UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
For the quarterly period ended June 30, 2014
OR
For the transition period from to
Commission file number 1-35166
FORTUNE BRANDS HOME & SECURITY, INC.
(Exact name of Registrant as specified in its charter)
520 Lake Cook Road, Deerfield, Illinois 60015-5611
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (847) 484-4400
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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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 number of shares outstanding of the registrant’s common stock, par value $0.01 per share, at July 25, 2014 was 158,471,423.
PART I. FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Six and Three Months Ended June 30, 2014 and 2013
(In millions, except per share amounts)
(Unaudited)
Net sales
Cost of products sold
Selling, general and administrative expenses
Amortization of intangible assets
Restructuring charges
Operating income
Interest expense
Other expense, net
Income before income taxes
Income tax provision
Net income
Less: Noncontrolling interests
Net income attributable to Home & Security
Basic earnings per common share
Diluted earnings per common share
Comprehensive income
See notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions)
Assets
Current assets
Cash and cash equivalents
Accounts receivable, net
Inventories
Other current assets
Total current assets
Property, plant and equipment, net of accumulated depreciation
Goodwill
Other intangible assets, net of accumulated amortization
Other assets
Total assets
Liabilities and equity
Current liabilities
Notes payable to banks
Accounts payable
Other current liabilities
Total current liabilities
Long-term debt
Deferred income taxes
Other non-current liabilities
Total liabilities
Commitments and contingencies (see Note 17)
Equity
Home & Security stockholders’ equity
Common stock(a)
Paid-in capital
Accumulated other comprehensive income
Retained earnings
Treasury stock
Total Home & Security stockholders’ equity
Noncontrolling interests
Total equity
Total liabilities and equity
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 2014 and 2013
Operating activities
Non-cash pre-tax expense:
Depreciation
Amortization
Stock-based compensation
Recognition of actuarial losses
Asset impairment charge
Changes in assets and liabilities:
Increase in accounts receivable
Increase in inventories
(Decrease) increase in accounts payable
(Increase) decrease in other assets
Decrease in accrued expenses and other liabilities
Increase in accrued taxes
Net cash (used in) provided by operating activities
Investing activities
Capital expenditures
Proceeds from the disposition of assets
Cost of acquisition, net of cash
Net cash used in investing activities
Financing activities
Increase in short-term debt, net
Issuance of long-term debt
Repayment of long-term debt
Proceeds from the exercise of stock options
Treasury stock purchases(a)
Excess tax benefit from the exercise of stock-based compensation
Dividends to stockholders
Other financing, net
Net cash (used in) provided by financing activities
Effect of foreign exchange rate changes on cash
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
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CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
Balance at December 31, 2012
Comprehensive income:
Other comprehensive income
Stock options exercised
Tax benefit on exercise of stock options
Treasury stock purchase
Dividends ($0.10 per Common share)
Dividends paid to noncontrolling interests
Balance at June 30, 2013
Balance at December 31, 2013
Dividends ($0.12 per Common share)
Balance at June 30, 2014
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation and Principles of Consolidation
References to “Home & Security,” “the Company,” “we,” “our” and “us” refer to Fortune Brands Home & Security, Inc. and its consolidated subsidiaries as a whole, unless the context otherwise requires.
The Company is a leading home and security products company with a portfolio of leading branded products used for residential home repair, remodeling, new construction, security applications and storage.
The condensed consolidated balance sheet as of June 30, 2014, the related condensed consolidated statements of comprehensive income for the six-month and three-month periods ended June 30, 2014 and 2013 and the related condensed consolidated statements of cash flows and equity for the six-month periods ended June 30, 2014 and 2013 are unaudited. In the opinion of management, all adjustments considered necessary for a fair presentation of the results of operations for the interim periods have been included and are of a normal, recurring nature. Interim results may not be indicative of results for a full year.
The condensed consolidated financial statements and notes are presented pursuant to the rules and regulations of the Securities and Exchange Commission and do not contain certain information included in our annual consolidated financial statements and notes. The year-end condensed consolidated balance sheet was derived from the audited financial statements, but does not include all disclosures required by U.S. generally accepted accounting principles (“GAAP”). This Quarterly Report on Form 10-Q should be read in conjunction with the audited consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2013.
2. Recently Issued Accounting Standards
Revenue from Contracts with Customers
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers.” This ASU clarifies the accounting for revenue arising from contracts with customers and specifies the disclosures that an entity should include in its financial statements. The amendment is effective for annual reporting periods beginning after December 15, 2016 (calendar year 2017 for Home & Security). We are assessing the impact the adoption of this standard will have on our financial statements.
Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity
In April 2014, the FASB issued ASU 2014-08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” This ASU changes the definition of discontinued operations and requires expanded disclosures. The amendment is effective for annual periods beginning on or after December 15, 2014 (calendar year 2015 for Home & Security). Early adoption is permitted. We do not expect this standard to have a material effect on our financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. Balance Sheet Information
Supplemental information on our balance sheets is as follows:
Inventories:
Raw materials and supplies
Work in process
Finished products
Total inventories
Property, plant and equipment, gross
Less: accumulated depreciation
Property, plant and equipment, net
4. Acquisition
In June 2013, our Kitchen & Bath Cabinetry business acquired 100% of the voting equity of Woodcrafters Home Products Holding, LLC (“WoodCrafters”), a manufacturer of bathroom vanities and tops for a purchase price of $302 million. We paid the purchase price using a combination of cash on hand and borrowings under our existing credit facilities. This acquisition greatly expanded our offerings of bathroom cabinetry products. Net sales and operating income of WoodCrafters in the second quarter of 2014 were approximately $50 million and $7 million, respectively, and in the first six months of 2014 were approximately $100 million and $12 million, respectively.
