MASCO CORP /DE/ - Annual Report: 2009 (Form 10-K)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

 

MASCO CORPORATION

(Exact name of Registrant as Specified in its Charter)

 

 

Registrant’s telephone number, including area code: 313-274-7400

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

 

Securities Registered Pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of the Registrant’s Common Stock held by non-affiliates of the Registrant on June 30, 2009 (based on the closing sale price of $9.58 of the Registrant’s Common Stock, as reported by the New York Stock Exchange on such date) was approximately $3,338,607,000.          .

 

Number of shares outstanding of the Registrant’s Common Stock at January 31, 2010:

 

358,778,000 shares of Common Stock, par value $1.00 per share

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s definitive Proxy Statement to be filed for its 2010 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K

 

 

Masco Corporation
2009 Annual Report on Form 10-K

TABLE OF CONTENTS

 

 

 

Masco Corporation manufactures, distributes and installs home improvement and building products, with emphasis on brand-name consumer products and services holding leadership positions in their markets. We are among the largest manufacturers in North America of a number of home improvement and building products, including faucets, cabinets, architectural coatings and windows and we are one of the largest installers of insulation for the new home construction market. We generally provide broad product offerings in a variety of styles and price points and distribute products through multiple channels, including directly to homebuilders and wholesale and retail channels. Approximately 79 percent of our 2009 sales were generated by our North American operations.

 

Over the past three years, we have experienced a significant downturn in the home improvement and new home construction markets. As a result, we have been focused on the strategic rationalization of our businesses, including business consolidations, plant closures, headcount reductions, system implementations and other cost savings initiatives. Throughout our businesses, we have closed several plants and since 2006, we have closed over 90 locations formerly operated by our Installation and Other Services segment.

 

We continue to focus on our cost structure and we are driving process improvement through the implementation of the Masco Business System (“MBS”). The MBS is the integrated leadership practices, processes, tools and capabilities that enable the effective and consistent execution of our strategies and operating plans to maximize our full potential. Through the MBS, we are advancing our strategy of growing organic sales based on a better understanding of our customer needs and investing in new product innovation. We are also focusing on enhancing customer experience through improvements in product quality. In 2009, we introduced several new products, including BEHR PREMIUM PLUS ULTRA INTERIOR^® paint and the SIMPLICITY^tm window by Milgard, and we expanded the DIAMOND^tm Seal Technology faucets offered by Delta. We have also begun several new initiatives, including programs related to retro-fit home energy efficiency services, the sale of BEHR^® paint to professional painters through The Home Depot and the combination of our North American cabinet business units to form Masco Cabinetry.

We report our financial results in five business segments aggregated by similarity in products and services. The following table sets forth, for the three years ended December 31, 2009, the contribution of our segments to net sales and operating profit. Additional financial information concerning our operations by segment and by geographic regions, as well as general corporate expense, net, as of and for the three years ended December 31, 2009, is set forth in Note O to our consolidated financial statements included in Item 8 of this Report.

 

 

 

 

 

Cabinets and Related Products

 

In North America, we manufacture and sell economy, stock, semi-custom, assembled and ready-to-assemble cabinetry for kitchen, bath, storage, home office and home entertainment applications in a broad range of styles and price points. In Europe, we manufacture and sell assembled and ready-to-assemble kitchen, bath, storage, home office and home entertainment cabinetry. These products are primarily sold in the United States and in Europe under a number of trademarks including KRAFTMAID^®, DISTINCTIONS^®, TVILUM-SCANBIRK^tm and WOODGATE^® primarily to dealers and home centers, and under the brands MERILLAT^®, MOORES^tm and QUALITY CABINETS^® primarily to distributors and homebuilders for both the home improvement and new home construction markets. Cabinet sales are significantly affected by levels of activity in both new home construction and retail consumer spending, particularly spending for major home

improvement products. A significant portion of our sales for the home improvement market is made through home center retailers.

 

Over the past several years, this segment of our business has been particularly affected by the downturn in the home improvement and new home construction markets due to new homebuilders producing smaller homes with smaller kitchens and end-consumers shifting to lower price point products. In 2009, we closed several manufacturing plants in this segment. We are currently focused on improving cabinet production efficiencies at lower volumes while maintaining our ability to respond effectively to increased demand when the home improvement and new home construction markets improve. By the end of 2010, we expect that we will be able to manufacture a common base cabinet at all of our plants that principally manufacture cabinets for the new home construction market in North America. We have also expanded our product offerings in this segment to include the manufacture and sale of countertops in North America.

 

The cabinet manufacturing industry in the United States and Europe is highly competitive, with several large competitors and numerous local and regional competitors. In addition to price, we believe that competition in this industry is based largely on product quality, responsiveness to customer needs, product features and selection. Significant North American competitors include American Woodmark Corporation and Fortune Brands, Inc.

 

In February 2010, we announced the combination of our Builder Cabinet Group and Retail Cabinet Group to form Masco Cabinetry. We believe that the creation of Masco Cabinetry will help us establish an even stronger position to lead the cabinet category within the repair and remodel and new home construction markets. Masco Cabinetry will focus on all channels of distribution by offering a broad portfolio of cabinets and countertops at a wide range of price points and in a variety of styles.

 

Plumbing Products

 

Our plumbing products segment sells a wide variety of faucet and showering devices that are manufactured by or for us. Our plumbing products are sold in North America and Europe under various brand names including DELTA^®, PEERLESS^®, HANSGROHE^®, AXOR^®, BRIZO^®, BRASSTECH^®, BRISTAN^tm, NEWPORT BRASS^®, ALSONS^®, SIRRUS^tm and PLUMB SHOP^®. Products include single-handle and double-handle faucets, showerheads, handheld showers and valves, which are sold to major retail accounts and to wholesalers and distributors who sell these products to plumbers, building contractors, remodelers, smaller retailers and others.

 

We believe that our products in this segment are among the leaders in sales in the North American and European markets, with American Standard, Kohler, Moen and Price Pfister as major brand competitors. We also have several European competitors, primarily in Germany, including Friedrich Grohe. We face significant competition from private label products (including house brands sold by certain of our customers). Many of the faucet and showering products with which our products compete are manufactured in Asia. The businesses in our Plumbing Products segment source products from Asia and manufacture products in the United States, Europe, and Asia.

 

Other plumbing products manufactured and sold by us include AQUA GLASS^®, MIROLIN^® and AMERICAN SHOWER & BATH^tm acrylic and gelcoat bath and shower enclosure units, shower trays and laundry tubs, which are sold primarily to wholesale plumbing distributors and home center retailers for the North American home improvement and new home construction markets. Our spas are manufactured and sold under HOT SPRING^®, CALDERA^® and other trademarks directly to independent dealers. Major competitors include Kohler, Lasco, Maax and Jacuzzi. We sell HÜPPE^® shower enclosures through wholesale channels primarily in western Europe. HERITAGE^tm ceramic and acrylic bath fixtures and faucets are principally sold in the United Kingdom directly to selected retailers.

 

Also included in the Plumbing Products segment are brass and copper plumbing system components and other plumbing specialties, which are sold to plumbing, heating and hardware wholesalers and to home center retailers, hardware stores, building supply outlets and other mass merchandisers. These products are

marketed in North America for the wholesale trade under the BRASSCRAFT^® and BRASSTECH trademarks and for the “do-it-yourself” market under the MASTER PLUMBER^® and PLUMB SHOP trademarks and are also sold under private label.

 

In addition to price, we believe that competition in our Plumbing Products markets is based largely on brand reputation, product quality, product innovation and features, and breadth of product offering.

 

A substantial portion of our plumbing products are made from brass, the major components of which are copper and zinc. From time to time, we have encountered volatility in the price of brass. In the past, we have implemented a hedging strategy to attempt to minimize the impact of commodity price volatility; a hedging strategy may be implemented in the future. Legislation enacted in California and Vermont, which became effective in January 2010, mandates new standards for acceptable lead content in plumbing products sold in those states. Similar legislation may be considered by other states. Faucet and water supply valve manufacturers, including our plumbing product companies, will be required to obtain adequate supplies of lead-free brass or suitable alternative materials for continued production of faucets.

 

In 2008, our Delta Faucet business introduced a new water delivery system known as DIAMOND Seal Technology. DIAMOND Seal Technology reduces the number of potential leak points in a faucet, simplifies installation and satisfies the legislation enacted in California and Vermont regulating the acceptable lead content in plumbing products. Delta Faucet, in the near-term, plans to incorporate DIAMOND Seal Technology into its domestically manufactured single-handle faucets and, in the future, plans to expand the application of the technology to most other Delta faucets. The success of DIAMOND Seal Technology depends on many factors, including the performance of the technology and the market’s acceptance of the technology as well as Delta’s ability to integrate successfully the technology into its most popular faucets.

 

Installation and Other Services

 

Our Installation and Other Services segment sells installed building products and distributes building products primarily to the new home construction market, and to a lesser extent, the commercial construction market, throughout the United States. In order to respond to the significant decrease in demand in the new home construction industry over the past three years, we have implemented several cost savings initiatives involving the consolidation and closure of over 90 branch locations. This rationalization has been accomplished while maintaining our strategic presence in most of the top 100 Metropolitan Statistical Areas (“MSA”) in the United States. In addition, over the past two years, in this segment, we have de-emphasized the installation of certain non-insulation building products that are not core to our service offering, including windows and paint. In addition to insulation, our current offering of installed building products primarily consists of gutters, after-paint products, framing components, fireplaces, garage doors and cabinets. The installation and distribution of insulation comprised approximately nine percent, 11 percent and 12 percent of our consolidated net sales for the years ended December 31, 2009, 2008 and 2007, respectively. Installed building products are supplied primarily to custom and production homebuilders by our network of branches located in most MSA’s throughout the United States. Distributed products include insulation, insulation accessories, gutters, roofing and fireplaces. Distributed products are sold primarily to contractors and dealers from distribution centers in various parts of the United States.

 

Within this segment, we have also begun several new initiatives related to improved energy efficiency, including energy audit services and related home improvements targeted at the retrofit and remodeling markets.

 

In addition to price, we believe that competition in this industry is based largely on customer service and the quality of installation service. We believe that we are the largest national provider of installed insulation in the new home construction industry in the United States. Our competitors include several regional contractors, as well as numerous local contractors and lumber yards. We believe that our financial resources are substantial compared to regional and local contractors.

