MASCO CORP /DE/ - Annual Report: 2010 (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, 2010 (based on the closing sale price of $10.76 of the Registrant’s Common Stock, as reported by the New York Stock Exchange on such date) was approximately $3,177,733,000.          .

 

Number of shares outstanding of the Registrant’s Common Stock at January 31, 2011:

 

 

358,113,000 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 2011 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.

 

 

Masco Corporation
2010 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 78 percent of our 2010 sales were generated by our North American operations.

 

We continue to experience a prolonged and substantial downturn in the home improvement and new home construction markets. As a result, during 2010, we continued to focus on the strategic rationalization of our businesses, including business consolidations, plant closures, headcount reductions, system implementations and other cost savings initiatives. Since 2006, across our businesses, we have closed 23 manufacturing facilities; also, since 2006, we have closed approximately 100 locations formerly operated by our Installation and Other Services segment. In 2010, we began the combination of our North American retail and builder cabinet businesses to form Masco Cabinetry. In 2010, we decided to discontinue the manufacture of ready-to-assemble and other non-core in-stock assembled cabinet product lines, as they were not consistent with Masco Cabinetry’s strategy of growth through brand building and innovation. In 2010, we also decided to close a cabinet manufacturing facility that had previously been idled.

 

We continue to focus on our cost structure and 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 2010, we introduced several new products, including the ESSENCE SERIES^tm wood and fiberglass window by Milgard, the RED^® line of staple guns and nail tackers and the ACE^® Salt water sanitizing system. We are also continuing to invest in several initiatives launched in 2009, including programs related to BEHR PREMIUM PLUS ULTRA^® interior paint, the DELTA^® TOUCH₂O^® faucet, retro-fit home energy efficiency services and the sale of BEHR^® and KILZ^® branded products to professional painters.

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, 2010, the contribution of our segments to net sales and operating (loss) 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, 2010, 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 and semi-custom assembled 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 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 MERILLAT^®, MOORES^tm and QUALITY CABINETS^tm brands 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. We have also

expanded our product offerings in this segment to include the manufacture and sale of countertops in North America.

 

Over the past several years, the new home construction market has declined over 70 percent since the peak; this segment has been particularly affected by this downturn, as well as builders producing smaller homes with smaller kitchens. This segment has also been negatively affected by a downturn in the repair and remodel market, particularly by consumers deferring expenditures for big-ticket items.

 

In 2010, we began 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 offer a three brand portfolio of cabinets covering several price points addressing consumer preferences. Masco Cabinetry will also focus on growing the countertop business.

 

Over the past several years, we have closed several manufacturing plants in this segment. In 2010, we decided to discontinue the manufacture of ready-to-assemble and other non-core in-stock assembled cabinet product lines, as they were not consistent with Masco Cabinetry’s strategy of growth through brand building and innovation. This will result in the closure of two additional manufacturing facilities in the second quarter of 2011. In 2010, we also decided to close a manufacturing facility that had been previously idled.

 

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. We expect that by the end of the second quarter of 2011, we will be able to manufacture common cabinetry at most of our plants that principally manufacture cabinets for the new home construction market 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. Our significant North American competitors include American Woodmark Corporation and Fortune Brands, Inc.

 

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, GINGER^®, NEWPORT BRASS^®, ALSONS^®, SIRRUS^tm and PLUMB SHOP^®. Our 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, in turn, sell our products to plumbers, building contractors, remodelers, smaller retailers and others.

 

We believe that our plumbing products 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 products branded as AQUA GLASS^®, MIROLIN^® and AMERICAN SHOWER & BATH^tm acrylic and gelcoat tub and shower systems, 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. We have encountered volatility in the price of brass. We have implemented a hedging strategy to attempt to minimize the impact of commodity price volatility. Legislation enacted in California, Vermont and Maryland mandates new standards for acceptable lead content in plumbing products sold in those states. Federal legislation mandating a national standard for lead content in plumbing products will become effective in January 2014. 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 and certain of our plumbing products.

 

In 2008, our Delta Faucet business introduced faucets incorporating its TOUCH₂O technology and, in the future, Delta Faucet plans to expand the use of its capacitance sensing PROXIMITY^tm technology in its product offerings. Also in 2008, our Delta Faucet business introduced a new water delivery system known as DIAMOND^tm Seal Technology. DIAMOND Seal Technology reduces the number of potential leak points in a faucet, simplifies installation and satisfies the legislation described above regulating the acceptable lead content in plumbing products. Delta Faucet has continued to incorporate DIAMOND Seal Technology into most of its 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 Faucet’s ability to successfully integrate 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 and retro-fit markets, throughout the United States. In order to respond to the significant decrease in demand in the new home construction industry over the past several years, we have implemented various cost savings initiatives including the consolidation and closure of approximately 100 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, 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, we offer gutters, after-paint products, framing components, fireplaces, garage doors and cabinets. The installation and distribution of insulation comprised approximately eight percent, nine percent and eleven percent of our consolidated net sales for the years ended December 31, 2010, 2009 and 2008, respectively. Installed building products are supplied primarily to custom and production homebuilders by our network of branches located across the United States. Distributed products include insulation, insulation accessories, gutters, fireplaces and roofing. Distributed products are sold primarily to contractors and dealers (including lumber yards) from distribution centers in various parts of the United States.

 

Within this segment, we have launched several new initiatives related to improved energy efficiency, including energy audit and repair services and retrofit installation services delivered directly to homeowners as well as through retailers and dealer outlets.

 

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 and waterproofing products. The products are sold in the United States, Canada, China, Mexico and South America under the brand names BEHR^®, KILZ^® and EXPRESSIONS^® to “do-it-yourself” and professional customers through home centers, paint stores and other retailers. Net sales of architectural coatings comprised approximately 20 percent, 20 percent and 15 percent of our consolidated net sales for the years ended December 31, 2010, 2009 and 2008, 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 products are 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^® branded 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, Top Knobs, Direct Import, Hickory Hardware and Stanley Black & Decker. Decorative bath hardware and shower accessories are sold under the brand names FRANKLIN BRASS^® and DECOR BATHWARE^® to distributors, home centers and other retailers. Competitors include Moen and GATCO.