The following table summarizes the final allocation of the purchase price to fair values of assets acquired and liabilities assumed as of the date of the acquisition.
Accounts receivable
Property, plant and equipment
Identifiable intangible assets
Other liabilities and accruals
Net assets acquired
Goodwill primarily represents expected supply chain synergies. Identifiable intangible assets primarily consisted of customer relationships ($75.9 million) and technology ($9.6 million). The useful lives of these identifiable intangible assets are 18 years and 10 years, respectively.
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5. Goodwill and Identifiable Intangible Assets
We had goodwill of $1,520.6 million as of June 30, 2014. The change in the net carrying amount of goodwill by segment was as follows:
Goodwill at December 31, 2013 (a)
Year-to-date translation adjustments
Acquisition-related adjustments
Goodwill at June 30, 2014 (a)
Amortizable identifiable intangible assets, principally tradenames and customer relationships, are subject to amortization over their estimated useful life, 5 to 30 years, based on the assessment of a number of factors that may impact useful life. These factors include historical and tradename performance with respect to consumer name recognition, geographic market presence, market share, plans for ongoing tradename support and promotion, and other relevant factors.
The gross carrying value and accumulated amortization by class of intangible assets as of June 30, 2014 and December 31, 2013 were as follows:
Indefinite-lived tradenames
Amortizable intangible assets
Tradenames
Customer and contractual relationships
Patents/proprietary technology
Total
Total identifiable intangibles
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5. Goodwill and Identifiable Intangible Assets (Continued)
In the first half of 2014, no events or circumstances occurred that would have required us to perform interim impairment tests of goodwill or indefinite-lived intangible assets. As of December 31, 2013, the fair value of each of our reporting units except for one of the reporting units in the Advanced Material Doors & Windows segment exceeded the carrying value by a substantial margin. The estimated excess fair value of this reporting unit was less than 10%. In addition, for one of the tradenames within this reporting unit, fair value exceeded its carrying value by less than 10%. Accordingly, a reduction in the estimated fair value of this reporting unit or tradename could trigger an impairment. As of June 30, 2014, the book values of the goodwill of this reporting unit and this tradename were $86.1 million and $58.4 million, respectively.
The events and/or circumstances that could have a potential negative effect on the estimated fair value of our reporting units and indefinite-lived tradenames include: actual new construction and repair and remodel growth rates that lag our assumptions, actions of key customers, volatility of discount rates, continued economic uncertainty, higher levels of unemployment, weak consumer confidence, and lower levels of discretionary consumer spending. In addition, future decisions we could make with regard to acquisitions and divestitures could trigger a requirement to measure certain assets as held for sale with the resulting change in measurement standard potentially triggering impairments. While our cash flow projections used to assess impairment of our goodwill and other intangible assets held for use are influenced by a number of variables, they are most significantly influenced by our projection for the continued recovery of the U.S. home products markets in the next three years and our ability to execute on various planned cost reduction initiatives supporting operating income improvements forecasted to occur over the next three years. We evaluate our projection of the U.S. home products market periodically and in connection with our annual operating plans finalized in the fourth quarter of each year. The U.S. home products market is highly dependent on U.S. new home construction and the rate of spending on repair and remodel activities. Our projection for the U.S. home products markets is inherently subject to a number of uncertain factors, such as employment, home prices, credit availability, and the rate of home foreclosures. Significant changes in these and other factors could cause us to change our cash flow projections in future periods which could trigger impairment of goodwill or indefinite-lived intangible assets in the period in which such changes occur.
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6. External Debt and Financing Arrangements
We have a $650 million committed revolving credit facility, as well as a $350 million term loan, both of which expire in July 2018. On June 30, 2014 and December 31, 2013, our outstanding borrowings under these facilities were $595.0 million and $350.0 million, respectively. The interest rates under these facilities are variable based on LIBOR at the time of the borrowing and the Company’s leverage as measured by a debt to Adjusted EBITDA ratio. Based upon the Company’s debt to Adjusted EBITDA ratio at June 30, 2014, the Company’s borrowing rate could range from LIBOR + 1.0% to LIBOR + 2.0%. As of June 30, 2014, we were in compliance with all covenants under these facilities.
At June 30, 2014 and December 31, 2013, there were $10.1 million and $6.0 million of external short-term borrowings outstanding, respectively, comprised of notes payable to banks that are used for general corporate purposes. These amounts pertained to uncommitted bank lines of credit in China and India, which provide for unsecured borrowings for working capital of up to $22.7 million in aggregate, as of June 30, 2014 and December 31, 2013. The weighted-average interest rates on these borrowings were 7.2% and 12.4% in the six-month periods ended June 30, 2014 and 2013, respectively. The weighted-average interest rates on these borrowings were 5.3% and 12.6% in the three-month periods ended June 30, 2014 and 2013, respectively.
