filings.toolsItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
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The financial and business analysis below provides information which we believe is relevant to an assessment and understanding of our consolidated financial position, results of operations and cash flows. This financial and business analysis should be read in conjunction with the consolidated financial statements and related notes.
The following discussion and certain other sections of this Report contain statements reflecting our views about our future performance and constitute "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as "anticipate," "intend," "plan," "believe," "estimate," "expect," "assume," "seek," "appear," "may," "should," "will," "forecast" and similar references to future periods. These views involve risks and uncertainties that are difficult to predict and, accordingly, our actual results may differ materially from the results discussed in such forward-looking statements. We caution you against relying on any of these forward-looking statements. In addition to the various factors included in the "Executive Level Overview," "Critical Accounting Policies and Estimates" and "Outlook for the Company" sections, our future performance may be affected by our reliance on new home construction and home improvement, our reliance on key customers, the cost and availability of raw materials, shifts in consumer preferences and purchasing practices, our ability to improve our underperforming businesses and our ability to maintain our competitive position in our industries. These and other factors are discussed in detail in Item 1A "Risk Factors" of this Report. Any forward-looking statement made by us speaks only as of the date on which it was made. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. Unless required by law, we undertake no obligation to update publicly any forward-looking statements as a result of new information, future events or otherwise.
Executive Level Overview
We manufacture, distribute and install home improvement and building products. These products are sold for home improvement and new home construction through mass merchandisers, hardware stores, home centers, homebuilders, distributors and other outlets for consumers and contractors and direct to the consumer.
2013 Results. Net sales were positively affected by increased new home construction and repair and remodel activity in the U.S. and Europe. Our results of operations were positively affected by increased sales volume and the related absorption of fixed costs, as well as a more favorable relationship between selling prices and commodity costs. Also, all of our businesses were positively affected by the benefits associated with the business rationalizations and process improvement initiatives that we have implemented over the last several years.
Our Cabinets and Related Products segment was affected by increased sales volume and selling prices, partially offset by a less favorable product mix. Our Plumbing Products segment results were favorably affected by increased sales volume and increased selling prices of our North American and International operations, partially offset by the loss of a portion of our bath products business. The Decorative Architectural Products segment was affected by increased sales volume, partially offset by a less favorable relationship between selling prices and commodity costs. The Installation and Other Services and Other Specialty Products segments were positively affected by increased sales volume and increased selling prices.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these financial statements requires us to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of any contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We regularly review our estimates and assumptions, which are based upon historical experience, as well as current economic conditions and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of certain assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and assumptions.
We believe that the following critical accounting policies are affected by significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition and Receivables
We recognize revenue as title to products and risk of loss is transferred to customers or when services are rendered. We record revenue for unbilled services performed based upon estimates of material and labor incurred in the Installation and Other Services segment; such amounts are recorded in Receivables. We record estimated reductions to revenue for customer programs and incentive offerings, including special pricing and co-operative advertising arrangements, promotions and other volume-based incentives. We maintain allowances for doubtful accounts receivable for estimated losses resulting from the inability of customers to make required payments. In addition, we monitor our customer receivable balances and the credit worthiness of our customers on an on-going basis. During downturns in our markets, declines in the financial condition and creditworthiness of customers impact the credit risk of the receivables involved and we have incurred bad debt expense related to customer defaults. Our bad debt expense was $8 million, $14 million and $12 million for the years ended December 31, 2013, 2012 and 2011, respectively.
Inventories
We record inventories at the lower of cost or net realizable value, with expense estimates made for obsolescence or unsaleable inventory equal to the difference between the recorded cost of inventories and their estimated market value based upon assumptions about future demand and market conditions. On an on-going basis, we monitor these estimates and record adjustments for differences between estimates and actual experience. Historically, actual results have not significantly deviated from those determined using these estimates.
Financial Investments
We follow accounting guidance that defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements for our financial investments and liabilities. This guidance defines fair value as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." Further, it defines a fair value hierarchy, as follows: Level 1 inputs as quoted prices in active markets for identical assets or liabilities; Level 2 inputs as observable inputs other than Level 1 prices, such as quoted market prices for similar assets or liabilities or other inputs that are observable or can be corroborated by market data; and Level 3 inputs as unobservable inputs that are supported by little or no market activity and that are financial instruments whose value is determined using pricing models or instruments for which the determination of fair value requires significant management judgment or estimation.
If applicable, we record investments in available-for-sale securities at fair value, and unrealized gains or losses (that are deemed to be temporary) are recognized, net of tax effect, through shareholders' equity, as a component of other comprehensive income in our consolidated balance sheet.
In the past, we have invested excess cash in auction rate securities. Auction rate securities are investment securities that have interest rates which are reset every 7, 28 or 35 days. At December 31, 2013, our investment in auction rate securities was $22 million; we have not increased our investment in auction rate securities since 2007. The fair value of auction rate securities is estimated, on a recurring basis, using a discounted cash flow model (Level 3 input). If we changed the discount rate used in the fair value estimate by 75 basis points, the value of the auction rate securities would change by approximately $1 million.
We have maintained investments in a number of private equity funds, which aggregated $63 million at December 31, 2013. We carry our investments in private equity funds and other private investments at cost. It is not practicable for us to estimate a fair value for private equity funds and other private investments because there are no quoted market prices, and sufficient information is not readily available for us to utilize a valuation model to determine the fair value for each fund. These investments are evaluated, on a non-recurring basis, for potential other-than-temporary impairment when impairment indicators are present, or when an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of the investment. Due to the significant unobservable inputs, the fair value measurements used to evaluate impairment are a Level 3 input.
