that the Company expects to recover from liability
insurers. This estimate includes costs (for notice and claims
administration) of $5 to $6 million, attorney fees of $25 million,
merchandise certificate costs ranging from $5 to $11 million, and cash
awards ranging from $61 to $102 million.
14
MASCO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONCLUDED)
Note M - concluded:
Management believes, based on the advice of outside counsel, that these
settlements described above will receive final approval without substantial
changes, although there can be no assurance in that regard. The Company
estimates that the combined cost of both settlements and the Company's
additional legal costs (estimated at $2 million) will range from $166
million to $206 million. The Company has concluded that no amount within
that range is more likely than any other, and therefore has reflected $166
million as a liability in the third quarter 2002 consolidated financial
statements in accordance with generally accepted accounting principles. The
Company is currently negotiating its liability insurers' contribution to
the cost of the settlements. However, no insurance amounts have been
recorded as of September 30, 2002. Recoveries from liability insurers or
other third parties will be recorded at such time as they are agreed to,
or otherwise received. After receiving final court approval, the Company
expects that payment of the settlements will commence in the second
quarter of 2003 and will be completed by the first quarter of 2004.
15
MASCO CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THIRD QUARTER 2002 AND THE FIRST NINE MONTHS 2002 VERSUS
THIRD QUARTER 2001 AND THE FIRST NINE MONTHS 2001
SALES AND OPERATIONS
The following tables set forth the Company's net sales and operating profit
margin information by segment and geographic area, dollars in millions:
Percent Increase
(Decrease)
Three Months Ended -----------------
September 30 2002 2002
------------------ vs. vs.
2002 2001 2001 2001(A)
------ ------ ------ ------
NET SALES:
Cabinets and Related Products $ 738 $ 684 8% 13%
Plumbing Products 535 455 18% 9%
Installation and Other Services 489 417 17% 3%
Decorative Architectural Products 439 389 13% 13%
Other Specialty Products 317 282 12% 13%
------ ------
Total $2,518 $2,227 13% 10%
====== ======
North America $2,114 $1,884 12% 10%
International, principally Europe 404 343 18% 11%
------ ------
Total, as above $2,518 $2,227 13% 10%
====== ======
Nine Months Ended
September 30
------------------
2002 2001
------ ------
NET SALES:
Cabinets and Related Products $2,076 $1,906 9% 10%
Plumbing Products 1,508 1,317 15% 11%
Installation and Other Services 1,277 1,292 (1%) 3%
Decorative Architectural Products 1,238 1,128 10% 10%
Other Specialty Products 833 544 53% 1%
------ ------
Total $6,932 $6,187 12% 9%
====== ======
North America $5,882 $5,252 12% 10%
International, principally Europe 1,050 935 12% 3%
------ ------
Total, as above $6,932 $6,187 12% 9%
====== ======
Three Months Ended Nine Months Ended
September 30 September 30
------------------------- --------------------------
2002 2001(C) 2001(D) 2002 2001(C) 2001(D)
------------------------- --------------------------
OPERATING PROFIT MARGIN: (B)
Cabinets and Related Products 15.4% 9.4% 8.8% 13.5% 11.1% 10.5%
Plumbing Products 15.5% 16.0% 15.6% 16.0% 14.0% 13.7%
Installation and Other Services 16.8% 18.5% 15.6% 17.0% 16.6% 14.0%
Decorative Architectural Products 22.1% 21.6% 20.8% 22.2% 20.6% 19.8%
Other Specialty Products 22.1% 22.3% 21.3% 19.8% 17.8% 15.8%
North America 18.4% 16.9% 16.0% 17.7% 15.7% 14.7%
International, principally Europe 13.9% 12.5% 10.2% 13.3% 12.3% 10.3%
Total 17.7% 16.2% 15.1% 17.0% 15.2% 14.1%
(A) Percentage change in sales, excluding acquisitions and divestitures.
(B) Before general corporate expense and the charge for litigation settlement.
(C) Excluding goodwill amortization expense.
(D) Including goodwill amortization expense.