7. Financial Instruments
We do not enter into financial instruments for trading or speculative purposes. We principally use financial instruments to reduce the impact of changes in foreign currency exchange rates and commodities used as raw materials in our products. The principal derivative financial instruments we enter into on a routine basis are foreign exchange contracts. Derivative financial instruments are recorded at fair value. The counterparties to derivative contracts are major financial institutions. Management currently believes that the risk of incurring material losses is unlikely and that the losses, if any, would be immaterial to the Company. In addition, from time to time, we enter into commodity swaps.
Our primary foreign currency hedge contracts pertain to the Canadian dollar, the Chinese yuan and the Mexican peso. The gross U.S. dollar equivalent notional amount of all foreign currency derivative hedges outstanding at June 30, 2014 was $259.3 million, representing a net settlement liability of $3.0 million. Based on foreign exchange rates as of June 30, 2014, we estimate that $2.4 million of net foreign currency derivative gains included in other comprehensive income as of June 30, 2014 will be reclassified to earnings within the next twelve months.
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7. Financial Instruments (Continued)
The fair values of derivative instruments on the consolidated balance sheets as of June 30, 2014 and December 31, 2013 were:
Location
Foreign exchange contracts
Net investment hedges
Liabilities
Commodity contracts
The effects of derivative financial instruments on the statements of comprehensive income for the six and three months ended June 30, 2014 and 2013 were:
Type of hedge
Cash flow
Fair value
The effective portion of cash flow hedges recognized in other comprehensive income were net (losses) gains of $(2.9) million and $2.3 million in the six months ended June 30, 2014 and 2013, respectively. The effective portion of cash flow hedges recognized in other comprehensive income were net (losses) gains of $(2.5) million and $0.7 million in the three months ended June 30, 2014 and 2013, respectively. In the six and three months ended June 30, 2014 and 2013, the ineffective portion of cash flow hedges recognized in other expense, net, was insignificant.
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8. Fair Value Measurements
Assets and liabilities measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013 were as follows:
Derivative financial instruments (level 2)
Deferred compensation program assets (level 1)
The principal derivative financial instruments we enter into on a routine basis are foreign exchange contracts. In addition, from time to time, we enter into commodity swaps. Derivative financial instruments are recorded at fair value.
ASC requirements for Fair Value Measurements and Disclosures establish a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels. Level 1 inputs, the highest priority, are quoted prices in active markets for identical assets or liabilities. Level 2 inputs reflect inputs other than quoted prices included in Level 1 that are either observable directly or through corroboration with observable market data. Level 3 inputs are unobservable inputs, due to little or no market activity for the asset or liability, such as internally-developed valuation models. We do not have any assets or liabilities measured at fair value on a recurring basis that are Level 3.
The carrying value of the Company’s long-term debt as of June 30, 2014 and December 31, 2013 of $595.0 million and $350.0 million, respectively, approximated fair value. The fair value of the Company’s long-term debt was determined primarily by using broker quotes, which are Level 2 inputs.
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9. Defined Benefit Plans
The components of net periodic benefit cost (income) for pension and postretirement benefits for the six and three months ended June 30, 2014 and 2013 were as follows:
Service cost
Interest cost
Expected return on plan assets
Recognition of prior service credits
Net periodic benefit cost (income)
In the first quarter of 2014, we communicated our decision to amend certain postretirement benefits to reduce health benefits for certain current and retired employees. The impact of these changes was a reduction in accrued retiree benefit plan liabilities of $14.7 million and we recorded actuarial losses of $0.6 million and prior service credits of $3.7 million. In the first quarter of 2013, we communicated our decision to amend certain postretirement benefit plans to reduce health benefits for certain current and retired employees and as a result we recognized actuarial losses of $4.6 million in the first quarter of 2013. Liability reductions from these plan amendments are recorded as amortization of prior service cost in net income in accordance with accounting requirements. See Note 16, “Accumulated Other Comprehensive Income,” for information on the impact on accumulated other comprehensive income.
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10. Income Taxes
The effective income tax rates for the six months ended June 30, 2014 and 2013 were 30.7% and 33.9%, respectively. The effective income tax rate for 2014 was favorably impacted by the release of valuation allowances related to state net operating loss carryforwards and by the tax benefit associated with the anticipated year-over-year increase of the Domestic Production Activity (Internal Revenue Code Section 199) deduction. The effective income tax rate in 2013 was unfavorably impacted by an increase in the valuation allowance related to an investment impairment charge for which we could not record an income tax benefit and favorably impacted by the tax benefits associated with the extension of the U.S. research and development credit under The American Taxpayer Relief Act of 2012.
The effective income tax rates for the three months ended June 30, 2014 and 2013 were 30.0% and 35.0%, respectively. The effective income tax rate for 2014 was favorably impacted by the release of valuation allowances related to state net operating loss carryforwards and by the tax benefit associated with the anticipated year-over-year increase of the Domestic Production Activity (Internal Revenue Code Section 199) deduction. The effective income tax rate in 2013 was unfavorably impacted by an increase in the valuation allowance related to an investment impairment charge for which we could not record an income tax benefit.
It is reasonably possible that, within the next 12 months, total unrecognized tax benefits may decrease in the range of $2 million to $6 million, primarily as a result of the conclusion of pending U.S. federal, state and foreign income tax proceedings.
11. Product Warranties
We generally record warranty expense at the time of sale. We offer our customers various warranty terms based on the type of product that is sold. Warranty expense is determined based on historic claim experience and the nature of the product category. The following table summarizes activity related to our product warranty liability for the six months ended June 30, 2014 and 2013, respectively.