Decorative Architectural Products

 

We produce architectural coatings including paints, primers, specialty paint products, stains, varnishes and waterproofing products. The products are sold in the United States, Canada, China, Mexico and South America under the brand names BEHR^®, KILZ^®, CASUAL COLORS^® and EXPRESSIONS^® to the “do-it-yourself” and professional markets through home centers, paint stores and other retailers. Net sales of architectural coatings comprised approximately 20 percent, 15 percent and 13 percent of our consolidated net sales for the years ended December 31, 2009, 2008 and 2007, respectively. Competitors in the architectural coatings market include large national and international brands such as Benjamin Moore, Glidden, Olympic, Sherwin-Williams, Valspar and Zinsser, as well as many regional and other national brands. In addition to price, we believe that competition in this industry is based largely on product quality, technology and product innovation, customer service and brand reputation.

 

Our BEHR brand is sold through The Home Depot, the segment’s and our largest customer. The paint departments at The Home Depot stores include the Behr color center and computer kiosk with the COLOR SMART BY BEHR^® computerized color-matching system that enables consumers to select and coordinate their paint-color selection. In 2009, Behr’s product offering was enhanced by the introduction of the BEHR PREMIUM PLUS ULTRA INTERIOR paint, which is a high-quality, low volatile organic compound, interior paint and primer in one. The loss of this segment’s sales to The Home Depot would have a material adverse effect on this segment’s business and on our consolidated business as a whole.

 

Titanium dioxide is a major ingredient in the manufacture of paint. Shortages of supply and cost increases for titanium dioxide in the past have resulted from surges in global demand and from production capacity limitations. Petroleum products are also used in the manufacture of architectural coatings. Significant increases in the cost of crude oil and natural gas lead to higher raw material costs (e.g., for resins, solvents and packaging, as well as titanium dioxide), which can adversely affect the segment’s results of operations.

 

Our Decorative Architectural Products segment also includes LIBERTY^® cabinet, door, window and other hardware, which is manufactured for us and sold to home centers, other retailers, original equipment manufacturers and wholesale markets. Key competitors in North America include Amerock, Belwith, Umbra and Stanley. Decorative bath hardware and shower accessories are sold under the brand names FRANKLIN BRASS^® and DECOR BATHWARE^® to distributors, home center retailers and other retailers. Competitors include Moen and Globe Union.

 

Other Specialty Products

 

We manufacture and sell vinyl, fiberglass and aluminum windows and patio doors under the MILGARD^® brand name to the home improvement and new home construction markets, principally in the western United States. MILGARD products are sold primarily through dealers and, to a lesser extent, directly to production homebuilders and through lumber yards and home center retailers. In 2009, Milgard expanded its product line with the introduction of the SIMPLICITY Window, which is an energy-efficient vinyl window targeted to value-conscious customers. This segment’s competitors in North America include national brands, such as Jeld-Wen, Simonton, Pella and Andersen, and numerous regional brands. In the United Kingdom, we manufacture and sell windows, related products and components under several brand names including GRIFFIN^tm, CAMBRIAN^tm, PREMIER^tm and DURAFLEX^tm. Sales are primarily through dealers and wholesalers to the repair and remodeling markets, although our Duraflex business is also a supplier to other window fabricators. United Kingdom competitors include many small and mid-sized firms and a few large, vertically integrated competitors. In addition to price, we believe that competition in this industry is based largely on customer service and product quality.

 

We manufacture and sell a complete line of manual and electric staple gun tackers, staples and other fastening tools under the brand names ARROW^® and POWERSHOT^®. We sell these products through various distribution channels including home centers and other retailers and wholesalers. Our principal North American competitor in this product line is Stanley.

Additional Information

 

 

Available Information

 

Our website is www.masco.com. Our periodic reports and all amendments to those reports required to be filed or furnished pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 are available free of charge through our website. This Form 10-K is being posted on our website concurrently with its filing with the Securities and Exchange Commission. We will continue to post our periodic reports on Form 10-Q and our current reports on Form 8-K and any amendments to those documents to our website as soon as reasonably practicable after those reports are filed with or furnished to the Securities and Exchange Commission. Material contained on our website is not incorporated by reference into this Report on Form 10-K.

 

There are a number of business risks and uncertainties that have affected and may continue to affect our business. These risks and uncertainties have negatively impacted our current results and could cause our future results to differ from past performance or expected results, including results described in statements elsewhere in this Report that constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. The effect on us of certain of these risk factors is discussed below under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Additional risks and uncertainties not presently known to us, or that we currently believe to be immaterial, also may adversely impact our business, financial condition and results of operations. These risks and uncertainties include, but are not limited to, the following, which we consider to be most relevant to our specific business activities.

A significant portion of our business relies on home improvement and new home construction activity levels, both of which have experienced a significant downturn.

 

A significant portion of our business relies on home improvement (including repair and remodeling) and new home construction activity levels, principally in North America and Europe. The new home construction market, which is cyclical in nature, has undergone a significant downturn marked by declines in the demand for new homes, an oversupply of new and existing homes on the market and a reduction in the availability of financing for homebuyers. The oversupply of existing homes held for sale has been exacerbated by a growing number of home mortgage foreclosures, which has contributed to the downward pressure on home prices.

 

Unlike most previous cyclical declines in new home construction, this economic decline has also adversely affected our home improvement businesses. Low levels of consumer confidence and the downward pressure on home prices have made it much more difficult for homeowners to make additional investments in their homes, such as kitchen and bath remodeling projects. Further, disruptions in the credit markets have limited the ability of consumers to finance home improvements.

 

We believe that, during the third and fourth quarters of 2009, there have been some signs of stabilization in our markets and we continue to believe that the long-term outlook for the home improvement and new home construction markets is favorable. However, we cannot predict the type, timing or strength of a recovery in our markets. Depressed activity levels in consumer spending for home improvements and new home construction have adversely affected our results of operations and our financial position.

 

Furthermore, the economic turmoil has caused certain shifts in consumer preferences and purchasing practices and has resulted in changes in the business models and strategies of our customers. Such shifts, which may or may not be long-term, have altered the nature and prices of products demanded by the end-consumer and our customers. If we do not timely and effectively respond to these changing consumer preferences, our relationships with our customers could be adversely affected, the demand for our products could be reduced and our market share could be negatively affected.

 

A prolonged economic downturn could reduce our financial resources and flexibility.

 

The valuation of assets on our balance sheet, particularly goodwill and other indefinite-lived intangible assets, is largely dependent upon the expectations for future performance of our businesses. A further decline in the expectation of our future performance or a continuation of the adverse conditions in the new home construction markets may cause us to recognize non-cash impairment charges, which are not determinable at this time, for certain long-lived assets, including goodwill, and could result in a reduction in our shareholders’ equity in the future. Such a reduction in our shareholders’ equity may limit our borrowing capacity under our existing Five-Year Revolving Credit Agreement.

 

We rely on key customers and may encounter conflicts within and between our distribution channels.

 

The size and importance of individual customers to our businesses has increased as customers in our major distribution channels have consolidated or exited the business. Larger customers can make significant changes in their volume of purchases and can otherwise significantly affect the prices we receive for our products and services, our costs of doing business with them and the terms and conditions on which we do business. Sales of our home improvement and building products to home center retailers are substantial. In 2009, sales to our largest customer, The Home Depot, were $2.1 billion (approximately 26 percent of our consolidated net sales). Lowe’s is our second largest customer. In 2009, our sales to Lowe’s were less than 10 percent of our consolidated net sales. Although homebuilders, dealers and other retailers represent other channels of distribution for our products and services, the loss of a substantial portion of our sales to The Home Depot or the loss of our sales to Lowe’s would have a material adverse effect on our business.

 

As some of our customers expand their markets and their targeted customers, conflicts between our existing distribution channels have occurred, and will continue to occur. In addition, we may undermine the

business relationships we have with customers who purchase our products through traditional wholesale channels as we increase the amount of business we transact directly with our larger customers. In addition, our large retail customers are increasingly requesting product exclusivity, which may affect the products we can offer to other customers.

 

Our principal markets are highly competitive.

 

The major geographic markets for our products and services are highly competitive and, in recent years, competition has intensified significantly. Competition is further intensified during economic downturns. Home center retailers are increasing their purchases of products directly from manufacturers, particularly low-cost suppliers in Asia, for sale as private label and house brand merchandise. Also, home center retailers, which have historically concentrated their sales efforts on retail consumers and remodelers, are increasingly turning their marketing efforts directly toward professional contractors and installers. We believe that competition in our industries is based largely on price, product and service quality, brand reputation, customer service and product features and innovation. Although the relative importance of such factors varies among customers and product categories, price is often a primary factor.

 

In addition to the challenges we have faced as a result of the economic downturn in our markets, our ability to maintain our competitive positions in our markets and to grow our businesses depends to a large extent upon successfully maintaining our relationships with major customers, implementing growth strategies in our existing markets and entering new geographic markets, capitalizing on and strengthening our brand names, managing our cost structure, accommodating shorter life-cycles for our products and product development and innovation.

 

The cost and availability of materials and the performance of our supply chain affect our operating results.

 

It has been, and likely will continue to be, difficult for us to pass on to customers cost increases for commodities or other materials that are major components of our products or services. In addition, we may incur substantial costs as part of our strategy to hedge against price volatility of certain commodities we purchase and we may make commitments to purchase supplies at prices that subsequently exceed their market prices. Delays in adjusting, or in our inability to adjust, selling prices may be due to factors such as our existing arrangements with customers, competitive considerations and customer resistance to price increases. Further, when commodity prices decline, we receive pressure from our customers to reduce prices for our products and services. Changes in energy costs and certain commodities not only impact our production costs, but also the cost to transport our products.

 

We manufacture products in Asia and source products and components from third parties in Asia. The distances involved in these arrangements, together with differences in business practices, shipping and delivery requirements, the limited number of suppliers, and laws and regulations, have increased the difficulty of managing our supply chain, the complexity of our supply chain logistics and the potential for interruptions in our production scheduling.

 

We rely heavily or exclusively on outside suppliers for certain of our products or key components. If there is an interruption in these sources of supply, we may experience difficulty or delay in substituting alternatives and our business may be disrupted.

 

International political, monetary, economic and social developments affect our business.