 

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 centers. In late 2010, Milgard introduced the ESSENCE SERIES of wood and fiberglass windows and doors, including the ESSENCE SERIES Wood Window, a window that combines a wood interior with a fiberglass exterior. 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 Black & Decker. In 2010, Arrow introduced a new product line of staple guns and nail tackers, which are Reliable, Ergonomic and Durable (RED^®).

 

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 as soon as reasonably practicable after those reports are electronically filed with or furnished to the Securities and Exchange Commission. This Report is being posted on our website concurrently with its filing with the Securities and Exchange Commission. Material contained on our website is not incorporated by reference into this Report.

 

There are a number of business risks and uncertainties that could affect our business. These risks and uncertainties could cause our actual results to differ from past performance or expected results. We consider the following risks and uncertainties to be most relevant to our specific business activities. 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.

A significant portion of our business relies on home improvement and new home construction activity levels, both of which are experiencing a prolonged and substantial 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, is experiencing a prolonged and substantial downturn marked by continued softness in the demand for new homes, an oversupply of new and existing homes on the market and more stringent standards for homebuyers seeking financing. The oversupply of existing homes held for sale is exacerbated by a growing number of home mortgage foreclosures as well as uncertainties in the home foreclosure process, which are contributing to the downward pressure on home prices.

 

Unlike most previous cyclical declines in new home construction, this economic decline is also adversely affecting our home improvement businesses. Continued low levels of consumer confidence, high levels of unemployment and the downward pressure on home prices have made consumers increasingly reluctant to make additional investments in existing homes, such as kitchen and bath remodeling projects. The increasing number of households with negative equity in their homes and more conservative lending practices, including for home equity loans which are often used to finance repairs and remodeling, are limiting the ability of consumers to finance home improvements.

 

Although we believe that the long-term outlook for the home improvement and new home construction markets is favorable, we cannot predict the type, timing or strength of a recovery in our markets. Prolonged depressed activity levels in consumer spending for home improvements and new home construction will continue to adversely affect our results of operations and our financial position and may disproportionately affect certain of our business segments that are most heavily dependent on new home construction markets and large consumer investments in home remodeling projects.

 

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

 

Our credit agreement contains various financial covenants we must comply with, including covenants regarding debt to total capitalization. At December 31, 2010, we had additional borrowing capacity, subject to availability, of up to $113 million; alternatively, we could absorb a reduction in shareholders’ equity of $61 million and remain in compliance with this covenant.

 

We have recently amended our credit agreement to allow for the add-back to shareholders’ equity of the impairment charges we took in 2010 for financial investments, goodwill and other intangible assets and changes to the valuation allowance on our deferred tax assets included in income tax expense aggregating $986 million, after tax. The amendment (deemed to be effective and applicable as of December 31, 2010) also allows us to add-back, if incurred, up to $350 million, in the aggregate, of future non-cash charges. We currently have borrowing capacity approximating $1 billion available under the Credit Agreement. See Footnote K for a detailed discussion of the terms of our credit facility and the recent amendment.

 

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 further deterioration in expectations regarding the timing and the extent of the recovery of the new home construction market, may cause us to recognize additional non-cash, pre-tax impairment charges, which are not determinable at this time, for certain long-lived assets, including goodwill. This could result in additional impairment charges for goodwill and other indefinite-lived intangible assets or other long-lived assets and a further reduction in shareholders’ equity. Such charges and potential reduction in shareholders’ equity may limit our borrowing capacity under our credit agreement. There can be no assurance that we would be able to further amend the credit agreement or to obtain alternative financing, that any such financing would be on acceptable terms or that we would be permitted to do so under the terms of our existing financing arrangements.

The volatile and challenging economic conditions of the past two years have caused shifts in consumer preferences and purchasing practices.

 

The volatile and challenging economic environment of the past two years has caused shifts in consumer preferences and purchasing practices and changes in the business models and strategies of our customers. Such shifts, which may or may not be long-term, have altered the type and prices of products demanded by the end-consumer and our customers. Over the past two years, we have seen a downward trend in the size of the new homes being built, resulting in smaller kitchens and baths. In addition, consumers have shown an increasing interest in lower-cost products. If we do not timely and effectively identify and respond to these changing consumer preferences, our relationships with our customers could be harmed, the demand for our products could be reduced and our market share could be negatively affected.

 

Our response to the prolonged downturn has been to continue our focus on implementation of cost savings initiatives, which have been costly and may not be effective.

 

During the current downturn in the home improvement and new home construction markets, we have focused on cost saving initiatives, including rationalizing our businesses through business consolidations, plant closures, headcount reductions, system implementations and other cost saving initiatives. During 2010 and 2009, we incurred pre-tax costs and charges of $208 million and $94 million, respectively, related to these initiatives. In the future, we may incur costs and charges relating to additional cost savings initiatives.

 

We may not fully achieve the anticipated cost savings from these initiatives. If we do not effectively balance our focus on cost savings with the need to maintain a strong sales presence for our brands, we could lose market share. If the eventual recovery of our markets is fast-paced and robust, we may not be able to replace our reduced manufacturing and installation capacity in a timely fashion and our ability to respond to increased demand could be limited.

 

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 centers are substantial. In 2010, sales to our largest customer, The Home Depot, were $2.0 billion (approximately 26 percent of our consolidated net sales). Lowe’s is our second largest customer. In 2010, our sales to Lowe’s were less than ten 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 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 our ability to offer products 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 centers are increasing their purchases of products directly from low-cost overseas suppliers for sale as private label and house brand merchandise. Additionally, home centers, 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 on price, product and service quality, brand reputation, customer service and product features and innovation.

 

In addition to the challenges we have faced as a result of the economic downturn, 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, in certain cases, exclusively on outside suppliers for certain of our products or key components. Generally, these products and components are obtainable from various sources and in sufficient quantities. However, the loss of, or a substantial decrease in the availability of products or components from our suppliers, or the loss of key supplier arrangements may disrupt our business and could adversely impact our financial condition, operating results and cash flows.

