- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005 COMMISSION FILE NUMBER 1-5794
MASCO CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<Table>
DELAWARE 38-1794485
(State of Incorporation) (I.R.S. Employer Identification No.)
21001 VAN BORN ROAD, TAYLOR, MICHIGAN 48180
(Address of Principal Executive Offices) (Zip Code)
</Table>
Registrant's telephone number, Including Area Code: 313-274-7400
Securities Registered Pursuant to Section 12(b) of the Act:
<Table>
<Caption>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ---------------------
Common Stock, $1.00 par value New York Stock Exchange, Inc.
Zero Coupon Convertible Senior
Notes Due 2031 New York Stock Exchange, Inc.
Zero Coupon Convertible Senior
Notes Series B Due 2031 New York Stock Exchange, Inc.
</Table>
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 [X] No [ ]
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 [ ] No [X]
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate 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. [X]
Indicate by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer (See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act).
<Table>
Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ]
</Table>
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The aggregate market value of the Registrant's Common Stock held by
non-affiliates of the Registrant on June 30, 2005 (based on the closing sale
price of $31.76 of the Registrant's Common Stock, as reported by the New York
Stock Exchange on such date) was approximately $13,445,055,000.
Number of shares outstanding of the Registrant's Common Stock at January 31,
2006:
416,300,000 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 2006
Annual Meeting of Stockholders are incorporated by reference into Part III of
this Form 10-K.
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- --------------------------------------------------------------------------------
MASCO CORPORATION
2005 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
<Table>
<Caption>
ITEM PAGE
- ---- ----
PART I
1. Business.................................................... 2
1A. Risk Factors................................................ 6
1B. Unresolved Staff Comments................................... 8
2. Properties.................................................. 8
3. Legal Proceedings........................................... 9
4. Submission of Matters to a Vote of Security Holders......... 9
Supplementary Item. Executive Officers of the Registrant.... 9
PART II
5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities......... 10
6. Selected Financial Data..................................... 11
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 12
7A. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 31
8. Financial Statements and Supplementary Data................. 32
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 71
9A. Controls and Procedures..................................... 71
9B. Other Information........................................... 71
PART III
10. Directors and Executive Officers of the Registrant.......... 72
11. Executive Compensation...................................... 72
12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters................ 72
13. Certain Relationships and Related Transactions.............. 72
14. Principal Accountant Fees and Services...................... 72
PART IV
15. Exhibits and Financial Statement Schedule................... 73
Signatures.................................................. 76
FINANCIAL STATEMENT SCHEDULE
Valuation and Qualifying Accounts........................... 77
</Table>
1
PART I
ITEM 1. BUSINESS.
Masco Corporation manufactures, sells and installs home improvement and
building products, with emphasis on brand name products and services holding
leadership positions in their markets. The Company is among the largest
manufacturers in North America of brand-name consumer products designed for the
home improvement and new construction markets. The Company's operations consist
of five business segments that are based on similarities in products and
services. The following table sets forth, for the three years ended December 31,
2005, the contribution of the Company's segments to net sales and operating
profit. Additional financial information concerning the Company's operations by
segment, as well as general corporate expense, as of and for the three years
ended December 31, 2005, is set forth in Note P to the Company's Consolidated
Financial Statements included in Item 8 of this Report.
<Table>
<Caption>
(IN MILLIONS)
NET SALES (1)
---------------------------
2005 2004 2003
------- ------- -------
Cabinets and Related Products................... $ 3,324 $ 3,065 $ 2,684
Plumbing Products............................... 3,176 3,057 2,684
Installation and Other Services................. 3,063 2,771 2,411
Decorative Architectural Products............... 1,681 1,610 1,449
Other Specialty Products........................ 1,398 1,347 1,148
------- ------- -------
Total......................................... $12,642 $11,850 $10,376
======= ======= =======
</Table>
<Table>
<Caption>
OPERATING PROFIT (1)(2)(3)(4)
------------------------------
2005 2004 2003
-------- -------- --------
Cabinets and Related Products................... $ 515 $ 519 $ 406
Plumbing Products............................... 367 370 343
Installation and Other Services................. 382 358 368
Decorative Architectural Products............... 252 269 210
Other Specialty Products........................ 239 233 178
------- ------- -------
Total......................................... $ 1,755 $ 1,749 $ 1,505
======= ======= =======
</Table>
--------------------------------------
(1) Amounts exclude discontinued operations.
(2) Operating profit is before general corporate expense, gains on sale
of corporate fixed assets, net, and accelerated benefit expense
related to the unexpected passing of the Company's President and
Chief Operating Officer in 2003.
(3) Operating profit is before the Behr litigation settlement income of
$6 million, $30 million and $72 million in 2005, 2004 and 2003,
respectively, pertaining to the Decorative Architectural Products
segment.
(4) Operating profit includes goodwill impairment charges as follows:
For 2005 - Plumbing Products - $7 million; Decorative Architectural
Products - $26 million; and Other Specialty Products - $36 million.
For 2004 - Plumbing Products - $25 million; Decorative Architectural
Products - $62 million; and Other Specialty Products - $25 million.
For 2003 - Plumbing Products - $17 million; Decorative Architectural
Products - $5 million; and Other Specialty Products - $31 million.
Except as the context otherwise indicates, the terms "Masco" and the
"Company" refer to Masco Corporation and its consolidated subsidiaries.
2
CABINETS AND RELATED PRODUCTS
In North America, the Company manufactures and sells economy, stock,
semi-custom, assembled and ready-to-assemble cabinetry for kitchen, bath,
storage, home office and home entertainment applications in a broad range of
styles and price points. In Europe, the Company manufactures assembled and
ready-to-assemble kitchen, bath, storage, home office and home entertainment
cabinetry and other products. These products are sold under a number of
trademarks including KRAFTMAID(R), MILL'S PRIDE(R) and TVILUM-SCANBIRK(TM)
primarily to dealers and home centers, and under the names BLUESTONE(TM),
MERILLAT(R), MOORES(TM) and QUALITY CABINETS(R) primarily to distributors and
directly to builders for both the home improvement and new construction markets.
The cabinet manufacturing industry in the United States and Europe is
highly competitive, with several large and hundreds of smaller competitors. The
Company believes that it is the largest manufacturer of kitchen and bath
cabinetry in North America based on sales revenue for 2005. Significant North
American competitors include American Woodmark Corporation and Fortune Brands
Inc.
In response to an increased demand for the Company's cabinet products and
to maintain desired delivery times, the Company is constructing significant
capacity additions to its North American cabinet operations. Construction is
anticipated to be completed in early 2007.
PLUMBING PRODUCTS
In North America, the Company manufactures and sells a wide variety of
faucet and showering devices under several brand names. The most widely known of
these are the DELTA(R), PEERLESS(R), BRIZO(TM)and NEWPORT BRASS(R) single and
double handle faucets used in kitchen, lavatory and other sinks and in bath and
shower applications. The Company's faucets are sold by manufacturers'
representatives and Company sales personnel to major retail accounts and to
distributors who sell the faucets to plumbers, building contractors, remodelers,
smaller retailers and others. Showerheads, handheld showers and valves are sold
under the brand names ALSONS(R), DELTA, PEERLESS and PLUMB SHOP(R). The Company
manufactures kitchen and bath faucets, showering devices and various other
plumbing products for European markets under the brand names AXOR(TM),
BRISTAN(TM), DAMIXA(R), GUMMERS(TM), HANSGROHE(R) and NEWTEAM(TM), which are
sold through multiple distribution channels. AXOR and HANSGROHE products are
also sold in North America through retailers and distributors.
Masco believes that its faucet operations are among the leaders in sales in
the North American market, with American Standard, Kohler, Moen and Price
Pfister as major brand competitors. The Company also has several major
competitors, including Friedrich Grohe, among the European manufacturers of
faucets and accessories, primarily in Germany and Italy. The Company also faces
significant competition from private label products (including house brands sold
by certain of the Company's customers), much of which is manufactured by foreign
firms.
Other plumbing products manufactured and sold by the Company include AQUA
GLASS(R) and MIROLIN(R) acrylic and gelcoat bath and shower units, which are
sold primarily to wholesale plumbing distributors and major retail accounts for
the home improvement and new home construction markets. Bath and shower
enclosure units, shower trays and laundry tubs are manufactured and sold under
the brand name AMERICAN SHOWER & BATH(TM). These products are sold to home
centers, hardware stores and mass merchandisers for the "do-it-yourself" market.
The Company's spas are manufactured and sold under HOT SPRING(R), CALDERA(R) and
other trademarks directly to independent dealers. Other plumbing products for
the international market include HUPPE(R) and BREUER(TM) shower enclosures sold
by the Company through wholesale channels and home centers primarily in Germany
and Western Europe. HERITAGE(TM) ceramic and acrylic bath fixtures and faucets
are principally sold in the United Kingdom directly to selected retailers.
GLASS(TM) and PHARO(TM) acrylic bathtubs and steam shower enclosures are sold in
Europe.
3
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 centers, hardware stores,
building supply outlets and other mass merchandisers. These products are
marketed in North America for the wholesale trade under the BRASSCRAFT(R) and
BRASSTECH(R) trademarks and for the "do-it-yourself" market under the MASTER
PLUMBER(R) and PLUMB SHOP trademarks and are also sold under private label.
The Company features a durable coating on many of its decorative faucets
and other products that offers tarnish protection and scratch resistance under
the trademark BRILLIANCE(R). This finish is currently available on many of the
Company's kitchen and bath products.
INSTALLATION AND OTHER SERVICES
The Company's Installation and Other Services segment operates over 290
local installation branch offices throughout most of the United States and in
Canada. These branches supply and install primarily insulation and, in many
locations, other building products including cabinetry, fireplaces, gutters,
garage doors, bath accessories, shelving, windows and paint. The Company also
operates over 60 local distribution centers throughout North America that supply
insulation and other products including insulation accessories, cabinetry,
roofing, gutters, drywall and fireplaces. Installation services are provided
primarily to production home builders and custom home builders in the new
construction market and distribution sales are made directly to contractors.
Installation operations are conducted in local markets through various names.
The Company's competitors in this market include several regional contractors
and lumber yards, as well as numerous local installers. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" under
Item 7 of this Report for additional information regarding the availability of
insulation and price changes for this material.
Net sales of installed and distributed insulation comprised 15 percent, 15
percent and 16 percent of the Company's consolidated net sales for the years
ended December 31, 2005, 2004 and 2003, respectively. Net sales of
non-insulation products have increased over the last several years and
represented approximately 38 percent of the segment's revenues for 2005.
DECORATIVE ARCHITECTURAL PRODUCTS
The Company manufactures architectural coatings including paints, specialty
paint products, stains, varnishes and waterproofings. BEHR(R) paint and stain
products, such as PREMIUM PLUS(R), and MASTERCHEM(R) specialty paint products,
including KILZ(R) branded products, are sold in the United States and Canada
primarily to the "do-it-yourself" market through home centers and other
retailers. Net sales of architectural coatings comprised approximately 11
percent of the Company's consolidated net sales for each of the years ended
December 31, 2005, 2004 and 2003, respectively. Competitors in the architectural
coatings market include large multi-national companies such as Benjamin Moore &
Co., ICI Paints, PPG Industries, Inc., Sherwin-Williams and Valspar, as well as
many smaller regional and national companies.
The Company has established Color Solutions Centers(TM) in over 1,700 Home
Depot stores throughout the United States. These centers enhance the
paint-buying experience by helping consumers to interactively design and
coordinate their product selection. Behr's PREMIUM PLUS brand, its principal
product line, is sold exclusively through The Home Depot stores.
The Decorative Architectural Products segment also includes LIBERTY(R)
cabinet, decorative door and builders' hardware, which is manufactured for the
Company and sold to home centers, other retailers, original equipment
manufacturers and wholesale markets. Key competitors in these product lines in
North America include Amerock, Belwith, National, Umbra and Stanley. Decorative
bath hardware and shower accessories are sold under the brand names FRANKLIN
BRASS(R) and BATH UNLIMITED(R) to distributors, home centers and other
retailers. Competitors include Moen and Globe Union.
4
AVOCET(TM) builders' hardware products, including locks and door and window
hardware, are manufactured and sold to home centers and other retailers,
builders and original equipment door and window manufacturers primarily in the
United Kingdom.
OTHER SPECIALTY PRODUCTS
The Company manufactures and sells windows and patio doors under the
MILGARD(R) brand name directly to the new construction and home improvement
markets, principally in the western United States. The Company fabricates and
sells vinyl windows and sunrooms under the GRIFFIN(TM)and CAMBRIAN(TM) brand
names for the United Kingdom building trades. The Company extrudes and sells
vinyl frame components for windows, patio doors and sunrooms under the brand
name DURAFLEX(TM) for the European building trades.
The Company manufactures and sells a complete line of manual and electric
staple gun tackers, staples and other fastening tools under the brand names
ARROW(R) and POWERSHOT(R). These products are sold through various distribution
channels including wholesalers, home centers and other retailers. SAFLOK(R)
electronic locksets are sold primarily to the hospitality market, and LAGARD(R)
commercial safe and ATM locks are manufactured and sold to commercial markets.
The Company also manufactures residential hydronic radiators and heat
convectors under the brand names BRUGMAN(R), SUPERIA(TM), THERMIC(TM) and
VASCO(R), which are sold to the European wholesale market from operations in
Belgium, The Netherlands and Poland.
DISCONTINUED OPERATIONS
As part of its strategic planning, the Company continues to review all of
its businesses to determine which businesses may not be core to continuing
operations. In 2003, the Company completed the sale of three of its North
American businesses. In early 2004, the Company determined that several European
businesses were not core to the Company's long-term growth strategy and,
accordingly, embarked on a plan of disposition, which was completed in early
2005. During 2005, the Company identified and sold two additional businesses,
one in Europe and one in North America, pursuant to the Company's determination
that these business units were not core to the Company's long-term cabinet
platform strategy. The businesses sold during 2003, 2004 and 2005 had combined
2003 net sales of $758 million. Additional information is set forth in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in Item 7 of this Report.
ADDITIONAL INFORMATION
- Over 80 percent of the Company's net sales are generated by operations in
North America (primarily in the United States). International operations
comprise the balance and are located principally in Belgium, Denmark,
Germany, Italy, The Netherlands and the United Kingdom. See Note P to the
Company's Consolidated Financial Statements included in Item 8 of this
Report.
- Financial information concerning the Company's export sales and foreign
and United States operations, including the net sales, operating profit
and assets attributable to the Company's segments and to the Company's
North American and International operations, as of and for the three
years ended December 31, 2005, are included in Item 8 of this Report in
Note P to the Company's Consolidated Financial Statements.
- The peak season for home construction and remodeling generally
corresponds with the second and third calendar quarters. As a result, the
Company generally experiences stronger sales during these quarters.
- The Company does not consider backlog orders to be material.
5
- Compliance with federal, state and local regulations relating to the
discharge of materials into the environment, or otherwise relating to the
protection of the environment, is not expected to result in material
capital expenditures by the Company or to have a material adverse effect
on the Company's earnings or competitive position.
- See Item 1A, "Risk Factors," for a discussion of the importance of major
customers, competitive conditions and certain other business risks and
uncertainties that may affect our operations.
AVAILABLE INFORMATION
The Company's website is www.masco.com. The Company's 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 its website. During the period covered by this
Report, the Company posted its periodic reports on Form 10-K and Form 10-Q and
its current reports on Form 8-K and any amendments to those documents to its
website as soon as reasonably practicable after those reports were filed or
furnished electronically with the Securities and Exchange Commission. The
Company will continue to post to its website such reports and amendments to
those reports as soon as reasonably practicable after those reports are filed
with or furnished to the Securities and Exchange Commission. Material contained
on the Company's website is not incorporated by reference into this Report on
Form 10-K.
PATENTS AND TRADEMARKS
The Company holds United States and foreign patents covering its vapor
deposition finish and various design features and valve constructions used in
certain of its faucets and holds numerous other patents and patent applications,
licenses, trademarks and trade names. As a manufacturer of brand-name consumer
products, the Company views its trademarks and other proprietary rights as
important, but does not believe that there is any reasonable likelihood of a
loss of such rights that would have a material adverse effect on the Company's
present business as a whole.
EMPLOYEES
At December 31, 2005, the Company employed approximately 62,000 people.
Satisfactory relations have generally prevailed between the Company and its
employees.
ITEM 1A. RISK FACTORS.
There are a number of business risks and uncertainties that may affect our
operations. These risks and uncertainties could cause future results to differ
from past performance or expected results, including results described in
statements elsewhere in this Report that constitute "forward-looking statements"
under the Private Securities Litigation Reform Act of 1995. The impact on our
operations of certain of these risk factors is discussed below under Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." Additional risks and uncertainties not presently known to us or
that we currently believe to be immaterial also may adversely impact our
business. Should any risks or uncertainties develop into actual events, these
developments could have material adverse effects on our business, financial
condition, and results of operations. These risks and uncertainties include, but
are not limited to, the following, which we consider to be most relevant to our
specific business activities.
A SIGNIFICANT PORTION OF OUR BUSINESS RELIES ON RESIDENTIAL CONSTRUCTION
ACTIVITY.
Our results of operations are affected by levels of home improvement and
residential construction activity, principally in North America and Europe
(including repair and remodeling and new construction). Interest rates, energy
costs, consumer confidence, general and regional economic conditions, and
weather conditions and natural disasters can significantly impact levels of home
improvement and residential construction activity. Historically, the Company has
largely offset the impact on its reve-
6
nues of cyclical declines in the new construction and home improvement markets
through new product introductions, acquisitions and market share gains. We have
increased our emphasis on new product development in recent years, but we have
reduced our prior focus on growth through acquisitions in favor of organic
growth. Consequently, our financial performance will, in part, reflect our
success in implementing our growth strategies in our existing markets and in
introducing new products or entering new geographic markets.
WE RELY ON OUR KEY CUSTOMERS.
The size and importance of individual customers has increased because
customers in our major distribution channels have consolidated. Larger customers
can effect significant changes in their volume of purchases and can otherwise
significantly affect the terms and conditions on which we do business. Further,
as these same customers expand their markets and targeted customers, conflicts
occur, and in some instances we also become their competitors. Our relationships
with home centers are particularly important because sales of our home
improvement and building products to home center retailers are substantial. In
2005, sales to the Company's largest customer, The Home Depot, were $2.7 billion
(approximately 21 percent of total sales). Although builders, dealers and other
retailers represent other channels of distribution for the Company's products,
the loss of a substantial portion of our sales to The Home Depot would have a
material adverse impact on the Company.
WE FACE SIGNIFICANT COMPETITION IN THE U.S. AND GLOBAL MARKETS.
The major markets for our products and services are highly competitive and
in recent years global competition has increased significantly. Competition in
our home improvement and building product lines is based largely on performance,
quality, brand reputation, style, delivery, customer service, exclusivity and
price. Competition in the markets for our service businesses is based primarily
on price, customer service, scope of capabilities, installation quality and
financial strength. Although the relative importance of such factors varies
between customers and among product categories, price is often a primary factor.
Our ability to maintain our leadership positions in our markets and to grow our
businesses depends to a large extent upon our success in maintaining our
relationships with our major customers, managing our cost structure and
introducing new products.
OUR OPERATING RESULTS ARE AFFECTED BY THE COST AND AVAILABILITY OF RAW MATERIAL.
When we incur cost increases for raw materials, energy and other
commodities, it may be difficult for us to completely offset the impact with
price increases on a timely basis due to outstanding commitments to our
customers, competitive considerations and our customers' resistance to accepting
such price increases. Some of our operations, including the Installation and
Other Services segment, encounter shortages or unusual price increases in raw
materials from time to time. A substantial decrease in the availability of
products from our suppliers or the loss of key supplier arrangements could
adversely impact our results of operations.
OUR INTERNATIONAL BUSINESS HAS DIFFERENT RISKS FROM THOSE OF OUR NORTH AMERICAN
BUSINESS.
Over 15 percent of our sales are derived outside of North America
(principally in Europe) and are transacted in currencies other than U.S. dollars
(principally euros and Great Britain pounds). Our international business faces
political, monetary, economic and other risks that vary from country to country.
Our international operating results have been adversely influenced in recent
years, in part due to softness in the European markets and competitive pricing
pressures on certain products. Our operating results can fluctuate based on
changes in U.S. dollar exchange rates, which also presents difficulty in
comparing operating performance from period to period.
7
WE HAVE FINANCIAL COMMITMENTS AND INVESTMENTS IN FINANCIAL ASSETS, INCLUDING
ASSETS THAT ARE NOT READILY MARKETABLE AND INVOLVE FINANCIAL RISK.
We maintain investments in a number of private equity funds and in
marketable securities. 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 and the amounts realized upon liquidation.
In addition, we have commitments that require us, when requested, to contribute
additional capital to these private equity funds.
PRODUCT LIABILITY CLAIMS AND OTHER LITIGATION COULD BE COSTLY.
Increasingly, homebuilders (including our customers) are subject to
construction defect and home warranty claims in the ordinary course of their
business. Our contractual commitments to these customers typically include our
agreement to indemnify them for liability for the performance of our products or
services or the performance of other products that we install. We are also
subject to product safety recalls and direct claims for product liability,
including putative class actions, which can result in significant liability and
be costly to defend. See Note U to the consolidated financial statements
included in Item 8 of this Report for additional information about litigation
involving our businesses.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2. PROPERTIES.
The table below lists the Company's principal North American properties for
segments other than Installation and Other Services.
<Table>
<Caption>
WAREHOUSE AND
BUSINESS SEGMENT MANUFACTURING DISTRIBUTION
---------------- ------------- -------------
Cabinets and Related Products................... 21 36
Plumbing Products............................... 29 13
Decorative Architectural Products............... 10 10
Other Specialty Products........................ 22 7
-- --
Totals........................................ 82 66
== ==
</Table>
Most of the Company's North American manufacturing facilities range in size
from single buildings of approximately 10,000 square feet to complexes that
exceed 1,000,000 square feet. The Company owns most of its North American
manufacturing facilities, none of which are subject to significant encumbrances.
A substantial number of its warehouse and distribution facilities are leased.
In addition, the Company's Installation and Other Services segment operates
over 290 local installation branch offices and over 60 local distribution
centers in North America, the majority of which are leased.
8
The table below lists the Company's principal properties outside of North
America.
<Table>
<Caption>
WAREHOUSE AND
BUSINESS SEGMENT MANUFACTURING DISTRIBUTION
---------------- ------------- -------------
Cabinets and Related Products................... 4 22
Plumbing Products............................... 22 33
Decorative Architectural Products............... 3 2
Other Specialty Products........................ 13 5
-- --
Totals........................................ 42 62
== ==
</Table>
Most of these international facilities are located in Belgium, China,
Denmark, Germany, Italy, The Netherlands, Poland and the United Kingdom. The
Company generally owns its international manufacturing facilities, none of which
are subject to significant encumbrances, and leases its warehouse and
distribution facilities.
The Company's corporate headquarters are located in Taylor, Michigan and
are owned by the Company. The Company owns an additional building near its
corporate headquarters that is used by its corporate research and development
department.
Each of the Company's operating divisions assesses the manufacturing,
distribution and other facilities needed to meet its operating requirements. The
Company's buildings, machinery and equipment have been generally well maintained
and are in good operating condition. As noted, the Company is constructing
significant capacity additions to its cabinet operations, but otherwise,
generally, the Company's facilities have sufficient capacity and are adequate
for its production and distribution requirements.
ITEM 3. LEGAL PROCEEDINGS.
Information regarding legal proceedings involving the Company is set forth
in Note U to the Company's consolidated financial statements included in Item 8
of this Report.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
SUPPLEMENTARY ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT
(PURSUANT TO INSTRUCTION 3 TO ITEM 401(b) OF REGULATION S-K).
<Table>
<Caption>
EXECUTIVE
OFFICER
NAME POSITION AGE SINCE
---- ----------------------------------------------------- --- ---------
Richard A. Manoogian........... Chairman of the Board and Chief Executive Officer 69 1962
Alan H. Barry.................. President and Chief Operating Officer 63 2003
David A. Doran................. Vice President - Taxes 64 1984
Daniel R. Foley................ Vice President - Human Resources 64 1996
Eugene A. Gargaro, Jr. ........ Vice President and Secretary 63 1993
John R. Leekley................ Senior Vice President and General Counsel 62 1979
John G. Sznewajs............... Vice President - Corporate Development and Treasurer 38 2005
Timothy Wadhams................ Senior Vice President and Chief Financial Officer 57 2001
</Table>
Executive officers, who are elected by the Board of Directors, serve for a
term of one year or less. Each elected executive officer has been employed in a
managerial capacity with the Company for over five years except Mr. Wadhams. Mr.
Wadhams was employed by the Company from 1976 to 1984. From 1984 until he
rejoined the Company in 2001, he was an executive of Metaldyne Corporation
(formerly MascoTech, Inc.), most recently serving as its Executive Vice
President - Finance and Administration and Chief Financial Officer. Mr. Barry
was elected to his present position in April 2003. He had served as a Group
President of the Company since 1996. Mr. Sznewajs was elected to his current
positions in August 2005. He had previously served as Vice President - Business
Development since 2003 and before that time served in various capacities in the
Business Development Department from 1996 to 2003.