 

Over 21 percent of our sales are derived outside of North America (principally in Europe) and are transacted in currencies other than U.S. dollars (principally European euros and Great Britain pounds). In addition, we manufacture products in Asia and source products and components from third parties in Asia. Our international business faces risks associated with changes in political, monetary, economic and social environments, labor conditions and practices, the laws, regulations and policies of foreign governments, cultural differences and differences in enforcement of contract and intellectual property rights. U.S. laws affecting activities of U.S. companies doing business abroad, including tax laws and laws regulating various

business practices, also impact our international business. Our international operating results may be influenced, when compared to our North American results, in part due to relative economic conditions in the European markets and due to competitive pricing pressures on certain products. The financial reporting of our consolidated operating results is affected by fluctuations in currency exchange rates, which may present challenges in comparing operating performance from period to period and in forecasting future performance.

 

We have financial commitments and investments in financial assets, including assets that are not readily marketable and involve financial risk.

 

We have maintained investments in available-for-sale securities (including marketable and auction rate securities) and a number of private equity funds, although we are reducing such investments. Since there is no active trading market for investments in private equity funds, they are for the most part illiquid. These investments, by their nature, can also have a relatively higher degree of business risk, including financial leverage, than other financial investments. Future changes in market conditions, the future performance of the underlying investments or new information provided by private equity fund managers could affect the recorded values of such investments or the amounts realized upon liquidation. In addition, we have commitments that require us to contribute additional capital to these private equity funds upon receipt of a capital call from the private equity fund. The decline in economic conditions in 2008 resulted in the decline in the value of our investments in debt and equity securities, including assets held in our pension plans. At December 31, 2009, the fair value of such investments and assets remains at reduced levels.

 

Claims and litigation could be costly.

 

We are, from time to time, involved in various claims, litigation matters and regulatory proceedings that arise in the ordinary course of our business and which could have a material adverse effect on us. These matters may include contract disputes, personal injury claims, warranty disputes, environmental claims or proceedings, other tort claims, employment and tax matters and other proceedings and litigation, including class actions.

 

In recent years, we have experienced class action lawsuits predicated upon claims for antitrust violations, product liability and wage and hour issues. We have generally denied liability and have vigorously defended these cases. Due to their scope and complexity, however, such lawsuits are particularly costly to resolve and significant exposures have been alleged.

 

We are subject to product safety regulations, recalls and direct claims for product liability that can result in significant liability and, regardless of the ultimate outcome, can be costly to defend. Also, we increasingly rely on other manufacturers to provide us with products or components for products that we sell. As a result of the difficulty of controlling the quality of products or components sourced from other manufacturers, we are exposed to risks relating to the quality of such products and to limitations on our recourse against such suppliers.

 

Increasingly, homebuilders, including our customers, are subject to construction defect and home warranty claims in the ordinary course of their business. Our contractual arrangements with these customers typically include the agreement to indemnify them against liability for the performance of our products or services or the performance of other products that we install. These claims, often asserted several years after completion of construction, frequently result in lawsuits against the homebuilders and many of their subcontractors, including us, and require us to incur defense costs even when our products or services are not the principal basis for the claims.

 

Although we intend to defend all claims and litigation matters vigorously, given the inherently unpredictable nature of claims and litigation, we cannot predict with certainty the outcome or effect of any claim or litigation matter, and there can be no assurance as to the ultimate outcome of any such matter.

 

We maintain insurance against some, but not all, of these risks of loss resulting from claims and litigation. We may elect not to obtain insurance if we believe the cost of available insurance is excessive relative to the

risks presented. The levels of insurance we maintain may not be adequate to fully cover any and all losses or liabilities. If any significant accident, judgment, claim or other event is not fully insured or indemnified against, it could have a material adverse impact on our business, financial condition and results of operations.

 

See Note S to the consolidated financial statements included in Item 8 of this Report for additional information about litigation involving our businesses.

 

Government and industry responses to environmental and health and safety concerns could impact our capital expenditures and operating results.

 

Government regulations pertaining to health and safety (including protection of employees as well as consumers) and environmental concerns continue to emerge, domestically as well as internationally. In addition to having to comply with current requirements (including requirements that do not become effective until a future date), even more stringent requirements could be imposed on our industries in the future. Compliance with these regulations (such as the restrictions on lead content in plumbing products and on volatile organic compounds and formaldehyde emissions that are applicable to certain of our businesses) may require us to alter our manufacturing and installation processes and our sourcing. Such actions could adversely impact our operating results, and our ability to effectively and timely meet such regulations could adversely impact our competitive position.

 

The long-term performance of our businesses relies on our ability to attract, develop and retain talented management.

 

To be successful, we must attract, develop and retain highly qualified and talented personnel in management, sales, marketing and product design and innovation and, as we consider entering new international markets, skilled personnel familiar with these markets. We compete with multinational firms for these employees and we invest significant resources in recruiting, developing, motivating and retaining them. The failure to attract, develop, motivate and retain key employees could negatively affect our competitive position and our operating results.

 

None.

 

The table below lists our principal North American properties for segments other than Installation and Other Services.

 

 

Most of our North American facilities range in size from single warehouse buildings of approximately 10,000 square feet to complex manufacturing facilities that exceed 1,000,000 square feet. We own most of our North American manufacturing facilities, none of which are subject to significant encumbrances. A substantial number of our warehouse and distribution facilities are leased.

 

In addition, our Installation and Other Services segment operates over 180 installation branch locations and over 70 distribution centers in the United States, most of which are leased.

 

The table below lists our principal properties outside of North America.

 

 

Most of these international facilities are located in China, Denmark, Germany and the United Kingdom. We generally own our international manufacturing facilities, none of which are subject to significant encumbrances. A substantial number of our warehouse and distribution facilities are leased.

 

Our corporate headquarters are located in Taylor, Michigan and are owned by us. We own an additional building near our corporate headquarters that is used by our corporate research and development department.

 

Each of our operating divisions assesses the manufacturing, distribution and other facilities needed to meet its operating requirements. Our buildings, machinery and equipment have been generally well maintained and are in good operating condition. In general, our facilities have sufficient capacity and are adequate for our production and distribution requirements.

 

Information regarding legal proceedings involving us is set forth in Note S to our consolidated financial statements included in Item 8 of this Report.

 

Not applicable.

 

 

Executive officers are elected annually by our Board of Directors. Each of the above executive officers has been employed by us for at least the past five years. Mr. DeMarie was elected Executive Vice President in July 2007 and became Chief Operating Officer in December 2007. He had previously served as Group President of our Installation and Other Services segment since 2003. He served as President and Chief Executive Officer of Masco Contractor Services and in other managerial roles since 1995. Mr. Sznewajs was elected to his current position in July 2007. He had previously served as Vice President and Treasurer since 2005 and Vice President – Business Development since 2003 and before that time served in various capacities in the Business Development Department from 1996 to 2003. Mr. Anderson has served as our Vice President – Controller since 2007. From 2005 to 2007, he served as Vice President-Controller, Corporate Accounting. From 2001 to 2004, Mr. Anderson served as Group Vice President. Mr. Greenwood has served as Vice President – Human Resources of the Company since July 2007. Prior to 2007, Mr. Greenwood was the Company’s Director of Employee Relations since 1992. Mr. Wittrock was elected Vice President, General Counsel and Secretary in 2009. From May 2009 to November 2009, Mr. Wittrock was Assistant General Counsel and Director – Operations of the Legal Department. Prior to May 2009, Mr. Wittrock served as the Company’s Assistant General Counsel for over 20 years.

 

 

The New York Stock Exchange is the principal market on which our common stock is traded. The following table indicates the high and low sales prices of our common stock as reported by the New York Stock Exchange and the cash dividends declared per common share for the periods indicated:

 

 

On February 10, 2010, there were approximately 5,700 holders of record of the Company’s common stock.

 

We expect that our practice of paying quarterly dividends on our common stock will continue, although the payment of future dividends is at the discretion of our Board of Directors and will depend upon our earnings, capital requirements, financial condition and other factors. In 2009, we reduced the quarterly dividend from $.235 per common share to its current level of $.075 per common share.

Performance Graph

 

The table below sets forth a line graph comparing the cumulative total shareholder return on our common stock with the cumulative total return of (i) the Standard & Poor’s 500 Composite Stock Index (“S&P 500 Index”), (ii) The Standard & Poor’s Industrials Index (“S&P Industrials Index”) and (iii) the Standard & Poor’s Consumer Durables & Apparel Index (“S&P Consumer Durables & Apparel Index”), from December 31, 2004 through December 31, 2009, when the closing price of our common stock was $13.81. The graph assumes investments of $100 on December 31, 2004 in our common stock and in each of these three indices and the reinvestment of dividends.

 

PERFORMANCE GRAPH

 

 

The table below sets forth the value, as of December 31 for each of the years indicated, of a $100 investment made on December 31, 2004 in each of our common stock, the S&P 500 Index, the S&P Industrials Index and the S&P Consumer Durables & Apparel Index and the reinvestment of dividends.

 

 

In July 2007, our Board of Directors authorized the purchase of up to 50 million shares of our common stock in open-market transactions or otherwise. At December 31, 2009, we had remaining authorization to repurchase up to 30 million shares. During 2009, we repurchased and retired two million shares of our common stock, for cash aggregating $11 million to offset the dilutive impact of the 2009 grant of two million shares of long-term stock awards.

 

 

 

The financial and business analysis below provides information which we believe is relevant to an assessment and understanding of our consolidated financial position, results of operations and cash flows. This financial and business analysis should be read in conjunction with the consolidated financial statements and related notes.

 

The following discussion and certain other sections of this Report contain statements reflecting our views about our 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, our actual results may differ materially from the results discussed in such forward-looking statements. Readers should consider that various factors, including those discussed in Item 1A “Risk Factors” of this Report, the “Executive Level Overview,” “Critical Accounting Policies and Estimates” and “Outlook for the Company” sections, may affect our performance. We undertake no obligation to update publicly any forward-looking statements as a result of new information, future events or otherwise.

 

Executive Level Overview

 

We manufacture, distribute and install home improvement and building products. These products are sold to the home improvement and new home construction markets through mass merchandisers, hardware stores, home centers, homebuilders, distributors and other outlets for consumers and contractors.