 

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

 

Over 20 percent of our sales are made outside of North America (principally in Europe) and are transacted in currencies other than U.S. dollars (principally the euro and the British pound sterling). Increased international sales make up an important part of our future strategic plans. 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 continue to reduce our investment in private equity funds. 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.

 

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, automobile liability and other personal injury claims, warranty disputes, environmental claims or proceedings, other tort claims, employment and tax matters and other proceedings and litigation, including class actions.

 

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 or manage. Also, we increasingly rely on other manufacturers to provide us with products or components for products that we sell. Due to 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.

 

We have also experienced class action lawsuits in recent years 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, these lawsuits are particularly costly to resolve and significant exposures have been alleged.

 

Increasingly, our homebuilder customers are subject to construction defect and home warranty claims in the ordinary course of their business. Our contractual arrangements with these customers may include our agreement to defend and indemnify them against various liabilities caused by our negligence. These claims, often asserted several years after completion of construction, can result in complex lawsuits or claims against the homebuilders and many of their subcontractors, including us, and may require us to incur defense and indemnity 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.

 

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.

 

We are subject to U.S. and foreign government regulations pertaining to health and safety (including protection of employees and consumers), climate disruption and environmental issues. In addition to

complying with current requirements and requirements that will become effective at a future date, even more stringent requirements could be imposed on our industries in the future. Compliance with these regulations 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 personnel.

 

To be successful, we must attract, develop and retain highly qualified and talented personnel and, as we consider entering new international markets, skilled personnel familiar with these markets. We compete for employees with a broad range of employers in many different industries, including large multinational firms, 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.

 

Our Installation and Other Services segment operates approximately 200 installation branch locations and approximately 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 our 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 international 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. We believe 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 and is incorporated herein by reference.

Supplementary Item. Executive Officers of the Registrant
(Pursuant to Instruction 3 to Item 401(b) of Regulation S-K).

 

 

Executive officers are elected annually by our Board of Directors. Each of the executive officers named above 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. 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, 2011, there were approximately 5,500 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.

 

Equity Compensation Plan Information

 

The Company grants equity under its 2005 Long Term Stock Incentive Plan (the “Plan”). The following table sets forth information as of December 31, 2010 concerning the Plan, which was approved by our stockholders. The Company does not have any equity compensation plans that are not approved by stockholders.

 

 

The remaining information required by this Item will be contained in the Company’s definitive Proxy Statement for its 2011 Annual Meeting of Stockholders, to be filed on or before April 30, 2011, and such information is incorporated herein by reference.

Performance Graph

 

The table below compares 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, 2005 through December 31, 2010, when the closing price of our common stock was $12.66. The graph assumes investments of $100 on December 31, 2005 in our common stock and in each of the 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, 2005 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 includes 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, 2010, we had remaining authorization to repurchase up to 27 million shares. During 2010, we repurchased and retired three million shares of our common stock, for cash aggregating $45 million to offset the dilutive impact of the 2010 grant of three million shares of long-term stock awards. We did not purchase any shares during the three months ended December 31, 2010.

 

 

 

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. Forward-looking statements can be identified by words such as “anticipate,” “intend,” “plan,” “believe,” “estimate,” “expect,” “assume,” “seek,” “appear,” “may,” “should”, “will” and similar references to future periods. 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. We caution you against relying on any of these forward-looking statements. In addition to the various factors included in the “Executive Level Overview,” “Critical Accounting Policies and Estimates” and “Outlook for the Company” sections, our future performance may be affected by our reliance on new home construction and home improvement levels, our reliance on key customers, the cost and availability of raw materials, shifts in consumer preferences and purchasing practices, and our ability to achieve cost savings through the Masco Business System and other initiatives. These and other factors are discussed in detail in Item 1A “Risk “Factors” of this Report. Any forward-looking statement made by us in this Report speaks only as of the date on which it was made. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. 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 2010, we continued to experience further sales volume declines for our cabinets, Installation and Other Services and builders’ hardware products. The sales volume decline for our installation and other services is primarily related to reduced revenue per job and the loss of market share in the new home construction market. The sales volume decline for our cabinet products is related to lower repair and remodel activity and shifting consumer preference to lower price point products, which has resulted in loss of market share related to cabinet repair and remodel activity with big box customers. Such sales volume declines were partially offset by a more favorable product mix of plumbing products and paints and stains. Net sales decreased three percent in 2010 from 2009, 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 on corporate fixed assets, net — see Footnote O of the consolidated financial statements) declined to 4.4 percent of sales in 2010 from 6.2 percent of sales in 2009.

 

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 2010), 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 $19 million, $34 million and $41 million for the years ended December 31, 2010, 2009 and 2008, 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 $10 million, $22 million and $28 million for the years ended December 31, 2010, 2009 and 2008, 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, 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 $62 million and $106 million, respectively, at December 31, 2010. 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.

 

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, 2010, 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, on a recurring basis, using 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 and other private investments at cost. It is not practicable for us to estimate a fair value for private equity funds and other private investments 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 residential and commercial construction, bio-technology, health care and information technology sectors in which the applicable funds’ investments operate.

 

At December 31, 2010, we have investments in 17 venture capital funds, with an aggregate carrying value of $22 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, 2010, we also have investments in 26 buyout funds, with an aggregate carrying value of $84 million. The buyout funds invest in later-stage, established businesses and 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 2010, we recognized non-cash, pre-tax impairment charges of $34 million related to our investment in Asahi Tec ($28 million), three private equity funds ($4 million) and one private investment ($2 million).

 

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 because 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 2010, 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 1.5 million units in 2015 (terminal growth year) and operating profit margins improving to approximate historical margins for those business units by 2015 (terminal growth year). We generally utilize our weighted average cost of capital (discount rate) of approximately eight percent to discount the estimated cash flows. However, in 2010, due to market conditions, we increased the discount rate to a range of nine percent to eleven percent for most of our reporting units, based upon a review of the current risks impacting our businesses.