9
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
The New York Stock Exchange is the principal market on which the Company's
Common Stock is traded. The following table indicates the high and low sales
prices of the Company's Common Stock as reported by the New York Stock Exchange
and the cash dividends declared per common share for the periods indicated:
<Table>
<Caption>
MARKET PRICE
--------------- DIVIDENDS
QUARTER HIGH LOW DECLARED
- ------- ------ ------ ---------
2005
Fourth................................. $31.20 $27.15 $.20
Third.................................. 34.70 29.37 .20
Second................................. 34.94 29.57 .20
First.................................. 38.43 32.90 .20
----
Total............................... $.80
====
2004
Fourth................................. $37.02 $32.87 $.18
Third.................................. 35.00 29.69 .18
Second................................. 31.47 26.29 .16
First.................................. 30.80 25.88 .16
----
Total............................... $.68
====
</Table>
On February 28, 2006 there were approximately 6,400 holders of record of
the Company's Common Stock.
The Company expects that its practice of paying quarterly dividends on its
Common Stock will continue, although the payment of future dividends is at the
discretion of the Company's Board of Directors and will depend upon the
Company's earnings, capital requirements, financial condition and other factors.
In March 2005, the Company's Board of Directors authorized the purchase of
up to 50 million shares of the Company's Common Stock in open-market
transactions or otherwise. The following table provides information regarding
the Company's purchase of Company Common Stock for the three months ended
December 31, 2005, in millions except average price paid per common share data:
<Table>
<Caption>
TOTAL NUMBER OF SHARES MAXIMUM NUMBER OF
PURCHASED AS PART OF SHARES THAT MAY YET
TOTAL NUMBER OF AVERAGE PRICE PAID PUBLICLY ANNOUNCED BE PURCHASED UNDER
PERIOD SHARES PURCHASED PER COMMON SHARE PLANS OR PROGRAMS THE PLANS OR PROGRAMS
- ------ ---------------- ------------------ ---------------------- ---------------------
10/01/05 - 10/31/05..... 3 $28.79 3 34
11/01/05 - 11/30/05..... 3 $29.00 3 31
12/01/05 - 12/31/05..... 2 $29.64 2 29
-- --
Total for the quarter... 8 $29.11 8
== ==
</Table>
For information regarding securities authorized for issuance under the
Company's equity compensation plans, see Part III, Item 12 of this Report.
10
ITEM 6. SELECTED FINANCIAL DATA.
<Table>
<Caption>
(DOLLARS IN MILLIONS, EXCEPT PER COMMON SHARE DATA)
2005 2004 2003 2002 2001
-------- -------- -------- -------- --------
Net sales (1)................................ $12,642 $11,850 $10,376 $ 8,653 $ 7,545
Operating profit (1),(2),(3),(4),(5),(7)..... $ 1,577 $ 1,592 $ 1,449 $ 1,234 $ 989
Income from continuing operations
(1),(2),(3),(4),(5),(6),(7),(8)............ $ 872 $ 949 $ 769 $ 524 $ 168
Per share of common stock:
Income from continuing operations:
Basic................................... $ 2.07 $ 2.13 $ 1.60 $ 1.08 $ 0.37
Diluted................................. $ 2.03 $ 2.08 $ 1.57 $ 1.02 $ 0.35
Dividends declared......................... $ 0.80 $ 0.68 $ 0.60 $ 0.55 $ 0.53
Dividends paid............................. $ 0.78 $ 0.66 $ 0.58 $ 0.54 1/2 $ 0.52 1/2
Income from continuing operations as a % of:
Net sales.................................. 7% 8% 7% 6% 2%
Shareholders' equity (9)................... 16% 17% 15% 13% 5%
At December 31:
Total assets............................... $12,559 $12,541 $12,173 $12,050 $ 9,021
Long-term debt............................. $ 3,915 $ 4,187 $ 3,848 $ 4,316 $ 3,628
Shareholders' equity....................... $ 4,848 $ 5,423 $ 5,456 $ 5,294 $ 3,958
</Table>
- ------------------------------
(1) Amounts exclude discontinued operations.
(2) The year 2005 includes a non-cash goodwill impairment charge of $69 million
after tax ($69 million pre-tax) and income of $4 million after tax ($6
million pre-tax) related to the Behr litigation settlement. See Note U to
the Consolidated Financial Statements.
(3) The year 2004 includes a non-cash goodwill impairment charge of $104 million
after tax ($112 million pre-tax) and income of $19 million after tax ($30
million pre-tax) related to the Behr litigation settlement. See Note U to
the Consolidated Financial Statements.
(4) The year 2003 includes a non-cash goodwill impairment charge of $47 million
after tax ($53 million pre-tax) and income of $45 million after tax ($72
million pre-tax) related to the Behr litigation settlement. See Note U to
the Consolidated Financial Statements.
(5) The year 2002 includes a $92 million after tax ($147 million pre-tax), net
charge related to the Behr litigation settlement and pre-tax income of $16
million for the planned disposition of a business.
(6) The year 2002 includes a $92 million after tax ($117 million pre-tax),
non-cash goodwill impairment charge recognized as a cumulative effect of a
change in accounting principle.
(7) Operating profit for 2001 includes goodwill amortization expense of $86
million.
(8) The year 2001 includes a $344 million after-tax ($530 million pre-tax),
non-cash charge for the write-down of certain investments, principally
securities of Furnishings International Inc.
(9) Based on shareholders' equity as of the beginning of the year.
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The financial and business analysis below provides information which the
Company believes is relevant to an assessment and understanding of the Company's
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 the Company's views about its future performance and
constitute "forward-looking statements" under the Private Securities Litigation
Reform Act of 1995. These views involve risks and uncertainties that are
difficult to predict and, accordingly, the Company's actual results may differ
materially from the results discussed in such forward-looking statements.
Readers should consider that various factors, including those discussed in Item
1A "Risk Factors" of this Report, the "Executive Level Overview," "Critical
Accounting Policies and Estimates" and "Outlook for the Company" sections, may
affect the Company's performance. The Company undertakes no obligation to update
publicly any forward-looking statements as a result of new information, future
events or otherwise.
EXECUTIVE LEVEL OVERVIEW
The Company manufactures and installs home improvement and building
products. These products are sold to the home improvement and home construction
markets through mass merchandisers, hardware stores, home centers, builders,
distributors and other outlets for consumers and contractors.
Factors that affect the Company's results of operations include the levels
of home improvement and residential construction activity principally in North
America and Europe (including repair and remodeling and new construction), the
importance of and the Company's relationships with key customers (including The
Home Depot, which represented approximately 21 percent of the Company's sales in
2005), the Company's ability to maintain its leadership positions in its markets
in the face of increasing global competition, the Company's ability to
effectively manage its overall cost structure and the availability and cost of
raw materials. The Company's International business faces political, monetary,
economic and other risks that vary from country to country, as well as
fluctuations in European currency exchange rates. Further, the Company has
financial commitments and investments in financial assets that are not readily
marketable and that involve financial risk. In addition, product liability
claims and other litigation could be costly. These factors are discussed in more
detail in Item 1A "Risk Factors" of this Report. Historically, the Company has
largely offset the impact on its revenues of cyclical declines in the new
construction and home improvement markets through new product introductions,
acquisitions and market share gains. While acquisitions have enabled the Company
to build the critical mass that has given the Company strong positions in the
markets it serves, the Company has put less emphasis on growth through
acquisitions to focus on organic sales growth.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's discussion and analysis of its financial condition and
results of operations are based on the Company's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these
financial statements requires the Company 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. The Company regularly reviews its estimates and assumptions,
which are based on historical experience and various other factors that are
believed 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.
The Company believes that the following critical accounting policies are
affected by significant judgments and estimates used in the preparation of its
consolidated financial statements.
12
REVENUE RECOGNITION AND RECEIVABLES
The Company recognizes revenue as title to products and risk of loss is
transferred to customers or when services are rendered. The Company records
estimated reductions to revenue for customer programs and incentive offerings,
including special pricing and co-operative advertising arrangements, promotions
and other volume-based incentives. Allowances for doubtful accounts receivable
are maintained for estimated losses resulting from the inability of customers to
make required payments.
INVENTORIES
Inventories are recorded 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 on assumptions about future demand and market conditions. On an
on-going basis, the Company monitors these estimates and records adjustments for
differences between estimates and actual experience. Historically, actual
results have not significantly deviated from those determined using these
estimates.
FINANCIAL INVESTMENTS
The Company maintains investments in marketable securities, which
aggregated $115 million, and a number of private equity funds, which aggregated
$262 million, at December 31, 2005. The investments in private equity funds are
carried at cost and are evaluated for impairment at each reporting period, or
when circumstances indicate an impairment may exist, using information made
available by the fund managers and other assumptions. The investments in
marketable securities are carried at fair value, and unrealized gains and
unrealized losses (that are deemed to be temporary) are recorded as a component
of shareholders' equity, net of tax effect, in other comprehensive income. The
Company records an impairment charge to earnings when an investment has
experienced a decline in value that is deemed to be other-than-temporary. Future
changes in market conditions, the performance of underlying investments or new
information provided by private equity fund managers could affect the recorded
values of such investments and the amounts realized upon liquidation.
Based on its review, in the third quarter of 2005, the Company recognized
an impairment charge of $28 million related to its investment in four million
shares of Furniture Brands International (NYSE:FBN) common stock to reduce the
cost basis from $25.05 per share to the market value at September 30, 2005 of
$18.03 per share. In 2004, the Company also recognized an impairment charge of
$21 million related to the Company's investment in FBN. At December 31, 2005,
the FBN common stock was in an unrealized gain position; the aggregate carrying
value of the investment was $90 million. The FBN common stock, included in
marketable securities, was received in June 2002 from the Company's investment
in Furnishings International Inc. debt.
The Company's investments in private equity funds and other private
investments are carried at cost and are evaluated for impairment at each
reporting period, or when circumstances, including the maturity of the fund,
indicate impairment may exist. 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. 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 and the amounts realized upon liquidation. Based on
the Company's review of its private equity funds, the Company considered the
decline in the estimated market value of certain of its private equity fund
investments to be other-than-temporary and, accordingly, recognized an
impairment charge of $15 million in the third quarter of 2005. At December 31,
2005, the carrying value of the Company's investments in private equity funds
exceeded the estimated market value, as determined by the fund managers, by
approximately $19 million, which the Company considers to be a temporary decline
in the estimated fair value.
13
GOODWILL AND OTHER INTANGIBLE ASSETS
The Company records the excess of purchase cost over the fair value of net
tangible assets of acquired companies as goodwill or other identifiable
intangible assets. In accordance with Statement of Financial Accounting
Standards ("SFAS") No. 142 "Goodwill and Other Intangible Assets," in the fourth
quarter of each year, or as an event occurs or circumstances change that would
more likely than not reduce the fair value of a reporting unit below its
carrying amount, the Company completes the impairment testing of goodwill
utilizing a discounted cash flow method.
Determining market values using a discounted cash flow method requires the
Company to make significant estimates and assumptions, including long-term
projections of cash flows, market conditions and appropriate discount rates. The
Company's judgments are based on historical experience, current market trends,
consultations with external valuation specialists and other information. While
the Company believes that the estimates and assumptions underlying the valuation
methodology are reasonable, different estimates and assumptions could result in
a different outcome. In estimating future cash flows, the Company relies 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. The Company generally develops these forecasts based on recent sales
data for existing products, planned timing of new product launches, estimated
housing starts and repair and remodeling estimates for existing homes.
In the fourth quarter of 2005, the Company estimated that future discounted
cash flows projected for most of its reporting units were greater than the
carrying values. Any increases in estimated discounted cash flows would have no
impact on the reported value of goodwill.
If the carrying amount of a reporting unit exceeds its fair value, the
Company measures the possible goodwill impairment loss based on 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. 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. This test for 2005
indicated that goodwill related to certain European businesses was impaired. The
Company recognized a non-cash, pre-tax impairment charge of $69 million ($69
million, after tax) in the fourth quarter of 2005.
The Company reviews its individual indefinite-lived intangible assets for
impairment annually and if an event occurs or circumstances change that indicate
the assets may be impaired without regard to the reporting unit. The Company
considers the implications of both external (e.g., market growth, competition
and local economic conditions) and internal (e.g., product sales, profit margins
and expected product growth) factors and their potential impact on cash flows
related to the intangible asset in both the near and long term.
Intangible assets with finite useful lives are amortized over their
estimated lives. The Company evaluates 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.
EMPLOYEE RETIREMENT PLANS
Accounting for defined-benefit pension plans involves estimating the cost
of benefits to be provided in the future, based on vested years of service, and
attributing those costs over the time period each employee works. Pension costs
and obligations of the Company are developed 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. The Company considers current market conditions, including changes
in interest rates, in selecting these assumptions. The Company selects these
assumptions with assistance from outside advisors such as consul-
14
tants, lawyers and actuaries. Changes in assumptions used could result in
changes to the related pension costs and obligations within the Company's
consolidated financial statements in any given period.
In 2005, the Company decreased its discount rate for obligations to an
average of 5.25 percent from 5.75 percent. The discount rate for obligations was
based on the expected duration of each defined-benefit pension plan's
liabilities matched to the December 31, 2005 Citigroup Pension Discount Curve.
Such rates for the Company's defined-benefit pension plans ranged from 4.00
percent to 5.75 percent, with the most significant portion of the liabilities
having a discount rate for obligations of 5.25 percent or higher. The assumed
asset return was primarily 8.50 percent, reflecting the expected long-term
return on plan assets.
The Company's underfunded amount, or the difference between the projected
benefit obligation and plan assets, increased to $231 million from $193 million
in 2004, primarily due to asset returns below projections. Qualified domestic
pension plan assets in 2005 had a net gain of approximately four percent
compared with average returns of five percent for the largest 1,000 Plan
Benchmark.
The Company's projected benefit obligation relating to the unfunded
non-qualified supplemental defined-benefit pension plans was $143 million at
December 31, 2005 compared with $125 million at December 31, 2004.
The Company expects pension expense for its qualified defined-benefit
pension plans to increase by $2 million in 2006 compared with 2005. If the
Company assumed that the future return on plan assets was one-half percent lower
than the assumed asset return, the 2006 pension expense would increase by an
additional $2 million.
STOCK OPTIONS AND AWARDS
The Company's 2005 Long Term Stock Incentive Plan (the "2005 Plan")
replaced the 1991 Long Term Stock Incentive Plan (the "1991 Plan") in May 2005
and provides for the issuance of stock-based incentives in various forms. At
December 31, 2005, outstanding stock-based incentives were in the form of
restricted long-term stock awards, stock appreciation rights, phantom stock
awards and stock options. Additionally, the Company's 1997 Non-Employee
Directors Stock Plan (the "1997 Plan") provides for the payment of part of the
compensation to non-employee Directors in Company common stock.
Restricted Long-Term Stock Awards
Long-term stock awards are granted to key employees and non-employee
Directors of the Company and do not cause net share dilution as the Company
continues the practice of reacquiring an equal number of shares on the open
market. The unvested stock awards, aggregating $185 million (9 million common
shares) at December 31, 2005 are included as a reduction in shareholders' equity
and are being expensed based on the respective vesting periods, principally 10
years. Compensation expense for the annual vesting of long-term stock awards was
$44 million for the year ended December 31, 2005.
Stock Options
Fixed price stock options are granted to key employees and non-employee
Directors of the Company. The grant date exercise price equals the market price
of Company common stock on the date of grant. These options generally become
exercisable in installments beginning on the first anniversary from the date of
grant and expire no later than 10 years after the grant date. Restoration stock
options under the 1991 Plan become exercisable six months from the date of
grant. The 2005 Plan does not permit the granting of restoration stock options,
except for restoration options resulting from the options granted under the 1991
Plan.
15
The Company began using the fair value method of accounting for options
granted, modified or settled subsequent to January 1, 2003, and options granted
prior to January 1, 2003 continue to be accounted for using the intrinsic value
method as of December 31, 2005. Effective January 1, 2006, the Company will
adopt SFAS No. 123R "Accounting for Stock-Based Compensation," using the
Modified Prospective Application ("MPA") method. SFAS No. 123R requires
companies to measure and recognize the cost (fair value) of employee services
received in exchange for stock options. The MPA method will require the Company
to record expense for unvested stock options that were awarded prior to January
1, 2003 through the remaining vesting periods. The expense for unvested stock
options at January 1, 2006 will be based on the grant-date fair value of those
awards as calculated for pro forma disclosure under SFAS No. 123. Changes to the
grant-date fair value of stock options granted before January 1, 2006 are
prohibited. The MPA method does not require the restatement of prior-year
information. The amount of expense related to total unvested stock options
remaining at December 31, 2005 was $104 million; such options have a weighted
average vesting period of over 3 years.
The fair value of stock options was estimated at the grant date using a
Black-Scholes option pricing model with the following assumptions for 2005:
risk-free interest rate - 4.1%, dividend yield - 2.3%, volatility factor - 35.8%
and expected option life - 7 years. For SFAS No. 123R calculation purposes, the
weighted average grant-date fair value of option shares, including restoration
options, granted in 2005 was $10.33 per option share. The fair value for each
option grant is calculated and the related expense is recorded over the vesting
period of the option grant.
If the Company increased its 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 2005 would increase 44 percent. If the Company
decreased its 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 2005 would decrease 55 percent.
INCOME TAXES
The Company has considered potential sources of future foreign taxable
income in assessing the need for establishing a valuation allowance against its
deferred tax assets at December 31, 2005 and 2004, related to its after-tax
foreign tax credit carryforward of $50 million. Should the Company determine
that it would not be able to realize all or part of its deferred tax assets in
the future, a valuation allowance would be recorded in the period such
determination is made.
OTHER COMMITMENTS AND CONTINGENCIES
Certain of the Company's 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,
the Company accrues a warranty liability for estimated costs to provide
products, parts or services to repair or replace products in satisfaction of
warranty obligations. The Company's estimate of costs to service its warranty
obligations is based on historical experience and expectations of future
conditions. To the extent that the Company experiences any changes in warranty
claim activity or costs associated with servicing those claims, its warranty
liability is adjusted accordingly.
The Company is subject to lawsuits and pending or asserted claims
(including income taxes) with respect to matters generally arising in the
ordinary course of business. Liabilities and costs associated with these matters
require estimates and judgments based on the professional knowledge and
experience of management and its legal counsel. When estimates of the Company's
exposure for lawsuits and pending or asserted claims meet the criteria for
recognition under SFAS No. 5, "Accounting for Contingencies," amounts are
recorded as charges to earnings. The ultimate resolution of any such exposure to
the Company may differ due to subsequent developments. See Note U to the
Company's consolidated financial statements for information regarding legal
proceedings involving the Company.
16
CORPORATE DEVELOPMENT STRATEGY
Acquisitions in past years have enabled the Company to build a critical
mass that has given the Company a strong position in the markets it serves and
has increased the Company's importance to its customers. The Company is now
intensifying its focus on leveraging the critical mass to build greater value
for its shareholders. The Company's focus includes additional cost reduction
initiatives, as well as increasing synergies among the Company's business units.
The Company expects to maintain a more balanced growth strategy of organic
growth, share repurchases and fewer acquisitions with increased emphasis on cash
flow and return on invested capital. As part of its strategic planning, the
Company continues to review all of its businesses to determine which businesses
may not be core to continuing operations.
In 2003, the Company completed the sale of its Baldwin Hardware, Weiser
Lock and Marvel Group businesses. Total gross proceeds from the sale of Baldwin
Hardware, Weiser Lock and Marvel Group were $289 million; the Company recognized
a pre-tax net gain on the disposition of these businesses of $89 million.
In 2004, the Company determined that several European businesses were not
core to the Company's long-term growth strategy and, accordingly, embarked on a
plan of disposition (the "2004 Plan").
During 2004, in separate transactions, the Company completed the sale of
its Jung Pumpen, The Alvic Group, Alma Kuchen, E. Missel and SKS Group
businesses in Europe. In 2004, the Company reduced its estimate of expected
proceeds and recognized pre-tax charges of $139 million ($151 million including
tax effect) for those businesses that were expected to be divested at a loss.
Any gains resulting from the dispositions were recognized as such transactions
were completed. Total gross proceeds from the sale of these companies were $199
million, including cash of $193 million and notes receivable of $6 million. The
Company recognized a pre-tax, net gain (principally related to the sale of Jung
Pumpen) on the disposition of these businesses of $106 million.
During 2005, in separate transactions, the Company disposed of its Gebhardt
Consolidated and GMU Group businesses in Europe as part of the Company's 2004
Plan. Gebhardt Consolidated supplies ventilation products and GMU Group
manufactures cabinets. Total gross proceeds from the sale of Gebhardt
Consolidated and GMU Group were $130 million; the Company recognized a pre-tax
net gain (principally related to the sale of Gebhardt Consolidated) on the
disposition of these businesses of $9 million. Net proceeds from the disposition
of businesses completed in 2005 and 2004, pursuant to the Company's 2004 Plan,
aggregated $280 million.
Also during 2005, in separate transactions, the Company completed the
disposition of Zenith Products and Aran Group; such dispositions were completed
pursuant to the Company's determination that these business units were not core
to the Company's long-term cabinet platform strategy. Zenith Products
manufactures bathroom storage and organization products for the North American
retail market and Aran Group is a European manufacturer of assembled and
ready-to-assemble kitchen cabinets; both business units were in the Cabinets and
Related Products segment. Total gross proceeds from the sale of Zenith Products
and Aran Group were $189 million; the Company recognized a pre-tax net gain
(principally related to the sale of Zenith Products) on the disposition of these
businesses of $50 million.
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets," the Company accounted for the businesses held for sale at
December 31, 2004, as well as other businesses which were sold in 2005, 2004 and
2003, as discontinued operations. There were no businesses held for sale at
December 31, 2005. The sales and results of operations of the businesses sold in
2005, 2004 and 2003 are included in the Company's results from discontinued
operations through the date of disposition. During the time the Company owned
these businesses, they had net sales of $242 million, $581 million and $758
million in 2005, 2004 and 2003, respectively, and income (loss) from
17
discontinued operations before income taxes of $39 million, $5 million and $(10)
million in 2005, 2004 and 2003, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has largely funded its growth through cash
provided by a combination of its operations, long-term bank debt and other
borrowings, and by the issuance of Company common stock, including issuances for
certain mergers and acquisitions.
Bank credit lines are maintained to ensure the availability of funds. At
December 31, 2005, debt agreements with banks syndicated in the United States
relate to a $2.0 billion 5-Year Revolving Credit Agreement which expires in
November 2009. This agreement allows for borrowings denominated in U.S. dollars
or European euros. Interest is payable on borrowings under this agreement based
on various floating-rate options as selected by the Company.
In February 2006, the Company amended the terms of the $2.0 billion 5-Year
Revolving Credit Agreement; the amendment primarily affected the requirement for
the Company to maintain certain levels of net worth.
The 5-Year Revolving Credit Agreement, as amended, contains limitations on
additional borrowings; at December 31, 2005, the Company had additional
borrowing capacity, subject to availability, of up to $2.5 billion. The 5-Year
Revolving Credit Agreement, as amended, also contains a requirement for
maintaining a certain level of net worth; at December 31, 2005, the Company's
net worth exceeded such requirement by approximately $842 million.
At December 31, 2005, the amount of debt and equity securities issuable
under the Company's unallocated shelf registration statement with the Securities
and Exchange Commission was $1.5 billion.
The Company had cash and cash investments of $1,964 million at December 31,
2005 as a result of strong cash flows from operations, proceeds from the
disposition of certain businesses and financial investments, and the issuance of
fixed-rate debt.
During 2005, the Company increased its quarterly common stock dividend 11
percent to $.20 per common share. This marks the 47th consecutive year in which
dividends have been increased. Although the Company is aware of the greater
interest in yield by many investors and has maintained an increased dividend
payout in recent years, the Company continues to believe that its shareholders'
long-term interests are best served by investing a significant portion of its
earnings in the future growth of the Company.
Maintaining high levels of liquidity and cash flow are among the Company's
financial strategies. The Company's total debt as a percent of total
capitalization increased to 49 percent at December 31, 2005 from 44 percent at
December 31, 2004. Repurchases and retirement of Company common stock
contributed to the increase in the total debt to total capitalization ratio. The
Company's working capital ratio was 1.8 to 1 and 2.1 to 1 at December 31, 2005
and 2004, respectively. The decline in the current ratio is primarily due to the
reclassification to current liabilities of $800 million of 6.75% notes that are
due and payable on March 15, 2006. The Company intends to use a portion of its
cash to retire the notes due March 2006.
The derivatives used by the Company during the year ended December 31, 2005
consist of interest rate swaps entered into in 2005, for the purpose of
effectively converting a portion of fixed-rate debt to variable-rate debt.
Generally, under interest rate swap agreements, the Company agrees with a
counterparty to exchange the difference between fixed-rate and variable-rate
interest amounts calculated by reference to an agreed notional principal amount.
The derivative contracts are with two major creditworthy institutions, thereby
minimizing the risk of credit loss. The interest rate swap agreements are
designated as fair-value hedges, and the interest rate differential on interest
rate swaps used to hedge existing debt is recognized as an adjustment to
interest expense over the term of the agreement.
18
For fair-value hedge transactions, changes in the fair value of the derivative
and changes in the fair value of the item hedged are recognized in determining
earnings.