 

During 2009, we experienced a decline in our markets, including a decline in new home construction of over 38 percent from 2008, as well as a decline in consumer spending for home improvement products. Net sales decreased 18 percent in 2009 from 2008, and operating profit (as adjusted to exclude impairment charges for goodwill and other intangible assets, general corporate expense, net, charge for defined-benefit plan curtailment, charge for litigation settlements, accelerated stock compensation expense and (loss) gain on corporate fixed assets, net — see Footnote O of the consolidated financial statements) declined to 6.2 percent of sales in 2009 from 7.5 percent of sales in 2008.

 

Factors that affect our results of operations include the levels of home improvement activity and new home construction principally in North America and Europe, the importance of our relationships with key customers (including The Home Depot, which represented approximately 26 percent of net sales in 2009), our ability to maintain our leadership positions in our U.S. and global markets in the face of increasing competition and our ability to effectively manage our overall cost structure, including the cost and availability of materials. Our International businesses face political, monetary, economic and other risks that vary from country to country, as well as fluctuations in currency exchange rates. Further, we have financial commitments and investments in financial assets that are not readily marketable and that involve financial risk. In addition, litigation could be costly. These and other factors are discussed in more detail in Item 1A “Risk Factors” of this Report.

 

Critical Accounting Policies and Estimates

 

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires us to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of any contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We regularly review our estimates and assumptions, which are based upon historical experience, as well as current economic conditions and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of certain assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and assumptions.

We believe that the following critical accounting policies are affected by significant judgments and estimates used in the preparation of our consolidated financial statements.

 

 

We recognize revenue as title to products and risk of loss is transferred to customers or when services are rendered. We record revenue for unbilled services performed based upon estimates of labor incurred in the Installation and Other Services segment; such amounts are recorded in Receivables. We record estimated reductions to revenue for customer programs and incentive offerings, including special pricing and co-operative advertising arrangements, promotions and other volume-based incentives. We maintain allowances for doubtful accounts receivable for estimated losses resulting from the inability of customers to make required payments. In addition, we monitor our customer receivable balances and the credit worthiness of our customers on an on-going basis. During downturns in our markets, declines in the financial condition and creditworthiness of customers impact the credit risk of the receivables involved and we have incurred additional bad debt expense related to customer defaults. Our bad debt expense was $34 million, $41 million and $29 million for the year ended December 31, 2009, 2008 and 2007, respectively.

 

In North America, we manufacture products (principally windows, doors and cabinets) and provide installation of insulation and other products and services to homebuilders. Our bad debt expense related to homebuilders was $22 million, $28 million and $23 million for the years ended December 31, 2009, 2008 and 2007, respectively.

 

 

We record inventories at the lower of cost or net realizable value, with expense estimates made for obsolescence or unsaleable inventory equal to the difference between the recorded cost of inventories and their estimated market value based upon assumptions about future demand and market conditions. On an on-going basis, we monitor these estimates and record adjustments for differences between estimates and actual experience. Historically, actual results have not significantly deviated from those determined using these estimates.

 

 

On January 1, 2008, we adopted accounting guidance that defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements for our financial investments and liabilities. This guidance defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Further, it defines a fair value hierarchy for measurement and disclosure of the fair value for financial instruments, as follows: Level 1 inputs as quoted prices in active markets for identical assets or liabilities; Level 2 inputs as observable inputs other than Level 1 prices, such as quoted market prices for similar assets or liabilities or other inputs that are observable or can be corroborated by market data; and Level 3 inputs as unobservable inputs that are supported by little or no market activity and that are financial instruments whose value is determined using pricing models or instruments for which the determination of fair value requires significant management judgment or estimation.

 

We have maintained investments in available-for-sale securities and a number of private equity funds, which aggregated $110 million and $123 million, respectively, at December 31, 2009. We record investments in available-for-sale securities at fair value, and unrealized gains or losses (that are deemed to be temporary) are recognized, net of tax effect, through shareholders’ equity, as a component of other comprehensive income in our consolidated balance sheet. We estimated the fair value of investments in available-for-sale securities using primarily Level 1 inputs. We estimated the fair value of our investment in Asahi Tec preferred stock using a discounted cash flow model (Level 3 input). If we changed the discount rate used in the fair value estimate by 100 basis points, the value of the Asahi Tec preferred stock would change by approximately three percent.

In the past, we have invested excess cash in auction rate securities. Auction rate securities are investment securities that have interest rates which are reset every 7, 28 or 35 days. At December 31, 2009, our investment in auction rate securities was $22 million; we have not increased our investment in auction rate securities since 2007. The fair value of auction rate securities is estimated based on a discounted cash flow model (Level 3 input). If we changed the discount rate used in the fair value estimate by 75 basis points, the value of the auction rate securities would change by approximately $1 million.

 

We carry our investments in private equity funds at cost. It is not practicable for us to estimate a fair value for private equity funds because there are no quoted market prices, and sufficient information is not readily available for us to utilize a valuation model to determine the fair value for each fund. These investments are evaluated, on a non-recurring basis, for potential other-than-temporary impairment when impairment indicators are present, or when an event or change in circumstances has occurred, that may have a significant adverse effect on the fair value of the investment. Due to the significant unobservable inputs, the fair value measurements used to evaluate impairment are a Level 3 input.

 

Impairment indicators we consider include the following: whether there has been a significant deterioration in earnings performance, asset quality or business prospects; a significant adverse change in the regulatory, economic or technological environment; a significant adverse change in the general market condition or geographic area in which the investment operates; industry and sector performance; current equity and credit market conditions; and any bona fide offers to purchase the investment for less than the carrying value. We also consider specific adverse conditions related to the financial health of and business outlook for the fund, including industry and sector performance. The significant assumptions utilized in analyzing a fund for potential other-than-temporary impairment include current economic conditions, market analysis for specific funds and performance indicators in the automotive and transportation, residential and commercial construction, bio-technology, health care and information technology sectors in which the applicable funds’ investments operate.

 

At December 31, 2009, we have investments in 17 venture capital funds, with an aggregate carrying value of $28 million. The venture capital funds invest in start-up or smaller, early-stage established businesses, principally in the information technology, bio-technology and health care sectors. At December 31, 2009, we also have investments in 28 buyout funds, with an aggregate carrying value of $95 million. The buyout funds invest in later-stage, established businesses and, other than the Heartland Industrial Partners Fund, which is primarily in the automotive and transportation sector, no buyout fund has a concentration in a particular sector.

 

Since there is no active trading market for these investments, they are for the most part illiquid. These investments, by their nature, can also have a relatively higher degree of business risk, including financial leverage, than other financial investments. The timing of distributions from the funds, which depends on particular events related to the underlying investments, as well as the funds’ schedules for making distributions and their needs for cash, can be difficult to predict. As a result, the amount of income we record from these investments can vary substantially from quarter to quarter. Future changes in market conditions, the future performance of the underlying investments or new information provided by private equity fund managers could affect the recorded values of these investments and the amounts realized upon liquidation.

 

We record an impairment charge to earnings when an investment has experienced a decline in fair value that is deemed to be other-than-temporary. During 2009, we recognized non-cash, pre-tax impairment charges of $10 million related to our investment in five private equity funds.

 

 

We record the excess of purchase cost over the fair value of net tangible assets of acquired companies as goodwill or other identifiable intangible assets. In the fourth quarter of each year, or as events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount, we complete the impairment testing of goodwill utilizing a discounted cash flow method. We selected the discounted cash flow methodology as we believe that it is comparable to what would be used by other market participants. We have defined our reporting units and completed the impairment testing of

goodwill at the operating segment level, as defined by accounting guidance. Our operating segments are reporting units that engage in business activities, for which discrete financial information, including five-year forecasts, are available.

 

Determining market values using a discounted cash flow method requires us to make significant estimates and assumptions, including long-term projections of cash flows, market conditions and appropriate discount rates. Our judgments are based upon historical experience, current market trends, consultations with external valuation specialists and other information. While we believe that the estimates and assumptions underlying the valuation methodology are reasonable, different estimates and assumptions could result in different outcomes. In estimating future cash flows, we rely on internally generated five-year forecasts for sales and operating profits, including capital expenditures, and generally a one to three percent long-term assumed annual growth rate of cash flows for periods after the five-year forecast. We generally develop these forecasts based upon, among other things, recent sales data for existing products, planned timing of new product launches, estimated housing starts and repair and remodeling estimates for existing homes.

 

In 2009, for our reporting units that primarily sell to the new home construction market (including those in the Installation and Other Services segment), we utilized estimated housing starts, from independent industry sources, growing from current levels to 1.6 million units in 2014 (terminal growth year) and operating profit margins improving to approximate historical margins for those business units by 2014 (terminal growth year). We generally utilize our weighted average cost of capital (discount rate) of approximately nine percent to discount the estimated cash flows. However, in 2009 and 2008, due to market conditions, we increased the discount rate for most of our reporting units, based upon a review of the current risks impacting our businesses.

 

In the fourth quarter of 2009, we estimated that future discounted cash flows projected for most of our reporting units were greater than the carrying values. Any increases in estimated discounted cash flows would have no effect on the reported value of goodwill.

 

If the carrying amount of a reporting unit exceeds its fair value, we measure the possible goodwill impairment based upon an allocation of the estimate of fair value of the reporting unit to all of the underlying assets and liabilities of the reporting unit, including any previously unrecognized intangible assets (Step Two Analysis). The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. An impairment loss is recognized to the extent that a reporting unit’s recorded goodwill exceeds the implied fair value of goodwill.

 

In 2009, we recognized non-cash, pre-tax impairment charges for goodwill aggregating $262 million ($180 million, after tax). The pre-tax impairment charge of $39 million relates to our European shower enclosure manufacturer and reflects a decline in the reporting unit’s anticipated long-term outlook. The pre-tax impairment charge of $223 million relates to our manufacturer of staple gun tackers and other fastening tools and reflects a decline in the reporting unit’s anticipated long-term outlook.

 

A five percent decrease in the estimated fair value of our reporting units at December 31, 2009 would have resulted in a Step Two Analysis and probable goodwill impairment for one reporting unit in the Installation and Other Services segment. A ten percent decrease in the estimated fair value of our reporting units at December 31, 2009 would have resulted in a Step Two Analysis and probable goodwill impairment for one reporting unit in the Cabinets and Related Products segment, one reporting unit in the Installation and Other Services segment and one reporting unit in the Other Specialty Products segment.