Reserve balance at January 1,
Provision for warranties issued
Settlements made (in cash or in kind)
Reserve balance at June 30,
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12. Information on Business Segments
Net sales and operating income for the six months ended June 30, 2014 and 2013 by segment were as follows:
Net Sales
Kitchen & Bath Cabinetry
Plumbing & Accessories
Advanced Material Windows & Door Systems
Security & Storage
Operating Income
Less: Corporate expenses
Corporate expenses
General and administrative expense
Defined benefit plan costs
Total Corporate expenses
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12. Information on Business Segments (Continued)
Net sales and operating income for the three months ended June 30, 2014 and 2013 by segment were as follows:
13. Other Expense, Net
The components of other expense, net, were as follows:
Other
Total other expense, net
In the second quarter of 2013, we recorded a $6.2 million impairment charge pertaining to a cost method investment due to an other-than-temporary decline in the fair value of the investment. As a result of the impairment, the carrying value of the investment has been reduced to zero and the Company is not subject to further impairment or funding obligations with regard to this investment.
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14. Restructuring and Other Charges
Pre-tax restructuring and other charges for the six and three months ended June 30, 2014 and 2013 are shown below.
Corporate
Restructuring and other charges in the first six months of 2014 resulted from product line rationalization in the storage product line within our Security & Storage segment and severance charges in Corporate, partially offset by a benefit from release of a foreign currency gain associated with the dissolution of a foreign entity in the Plumbing & Accessories segment. The Company’s restructuring liability was not material as of June 30, 2014 and December 31, 2013.
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15. Earnings Per Share
The computations of earnings per common share were as follows:
Basic average shares outstanding
Stock-based awards
Diluted average shares outstanding
Antidilutive stock-based awards excluded from weighted-average number of shares outstanding for diluted earnings per share
16. Accumulated Other Comprehensive Income
Total accumulated other comprehensive income consists of net income and other changes in business equity from transactions and other events from sources other than shareholders. It includes currency translation gains and losses, unrealized gains and losses from derivative instruments designated as cash flow hedges, and defined benefit plan adjustments. The components of and changes in accumulated other comprehensive income, net of tax, were as follows:
Amounts classified into accumulated other comprehensive income
Amounts reclassified from accumulated other comprehensive income
Net current-period other comprehensive income
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16. Accumulated Other Comprehensive Income (Continued)
The reclassifications out of accumulated other comprehensive income for the three and six months ended June 30, 2014 and 2013 were as follows:
Details about Accumulated Other
Comprehensive Income Components
Gains on cash flow hedges
Defined benefit plan items
Recognition of prior service cost
Total reclassifications for the period
(Loss) gain on cash flow hedges
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17. Contingencies
Litigation
We are defendants in lawsuits associated with the normal conduct of our businesses and operations. It is not possible to predict the outcome of the pending actions, and, as with any litigation, it is possible that these actions could be decided unfavorably to the Company. The Company believes that there are meritorious defenses to these actions and that these actions will not have a material effect upon our results of operations, cash flows or financial condition, and where appropriate, these actions are being vigorously contested.
Environmental
Compliance with federal, state and local laws regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, did not have a material effect on capital expenditures, earnings or the competitive position of Home & Security during the six months ended June 30, 2014 and 2013. We are involved in remediation activities to clean up hazardous wastes as required by federal and state laws. Liabilities for remediation costs of each site are based on our best estimate of undiscounted future costs, excluding possible insurance recoveries or recoveries from other third parties. Uncertainties about the status of laws, regulations, technology and information related to individual sites make it difficult to develop estimates of environmental remediation exposures.
18. Subsequent Event
On July 29, 2014, the Company acquired Sentry Safe, a leading manufacturer of personal safes with estimated annual sales of $150 million, for a purchase price of $117.5 million in cash, subject to certain post-closing adjustments. The purchase price was funded from existing credit facilities. This acquisition broadens our product offering within our Master Lock business. An allocation of the purchase price will be completed after asset and liability valuations are finalized. Final adjustments will reflect the fair value assigned to the assets, including intangible assets, and assumed liabilities.
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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and the notes thereto, which are included in this report, as well as our audited consolidated financial statements for the year ended December 31, 2013, which are included in our Annual Report on Form 10-K for the year ended December 31, 2013.
This discussion contains forward-looking statements that are made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934 (the “Exchange Act”), as amended, regarding business strategies, market potential, future financial performance, our raw material costs, the activities of our competitors and other matters. Statements preceded by, followed by or that otherwise include the words “believes,” “expects,” “anticipates,” “intends,” “projects,” “estimates,” “plans” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” “may” and “could” are generally forward-looking in nature and not historical facts. The forward-looking statements are not historical facts, but rather are based on expectations, estimates, assumptions and projections about our industry, business and future financial results, based on information available at the time this report is filed with the Securities and Exchange Commission, or with respect to any document incorporated by reference, available as of the time such document was prepared. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including but not limited to: (i) by our reliance on the North American home improvement, repair and new home construction activity levels, (ii) the North American and global economies, (iii) risk associated with entering into potential strategic acquisitions and integrating acquired property, (iv) our ability to remain competitive, innovative and protect our intellectual property, (v) our reliance on key customers and suppliers, (vi) the cost and availability associated with our supply chains and the availability of raw materials, (vii) risk of increases in our postretirement benefit-related costs and funding requirements, (viii) compliance with tax, environmental and federal, state and international laws and industry regulatory standards and (ix) the risk of doing business internationally. These and other factors are discussed in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2013. We undertake no obligation to, and expressly disclaim any such obligation to, update or clarify any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events, new information or changes to future results over time or otherwise, except as required by law.