The average variable interest rates are based on the London Interbank
Offered Rate ("LIBOR") plus a fixed adjustment factor. The average effective
rate on the interest rate swaps was 5.519%. At December 31, 2005, the interest
rate swap agreements covered a notional amount of $850 million of the Company's
fixed-rate debt due July 15, 2012 at an interest rate of 5.875%. The hedges are
considered 100 percent effective because all of the critical terms of the
derivative financial instruments match those of the hedged item. Accordingly, no
gain or loss on the value of the hedges was recognized in the Company's
consolidated statements of income for the years ended December 31, 2005 and
2004. The amount recognized as a reduction of interest expense was $3 million
for the year ended December 31, 2005.
Certain of the Company's European operations also entered into foreign
currency forward contracts for the purpose of managing exposure to currency
fluctuations, primarily related to the United States dollar and the Great
Britain pound.
CASH FLOWS
Significant sources and (uses) of cash in the past three years are
summarized as follows, in millions:
<Table>
<Caption>
2005 2004 2003
------ ------ ------
Net cash from operating activities.......................... $1,374 $1,454 $1,421
Increase (decrease) in debt, net............................ 407 (13) (541)
Net proceeds from disposition of:
Businesses, net of cash disposed.......................... 278 172 284
Equity investment......................................... - - 75
Proceeds from settlement of swaps........................... - 55 -
Issuance of Company common stock............................ 33 58 37
Acquisition of businesses, net of cash acquired............. (25) (16) (239)
Capital expenditures........................................ (282) (310) (271)
Cash dividends paid......................................... (339) (302) (286)
Purchase of Company common stock............................ (986) (943) (827)
Proceeds from financial investments, net.................... 193 330 55
Effect of exchange rates.................................... (5) 29 52
Other, net.................................................. 22 (15) (32)
------ ------ ------
Cash increase (decrease).......................... $ 670 $ 499 $ (272)
====== ====== ======
</Table>
The Company's cash and cash investments increased $708 million (including
cash at businesses held for sale at January 1, 2005) to $1,964 million at
December 31, 2005, from $1,256 million at December 31, 2004.
Net cash provided by operations of $1.4 billion consisted primarily of net
income adjusted for non-cash and certain other items, including depreciation and
amortization expense of $241 million, net gain on disposition of businesses of
$63 million, net gain on disposition of financial investments of $98 million,
income of $6 million related to the Behr litigation settlement, a $69 million
charge related to goodwill impairment, a $45 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 Notes.
The Company continues to emphasize balance sheet management, including
working capital management and cash flow generation. Days sales in accounts
receivable decreased to 48 days at December 31, 2005 from 49 days at December
31, 2004, and days sales in inventories decreased to 46 days at December 31,
2005 from 49 days at December 31, 2004. Accounts payable days were 36 days
19
at both December 31, 2005 and 2004. The Company continues to implement working
capital improvement initiatives.
Cash used for financing activities was $885 million, and included cash
outflows of $339 million for cash dividends paid, $87 million for the net
payment of debt and $986 million for the acquisition and retirement of Company
common stock in open-market transactions. Cash provided by financing activities
included $494 million from the issuance of notes (net of issuance costs) and $33
million from the issuance of Company common stock, primarily from the exercise
of stock options.
At December 31, 2005, the Company had remaining Board of Directors'
authorization to repurchase up to an additional 29 million shares of its common
stock in open-market transactions or otherwise. In January 2006, the Company
repurchased an additional three million shares of Company common stock and
expects to continue its Company common share repurchase program throughout 2006.
Cash provided by investing activities was $186 million, and included $278
million of net proceeds from the disposition of businesses, $193 million from
the net sale of financial investments and $22 million from other net cash
inflows. Cash used for investing activities included $282 million for capital
expenditures and $25 million for acquisitions and additional acquisition-related
consideration relating to previously acquired companies. The Company expects to
continue to monetize the marketable securities portfolio over the next several
quarters.
The Company continues to invest in automating its manufacturing operations
and increasing its capacity and its productivity, in order to be a more
efficient producer and to improve customer service. Capital expenditures for
2005 were $282 million, compared with $310 million for 2004 and $271 million for
2003; for 2006, capital expenditures, excluding any potential 2006 acquisitions,
are expected to approximate $420 million. Capital expenditures for 2006 include
significant capacity additions to the Company's North American cabinet
operations for which construction is anticipated to be completed in early 2007.
Depreciation and amortization expense for 2005 totaled $241 million, compared
with $237 million for 2004 and $244 million for 2003; for 2006, depreciation and
amortization expense, excluding any potential 2006 acquisitions, is expected to
approximate $250 million. Amortization expense totaled $28 million, $26 million
and $32 million in 2005, 2004 and 2003, respectively.
Costs of environmental responsibilities and compliance with existing
environmental laws and regulations have not had, nor in the opinion of the
Company are they expected to have, a material effect on the Company's capital
expenditures, financial position or results of operations.
The Company believes that its present cash balance and cash flows from
operations are sufficient to fund its near-term working capital and other
investment needs. The Company believes that its 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, future financial
market activities and proceeds from asset sales.
20
CONSOLIDATED RESULTS OF OPERATIONS
The Company reports its financial results in accordance with generally
accepted accounting principles ("GAAP") in the United States. However, the
Company believes 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, the Company's reported results.
SALES AND OPERATIONS
Net sales for 2005 were $12.6 billion, representing an increase of seven
percent over 2004. Excluding results from acquisitions, net sales also increased
seven percent compared with 2004. The increase in net sales in 2005 is
principally due to continued strength in the new construction market for the
Company's cabinet and window products and installation sales, as well as selling
price increases for certain products. The following table reconciles reported
net sales to net sales excluding acquisitions and the effect of currency
translation, in millions:
<Table>
<Caption>
TWELVE MONTHS
ENDED DECEMBER 31
------------------
2005 2004
------- -------
Net sales, as reported...................................... $12,642 $11,850
- Acquisitions............................................ (21) -
------- -------
Net sales, excluding acquisitions........................... 12,621 11,850
- Currency translation.................................... 5 -
------- -------
Net sales, excluding acquisitions and the effect of
currency.................................................. $12,626 $11,850
======= =======
</Table>
The Company's gross profit margins were 28.5 percent, 30.9 percent and 30.7
percent for the years ended December 31, 2005, 2004 and 2003, respectively. The
decrease in the 2005 gross profit margins reflects additional increased
commodity, energy and freight costs, as well as a less favorable product mix,
offset in part by increased sales volume and increased selling prices for
certain products. The 2004 gross profit margins reflected increased sales volume
and increased selling prices, offset in part by initial increases in commodity
costs, as well as sales in segments with somewhat lower gross margins. Operating
results for the year ended December 31, 2003 were reduced by non-cash, pre-tax
charges of $59 million relating to two United Kingdom business units.
Selling, general and administrative expenses as a percent of sales were
15.6 percent in 2005 compared with 16.8 percent in 2004 and 16.9 percent in
2003. Selling, general and administrative expenses for the year ended December
31, 2005 reflect lower compensation costs resulting from business unit
consolidations and reduced Company financial performance related to incentive
compensation, as well as reduced outside professional fees including fees
associated with complying with Sarbanes-Oxley legislation. Selling, general and
administrative expenses in 2004 include the benefit of lower promotion and
advertising costs offset by higher costs and expenses associated with complying
with Sarbanes-Oxley legislation and increased expenses associated with stock
options. Selling, general and administrative expenses for the year ended
December 31, 2003 include $16 million of accelerated benefit expense related to
the unexpected passing of the Company's President and Chief Operating Officer.
Operating profit for the years ended December 31, 2005, 2004 and 2003
includes $6 million, $30 million and $72 million, respectively, of income
regarding the Behr litigation settlement. Operating profit margins, as reported,
were 12.5 percent, 13.4 percent and 14.0 percent in 2005, 2004 and 2003,
respectively. Operating profit margins, excluding the goodwill impairment
charges and the income regarding the Behr litigation settlement, were 13.0
percent, 14.1 percent and 13.8 percent in 2005, 2004 and 2003, respectively.
Operating profit margins in 2005 were negatively impacted by increased
commodity, energy, freight and other petroleum-based product costs, which have
not been offset by
21
selling price increases, as well as charges aggregating approximately $30
million related to certain profit improvement initiatives.
OTHER INCOME (EXPENSE), NET
In 2005, 2004 and 2003, the Company recorded $45 million, $21 million and
$19 million, respectively, of non-cash, pre-tax charges for the write-down of
certain financial investments.
In the third quarter of 2005, the Company recognized an impairment charge
of $28 million related to its investment of four million shares of Furniture
Brands International (NYSE: FBN) common stock to reduce the cost basis from
$25.05 per share to the market value at September 30, 2005 of $18.03 per share.
In 2004, the Company recognized an impairment charge of $21 million related to
the Company's investment in FBN. At December 31, 2005, the FBN common stock was
in an unrealized gain position; the aggregate carrying value was $90 million at
December 31, 2005. The FBN common stock, included in marketable securities, was
received in June 2002 from the Company's investment in Furnishings International
Inc. debt. Based on the Company's review of its private equity funds, the
Company considered the decline in the estimated market value of certain of its
private equity fund investments to be other-than-temporary and, accordingly,
recognized an impairment charge of $15 million in the third quarter of 2005.
Other, net in 2005 includes $30 million of realized gains, net, from the
sale of marketable securities, dividend income of $16 million and $68 million of
income from other investments, net. Other, net in 2005 also includes currency
transaction losses of $25 million and other miscellaneous items.
Other, net in 2004 includes $50 million of realized gains, net, from the
sale of marketable securities, dividend income of $27 million and $42 million of
income from other investments, net. Other, net in 2004 also includes currency
transaction gains of $26 million and other miscellaneous items.
Other, net in 2003 includes $23 million of realized gains, net, from the
sale of marketable equity securities, dividend income of $25 million and $17
million of income from other investments, net. Other, net in 2003 also includes
a $5 million gain from the sale of the Company's equity investment in Emco, $7
million of losses on the early retirement of debt, currency transaction losses
of $4 million and other miscellaneous items.
Interest expense was $247 million, $217 million and $260 million in 2005,
2004 and 2003, respectively. The increase in interest expense in 2005 is
primarily due to the issuance of fixed-rate notes in June 2005, as well as the
impact of increasing interest rates. The decrease in interest expense in 2004 is
primarily due to debt retirement, as well as the effect of the interest rate
swap agreements that converted a certain amount of fixed-rate debt to lower
variable-rate debt and reduced interest expense by $22 million for the year
ended December 31, 2004.
INCOME AND EARNINGS PER COMMON SHARE FROM CONTINUING OPERATIONS
Income from continuing operations and diluted earnings per common share for
2005 were $872 million and $2.03 per common share, respectively. Income from
continuing operations for 2005 includes a non-cash, pre-tax goodwill impairment
charge of $69 million ($69 million or $.16 per common share, after tax) and
income related to the Behr litigation settlement of $6 million pre-tax ($4
million or $.01 per common share, after tax). Income from continuing operations
and diluted earnings per common share for 2004 were $949 million and $2.08 per
common share, respectively. Income from continuing operations for 2004 includes
a non-cash, pre-tax goodwill impairment charge of $112 million ($104 million or
$.23 per common share, after tax) and income related to the Behr litigation
settlement of $30 million pre-tax ($19 million or $.04 per common share, after
tax). Income from continuing operations and diluted earnings per common share
for 2003 were $769 million and $1.57 per common share, respectively. Income from
continuing operations for 2003 includes a non-cash, pre-tax goodwill impairment
charge of $53 million ($47 million or $.10 per common share, after
22
tax) and income related to the Behr litigation settlement of $72 million pre-tax
($45 million or $.09 per common share, after tax).
The Company's effective tax rate for income from continuing operations was
37 percent in 2005, 2004 and 2003. The Company estimates that its effective tax
rate should approximate 36 percent for 2006.
OUTLOOK FOR THE COMPANY
The Company believes that higher commodity costs experienced in late 2005
will continue to adversely affect its near-term operating performance. The
Company has already implemented and continues to implement additional selling
price increases on a number of its products, and believes that by the end of the
first half of 2006, many of these cost increases will be largely offset by such
price increases.
The Company remains committed to its strategy of value creation and
continues to be focused on the simplification of its business model, cash flow
generation, improvement in return on invested capital and the return of cash to
shareholders through share repurchases and dividends.
Consistent with this strategy, the Company is pursuing a variety of
initiatives to offset cost increases and increase operating profit, including
sourcing programs, the restructuring of certain of its businesses (including
consolidations), manufacturing rationalization, headcount reductions and other
profit improvement programs. While the Company has incurred and will incur
additional expenses and charges related to these programs, implementing these
initiatives should improve the Company's earnings outlook for 2006 and beyond.
As part of its strategy, in January 2006, the Company announced a plant
closure in the Plumbing Products segment; costs associated with this plant
closure and other profit improvement programs are currently expected to
approximate $70 million and are expected to be incurred during 2006.
23
BUSINESS SEGMENT AND GEOGRAPHIC AREA RESULTS
The following table sets forth the Company's net sales and operating profit
information by business segment and geographic area, dollars in millions.
<Table>
<Caption>
PERCENT INCREASE
-----------------
2005 2004
VS. VS.
2005 2004 2003 2004 2003
------- ------- ------- ------ -------
NET SALES:
Cabinets and Related Products..................... $ 3,324 $ 3,065 $ 2,684 8% 14%
Plumbing Products................................. 3,176 3,057 2,684 4% 14%
Installation and Other Services................... 3,063 2,771 2,411 11% 15%
Decorative Architectural Products................. 1,681 1,610 1,449 4% 11%
Other Specialty Products.......................... 1,398 1,347 1,148 4% 17%
------- ------- -------
TOTAL......................................... $12,642 $11,850 $10,376 7% 14%
======= ======= =======
North America..................................... $10,513 $ 9,740 $ 8,645 8% 13%
International, principally Europe................. 2,129 2,110 1,731 1% 22%
------- ------- -------
TOTAL......................................... $12,642 $11,850 $10,376 7% 14%
======= ======= =======
</Table>
<Table>
<Caption>
2005 2005(B) 2004 2004(B) 2003 2003(B)
------ ------- ------- ------- ------ -------
OPERATING PROFIT: (A)
Cabinets and Related Products..................... $ 515 $ 515 $ 519 $ 519 $ 406 $ 406
Plumbing Products................................. 367 374 370 395 343 360
Installation and Other Services................... 382 382 358 358 368 368
Decorative Architectural Products................. 252 278 269 331 210 215
Other Specialty Products.......................... 239 275 233 258 178 209
------ ------- ------- ------- ------ ------
TOTAL......................................... $1,755 $ 1,824 $ 1,749 $ 1,861 $1,505 $1,558
------ ------- ------- ------- ------ ------
North America..................................... $1,577 $ 1,577 $ 1,616 $ 1,616 $1,411 $1,411
International, principally Europe................. 178 247 133 245 94 147
------ ------- ------- ------- ------ ------
TOTAL......................................... 1,755 1,824 1,749 1,861 1,505 1,558
General corporate expense, net.................... (192) (192) (194) (194) (115) (115)
Gains on sale of corporate fixed assets, net...... 8 8 7 7 3 3
Income regarding litigation settlement............ 6 6 30 30 72 72
Expense related to accelerated benefits, net...... - - - - (16) (16)
------ ------- ------- ------- ------ ------
TOTAL OPERATING PROFIT................................ $1,577 $ 1,646 $ 1,592 $ 1,704 $1,449 $1,502
====== ======= ======= ======= ====== ======
</Table>
<Table>
<Caption>
2005 2005(B) 2004 2004(B) 2003 2003(B)
------ ------- ------- ------- ------ -------
OPERATING PROFIT MARGIN: (A)
Cabinets and Related Products..................... 15.5% 15.5% 16.9% 16.9% 15.1% 15.1%
Plumbing Products................................. 11.6% 11.8% 12.1% 12.9% 12.8% 13.4%
Installation and Other Services................... 12.5% 12.5% 12.9% 12.9% 15.3% 15.3%
Decorative Architectural Products................. 15.0% 16.5% 16.7% 20.6% 14.5% 14.8%
Other Specialty Products.......................... 17.1% 19.7% 17.3% 19.2% 15.5% 18.2%
North America..................................... 15.0% 15.0% 16.6% 16.6% 16.3% 16.3%
International, principally Europe................. 8.4% 11.6% 6.3% 11.6% 5.4% 8.5%
TOTAL......................................... 13.9% 14.4% 14.8% 15.7% 14.5% 15.0%
TOTAL OPERATING PROFIT MARGIN, AS REPORTED............ 12.5% N/A 13.4% N/A 14.0% N/A
</Table>
(A) Before: general corporate expense; accelerated benefit expense related to
the unexpected passing of the Company's President and Chief Operating
Officer in 2003; and income regarding the Behr litigation settlement
(related to the Decorative Architectural Products segment).
(B) Excluding goodwill impairment charge. The 2005 goodwill impairment charge
was as follows: Plumbing Products - $7 million; Decorative Architectural
Products - $26 million; and Other Specialty Products - $36 million. The 2004
goodwill impairment charge was as follows: Plumbing Products - $25 million;
Decorative Architectural Products - $62 million; and Other Specialty
Products - $25 million. The 2003 goodwill impairment charge was as follows:
Plumbing Products - $17 million; Decorative Architectural Products - $5
million; and Other Specialty Products - $31 million. These charges relate to
certain of the Company's European businesses.
24
BUSINESS SEGMENT RESULTS DISCUSSION
Changes in operating profit margins in the following Business Segment and
Geographic Area Results discussion exclude general corporate expense, the income
regarding the litigation settlement and the goodwill impairment charges in 2005,
2004 and 2003.
CABINETS AND RELATED PRODUCTS
Net sales of Cabinets and Related Products increased eight percent in 2005
compared with 2004 and increased 14 percent in 2004 compared with 2003. The 2005
sales increases in this segment were primarily attributable to increased sales
volume in the new construction market, as well as certain selling price
increases. The sales increases in 2004 were primarily due to increased sales
volume of assembled cabinets largely through North American retail distribution
channels at major home centers and through the new construction market in the
United States, as well as a more favorable product mix. This segment was
favorably influenced by a weaker U.S. dollar in 2004, which affected the
translation of local currencies of European operations included in this segment.
Operating profit margins were 15.5 percent, 16.9 percent and 15.1 percent
for the years ended December 31, 2005, 2004 and 2003, respectively. Operating
profit margins in 2005 reflect increased commodity and freight costs, as well as
a shift to a less favorable product mix, which offset the positive impact of
higher unit sales volume. Operating profit margins in this segment were also
negatively affected by manufacturing and distribution inefficiencies due to
increased demand for assembled cabinets in North America. The Company has major
capital expansion programs to increase North American assembled cabinet
manufacturing capacity for both the retail and new construction markets. These
new facilities, located in the Western U.S., are expected to be in production in
early 2007. Operating profit margins in 2004 reflect the positive impact of
higher unit sales volume, as well as certain cost improvement initiatives.
PLUMBING PRODUCTS
Net sales of Plumbing Products increased four percent in 2005 compared with
2004 principally due to increased sales through the Company's wholesale
distribution channel and the increased sales of certain European operations
included in this segment. While sales volumes have increased, such increases
were offset by a less favorable product mix and by continuing weakness impacting
certain products sold through retail markets. Net sales of Plumbing Products
increased 14 percent in 2004 compared with 2003 primarily due to increased sales
volume in the retail markets in North America and Europe and in the new
construction market in North America. A weaker U.S. dollar also had a favorable
impact on the translation of local currencies of European operations included in
this segment in 2004.
Operating profit margins were 11.8 percent, 12.9 percent and 13.4 percent
for the years ended December 31, 2005, 2004 and 2003, respectively. Operating
profit margins in this segment in 2005 were adversely affected by charges
aggregating $12 million related to certain profit improvement initiatives,
including severance costs and costs associated with exiting a product line. The
operating profit margins in this segment in 2005 were also adversely affected by
increased commodity costs, which have not been offset by selling price increases
and a less favorable product mix, which more than offset increased sales volume
in the wholesale distribution channel. The Company's Plumbing Products segment
continues to be negatively impacted by import competition, as well as a product
mix shift towards lower-margin faucets within the North American retail
channels. As part of the Company's strategic review of its businesses, the
Company determined that in order to remain competitive, it is necessary to
increase off-shore sourcing at lower costs, while consolidating and reducing
manufacturing operations in North America. Consistent with this determination,
in January 2006, the Company announced a North American plant closure in this
segment; the costs and expenses associated with this plant closure and other
profit improvement initiatives are expected to approximate $70 million and
25
will be incurred during 2006. The Company anticipates that this closure will
improve the outlook for its plumbing-related business beyond 2006. Operating
profit margins in 2004 compared with 2003 reflect an increase in European sales
(which are generally at lower margins), as well as increased material costs,
offset in part by increased sales volume.
INSTALLATION AND OTHER SERVICES
Net sales of Installation and Other Services increased 11 percent in 2005
compared with 2004 and increased 15 percent in 2004 compared with 2003. The
increases in net sales in 2005 and 2004 were primarily due to increased selling
prices, as well as increased sales volume of non-insulation products and
continued strength in the new construction market.
Operating profit margins were 12.5 percent, 12.9 percent and 15.3 percent
for the years ended December 31, 2005, 2004 and 2003, respectively. The slight
decline in the 2005 operating profit margin was primarily attributable to
continued increases in sales of generally lower-margin, non-insulation products,
as well as the time lag in implementing selling price increases related to
material cost increases, partially offset by the favorable impact of higher
sales volume. The 2004 operating profit margin decline was primarily
attributable to the time lag in implementing selling price increases related to
material cost increases, as well as an increase in sales of generally
lower-margin, non-insulation products.
Within the Installation and Other Services segment, the availability of
fiberglass insulation to support the Company's installation and distribution
activities continues to be constrained. The high level of demand for fiberglass
insulation as a result of the continued strong new construction market has
outpaced the industry's capacity to produce additional product. The Company
believes that these conditions will persist at least through the first half of
2006 and is working with its diverse supplier base to secure the appropriate
amount of material. At the current time, the Company believes that it will be
able to do so, but if the Company cannot obtain the required amount of material,
this could have a negative impact on its operations.
DECORATIVE ARCHITECTURAL PRODUCTS
Net sales of Decorative Architectural Products increased four percent in
2005 compared with 2004 and increased 11 percent in 2004 compared with 2003. The
increase in net sales in 2005 was primarily due to increased selling prices for
paints and stains. The increase in net sales in 2004 was primarily due to higher
unit sales volume of paints and stains, as well as increased sales of decorative
hardware.
Operating profit margins were 16.5 percent, 20.6 percent and 14.8 percent
for the years ended December 31, 2005, 2004 and 2003, respectively. Operating
profit margins for this segment in 2005 were negatively impacted by increased
material and freight costs, which were not completely offset by increased
selling prices related to paints and stains. The operating profit margin
improvement in 2004 includes the effect of increased sales volume of paints and
stains and increased sales volume and improved operating performance of the
Company's decorative hardware businesses, offset in part by increased material
and promotion costs.
Operating profit margins for this segment in 2003 were impacted by
increased advertising and marketing costs, including additional costs associated
with new in-store paint display centers, and fixed asset and inventory
adjustments reflecting excess, obsolete and resourced products related to
decorative hardware. Operating profit margins for this segment in 2003 were
negatively affected by non-cash, pre-tax charges of $55 million related to a
business system implementation failure at a United Kingdom business unit.
OTHER SPECIALTY PRODUCTS
Net sales of Other Specialty Products increased four percent in 2005
compared with 2004, principally due to increased sales volume and certain
selling price increases of vinyl and fiberglass windows
26
and patio doors to North American new construction markets, which were partially
offset by reduced sales of European operations included in this segment. Net
sales of Other Specialty Products increased 17 percent in 2004 compared with
2003, principally due to increased sales of vinyl and fiberglass windows and
doors in North America. A weaker U.S. dollar in 2004 also had a favorable effect
on the translation of local currencies of European operations included in this
segment.
Operating profit margins were 19.7 percent, 19.2 percent and 18.2 percent
for the years ended December 31, 2005, 2004 and 2003, respectively. Operating
profit margins in this segment in 2005 were negatively affected by increased
commodity costs and the lower results of European operations, reflecting charges
related to profit improvement initiatives, offset in part by reduced state use
tax expense. The operating profit margin improvement in 2004 was primarily
attributable to increased sales volume of windows. The operating profit margins
in 2003 reflect increased material and insurance costs, as well as lower results
of European operations.
GEOGRAPHIC AREA RESULTS DISCUSSION
NORTH AMERICA
Net sales from North American operations increased eight percent in 2005
compared with 2004, and increased 13 percent in 2004 compared with 2003,
primarily due to continued strength in the new construction market and increased
sales volume of cabinets, installed sales of insulation and non-insulation
products, and vinyl and fiberglass windows and patio doors, as well as increased
selling prices for certain products.
Operating profit margins were 15.0 percent, 16.6 percent and 16.3 percent
for the years ended December 31, 2005, 2004 and 2003, respectively. Operating
profit margins in 2005 were negatively impacted by continued increases in
commodity, energy, freight and other petroleum-based product costs, which have
not been offset by selling price increases, partially offset by increased sales
volume of cabinets, installation services and windows and patio doors to the new
construction market. Operating profit margins in 2004 were positively affected
by increases in sales volume of assembled cabinets, faucets, paints and stains,
vinyl and fiberglass windows and patio doors and installed sales of insulation
and non-insulation products. Operating profit margins in 2004 were negatively
impacted by increased commodity costs, which offset lower sales promotion costs.