 

We review our other indefinite-lived intangible assets for impairment annually, in the fourth quarter, or as events occur or circumstances change that indicate the assets may be impaired without regard to the reporting unit. We consider the implications of both external (e.g., market growth, competition and local economic conditions) and internal (e.g., product sales and expected product growth) factors and their potential impact on cash flows related to the intangible asset in both the near-and long-term.

 

Intangible assets with finite useful lives are amortized using the straight-line method over their estimated useful lives. We evaluate the remaining useful lives of amortizable identifiable intangible assets at each

reporting period to determine whether events and circumstances warrant a revision to the remaining periods of amortization.

 

 

Our 2005 Long Term Stock Incentive Plan (the “2005 Plan”) provides for the issuance of stock-based incentives in various forms to employees and non-employee Directors. At December 31, 2009, outstanding stock-based incentives were in the form of long-term stock awards, stock options, phantom stock awards and stock appreciation rights.

 

 

We grant long-term stock awards to key employees and non-employee Directors and do not cause net share dilution inasmuch as we continue the practice of repurchasing and retiring an equal number of shares on the open market. We measure compensation expense for stock awards at the market price of our common stock at the grant date. There was $126 million (nine million common shares) of total unrecognized compensation expense related to unvested stock awards at December 31, 2009, which was included as a reduction of common stock and paid-in capital. Effective January 1, 2006, we recognize this expense ratably over the shorter of the vesting period of the stock awards, typically 5 to 10 years (except for stock awards held by grantees age 66 or older, which vest over five years), or the length of time until the grantee becomes retirement-eligible at age 65. For stock awards granted prior to January 1, 2006, we recognize this expense over the vesting period of the stock awards, typically 10 years, or for executive grantees that are, or will become, retirement-eligible during the vesting period, we recognize the expense over five years or immediately upon a grantee’s retirement. Pre-tax compensation expense for the annual vesting of long-term stock awards was $37 million for 2009.

 

 

We grant stock options to key employees and non-employee Directors. The exercise price equals the market price of our common stock at the grant date. These options generally become exercisable (vest ratably) over five years beginning on the first anniversary from the date of grant and expire no later than 10 years after the grant date.

 

We measure compensation expense for stock options using a Black-Scholes option pricing model. For stock options granted subsequent to January 1, 2006, we recognize this compensation expense ratably over the shorter of the vesting period of the stock options, typically five years, or the length of time until the grantee becomes retirement-eligible at age 65. The expense for unvested stock options at January 1, 2006 is based upon the grant date fair value of those options as calculated using a Black-Scholes option pricing model. For stock options granted prior to January 1, 2006, we recognize this compensation expense ratably over the vesting period of the stock options, typically five years. Pre-tax compensation expense for stock options was $25 million for 2009.

 

We estimated the fair value of stock options at the grant date using a Black-Scholes option pricing model with the following assumptions for 2009: risk-free interest rate — 2.60%, dividend yield — 3.70%, volatility factor — 39.18% and expected option life — 6 years. For expense calculation purposes, the weighted average grant-date fair value of option shares granted in 2009 was $2.28 per option share.

 

If we increased our assumptions for the risk-free interest rate and the volatility factor by 50 percent, the expense related to the fair value of stock options granted in 2009 would increase by 53 percent. If we decreased our assumptions for the risk-free interest rate and the volatility factor by 50 percent, the expense related to the fair value of stock options granted in 2009 would decrease by 61 percent.

 

 

Accounting for defined-benefit pension plans involves estimating the cost of benefits to be provided in the future, based upon vested years of service, and attributing those costs over the time period each

employee works. We develop our pension costs and obligations from actuarial valuations. Inherent in these valuations are key assumptions regarding inflation, expected return on plan assets, mortality rates, compensation increases and discount rates for obligations and expenses. We consider current market conditions, including changes in interest rates, in selecting these assumptions. Changes in assumptions used could result in changes to reported pension costs and obligations within our consolidated financial statements.

 

In March 2009, based on management’s recommendation, the Board of Directors approved a plan to freeze all future benefit accruals under substantially all of our domestic qualified and non-qualified defined-benefit pension plans. The freeze was effective January 1, 2010. As a result of this action, the liabilities for the plans impacted by the freeze were remeasured and we recognized a curtailment charge of $8 million in the first quarter of 2009.

 

In December 2009, we decreased our discount rate for obligations to an average of 5.80 percent from 6.10 percent. The discount rate for obligations was based upon the expected duration of each defined-benefit pension plan’s liabilities matched to the December 31, 2009 Citigroup Pension Discount Curve. The discount rates we use for our defined-benefit pension plans ranged from 2.60 percent to 6.25 percent, with the most significant portion of the liabilities having a discount rate for obligations of 5.60 percent or higher. The assumed asset return was primarily 8.00 percent, reflecting the expected long-term return on plan assets.

 

Our net underfunded amount for our qualified defined-benefit pension plans, the difference between the projected benefit obligation and plan assets, decreased to $332 million at December 31, 2009 from $344 million at December 31, 2008, primarily due to the decision to freeze all future benefit accruals; in accordance with accounting guidance, the underfunded amount has been recognized on our consolidated balance sheets at December 31, 2009 and 2008. Qualified domestic pension plan assets in 2009 had a net gain of approximately 22 percent compared to average gains of 21 percent for the corporate funds universe within the Independent Consultant Cooperative.

 

Our projected benefit obligation for our unfunded non-qualified defined-benefit pension plans was $152 million at December 31, 2009 compared with $147 million at December 31, 2008; such unfunded amount has been recognized on our consolidated balance sheets at December 31, 2009 and 2008.

 

We expect pension expense for our qualified defined-benefit pension plans to be $33 million in 2010 compared with $40 million in 2009. If we assumed that the future return on plan assets was one-half percent lower than the assumed asset return and the discount rate decreased by 50 basis points, the 2010 pension expense would increase by $4 million. We expect pension expense for our non-qualified defined-benefit pension plans to be $8 million in 2010 compared with $15 million in 2009.

 

We have several funding options and credits available and we anticipate that we will be required to contribute approximately $20 million to $25 million in 2010 to our qualified defined-benefit plans.

 

 

We have considered potential sources of future taxable income in determining the amount of valuation allowance against our deferred tax assets. Of the $582 million of deferred tax assets recorded at December 31, 2009 net of the valuation allowance, $432 million is anticipated to be realized through the future reversal of existing taxable temporary differences recorded as a deferred tax liability, and $150 million is anticipated to be realized through future gains from investments and other identified tax-planning strategies, including the potential sale of certain operating assets and through capital gains in the carryback period.

 

The continued utilization of our tax-planning strategies is largely dependent upon the future performance of certain businesses. A significant decline in the expectation of future performance may impact our valuation allowance assessment.

 

Should we determine that we would not be able to realize our deferred tax assets in the future, an adjustment to the valuation allowance would be recorded in the period such determination is made. The need

to maintain a valuation allowance against deferred tax assets may cause greater volatility in our effective tax rate.

 

Effective January 1, 2007, the FASB issued new guidance which allows the recognition of only those income tax benefits that have a greater than 50 percent likelihood of being sustained upon examination by the taxing authorities. This new guidance establishes a lower threshold for recognizing reserves for income tax contingencies on uncertain tax positions (referred to as “unrecognized tax benefits”). Therefore, we believe that there is a greater potential for volatility in our effective tax rate because this lower threshold allows changes in the income tax environment and the inherent complexities of income tax law in a substantial number of jurisdictions to affect our unrecognized tax benefits computation to a greater degree than with prior guidance.

 

While we believe we have adequately provided for our uncertain tax positions, amounts asserted by taxing authorities could vary from our accrued liability for unrecognized tax benefits. Accordingly, additional provisions for tax-related matters, including interest and penalties, could be recorded in income tax expense in the period revised estimates are made or the underlying matters are settled or otherwise resolved.

 

 

Certain of our products and product finishes and services are covered by a warranty to be free from defects in material and workmanship for periods ranging from one year to the life of the product. At the time of sale, we accrue a warranty liability for estimated costs to provide products, parts or services to repair or replace products in satisfaction of warranty obligations. Our estimate of costs to service our warranty obligations is based upon historical experience and expectations of future conditions. To the extent that we experience any changes in warranty claim activity or costs associated with servicing those claims, our warranty liability is adjusted accordingly.

 

The majority of our business is at the consumer retail level through home centers and major retailers. A consumer may return a product to a retail outlet that is a warranty return. However, certain retail outlets do not distinguish between warranty and other types of returns when they claim a return deduction from us. Our revenue recognition policy takes into account this type of return when recognizing revenue, and we record deductions at the time of sale.

 

We are subject to lawsuits and pending or asserted claims with respect to matters generally arising in the ordinary course of business. Liabilities and costs associated with these matters require estimates and judgments based upon our professional knowledge and experience and that of our legal counsel. When estimates of our exposure for lawsuits and pending or asserted claims meet the criteria for recognition under accounting guidance, amounts are recorded as charges to earnings. The ultimate resolution of these exposures may differ due to subsequent developments. See Note S to our consolidated financial statements for information regarding certain of our legal proceedings.

 

Corporate Development Strategy

 

Our current business strategy includes the rationalization of our business units, including consolidations, and increasing synergies among our business units. Going forward, we expect to maintain a balanced growth strategy with emphasis on cash flow, organic growth with fewer acquisitions and growth through new product development, start-up businesses related to home energy services and greenfield locations related to certain Installation and Other Services businesses. As part of our strategic planning, we continue to review all of our businesses to determine which businesses may not be core to our long-term growth strategy.

 

During 2009, we sold two European business units in the Plumbing Products segment that were not core to our long-term growth strategy. We recognized a net pre-tax loss of $43 million in 2009 related to these transactions.

 

We accounted for the business units which were sold in 2009, 2008 and 2007, as discontinued operations. See Note B to the consolidated financial statements for more information.

During 2009, we acquired a small business in the Plumbing Products segment; this business allows us to expand into a developing market and had annual sales of $11 million, for a net purchase price of $6 million in cash. During 2008, we acquired a relatively small countertop business (Cabinet and Related Products segment). This business, which allows us to expand products and services we offer to our customers, had annual sales of over $40 million. During 2007, we acquired several relatively small installation service businesses (Installation and Other Services segment), as well as Erickson Construction Company and Guy Evans, Inc. (Installation and Other Services segment).