16
MASCO CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
NET SALES
Net sales for the three-month and nine-month periods ended September 30,
2002 increased 13 percent and 12 percent, respectively, from the comparable
periods in 2001. Excluding acquisitions and divestitures, net sales increased 10
percent and 9 percent for the three-month and nine-month periods ended September
30, 2002, respectively, over the comparable periods of the prior year. The
increase in net sales in 2002 is principally due to improved economic and
business conditions in certain of the Company's markets, which contributed to
higher unit sales volume of certain products, particularly cabinets,
architectural coatings, decorative hardware, vinyl windows and faucets.
OPERATING MARGINS
The Company's gross profit margins increased to 31.8 percent and 31.9
percent for the three-month and nine-month periods ended September 30, 2002,
respectively, from 30.5 percent and 30.1 percent for the comparable periods in
2001, respectively. The increase in gross profit margin reflects sales volume
increases in all of the Company's business segments as well as the favorable
influence of the Company's profit improvement initiatives. Selling, general and
administrative expenses, including general corporate expense but excluding the
litigation settlement charge, as a percentage of sales decreased to 15.1 percent
and 15.9 percent for the three-month and nine-month periods ended September 30,
2002, respectively, as compared with 15.4 percent and 16.1 percent for the
comparable periods of the prior year, respectively.
The Company's operating profit margins, before the charge for litigation
settlement in 2002, and after general corporate expense and excluding goodwill
amortization expense in 2001, was 16.7 percent and 16.0 percent for the
three-month and nine-month periods ended September 30, 2002, respectively, as
compared with 15.1 percent and 14.0 percent for the comparable periods in 2001,
respectively. Operating profit margins, before both general corporate expense
and the litigation settlement charge and excluding goodwill amortization expense
in 2001, were 17.7 percent and 17.0 percent for the three-month and nine-month
periods ended September 30, 2002, respectively, as compared with 16.2 percent
and 15.2 percent for the comparable periods in 2001, respectively. The Company's
operating profit margin increased in the third quarter and the nine months ended
September 30, 2002, as compared with the comparable periods in 2001, principally
as a result of fixed costs being spread over a higher sales level as well as
the favorable influence of the Company's profit improvement initiatives.
SEGMENT AND GEOGRAPHIC AREA RESULTS
Changes in net sales in the following discussion exclude the impact of
acquisitions and divestitures. Changes in operating profit margin in the
following discussion exclude goodwill amortization expense and the charge for
litigation settlement.
17
MASCO CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net sales of Cabinets and Related Products increased 13 percent and 10
percent for the three-month and nine-month periods ended September 30, 2002,
respectively, from the comparable periods of the prior year due to increased
sales volume of cabinets largely through expansion of North American retail
distribution channels as well as new product introductions. Operating profit
margins for the Cabinets and Related Products segment were 15.4 percent and 13.5
percent for the three-month and nine-month periods ended September 30, 2002,
respectively, compared with 9.4 percent and 11.1 percent for the comparable
periods of the prior year, respectively. The increase in operating profit
margins is primarily due to increased unit sales volume, profit improvement
initiatives and the reduction of plant shutdown costs and other asset
write-downs, offset in part by costs related to a discontinued product line.
Net sales of Plumbing Products increased 9 percent and 11 percent for the
three-month and nine-month periods ended September 30, 2002, respectively, from
the comparable periods of the prior year. These increases represent the
favorable influence of new product introductions which contributed to higher
unit sales volume of faucets to retailers in 2002 as well as increased growth in
the wholesale distribution channels. The increase in sales of Plumbing Products
in 2002 also includes the influence of inventory reduction programs of certain
key customers in the first six months of 2001, which reduced sales for 2001 and
favorably influenced the first nine months of 2002 versus 2001 comparisons.
Operating profit margins for the Plumbing Products segment were 15.5 percent and
16.0 percent for the three-month and nine-month periods ended September 30,
2002, respectively, compared with 16.0 percent and 14.0 percent for the
comparable periods of the prior year. Operating profit margins in the first nine
months of 2002 were primarily favorably affected by the leveraging of fixed
costs over increased unit sales volume as well as the Company's profit
improvement initiatives. Operating profit margins in the third quarter of 2002
were adversely affected by product mix and higher insurance costs compared with
the third quarter of 2001.