The operating profit margins in 2003 reflect increased sales in segments that
have somewhat lower operating profit margins, increased commodity and energy
costs, as well as increased advertising and promotion costs.
INTERNATIONAL, PRINCIPALLY EUROPE
Net sales of the Company's International operations increased one percent
in 2005 compared with 2004, primarily due to increased local currency sales of
exported plumbing products and ready-to-assemble cabinets, offset in part by
declining sales of windows and other plumbing products. Net sales of the
Company's International operations increased 22 percent in 2004 compared with
2003, due to increased sales of plumbing products, ready-to-assemble cabinets
and windows. A weaker U.S. dollar had a positive effect on the translation of
European results in 2004, increasing European net sales in 2004 by 12 percent.
Operating profit margins were 11.6 percent, 11.6 percent and 8.5 percent
for the years ended December 31, 2005, 2004 and 2003, respectively. Operating
profit margins for 2005 were affected by increased commodity costs and costs
associated with certain profit improvement initiatives, as well as a less
favorable product mix. Operating profit margins for 2004 were positively
affected by increases in sales volume of plumbing products, ready-to-assemble
cabinets and windows. Operating profit margins for International operations for
2003 were adversely affected by the non-cash, pre-tax charges relating to
accounting irregularities discussed previously.
27
OTHER MATTERS
COMMITMENTS AND CONTINGENCIES
Litigation
Information regarding legal proceedings involving the Company is set forth
in Note U to the consolidated financial statements.
Other Commitments
With respect to the Company's investments in private equity funds, the
Company had, at December 31, 2005, commitments to contribute up to $95 million
of additional capital to such funds, representing the Company's aggregate
capital commitment to such funds less capital contributions made to date. The
Company is contractually obligated to make additional capital contributions to
each of its private equity funds, upon receipt of a capital call from the
private equity fund. The Company has 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 the Company's investment in the private equity
fund when paid.
During 2000, approximately 300 of the Company's key employees purchased
from the Company 8.4 million shares of Company common stock for cash totaling
$156 million under an Executive Stock Purchase Program ("Program"). The stock
was purchased at $18.50 per share, the approximate market price of the common
stock at the time of purchase. During 2005, participants in the Program settled
their remaining outstanding five-year full recourse personal loans with a bank
syndicate. The Company had guaranteed the repayment of the loans; however, all
such loans were settled with no requirement for the Company to fulfill such
guarantees.
The Company enters into contracts, which include reasonable and customary
indemnifications that are standard for the industries in which it operates. Such
indemnifications include claims made against builders by homeowners for issues
relating to the Company's products and workmanship. In conjunction with
divestitures and other transactions, the Company occasionally provides
reasonable and customary indemnifications relating to various items, including:
the enforceability of trademarks; legal and environmental issues; provisions for
sales returns; and asset valuations. The Company has never had to pay a material
amount related to these indemnifications, and evaluates the probability that
amounts may be incurred and appropriately records an estimated liability when
probable.
Warranty
Certain of the Company's 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,
the Company accrues a warranty liability for estimated costs to provide
products, parts or services to repair or replace products in satisfaction of
warranty obligations. The Company's estimate of costs to service its warranty
obligations is based on historical experience and expectations of future
conditions. To the extent that the Company experiences any changes in warranty
claim activity or costs associated with servicing those claims, its warranty
liability is adjusted accordingly. See Note U to the consolidated financial
statements for additional information.
A significant portion of the Company's 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 the Company. The Company's revenue recognition policy
takes into account this type of return when recognizing revenue, and deductions
are recorded at the time of sale.
28
CONTRACTUAL OBLIGATIONS
The following table provides payment obligations related to current
contracts at December 31, 2005, in millions:
<Table>
<Caption>
PAYMENTS DUE BY PERIOD
-----------------------------------------------
LESS THAN 2-3 4-5 MORE THAN
1 YEAR YEARS YEARS 5 YEARS TOTAL
--------- ------ ----- --------- ------
Debt (A)................................ $ 832 $1,588 $ 11 $2,344 $4,775
Operating leases........................ 110 123 64 61 358
Private equity funds (B)................ 32 32 31 - 95
Defined-benefit plans................... 38 20 25 70 153
Currently payable income taxes.......... 61 - - - 61
Interest (C)............................ 180 297 276 1,124 1,877
Post-retirement obligations............. - 1 1 4 6
Purchase commitments (D)................ 211 13 - - 224
------ ------ ---- ------ ------
Total................................. $1,464 $2,074 $408 $3,603 $7,549
====== ====== ==== ====== ======
</Table>
(A) The Company has included $876 million related to the Zero Coupon
Convertible Notes, which will be the accreted value on January 20,
2007.
(B) There is no schedule for the capital commitments to the private equity
funds; such allocation was estimated by the Company.
(C) The Company assumed that all debt would be held to maturity.
(D) Excludes contracts that do not require volume commitments or open or
pending purchase orders.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 151, "Inventory Costs," which amends Accounting Research Bulletin No.
43. SFAS No. 151 clarifies the treatment of abnormal costs as period costs
rather than as a portion of inventory costs. The adoption of SFAS No. 151 is
effective January 1, 2006, and is not expected to have a material impact on the
Company's consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections - a Replacement of APB Opinion No. 20 and SFAS No. 3." SFAS No. 154
requires retrospective application to prior periods' financial statements of a
voluntary change in accounting principle, unless it is impracticable.
Previously, most voluntary changes in accounting principle were recognized by
including the cumulative effect in net income of the period of the change. The
adoption of SFAS No. 154 is effective for accounting changes and error
corrections subsequent to December 31, 2005, and is not expected to have a
material effect on the Company's consolidated financial statements.
In March 2005, the FASB issued Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations - an Interpretation of SFAS No. 143,"
("FIN 47"). FIN 47 requires recognition of the fair value of a legal obligation
to perform asset retirement activities when the obligation is incurred,
generally upon acquisition or construction or through normal operation of the
asset. Previously, there were diverse accounting practices regarding the
recognition and timing of such obligations. The adoption of FIN 47 was effective
for the year ended December 31, 2005, and did not have a material effect on the
Company's consolidated financial statements.
29
In December 2004, the FASB issued SFAS No. 123R, "Accounting for
Stock-Based Compensation," which supersedes SFAS No. 123, SFAS No. 148 and
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees." SFAS No. 123R requires companies to measure and recognize the
cost (fair value) of employee services received in exchange for stock options.
SFAS No. 123R also clarifies and expands guidance in several areas including
measuring fair value and classification of employee stock-based compensation,
including stock options, restricted stock awards and stock appreciation rights.
The Company will adopt SFAS No. 123R effective January 1, 2006 using the
Modified Prospective Application ("MPA") method. The MPA method will require the
Company to record expense for unvested stock options that were awarded prior to
January 1, 2003 through the remaining vesting periods. The expense for unvested
stock options at January 1, 2006 will be based on the grant-date fair value of
those awards as calculated for pro forma disclosure under SFAS No. 123. Changes
to the grant-date fair value of stock options granted before January 1, 2006 are
prohibited. The MPA method does not require restatement of prior-year
information. The Company expects this additional expense to approximate $7
million pre-tax in 2006. The Company has been using the fair value method for
options granted, modified or settled subsequent to January 1, 2003. The Company
is currently evaluating the impact that the other provisions of SFAS No. 123R
will have on its consolidated financial statements.
30
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company has considered the provisions of Financial Reporting Release
No. 48, "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."
The Company is exposed to the impact of changes in interest rates and
foreign currency exchange rates in the normal course of business and to market
price fluctuations related to its marketable securities and other investments.
The Company has limited involvement with derivative financial instruments and
uses such instruments to the extent necessary to manage exposure to fluctuations
in interest rates and foreign currency fluctuations. See Note F to the
consolidated financial statements for additional information regarding the
Company's derivative instruments.
The derivatives used by the Company for the year ended December 31, 2005
consist of interest rate swap agreements entered into in 2004 for the purpose of
effectively converting a portion of fixed-rate debt to variable-rate debt. The
Company, including certain European operations, also entered into foreign
currency forward contracts to manage exposure to currency fluctuations related
primarily to the United States dollar and the Great Britain pound.
At December 31, 2005, the Company performed sensitivity analyses to assess
the potential loss in the fair values of market risk sensitive instruments
resulting from a hypothetical change of 200 basis points in average interest
rates, a 10 percent change in foreign currency exchange rates or a 10 percent
decline in the market value of the Company's long-term investments. Based on the
analyses performed, such changes would not be expected to materially affect the
Company's consolidated financial position, results of operations or cash flows.
31
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
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, 2005
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, 2005.
Management's assessment of the effectiveness of Masco Corporation's
internal control over financial reporting as of December 31, 2005 has been
audited by PricewaterhouseCoopers LLP, an independent registered public
accounting firm, as stated in their report which expressed unqualified opinions
on management's assessment and the effectiveness of Masco Corporation's internal
control over financial reporting as of December 31, 2005. Additionally,
PricewaterhouseCoopers LLP expressed an unqualified opinion on the Company's
2005 consolidated financial statements. This report appears under Item 8.
Financial Statements and Supplementary Data under the heading Report of
Independent Registered Public Accounting Firm.
32
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
of Masco Corporation:
We have completed integrated audits of Masco Corporation's 2005 and 2004
consolidated financial statements and of its internal control over financial
reporting as of December 31, 2005, and an audit of its 2003 consolidated
financial statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Our opinions, based on our audits,
are presented below.
CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
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,
2005 and 2004, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 2005 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. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit of financial statements
includes 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. We believe that our audits provide a
reasonable basis for our opinion.
INTERNAL CONTROL OVER FINANCIAL REPORTING
Also, in our opinion, management's assessment, included in Management's
Report on Internal Control Over Financial Reporting appearing under Item 8, that
the Company maintained effective internal control over financial reporting as of
December 31, 2005 based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), is fairly stated, in all material respects, based on those
criteria. Furthermore, in our opinion, the Company maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2005, based on criteria established in Internal Control - Integrated Framework
issued by the COSO. The Company's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on management's assessment and on the
effectiveness of the Company's internal control over financial reporting based
on our audit. We conducted our audit of internal control over financial
reporting in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting,
evaluating management's assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audit provides 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
33
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
March 2, 2006
34
MASCO CORPORATION AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AT DECEMBER 31, 2005 AND 2004
<Table>
<Caption>
(IN MILLIONS, EXCEPT SHARE DATA)
ASSETS
2005 2004
------- -------
Current Assets:
Cash and cash investments................................. $ 1,964 $ 1,256
Receivables............................................... 1,716 1,732
Inventories............................................... 1,127 1,132
Prepaid expenses and other................................ 316 282
------- -------
Total current assets.............................. 5,123 4,402
Property and equipment, net................................. 2,173 2,272
Goodwill.................................................... 4,171 4,408
Other intangible assets, net................................ 307 326
Assets held for sale........................................ - 163
Other assets................................................ 785 970
------- -------
Total Assets...................................... $12,559 $12,541
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Notes payable............................................. $ 832 $ 80
Accounts payable.......................................... 837 837
Accrued liabilities....................................... 1,225 1,230
------- -------
Total current liabilities......................... 2,894 2,147
Long-term debt.............................................. 3,915 4,187
Liabilities held for sale................................... - 44
Deferred income taxes and other............................. 902 740
------- -------
Total Liabilities................................. 7,711 7,118
------- -------
Commitments and contingencies
Shareholders' Equity:
Preferred shares authorized: 1,000,000; issued:
2005 - None; 2004 - None............................... - -
Common shares authorized: 1,400,000,000; issued and
outstanding:
2005 - 419,040,000; 2004 - 446,720,000................. 419 447
Paid-in capital........................................... - 642
Retained earnings......................................... 4,286 3,880
Accumulated other comprehensive income.................... 328 627
Less: Restricted stock awards............................. (185) (173)
------- -------
Total Shareholders' Equity........................ 4,848 5,423
------- -------
Total Liabilities and Shareholders' Equity........ $12,559 $12,541
======= =======
</Table>
See notes to consolidated financial statements.
35
MASCO CORPORATION AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
<Table>
<Caption>
(IN MILLIONS, EXCEPT PER COMMON SHARE DATA)
2005 2004 2003
------- ------- -------
Net sales................................................... $12,642 $11,850 $10,376
Cost of sales............................................... 9,033 8,187 7,192
------- ------- -------
Gross profit......................................... 3,609 3,663 3,184
Selling, general and administrative expenses................ 1,969 1,989 1,754
(Income) regarding litigation settlement.................... (6) (30) (72)
Goodwill impairment charge.................................. 69 112 53
------- ------- -------
Operating profit..................................... 1,577 1,592 1,449
------- ------- -------
Other income (expense), net:
Impairment charge for investments......................... (45) (21) (19)
Other, net................................................ 127 188 77
Interest expense.......................................... (247) (217) (260)
------- ------- -------
(165) (50) (202)
------- ------- -------
Income from continuing operations before income taxes
and minority interest............................. 1,412 1,542 1,247
Income taxes................................................ 518 574 465
------- ------- -------
Income from continuing operations before minority
interest.......................................... 894 968 782
Minority interest........................................... 22 19 13
------- ------- -------
Income from continuing operations.................... 872 949 769
Income (loss) from discontinued operations, net of income
taxes..................................................... 68 (56) 37
------- ------- -------
Net income........................................... $ 940 $ 893 $ 806
======= ======= =======
Earnings per common share:
Basic:
Income from continuing operations...................... $2.07 $2.13 $1.60
Income (loss) from discontinued operations, net of
income taxes......................................... .16 (.13) .08
------- ------- -------
Net income............................................. $2.23 $2.01 $1.68
======= ======= =======
Diluted:
Income from continuing operations...................... $2.03 $2.08 $1.57
Income (loss) from discontinued operations, net of
income taxes......................................... .16 (.12) .08
------- ------- -------
Net income............................................. $2.19 $1.96 $1.64
======= ======= =======
</Table>
See notes to consolidated financial statements.
36
MASCO CORPORATION AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
<Table>
<Caption>
(IN MILLIONS)
2005 2004 2003
------ ------- -------
Cash Flows From (For):
Operating Activities:
Net income............................................. $ 940 $ 893 $ 806
Depreciation and amortization.......................... 241 237 244
Deferred income taxes.................................. 75 91 179
(Gain) loss on disposition of businesses, net.......... (63) 33 (89)
Loss on early retirement of debt....................... - - 7
(Gain) on disposition of investments, net.............. (98) (92) (40)
European charges....................................... - - 54
(Income) regarding litigation settlement............... (6) (30) (72)
Impairment charges:
Investments.......................................... 45 21 19
Goodwill............................................. 69 168 142
Other items, net....................................... 162 143 135
Increase in receivables................................ (94) (114) (126)
(Increase) decrease in inventories..................... (57) (138) 39
Increase in accounts payable and accrued liabilities,
net................................................... 160 242 123
------ ------- -------
Net cash from operating activities................ 1,374 1,454 1,421
------ ------- -------
Financing Activities:
Increase in debt....................................... 33 33 46
Payment of debt........................................ (120) (73) (135)
Issuance of notes, net................................. 494 293 -
Retirement of notes.................................... - (266) (452)
Proceeds from settlement of swaps...................... - 55 -
Purchase of Company common stock....................... (986) (943) (827)
Issuance of Company common stock....................... 33 58 37
Cash dividends paid.................................... (339) (302) (286)
------ ------- -------
Net cash (for) financing activities............... (885) (1,145) (1,617)
------ ------- -------
Investing Activities:
Capital expenditures................................... (282) (310) (271)
Purchases of marketable securities..................... (155) (349) (377)
Proceeds from marketable securities.................... 301 629 421
Proceeds from disposition of:
Businesses, net of cash disposed..................... 278 172 284
Other investments, net............................... 47 50 11
Equity investment.................................... - - 75
Acquisition of businesses, net of cash acquired........ (25) (16) (239)
Other, net............................................. 22 (15) (32)
------ ------- -------
Net cash from (for) investing activities.......... 186 161 (128)
------ ------- -------
Effect of exchange rates on cash and cash investments..... (5) 29 52
------ ------- -------
Cash and Cash Investments:
Increase (decrease) for the year....................... 670 499 (272)
Cash at businesses held for sale....................... 38 (38) -
At January 1........................................... 1,256 795 1,067
------ ------- -------
At December 31......................................... $1,964 $ 1,256 $ 795
====== ======= =======
</Table>
See notes to consolidated financial statements.
37
MASCO CORPORATION AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
<Table>
<Caption>
(IN MILLIONS, EXCEPT PER SHARE DATA)
ACCUMULATED
PREFERRED COMMON OTHER RESTRICTED
SHARES SHARES PAID-IN RETAINED COMPREHENSIVE STOCK
TOTAL ($1 PAR VALUE) ($1 PAR VALUE) CAPITAL EARNINGS INCOME AWARDS
------ -------------- -------------- ------- -------- ------------- ----------
Balance, January 1, 2003............. $5,294 $ - $489 $2,207 $2,784 $ (22) $(164)
Net income........................... 806 806
Cumulative translation adjustments... 393 393
Unrealized gain on marketable
securities, net of income tax of
$31................................ 53 53
Minimum pension liability, net of
income tax credit of $1............ (3) (3)
------
Total comprehensive income......... 1,249
Shares issued........................ 64 5 59
Shares repurchased................... (779) (35) (744)
Settlement of stock-price
guarantees......................... (67) (67)
Cash dividends declared.............. (291) (291)
Stock-based compensation............. (14) (1) (12) (1)
------ ----- ---- ------ ------ ----- -----
Balance, December 31, 2003........... $5,456 $ - $458 $1,443 $3,299 $ 421 $(165)
Net income........................... 893 893
Cumulative translation adjustments... 214 214
Unrealized loss on marketable
securities, net of income tax
credit of $2....................... (3) (3)
Minimum pension liability, net of
income tax credit of $3............ (5) (5)
------
Total comprehensive income......... 1,099
Shares issued........................ 58 20 38
Shares retired:
Repurchased........................ (903) (31) (872)
Surrendered........................ (15) (15)
Cash dividends declared.............. (312) (312)
Stock-based compensation............. 40 48 (8)
------ ----- ---- ------ ------ ----- -----
Balance, December 31, 2004........... $5,423 $ - $447 $ 642 $3,880 $ 627 $(173)
Net income........................... 940 940
Cumulative translation adjustments... (251) (251)
Unrealized loss on marketable
securities, net of income tax
credit of $5....................... (10) (10)
Minimum pension liability, net of
income tax credit of $23........... (38) (38)
------
Total comprehensive income......... 641
Shares issued........................ 105 4 101
Shares retired:
Repurchased........................ (986) (31) (758) (197)
Surrendered........................ (33) (1) (32)
Cash dividends declared.............. (337) (337)
Stock-based compensation............. 35 47 (12)
------ ----- ---- ------ ------ ----- -----
Balance, December 31, 2005........... $4,848 $ - $419 $ - $4,286 $ 328 $(185)
====== ===== ==== ====== ====== ===== =====
</Table>
See notes to consolidated financial statements.
38
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. ACCOUNTING POLICIES
Principles of Consolidation. The consolidated financial statements include
the accounts of Masco Corporation and all majority-owned subsidiaries. All
significant intercompany transactions have been eliminated. In the first quarter
of 2004, the Company adopted Financial Accounting Standards Board ("FASB")
Interpretation No. 46 - Revised ("FIN 46R"), "Consolidation of Variable Interest
Entities." The Company consolidates the assets, liabilities and results of
operations of variable interest entities, for which the Company is the primary
beneficiary, in accordance with FIN 46R.
Use of Estimates and Assumptions in the Preparation of Financial
Statements. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires the Company 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 period. Actual results may differ
from these estimates and assumptions.
Revenue Recognition. The Company recognizes revenue as title to products
and risk of loss is transferred to customers or services are rendered, net of
applicable provisions for discounts, returns and allowances. The Company
generally recognizes customer program costs, including co-operative advertising
and customer incentives, as a reduction to net sales. Amounts billed for
shipping and handling are included in net sales, while costs incurred for
shipping and handling are included in cost of sales.
Foreign Currency. The financial statements of the Company's foreign
subsidiaries are measured using the local currency as the functional currency.
Assets and liabilities of these subsidiaries are translated at exchange rates as
of the balance sheet date. Revenues and expenses are translated at average
exchange rates in effect during the year. The resulting cumulative translation
adjustments have been recorded in other comprehensive income. Realized foreign
currency transaction gains and losses are included in the consolidated
statements of income.
Cash and Cash Investments. The Company considers all highly liquid
investments with an initial maturity of three months or less to be cash and cash
investments.
Receivables. The Company does significant business with a number of
individual customers, including certain home centers. The Company monitors its
exposure for credit losses and records related allowances for doubtful accounts.
Allowances are estimated based upon specific customer balances, where a risk of
default has been identified, and also include a provision for non-customer
specific defaults based upon historical collection, return and write-off
activity. A separate allowance is recorded for customer incentive rebates and is
generally based upon sales activity. Accounts and notes receivable are presented
net of certain allowances (including allowances for doubtful accounts) of $78
million and $82 million at December 31, 2005 and 2004, respectively.
Property and Equipment. Property and equipment, including significant
betterments to existing facilities, are recorded at cost. Upon retirement or
disposal, the cost and accumulated depreciation are removed from the accounts
and any gain or loss is included in the consolidated statements of income.
Maintenance and repair costs are charged against earnings as incurred.
Customer Promotion Costs. The Company records estimated reductions to
revenue for customer programs and incentive offerings, including special pricing
and co-operative advertising arrangements, promotions and other volume-based
incentives. In-store displays that are owned by the Company and used to market
the Company's products are included in other assets in the consolidated balance
sheets and are amortized over the expected useful life of three years; related
amortization expense is classified as a selling expense in the consolidated
statements of income.
39
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
A. ACCOUNTING POLICIES - (CONTINUED)
Depreciation. Depreciation expense is computed principally using the
straight-line method over the estimated useful lives of the assets. Annual
depreciation rates are as follows: buildings and land improvements, 2 to 10
percent, and machinery and equipment, 5 to 33 percent. Depreciation expense was
$209 million, $204 million and $189 million in 2005, 2004 and 2003,
respectively.
Goodwill and Other Intangible Assets. Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," requires
goodwill and other intangible assets to be tested for impairment annually and
under certain circumstances. The Company performs such testing of goodwill and
other indefinite-lived 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. The Company
compares the fair value of the reporting units to the carrying value of the
reporting units for goodwill impairment testing. Fair value is determined using
a discounted cash flow method.
The Company reviews its individual indefinite-lived intangible assets for
impairment annually and if an event occurs or circumstances change that indicate
the assets may be impaired without regard to the reporting unit. The Company
considers the implications of both external (e.g., market growth, competition
and local economic conditions) and internal (e.g., product sales, profit margins
and expected product growth) factors and their potential impact on cash flows
related to the intangible asset in both the near and long term.
Intangible assets with finite useful lives are amortized using the
straight-line method over their estimated useful lives. The Company evaluates
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.
Fair Value of Financial Instruments and Derivative Instruments. The
carrying value of financial instruments reported in the consolidated balance
sheets for current assets, current liabilities and long-term variable-rate debt
approximates fair value. The fair value of financial instruments that are
carried as non-current investments is based principally on information from
investment fund managers and other assumptions, on quoted market prices for
those or similar investments, by estimating the fair value of consideration to
be received or by discounting future cash flows using a discount rate that
reflects the risk of the underlying investments. The fair value of the Company's
long-term fixed-rate debt instruments is based principally on quoted market
prices for the same or similar issues or the current rates available to the
Company for debt with similar terms and remaining maturities. The aggregate
market value of non-current investments and long-term debt at December 31, 2005
was approximately $567 million and $3,654 million, compared with the aggregate
carrying value of $586 million and $3,915 million, respectively. At December 31,
2004 such aggregate market value was approximately $794 million and $4,026
million, compared with the aggregate carrying value of $785 million and $4,187
million, respectively.
The Company uses derivative financial instruments to manage exposure to
fluctuations in earnings and cash flows resulting from changes in foreign
currency exchange rates and interest rates. Derivative financial instruments are
recorded in the consolidated balance sheets as either an asset or liability
measured at fair value. For each derivative instrument that is designated and
qualifies as a fair-value hedge, the gain or loss on the derivative instrument,
as well as the offsetting loss or gain on the hedged item attributable to the
hedged risk, are recognized in determining current earnings during the period of
the change in fair values. For derivative instruments not designated as hedging
instruments, the gain or loss is recognized in determining current earnings
during the period of change.
40
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
A. ACCOUNTING POLICIES - (CONTINUED)
Stock Options and Awards. The Company elected to change its method of
accounting for stock-based compensation and implemented the fair value method
prescribed by SFAS No. 123, "Accounting for Stock-Based Compensation," effective
January 1, 2003. The Company is using the prospective method, as defined by SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure - an amendment to SFAS No. 123," for determining stock-based
compensation expense. Accordingly, options granted, modified or settled
subsequent to January 1, 2003 are accounted for using the fair value method, and
options granted prior to January 1, 2003 continue to be accounted for using the
intrinsic value method.
In December 2004, the FASB issued SFAS No. 123R, "Accounting for
Stock-Based Compensation," which supersedes SFAS No. 123, SFAS No. 148 and
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees." SFAS No. 123R requires companies to measure and recognize the
cost (fair value) of employee services received in exchange for stock options.