OVERVIEW
References to “Home & Security,” “the Company,” “we,” “our” and “us” refer to Fortune Brands Home & Security, Inc. and its consolidated subsidiaries as a whole, unless the context otherwise requires. The Company is a leader in home and security products focused on the design, manufacture and sale of market-leading branded products in the following categories: kitchen and bath cabinetry, plumbing and accessories, advanced material windows products and entry door systems and security and storage products.
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OVERVIEW (Continued)
We believe the Company has certain competitive advantages including market-leading brands, a diversified mix of channels, and lean and flexible supply chains, as well as a tradition of strong innovation and customer service. We are focused on outperforming our markets in growth, profitability and returns in order to drive increased shareholder value. We believe the Company’s track record reflects the long-term attractiveness and potential of our categories and our leading brands. As consumer demand and the housing market improve from current levels, we expect the benefits of operating leverage and strategic spending will help us continue to achieve profitable organic growth.
We believe our most attractive opportunities are to invest in profitable organic growth initiatives. We also believe that as the market continues to improve, we have the potential to generate additional growth from leveraging our cash flow and balance sheet strength by pursuing accretive strategic acquisitions and returning cash to shareholders through a combination of dividends and repurchases under our share repurchase programs as explained in further detail under “Liquidity and Capital Resources” below.
The U.S. market for our home products consists of spending on both new home construction and repair and remodel activities within existing homes, with the substantial majority of the markets we serve consisting of repair and remodel spending. We believe that the U.S. market for our home products is in the early stages of a multi-year recovery and that continued improvement will largely depend on consumer confidence, employment, home prices and credit availability. Over the long term, we believe that the U.S. home products market will benefit from favorable population and immigration trends, which will drive demand for new housing units, and from aging existing housing stock that will continue to need to be repaired and remodeled.
We may be impacted by fluctuations in raw material and transportation costs and promotional activity among our competitors. We strive to offset the potential unfavorable impact of these items with productivity initiatives and price increases.
On July 29, 2014, the Company acquired Sentry Safe, a leading manufacturer of personal safes with estimated annual sales of $150 million, for a purchase price of $117.5 million in cash, subject to certain post-closing adjustments. The purchase price was funded from our existing credit facilities. This acquisition broadens our product offering within our Master Lock business. An allocation of the purchase price will be completed after asset and liability valuations are finalized. Final adjustments will reflect the fair value assigned to the assets, including intangible assets, and assumed liabilities.
In June 2013, our Kitchen & Bath Cabinetry business acquired WoodCrafters Home Products Holding, LLC (“WoodCrafters”), a manufacturer of bathroom vanities and tops. The financial results of WoodCrafters are included in the Company’s results of operations and cash flows beginning in the third quarter of 2013.
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RESULTS OF OPERATIONS
Six Months Ended June 30, 2014 Compared To Six Months Ended June 30, 2013
The following discussion of consolidated results of operations and segment results refers to the six months ended June 30, 2014 compared to the six months ended June 30, 2013. Consolidated results of operations should be read in conjunction with segment results of operations.
Net sales increased $178.0 million, or 9%. The increase was due to the benefit of the acquisition of WoodCrafters (approximately $100 million), higher sales volume primarily from the continuing improvement in U.S. market conditions for home products and price increases to help mitigate material cost increases. These increases were partially offset by the impact of extreme weather in certain regions of the U.S. during the first quarter of 2014 and approximately $10 million of unfavorable foreign exchange.
Cost of products sold increased $140.1 million, or 11%, due to higher sales volume, higher costs associated with manufacturing capacity increases to support long-term growth and inefficiencies related to extreme weather in the first quarter of 2014. These cost increases were partially offset by the benefit of productivity improvements.
Selling, general and administrative expenses decreased $2.5 million due to the timing of spending and lower employee-related costs, partially offset by higher volume-related costs.
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RESULTS OF OPERATIONS (Continued)
Amortization of intangible assets increased $2.9 million due to amortization of identifiable intangible assets associated with the WoodCrafters acquisition.
Restructuring charges of $3.1 million in the six months ended June 30, 2014 related to product line rationalization in the storage product line within our Security & Storage segment in the first quarter of 2014 and Corporate severance charges in the second quarter, partially offset by a benefit from a foreign currency gain associated with dissolution of a foreign entity in the Plumbing & Accessories segment. Restructuring charges of $1.2 million in the six months ended June 30, 2013 related to supply chain initiatives.
Operating income increased $35.6 million, or 22%, primarily due to higher sales volume from our growth initiatives and improving U.S. home products market conditions, benefit from the WoodCrafters acquisition (approximately $12 million) and lower selling, general and administrative expenses. Operating income was unfavorably impacted by planned costs associated with manufacturing capacity increases to support long-term growth, as well as inefficiencies resulting from extreme weather in the first quarter of 2014.
Interest expense increased $0.6 million due to higher average borrowings, partially offset by lower average interest rates.
Other expense, net, was $0.3 million in the six months ended June 30, 2014, compared to $5.9 million in the six months ended June 30, 2013. The decrease of $5.6 million was due to a $6.2 million impairment charge pertaining to a cost method investment in 2013.