Net sales of Installation and Other Services increased 3 percent for both
the three-month and nine-month periods ended September 30, 2002, from the
comparable periods of the prior year. The increase in net sales attributable to
this segment in 2002 occurred despite lower insulation material purchase costs
and related lower market pricing, which partially offset increases of
non-insulation installed products. Operating profit margins for the Installation
and Other Services segment were 16.8 percent and 17.0 percent for the
three-month and nine-month periods ended September 30, 2002, respectively,
compared with 18.5 percent and 16.6 percent for the comparable periods of the
prior year. Operating profit margins in this segment were affected by lower
margins of acquired companies for the three months ended September 30, 2002 and
product mix for the nine months ended September 30, 2002.
18
MASCO CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net sales of Decorative Architectural Products increased 13 percent and 10
percent for the three-month and nine-month periods ended September 30, 2002,
respectively, from the comparable periods of the prior year, due largely to
higher unit sales volume of paints, stains and decorative hardware through North
American retail distribution channels. Operating profit margins for the
Decorative Architectural Products segment were 22.1 percent and 22.2 percent for
the three-month and nine-month periods ended September 30, 2002, respectively,
compared with 21.6 percent and 20.6 percent for the comparable periods of the
prior year. The improvement in operating profit margins for this segment reflect
the leveraging of fixed costs over higher unit sales volume, the absence of
plant start-up and relocation costs that contributed to lower operating margins
in 2001 and lower levels of bad debt expense and certain asset write-downs in
2002 compared with 2001.
Net sales of Other Specialty Products increased 13 percent and 1 percent
for the three-month and nine-month periods ended September 30, 2002,
respectively, from the comparable periods of the prior year. The increase in net
sales in the third quarter 2002 is primarily due to increased sales of vinyl
windows. A weaker U.S. dollar also had a favorable effect on the translation of
local currencies of European operations included in this segment. Operating
profit margins were 22.1 percent and 19.8 percent for the three-month and nine-
month periods ended September 30, 2002, respectively, compared with 22.3
percent and 17.8 percent for the comparable periods of the prior year. The
improvement in operating profit margins in the nine months ended September 30,
2002 reflects the positive influence of recent acquisitions, which in aggregate
have higher operating profit margins than the segment average.
Net sales from North American operations increased 10 percent for both the
three-month and nine-month periods ended September 30, 2002 from the comparable
periods of 2001. Operating profit margins for North American operations were
18.4 percent and 17.7 percent for the three-month and nine-month periods ended
September 30, 2002, respectively, compared with 16.9 percent and 15.7 percent
for the comparable periods of the prior year. The increase in operating profit
margins principally reflects the leveraging of fixed costs over increased sales
volume, product mix and the influence of the Company's profit improvement
initiatives. Additionally, in 2001, North American operations were negatively
affected by plant shutdown charges and asset write-downs that favorably
influenced the 2002 versus 2001 comparisons.
Net sales from International operations increased 11 percent and 3 percent
for the three-month and nine-month periods ended September 30, 2002,
respectively, from the comparable periods of 2001. A weaker U.S. dollar had a
favorable influence on the translation of International sales in the third
quarter of 2002. International sales in local currencies increased 2 percent for
the third quarter 2002 and were flat for the nine-month period ended September
30, 2002. Operating profit margins for International operations were 13.9
percent and 13.3 percent for the three-month and nine-month periods ended
September 30, 2002, respectively, compared with 12.5 percent and 12.3 percent
for the comparable periods of the prior year. Operating profit margins for
International operations benefited from profit improvement initiatives as well
as the positive influence of recent acquisitions which in aggregate have higher
operating profit margins than the International operations' average.