SFAS No. 123R also clarifies and expands guidance in several areas including
measuring fair value and classification of employee stock-based compensation,
including stock options, restricted stock awards and stock appreciation rights.
The Company will adopt SFAS No. 123R effective January 1, 2006 using the
Modified Prospective Application ("MPA") method. The MPA method will require the
Company to record expense for unvested stock options that were awarded prior to
January 1, 2003 through the remaining vesting periods. The expense for unvested
stock options at January 1, 2006 will be based on the grant-date fair value of
those awards as calculated for pro forma disclosure under SFAS No. 123. Changes
to the grant-date fair value of stock options granted before January 1, 2006 are
prohibited. The MPA method does not require the restatement of prior-year
information. This additional expense is expected to approximate $7 million
pre-tax in 2006. The Company is currently evaluating the impact that the other
provisions of SFAS No. 123R will have on its consolidated financial statements.
In 2005, 2004 and 2003, 4,363,600, 5,627,000 and 5,121,800 option shares,
respectively, including restoration option shares, net of cancellations, were
awarded and the related expense of $29 million, $21 million and $3 million was
included in the Company's consolidated statements of income for the years ended
December 31, 2005, 2004 and 2003 (the first year that such expense was
recorded), respectively. The following table illustrates the pro forma effect on
net income and earnings per
41
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
A. ACCOUNTING POLICIES - (CONTINUED)
common share as if the fair value method were applied to all previously issued
stock options, in millions, except per common share amounts:
<Table>
<Caption>
2005 2004 2003
----- ----- -----
Net income, as reported................................. $ 940 $ 893 $ 806
Add:
Stock-based employee compensation expense included in
reported net income, net of tax.................... 47 48 41
Deduct:
Stock-based employee compensation expense, net of
tax................................................ (47) (48) (41)
Stock-based employee compensation expense determined
under the fair value method for stock options
granted prior to 2003, net of tax.................. (7) (12) (12)
----- ----- -----
Pro forma net income.................................... $ 933 $ 881 $ 794
===== ===== =====
Earnings per common share:
Basic as reported..................................... $2.23 $2.01 $1.68
Basic pro forma....................................... $2.21 $1.98 $1.66
Diluted as reported................................... $2.19 $1.96 $1.64
Diluted pro forma..................................... $2.17 $1.93 $1.62
</Table>
For SFAS No. 123R calculation purposes, the weighted average grant date
fair values of option shares, including restoration options, granted in 2005,
2004 and 2003, were $10.33, $10.36 and $8.89, respectively. The fair values of
these options were estimated at the grant dates using a Black-Scholes option
pricing model with the following assumptions for 2005, 2004 and 2003,
respectively: risk-free interest rate - 4.1%, 4.4% and 3.3%; dividend
yield - 2.3%, 2.1% and 2.3%; volatility factor - 35.8%, 37.0% and 37.0%; and
expected option life - 7 years, 6 years and 7 years.
Reclassifications. Certain prior-year amounts have been reclassified to
conform to the 2005 presentation in the consolidated financial statements. The
results of operations related to 2005, 2004 and 2003 dispositions of businesses
have been reclassified and separately stated in the accompanying consolidated
statements of income for 2005, 2004 and 2003. In the Company's consolidated
statements of cash flows, the cash flows from discontinued operations are not
separately classified.
Other Recently Issued Accounting Pronouncements. In November 2004, the FASB
issued SFAS No. 151, "Inventory Costs," which amends Accounting Research
Bulletin No. 43. SFAS No. 151 clarifies the treatment of abnormal costs as
period costs rather than as a portion of inventory costs. The adoption of SFAS
No. 151 is effective January 1, 2006, and is not expected to have a material
impact on the Company's consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections - a Replacement of APB Opinion No. 20 and SFAS No. 3." SFAS No. 154
requires retrospective application to prior periods' financial statements of a
voluntary change in accounting principle, unless it is impracticable.
Previously, most voluntary changes in accounting principle were recognized by
including the cumulative effect in net income of the period of the change. The
adoption of SFAS No. 154 is effective for accounting changes and error
corrections subsequent to December 31, 2005, and is not expected to have a
material effect on the Company's consolidated financial statements.
In March 2005, the FASB issued Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations - an Interpretation of SFAS No. 143,"
("FIN 47"). FIN 47 requires recognition of the
42
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
A. ACCOUNTING POLICIES - (CONCLUDED)
fair value of a legal obligation to perform asset retirement activities when the
obligation is incurred, generally upon acquisition or construction or through
normal operation of the asset. Previously, there were diverse accounting
practices regarding the recognition and timing of such obligations. The adoption
of FIN 47 was effective for the year ended December 31, 2005, and did not have a
material effect on the Company's consolidated financial statements.
B. DISCONTINUED OPERATIONS
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," addresses the accounting and reporting for the impairment or disposal
of long-lived assets. SFAS No. 144 broadens the presentation of discontinued
operations to include a component of the Company, which comprises operations and
cash flows, that can be clearly distinguished from the rest of the Company. In
accordance with SFAS No. 144, the Company has accounted for the businesses held
for sale at December 31, 2004, as well as other businesses which were sold in
2005, 2004 and 2003, as discontinued operations.
In 2003, the Company completed the sale of its Baldwin Hardware, Weiser
Lock and Marvel Group businesses. Total gross proceeds from the sale of these
companies were $289 million; the Company recognized a pre-tax net gain on the
disposition of these businesses of $89 million.
In 2004, the Company determined that several European businesses were not
core to the Company's long-term growth strategy and, accordingly, embarked on a
plan of disposition (the "2004 Plan"). The discontinued operations were
previously included in each of the Company's segments, except the Installation
and Other Services segment. In 2004, the Company reduced its estimate of
expected proceeds and recognized pre-tax charges of $139 million ($151 million
including tax effect) for those businesses that were expected to be divested at
a loss. Any gains resulting from the dispositions were recognized when the
transactions were completed. During 2004, in separate transactions, the Company
completed the sale of its Jung Pumpen, The Alvic Group, Alma Kuchen, E. Missel
and SKS Group businesses in Europe. Total gross proceeds from the sale of these
companies were $199 million, including cash of $193 million and notes receivable
of $6 million. The Company recognized a pre-tax net gain (principally related to
the sale of Jung Pumpen) on the disposition of these businesses of $106 million.
During 2005, in separate transactions, the Company disposed of its Gebhardt
Consolidated and GMU Group businesses in Europe as part of the Company's 2004
Plan. Gebhardt Consolidated supplies ventilation products and GMU Group
manufactures cabinets. Total gross proceeds from the sale of Gebhardt
Consolidated and GMU Group were $130 million; the Company recognized a pre-tax
net gain (principally related to the sale of Gebhardt Consolidated) on the
disposition of these businesses of $9 million. Net proceeds from the disposition
of businesses completed in 2005 and 2004, pursuant to the Company's 2004 Plan,
aggregated $280 million.
During 2005, the Company recorded as income from discontinued operations,
approximately $3 million related to the reversal of severance and termination
accruals that were recorded in 2004 as part of the 2004 Plan. The Company also
recorded income of approximately $4 million (included in gain on disposal of
discontinued operations, net) related to the reversal of expected fee and
expense accruals that were recorded in 2004 as part of the 2004 Plan. The
Company does not expect to incur any additional severance costs or fees and
expenses related to the 2004 Plan.
Also during 2005, in separate transactions, the Company completed the
disposition of Zenith Products and Aran Group; such dispositions were completed
pursuant to the Company's determination that these business units were not core
to the Company's long-term cabinet platform strategy. Zenith Products
manufactures bathroom storage and organization products for the North American
43
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
B. DISCONTINUED OPERATIONS - (CONCLUDED)
retail market and Aran Group is a European manufacturer of assembled and
ready-to-assemble kitchen cabinets; both business units were in the Cabinets and
Related Products segment. Total gross proceeds from the sale of Zenith Products
and Aran Group were $189 million; the Company recognized a pre-tax net gain
(principally related to the sale of Zenith Products) on the disposition of these
businesses of $50 million.
Gains from the 2005, 2004 and 2003 dispositions are included in income
(loss) from discontinued operations in the consolidated statements of income.
Selected financial information for the 2005, 2004 and 2003 discontinued
operations, during the period owned by the Company, was as follows for the years
ended December 31, 2005, 2004 and 2003, in millions:
<Table>
<Caption>
2005 2004 2003
---- ----- ----
Net sales................................................... $242 $ 581 $758
==== ===== ====
Income (loss) from discontinued operations.................. $ 39 $ 5 $(10)
Gain on disposal of discontinued operations, net............ 63 106 89
Impairment of assets held for sale.......................... - (139) -
---- ----- ----
Income (loss) before income taxes........................... 102 (28) 79
Income tax.................................................. (34) (28) (42)
---- ----- ----
Income (loss) from discontinued operations, net of income
taxes.................................................. $ 68 $ (56) $ 37
==== ===== ====
</Table>
The $63 million gain in 2005 on disposal of discontinued operations, net,
is principally related to the businesses sold in the fourth quarter of 2005;
such businesses were not included in the 2004 Plan or the impairment of assets
held for sale in 2004.
Included in income tax above is income tax related to income (loss) from
discontinued operations of $11 million, $4 million and $5 million in 2005, 2004,
and 2003, respectively. Income (loss) before income taxes above includes
non-cash, pre-tax goodwill impairment charges of $56 million and $89 million for
the years ended December 31, 2004 and 2003, respectively.
The unusual relationship between income tax and (loss) before income taxes
in 2004 (including the impairment charge for assets held for sale and the net
gain on disposals) resulted primarily from the expected loss providing no
current tax benefit and from the reversal of deferred tax assets of the
discontinued operations which were no longer expected to be realized.
C. ACQUISITIONS
During 2005, 2004, and 2003, the Company acquired several relatively small
businesses (primarily in the Installation and Other Services segment). The
results of these acquisitions are included in the consolidated financial
statements from the respective dates of acquisition. The aggregate net purchase
44
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
C. ACQUISITIONS - (CONCLUDED)
price of these acquisitions was as follows for the years ended December 31,
2005, 2004 and 2003, in millions:
<Table>
<Caption>
2005 2004 2003
---- ---- ----
Cash, net................................................... $10 $ 8 $57
Assumed debt................................................ 2 2 6
--- --- ---
Total net purchase price............................... $12 $10 $63
=== === ===
</Table>
Certain purchase agreements provided for the payment of additional
consideration in either cash or Company common stock, contingent upon whether
certain conditions were met, including the operating performance of the acquired
business and the price of the Company's common stock. At December 31, 2005,
there were no outstanding contingent purchase price commitments or stock price
guarantees. The Company paid an additional $15 million, $31 million (including
$8 million in cash) and $182 million of acquisition-related consideration,
including amounts to satisfy share price guarantees, contingent consideration
and other purchase price adjustments in 2005, 2004 and 2003, respectively,
relating to previously acquired companies. Common shares that were contingently
issuable at December 31, 2004 and 2003 were included in the computation of
diluted earnings per common share for 2004 and 2003, respectively.
D. INVENTORIES
<Table>
<Caption>
(IN MILLIONS)
AT DECEMBER 31
----------------
2005 2004
------ ------
Finished goods.............................................. $ 525 $ 577
Raw material................................................ 427 406
Work in process............................................. 175 149
------ ------
Total.................................................. $1,127 $1,132
====== ======
</Table>
Inventories which include purchased parts, materials, direct labor and
applied manufacturing overhead, are stated at the lower of cost or net
realizable value, with cost determined principally by use of the first-in,
first-out method.
E. INVESTMENTS
FINANCIAL INVESTMENTS
The Company has maintained investments in marketable securities and a
number of private equity funds, principally as part of its tax planning
strategies, as any gains enhance the utilization of
45
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
E. INVESTMENTS - (CONTINUED)
any current and future tax capital losses. Included in other assets were the
following financial investments, in millions:
<Table>
<Caption>
AT DECEMBER 31
--------------
2005 2004
---- ----
Marketable securities:
Furniture Brands International............................ $ 90 $100
Other..................................................... 25 163
Private equity funds........................................ 262 308
Metaldyne Corporation....................................... 94 84
TriMas Corporation.......................................... 46 46
Other investments........................................... 12 9
---- ----
Total.................................................. $529 $710
==== ====
</Table>
Investments in marketable securities are accounted for as
available-for-sale. Accordingly, the Company records these investments at fair
value, and unrealized gains and losses (that are deemed to be temporary) are
recognized, net of tax effect, through shareholders' equity, as a component of
other comprehensive income. Realized gains and losses and charges for
other-than-temporary impairments are included in determining net income, with
related purchase costs based on specific identification.
The Company had investments in 20 different marketable securities at
December 31, 2005. The Company reviews industry analyst reports, key ratios and
statistics, market analyses and other factors for each investment to determine
if an unrealized loss is other-than-temporary. Based on this review, in the
third quarter of 2005, the Company recognized an impairment charge of $28
million related to its investment in four million shares of Furniture Brands
International (NYSE: FBN) common stock to reduce the cost basis from $25.05 per
share to the market value at September 30, 2005 of $18.03 per share. In 2004,
the Company also recognized an impairment charge of $21 million related to the
Company's investment in FBN. At December 31, 2005, the FBN common stock was in
an unrealized gain position; the aggregate carrying value of the investment was
$90 million. The FBN common stock, included in marketable securities, was
received in June 2002 from the Company's investment in Furnishings International
Inc. debt.
The Company's investments in private equity funds and other private
investments are carried at cost and are evaluated for impairment at each
reporting period, or when circumstances, including the maturity of the fund,
indicate impairment may exist. 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. 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 and the amounts realized upon liquidation. Based on
the Company's review of its private equity funds, the Company considered the
decline in the estimated market value of certain of its private equity fund
investments to be other-than-temporary and, accordingly, recognized an
impairment charge of $15 million in the third quarter of 2005. At December 31,
2005, the carrying value of the Company's investments in private equity funds
exceeded the estimated market value, as determined by the fund managers, by
approximately $19 million, which the Company considers to be a temporary decline
in estimated fair value.
In November 2000, the Company reduced its common equity ownership in
Metaldyne Corporation (formerly MascoTech, Inc.) through a recapitalization
merger with an affiliate of Heartland Indus-
46
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
E. INVESTMENTS - (CONCLUDED)
trial Partners, L.P., a private equity fund in which the Company has invested
$47 million (representing less than five percent of the fund). The Company
currently owns six percent of the common equity of Metaldyne. The Company also
holds preferred stock of Metaldyne, which accrues dividends at the rate of 15
percent per year. In June 2002, Metaldyne sold approximately 66 percent of the
fully diluted common equity of its TriMas Corporation subsidiary to Heartland
Industrial Partners, L.P. The Company exercised its right to its proportionate
share and acquired approximately six percent of TriMas Corporation common stock
for $25 million. In November 2004, the Company acquired an additional investment
in TriMas common stock from Metaldyne for an aggregate cost of $21 million. The
Company had an approximate 10 percent ownership in TriMas Corporation common
stock at December 31, 2005 and 2004. Metaldyne is an automotive supplier and
TriMas is a diversified manufacturer with a significant portion of its business
associated with transportation products. The economic environment for businesses
associated with the automotive and transportation industries is challenging and
impacted by rising commodity and energy costs and customer resistance to price
increases to offset such cost increases.
The Company's investments in marketable securities were as follows, in
millions:
<Table>
<Caption>
PRE-TAX
------------------------
UNREALIZED UNREALIZED RECORDED
COST BASIS GAINS LOSSES BASIS
---------- ---------- ---------- --------
December 31, 2005.................... $ 94 $21 $ - $115
December 31, 2004.................... $227 $36 $ - $263
</Table>
Income from financial investments, net, included in other, net, within
other income (expense), net, was as follows, in millions:
<Table>
<Caption>
2005 2004 2003
---- ---- ----
Realized gains from marketable securities................. $ 39 $ 70 $ 38
Realized losses from marketable securities................ (9) (20) (15)
Dividend income from marketable securities................ 4 14 16
Income from other investments, net........................ 68 42 17
Dividend income from other investments.................... 12 13 9
---- ---- ----
Income from financial investments, net............... $114 $119 $ 65
==== ==== ====
Impairment charge:
Marketable securities................................... $(30) $(21) $ (3)
Private equity funds.................................... (15) -- (16)
---- ---- ----
Total impairment charge.............................. $(45) $(21) $(19)
==== ==== ====
</Table>
EQUITY INVESTMENTS
In 2003, the Company completed the sale of its 42 percent equity investment
in Emco Limited, a Canadian distributor of plumbing and related products with
approximate 2002 sales of $860 million, for cash proceeds of $75 million. The
sale resulted in a pre-tax gain of $5 million.
F. DERIVATIVES
During 2003, the Company entered into interest rate swap agreements for the
purpose of effectively converting a portion of fixed-rate debt to variable-rate
debt. In 2004, the Company terminated two interest rate swaps relating to $850
million of fixed-rate debt. These swap agreements were
47
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
F. DERIVATIVES - (CONCLUDED)
accounted for as fair value hedges. The gain of approximately $45 million from
the termination of these swaps is being amortized as a reduction of interest
expense over the remaining term of the debt, through July 2012.
In early 2004, the Company entered into new interest rate swap agreements
for the purpose of effectively converting a portion of fixed-rate debt to
variable-rate debt. The derivative contracts are with two major creditworthy
institutions, thereby minimizing the risk of credit loss. The interest rate swap
agreements are designated as a fair-value hedge, and the interest rate
differential on interest rate swaps used to hedge existing debt is recognized as
an adjustment to interest expense over the term of the agreement. The average
variable interest rates are based on LIBOR plus a fixed adjustment factor. The
average effective rate on the interest rate swaps was 5.519% in 2005. At
December 31, 2005, the interest rate swap agreements covered a notional amount
of $850 million of the Company's fixed-rate debt due July 15, 2012 with an
interest rate of 5.875%. The hedges are considered 100 percent effective;
therefore, the fair value of $43 million and $24 million was recorded in
long-term debt with a corresponding increase to other assets in the Company's
consolidated balance sheets at December 31, 2005 and 2004, respectively.
The amount recognized as a reduction of interest expense was $3 million,
$22 million and $3 million for the years ended December 31, 2005, 2004 and 2003,
respectively.
At December 31, 2005, the Company, including certain European operations,
had entered into foreign currency forward contracts with notional amounts of $12
million, $10 million and $4 million to manage exposure to currency fluctuations
in the United States dollar, Great Britain pound and various other currencies,
respectively. At December 31, 2004, certain of the Company's European operations
had entered into foreign currency forward contracts with notional amounts of $24
million, $29 million and $1 million to manage exposure to currency fluctuations
in the United States dollar, Great Britain pound and various other currencies,
respectively. Based on year-end market prices, no asset or liability was
recorded at December 31, 2005 and 2004, as the forward price is substantially
the same as the contract price. The counterparties to the Company's forward
contracts are major financial institutions. In the unlikely event that the
counterparties fail to meet the terms of a foreign currency forward contract,
the Company's exposure is limited to the foreign currency rate differential.
G. PROPERTY AND EQUIPMENT
<Table>
<Caption>
(IN MILLIONS)
AT DECEMBER 31
---------------
2005 2004
------ ------
Land and improvements....................................... $ 188 $ 191
Buildings................................................... 974 980
Machinery and equipment..................................... 2,356 2,364
------ ------
3,518 3,535
Less: Accumulated depreciation.............................. 1,345 1,263
------ ------
Total.................................................. $2,173 $2,272
====== ======
</Table>
The Company leases certain equipment and plant facilities under
noncancellable operating leases. Rental expense related to these leases,
recorded in the consolidated statements of income, totaled approximately $146
million, $142 million and $122 million during 2005, 2004 and 2003, respectively.
Future minimum lease payments at December 31, 2005 were approximately as
follows: 2006 - $110 million; 2007 - $74 million; 2008 - $49 million; 2009 - $33
million; and 2010 and beyond - $92 million.
48
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
G. PROPERTY AND EQUIPMENT - (CONCLUDED)
The Company leases operating facilities from certain related parties,
primarily former owners (and in certain cases, current management personnel) of
companies acquired. The Company recorded approximately $12 million and $13
million of rental expense paid in 2005 and 2004, respectively, to such related
parties.
H. GOODWILL AND OTHER INTANGIBLE ASSETS
The changes in the carrying amount of goodwill for the years ended December
31, 2005 and 2004, by segment, are as follows, in millions:
<Table>
<Caption>
BALANCE PRE-TAX BALANCE
DEC. 31, DISCONTINUED IMPAIRMENT DEC. 31,
2004 ADDITIONS (A) OPERATIONS (B) CHARGE OTHER (C) 2005
-------- ------------- -------------- ---------- --------- --------
Cabinets and Related Products...... $ 644 $ 2 $(39) $ - $ (60) $ 547
Plumbing Products.................. 514 - - (7) (46) 461
Installation and Other Services.... 1,710 8 - - - 1,718
Decorative Architectural
Products......................... 344 - - (26) (7) 311
Other Specialty Products........... 1,196 12 - (36) (38) 1,134
------ --- ---- ----- ----- ------
Total............................ $4,408 $22 $(39) $ (69) $(151) $4,171
====== === ==== ===== ===== ======
</Table>
<Table>
<Caption>
BALANCE PRE-TAX BALANCE
DEC. 31, DISCONTINUED IMPAIRMENT DEC. 31,
2003 ADDITIONS (A) OPERATIONS (B) CHARGE OTHER (C) 2004
-------- ------------- -------------- ---------- --------- --------
Cabinets and Related Products...... $ 708 $ 7 $(64) $ (56) $ 49 $ 644
Plumbing Products.................. 498 8 - (25) 33 514
Installation and Other Services.... 1,701 10 - - (1) 1,710
Decorative Architectural
Products......................... 398 - - (62) 8 344
Other Specialty Products........... 1,186 8 (4) (25) 31 1,196
------ --- ---- ----- ----- ------
Total............................ $4,491 $33 $(68) $(168) $ 120 $4,408
====== === ==== ===== ===== ======
</Table>
(A) Additions include acquisitions and contingent consideration for prior
acquisitions of $7 million and $15 million, respectively, for 2005 and $8
million and $25 million, respectively, for 2004.
(B) During 2005, the Company completed the disposition of two business units
that were not previously classified as discontinued operations. During 2004,
the Company reclassified the goodwill related to European businesses held as
discontinued operations. The Company also recognized charges in 2004 for
those businesses expected to be divested at a loss; the charges included a
write-down of goodwill of $64 million.
(C) Other includes principally foreign currency translation adjustments and
reclassifications and purchase price adjustments related to the finalization
of certain purchase price allocations.
The Company completed its annual impairment testing of goodwill and other
indefinite-lived intangible assets in the fourth quarters of 2005 and 2004. This
test indicated that other indefinite-lived intangible assets were not impaired;
however, goodwill recorded for certain of the Company's European businesses was
impaired, principally due to the continuing weakness in certain European
markets. The Company recognized the related non-cash, pre-tax impairment charge
for continuing operations of $69 million ($69 million, after tax) and $112
million ($104 million, after tax) for the years ended December 31, 2005 and
2004, respectively.
49
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
H. GOODWILL AND OTHER INTANGIBLE ASSETS - (CONCLUDED)
Other indefinite-lived intangible assets of $254 million at December 31,
2005 and $255 million at December 31, 2004 primarily include registered
trademarks. The carrying value of the Company's definite-lived intangible assets
was $53 million at December 31, 2005 (net of accumulated amortization of $58
million) and $71 million at December 31, 2004 (net of accumulated amortization
of $65 million) and principally includes customer relationships and non-compete
agreements, with a weighted average amortization period of 12 years in 2005 and
10 years in 2004. Amortization expense related to the definite-lived intangible
assets was $22 million, $20 million and $25 million in 2005, 2004 and 2003,
respectively.
At December 31, 2005, amortization expense related to the definite-lived
intangible assets during each of the next five years was approximately as
follows: 2006 - $10 million; 2007 - $7 million; 2008 - $7 million; 2009 - $6
million; and 2010 - $5 million.
I. OTHER ASSETS
<Table>
<Caption>
(IN MILLIONS)
AT DECEMBER 31
--------------
2005 2004
----- -----
Financial investments (Note E).............................. $529 $710
In-store displays........................................... 81 95
Prepaid benefit cost (Note O)............................... 43 44
Debenture expense........................................... 25 24
Notes receivable............................................ 14 16
Other....................................................... 93 81
---- ----
Total..................................................... $785 $970
==== ====
</Table>
J. ACCRUED LIABILITIES
<Table>
<Caption>
(IN MILLIONS)
AT DECEMBER 31
---------------
2005 2004
------ ------
Employee retirement plans................................... $ 216 $ 223
Salaries, wages and commissions............................. 201 209
Insurance................................................... 194 183
Advertising and sales promotion............................. 140 136
Warranty (Note U)........................................... 105 100
Dividends payable........................................... 83 81
Interest.................................................... 74 73
Income taxes................................................ 61 59
Property, payroll and other taxes........................... 57 64
Litigation.................................................. 10 22
Other....................................................... 84 80
------ ------
Total..................................................... $1,225 $1,230
====== ======
</Table>
50
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
K. DEBT
<Table>
<Caption>
(IN MILLIONS)
AT DECEMBER 31
---------------
2005 2004
------ ------
Notes and debentures:
6.75 %, due Mar. 15, 2006................................. $ 800 $ 800
4.625%, due Aug. 15, 2007................................. 300 300
5.75 %, due Oct. 15, 2008................................. 100 100
5.875%, due July 15, 2012................................. 850 850
7.125%, due Aug. 15, 2013................................. 200 200
4.8 %, due June 15, 2015................................. 500 -
6.625%, due Apr. 15, 2018................................. 114 114
7.75 %, due Aug. 1, 2029.................................. 296 296
6.5 %, due Aug. 15, 2032................................. 300 300
Zero Coupon Convertible Senior Notes due 2031 (accreted
value)................................................. 848 823
Floating-Rate Notes, due 2007............................. 300 300
Notes payable to banks.................................... - -
Other..................................................... 139 184
------ ------
4,747 4,267
Less: Current portion....................................... 832 80
------ ------
Total Long-term debt................................... $3,915 $4,187
====== ======
</Table>
All of the notes and debentures above are senior indebtedness and, other
than bank notes, the 6.625% notes due 2018 and the 7.75% notes due 2029, are
redeemable at the Company's option.