 

The results of these acquisitions are included in the consolidated financial statements from the respective dates of acquisition.

 

Liquidity and Capital Resources

 

Historically, we have largely funded our growth through cash provided by a combination of our operations, long-term bank debt and the issuance of notes in the financial markets, and by the issuance of our common stock, including issuances for certain mergers and acquisitions.

 

Maintaining high levels of liquidity and focusing on cash generation are among our financial strategies; such strategies have led to cash of over $1.4 billion at December 31, 2009. Our total debt as a percent of total capitalization was 58 percent and 57 percent at December 31, 2009 and 2008, respectively.

 

At our request, in late April 2009, our Bank Group modified the terms of our Five-Year Revolving Credit Agreement, which expires in February 2011. After reviewing our anticipated liquidity position, we requested that the maximum amount we could borrow under this facility be reduced to $1.25 billion from $2.0 billion; in addition, the debt to total capitalization ratio requirement has been increased from 60 percent to 65 percent. The debt to total capitalization ratio and the minimum net worth covenants have also been amended to allow the add-back, if incurred, of up to the first $500 million of certain non-cash charges, including goodwill and other intangible asset impairment charges that would negatively impact shareholders’ equity. We incurred approximately $2 million of fees and expenses associated with the Amendment. If the facility is utilized, we will incur higher borrowing costs as a result of the Amendment.

 

The Amended Five-Year Revolving Credit Agreement contains a requirement for maintaining a certain level of net worth; at December 31, 2009, our net worth exceeded such requirement by $1.0 billion. Under the terms of the Amended Five-Year Revolving Credit Agreement, any outstanding Letters of Credit reduce our borrowing capacity. At December 31, 2009, we had $83 million of unused Letters of Credit. The Amended Five-Year Revolving Credit Agreement also contains limitations on additional borrowings, related to the debt to total capitalization requirements; at December 31, 2009, we had additional borrowing capacity, subject to availability, of up to $1.2 billion. In addition, at December 31, 2009, we could absorb a reduction to shareholders’ equity of approximately $867 million, and remain in compliance with the debt to total capitalization covenant.

 

In order to borrow under the Amended Five-Year Revolving Credit Agreement, there must not be any defaults in our covenants in the credit agreement (i.e., in addition to the two financial covenants, principally limitations on subsidiary debt, negative pledge restrictions, legal compliance requirements and maintenance of insurance) and our representations and warranties in the credit agreement must be true in all material respects on the date of borrowing (i.e., principally no material adverse change or litigation likely to result in a material adverse change, in each case since December 31, 2008, no material ERISA or environmental non-compliance and no material tax deficiency). We were in compliance with all debt covenants at December 31, 2009 and 2008.

 

We had cash and cash investments of over $1.4 billion at December 31, 2009 principally as a result of strong cash flows from operations.

 

Our cash and cash investments consist of overnight interest bearing money market demand and time deposit accounts, money market mutual funds containing government securities and treasury obligations. While we attempt to diversify these investments in a prudent manner to minimize risk, it is possible that future changes in the financial markets could affect the security or availability of these investments.

We have maintained investments in available-for-sale and marketable securities and a number of private equity funds, principally as part of our tax planning strategies, as any gains enhance the utilization of any current and future capital tax losses. We determined that the longer maturity of private equity funds would be advantageous and complement our investment in more liquid available-for-sale and marketable securities to balance risk. Since we have significantly reduced our capital tax losses in part by generating capital gains from investments and other sources, we have and will continue to reduce our investments in long-term financial assets.

 

During 2009, we announced the reduction of our quarterly dividend to $.075 per common share from $.235 per common share.

 

We have a scheduled maturity of our long-term indebtedness in March 2010 when $300 million of our Floating Rate Notes become due. Subsequent to this maturity, we have no scheduled maturities until July 2012 when our $850 million of 5.875% fixed rate notes become due.

 

Our working capital ratio was 1.9 to 1 and 2.1 to 1 at December 31, 2009 and 2008, respectively.

 

We have entered into foreign currency forward contracts to manage exposure to currency fluctuations, primarily related to the European euro and the U.S. dollar.

 

Cash Flows

 

Significant sources and (uses) of cash in the past three years are summarized as follows, in millions:

 

 

Our cash and cash investments increased $385 million to $1,413 million at December 31, 2009, from $1,028 million at December 31, 2008.

 

Net cash provided by operations of $705 million consisted primarily of net (loss) adjusted for non-cash and certain other items, including depreciation and amortization expense of $254 million, net loss on disposition of businesses of $40 million, a $262 million charge for the impairment of goodwill, a $10 million charge for the impairment of financial investments and other non-cash items, including stock-based compensation expense, amortization expense related to in-store displays and interest expense on the Zero Coupon Convertible Senior Notes, as well as a net decrease in working capital of $235 million.

We continue to emphasize balance sheet management, including working capital management and cash flow generation. Days sales in accounts receivable were 48 days at December 31, 2009 compared with 50 days at December 31, 2008, and days sales in inventories were 48 days at both December 31, 2009 and 2008. Accounts payable days were 47 days at December 31, 2009 and 43 days at December 31, 2008. Working capital (defined as accounts receivable and inventories less accounts payable) as a percent of sales was 14.7 percent at both December 31, 2009 and 2008.

 

Net cash used for financing activities was $197 million, and included cash outflows of $166 million for cash dividends paid, $11 million for the net payment of debt and $11 million for the acquisition of our common stock to offset the dilutive impact of long-term stock awards granted in 2009.

 

At December 31, 2009, we had remaining Board of Directors’ authorization to repurchase up to an additional 30 million shares of our common stock in open-market transactions or otherwise. We believe that our present cash balance and cash flows from operations are sufficient to fund our near-term working capital and other investment needs. We believe that our longer-term working capital and other general corporate requirements will be satisfied through cash flows from operations and, to the extent necessary, from bank borrowings and future financial market activities. Consistent with past practice, we anticipate repurchasing shares in 2010 to offset any dilution from long-term stock awards granted or stock options exercised as part of our compensation programs.

 

Net cash used for investing activities was $118 million, and included $125 million for capital expenditures and $8 million for acquisitions. Cash provided by investing activities included primarily $31 million of net proceeds from the disposition of businesses and property and equipment and $11 million from the net sale of financial investments.

 

We invest in automating our manufacturing operations to increase our productivity to improve customer service and to support new product innovation. Capital expenditures for 2009 were $125 million, compared with $200 million for 2008 and $248 million for 2007; for 2010, capital expenditures, excluding any potential 2010 acquisitions, are expected to approximate $190 million. Depreciation and amortization expense for 2009 totaled $254 million, compared with $238 million for 2008 and $248 million for 2007; for 2010, depreciation and amortization expense, excluding any potential 2010 acquisitions, is expected to approximate $240 million. Amortization expense totaled $17 million, $17 million and $20 million in 2009, 2008 and 2007, respectively.

 

Costs of environmental responsibilities and compliance with existing environmental laws and regulations have not had, nor, in our opinion, are they expected to have, a material effect on our capital expenditures, financial position or results of operations.

 

Consolidated Results of Operations

 

We report our financial results in accordance with generally accepted accounting principles (“GAAP”) in the United States. However, we believe that certain non-GAAP performance measures and ratios, used in managing the business, may provide users of this financial information with additional meaningful comparisons between current results and results in prior periods. Non-GAAP performance measures and ratios should be viewed in addition to, and not as an alternative for, our reported results.

 

Net sales for 2009 were $7.8 billion, representing a decrease of 18 percent from 2008. Excluding results from acquisitions and the effect of currency translation, net sales decreased 16 percent compared with 2008. The following table reconciles reported net sales to net sales excluding acquisitions and the effect of currency translation, in millions:

 

 

Net sales for 2009 were adversely affected by declines in the new home construction market, which reduced sales volume by approximately nine percent compared to 2008. Economic conditions remain difficult in the new home construction market as full-year 2009 housing starts have declined over 38 percent to 554,000 from 2008. Net sales for 2009 were also negatively affected by declines in consumer spending for home improvement products, which contributed to lower sales volume, reducing net sales by approximately six percent compared to 2008. Such declines were partially offset by net selling price increases for certain products, which increased sales by approximately one percent compared to 2008.

 

Net sales volume of our International products declined in local currencies and reduced consolidated net sales by approximately three percent compared to 2008. A stronger U.S. dollar decreased sales by two percent compared to 2008.

 

Our gross profit margins were 25.9 percent, 24.9 percent and 27.5 percent in 2009, 2008 and 2007, respectively. The increase in the 2009 gross profit margin reflects the improved relationship between selling prices and commodity costs and the benefits associated with our business rationalizations and other cost savings initiatives.

 

Selling, general and administrative expenses as a percent of sales were 21.8 percent in 2009 compared with 19.0 percent in 2008 and 17.1 percent in 2007. Selling, general and administrative expenses as a percent of sales in 2009 and 2008 reflect lower sales volume, increased advertising expenses related to new product introductions and increased system implementation costs.

 

Operating profit in 2009, 2008 and 2007 includes $94 million, $78 million and $78 million, net, respectively, of costs and charges related to our business rationalizations and other cost savings initiatives. Operating profit in 2009, 2008 and 2007 includes $262 million, $467 million and $119 million, respectively, of impairment charges for goodwill and other intangible assets. Operating profit in 2009 and 2008 includes $7 million and $9 million, respectively, of charges for litigation settlements. Operating profit margins, as reported, were 0.7 percent, 0.9 percent and 9.3 percent in 2009, 2008 and 2007, respectively. Operating profit margins, excluding the items above, were 5.4 percent, 6.8 percent and 11.0 percent in 2009, 2008 and 2007, respectively.

 

Operating profit margins in 2009 were negatively affected by lower sales volume and the related under-absorption of fixed costs and lower selling prices related to the decline in the new home construction market in North America as well as lower sales volume of plumbing products in the North American and International home improvement markets. Such declines were partially offset by increased sales of paints and stains, the improved relationship between selling prices and commodity costs across our businesses and the benefits associated with business rationalizations and other cost savings initiatives. Operating profit margins in 2008 were adversely affected by accelerating declines in new home construction and a continued decline in consumer spending in North American and International markets, both of which negatively impacted the

sales volume in each of our segments and negatively impacted operating profit margins by approximately two percentage points compared to 2007. Operating profit margins in 2007 were adversely affected by a decline in new home construction and a moderation in consumer spending in North America, both of which negatively impacted the sales volume of installation and other services, cabinets and windows and doors.