 

In the fourth quarter of 2010, 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 2010, we recognized non-cash, pre-tax impairment charges for goodwill aggregating $711 million ($587 million, after tax). The pre-tax impairment charge relates to our North American Installation business and reflects the weak level of new home construction activity in 2010, the historic low levels of new housing starts and the expectation that the recovery in the new home construction market will be modestly slower than previously anticipated. We increased the discount rate used to estimate the fair value of our businesses in the new home construction industry, due to the uncertainty regarding the timing and trajectory of the recovery in the new home construction market. These changes resulted in our book value exceeding the estimated fair value of the business, resulting in the impairment charge for goodwill.

 

A 10 percent decrease in the estimated fair value of our reporting units at December 31, 2010 would not have resulted in any additional analysis of goodwill impairment for any additional business unit.

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. In 2010, we recognized non-cash, pre-tax impairment charges for other indefinite-lived intangible assets of $10 million ($6 million, after tax). The pre-tax impairment charges recorded in 2010 were as follows: Plumbing Products segment — $1 million, and Installation and Other Services segment — $9 million.

 

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, 2010, 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 $127 million (ten million common shares) of total unrecognized compensation expense related to unvested stock awards at December 31, 2010, which was included as a reduction of common stock and paid-in capital. Effective January 1, 2010, the vesting period for stock awards awarded after January 1, 2010 is 5 years. 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 5 to 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 2010.

 

 

We grant stock options to key employees. 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 $22 million for 2010.

 

We estimated the fair value of stock options at the grant date using a Black-Scholes option pricing model with the following assumptions for 2010: risk-free interest rate — 2.76%, dividend yield — 2.17%, volatility

factor — 46.03% and expected option life — 6 years. For expense calculation purposes, the weighted average grant-date fair value of option shares granted in 2010 was $5.30 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 2010 would increase by 43 percent. If we lowered 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 2010 would decrease by 53 percent.

 

 

In March 2009, the Board of Directors approved freezing 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 these plans were remeasured and we recognized a curtailment charge of $8 million in the first quarter of 2009. In addition, certain assumptions appropriate for on-going plans (e.g., turnover, mortality and compensation increases) were modified or eliminated for the remeasurement.

 

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 December 2010, we decreased our discount rate for obligations to an average of 5.30 percent from 5.80 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, 2010 Towers Watson Rate Link curve. The discount rates we use for our defined-benefit pension plans ranged from 2.30 percent to 5.55 percent, with the most significant portion of the liabilities having a discount rate for obligations of 5.00 percent or higher. The assumed asset return was primarily 7.25 percent, reflecting the expected long-term return on plan assets.

 

Our net underfunded amount for our qualified defined-benefit pension plans, which is the difference between the projected benefit obligation and plan assets, increased to $359 million at December 31, 2010 from $332 million at December 31, 2009, primarily due to lower rates of return in the bond market in 2010. In accordance with accounting guidance, the underfunded amount has been recognized on our consolidated balance sheets at December 31, 2010 and 2009. Qualified domestic pension plan assets in 2010 had a net gain of approximately 12 percent compared to average gains of 13 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 $163 million at December 31, 2010 compared with $152 million at December 31, 2009. This unfunded amount has been recognized on our consolidated balance sheets at December 31, 2010 and 2009.

 

We expect pension expense for our qualified defined-benefit pension plans to be $24 million in 2011 compared with $23 million in 2010. 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 2011 pension expense would increase by $4 million. We expect pension expense for our non-qualified defined-benefit pension plans to be $9 million in 2011 compared with $9 million in 2010.

 

We have several funding options and credits available and we anticipate that we will be required to contribute approximately $30 million to $35 million in 2011 to our qualified defined-benefit plans.

 

The accounting guidance for income taxes requires that the future realization of deferred tax assets depends on the existence of sufficient taxable income in future periods. Possible sources of taxable income include taxable income in carryback periods, the future reversal of existing taxable temporary differences recorded as a deferred tax liability, tax-planning strategies that generate future income or gains in excess of anticipated losses in the carryforward period and projected future taxable income.

 

If, based upon all available evidence, both positive and negative, it is more likely than not (more than 50 percent likely) such deferred tax assets will not be realized, a valuation allowance is recorded. Significant weight is given to positive and negative evidence that is objectively verifiable. A company’s three-year cumulative loss position is significant negative evidence in considering whether deferred tax assets are realizable and the accounting guidance restricts the amount of reliance the Company can place on projected taxable income to support the recovery of the deferred tax assets.

 

In the fourth quarter of 2010, we recorded a $371 million valuation allowance against our U.S. Federal deferred tax assets as a non-cash charge to income tax expense. In reaching this conclusion, we considered the weaker retail sales of certain of our building products and the slower than anticipated recovery in the U.S. housing market which led to U.S. operating losses and significant U.S. goodwill impairment charges, that primarily occurred in the fourth quarter of 2010, causing us to be in a three-year cumulative U.S. loss position. These factors negatively impact our ability to utilize previously identified tax-planning strategies that included the potential sale of certain non-core operating assets to support the realization of our U.S. Federal deferred tax assets, since current year losses are heavily weighted in determining if sufficient income would exist in the carryforward period to realize the benefit of the strategies.

 

Recording the valuation allowance does not restrict our ability to utilize the future deductions and net operating losses associated with the deferred tax assets assuming taxable income is recognized in future periods.

 

A rebound in the U.S. housing market from the current historic lows and retail sales of building products improving from their current levels should have a positive impact on our operating results in the U.S. A return to sustained profitability in the U.S. should result in objective positive evidence thereby warranting consideration of our previously identified tax-planning strategies and the potential reversal of all or a portion of the valuation allowance.

 

The $228 million of deferred tax assets at December 31, 2010, for which there are no valuation allowance recorded, is anticipated to be realized through the future reversal of existing taxable temporary differences recorded as deferred tax liabilities at December 31, 2010.

 

Should we determine that we would not be able to realize our remaining 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.