Income taxes
Noncontrolling interest was $0.7 million and $0.4 million in the six months ended June 30, 2014 and 2013, respectively.
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Net income attributable to Home & Security was $134.1 million in the six months ended June 30, 2014 compared to $101.3 million in the six months ended June 30, 2013. The increase of $32.8 million was primarily due to higher operating income, a decrease in other expense, net, and the impact of the lower effective income tax rate.
Results By Segment
Net sales increased $141.1 million, or 19%, due primarily to the benefit of the acquisition of WoodCrafters and strength in repair and remodel market volume. Net sales also benefited from price increases to help mitigate raw material cost increases and favorable product mix. Net sales were unfavorably affected by extreme weather in certain regions of the U.S. during the first quarter of 2014 and approximately $5 million of unfavorable foreign exchange.
Operating income increased $16.3 million, or 33%, due to the acquisition of WoodCrafters. Operating income also benefited from price increases to help mitigate raw material cost increases (wood-related), productivity improvements and improved product mix. Operating income was unfavorably impacted by higher costs associated with manufacturing capacity increases to support long-term growth and operating inefficiencies caused by extreme weather in certain regions of the U.S. in the first quarter of 2014.
Net sales increased $18.5 million, or 3%, due to higher sales volume in the U.S. driven primarily by improving U.S. market conditions, price increases to help mitigate raw material cost increases and approximately $10 million in higher international sales including China and Canada. These benefits were partially offset by the adverse impact of weather in certain regions of the U.S. in the first quarter of 2014 and approximately $5 million of unfavorable foreign exchange.
Operating income increased $16.5 million, or 15%, due to higher sales volume, cost saving initiatives, and lower selling, general and administrative expenses due to the timing of spending. These benefits were partially offset by planned strategic and supply chain initiatives to increase capacity for long-term growth and the impact of extreme weather in certain regions of the U.S. in the first quarter of 2014.
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Net sales increased $22.2 million, or 7%, due to higher sales volume driven primarily by improved conditions in the U.S. home products market and price increases to help mitigate raw material cost increases, partially offset by the adverse impact of extreme weather in certain regions of the U.S in the first quarter of 2014. Net sales of door systems grew $17.0 million, or 10%, and net sales of window products increased $5.2 million, or 4%.
Operating income increased $6.1 million in the first half of 2014 to $7.4 million, compared to $1.3 million in the same period of 2013, due to higher sales volume. Operating income also benefited from price increases to help mitigate raw material cost increases and cost savings initiatives. These benefits were partially offset by higher costs related to planned capacity investments and inefficiencies from extreme weather in the first quarter of 2014.
Net sales decreased $3.8 million, or 1%. Net sales of storage products were down $8.3 million, or 12%, due to the timing of new product introductions, lower overall demand for tool storage and the exit from some lower margin storage product lines. Net sales of security products increased $4.5 million, or 2%, due to higher sales volume.
Operating income decreased $9.0 million, or 23%, due to higher raw material costs, $2.2 million in restructuring and other charges primarily related to product line rationalization in the storage product line, lower sales of storage products, and higher selling and administrative expenses to support long-term growth in security products. Operating income benefited from higher sales volume of security products.
Corporate expenses decreased $5.7 million due to lower actuarial losses ($4.8 million) recognized in the first six months of 2014 compared to 2013. These losses related to defined benefit plan amendments that required a remeasurement of certain postretirement benefit liabilities. General and administrative expenses decreased $1.2 million primarily due to lower consulting expense, employee-related costs and transaction expenses associated with acquisition-related activities.
Defined benefit plan recognition of actuarial losses
In future periods the Company may record in the Corporate segment material expense or income associated with actuarial gains and losses arising from periodic remeasurement of our liabilities for defined benefit plans. At a minimum the Company will remeasure its defined benefit plan liabilities in the fourth quarter of each year. Remeasurements due to plan amendments and settlements may also occur in interim periods during the year. Remeasurement of these liabilities attributable to updating our liability discount rates and expected return on assets may, in particular, result in material income or expense recognition.
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Three Months Ended June 30, 2014 Compared To Three Months Ended June 30, 2013
The following discussion of consolidated results of operations and segment results refers to the three months ended June 30, 2014 compared to the three months ended June 30, 2013. Consolidated results of operations should be read in conjunction with segment results of operations.
Net sales increased $101.8 million, or 10%. The increase was due to higher sales volume primarily from the continuing improvement in U.S. market conditions for home products, the benefit of the acquisition of WoodCrafters (approximately $50 million) and price increases to help mitigate material cost increases, partially offset by unfavorable foreign exchange of approximately $5 million.
Cost of products sold increased $78.4 million, or 12%, due to higher sales volume and higher costs associated with manufacturing capacity increases to support long-term growth, partially offset by the benefit of productivity improvements.
Selling, general and administrative expenses decreased $8.7 million, or 3%, primarily due to the timing of spending and lower employee-related costs.
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Amortization of intangible assets increased $1.5 million due to the amortization of identifiable intangible assets associated with the WoodCrafters acquisition.
Restructuring charges of $0.8 million in the three months ended June 30, 2014 primarily related to Corporate severance costs, partially offset by a benefit from a foreign currency gain associated with dissolution of a foreign entity in the Plumbing & Accessories segment. Restructuring charges of $0.3 million in the three months ended June 30, 2013, related to supply chain initiatives.