On June 10, 2005, the Company issued $500 million of fixed-rate 4.8% notes
due 2015, resulting in net proceeds of $494 million. The Company reclassified
$800 million of 6.75% notes due March 2006 to current liabilities; the Company
intends to use a portion of its cash to retire this debt.
On March 9, 2004, the Company issued $300 million of floating-rate notes
due 2007, resulting in net proceeds of $299 million. The interest rate is
calculated based on the three-month LIBOR plus .25%; such rate averaged 3.6% and
1.8% for the years ended December 31, 2005 and 2004, respectively. During 2004,
the Company retired the remaining $266 million of 6% notes due May 2004.
In July 2001, the Company issued $1.9 billion principal amount at maturity
of Zero Coupon Convertible Senior Notes due 2031 ("Old Notes"), resulting in
gross proceeds of $750 million. The issue price per Note was $394.45 per $1,000
principal amount at maturity, which represented a yield to maturity of 3.125%
compounded semi-annually. In December 2004, the Company completed an exchange of
the outstanding Old Notes for Zero Coupon Convertible Senior Notes Series B due
July 2031 ("New Notes" or "Notes"). The Company exchanged the Notes as a result
of EITF No. 04-08 that would have required the total number of shares underlying
the Old Notes to be included in the calculation of diluted earnings per common
share, whether or not the Old Notes were convertible according to their terms.
The issue price of the New Notes was the equivalent of the accreted value of the
Old Notes on the date of the exchange, or $438.54 per $1,000 principal amount at
maturity, which continues to represent a yield to maturity of 3.125% compounded
semi-annually. In addition, in consideration for exchanging the Old Notes,
holders of the New Notes received an exchange fee of
51
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
K. DEBT - (CONTINUED)
$1.25 per $1,000 principal amount at maturity of the New Notes, which
approximated $2 million and was expensed through the following put date of
January 20, 2005.
From July 2002 through December 31, 2005, holders of $27.2 million and $1.6
million principal amount at maturity of Old Notes and New Notes, respectively,
exercised their right to require the Company to repurchase such Notes for $11.1
million cash and $.7 million cash, respectively, the accreted value of the Notes
on the date of exercise. During 2005, the Company repurchased $.8 million
principal amount at maturity of Old Notes for cash of $.4 million, the accreted
value of such Notes on the date of repurchase. At December 31, 2005, over 99
percent of the outstanding Notes were New Notes.
The New Notes have substantially the same terms as the Old Notes, except
for the form of consideration payable upon conversion. Upon conversion of the
Old Notes, the Company would have delivered shares of its common stock at the
applicable conversion rate. Upon conversion of the New Notes, the Company will
pay the principal return, equal to the lesser of (1) the accreted value of the
Notes in only cash, and (2) the conversion value, as defined, which will be
settled in cash or shares of Company common stock, or a combination of both, at
the option of the Company. Similar to the Old Notes, the New Notes are
convertible if the average price of Company common stock for the 20 days
immediately prior to the conversion date exceeds 118 2/3, declining by 1/3% each
year thereafter, of the accreted value of the New Notes ($452.82 per $1,000
principal amount at maturity as of December 31, 2005) divided by the conversion
rate of 12.7317 shares for each $1,000 principal amount at maturity of the New
Notes or $42.21 per common share at December 31, 2005. The New Notes, similar to
the Old Notes, also become convertible if the Company's credit rating is reduced
to below investment grade, or if certain actions are taken by the Company.
Similar to the Old Notes, the Company will not pay interest in cash on the
Notes prior to maturity except in certain circumstances, including possible
contingent interest payments that are not expected to be material. Similar to
the Old Notes, holders of the New Notes have the option to require that the New
Notes be repurchased by the Company on January 20, 2007; July 20, 2011; and
every five years thereafter.
Until January 25, 2007, the Company may redeem all, but not part, of the
Notes at their accreted value, only if the closing price for the Company's
common stock on the New York Stock Exchange exceeds the conversion price of the
Notes by 130% for a specified period of time. The Company may, at any time on or
after January 25, 2007, redeem all or part of the Notes at their accreted value.
At December 31, 2005, the Company had a $2.0 billion 5-Year Revolving
Credit Agreement with a group of banks syndicated in the United States, which
expires in November 2009. This agreement allows for borrowings denominated in
U.S. dollars or European euros with interest payable based on various
floating-rate options as selected by the Company. There were no borrowings under
the 5-Year Revolving Credit Agreement at December 31, 2005 and 2004.
In February 2006, the Company amended the terms of the $2.0 billion 5-Year
Revolving Credit Agreement; the amendment primarily affected the requirement for
the Company to maintain certain levels of net worth.
The 5-Year Revolving Credit Agreement, as amended, contains limitations on
additional borrowings; at December 31, 2005, the Company had additional
borrowing capacity, subject to availability, of up to $2.5 billion. The 5-Year
Revolving Credit Agreement, as amended, also contains a requirement for
maintaining a certain level of net worth; at December 31, 2005, the Company's
net worth exceeded such requirement by $842 million.
52
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
K. DEBT - (CONCLUDED)
At December 31, 2005, the maturities of long-term debt during each of the
next five years were approximately as follows: 2006 - $832 million;
2007 - $1,483 million (including $876 million related to the Zero Coupon
Convertible Notes, the accreted value at the next put option date of January 20,
2007); 2008 - $105 million; 2009 - $10 million; and 2010 - $1 million.
At December 31, 2005, the amount of debt and equity securities issuable
under the Company's unallocated shelf registration statement with the Securities
and Exchange Commission was $1.5 billion.
Interest paid was $246 million, $219 million and $282 million in 2005, 2004
and 2003, respectively.
L. MINORITY INTEREST
The Company owns 64 percent of Hansgrohe AG. The aggregate minority
interest, net of dividends, of $89 million and $80 million at December 31, 2005
and 2004, respectively, is recorded in deferred income taxes and other
liabilities on the Company's consolidated balance sheets.
M. SHAREHOLDERS' EQUITY
In March 2005, the Company's Board of Directors authorized the repurchase
of up to 50 million shares for retirement of the Company's common stock in
open-market transactions or otherwise, replacing a previous Board of Directors
authorization established in 2003. At December 31, 2005, the Company had
remaining authorization to repurchase up to 29 million shares of its common
stock in open-market transactions or otherwise. Approximately 31 million common
shares in both 2005 and 2004, and 35 million common shares in 2003 were
repurchased and retired for cash aggregating $986 million, $903 million and $779
million in 2005, 2004 and 2003, respectively.
On the basis of amounts paid (declared), cash dividends per common share
were $.78 ($.80) in 2005, $.66 ($.68) in 2004 and $.58 ($.60) in 2003,
respectively. In 2005, the Company increased its quarterly cash dividend by 11
percent to $.20 per common share from $.18 per common share.
In 1995, the Company's Board of Directors announced the approval of a
Shareholder Rights Plan. The Rights were designed to enhance the Board's ability
to protect the Company's shareholders against, among other things, unsolicited
attempts to acquire control of the Company that do not offer an adequate price
to all shareholders or are otherwise not in the best interests of the
shareholders. The Rights were issued to shareholders of record in December 1995
and expired in December 2005.
ACCUMULATED OTHER COMPREHENSIVE INCOME
The Company's total comprehensive income was as follows for the years ended
December 31, 2005, 2004 and 2003, in millions:
<Table>
<Caption>
2005 2004 2003
----- ------ ------
Net income.................................................. $ 940 $ 893 $ 806
Other comprehensive income (loss):
Cumulative translation adjustments, net................... (251) 214 393
Unrealized (loss) gain on marketable securities, net...... (10) (3) 53
Minimum pension liability, net............................ (38) (5) (3)
----- ------ ------
Total comprehensive income............................. $ 641 $1,099 $1,249
===== ====== ======
</Table>
The unrealized (loss) gain, net, on marketable securities is net of income
tax (credit) of $(5) million, $(2) million and $31 million for 2005, 2004 and
2003, respectively. The minimum pension liability, net is
53
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
M. SHAREHOLDERS' EQUITY - (CONCLUDED)
net of income tax (credit) of $(23) million, $(3) million and $(1) million for
2005, 2004 and 2003, respectively.
The components of accumulated other comprehensive income were as follows,
in millions:
<Table>
<Caption>
AT
DECEMBER 31
----------------
2005 2004
------ ------
Cumulative translation adjustments, net..................... $ 419 $ 670
Unrealized gain on marketable securities, net............... 13 23
Minimum pension liability, net.............................. (104) (66)
------ ------
Accumulated other comprehensive income.................... $ 328 $ 627
====== ======
</Table>
The unrealized gain on marketable securities, net, is reported net of
income tax of $8 million and $13 million at December 31, 2005 and 2004,
respectively. The minimum pension liability is reported net of income tax credit
of $61 million and $38 million at December 31, 2005 and 2004, respectively.
There were no realized gains, net, on marketable securities to be
reclassified from accumulated other comprehensive income for the year ended
December 31, 2005. The realized gains, net, on marketable securities of $19
million, net of tax effect, for 2004 were included in determining net income and
were reclassified from accumulated other comprehensive income.
N. STOCK OPTIONS AND AWARDS
The Company's 2005 Long Term Stock Incentive Plan (the "2005 Plan")
replaced the 1991 Long Term Stock Incentive Plan (the "1991 Plan") in May 2005
and provides for the issuance of stock-based incentives in various forms. At
December 31, 2005, outstanding stock-based incentives were in the form of
restricted long-term stock awards, stock appreciation rights, phantom stock
awards and stock options. Additionally, the Company's 1997 Non-Employee
Directors Stock Plan (the "1997 Plan") provides for the payment of part of the
compensation to non-employee Directors in Company common stock. Compensation
expense related to stock-based incentives was as follows for the years ended
December 31, 2005, 2004 and 2003, in millions:
<Table>
<Caption>
2005 2004 2003
---- ---- ----
Restricted long-term stock awards........................... $44 $39 $50
Stock options............................................... 29 21 3
Stock appreciation rights and phantom stock awards.......... 2 17 12
--- --- ---
Total..................................................... $75 $77 $65
=== === ===
</Table>
RESTRICTED LONG-TERM STOCK AWARDS
Long-term stock awards are granted to key employees and non-employee
Directors of the Company and do not cause net share dilution inasmuch as the
Company continues the practice of reacquiring an equal number of shares on the
open market.
54
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
N. STOCK OPTIONS AND AWARDS - (CONTINUED)
The following table summarizes the long-term stock awards granted, net of
cancellations, for the three years ended December 31, 2005, shares in millions:
<Table>
<Caption>
2005 2004 2003
---- ---- ----
Stock award shares granted.................................. 1 2 2
Weighted average grant date fair value (per share).......... $36 $28 $19
</Table>
The unvested stock awards, aggregating $185 million (9 million common
shares) and $173 million (10 million common shares) at December 31, 2005 and
2004, respectively, are included as a reduction in shareholders' equity and are
being expensed based on the respective vesting periods, principally 10 years.
STOCK APPRECIATION RIGHTS AND PHANTOM STOCK AWARDS
In 2005, 2004 and 2003, the Company issued stock appreciation rights
("SARs") to certain foreign employees with cash compensation linked to the value
of 366,800 shares, 315,000 shares and 287,800 shares, respectively, of Company
common stock. The Company also issued phantom stock awards linked to the value
of 150,100 shares, 156,000 shares and 160,500 shares of Company common stock in
2005, 2004 and 2003, respectively.
STOCK OPTIONS
Fixed price stock options are granted to key employees and non-employee
Directors of the Company. The grant date exercise price equals the market price
of Company common stock on the date of grant. These options generally become
exercisable in installments beginning on the first anniversary from the date of
grant and expire no later than 10 years after the grant date. Restoration stock
options under the 1991 Plan become exercisable six months from the date of
grant. The 2005 Plan does not permit the granting of restoration stock options,
except for restoration options resulting from options granted under the 1991
Plan.
The following table summarizes the stock options granted for the three
years ended December 31, 2005, shares in millions:
<Table>
<Caption>
2005 2004 2003
------- ------- -------
Stock option shares granted...................... 4 4 4
Restoration stock option shares granted.......... - 2 1
Grant date exercise price range (per share)...... $28-$38 $26-$37 $23-$28
</Table>
55
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
N. STOCK OPTIONS AND AWARDS - (CONCLUDED)
A summary of the status of the Company's fixed stock options for the three
years ended December 31, 2005 is presented below, shares in millions:
<Table>
<Caption>
2005 2004 2003
---- ---- ----
Option shares outstanding, January 1........................ 26 26 26
Weighted average exercise price........................... $25 $22 $21
Option shares granted, including restoration options........ 4 6 5
Weighted average exercise price........................... $31 $31 $27
Option shares exercised..................................... 2 5 4
Weighted average exercise price........................... $20 $20 $20
Option shares canceled...................................... 1 1 1
Weighted average exercise price........................... $25 $23 $22
Option shares outstanding, December 31...................... 27 26 26
Weighted average exercise price........................... $26 $25 $22
Weighted average remaining option term (in years)......... 6 6 6
Option shares exercisable, December 31...................... 16 10 10
Weighted average exercise price........................... $25 $24 $22
</Table>
The following table summarizes information for stock option shares
outstanding and exercisable at December 31, 2005, shares in millions:
<Table>
<Caption>
OPTION SHARES OUTSTANDING OPTION SHARES EXERCISABLE
- --------------------------------------------- --------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
RANGE OF NUMBER OF REMAINING EXERCISE NUMBER OF EXERCISE
PRICES SHARES OPTION TERM PRICE SHARES PRICE
- -------- --------- ----------- -------- ------------ -----------
$16-22 10 5 Years $20 8 $20
23-28 5 7 Years 27 2 27
29-32 11 7 Years 30 5 30
33-38 1 3 Years 35 1 35
- -------- --------- ----------- -------- ------------ -----------
$16-38 27 6 Years $26 16 $25
======== ========= =========== ======== ============ ===========
</Table>
At December 31, 2005, a total of 25,004,000 shares and 382,300 shares of
Company common stock were available under the 2005 Plan and the 1997 Plan,
respectively, for the granting of stock options and other restricted long-term
stock incentive awards.
O. EMPLOYEE RETIREMENT PLANS
The Company sponsors defined-benefit and defined-contribution plans for
most of its employees. In addition, substantially all salaried employees
participate in non-contributory defined-contribution plans, to which payments
are determined annually by the Organization and Compensation Committee of the
Board of Directors. Aggregate charges to earnings under the Company's
defined-benefit and defined-contribution plans were $51 million and $42 million
in 2005, $55 million and $42 million in 2004 and $68 million and $38 million in
2003, respectively.
56
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
O. EMPLOYEE RETIREMENT PLANS - (CONTINUED)
Net periodic pension cost for the Company's qualified defined-benefit
pension plans includes the following components for the three years ended
December 31, 2005, in millions:
<Table>
<Caption>
2005 2004 2003
---- ---- ----
Service cost............................................... $ 18 $ 16 $ 16
Interest cost.............................................. 40 39 37
Expected return on plan assets............................. (42) (38) (28)
Amortization of prior-service cost......................... 1 1 1
Amortization of net loss................................... 5 6 7
---- ---- ----
NET PERIODIC PENSION COST............................. $ 22 $ 24 $ 33
==== ==== ====
</Table>
The following table provides a reconciliation of changes in the projected
benefit obligation, fair value of plan assets and the funded status of the
Company's qualified defined-benefit pension plans at December 31, in millions:
<Table>
<Caption>
2005 2004
----- -----
CHANGES IN PROJECTED BENEFIT OBLIGATION:
Projected benefit obligation at January 1................. $ 712 $ 638
Service cost.............................................. 18 16
Interest cost............................................. 40 39
Participant contributions................................. 1 1
Plan amendments........................................... (2) 2
Actuarial loss............................................ 50 36
Foreign currency exchange................................. (17) 12
Settlements............................................... (2) (3)
Benefit payments.......................................... (29) (29)
----- -----
PROJECTED BENEFIT OBLIGATION AT DECEMBER 31............ $ 771 $ 712
===== =====
CHANGES IN FAIR VALUE OF PLAN ASSETS:
Fair value of plan assets at January 1.................... $ 519 $ 421
Actual return on plan assets.............................. 30 56
Foreign currency exchange................................. (6) 5
Company contributions..................................... 27 68
Participant contributions................................. 1 1
Settlements............................................... (2) (3)
Benefit payments.......................................... (29) (29)
----- -----
FAIR VALUE OF PLAN ASSETS AT DECEMBER 31............... $ 540 $ 519
===== =====
FUNDED STATUS OF QUALIFIED DEFINED-BENEFIT PENSION PLANS:
Plan assets (less than) projected benefit obligation at
December 31............................................ $(231) $(193)
Unamortized net transition obligation..................... 1 1
Unamortized prior-service cost............................ 5 8
Unamortized net loss...................................... 194 140
----- -----
NET (LIABILITY) RECOGNIZED AT DECEMBER 31.............. $ (31) $ (44)
===== =====
</Table>
57
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
O. EMPLOYEE RETIREMENT PLANS - (CONTINUED)
The following represents amounts recognized in the Company's consolidated
balance sheets at December 31, in millions:
<Table>
<Caption>
2005 2004
----- -----
Accrued benefit liability................................... $(220) $(177)
Prepaid benefit cost........................................ 43 44
Intangible asset............................................ 9 8
Accumulated other comprehensive income...................... 137 81
----- -----
NET AMOUNTS RECOGNIZED................................. $ (31) $ (44)
===== =====
</Table>
Information for qualified defined-benefit pension plans with an accumulated
benefit obligation in excess of plan assets was as follows at December 31, in
millions:
<Table>
<Caption>
2005 2004
---- ----
Accumulated benefit obligation.............................. $712 $644
Fair value of plan assets................................... $535 $509
</Table>
The projected benefit obligation was in excess of plan assets for all
qualified defined-benefit pension plans.
PLAN ASSETS
Following is a summary of the Company's qualified defined-benefit pension
plan weighted average asset allocation at December 31:
<Table>
<Caption>
2005 2004
---- ----
Equity securities........................................... 83% 86%
Debt securities............................................. 4% 5%
Other....................................................... 13% 9%
---- ----
Total.................................................. 100% 100%
==== ====
</Table>
The investment objectives of the Company's qualified defined-benefit
pension plans are: 1) to earn a return, net of fees, greater than or equal to
the expected long-term rate of return on plan assets; 2) to diversify the
portfolio among various asset classes with the goal of reducing volatility of
return and reducing principal risk; and 3) to maintain liquidity sufficient to
meet Plan obligations. Target allocations are: equity securities (85%), debt
securities (5%) and other investments (10%).
Plan assets include approximately 1.4 million shares of Company common
stock valued at $43 million and $52 million at December 31, 2005 and 2004,
respectively.
The major assumptions used in accounting for the Company's defined-benefit
pension plans at December 31, 2005, 2004 and 2003 were primarily as follows:
<Table>
<Caption>
2005 2004 2003
----- ----- -----
Discount rate for obligations.......................... 5.25% 5.75% 6.25%
Expected return on plan assets......................... 8.50% 8.50% 8.50%
Rate of compensation increase.......................... 4.00% 4.00% 4.50%
Discount rate for net periodic pension cost............ 5.75% 6.25% 6.75%
</Table>
The discount rate for obligations is based on the expected duration of each
defined benefit pension plan's liabilities matched to the December 31, 2005
Citigroup Pension Discount Curve. Such rates for
58
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
O. EMPLOYEE RETIREMENT PLANS - (CONCLUDED)
the Company's defined benefit pension plans ranged from 4.00 percent to 5.75
percent, with the most significant portion of the liabilities having a discount
rate for obligations of 5.25 percent or higher.
The Company determined the expected long-term rate of return on plan assets
by reviewing an analysis of expected and historical rates of return of various
asset classes based on the current asset allocation of the plan assets. The
measurement date used to determine the defined-benefit pension expense is
primarily January 1.
OTHER
In addition to the Company's qualified defined-benefit pension plans, the
Company has unfunded non-qualified supplemental defined-benefit pension plans
covering certain employees, which provide for benefits in addition to those
provided by the qualified pension plans. The actuarial present value of
accumulated benefit obligations and projected benefit obligations related to
these non-qualified plans totaled $134 million and $143 million at December 31,
2005 and $118 million and $125 million at December 31, 2004, respectively. Net
periodic pension cost for these plans was $17 million in both 2005 and 2004 and
$13 million in 2003.
The Company sponsors certain post-retirement benefit plans that provide
medical, dental and life insurance coverage for eligible retirees and dependents
in the United States based on age and length of service. The aggregate present
value of the unfunded accumulated post-retirement benefit obligation
approximated $7 million and $6 million at December 31, 2005 and 2004,
respectively.
CASH FLOWS
The Company expects to contribute approximately $31 million to its
qualified defined-benefit pension plans in 2006. The Company also expects to pay
benefits of $7 million to participants of its unfunded non-qualified
supplemental defined-benefit pension plans in 2006.
The benefits expected to be paid in each of the next five years, and in
aggregate for the five years thereafter, relating to the Company's qualified
defined-benefit pension plans, are as follows: 2006 - $29 million; 2007 - $35
million; 2008 - $30 million; 2009 - $32 million; 2010 - $33 million; and 2011 -
2015 - $195 million. The benefits expected to be paid in each of the next five
years, and in aggregate for the five years thereafter, relating to the Company's
unfunded non-qualified supplemental defined-benefit pension plans, are as
follows: 2006 - $7 million; 2007 - $8 million; 2008 - $8 million; 2009 - $9
million; 2010 - $10 million; and 2011-2015 - $54 million.
59
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
P. SEGMENT INFORMATION
The Company's reportable segments were as follows:
Cabinets and Related Products - principally includes assembled and
ready-to-assemble kitchen and bath cabinets; home office workstations;
entertainment centers; storage products; bookcases; and kitchen utility
products.
Plumbing Products - principally includes faucets; plumbing fittings and
valves; showerheads and hand showers; bathtubs and shower enclosures;
and spas.
Installation and Other Services - principally includes the sale,
installation and distribution of insulation and other building products.
Decorative Architectural Products - principally includes paints and stains;
and door, window and other hardware.
Other Specialty Products - principally includes windows, window frame
components and patio doors; electronic locksets; staple gun tackers,
staples and other fastening tools; and hydronic radiators and heat
convectors.
The above products and services are sold and provided to the home
improvement and home construction markets through mass merchandisers, hardware
stores, home centers, builders, distributors and other outlets for consumers and
contractors.
The Company's operations are principally located in North America and
Europe. The Company's country of domicile is the United States of America.
Corporate assets consist primarily of real property, equipment, cash and
cash investments and other investments.
The Company's segments are based on similarities in products and services
and represent the aggregation of operating units for which financial information
is regularly evaluated by the Company's corporate operating executives in
determining resource allocation and assessing performance and is periodically
reviewed by the Board of Directors. Accounting policies for the segments are the
same as those for the Company. The Company primarily evaluates performance based
on operating profit and, other than general corporate expense, allocates
specific corporate overhead to each segment. Income regarding the Behr
litigation settlement has also been excluded from the evaluation of segment
operating profit.