 

The current accounting guidance allows the recognition of only those income tax positions that have a greater than 50 percent likelihood of being sustained upon examination by the taxing authorities. We believe that there is an increased potential for volatility in our effective tax rate because this threshold allows changes in the income tax environment and the inherent complexities of income tax law in a substantial number of jurisdictions to affect the computation of our liability for uncertain tax positions to a greater extent.

 

While we believe we have adequately provided for our uncertain tax positions, amounts asserted by taxing authorities could vary from our accrued liability for uncertain tax positions. 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 in the ordinary course of our 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 2010, we did not sell any business unit or acquire any business. We accounted for the business units which were sold in 2009 and 2008, as discontinued operations. See Note B to the consolidated financial statements for more information. The results of all 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 resulted in cash of over $1.7 billion at December 31, 2010. Our total debt as a percent of total capitalization was 72 percent and 58 percent at December 31, 2010 and 2009, respectively.

 

On June 21, 2010, the Company entered into a Credit Agreement (the “Credit Agreement”) with a bank group, with an aggregate commitment of $1.25 billion with a maturity date of January 10, 2014. Our previous 5-Year Revolving Credit Agreement dated as of November 5, 2004, as amended, was terminated at that time.

 

The Credit Agreement provides for an unsecured revolving credit facility available to the Company and one of its foreign subsidiaries, in U.S. dollars, European euros and certain other currencies. Borrowings under the revolver denominated in euros are limited to $500 million, equivalent. The Company can also borrow swingline loans up to $150 million and obtain letters of credit of up to $250 million. Any outstanding Letters of

Credit reduce the Company’s borrowing capacity. At December 31, 2010, the Company had $99 million of outstanding and unused Letters of Credit, reducing the Company’s borrowing capacity by such amount.

 

Our revolving credit loans bear interest under the Credit Agreement, at the Company’s option: at (A) a rate per annum equal to the greatest of (i) prime rate, (ii) the Federal Funds effective rate plus 0.50% and (iii) LIBOR plus 1.0% (the “Alternative Base Rate”); plus an applicable margin based upon the then-applicable corporate credit ratings of the Company; or (B) LIBOR plus an applicable margin based upon the then-applicable corporate credit ratings of the Company. The foreign currency revolving credit loans bear interest at a rate equal to LIBOR plus an applicable margin based upon the then-applicable corporate credit ratings of the Company.

 

The Credit Agreement contains financial covenants requiring the Company to maintain (A) a maximum debt to total capitalization ratio of 65 percent, and (B) a minimum interest coverage ratio equal to or greater than (i) 2.25 to 1.0 through the quarter ending on September 30, 2011 and (ii) 2.50 to 1.0 thereafter. The debt to total capitalization ratio allows 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, occurring from and after April 1, 2010, that would negatively impact shareholders’ equity.

 

Based on the limitations of the debt to total capitalization covenant (before the amendment discussed below), at December 31, 2010, the Company had additional borrowing capacity, subject to availability, of up to $113 million. Alternatively, at December 31, 2010, the Company could absorb a reduction to shareholders’ equity of approximately $61 million, and remain in compliance with the debt to total capitalization covenant.

 

In order to borrow under the Credit Agreement, there must not be any default in the Company’s 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 properties and insurance) and the Company’s 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, since December 31, 2009, in each case, no material ERISA or environmental non-compliance and no material tax deficiency). The Company was in compliance with all covenants and no borrowings have been made at December 31, 2010.

 

On February 11, 2011, the Company entered into an amendment (deemed to be effective and applicable as of December 31, 2010) of the Credit Agreement with its bank group (the “Amendment”). The Amendment provides for the add-back to shareholders’ equity in the Company’s maximum debt to capitalization covenant of (i) certain non-cash charges (including impairment charges for financial investments, goodwill and other intangible assets) and (ii) changes to the valuation allowance on our deferred tax assets included in income tax expense, each taken in 2010, which aggregate $986 million after tax. The Amendment also permits the Company to add-back, if incurred, up to $350 million in the aggregate of future non-cash charges. We currently have borrowing capacity approximating $1 billion available under the Credit Agreement.

 

We have no scheduled maturities until July 2012 when $791 million of 5.875% fixed rate notes become due. The holders of the Company’s Zero Coupon Convertible Senior Notes (“Notes”) have the right to redeem the Notes for cash on July 20, 2011 for approximately $58 million. The next cash redemption date is July 20, 2016.

 

We had cash and cash investments of over $1.7 billion at December 31, 2010, 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 2010, we paid a quarterly dividend of $.075 per common share.

 

Our working capital ratio was 2.3 to 1 and 1.9 to 1 at December 31, 2010 and 2009, 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. We have also entered into commodity contracts related to copper and zinc.

 

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 $302 million to $1,715 million at December 31, 2010, from $1,413 million at December 31, 2009.

 

Net cash provided by operations of $465 million consisted primarily of net (loss) adjusted for non-cash and certain other items, including depreciation and amortization expense of $279 million, a $721 million charge for the impairment of goodwill and other intangible assets, a $168 million net change in deferred taxes, a $67 million charge for the impairment of long-lived assets related to the closure of a cabinet facility, a $34 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 $49 million.

 

We continue to emphasize balance sheet management, including working capital management and cash flow generation. Days sales in accounts receivable were 47 days at December 31, 2010 compared with 48 days at December 31, 2009, and days sales in inventories were 49 days at December 31, 2010 and

48 days at December 31, 2009. Accounts payable days were 51 days at December 31, 2010 and 47 days at December 31, 2009. Working capital (defined as accounts receivable and inventories less accounts payable) as a percent of sales was 13.4 percent at December 31, 2010 and 14.7 percent at December 31, 2009; such improvement was primarily due to improved accounts payable management.

 

Net cash used for financing activities was $40 million, and included $359 million for the retirement of notes (retired $300 million of floating rate notes on March 12, 2010, the scheduled maturity date and, during the second quarter of 2010, we repurchased $59 million of 5.875% Notes due July 2012, in open-market transactions), partially offset by $494 million from the issuance of Notes, net of issuance costs. Financing activities also include cash outflows of $108 million for cash dividends paid, $2 million for the net payment of debt and $45 million for the acquisition of our common stock to offset the dilutive impact of long-term stock awards granted in 2010.

