Masco Corporation — Q3 2016 Form 10-Q
Business context and period. Unaudited results for the three and nine months ended September 30, 2016, compared with the same 2015 periods. Masco operates in plumbing, decorative architectural products, cabinetry, and windows and other specialty products. TopBuild was spun off in June 2015 and is reported as a discontinued operation for the applicable prior-period results.
Key financial results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $1.877 billion | $1.839 billion | $5.598 billion | $5.427 billion |
| Gross profit | $614 million | $589 million | $1.883 billion | $1.721 billion |
| Operating profit | $269 million | $258 million | $838 million | $702 million |
| Net income attributable to Masco | $134 million | $111 million | $393 million | $280 million |
| Diluted EPS | $0.40 | $0.32 | $1.17 | $0.81 |
| Operating margin, reported | 14.3% | 14.0% | 15.0% | 12.9% |
- Sales rose 2% in Q3 and 3% year to date; excluding acquisitions and currency effects, management reported growth of 3% and 4%, respectively.
- Gross margin was 32.7% in Q3 and 33.6% year to date, versus 32.0% and 31.7%. Management attributed improvement to volume, pricing relative to commodity costs, and cost savings, partly offset by higher warranty costs.
- Nine-month cash from operating activities was $382 million, versus $422 million. Capital expenditures were $117 million; investing activities used $40 million and financing activities used $759 million. Cash and cash investments were $1.041 billion at quarter-end.
- At September 30, total short- and long-term debt was approximately $3.0 billion, versus $3.407 billion at December 31, 2015. Cash, cash investments, and short-term deposits totaled approximately $1.2 billion, down from $1.7 billion. Current ratio improved to 2.1 from 1.4.
Changes, segments, and notable items
- Plumbing Products led growth: Q3 sales increased 5% and nine-month sales 6%; segment operating margins improved to 19.4% and 18.6%, respectively.
- Decorative Architectural Products sales rose 2% in Q3 and 3% year to date, with higher segment margins. Cabinetry sales fell 6% and 5%, respectively; Windows and Other Specialty Products sales fell 1% in Q3 but rose 3% year to date.
- Windows and Other Specialty Products recorded segment operating losses of $10 million in Q3 and $9 million for nine months, compared with profits of $23 million and $50 million in the prior periods. The segment was affected by higher warranty, labor, and ERP implementation costs.
- Masco issued $900 million of notes in March at 3.5% and 4.375%, then used proceeds and cash to retire $1.3 billion of higher-coupon notes. The early retirements generated $40 million of debt-extinguishment expense included in interest expense. Nine-month interest expense rose to $186 million from $171 million; Q3 expense declined to $43 million from $54 million.
- Warranty liability increased to $192 million from $152 million. A Windows and Other Specialty Products business recorded a $31 million estimate increase related to expected future claims.
- Masco repurchased and retired 8.3 million shares for approximately $252 million during the first nine months, paid $95 million in dividends, and announced an annual dividend increase to $0.40 per share beginning in Q4.
Outlook, risks, and controls
Management provided no numerical earnings or sales guidance. It cited positive long-term fundamentals for repair and remodeling and new home construction, and emphasized branded-product investment, innovation, operational excellence, and disciplined capital allocation. Risks include housing and remodeling activity, competition and brand strength, key-customer reliance, execution of strategic initiatives, cabinetry performance, raw-material costs and availability, suppliers, and international operations. The company reported compliance with its credit-facility covenants and no borrowings under the facility at quarter-end. Management said disclosure controls were effective; the ongoing Milgard ERP implementation modified certain controls but was not in response to an identified deficiency. The filing reported no material change to previously disclosed risk factors. Ordinary-course litigation and claims remain possible; management considered a material adverse outcome remote, while noting outcomes cannot be assured.
Investor verification priorities
- Assess whether the $31 million warranty estimate increase and subsequent claims experience adequately capture exposure in the Windows and Other Specialty Products segment.
- Review debt-refinancing economics, the $40 million extinguishment charge, ongoing interest costs, and headroom under the revolving-credit covenants.
- Track cabinetry volumes and the strategic exit from certain lower-margin direct-to-builder business, as well as the Windows segment’s return to profitability.
- Compare cash generation with buybacks, dividends, pension contributions, and capital needs; confirm foreign cash availability and the impact of currency movements.
- Monitor Milgard ERP implementation costs and control changes, plus any material developments in litigation or other contingencies.