60
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
P. SEGMENT INFORMATION - (CONTINUED)
The following table presents information about the Company by segment and
geographic area, in millions:
<Table>
<Caption>
NET SALES (1)(2)(3)(4)(5) OPERATING PROFIT (5)(9) ASSETS AT DECEMBER 31 (6)(10)
--------------------------- ------------------------ ------------------------------
2005 2004 2003 2005 2004 2003 2005 2004 2003
------- ------- ------- ------ ------ ------ -------- -------- --------
The Company's operations by segment
are:
Cabinets and Related Products..... $ 3,324 $ 3,065 $ 2,684 $ 515 $ 519 $ 406 $ 2,017 $ 2,272 $ 2,353
Plumbing Products................. 3,176 3,057 2,684 367 370 343 2,206 2,356 2,160
Installation and Other Services... 3,063 2,771 2,411 382 358 368 2,496 2,433 2,378
Decorative Architectural
Products........................ 1,681 1,610 1,449 252 269 210 976 1,086 1,089
Other Specialty Products.......... 1,398 1,347 1,148 239 233 178 2,128 2,224 2,195
------- ------- ------- ------ ------ ------ ------- ------- -------
Total......................... $12,642 $11,850 $10,376 $1,755 $1,749 $1,505 $ 9,823 $10,371 $10,175
======= ======= ======= ====== ====== ====== ======= ======= =======
The Company's operations by geographic
area are:
North America..................... $10,513 $ 9,740 $ 8,645 $1,577 $1,616 $1,411 $ 7,443 $ 7,145 $ 7,081
International, principally
Europe.......................... 2,129 2,110 1,731 178 133 94 2,380 3,226 3,094
------- ------- ------- ------ ------ ------ ------- ------- -------
Total, as above............... $12,642 $11,850 $10,376 1,755 1,749 1,505 9,823 10,371 10,175
======= ======= =======
General corporate expense, net (7)................................. (192) (194) (115)
Gains on sale of corporate fixed assets, net....................... 8 7 3
Income regarding litigation settlement (8)......................... 6 30 72
Expense related to accelerated benefits, net....................... - - (16)
------ ------ ------
Operating profit, as reported...................................... 1,577 1,592 1,449
Other income (expense), net........................................ (165) (50) (202)
------ ------ ------
Income from continuing operations before income taxes and minority
interest......................................................... $1,412 $1,542 $1,247
====== ====== ======
Corporate assets.............................................................................. 2,736 2,007 1,998
Assets held for sale.......................................................................... - 163 -
------- ------- -------
Total assets.......................................................................... $12,559 $12,541 $12,173
======= ======= =======
</Table>
<Table>
<Caption>
DEPRECIATION AND
PROPERTY ADDITIONS AMORTIZATION (5)
-------------------- --------------------
2005 2004 2003 2005 2004 2003
---- ---- ---- ---- ---- ----
The Company's operations by segment are:
Cabinets and Related Products........................... $ 77 $ 86 $ 54 $ 58 $ 55 $ 52
Plumbing Products....................................... 76 69 77 71 68 62
Installation and Other Services......................... 15 19 31 26 33 33
Decorative Architectural Products....................... 47 36 35 19 18 22
Other Specialty Products................................ 55 87 81 38 37 32
---- ---- ---- ---- ---- ----
270 297 278 212 211 201
Unallocated amounts, principally related to corporate
assets................................................ 9 6 7 24 18 17
Assets of dispositions (acquisitions), net.............. 3 7 (14) - - -
---- ---- ---- ---- ---- ----
Total............................................... $282 $310 $271 $236 $229 $218
==== ==== ==== ==== ==== ====
</Table>
61
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
P. SEGMENT INFORMATION - (CONCLUDED)
(1) Included in net sales in 2005, 2004 and 2003 were export sales from the
U.S. of $254 million, $218 million and $177 million, respectively.
(2) Intra-company sales between segments represented approximately one percent
of net sales in 2005, 2004 and 2003.
(3) Includes net sales to one customer in 2005, 2004 and 2003 of $2,654
million, $2,614 million and $2,429 million, respectively. Such net sales
were included in the following segments: Cabinets and Related Products,
Plumbing Products, Decorative Architectural Products and Other Specialty
Products.
(4) Net sales from the Company's operations in the U.S. were $10,187 million,
$9,490 million and $8,442 million in 2005, 2004 and 2003, respectively.
(5) Net sales, operating profit and depreciation and amortization expense for
2005, 2004 and 2003 exclude the results of businesses sold in 2005, 2004
and 2003, including those held for sale at December 31, 2004.
(6) Long-lived assets of the Company's operations in the U.S. and Europe were
$4,892 million and $1,610 million, $4,981 million and $2,017 million and
$4,859 million and $2,130 million at December 31, 2005, 2004 and 2003,
respectively.
(7) General corporate expense includes those expenses not specifically
attributable to the Company's business segments.
(8) The income regarding litigation settlement relates to litigation discussed
in Note U pertaining to the Company's subsidiary, Behr Process Corporation,
which is included in the Decorative Architectural Products segment.
(9) Included in segment operating profit for 2005 were goodwill impairment
charges as follows: Plumbing Products - $7 million; Decorative
Architectural Products - $26 million; and Other Specialty Products - $36
million. Included in segment operating profit for 2004 were goodwill
impairment charges as follows: Plumbing Products - $25 million; Decorative
Architectural Products - $62 million; and Other Specialty Products - $25
million. Included in segment operating profit for 2003 were goodwill
impairment charges as follows: Plumbing Products - $17 million; Decorative
Architectural Products - $5 million; and Other Specialty Products - $31
million. The goodwill impairment charges were related to certain of the
Company's European businesses.
(10) Segment assets exclude the assets of discontinued operations.
Q. OTHER INCOME (EXPENSE), NET
Other, net, which is included in other income (expense), net, included the
following, in millions:
<Table>
<Caption>
2005 2004 2003
---- ---- ----
Income from cash and cash investments....................... $ 36 $ 11 $ 8
Other interest income....................................... 7 7 8
Income from financial investments, net (Note E)............. 114 119 65
Loss on early retirement of debt............................ - - (7)
Gain from sale of equity investment......................... - - 5
Other items, net............................................ (30) 51 (2)
---- ---- ---
Total other, net.......................................... $127 $188 $77
==== ==== ===
</Table>
Other items, net, in 2005, 2004 and 2003 include realized foreign currency
transaction (losses) gains of $(25) million, $26 million and $(4) million,
respectively, as well as other miscellaneous items.
62
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
R. INCOME TAXES
<Table>
<Caption>
(IN MILLIONS)
2005 2004 2003
------ ------ ------
Income from continuing operations before income taxes
and minority interest:
U.S................................................ $1,228 $1,384 $1,152
Foreign............................................ 184 158 95
------ ------ ------
$1,412 $1,542 $1,247
====== ====== ======
Provision for income taxes on income from continuing
operations before minority interest:
Currently payable:
U.S. Federal..................................... $ 349 $ 338 $ 207
State and local.................................. 37 46 34
Foreign.......................................... 80 80 19
Deferred:
U.S. Federal..................................... 53 93 173
State and local.................................. 6 8 9
Foreign.......................................... (7) 9 23
------ ------ ------
$ 518 $ 574 $ 465
====== ====== ======
Deferred tax assets at December 31:
Receivables........................................ $ 23 $ 28
Inventories........................................ 28 27
Other assets....................................... 38 34
Accrued liabilities................................ 171 140
Long-term liabilities.............................. 82 81
Capital loss carryforward.......................... - 21
Foreign tax credit carryforward.................... 50 50
------ ------
392 381
------ ------
Deferred tax liabilities at December 31:
Property and equipment............................. 304 346
Investment in foreign subsidiaries................. 32 38
Intangibles........................................ 296 227
Other, principally long-term liabilities........... 143 99
------ ------
775 710
------ ------
Net deferred tax liability at December 31............... $ 383 $ 329
====== ======
</Table>
At December 31, 2005 and 2004, net deferred tax liability consisted of net
short-term deferred tax assets included in prepaid expenses and other of $217
million and $175 million, respectively, and net long-term deferred tax
liabilities of $600 million and $504 million, respectively.
Changes to the U.S. tax law enacted in 2004 significantly impacted the
taxation of foreign earnings distributions. As a result, the Company made a
dividend distribution of accumulated earnings from certain of its foreign
subsidiaries of approximately $500 million in 2004. Prior to the dividend
distribution, such earnings had been permanently reinvested, pursuant to the
provisions of the APB Opinion No. 23, under the Company's previous tax planning
strategy to invest such earnings in operating and non-operating foreign
investments.
63
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
R. INCOME TAXES - (CONCLUDED)
This dividend distribution generated significant foreign tax credits that
were used to offset the majority of the U.S. tax on the 2004 dividend
distribution and created a $50 million foreign tax credit carryforward at
December 31, 2005 and 2004. The Company believes that the foreign tax credit
carryforward will be utilized before the newly enacted 10-year carryforward
period expires on December 31, 2014, principally with identified potential
sources of future income taxed in foreign jurisdictions at rates less than the
present U.S. rate of 35 percent. Therefore, a valuation allowance was not
recorded at December 31, 2005 and 2004.
The following is a reconciliation of the U.S. Federal statutory rate to the
provision for income taxes on income from continuing operations before minority
interest:
<Table>
<Caption>
2005 2004 2003
---- ---- ----
U.S. Federal statutory rate................................. 35% 35% 35%
State and local taxes, net of Federal tax benefit........... 2 2 2
Lower taxes on foreign earnings............................. (1) (1) (1)
Foreign goodwill impairment charges providing no tax
benefit................................................... 2 2 1
Domestic production deduction............................... (1) - -
Other, net.................................................. - (1) -
-- -- --
Effective tax rate........................................ 37% 37% 37%
== == ==
</Table>
Income taxes paid were approximately $457 million, $406 million and $328
million in 2005, 2004 and 2003, respectively.
S. EARNINGS PER COMMON SHARE
The following are reconciliations of the numerators and denominators used
in the computations of basic and diluted earnings per common share, in millions:
<Table>
<Caption>
2005 2004 2003
---- ---- ----
Numerator (basic and diluted):
Income from continuing operations......................... $872 $949 $769
Income (loss) from discontinued operations, net of income
taxes.................................................. 68 (56) 37
---- ---- ----
Net income................................................ $940 $893 $806
==== ==== ====
Denominator:
Basic common shares (based on weighted average)........... 422 445 479
Add:
Contingent common shares............................... 4 6 9
Stock option dilution.................................. 4 5 3
---- ---- ----
Diluted common shares..................................... 430 456 491
==== ==== ====
</Table>
At December 31, 2005, the Company did not include any common shares related
to the Zero Coupon Convertible Senior Notes ("Notes") in the calculation of
diluted earnings per common share, as the price of the Company's common stock at
December 31, 2005 did not exceed the equivalent accreted value of the Notes. At
December 31, 2004, the Company included approximately one million common shares
related to the Notes in the calculation of diluted earnings per common share, as
the price of the Company's common stock at December 31, 2004 exceeded the
equivalent accreted value of the Notes.
64
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
S. EARNINGS PER COMMON SHARE - (CONCLUDED)
Additionally, 1.0 million common shares for both 2005 and 2004 and 7.9
million common shares for 2003 related to stock options were excluded from the
computation of diluted earnings per common share due to their anti-dilutive
effect, since the option exercise price of those options was greater than the
Company's average common stock price during the respective years.
During 2004, holders of all 17,000 shares of the Company's convertible
preferred stock converted their preferred stock to approximately 17 million
shares of the Company's common stock. The convertible preferred shares carried
substantially the same attributes as Company common stock and had been treated
as if converted at a ratio of one share of preferred stock to 1,000 shares of
common stock for basic and diluted earnings per common share computations.
T. EUROPEAN CHARGES
During 2003, the Company recorded a non-cash, pre-tax charge which reduced
operating profit by approximately $35 million with respect to a United Kingdom
business unit in the Decorative Architectural Products segment. The charge
relates primarily to a business system implementation failure which allowed
former management of the business unit to circumvent internal controls and
artificially inflate the unit's operating profit in years prior to 2003. The
Company also determined that goodwill related to this business unit was impaired
and recorded an additional $5 million charge in 2003.
Finally, the Company determined that the strategic plan for this business
unit, relative to certain product offerings and customer focus, should be
changed. This revision in operating strategy resulted in 2003 pre-tax charges
aggregating approximately $15 million related principally to inventories and
receivables.
During 2003, the Company also detected that an employee at a United Kingdom
business unit in the Plumbing Products segment had circumvented internal
controls and overstated operating results by approximately $4 million in 2002.
The Company completed its review of the business unit in the fourth quarter of
2003 and determined that no further adjustment was necessary.
The Company implemented changes to its operational and financial structure
in Europe which included: reorganizing its European business operations into
product groups; the addition of group operating and financial personnel;
training and evaluation related to internal controls and the expansion of
internal audit involvement.
U. OTHER COMMITMENTS AND CONTINGENCIES
LITIGATION
The Company is subject to lawsuits and pending or asserted claims with
respect to matters generally arising in the ordinary course of business.
As the Company reported in previous filings, late in the second half of
2002, the Company and its subsidiary, Behr Process Corporation, agreed to two
Settlements (the National Settlement and the Washington State Settlement) to
resolve all class action lawsuits pending in the United States involving certain
exterior wood coating products formerly manufactured by Behr.
65
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
U. OTHER COMMITMENTS AND CONTINGENCIES - (CONTINUED)
The following is a reconciliation of the Company's Behr Process Settlement
liability, in millions:
<Table>
<Caption>
2005 2004
----- -----
Balance at January 1........................................ $ 19 $ 63
Payments on claims........................................ (10) (14)
Insurance proceeds........................................ (6) (10)
Adjustment of accrual..................................... - (20)
----- -----
Balance at December 31...................................... $ 3 $ 19
===== =====
</Table>
The Company expects that the evaluation, processing and payment of claims
for both the National Settlement and the Washington State Settlement should be
completed in the first half of 2006.
Early in 2003, a suit was brought against the Company and a number of its
insulation installation companies in the federal court in Atlanta, Georgia,
alleging that certain practices violate provisions of federal and state
antitrust laws. The plaintiff publicized the lawsuit with a press release and
stated in that release that the U.S. Department of Justice was investigating the
business practices of the Company's insulation installation companies. Although
the Company was unaware of any investigation at that time, the Company was later
advised that an investigation had been commenced but was subsequently closed
without any enforcement action recommended. Two additional lawsuits were
subsequently brought in Virginia making similar claims under the antitrust laws.
Both of these lawsuits have since been dismissed without any payment or
requirement for any change in business practices. During the second half of
2004, the same counsel who commenced the initial action in Atlanta filed six
additional lawsuits on behalf of several of Masco's competitors in the
insulation installation business. The plaintiffs then dismissed all of these
lawsuits and, represented by the same counsel, filed another action in the same
federal court as a putative class action against the Company, a number of its
insulation installation companies and certain of their suppliers. This suit
currently seeks class representation for all residential insulation contractors
(other than the defendants and their affiliates) that have directly purchased
fiberglass insulation suitable for residential installation from certain
insulation manufacturers. An additional lawsuit, seeking class action status and
alleging anticompetitive conduct, was recently filed in a Florida state court
against the Company and a number of its insulation suppliers. The Company will
be seeking the dismissal of each of these lawsuits and will be opposing
certification of the two actions currently pending which seek to proceed on a
class representation basis. Based on the advice of its outside counsel, the
Company believes that the conduct of the Company and its insulation installation
companies, which has been the subject of the above-described lawsuits, has not
violated any antitrust laws. There cannot, however, be any assurance that the
Company will ultimately prevail in some or any of these lawsuits or, if
unsuccessful, that the ultimate liability would not be material. The Company is
unable at this time to reliably estimate any potential liability which might
occur from an adverse judgment but does not believe that any adverse judgment
would have a material adverse effect on its businesses or the methods used by
its insulation installation companies in doing business.
In February 2003, a suit was served upon the Company's subsidiary, Milgard
Manufacturing, in the Solano County, California Superior Court, alleging design
defects in certain of Milgard's aluminum windows. The complaint requests class
action status for all owners of homes in California in which the windows are
installed, and seeks replacement costs and other damages. Plaintiffs' motion for
class certification is pending. The counsel representing plaintiffs have filed
similar lawsuits in California against several other aluminum window
manufacturers. Milgard denies that the windows are defective and is vigorously
defending the case. Based on the advice of its outside counsel, Milgard believes
that the case should not proceed as a class action and, if it is certified to
proceed on a class representa-
66
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
U. OTHER COMMITMENTS AND CONTINGENCIES - (CONTINUED)
tion basis, believes that it has meritorious defenses to the lawsuit. There
cannot, however, be any assurance that Milgard will ultimately prevail or, if it
is unsuccessful, that any ultimate liability would not be material. The Company
is unable at this time to reliably estimate any potential liability which might
occur from an adverse judgment against Milgard but does not believe that any
adverse judgment would have a material adverse effect on its business.
In the fall of 2004, the Company learned that European governmental
authorities are investigating possible anticompetitive business practices
relating to the plumbing and heating industries in Europe. The investigations
involve a number of European companies, including certain of the Company's
European manufacturing divisions and a number of other large businesses. As part
of its recently broadened governance activities, the Company, with the
assistance of its outside counsel, completed a review of the competition
practices of its European divisions, including those in the plumbing and heating
industries, and the Company is cooperating fully with the European governmental
authorities. Several private antitrust lawsuits have been filed in the United
States as putative class actions against, among others, the Company and certain
of the other companies being investigated relating to the defendants' plumbing
operations. These appear to be an outgrowth of the investigations being
conducted by European governmental authorities, and additional lawsuits
involving the same subject matter may be filed. Based upon the advice of its
outside counsel, the review of the competition practices of its European
divisions referred to above and other factors, the Company believes that it will
not incur material liability as a result of the matters that are the subject of
these investigations or as a result of any such lawsuits.
WARRANTY
Certain of the Company's 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,
the Company accrues a warranty liability for estimated costs to provide
products, parts or services to repair or replace products in satisfaction of
warranty obligations. The Company's estimate of costs to service its warranty
obligations is based on historical experience and expectations of future
conditions. To the extent that the Company experiences any changes in warranty
claim activity or costs associated with servicing those claims, its warranty
liability is adjusted accordingly.
The following is a reconciliation of the Company's warranty liability, in
millions:
<Table>
<Caption>
2005 2004
---- ----
Balance at January 1........................................ $100 $ 90
Accruals for warranties issued during the year............ 67 57
Accruals related to pre-existing warranties............... 1 9
Settlements made (in cash or kind) during the year........ (57) (48)
Discontinued operations................................... - (3)
Other, net................................................ (6) (5)
---- ----
Balance at December 31...................................... $105 $100
==== ====
</Table>
ACQUISITION-RELATED COMMITMENTS
As part of the agreement relating to the Company's acquisition of an
additional 37 percent equity ownership of Hansgrohe AG in December 2002
(increasing such ownership to 64 percent), certain minority shareholders of
Hansgrohe AG, representing four percent of Hansgrohe outstanding shares,
67
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
U. OTHER COMMITMENTS AND CONTINGENCIES - (CONTINUED)
hold an option expiring in December 2007 to require the Company to purchase such
shares in Hansgrohe either with cash or Company common stock. The put option can
only be exercised once by such minority shareholder and only with respect to all
of such shareholder's shares. The fair value of the put option is not material.
The amount payable under the put option to acquire shares is based on
Hansgrohe's operating results (principally a multiple of operating earnings
which is designed to reflect the appropriate fair value of the shares) and, if
exercised at December 31, 2005, would have approximated $26 million if settled
in cash; if the put option were settled in stock, the common shares to be issued
at December 31, 2005 would have approximated 952,700. Such shares are currently
included in the Company's diluted share count for computation of earnings per
common share.
The Company, as part of certain acquisition agreements, provided for the
payment of additional consideration in either cash or Company common stock,
contingent upon whether certain conditions were met, including the operating
performance of the acquired business and the price of the Company's common
stock. At December 31, 2005, there were no such outstanding contingent purchase
price commitments.
Stock Price Guarantees
During 2005, the Company settled the guarantee related to the value of 1.6
million shares of Company common stock for a stock price of $40 per share
related to a 2001 divestiture. The guarantee was settled for cash and stock
aggregating approximately $12 million. At December 31, 2005, there were no
outstanding stock price guarantees.
INVESTMENTS
With respect to the Company's investments in private equity funds, the
Company had, at December 31, 2005, commitments to contribute up to $95 million
of additional capital to such funds representing the Company's aggregate capital
commitment to such funds less capital contributions made to date. The Company is
contractually obligated to make additional capital contributions to each of its
private equity funds upon receipt of a capital call from the private equity
fund. The Company has 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 the Company's investment in the private equity fund when paid.
SHAREHOLDERS' EQUITY
During 2000, approximately 300 of the Company's key employees purchased
from the Company 8.4 million shares of Company common stock for cash totaling
$156 million under an Executive Stock Purchase Program ("Program"). The stock
was purchased at $18.50 per share, the approximate market price of the common
stock at the time of purchase. During 2005, participants in the program settled
their remaining outstanding five-year full recourse personal loans with a bank
syndicate. The Company had guaranteed the repayment of the loans; however, all
such loans were settled with no requirement for the Company to fulfill such
guarantees.
RESIDUAL VALUE GUARANTEES
The Company has residual value guarantees resulting from operating leases,
primarily related to certain of the Company's trucks and other vehicles, in the
Installation and Other Services segment. The operating leases are generally for
a minimum term of 18 to 24 months and are renewable monthly after the initial
term. After the end of the initial term, if the Company cancels the leases, the
Company must pay the lessor the difference between the guaranteed residual value
and the fair market value of the related vehicles. The value of lease-related
guarantees, including the obligation payable under the
68
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
U. OTHER COMMITMENTS AND CONTINGENCIES - (CONCLUDED)
residual value guarantees, assuming the fair value at lease termination is zero,
was approximately $129 million at December 31, 2005.
For all operating leases that contain residual value guarantee provisions
(principally related to vehicles), the Company calculates the amount due under
the guarantees and compares such amount to the fair value of the leased assets.
If the amount payable under the residual value guarantee exceeds the fair value
at lease termination, the Company would record a liability equal to such excess
with a corresponding charge to earnings. At December 31, 2005, the fair market
value exceeded the amount payable under the residual value guarantees and no
liability was recorded.
OTHER MATTERS
The Company enters into contracts, which include reasonable and customary
indemnifications that are standard for the industries in which it operates. Such
indemnifications include customer claims against builders for issues relating to
the Company's products and workmanship. In conjunction with divestitures and
other transactions, the Company generally provides reasonable and customary
indemnifications relating to various items including: the enforceability of
trademarks; legal and environmental issues; provisions for sales returns; and
asset valuations. The Company has never had to pay a material amount related to
these indemnifications and evaluates the probability that amounts may be
incurred and appropriately records an estimated liability when probable.
69
MASCO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONCLUDED)
V. INTERIM FINANCIAL INFORMATION (UNAUDITED)
<Table>
<Caption>
(IN MILLIONS, EXCEPT PER COMMON SHARE DATA)
QUARTERS ENDED
TOTAL -----------------------------------------------
YEAR DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31
------- ----------- ------------ ------- --------
2005:
Net sales.............................. $12,642 $3,146 $3,296 $3,286 $2,914
Gross profit........................... $ 3,609 $ 867 $ 946 $ 968 $ 828
Income from continuing operations...... $ 872 $ 142 $ 256 $ 267 $ 207
Net income............................. $ 940 $ 173 $ 262 $ 274 $ 231
Earnings per common share:
Basic:
Income from continuing
operations...................... $ 2.07 $ .34 $ .61 $ .63 $ .48
Net income........................ $ 2.23 $ .42 $ .63 $ .65 $ .53
Diluted:
Income from continuing
operations...................... $ 2.03 $ .34 $ .60 $ .62 $ .47
Net income........................ $ 2.19 $ .41 $ .61 $ .64 $ .52
2004:
Net sales.............................. $11,850 $2,975 $3,117 $3,004 $2,754
Gross profit........................... $ 3,663 $ 887 $ 978 $ 960 $ 838
Income from continuing operations...... $ 949 $ 139 $ 284 $ 289 $ 237
Net income............................. $ 893 $ 105 $ 359 $ 261 $ 168
Earnings per common share:
Basic:
Income from continuing
operations...................... $ 2.13 $ .32 $ .65 $ .65 $ .52
Net income........................ $ 2.01 $ .24 $ .82 $ .59 $ .37
Diluted:
Income from continuing
operations...................... $ 2.08 $ .31 $ .63 $ .64 $ .51
Net income........................ $ 1.96 $ .23 $ .80 $ .58 $ .36
</Table>
Earnings per common share amounts for the four quarters of 2005 and 2004
may not total to the earnings per common share amounts for the years ended
December 31, 2005 and 2004 due to the timing of common stock repurchases and the
effect of contingently issuable common shares.
Fourth quarter 2005 income from continuing operations and net income
include a $69 million after-tax ($69 million pre-tax), non-cash goodwill
impairment charge. Income from continuing operations and net income include
after-tax income related to the Behr litigation settlement of $1 million ($2
million pre-tax), $2 million ($3 million pre-tax) and $1 million ($1 million
pre-tax) in the first, second and third quarters of 2005, respectively. Net
income for 2005 includes after-tax income, net, related to discontinued
operations of $24 million ($22 million pre-tax), $7 million ($9 million
pre-tax), $6 million ($11 million pre-tax) and $31 million ($60 million pre-tax)
in the first, second, third and fourth quarters of 2005, respectively.
Fourth quarter 2004 income from continuing operations and net income
include a $104 million after-tax ($112 million pre-tax), non-cash goodwill
impairment charge. Income from continuing operations and net income include
after-tax income related to the Behr litigation settlement of $13 million ($21
million pre-tax), $4 million ($7 million pre-tax) and $1 million ($2 million
pre-tax) in the first, second and third quarters of 2004, respectively. Net
income for 2004 includes after-tax (loss) income, net related to discontinued
operations of $(69) million ($(51) million pre-tax), $(28) million ($(23)
million pre-tax), $75 million ($95 million pre-tax) and $(34) million ($(49)
million pre-tax) in the first, second, third and fourth quarters of 2004,
respectively.
70
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable
ITEM 9A. CONTROLS AND PROCEDURES.
(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
The Company, with the participation of the Chief Executive Officer and
Chief Financial Officer, conducted an evaluation of its disclosure controls and
procedures as required by Exchange Act Rules 13a-15(b) and 15d-15(b) as of
December 31, 2005. Based on this evaluation, the Company's management, including
the Chief Executive Officer and Chief Financial Officer, concluded that the
Company's disclosure controls and procedures were effective.