19
MASCO CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OTHER INCOME (EXPENSE), NET
Included in other interest income for the nine months ended September 30,
2001 is $30.3 million of interest income from indebtedness of Furnishings
International Inc. ("FII"). No such interest income was recorded for the three
months ended September 30, 2001. The recording of such interest income was
discontinued effective July 1, 2001 due to the impairment of the Company's
investment in FII.
In the third quarter of 2001, the Company recorded an aggregate $530
million pre-tax, non-cash charge for the write-down of certain investments,
including the Company's investments in FII and other non-operating assets.
The furniture industry in general and FII in particular had been adversely
affected by the ongoing economic weakness in its markets, the bankruptcies of
a number of major retailers and import competition. In light of these factors,
the Company reevaluated the carrying value of its investment in FII and
recorded a $460 million pre-tax, non-cash charge to write down this investment
to its estimated current fair value. The Company also recorded a $70 million
pre-tax, non-cash charge for an other-than-temporary decline in the fair value
of certain of the Company's, principally technology-related, investments.
Other, net for the three-month and nine-month periods ended September 30,
2002 includes $1.6 million and $(27.2) million, respectively, of realized gains
(losses), net from the sale of marketable securities, dividend income from
marketable securities of $1.5 million and $2.8 million, respectively, and $2.3
million and $6.7 million of income and gains (losses), net regarding other
investments, respectively. In addition, in the third quarter of 2002, the
Company incurred $13.8 million of losses related to interest ratelock
transactions entered into in anticipation of the Company issuing fixed rate debt
in the third quarter of 2002. There were no interest ratelock agreements
outstanding at September 30, 2002. Other, net for the three-month and nine-
month periods ended September 30, 2001 included $(3.2) million and $(.2)
million, respectively, of realized gains (losses), net from the sale of
marketable securities, dividend income from marketable securities of $.7 million
and $1.9 million, respectively, and $5.0 million and $9.7 million, respectively,
of income and gains (losses), net regarding other investments.
Interest expense for the three-month and nine-month periods ended September
30, 2002 was $61.0 million and $170.3 million, respectively, compared with $61.6
million and $179.3 million for the comparable periods of the prior year.
INCOME AND EARNINGS PER COMMON SHARE BEFORE THE
CUMULATIVE EFFECT OF ACCOUNTING CHANGE
Net income (loss) for the third quarter of 2002 increased to $122.8 million
and diluted earnings (loss) per common share increased to $.24 compared with
$(.39) per common share ($(.35) excluding goodwill amortization expense) for the
comparable period of 2001. Income before the cumulative effect of accounting
change for the nine-month period ended September 30, 2002 was $487.3 million and
related diluted earnings per common share was $.96 compared with $.15 per common
share ($.27 excluding goodwill amortization expense) for the comparable period
of the prior year.
20
MASCO CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The three-month and nine-month periods ended September 30, 2002 were
impacted by the charge for the litigation settlement of $166 million. The
three-month and nine-month periods ended September 30, 2001 were impacted by a
$530 million non-cash, pre-tax charge for the write-down of certain investments,
including the Company's investment in Furnishings International Inc. and other
non-operating assets.
The Company's effective tax rate, excluding the charge for litigation
settlement, was 34.2 percent and 34.1 percent for the third quarter and nine
months ended September 30, 2002, respectively, prior to the accounting change
effect, as compared with 35.0 percent (36.8 percent and 27.6 percent for the
three months and nine months ended September 30, 2001, respectively, excluding
goodwill amortization expense) for both of the comparable periods of the prior
year. The Company estimates that its effective tax rate should approximate 34.5
percent for the full year 2002, excluding the litigation settlement charge and
the accounting change effect.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE
On January 1, 2002, Statement of Financial Accounting Standards ("SFAS")
No. 142, "Goodwill and Other Intangible Assets," became effective. In accordance
with SFAS No. 142, the Company is no longer recording amortization expense
related to goodwill and other indefinite-lived intangible assets. The Company
adopted a new critical accounting policy regarding goodwill and other
indefinite-lived intangible assets. See Note A of the Condensed Consolidated
Financial Statements.