Operating income increased $30.1 million, or 28%, primarily due to higher sales volume from our growth initiatives and improving U.S. home products market conditions, as well as benefit from the WoodCrafters acquisition (approximately $7 million) and lower selling, general and administrative expenses. These benefits were partially offset by higher costs associated with manufacturing capacity increases to support long-term growth.
Interest expense increased $0.4 million to $2.1 million due to higher average borrowings, partially offset by lower average interest rates.
Other expense, net, was $0.8 million in the three months ended June 30, 2014, compared to $6.1 million in the three months ended June 30, 2013. The decrease of $5.3 million was primarily due to a $6.2 million impairment charge pertaining to a cost method investment in 2013.
Noncontrolling interest was $0.3 million and $0.2 million in the three months ended June 30, 2014 and 2013.
Net income attributable to Home & Security was $93.3 million in the three months ended June 30, 2014 compared to $64.0 million in the three months ended June 30, 2013. The increase of $29.3 million was primarily due to higher operating income, a decrease in other expense, net and the lower effective income tax rate.
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Net sales increased $75.5 million, or 19%, due primarily to the benefit of the acquisition of WoodCrafters and from strength in repair and remodel market volume. Net sales also benefited from price increases to help mitigate raw material cost increases and favorable product mix.
Operating income increased $10.7 million, or 30%, due to the acquisition of WoodCrafters, the benefit from price increases to help mitigate raw material increases (wood-related), improved product mix and productivity improvements. Operating income was unfavorably impacted by higher costs associated with manufacturing capacity increases to support long-term growth.
Net sales increased $17.5 million, or 5%, due to higher sales volume in the U.S. driven primarily by improving U.S. market conditions and higher sales volume in Canada. Net sales also benefited from price increases to help mitigate raw material cost increases. These benefits were partially offset by $5 million of unfavorable foreign exchange.
Operating income increased $16.2 million, or 29%, due to higher sales volume and lower selling, general and administrative expenses due to the timing of spending. Operating income also benefited from price increases to help mitigate raw material cost increases, cost saving initiatives, and a restructuring and other charges benefit of $1.6 million. These benefits were partially offset by approximately $3 million of unfavorable foreign exchange.
Net sales increased $16.4 million, or 9%, due to higher sales volume driven primarily by improved conditions in the U.S. home products market and the benefit of price increases to help mitigate cost increases. Net sales of door systems grew $11.1 million, or 11%, while net sales of window products were up $5.3 million, or 7%.
Operating income increased $5.3 million, or 54%, due to higher sales volume. Operating income also benefited from price increases to help mitigate raw material cost increases, cost savings initiatives, and the absence of 2013 restructuring charges of $0.7 million. These benefits were partially offset by higher costs related to planned capacity investments.
Net sales decreased $7.6 million, or 5%. Net sales of security products increased $1.3 million, or 1%. Net sales of storage products decreased $8.9 million, or 21%, due to the timing of new product introductions, lower overall demand for tool storage and the exit from some lower margin storage product lines.
Operating income decreased $6.5 million, or 25%, due to lower sales volume in storage products, raw material cost increases and higher selling and administrative expenses to support long-term growth in security products.
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Corporate expenses decreased $4.4 million primarily due to lower employee-related costs, consulting expense and transaction expenses associated with acquisition-related activities.
Defined benefit plan income
LIQUIDITY AND CAPITAL RESOURCES
Our primary liquidity needs are to support working capital requirements, fund capital expenditures and service indebtedness, as well as to finance acquisitions, repurchase shares of our common stock and pay dividends to stockholders, as deemed appropriate. Our principal sources of liquidity have been cash on hand, cash flows from operating activities and availability under our credit facilities. Our operating income is generated by our subsidiaries. There are no restrictions on the ability of our subsidiaries to pay dividends or make other distributions to Home & Security. In 2013, our Board of Directors declared a regular cash dividend of $0.10 per share of our outstanding common stock that was increased to $0.12 per share of our outstanding common stock beginning with the dividend payable in the first quarter of 2014. All future dividends are subject to the approval of our Board of Directors.
In the first half of 2014, we repurchased approximately 6.5 million shares of our outstanding common stock under the Company’s share repurchase programs for $264.8 million. As of June 30, 2014, the Company’s total remaining share repurchase authorization under the remaining programs was $224.5 million. In July 2014, we repurchased 2.9 million shares of our outstanding common stock for $112.4 million. The share repurchase programs do not obligate the Company to repurchase any specific dollar amount or number of shares and may be suspended or discontinued at any time.
In June 2013, our Kitchen & Bath Cabinetry business acquired WoodCrafters, a manufacturer of bathroom vanities and tops, for a purchase price of $302 million, subject to certain post-closing adjustments. The Company paid the purchase price using a combination of cash on hand and borrowings under our existing credit facilities.
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We periodically review our portfolio of brands and evaluate potential strategic transactions to increase shareholder value. However, we cannot predict whether or when we may enter into acquisitions, joint ventures or dispositions, make any purchases of shares of our common stock under our share repurchase programs, or pay dividends, or what impact any such transactions could have on our results of operations, cash flows or financial condition, whether as a result of the issuance of debt or equity securities, or otherwise. Our cash flows from operations, borrowing availability and overall liquidity are subject to certain risks and uncertainties, including those described in the section of our Annual Report on Form 10-K for the year-ended December 31, 2013 entitled “Item 1A. Risk Factors.”