 

At December 31, 2010, we had remaining Board of Directors’ authorization to repurchase up to an additional 27 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 2011 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 $109 million, and included $137 million for capital expenditures. Cash provided by investing activities included primarily $18 million of net proceeds from the disposition of property and equipment and $42 million from the net sale of financial investments.

 

We invest in automating our manufacturing operations to increase our productivity, improve customer service and support new product innovation. Capital expenditures for 2010 were $137 million, compared with $125 million for 2009 and $200 million for 2008; for 2011, capital expenditures, excluding any potential 2011 acquisitions, are expected to be approximately $230 million. Depreciation and amortization expense for 2010 totaled $279 million, compared with $254 million for 2009 and $238 million for 2008; for 2011, depreciation and amortization expense, excluding any potential 2011 acquisitions, is expected to be approximately $260 million. Amortization expense totaled $18 million, $17 million and $17 million in 2010, 2009 and 2008, respectively.

 

Costs of environmental responsibilities and compliance with existing environmental laws and regulations have not had, nor do we expect them 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 2010 were $7.6 billion, representing a decrease of three percent from 2009. Excluding results from acquisitions and the effect of currency translation, net sales decreased two percent compared

with 2009. The following table reconciles reported net sales to net sales excluding acquisitions and the effect of currency translation, in millions:

 

 

Net sales for 2010 were adversely affected by lower sales volume of installation and other services and cabinets, which, in aggregate, reduced sales by approximately three percent compared to 2009. Net sales for 2010 were also negatively affected by lower sales volume of builders’ hardware and North American plumbing products, which reduced net sales by approximately one percent compared to 2009. Such declines were partially offset by a more favorable product mix of plumbing products and paints and stains, which increased sales by approximately one percent compared to 2009. Net sales volume in 2010 of our International plumbing products and windows increased in local currencies and increased consolidated net sales by approximately one percent compared to 2009. A stronger U.S. dollar decreased sales by one percent compared to 2009.

 

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. 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 in 2009 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 24.2 percent, 25.9 percent and 24.9 percent in 2010, 2009 and 2008, respectively. The decrease in the 2010 gross profit margin reflects lower sales volume, increased depreciation expense related to plant closures and a less favorable relationship between selling prices and commodity costs. Such decreases were partially offset by the benefits associated with our business rationalizations and other cost savings initiatives.

 

Selling, general and administrative expenses as a percent of sales were 21.3 percent in 2010 compared with 21.8 percent in 2009 and 19.0 percent in 2008. Selling, general and administrative expenses as a percent of sales in 2010 and 2009 reflect lower sales volume, increased advertising expenses related to new product introductions and increased system implementation costs.

 

Operating (loss) profit in 2010, 2009 and 2008 includes $208 million, $94 million and $78 million, net, respectively, of costs and charges related to our business rationalizations and other cost savings initiatives. Operating (loss) profit in 2010, 2009 and 2008 includes $721 million, $262 million and $467 million, respectively, of impairment charges for goodwill and other intangible assets. Operating (loss) profit in 2009 includes $7 million of charges for litigation settlements. Operating (loss) profit margins, as reported, were (6.6) percent, 0.7 percent and 0.9 percent in 2010, 2009 and 2008, respectively. Operating profit margins, excluding the items above, were 5.7 percent, 5.4 percent and 6.8 percent in 2010, 2009 and 2008, respectively.

 

Operating margins in 2010 were positively affected by the benefits associated with business rationalizations and other cost savings initiatives, which more than offset the negative effect of lower sales volume and the less favorable relationship between selling prices and commodity costs.

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 in 2009 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.

 

 

During 2010, we recognized non-cash, pre-tax impairment charges aggregating $34 million related to financial investments ($28 million related to Asahi Tec preferred stock and $6 million related to private equity funds and other private investments).

 

Other, net, for 2010 included $9 million of income from financial investments, net. Other, net, for 2010 also included realized foreign currency losses of $2 million and other miscellaneous items.

 

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.

 

Interest expense was $251 million, $225 million and $228 million in 2010, 2009 and 2008, respectively. The increase in interest expense in 2010 is primarily due to the issuance of $500 million of 7.125% notes in March.

 

 

(Loss) and diluted (loss) per common share from continuing operations for 2010 were $(1,043) million and $(3.00) per common share, respectively. (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. (Loss) from continuing operations for 2010 included non-cash, pre-tax impairment charges for goodwill and other intangible assets of $721 million ($593 million or $1.70 per common share, after tax). (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).

 

Our effective tax rate for the loss from continuing operations was a 29 percent tax expense, a 33 percent tax benefit and a 69 percent tax expense in 2010, 2009 and 2008, respectively. Our effective tax rate for the loss from continuing operations, excluding the $371 million income tax expense related to a valuation allowance on our U.S. Federal deferred tax assets recorded in 2010 and impairment charges for goodwill and other intangibles, was a 32 percent tax benefit, a 30 percent tax expense and a 57 percent tax expense in 2010, 2009 and 2008, 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 uncertain tax positions related to a withholding tax issue from a formerly held European company due to a 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 2008 pre-tax income.

 

In the fourth quarter of 2010, we recorded a $371 million valuation allowance against our U.S. Federal deferred tax assets as a non-cash charge to income tax expense. In reaching this conclusion, we considered the weaker retail sales of certain of our building products and the slower than anticipated recovery in the U.S. housing market which led to U.S. operating losses and significant U.S. goodwill impairment charges, that primarily occurred in the fourth quarter of 2010, causing us to be in a three-year cumulative U.S. loss position. These factors negatively impact our ability to utilize previously identified tax-planning strategies that included the potential sale of certain non-core operating assets to support the realization of our U.S. Federal deferred tax assets, since current year losses are heavily weighted in determining if sufficient income would exist in the carryfoward period to realize the benefits of the strategies.