 

 

During 2009, we recognized non-cash, pre-tax impairment charges aggregating $10 million for our investments in private equity funds.

 

Other, net, for 2009 included $3 million of income from financial investments, net. Other, net, for 2009 also included realized foreign currency gains of $17 million and other miscellaneous items.

 

During 2008, we recognized non-cash, pre-tax impairment charges aggregating $58 million primarily related to financial investments in TriMas common stock ($31 million), Asahi Tec common stock ($1 million), private equity funds ($23 million) and other investments ($3 million).

 

Other, net, for 2008 included $3 million of realized losses, net, from the sale of marketable securities and $4 million of income from other investments, net. Other, net, for 2008 also included realized foreign currency losses of $29 million and other miscellaneous items.

 

During 2007, we recognized non-cash, pre-tax impairment charges aggregating $22 million related to financial investments in Furniture Brands International common stock ($6 million), Asahi Tec common stock ($3 million), auction rate securities ($3 million) and private equity funds ($10 million).

 

Other, net, for 2007 included $5 million of realized gains, net, from the sale of marketable securities, $6 million of dividend income and $38 million of income from other investments, net. Other, net, for 2007 also included $9 million of realized foreign currency gains and other miscellaneous items.

 

Interest expense was $225 million, $228 million and $258 million in 2009, 2008 and 2007, respectively. The decrease in interest expense in 2008 is primarily due to lower interest rates and the retirement of higher fixed-rate debt in 2007 and 2008.

 

 

(Loss) and diluted (loss) per common share from continuing operations for 2009 were $(140) million and $(.41) per common share, respectively. (Loss) and diluted (loss) per common share from continuing operations for 2008 were $(366) million and $(1.06) per common share, respectively. Income and diluted earnings per common share from continuing operations for 2007 were $502 million and $1.32 per common share, respectively. (Loss) from continuing operations for 2009 included non-cash, pre-tax impairment charges for goodwill of $262 million ($180 million or $.51 per common share, after tax). (Loss) from continuing operations for 2008 included non-cash, pre-tax impairment charges for goodwill and other intangible assets of $467 million ($445 million or $1.26 per common share, after tax). Income from continuing operations for 2007 included non-cash, pre-tax impairment charges for goodwill and other intangible assets of $119 million ($100 million or $.27 per common share, after tax).

 

Our effective tax rate for the loss from continuing operations was a 33 percent tax benefit in 2009 and a 69 percent tax expense in 2008 and for income from continuing operations was a 39 percent tax expense in 2007. Our effective tax rate for income from continuing operations, excluding the impairment charges for goodwill and other intangible assets, was 30 percent, 57 percent and 36 percent in 2009, 2008 and 2007, respectively. Compared to our normalized effective tax rate of 36 percent, the lower effective tax rate in 2009 is due primarily to the reversal of an accrual for unrecognized tax benefits related to a withholding tax issue from a formerly held European company due to a recent favorable court decision. The higher effective tax rate in 2008 reflects the additional U.S. tax on a repatriation of low-taxed earnings from certain foreign subsidiaries in order to utilize a foreign tax credit carryforward, combined with a decrease in our 2008 pre-tax income. We expect our tax rate for 2010 to be approximately 37 percent.

Outlook for the Company

 

We expect that business conditions in 2010 will improve compared to 2009. While we are concerned about the impact of current unemployment levels, foreclosure activity and access to financing, we believe that housing starts will improve in 2010 and will increase to a range of 600,000 to 700,000 units from 554,000 units in 2009.

 

While we anticipate that expenditures on repair and remodel activity will improve modestly in 2010 from 2009 levels, we believe that big-ticket items will continue to be deferred until general economic conditions, credit availability and home prices improve.

 

We are confident that the long-term fundamentals for the new home construction and home improvement markets are positive. We believe that our strong financial position, together with our current strategy of investing in leadership brands (including: KraftMaid and Merillat cabinets, Delta and Hansgrohe faucets, Behr paint and Milgard windows), our continued focus on innovation and our commitment to lean principles, will allow us to drive long-term growth and create value for our shareholders.

Business Segment and Geographic Area Results

 

The following table sets forth our net sales and operating profit (loss) information by business segment and geographic area, dollars in millions.

 

 

Business Segment Results Discussion

 

Changes in operating profit margins in the following Business Segment and Geographic Area Results discussion exclude general corporate expense, net, charge for defined-benefit plan curtailment, charge for litigation settlements, accelerated stock compensation expense, (loss) gain on corporate fixed assets, net, and impairment charges for goodwill and other intangible assets in 2009, 2008 and 2007.

 

Business Rationalizations and Other Initiatives

 

Over the past several years, we have been focused on the strategic rationalization of our businesses, including business consolidations, plant closures, headcount reductions, system implementations and other cost savings initiatives. For the year ended December 31, 2009, we incurred net costs and charges of $94 million pre-tax related to these initiatives. Based on current plans, we anticipate costs and charges related to our business rationalizations and other initiatives to approximate $38 million in 2010. We continue to evaluate our businesses and may implement additional rationalization programs based on changes in our markets which could result in further costs and charges. In February 2010, we announced the combination of our Builder Cabinet Group and Retail Cabinet Group to form Masco Cabinetry; the additional cost is currently estimated at approximately $30 million to $35 million.

 

For the year ended December 31, 2008, we incurred net costs and charges of $78 million pre-tax related to these initiatives. For the year ended December 31, 2007, we incurred net costs and charges of $78 million related to business rationalizations, net of an $8 million gain from the sale of fixed assets.

 

 

Net sales of Cabinets and Related Products decreased in 2009 primarily due to a decline in sales volume of cabinets in the new home construction and retail markets, as well as a less favorable product mix, which combined to reduce sales in this segment by approximately 24 percent compared to 2008 and 16 percent in 2008 compared to 2007. Net sales in this segment were also negatively impacted by lower local currency sales volume of International operations, which reduced sales in this segment by approximately three percent compared to 2008 and by approximately five percent in 2008 compared to 2007. Such declines were partially offset by increased selling prices, which increased sales by approximately one percent in 2009 compared to 2008. Net sales in this segment in 2007 were negatively affected by a decline in sales volume of cabinets in the new home construction market, as well as a decline in net sales of ready-to-assemble cabinets. A stronger U.S. dollar decreased sales by two percent in 2009 compared to 2008 and a weaker U.S. dollar increased sales by one percent in 2008 compared to 2007.

 

Operating profit margins in the Cabinets and Related Products segment in 2009 were negatively affected by lower sales volume in the new home construction and retail markets and the related under-absorption of fixed costs, as well as a less favorable product mix which, on a combined basis, reduced operating profit margins by approximately three percentage points compared to 2008. In 2009, operating profit margins in this segment were also negatively affected by increased plant closure and system implementation costs. Such declines were partially offset by the improved relationship between selling prices and commodity costs and the benefits associated with business rationalizations and other cost savings initiatives. Operating profit margins in this segment in 2008 were negatively affected by lower sales volume and the related under-absorption of fixed costs and a less favorable product mix which reduced operating profit margins by approximately six percentage points compared to 2007, as well as increased plant closure and system implementation costs. In 2008, operating profit margins were also negatively affected by lower results of International operations included in this segment, which reduced operating profit margins by approximately two percentage points compared to 2007. In 2007, operating profit margins in this segment were negatively affected by the decline in sales volume, as well as increased start-up costs and the under-utilization of two new plants, and increased severance costs. Such declines were partially offset by a gain on the sale of a manufacturing facility of $8 million and benefits associated with business rationalizations and other initiatives.

 

Net sales of Plumbing Products decreased in 2009 and 2008 primarily due to lower sales volume to North American retailers and wholesalers, which reduced sales by approximately ten percent in both 2009 compared to 2008 and in 2008 compared to 2007. Reflecting the weakened global economy, net sales in this segment in 2009 and 2008 were also negatively impacted by lower local currency sales volume of International operations, which reduced sales in this segment by approximately six percent in 2009 compared to 2008 and by approximately three percent in 2008 compared to 2007. Such declines were partially offset by net selling price increases, which increased sales by approximately three percent in both 2009 compared to 2008 and in 2008 compared to 2007. Net sales in this segment in 2007 were positively affected by increased sales volume of certain International operations, as well as increased selling prices, which were partially offset by declining sales volume to North American retail and wholesale customers. A stronger U.S. dollar decreased sales by three percent in 2009 compared to 2008 and a weaker U.S. dollar increased sales by two percent in 2008 compared to 2007.

 

Operating profit margins in the Plumbing Products segment in 2009 were positively affected by the improved relationship between selling prices and commodity costs, as well as a more favorable product mix and the benefits associated with business rationalizations and other cost savings initiatives. Operating profit margins in this segment in 2008 were negatively affected by the decline in North American and International sales volume, which reduced operating profit margins by approximately one percentage point compared to 2007; such declines were partially offset by net selling price increases. Operating profit margins in this segment in 2007 were negatively affected by increased commodity costs in early 2007, which were offset by selling price increases and the reduction of certain variable expenses, as well as lower rationalization costs.

 

 

Net sales of Installation and Other Services decreased in 2009 and 2008 primarily due to significantly lower sales volume related to the decline in the new home construction market which declined over 38 percent in 2009 compared to 2008, as well as lower selling prices. Net sales in this segment in 2007 were negatively affected by lower sales volume related to the slowdown in the new home construction market and declines in selling prices, partially offset by acquisitions.

 

Operating profit margins in the Installation and Other Services segment in 2009 were negatively affected by lower sales volume and the related under-absorption of fixed costs, selling price decreases and increased system implementation costs. Operating profit margins in this segment in 2008 were negatively affected by lower sales volume and the related under-absorption of fixed costs, as well as decreased selling prices and increased bad debt expense, which decreased operating profit margins by approximately seven percentage points; such declines were partially offset by material price decreases. Operating profit margins in this segment in 2007 were negatively affected by lower sales volume and the related under-absorption of fixed costs, lower selling prices and increased bad debt expense, severance and location closure costs and increased system implementation expenses; such declines were partially offset by reductions in material costs, as well as benefits associated with the business rationalizations and other initiatives.