The Company completed the two-step transitional goodwill impairment testing
in the second quarter of 2002. The first step of the test was to perform an
assessment of whether there is an indication that goodwill is impaired. To the
extent that an indication of impairment existed, the Company performed a second
test to measure the amount of the impairment. The Company tested for impairment
of its reporting units by comparing fair value to carrying value. Fair value was
determined using a discounted cash flow method. This evaluation indicated that
goodwill recorded for certain of the Company's business units, principally in
Europe, were impaired. Certain of the Company's European businesses have been
affected by continued weak market and economic conditions. On adoption of SFAS
No. 142, a non-cash impairment charge of $92.4 million, net of income tax
benefit of $24.4 million, was recognized as a cumulative effect of change in
accounting principle in the first half of 2002, effective January 1, 2002.
Determining market values using the discounted cash flow method requires
the Company to make significant estimates and assumptions including long-term
projections of cash flows, market conditions and appropriate discount rates. The
Company's judgments are based on historical experience, current market trends
and other information. While the Company believes that the estimates and
assumptions underlying the valuation model are reasonable, different assumptions
could result in a different outcome.
21
MASCO CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OTHER FINANCIAL INFORMATION
The Company's current ratio was 1.9 to 1 at September 30, 2002, as compared
with 2.1 to 1 at December 31, 2001; this decrease was due principally to the
reclassification from long-term debt to short-term debt of $200 million of
6-1/8% notes due September 2003.
For the nine months ended September 30, 2002, cash of $690.8 million was
provided by operating activities. Cash provided by financing activities was
$675.0 million, including $1,082.1 million from the issuance of fixed rate notes
in 2002, and $598.3 million from the issuance of Company common stock. Cash used
for financing activities included a $717.2 million net decrease in long-term
debt, primarily related to payments of bank debt, $60.5 million for the
acquisition of Company common stock in open-market transactions, $31.3 million
for the acquisition of Company common stock for the Company's long-term stock
incentive award plan, and $196.5 million for cash dividends paid. Cash used for
investing activities was $1,077.7 million, including $660.8 million for
acquisitions, $175.5 million for capital expenditures, and $304.3 million for
the net purchases of marketable securities and other investments. Cash provided
by investing activities included $15.4 million from the disposition of a
business and $47.4 million from other items. The aggregate of the preceding
items represents a net cash inflow of $288.1 million.
Days sales in accounts receivable increased to 57 days from 52 days at
September 30, 2001, primarily due to an extension of payment terms with a major
customer.
In September 2002, the Company increased its quarterly cash dividend to
$.14 from $.135 per common share. This marks the 44th consecutive year in which
dividends have been increased.
In May 2002, the Company sold 22 million shares of Company common stock in
a public offering, resulting in net proceeds to the Company of $598.3 million
(net of issuance costs of $14.4 million). On June 24, 2002, the Company issued
$500 million of 5-7/8% notes due 2012, resulting in net proceeds of $490.8
million. On August 20, 2002, the Company issued $300 million of 4-5/8% notes due
2007, resulting in net proceeds of $296.7 million. On August 20, 2002, the
Company also issued $300 million of 6-1/2% notes due 2032, resulting in net
proceeds of $294.6 million. These proceeds are net of aggregate debt issuance
costs of $17.9 million which are being amortized over the issue lives of the
related notes. The Company used the proceeds from the equity and debt issuances
to reduce bank indebtedness and for other general corporate purposes, including
investments in marketable securities and other investments.
On July 19, 2002, the Company announced that it amended the terms of its
Zero Coupon Convertible Senior Notes ("Notes") due July 20, 2031 to permit an
additional date, April 20, 2004, on which holders, at their option, can cause
the Company to repurchase the Notes, at the then accreted value of $429.57 per
Note, payable by the Company in cash on April 26, 2004. Under the original terms
of the Notes, holders of $26.4 million of Notes required the Company to
repurchase, for $10.7 million cash, the accreted value of such Notes on July 23,
2002.
