Masco Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited. Masco sells branded building and home-improvement products through Plumbing Products, Decorative Architectural Products, Cabinetry Products, and Windows and Other Specialty Products. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $1,920 | $1,778 | +8% |
| Gross profit / margin | $619 / 32.2% | $605 / 34.0% | Profit +2%; margin down 1.8 points |
| Operating profit / margin | $244 / 12.7% | $257 / 14.5% | Profit down 5%; margin down 1.8 points |
| Income before taxes | $200 | $210 | Down 5% |
| Net income attributable to Masco | $149 | $138 | Up 8% |
| Diluted EPS | $0.47 | $0.43 | Up 9% |
| Net cash from (used for) operations | $(55) | $(149) | Use reduced by $94 |
| Capital expenditures | $40 | $37 |
Reported sales growth excluding acquisitions, divestitures, and currency translation was 5%. Segment sales changed as follows: Plumbing Products +11%, Decorative Architectural Products +10%, Cabinetry Products −6%, and Windows and Other Specialty Products +4%. Segment operating profit fell in all but Plumbing, with reported segment margins lower year over year.
Operating cash flow reflected seasonal increases in receivables and inventories: receivables used $216 million and inventories used $87 million. Operating cash flow less capital expenditures was approximately negative $95 million; this simple measure is not company-reported free cash flow.
Balance sheet, debt, and liquidity
- At March 31, cash and cash investments were $370 million and short-term bank deposits were $99 million, totaling $469 million, versus $1.3 billion at December 31, 2017.
- Current assets were $2.993 billion and current liabilities $1.770 billion; the reported current ratio declined to 1.7 from 2.0, mainly reflecting cash paid for Kichler.
- Long-term debt was $2.971 billion and notes payable $116 million. The company reported no borrowings under its $750 million revolving facility and compliance with its covenants. The facility matures in May 2020 and includes a maximum adjusted net leverage ratio of 4.0:1 and minimum adjusted interest coverage of 2.5:1.
- Total equity was $183 million; Masco shareholders’ equity was a deficit of $72 million. The filing stated that cash, operating cash flows, and credit availability were sufficient for near-term needs.
Material changes and unusual items
- Masco acquired substantially all net assets of Kichler, a decorative lighting and ceiling-fan business, on March 9 for $548 million net of cash acquired, funded with cash on hand. Kichler contributed $27 million of Q1 sales. Purchase accounting included $243 million of intangible assets and $46 million of goodwill; allocation remained preliminary.
- Q1 investing cash use was $574 million, principally the Kichler acquisition and $40 million of capital expenditures. Financing cash use was $215 million, including $150 million of share repurchases, $33 million of dividends, and $32 million of employee withholding taxes on stock compensation.
- Masco repurchased and retired 3.7 million shares during the quarter, including shares delivered under an accelerated repurchase agreement. Approximately $1.14 billion remained under its $1.5 billion authorization. The quarterly dividend was $0.105 per share, compared with $0.100 a year earlier.
- Interest expense declined to $41 million from $43 million, which management attributed to refinancing debt at more favorable rates. The effective tax rate was 20%, versus 30%, primarily reflecting a larger stock-based compensation tax benefit in 2018.
- Adoption of ASC 606 was retrospective; the filing recast prior-period results. The company also adopted guidance permitting reclassification of $59 million of disproportionate tax effects from accumulated other comprehensive loss to retained deficit. These accounting changes should be considered when comparing periods.
Management commentary, outlook, and risks
Management cited a weaker relationship between selling prices and commodity costs, strategic growth spending, and program-launch and display expenses as pressures on gross margin. Segment-specific pressures included logistics and other expenses, legal expenses and Kichler inventory step-up recognition, restructuring costs, and weaker international window mix. Increased volume and cost-saving initiatives partly offset pressures. Management did not provide quantified full-year revenue or earnings guidance; it said it believed industry fundamentals remained strong and emphasized branded-product investment, innovation, operational excellence, portfolio management, and disciplined capital allocation.
Risks highlighted include housing repair/remodel and new-construction activity, competition and brand strength, key-customer reliance, raw-material costs and supplier dependence, international operations and currency exposure, acquisition integration, technology and information systems, and sustaining improvements in the U.S. windows business. Ordinary-course claims and litigation were described as unlikely to have a material adverse effect, although outcomes are not assured. Risk factors were reported as unchanged from the 2017 Form 10-K. A major Delta Faucet ERP implementation was planned for Q2 2018; management said it was not prompted by an identified control weakness but would modify some controls and involved significant scale and complexity.
Key facts for investors to verify
- Whether sales growth excluding acquisitions, divestitures, and currency translation is sustained, and how much Kichler contributes after the acquisition period.
- Whether pricing can offset commodity-cost inflation and reverse the decline in gross and segment operating margins.
- Cash conversion and seasonal working-capital needs, given negative Q1 operating cash flow and the sharp reduction in cash after the acquisition and capital returns.
- Kichler’s final purchase-price allocation, integration progress, and realized synergies relative to the cash purchase price.
- Debt covenant headroom, credit-facility availability, and capital allocation while Masco continues repurchases and dividends.
- The effect of the Delta ERP implementation on operations and internal controls, and developments in litigation, warranty obligations, and other disclosed risks.