(B) MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING.
Management's report on the Company's internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) is included in Item 8 of this Report under the heading
Management's Report on Internal Control over Financial Reporting, and the
related report of the Company's independent registered public accounting firm is
included under the heading Report of Independent Registered Public Accounting
Firm under the same Item.
(C) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING.
There were no changes in the Company's internal control over financial
reporting that occurred during the last fiscal quarter that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
ITEM 9B. OTHER INFORMATION.
Effective, March 1, 2006, the Company amended its Restated Certificate of
Incorporation by filing a Certificate of Elimination of Series A Participating
Cumulative Preferred Stock with the Secretary of State of the State of Delaware,
which removed all references to such Series A Participating Cumulative Preferred
Stock from the Company's Restated Certificate of Incorporation. Thereafter, the
Company filed with the Secretary of State of the State of Delaware a Restated
Certificate of Incorporation, a copy of which is included as Exhibit 3.i to this
Report.
71
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Certain information regarding executive officers required by this Item is
set forth as a Supplementary Item at the end of Part I hereof (pursuant to
Instruction 3 to Item 401(b) of Regulation S-K). The Company's Code of Business
Ethics applies to all employees, officers and directors including the Principal
Executive Officer and Principal Financial Officer and Principal Accounting
Officer, and is posted on the Company's website at www.masco.com. Other
information required by this Item will be contained in the Company's definitive
Proxy Statement for its 2006 Annual Meeting of Stockholders, to be filed on or
before April 28, 2006, and such information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION.
Information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2006 Annual Meeting of Stockholders, to be
filed on or before April 28, 2006, and such information is incorporated herein
by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
EQUITY COMPENSATION PLAN INFORMATION
The Company has three equity compensation plans, the 1991 Long Term Stock
Incentive Plan (under which further grants have been discontinued), 2005 Long
Term Stock Incentive Plan and the 1997 Non-Employee Directors Stock Plan. The
following table sets forth information as of December 31, 2005 concerning the
Company's three equity compensation plans, each of which was approved by
stockholders. The Company does not have any equity compensation plans that are
not approved by stockholders.
<Table>
<Caption>
NUMBER OF WEIGHTED NUMBER OF SECURITIES
SECURITIES TO BE AVERAGE PER REMAINING AVAILABLE FOR
ISSUED UPON SHARE EXERCISE FUTURE ISSUANCE UNDER
EXERCISE OF PRICE OF EQUITY COMPENSATION PLANS
OUTSTANDING OUTSTANDING (EXCLUDING SECURITIES
OPTIONS, WARRANTS OPTIONS, WARRANTS REFLECTED IN THE
PLAN CATEGORY AND RIGHTS AND RIGHTS FIRST COLUMN)
------------- ----------------- ----------------- -------------------------
Equity compensation plans approved
by stockholders................... 27,266,000 $25.92 25,386,000
</Table>
The remaining information required by this Item will be contained in the
Company's definitive Proxy Statement for its 2006 Annual Meeting of
Stockholders, to be filed on or before April 28, 2006, and such information is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2006 Annual Meeting of Stockholders, to be
filed on or before April 28, 2006, and such information is incorporated herein
by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2006 Annual Meeting of Stockholders, to be
filed on or before April 28, 2006, and such information is incorporated herein
by reference.
72
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULE.
(a) LISTING OF DOCUMENTS.
(1) Financial Statements. The Company's Consolidated Financial
Statements included in Item 8 hereof, as required at December 31,
2005 and 2004, and for the years ended December 31, 2005, 2004 and
2003, consist of the following:
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Cash Flows
Consolidated Statements of Shareholders' Equity
Notes to Consolidated Financial Statements
(2) Financial Statement Schedule.
(i) Financial Statement Schedule of the Company appended hereto, as
required for the years ended December 31, 2005, 2004 and 2003,
consists of the following:
II. Valuation and Qualifying Accounts
(3) Exhibits.
<Table>
<Caption>
EXHIBIT
NUMBER
-------
3.i Restated Certificate of Incorporation of Masco Corporation
and amendments thereto (Filed herewith).
3.ii Bylaws of Masco Corporation, as amended December 5, 2001
(Incorporated by reference to Exhibit 3.ii of Masco's 2002
Form 10-K filed 3-14-2003).
4.a.i Indenture dated as of December 1, 1982 between Masco
Corporation and Morgan Guaranty Trust Company of New York,
as Trustee (Incorporated by reference to Exhibit 4.a of
Masco's 2001 Form 10-K filed 3-28-2002), and Directors'
resolutions establishing Masco Corporation's:
(i) 7 1/8% Debentures Due August 15, 2013 (Incorporated by
reference to Exhibit 4.a.i of Masco's 2003 Form 10-K filed
2-27-2004);
(ii) 6.625% Debentures Due April 15, 2018 (Incorporated by
reference to Exhibit 4.a.i of Masco's 2003 Form 10-K filed
2-27-2004);
(iii) 5.75% Notes Due October 15, 2008 (Incorporated by
reference to Exhibit 4.a.i of Masco's 2003 Form 10-K filed
2-27-2004); and
(iv) 7 3/4% Debentures Due August 1, 2029 (Incorporated by
reference to Exhibit 4.a.i of Masco's 2004 Form 10-K filed
3-16-2005).
4.a.ii Agreement of Appointment and Acceptance of Successor Trustee
dated as of July 25, 1994 among Masco Corporation, Morgan
Guaranty Trust Company of New York and The First National
Bank of Chicago (Incorporated by reference to Exhibit 4.a.ii
of Masco's 2004 Form 10-K filed 3-16-2005).
4.a.iii Supplemental Indenture dated as of July 26, 1994 between
Masco Corporation and The First National Bank of Chicago
(Incorporated by reference to Exhibit 4.a.iii of Masco's
2004 Form 10-K filed 3-16-2005).
4.b.i Indenture dated as of February 12, 2001 between Masco
Corporation and J.P. Morgan Trust Company, National
Association (successor in interest to Bank One Trust
Company, National Association), as Trustee (Filed herewith)
and Directors' Resolutions establishing Masco Corporation's:
(i) 6 3/4% Notes Due March 15, 2006 (Filed herewith);
(ii) 5 7/8% Notes Due July 15, 2012 (Incorporated by
reference to Exhibit 4.b.i of Masco's 2002 Form 10-K filed
3-14-2003);
</Table>
73
<Table>
<Caption>
EXHIBIT
NUMBER
-------
(iii) 4 5/8% Notes Due August 15, 2007 (Incorporated by
reference to Exhibit 4.b.i of Masco's 2002 Form 10-K filed
3-14-2003);
(iv) 6 1/2% Notes Due August 15, 2032 (Incorporated by
reference to Exhibit 4.b.i of Masco's 2002 Form 10-K filed
3-14-2003);
(v) Floating Rate Notes Due 2007 (Incorporated by reference
to Exhibit 4.b.i of Masco's 2004 Form 10-K filed 3-16-2005);
and
(vi) 4.80% Notes Due December 15, 2015 (Incorporated by
reference to Exhibit 4.b.i of Masco's 2nd Quarter Form 10-Q
filed 8-04-2005).
4.b.ii First Supplemental Indenture dated as of July 20, 2001 to
the Indenture dated February 12, 2001 by and among Masco
Corporation and J.P. Morgan Trust Company, National
Association (successor in interest to Bank One Trust
Company, National Association), as Trustee, relating to the
Company's Zero Coupon Convertible Senior Notes Due July 20,
2031 (Incorporated by reference to Exhibit 4.a.vi of Masco's
2nd Quarter Form 10-Q filed 8-07-2001), Amendment No. 1
dated as of July 19, 2002 (Incorporated by reference to
Exhibit 4.b of Masco's 2nd Quarter Form 10-Q filed
8-13-2002) and Amendment No. 2 dated as of November 2, 2004
(Incorporated by reference to Exhibit 4 of Masco's 3rd
Quarter Form 10-Q filed 11-04-2004).
4.b.iii Second Supplemental Indenture between Masco Corporation and
J.P. Morgan Trust Company, National Association, as trustee
dated as of December 23, 2004 (including form of Zero Coupon
Convertible Senior Note, Series B due 2031) (Incorporated by
reference to Exhibit 10.1 of Masco's Form 8-K filed 12-23-
2004).
4.c U.S. $2 billion 5-Year Revolving Credit Agreement dated as
of November 5, 2004 among Masco Corporation and Masco
Europe, S.a r.l. as borrowers, the banks party thereto, as
lenders, J.P. Morgan Securities Inc. and Citigroup Global
Markets, Inc., as Joint Lead Arrangers and Joint Book
Runners and Citibank, N.A., as Syndication Agent, Sumitomo
Mitsui Banking Corporation, as Documentation Agent, and Bank
One, NA (Main Office Chicago), as Administrative Agent
(Incorporated by reference to Exhibit 4 of Masco's Form 8-K
filed 11-12-2004), as amended by Amendment No. 1 dated
February 10, 2006. (Incorporated by reference to Exhibit 4
of Masco's Form 8-K filed 2-15-06).
NOTE: Other instruments, notes or extracts from agreements
defining the rights of holders of long-term debt of Masco
Corporation or its subsidiaries have not been filed since
(i) in each case the total amount of long-term debt
permitted thereunder does not exceed 10 percent of Masco
Corporation's consolidated assets, and (ii) such
instruments, notes and extracts will be furnished by Masco
Corporation to the Securities and Exchange Commission upon
request.
NOTE: Exhibits 10.a through 10.i constitute the management
contracts and executive compensatory plans or arrangements
in which certain of the Directors and executive officers of
the Company participate.
10.a Masco Corporation 1991 Long Term Stock Incentive Plan (as
amended and restated October 27, 2005) (Filed herewith).
(i) Forms of Restricted Stock Award Agreement for awards
prior to January 1, 2005 (Incorporated by reference to
Exhibit 10.a.i of Masco's 3rd Quarter Form 10-Q filed
11-04-2004) and for awards on and after January 1, 2005
(Incorporated by reference to Exhibit 10.1 of Masco's
Form 8-K filed 1-06-2005);
(ii) Forms of Restoration Stock Option (Incorporated by
reference to Exhibit 10.a.ii of Masco's 3rd Quarter Form
10-Q filed 11-04-2004);
(iii) Forms of Stock Option Grant (Incorporated by reference
to Exhibit 10.a.iii of Masco's 3rd Quarter Form 10-Q filed
11-04-2004);
</Table>
74
<Table>
<Caption>
EXHIBIT
NUMBER
-------
(iv) Forms of Stock Option Grant for Non-Employee Directors
(Incorporated by reference to Exhibit 10.a.iv of Masco's 3rd
Quarter Form 10-Q filed 11-04-2004); and
(v) Forms of amendment to Award Agreements (Filed herewith).
10.b Masco Corporation 2005 Long Term Stock Incentive Plan
(Incorporated by reference to Exhibit 99.1 of Masco's Form
8-K filed 5-13-2005).
(i) Form of Restricted Stock Award (Filed herewith);
(ii) Form of Stock Option Grant (Filed herewith);
(iii) Form of Restoration Stock Option (Filed herewith); and
(iv) Form of Stock Option Grant for Non-Employee Directors
(Filed herewith).
10.c Forms of Masco Corporation Supplemental Executive Retirement
and Disability Plan. (Filed herewith).
10.d Masco Corporation 2002 Annual Incentive Compensation Plan
(Incorporated by reference to Exhibit 10.d of Masco's 2002
Form 10-K filed 3-14-2003).
10.e Masco Corporation 1997 Non-Employee Directors Stock Plan (as
amended and restated October 27, 2005) (Filed herewith).
(i) Form of Restricted Stock Award Agreement (Filed
herewith);
(ii) Form of Stock Option Grant (Filed herewith); and
(iii) Form of amendment to Award Agreements (Filed
herewith).
10.f Other compensatory arrangements for executive officers
(Filed herewith).
10.g Masco Corporation 2004 Restricted Stock Award Program
(Incorporated by reference to Exhibit 10.b of Masco's 2nd
Quarter Form 10-Q filed 8-5-2004).
10.h Compensation of Directors (Incorporated by reference to
Exhibit 10.o of Masco's 2004 Form 10-K filed 3-16-2005).
10.i Masco Corporation Retirement Benefit Restoration Plan dated
January 1, 1995, as amended October 1, 2004 (Incorporated by
reference to Exhibit 10.p of Masco's 2004 Form 10-K filed
3-16-2005).
10.j Shareholders Agreement by and among MascoTech, Inc. (now
known as Metaldyne Corporation), Masco Corporation, Richard
Manoogian, certain of their respective affiliates and other
co-investors as party thereto, dated as of November 28, 2000
(Filed herewith).
12 Computation of Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends (Filed herewith).
21 List of Subsidiaries (Filed herewith).
23 Consent of Independent Registered Public Accounting Firm
relating to Masco Corporation's Consolidated Financial
Statements and Financial Statement Schedule (Filed
herewith).
31.a Certification by Chief Executive Officer required by Rule
13a-14(a)/15d-14(a) (Filed herewith).
31.b Certification by Chief Financial Officer required by Rule
13a-14(a)/15d-14(a) (Filed herewith).
32 Certifications required by Rule 13a-14(b) or Rule 15d-14(b)
and Section 1350 of Chapter 63 of the United States Code
(Filed herewith).
</Table>
THE COMPANY WILL FURNISH TO ITS STOCKHOLDERS A COPY OF ANY OF THE ABOVE
EXHIBITS NOT INCLUDED HEREIN UPON THE WRITTEN REQUEST OF SUCH STOCKHOLDER AND
THE PAYMENT TO THE COMPANY OF THE REASONABLE EXPENSES INCURRED BY THE COMPANY IN
FURNISHING SUCH COPY OR COPIES.
75
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MASCO CORPORATION
BY /s/ TIMOTHY WADHAMS
------------------------------------
TIMOTHY WADHAMS
Senior Vice President and Chief
Financial Officer
March 2, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.
<Table>
PRINCIPAL EXECUTIVE OFFICER:
/s/ RICHARD A. MANOOGIAN Chairman of the Board and Chief
- -------------------------------------- Executive Officer
Richard A. Manoogian
PRINCIPAL FINANCIAL OFFICER AND
PRINCIPAL ACCOUNTING OFFICER:
/s/ TIMOTHY WADHAMS Senior Vice President and Chief
- -------------------------------------- Financial Officer
Timothy Wadhams
/s/ DENNIS W. ARCHER Director
- --------------------------------------
Dennis W. Archer
/s/ THOMAS G. DENOMME Director
- --------------------------------------
Thomas G. Denomme
/s/ PETER A. DOW Director
- --------------------------------------
Peter A. Dow
/s/ ANTHONY F. EARLEY, JR. Director March 2, 2006
- --------------------------------------
Anthony F. Earley, Jr.
/s/ VERNE G. ISTOCK Director
- --------------------------------------
Verne G. Istock
/s/ DAVID L. JOHNSTON Director
- --------------------------------------
David L. Johnston
/s/ J. MICHAEL LOSH Director
- --------------------------------------
J. Michael Losh
/s/ MARY ANN VAN LOKEREN Director
- --------------------------------------
Mary Ann Van Lokeren
</Table>
76
MASCO CORPORATION
SCHEDULE II. VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
<Table>
<Caption>
(IN MILLIONS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- ---------------------------------------- ---------- ------------------------ ---------- ----------
ADDITIONS
------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- ---------------------------------------- ---------- ---------- ---------- ---------- ----------
(A) (B)
Allowance for doubtful accounts,
deducted from accounts receivable in
the balance sheet:
2005............................... $82 $13 $(5) $(12) $78
=== === === ==== ===
2004............................... $84 $19 $(6) $(15) $82
=== === === ==== ===
2003............................... $69 $23 $(2) $ (6) $84
=== === === ==== ===
</Table>
(a) Allowance of companies acquired and companies disposed of, net.
(b) Deductions, representing uncollectible accounts written off, less
recoveries of accounts written off in prior years.
77
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER
-------
3.i Restated Certificate of Incorporation of Masco Corporation
and amendments thereto (Filed herewith).
3.ii Bylaws of Masco Corporation, as amended December 5, 2001
(Incorporated by reference to Exhibit 3.ii of Masco's 2002
Form 10-K filed 3-14-2003).
4.a.i Indenture dated as of December 1, 1982 between Masco
Corporation and Morgan Guaranty Trust Company of New York,
as Trustee (Incorporated by reference to Exhibit 4.a of
Masco's 2001 Form 10-K filed 3-28-2002), and Directors'
resolutions establishing Masco Corporation's:
(i) 7 1/8% Debentures Due August 15, 2013 (Incorporated by
reference to Exhibit 4.a.i of Masco's 2003 Form 10-K filed
2-27-2004);
(ii) 6.625% Debentures Due April 15, 2018 (Incorporated by
reference to Exhibit 4.a.i of Masco's 2003 Form 10-K filed
2-27-2004);
(iii) 5.75% Notes Due October 15, 2008 (Incorporated by
reference to Exhibit 4.a.i of Masco's 2003 Form 10-K filed
2-27-2004); and
(iv) 7 3/4% Debentures Due August 1, 2029 (Incorporated by
reference to Exhibit 4.a.i of Masco's 2004 Form 10-K filed
3-16-2005).
4.a.ii Agreement of Appointment and Acceptance of Successor Trustee
dated as of July 25, 1994 among Masco Corporation, Morgan
Guaranty Trust Company of New York and The First National
Bank of Chicago (Incorporated by reference to Exhibit 4.a.ii
of Masco's 2004 Form 10-K filed 3-16-2005).
4.a.iii Supplemental Indenture dated as of July 26, 1994 between
Masco Corporation and The First National Bank of Chicago
(Incorporated by reference to Exhibit 4.a.iii of Masco's
2004 Form 10-K filed 3-16-2005).
4.b.i Indenture dated as of February 12, 2001 between Masco
Corporation and J.P. Morgan Trust Company, National
Association (successor in interest to Bank One Trust
Company, National Association), as Trustee (Filed herewith)
and Directors' Resolutions establishing Masco Corporation's:
(i) 6 3/4% Notes Due March 15, 2006 (Filed herewith);
(ii) 5 7/8% Notes Due July 15, 2012 (Incorporated by
reference to Exhibit 4.b.i of Masco's 2002 Form 10-K filed
3-14-2003);
(iii) 4 5/8% Notes Due August 15, 2007 (Incorporated by
reference to Exhibit 4.b.i of Masco's 2002 Form 10-K filed
3-14-2003);
(iv) 6 1/2% Notes Due August 15, 2032 (Incorporated by
reference to Exhibit 4.b.i of Masco's 2002 Form 10-K filed
3-14-2003);
(v) Floating Rate Notes Due 2007 (Incorporated by reference
to Exhibit 4.b.i of Masco's 2004 Form 10-K filed 3-16-2005);
and
(vi) 4.80% Notes Due December 15, 2015 (Incorporated by
reference to Exhibit 4.b.i of Masco's 2nd Quarter Form 10-Q
filed 8-04-2005).
4.b.ii First Supplemental Indenture dated as of July 20, 2001 to
the Indenture dated February 12, 2001 by and among Masco
Corporation and J.P. Morgan Trust Company, National
Association (successor in interest to Bank One Trust
Company, National Association), as Trustee, relating to the
Company's Zero Coupon Convertible Senior Notes Due July 20,
2031 (Incorporated by reference to Exhibit 4.a.vi of Masco's
2nd Quarter Form 10-Q filed 8-07-2001), Amendment No. 1
dated as of July 19, 2002 (Incorporated by reference to
Exhibit 4.b of Masco's 2nd Quarter Form 10-Q filed
8-13-2002) and Amendment No. 2 dated as of November 2, 2004
(Incorporated by reference to Exhibit 4 of Masco's 3rd
Quarter Form 10-Q filed 11-04-2004).
</Table>
<Table>
<Caption>
EXHIBIT
NUMBER
-------
4.b.iii Second Supplemental Indenture between Masco Corporation and
J.P. Morgan Trust Company, National Association, as trustee
dated as of December 23, 2004 (including form of Zero Coupon
Convertible Senior Note, Series B due 2031) (Incorporated by
reference to Exhibit 10.1 of Masco's Form 8-K filed
12-23-2004).
4.c U.S. $2 billion 5-Year Revolving Credit Agreement dated as
of November 5, 2004 among Masco Corporation and Masco
Europe, S.a r.l. as borrowers, the banks party thereto, as
lenders, J.P. Morgan Securities Inc. and Citigroup Global
Markets, Inc., as Joint Lead Arrangers and Joint Book
Runners and Citibank, N.A., as Syndication Agent, Sumitomo
Mitsui Banking Corporation, as Documentation Agent, and Bank
One, NA (Main Office Chicago), as Administrative Agent
(Incorporated by reference to Exhibit 4 of Masco's Form 8-K
filed 11-12-2004), as amended by Amendment No. 1 dated
February 10, 2006. (Incorporated by reference to Exhibit 4
of Masco's Form 8-K filed 2-15-06).
NOTE: Other instruments, notes or extracts from agreements
defining the rights of holders of long-term debt of Masco
Corporation or its subsidiaries have not been filed since
(i) in each case the total amount of long-term debt
permitted thereunder does not exceed 10 percent of Masco
Corporation's consolidated assets, and (ii) such
instruments, notes and extracts will be furnished by Masco
Corporation to the Securities and Exchange Commission upon
request.
NOTE: Exhibits 10.a through 10.i constitute the management
contracts and executive compensatory plans or arrangements
in which certain of the Directors and executive officers of
the Company participate.
10.a Masco Corporation 1991 Long Term Stock Incentive Plan (as
amended and restated October 27, 2005) (Filed herewith).
(i) Forms of Restricted Stock Award Agreement for awards
prior to January 1, 2005 (Incorporated by reference to
Exhibit 10.a.i of Masco's 3rd Quarter Form 10-Q filed
11-04-2004) and for awards on and after January 1, 2005
(Incorporated by reference to Exhibit 10.1 of Masco's
Form 8-K filed 1-06-2005);
(ii) Forms of Restoration Stock Option (Incorporated by
reference to Exhibit 10.a.ii of Masco's 3rd Quarter Form
10-Q filed 11-04-2004);
(iii) Forms of Stock Option Grant (Incorporated by reference
to Exhibit 10.a.iii of Masco's 3rd Quarter Form 10-Q filed
11-04-2004);
(iv) Forms of Stock Option Grant for Non-Employee Directors
(Incorporated by reference to Exhibit 10.a.iv of Masco's 3rd
Quarter Form 10-Q filed 11-04-2004); and
(v) Forms of amendment to Award Agreements (Filed herewith).
10.b Masco Corporation 2005 Long Term Stock Incentive Plan
(Incorporated by reference to Exhibit 99.1 of Masco's Form
8-K filed 5-13-2005).
(i) Form of Restricted Stock Award (Filed herewith);
(ii) Form of Stock Option Grant (Filed herewith);
(iii) Form of Restoration Stock Option (Filed herewith); and
(iv) Form of Stock Option Grant for Non-Employee Directors
(Filed herewith).
10.c Forms of Masco Corporation Supplemental Executive Retirement
and Disability Plan. (Filed herewith).
10.d Masco Corporation 2002 Annual Incentive Compensation Plan
(Incorporated by reference to Exhibit 10.d of Masco's 2002
Form 10-K filed 3-14-2003).
10.e Masco Corporation 1997 Non-Employee Directors Stock Plan (as
amended and restated October 27, 2005) (Filed herewith).
(i) Form of Restricted Stock Award Agreement (Filed
herewith);
(ii) Form of Stock Option Grant (Filed herewith); and
(iii) Form of amendment to Award Agreements (Filed
herewith).
10.f Other compensatory arrangements for executive officers
(Filed herewith).
</Table>
<Table>
<Caption>
EXHIBIT
NUMBER
-------
10.g Masco Corporation 2004 Restricted Stock Award Program
(Incorporated by reference to Exhibit 10.b of Masco's 2nd
Quarter Form 10-Q filed 8-5-2004).
10.h Compensation of Directors (Incorporated by reference to
Exhibit 10.o of Masco's 2004 Form 10-K filed 3-16-2005).
10.i Masco Corporation Retirement Benefit Restoration Plan dated
January 1, 1995, as amended October 1, 2004 (Incorporated by
reference to Exhibit 10.p of Masco's 2004 Form 10-K filed
3-16-2005).
10.j Shareholders Agreement by and among MascoTech, Inc. (now
known as Metaldyne Corporation), Masco Corporation, Richard
Manoogian, certain of their respective affiliates and other
co-investors as party thereto, dated as of November 28, 2000
(Filed herewith).
12 Computation of Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends (Filed herewith).
21 List of Subsidiaries (Filed herewith).
23 Consent of Independent Registered Public Accounting Firm
relating to Masco Corporation's Consolidated Financial
Statements and Financial Statement Schedule (Filed
herewith).
31.a Certification by Chief Executive Officer required by Rule
13a-14(a)/15d-14(a) (Filed herewith).
31.b Certification by Chief Financial Officer required by Rule
13a-14(a)/15d-14(a) (Filed herewith).
32 Certifications required by Rule 13a-14(b) or Rule
15d-14(b)and Section 1350 of Chapter 63 of the United States
Code (Filed herewith).
</Table>