22
MASCO CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Subsequent Event: On October 16, 2002, the Company issued $350 million of
5-7/8% notes due 2012, resulting in net proceeds of $356 million, including a
premium of $8.3 million and debt issuance costs of $2.3 million, which are being
amortized through 2012. The Company subsequently filed Registration Statements
with the Securities and Exchange Commission, pending effectiveness, to increase
the unallocated shelf registration pursuant to which the Company is able to
issue up to a combined $2 billion of debt and equity securities and 50 million
shares of Company common stock.
As disclosed in the Company's 2001 Form 10-K, the carrying value of the
Company's investment in Furnishings International Inc. ("FII") was adjusted in
2001 to the estimated fair value of proceeds expected to be received from the
liquidation of FII in satisfaction of amounts due to the Company for its
investment in pay-in-kind junior subordinated debt securities of FII and certain
advances to FII (collectively "FII debt").
During the second quarter of 2002, FII completed the disposition of its
operations. The fair value of the remaining net assets of FII represents
proceeds for the Company's investment in FII debt. The assets and liabilities
are primarily comprised of notes receivable, 4 million shares of Furniture
Brands International common stock and pension obligations of approximately $75
million. Certain non-Masco shareholders of FII have contributed their FII shares
back to FII resulting in Masco becoming the majority shareholder. Accordingly,
the assets and liabilities of FII have been recorded in the Company's condensed
consolidated financial statements.
The Company is subject to lawsuits and claims pending or asserted with
respect to matters generally arising in the ordinary course of business. Note M
of the Condensed Consolidated Financial Statements discusses specific claims
against the Company and its subsidiary, Behr Process Corporation, with respect
to several of Behr's exterior wood coating products.
The Company believes that its present cash balance, its cash flows from
operations and, to the extent necessary, bank borrowings and future financial
market activities, are sufficient to fund its working capital and other
investment needs.
RECENTLY ISSUED ACCOUNTING STANDARDS
On January 1, 2002, Statement of Financial Accounting Standards ("SFAS")
No. 142, "Goodwill and Other Intangible Assets," became effective. In accordance
with SFAS No. 142, the Company is no longer recording amortization expense
related to goodwill and other indefinite-lived intangible assets. See
"Cumulative Effect of Accounting Change" for additional discussion regarding the
adoption of this standard.
On January 1, 2002, SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" became effective. This statement addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. The adoption of SFAS No. 144 did not have a material effect on the
Company's consolidated financial statements.
23
MASCO CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Emerging Issues Task Force ("EITF") Issue No. 01-9, "Accounting for
Consideration Given by a Vendor to a Customer," became effective for the Company
in the first quarter of 2002. EITF No. 01-9 requires that certain expenses,
including co-operative advertising expenses and other customer-related
incentives, be recorded as a reduction in sales unless certain conditions are
met. The adoption of EITF No. 01-9 resulted in the reclassification of $20
million and $56 million of co-operative advertising expenses from selling
expense to a reduction in sales for the three months and nine months ended
September 30, 2001, respectively. This reclassification did not result in a
change in net income (loss) or earnings (loss) per common share.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs from Exit
or Disposal Activities" which requires, among other things, that a liability for
costs associated with an exit or disposal activity be recognized when the
liability is incurred. The adoption of SFAS No. 146 is effective for all exit or
disposal activities subsequent to December 31, 2002. The Company is currently
evaluating the impact that SFAS No. 146 will have on its consolidated financial
statements.
OUTLOOK FOR THE COMPANY
The Company's internal sales growth has continued to trend upward. The
upward trend in sales includes increased sales to retailers with above-average
increases in sales of cabinets, architectural coatings, decorative hardware and
faucets. The Company has also recently implemented several programs aimed at
improving return on assets and cash flow; the Company anticipates significant
future improvement in both of these areas which should contribute to future
margin improvement. Due to seasonal factors, the Company expects margins in the
fourth quarter to be modestly lower than margins achieved in the second and
third quarters.