 

Outlook for the Company

 

Although we continue to be concerned about foreclosure activity and access to financing, housing starts did improve in 2010 to 588,000 units. The negative trends impacting our business in the second half of 2010, including depressed new home construction, lower big-ticket repair and remodel activity and commodity cost pressures, have continued into 2011. We expect a challenging business environment, particularly in the first half of 2011; we expect the second half of 2011 to be stronger.

 

In addition to strategic rationalization and the continued emphasis on cash generation, we have identified, directed and encouraged initiatives at our business units that we expect will position us to benefit from future opportunities as the recovery takes shape. We have also led a focused effort to strengthen our brands and improve our ability to execute our business models. The implementation of the Masco Business System (MBS) across our business units provides a more disciplined approach to managing our businesses and has enhanced our long-range planning process. MBS emphasizes five core capabilities: customer focus, innovation, lean, quality and talent, which we believe are fundamental to our long-term success. MBS is already having a positive impact on our businesses as we enhance our understanding of customer and end-consumer needs, improve product quality and incorporate sustainability into our operations and products. As a result, we believe we have a robust pipeline of innovative new products. In addition, we are also improving our operational performance by emphasizing process and productivity improvements, simplifying organizational structure, rationalizing supply chains and enhancing our talent management process.

 

We believe and are confident that the long-term fundamentals for the new home construction and home improvement markets continue to be 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 on corporate fixed assets, net, and impairment charges for goodwill and other intangible assets in 2010, 2009 and 2008.

 

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, 2010, we incurred net costs and charges of $208 million pre-tax related to these initiatives. For the year ended December 31, 2009, we incurred net costs and charges of $94 million pre-tax related to these initiatives. For the year ended December 31, 2008, we incurred net costs and charges of $78 million pre-tax related to these initiatives.

 

As announced in February 2010, we have combined our Builder Cabinet Group and Retail Cabinet Group to form Masco Cabinetry. In 2010, we incurred costs and charges related to the integration of $20 million; in 2011, we expect to incur an additional $10 million of costs and charges related to the integration. In April 2010, Masco Cabinetry decided to discontinue the manufacture of ready-to-assemble and other non-core in-stock assembled cabinet product lines as they are not consistent with Masco Cabinetry’s strategy of growth through brand building and innovation. These product lines had aggregate annual sales of approximately $200 million in 2009. We plan to close two manufacturing facilities associated with these products in the first half of 2011. In 2010, we incurred costs and charges related to the exit of these product lines of $84 million, including non-cash charges of $69 million, principally related to accelerated depreciation for property, plant and equipment, and $15 million of other cash charges. In 2011, we expect to incur an additional $25 million of costs and charges related to the closure of the facilities associated with these product lines. In 2010, we also decided to close a cabinet manufacturing facility that had been previously idled; we incurred costs and charges related to the closure of $67 million. As a result of these actions within the Cabinets and Related Products segment, in 2010, we incurred pre-tax $171 million of total costs and charges related to Masco Cabinetry integration, product line exit and facility closure. In total, as described above, we expect to incur an additional $35 million of costs and charges related to these actions in 2011.

 

Based on current plans, we anticipate costs and charges related to our business rationalizations and other initiatives to approximate $65 million in 2011. 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.

 

 

Sales

 

Net sales of Cabinets and Related Products decreased in 2010 primarily due to lower sales volumes of North American cabinets, which reduced sales by approximately six percent compared to 2009. Sales in this segment in 2010 were also negatively affected by the planned exit of ready-to-assemble and other non-core in-stock assembled cabinet product lines, particle board and door product lines, which reduced sales by approximately four percent compared to 2009. Sales were also negatively affected by lower sales volume of International cabinets, which reduced sales in this segment by approximately three percent compared to 2009. A stronger U.S. dollar decreased sales by one percent in 2010 compared to 2009.

 

Net sales in this segment decreased in 2009 primarily due to a decline in sales volume in the new home construction and retail markets, as well as a less favorable product mix, which combined to reduce sales by approximately 24 percent compared to 2008. A stronger U.S. dollar decreased sales by two percent in 2009 compared to 2008.

Net sales in this segment in 2008 were negatively affected by a decline in sales volume in the new home construction and retail markets, as well as a less favorable product mix and lower local currency sales of International operations.

 

Operating Results

 

Operating margins in the Cabinets and Related Products segment in 2010 were negatively affected by lower sales volume and the related under-absorption of fixed costs, which reduced operating profit margins by approximately three percentage points. Operating profit margins in this segment in 2010 were also negatively affected by increased business rationalization expenses and a less favorable relationship between selling prices and commodity costs; such decreases more than offset the benefits associated with business rationalizations and other cost savings initiatives.

 

Operating margins in this 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 which 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 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, as well as lower results of International operations included in this segment.

 

 

Sales

 

Net sales of Plumbing Products increased in 2010 primarily due to a more favorable product mix to North American retailers and wholesalers, which increased sales by approximately two percent compared to 2009. Sales were also positively affected by increased selling prices, which increased sales by approximately two percent compared to 2009. In local currencies, sales of International operations increased sales in this segment by approximately three percent compared to 2009. Such increases were partially offset by lower sales volume to North American retailers and wholesalers, which reduced sales by one percent compared to 2009. A stronger U.S. dollar decreased sales by one percent in 2010 compared to 2009.

 

Net sales in this segment 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 2009 compared to 2008. 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. A stronger U.S. dollar decreased sales by three percent in 2009 compared to 2008.

 

Operating Results

 

Operating margins in the Plumbing Products segment in 2010 were positively affected by a more favorable product mix and the positive relationship between selling prices and commodity costs and the benefits associated with business rationalizations and other cost savings initiatives.

 

Operating margins in this 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 margins in this segment in 2008 were negatively affected by the decline in North American and International sales volume; such declines were partially offset by net selling price increases.