 

 

Net sales of Decorative Architectural Products increased in 2009, primarily due to increased retail sales volume of paints and stains, which offset lower retail sales volume of builders’ hardware. Sales of paints and stains in 2009 benefited from new product introductions and advertising and promotional activities. Net sales in this segment decreased in 2008, primarily due to lower retail sales volume of paints and stains and builders’ hardware, which more than offset selling price increases. Net sales in this segment in 2007 were positively affected by higher retail sales volume from new product introductions of paints and stains, which partially offset sales declines related to builder’s hardware.

 

Operating profit margins in the Decorative Architectural Products segment in 2009 were positively affected by increased sales volume of paints and stains, which more than offset lower sales volume of builders’ hardware. The operating profit margins in this segment also benefited from the improved

relationship between selling prices and commodity costs related to paints and stains and builders’ hardware, as well as lower program costs related to builders’ hardware. Operating profit margins in this segment in 2008 were negatively affected by lower sales volume of paints and stains and builders’ hardware, increasing material costs throughout 2008 and program costs for builders’ hardware, which more than offset the effect of selling price increases. Operating profit margins in this segment in 2007 primarily reflect increased sales volume of paints and stains, offset by increased advertising expenses.

 

 

Net sales of Other Specialty Products decreased primarily due to lower sales volume of windows in the western United States, selling price decreases and a less favorable product mix, which decreased sales in this segment by approximately 12 percent in 2009 compared to 2008. Net sales in this segment also decreased in 2009 due to a decline in retail sales of staple gun tackers and other fastening tools, which reduced sales in this segment by three percent in 2009 compared to 2008. Net sales in this segment in 2008 and 2007 were negatively impacted by lower sales volume of windows and doors, as well as a decline in the home improvement market. Net sales in this segment were also negatively impacted by lower local currency sales volume of International operations, which reduced sales in this segment by approximately two percent compared to 2007, due to the decline in the United Kingdom markets. A stronger U.S. dollar decreased sales by three percent in 2009 compared to 2008 and by one percent in 2008 compared to 2007.

 

Operating profit margins in the Other Specialty Products segment in 2009 reflect the benefits associated with business rationalizations and other cost savings initiatives which offset the negative affect of lower sales volume of windows and staple gun tackers and other fastening tools and the related under-absorption of fixed costs, as well as a less favorable product mix. Operating profit margins in this segment in 2008 were negatively affected by lower sales volume and the related under-absorption of fixed costs, which decreased operating profit margins by approximately seven percentage points compared to 2007, as well as increased plant closure costs. Operating profit margins were also negatively affected by lower results of International operations, which reduced operating profit margins by approximately two percentage points in 2008 compared to 2007. Operating profit margins in this segment in 2007 were negatively affected by lower sales volume of windows and doors in the new home construction market and lower results of International operations.

 

Geographic Area Results Discussion

 

 

North American net sales in 2009 were negatively affected by lower sales volume of installation and other services, cabinets and windows in the new home construction market which decreased sales from North American operations by approximately 12 percent in 2009 compared to 2008. In addition, North American net sales were negatively affected by lower retail sales volume of cabinets, plumbing products, builder’s hardware and staple gun tackers and other fastening tools, which aggregated to a net decrease in North American net sales of approximately nine percent in 2009 compared to 2008. Such declines were partially offset by increased sales of paints and stains and increased selling prices for certain products. North American net sales in 2008 were negatively affected by lower sales volume of installation and other services, cabinets and windows and doors in the new home construction market which decreased sales from North American operations by approximately 13 percent in 2008 compared to 2007. In addition, North American net sales were negatively affected by lower retail sales volume of cabinets, plumbing products, paints and stains and builder’s hardware, which aggregated to a net decrease in North American sales of approximately eight percent in 2008 compared to 2007. North American sales in 2007 were negatively affected by lower sales volume of installation and other services, cabinets and windows and doors in the new home construction market, as well as lower retail sales volume of certain products, partially offset by increased retail sales volume of paints and stains.

 

The declines in operating profit margins from North American operations in 2009 were primarily due to sales volume declines and the related under-absorption of fixed costs, selling price decreases and a less

favorable product mix in new home construction markets, which decreased operating profit margins by one percentage point in 2009 compared to 2008. Operating profit margins were also negatively affected by increased rationalization costs and charges in 2009 compared to 2008. Such declines were partially offset by the improved relationship between selling prices and commodity costs for cabinets, plumbing products and paints and stains, as well as the benefits associated with business rationalizations and other cost savings initiatives. The declines in operating profit margins from North American operations in 2008 were primarily due to declines in new home construction and consumer spending, which negatively impacted the sales volume of the Company’s products and decreased operating profit margins by approximately three percentage points in 2008 compared to 2007. The operating profit margins from North American operations in 2007 were negatively affected by declines in new home construction and consumer spending; such declines were partially offset by selling price increases, and the benefits associated with the Company’s business rationalizations and other initiatives.

 

 

Net sales from International operations decreased in 2009 primarily due to lower sales volume of plumbing products and cabinets, which reduced sales from International operations in local currencies by approximately 12 percent compared to 2008 and by approximately 13 percent in 2008 compared to 2007. Such declines were partially offset by selling price increases, which increased sales from International operations by approximately two percent in 2009 compared to 2008 and in 2008 compared to 2007. Net sales from International operations in 2007 were positively affected by increased sales volume of plumbing products. A stronger U.S. dollar decreased International net sales by seven percent in 2009 compared to 2008 and a weaker U.S. dollar increased International net sales by three percent in 2008 compared to 2007.

 

Operating profit margins in 2009 were positively affected by the improved relationship between selling prices and commodity costs, as well as the benefits associated with business rationalizations and other cost savings initiatives. Operating profit margins in 2008 were negatively affected by lower sales volumes and the related under-absorption of fixed costs, as well as increased severance and plant closure costs. Operating profit margins in 2007 were negatively affected by a less favorable product mix and material cost increases.

 

Other Matters

 

 

 

Information regarding our legal proceedings is set forth in Note S to the consolidated financial statements.

 

 

With respect to our investments in private equity funds, we had, at December 31, 2009, commitments to contribute up to $37 million of additional capital to such funds, representing our aggregate capital commitment to such funds less capital contributions made to date. We are contractually obligated to make additional capital contributions to these private equity funds upon receipt of a capital call from the private equity fund. We have no control over when or if the capital calls will occur. Capital calls are funded in cash and generally result in an increase in the carrying value of our investment in the private equity fund when paid.

 

We enter into contracts, which include reasonable and customary indemnifications that are standard for the industries in which we operate. Such indemnifications include claims made against builders by homeowners for issues relating to our products and workmanship. In conjunction with divestitures and other transactions, we occasionally provide reasonable and customary indemnifications relating to various items, including: the enforceability of trademarks; legal and environmental issues; and provisions for sales returns. We have never had to pay a material amount related to these indemnifications, and we evaluate the probability that amounts may be incurred and we appropriately record an estimated liability when probable.

Contractual Obligations

 

The following table provides payment obligations related to current contracts at December 31, 2009, in millions:

 

 

 

Recently Issued Accounting Pronouncements.

 

In June 2009, the FASB issued guidance regarding how a company determines when an entity that is insufficiently capitalized or is not controlled through voting should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities that most significantly impact the entity’s economic performance. This guidance is effective for the Company beginning January 1, 2010. The Company does not expect that the adoption will have a significant impact on its consolidated financial condition and results of operations.

 

We have considered the provisions of accounting guidance regarding disclosure of accounting policies for derivative financial instruments and derivative commodity instruments, and disclosure of quantitative and qualitative information about market risk inherent in derivative financial instruments, other financial instruments and derivative commodity instruments.

 

We are exposed to the impact of changes in interest rates and foreign currency exchange rates in the normal course of business and to market price fluctuations related to our marketable securities and other investments. We have limited involvement with derivative financial instruments and use such instruments to the extent necessary to manage exposure to fluctuations in interest rates and foreign currency fluctuations and from time to time commodity fluctuations. See Note F to the consolidated financial statements for additional information regarding our derivative instruments.

 

At December 31, 2009, we have entered into foreign currency forward contracts to manage exposure to currency fluctuations related primarily to the European euro and the U.S. dollar.

 

At December 31, 2009, we performed sensitivity analyses to assess the potential loss in the fair values of market risk sensitive instruments resulting from a hypothetical change of 10 percent in foreign currency exchange rates or a 10 percent decline in the market value of our long-term investments. Based upon the analyses performed, such changes would not be expected to materially affect our consolidated financial position, results of operations or cash flows.

 

Management’s Report on Internal Control Over Financial Reporting

 

The management of Masco Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. Masco Corporation’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

 

The management of Masco Corporation assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009 using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in “Internal Control — Integrated Framework.” Based on this assessment, management has determined that the Company’s internal control over financial reporting was effective as of December 31, 2009.

 

PricewaterhouseCoopers LLP, an independent registered public accounting firm, performed an audit of the Company’s consolidated financial statements and of the effectiveness of Masco Corporation’s internal control over financial reporting as of December 31, 2009. Their report expressed an unqualified opinion on the effectiveness of Masco Corporation’s internal control over financial reporting as of December 31, 2009 and expressed an unqualified opinion on the Company’s 2009 consolidated financial statements. This report appears under Item 8. Financial Statements and Supplementary Data under the heading Report of Independent Registered Public Accounting Firm.

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of Masco Corporation:

 

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Masco Corporation and its subsidiaries at December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 8. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

As discussed in Note A to the consolidated financial statements, the Company has changed the manner in which it accounts for noncontrolling interests in 2009. As discussed in Note Q to the consolidated financial statements, the Company changed its method of accounting for unrecognized tax benefits in 2007.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

PricewaterhouseCoopers LLP

Detroit, Michigan

February 16, 2010

MASCO CORPORATION AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

at December 31, 2009 and 2008

 

 

See notes to consolidated financial statements.

MASCO CORPORATION AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF INCOME

 

for the years ended December 31, 2009, 2008 and 2007

 

 

See notes to consolidated financial statements.

MASCO CORPORATION AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

for the years ended December 31, 2009, 2008 and 2007