FORWARD-LOOKING STATEMENTS
Certain sections of this Quarterly Report contain statements reflecting the
Company's views about its future performance and constitute "forward-looking
statements" under the Private Securities Litigation Reform Act of 1995. These
views involve risks and uncertainties that are difficult to predict and,
accordingly, the Company's actual results may differ materially from the results
discussed in such forward-looking statements. Readers should consider that
various factors, including changes in general economic conditions, competitive
market conditions and pricing pressures, relationships with key customers,
industry consolidation of retailers, wholesalers and builders, shifts in
distribution, the influence of e-commerce and other factors discussed in the
Company's Annual Report on Form 10-K and its other filings with the Securities
and Exchange Commission, may affect the Company's performance. The Company
undertakes no obligation to update publicly any forward-looking statements as a
result of new information, future events or otherwise.
24
MASCO CORPORATION
ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES
a. Evaluation of Disclosure Controls and Procedures
Based on their evaluation of the Company's disclosure controls and
procedures conducted within 90 days of the date of filing this report on
Form 10-Q, the Company's Chief Executive Officer and the Chief Financial
Officer have concluded that the Company's disclosure controls and
procedures (as defined in Rules 13a-14(c) and 15d-14(c) promulgated under
the Securities Exchange Act of 1934) are designed to be and are adequate to
ensure that information required to be disclosed by the Company in the
reports it files or submits under the Securities Exchange Act of 1934, as
amended, is recorded, processed, summarized and reported, within the time
periods specified in the rules and forms of the Securities and Exchange
Commission.
b. Changes in Internal Controls
There were no significant changes in the Company's internal controls or to
our knowledge, in other factors that could significantly affect these
controls subsequent to the date of their evaluation.
25
MASCO CORPORATION
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information regarding this item is set forth in Note M to the Company's
Condensed Consolidated Financial Statements included in Part I, Item 1 of this
Report.
ITEMS 2 THROUGH 5 ARE NOT APPLICABLE.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
12 - Computation of Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends
(b) REPORTS ON FORM 8-K:
Report on Form 8-K dated July 30, 2002, relating to the sworn
statement of facts and circumstances made pursuant to Order No.
4-460.
Report on Form 8-K dated August 20, 2002, filing the opinion of
John R. Leekley regarding the Company's Registration Statement on
Form S-3.
Report on Form 8-K dated September 18, 2002, describing an
adverse appellate court decision in the State of Washington
involving the Company's Behr Paint subsidiary.
Report on Form 8-K dated September 19, 2002, filing the Company's
press release clarifying information contained in the September
18, 2002 Form 8-K Report.
Report on Form 8-K dated October 4, 2002, updating previously
filed information on Form 8-K Reports dated September 18 and
September 19, 2002, including a statement of the Company's
current analysis of its potential financial exposure resulting
from the adverse appellate court decision in the State of
Washington involving the Company's Behr Paint subsidiary.
Report on Form 8-K dated October 16, 2002, filing the opinion of
John R. Leekley regarding the Company's Registration Statements
on Form S-3.
Report on Form 8-K dated October 29, 2002, filing the Company's
press release announcing preliminary settlement of certain class
action litigation.
26
MASCO CORPORATION
PART II. OTHER INFORMATION, CONCLUDED
SIGNATURE
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.
MASCO CORPORATION
-----------------
(Registrant)
DATE: NOVEMBER 13, 2002 BY: /s/ Timothy Wadhams
----------------------- -------------------------------------
Timothy Wadhams
Vice-President and
Chief Financial Officer
27
MASCO CORPORATION
CERTIFICATIONS
I, Richard Manoogian, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Masco Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 13, 2002 By: /s/ Richard Manoogian
------------------------ ------------------------------
Richard Manoogian
Chief Executive Officer
28
MASCO CORPORATION
CERTIFICATIONS
I, Timothy Wadhams, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Masco Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 13, 2002 By: /s/ Timothy Wadhams
-------------------------- ------------------------------
Timothy Wadhams
Vice President and
Chief Financial Officer
29
MASCO CORPORATION
EXHIBIT INDEX
EXHIBIT
Exhibit 12 Computation of Ratio of Earnings to Combined Fixed Charges and
Preferred Stock Dividends.