 

Sales

 

Net sales in the Installation and Other Services segment decreased in 2010 primarily due to lower sales volume related to reduced share in the new home construction market. Sales in this segment were also negatively affected by a downward trend in the size and content of new houses being constructed by our builder customers.

 

Net sales in this segment decreased in 2009 and 2008, primarily due to significantly lower sales volume related to the decline in the new home construction market, as well as lower selling prices.

 

Operating Results

 

Operating margins in the Installation and Other Services segment in 2010 continue to be negatively affected by lower sales volume in the new home construction market and the related under-absorption of fixed costs, as well as a less favorable relationship between selling prices and commodity costs. Additionally, investments in WellHome^SM negatively impacted this segment by approximately one percentage point. Such declines were partially offset by the benefits associated with business rationalization and other cost savings initiatives and lower system implementation costs in 2010.

 

Operating margins in this 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 in 2009.

 

Operating 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; such declines were partially offset by material price decreases.

 

 

Sales

 

Net sales of Decorative Architectural Products decreased in 2010, primarily due to lower sales volume of builders’ hardware and lower selling prices of paints and stains. Such declines in 2010 were partially offset by a more favorable product mix of paints and stains, related to new product introductions.

 

Net sales in this segment increased in 2009, primarily due to increased sales volume of paints and stains, which offset lower sales volume of builders’ hardware.

 

Net sales in this segment in 2008 were negatively affected by lower sales volume of paints and stains and builders’ hardware, which more than offset selling price increases.

 

Operating Results

 

Operating margins in the Decorative Architectural Products segment in 2010 were negatively affected by a less favorable relationship between selling prices and commodity costs related to paints and stains, as well as lower sales volume of builders’ hardware. Such declines more than offset the benefit of a more favorable product mix of paints and stains, related to new product introductions.

 

Operating margins in this 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 in 2009 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 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. Such declines more than offset the effect of selling price increases.

 

Sales

 

Net sales of Other Specialty Products increased in 2010 primarily due to increased sales volume of windows in North America, principally related to the energy-savings tax credit, which expired at the end of 2010, which increased sales in this segment by approximately one percent compared to 2009. Net sales were also positively affected by increased sales volume of staple gun tackers and other fastening tools, which increased sales in this segment by approximately one percent compared to 2009.

 

Net sales in this segment in 2009 were negatively affected by lower sales volume of windows, selling price decreases and a less favorable product mix, which decreased sales in this segment by approximately 12 percent in 2009 compared to 2008. A stronger U.S. dollar decreased sales by three percent in 2009 compared to 2008.

 

Net sales in this segment in 2008 were negatively affected by lower sales volume of windows, as well as a decline in the home improvement market.

 

Operating Results

 

Operating margins in the Other Specialty Products segment in 2010 reflect the negative effect of a less favorable relationship between selling prices and commodity costs and a less favorable windows product mix. Such declines offset the benefits associated with business rationalizations and other cost savings initiatives.

 

Operating margins in this segment in 2009 reflect the benefits associated with business rationalizations and other cost savings initiatives which offset the negative effect 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 margins in this segment in 2008 were negatively affected by lower sales volume and the related under-absorption of fixed costs, increased plant closure costs and the lower results of International operations.

 

Geographic Area Results Discussion

 

 

Sales

 

North American net sales in 2010 were negatively impacted by lower sales volume of installation and other services, cabinets, plumbing products, and builders’ hardware, which, in the aggregate, decreased sales by approximately four percent compared to 2009. Such declines were partially offset by a more favorable product mix of plumbing products and paints and stains, which increased sales by approximately one percent compared to 2009.

 

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 in 2009 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.

 

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.

Operating Results

 

The declines in operating profit margins from North American operations in 2010 were primarily due to lower sales volume and the related under-absorption of fixed costs and a less favorable relationship between selling prices and commodity costs, which decreased operating profit margins by two percentage point in 2010 compared to 2009. Operating profit margins were also negatively affected by increased business rationalization costs and charges in 2010 compared to 2009.

 

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.

 

Operating profit margins from North American operations in 2008 were negatively affected by declines in new home construction and consumer spending, which negatively impacted the sales volume of our products.

 

 

Sales

 

Net sales from International operations increased in local currencies by approximately five percent compared to 2009, primarily due to increased sales volume and increased selling prices of International plumbing products and windows, offset by lower sales volume of International cabinets. A stronger U.S. dollar decreased International net sales by five percent in 2010 compared to 2009.

 

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. Such declines in 2009 were partially offset by selling price increases. A stronger U.S. dollar decreased International net sales by seven percent in 2009 compared to 2008.

 

Net sales from International operations in 2008 were negatively affected by lower sales volume of plumbing products and cabinets.

 

Operating Results

 

Operating profit margins from International operations in 2010 were negatively affected by a less favorable product mix, partially offset by the benefits associated with business rationalizations and other cost savings initiatives.

 

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.

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, 2010, commitments to contribute up to $33 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, 2010, in millions:

 

 

 

Recently Issued Accounting Pronouncements.

 

Effective January 1, 2010, we adopted new FASB guidance regarding how a company determines when an entity is insufficiently capitalized or is not controlled through voting and should be consolidated. The adoption of this guidance did not have any impact on our 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, foreign currency exchange rates and commodity costs 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 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, 2010, 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, 2010, we have also entered into several contracts to manage our exposure to increases in the price of copper and zinc.

 

At December 31, 2010, 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, a 10 percent decline in the market value of our long-term investments or a 10 percent change in commodity costs. 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, 2010 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, 2010.

 

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, 2010. Their report expressed an unqualified opinion on the effectiveness of Masco Corporation’s internal control over financial reporting as of December 31, 2010 and expressed an unqualified opinion on the Company’s 2010 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, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 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, 2010, 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.

 

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 18, 2011

MASCO CORPORATION AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

at December 31, 2010 and 2009

 

 

See notes to consolidated financial statements.

MASCO CORPORATION AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF INCOME

 

for the years ended December 31, 2010, 2009 and 2008

 

 

See notes to consolidated financial statements.

MASCO CORPORATION AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

for the years ended December 31, 2010, 2009 and 2008