On June 30, 2014, we had cash and cash equivalents of $145.0 million, of which $121.3 million was held at non-U.S. subsidiaries. We manage our global cash requirements considering (i) available funds among the subsidiaries through which we conduct business, (ii) the geographic location of our liquidity needs, and (iii) the cost to access international cash balances. The repatriation of non-U.S. cash balances from certain subsidiaries could have adverse tax consequences as we may be required to pay and record income tax expense on those funds to the extent they were previously considered indefinitely reinvested.
Our operating cash flows are significantly impacted by the seasonality of our business. We typically generate our operating cash flow in the third and fourth quarters of each year.
We have a $650 million committed revolving credit facility, as well as a $350 million term loan, both of which expire in July 2018. Both facilities are to be used for general corporate purposes. On June 30, 2014 and December 31, 2013, our outstanding borrowings under these facilities were $595.0 million and $350.0 million, respectively. The interest rates under these facilities are variable based on LIBOR at the time of the borrowing and the Company’s leverage as measured by a debt to Adjusted EBITDA ratio (as defined in the agreements governing the facilities). Based upon the Company’s debt to Adjusted EBITDA ratio, the Company’s borrowing rate could range from LIBOR + 1.0% to LIBOR + 2.0%. At June 30, 2014, we were in compliance with all covenants under these facilities.
Cash Flows
Below is a summary of cash flows for the six months ended June 30, 2014 and 2013.
Net cash used in operating activities was $30.7 million in the six months ended June 30, 2014 compared to net cash provided of $45.9 million in the six months ended June 30, 2013. The increase in cash used of $76.6 million was primarily due to higher incentive compensation and customer program payments in the first quarter of 2014 compared to 2013 (approximately $35 million in aggregate), as well as higher working capital levels to support higher sales.
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Net cash used in investing activities was $47.5 million in the six months ended June 30, 2014 compared to $330.3 million in the six months ended June 30, 2013. The decrease of $282.8 million was primarily due to the acquisition of Woodcrafters in June 2013.
Net cash used in financing activities was $17.1 million in the six months ended June 30, 2014 compared to net cash provided of $71.9 million in the six months ended June 30, 2013. The increase in cash used of $89.0 million was primarily due to higher stock purchases in 2014 compared to 2013 ($241.5 million), two dividend payments in 2014 compared to one in 2013 (incremental $23.0 million) and lower proceeds from the exercise of stock options ($17.8 million), partially offset by higher net borrowings of $187.8 million.
Pension Plans
Subsidiaries of Home & Security sponsor their respective defined benefit pension plans that are funded by a portfolio of investments maintained within our benefit plan trust. As of December 31, 2013, the fair value of our total pension plan assets was $583.8 million, representing 90% of the accumulated benefit obligation liability. In 2014, we expect to make pension contributions of approximately $10 million. For the foreseeable future, we believe that we have sufficient liquidity to meet the minimum funding that may be required by the Pension Protection Act of 2006.
Foreign Exchange
We have investments in various foreign countries, principally Canada, Mexico, China and France. Therefore, changes in the value of the related currencies affect our financial statements when translated into U.S. dollars.
RECENTLY ISSUED ACCOUNTING STANDARDS
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There have been no material changes in the information provided in the section entitled “Quantitative and Qualitative Disclosures about Market Risk” in our Annual Report on Form 10-K for the year ended December 31, 2013.
(a) Evaluation of Disclosure Controls and Procedures.
The Company’s management has evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.
(b) Changes in Internal Control Over Financial Reporting.
There have not been any changes in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company is in the process of reviewing the internal control structure of acquired businesses and, if necessary, will make appropriate changes as we incorporate our controls and procedures into those recently acquired businesses.
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PART II. OTHER INFORMATION
(a) Other Litigation.
The Company is a defendant in lawsuits associated with the normal conduct of its businesses and operations. It is not possible to predict the outcome of the pending actions, and, as with any litigation, it is possible that these actions could be decided unfavorably to the Company. The Company believes that there are meritorious defenses to these actions and that these actions will not have a material adverse effect upon the Company’s results of operations, cash flows or financial condition, and, where appropriate, these actions are being vigorously contested.
(b) Environmental Matters.
We are subject to laws and regulations relating to the protection of the environment. It is not possible to quantify with certainty the potential impact of actions relating to environmental matters, particularly remediation and other compliance efforts that our subsidiaries may undertake in the future. In our opinion, however, compliance with current environmental protection laws (before taking into account estimated recoveries from third parties) will not have a material adverse effect upon our results of operations, cash flows or financial condition.
There have been no material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013 in the section entitled “Risk Factors.”
Below are the repurchases of common stock by the Company or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) for the three months ended June 30, 2014:
Issuer Purchases of Equity Securities
Three Months Ended
June 30, 2014
April 1 – April 30
May 1 – May 31
June 1 – June 30
Authorization date
Announcement date
Authorization amount of
shares of outstanding
common stock
Expiration date
July 25, 2012
February 25, 2014
June 2, 2014
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SIGNATURE
Pursuant to the requirements 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.
Date: July 31, 2014
/s/ E. Lee Wyatt, Jr.
(Duly authorized officer and principal financial
officer of the Registrant)
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EXHIBIT INDEX
Exhibit
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