Impairment indicators we consider include the following: whether there has been a significant deterioration in earnings performance, asset quality or business prospects; a significant adverse change in the regulatory, economic or technological environment; a significant adverse change in the general market condition or geographic area in which the investment operates; industry and sector performance; current equity and credit market conditions; and any bona fide offers to purchase the investment for less than the carrying value. We also consider specific adverse conditions related to the financial health of and business outlook for the fund, including industry and sector performance. The significant assumptions utilized in analyzing a fund for potential other-than-temporary impairment include current economic conditions, market analysis for specific funds and performance indicators in the applicable sectors.
We have and will continue to reduce our investments in long-term financial assets. At December 31, 2013, we have investments in 14 venture capital funds, with an aggregate carrying value of $15 million. The venture capital funds have invested in start-up or smaller, early-stage established businesses, principally in the information technology, bio-technology and health care sectors. At December 31, 2013, we also have investments in 15 buyout funds, with an aggregate carrying value of $48 million. The buyout funds have invested in later-stage, established businesses and no buyout fund has a concentration in a particular sector.
Since there is no active trading market for these investments, they are for the most part illiquid. These investments, by their nature, can also have a relatively higher degree of business risk, including financial leverage, than other financial investments. The timing of distributions from the funds, which depends on particular events related to the underlying investments, as well as the funds' schedules for making distributions and their needs for cash, can be difficult to predict. As a result, the amount of income we record from these investments can vary substantially from quarter to quarter. Future changes in market conditions, the future performance of the underlying investments or new information provided by private equity fund managers could affect the recorded values of these investments and the amounts realized upon liquidation.
We record an impairment charge to earnings when an investment has experienced a decline in fair value that is deemed to be other-than-temporary.
Goodwill and Other Intangible Assets
We record the excess of purchase cost over the fair value of net tangible assets of acquired companies as goodwill or other identifiable intangible assets. In the fourth quarter of each year, or as events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount, we complete the impairment testing of goodwill utilizing a discounted cash flow method. We selected the discounted cash flow methodology because we believe that it is comparable to what would be used by other market participants. We have defined our reporting units and completed the impairment testing of goodwill at the operating segment level, as defined by accounting guidance. Our operating segments are reporting units that engage in business activities for which discrete financial information, including five-year forecasts, is available.
Determining market values using a discounted cash flow method requires us to make significant estimates and assumptions, including long-term projections of cash flows, market conditions and appropriate discount rates. Our judgments are based upon historical experience, current market trends, consultations with external valuation specialists and other information. While we believe that the estimates and assumptions underlying the valuation methodology are reasonable, different estimates and assumptions could result in different outcomes. In estimating future cash flows, we rely on internally generated five-year forecasts for sales and operating profits, including capital expenditures, and generally a one to three percent long-term assumed annual growth rate of cash flows for periods after the five-year forecast. We generally develop these forecasts based upon, among other things, recent sales data for existing products, planned timing of new product launches, estimated housing starts and estimated repair and remodel activity.
In 2013, we utilized estimated housing starts, from independent industry sources, growing from current levels to 1.5 million units in 2018 (terminal growth year) and operating profit margins improving to approximate historical levels for those business units by 2018 (terminal growth year). We utilize our weighted average cost of capital of approximately 10 percent as the basis to determine the discount rate to apply to the estimated future cash flows. Our weighted average cost of capital increased in 2013 due to improving market conditions and an increased stock price. In 2013, due to improving market conditions and based upon our assessment of the risks impacting each of our businesses, we applied a risk premium to increase the discount rate to a range of 11.5 percent to 13.5 percent for most of our reporting units.
In the fourth quarter of 2013, we estimated that future discounted cash flows projected for all of our reporting units were greater than the carrying values. Any increases in estimated discounted cash flows would have no effect on the reported value of goodwill.
If the carrying amount of a reporting unit exceeds its fair value, we measure the possible goodwill impairment based upon an allocation of the estimate of fair value of the reporting unit to all of the underlying assets and liabilities of the reporting unit, including any previously unrecognized intangible assets (Step Two Analysis). The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. An impairment loss is recognized to the extent that a reporting unit's recorded goodwill exceeds the implied fair value of goodwill.
In 2013, we did not recognize any impairment charges for goodwill.
A 10 percent decrease in the estimated fair value of our reporting units at December 31, 2013 would not have resulted in any additional analysis of goodwill impairment for any additional business unit.
We review our other indefinite-lived intangible assets for impairment annually, in the fourth quarter, or as events occur or circumstances change that indicate the assets may be impaired without regard to the reporting unit. We consider the implications of both external (e.g., market growth, competition and local economic conditions) and internal (e.g., product sales and expected product growth) factors and their potential impact on cash flows related to the intangible asset in both the near- and long-term. In 2013, we did not recognize any impairment charges for other indefinite-lived intangible assets.
Intangible assets with finite useful lives are amortized using the straight-line method over their estimated useful lives. We evaluate the remaining useful lives of amortizable identifiable intangible assets at each reporting period to determine whether events and circumstances warrant a revision to the remaining periods of amortization.
Stock-Based Compensation
Our 2005 Plan provides for the issuance of stock-based incentives in various forms to employees and non-employee Directors. At December 31, 2013, outstanding stock-based incentives were in the form of long-term stock awards, stock options, phantom stock awards and stock appreciation rights.
Long-Term Stock Awards
We grant long-term stock awards to key employees and non-employee Directors and do not cause net share dilution inasmuch as we generally continue the practice of repurchasing and retiring an equal number of shares on the open market. We measure compensation expense for stock awards at the market price of our common stock at the grant date. There was $69 million (8 million common shares) of total unrecognized compensation expense related to unvested stock awards at December 31, 2013, which was included as a reduction of common stock and paid-in capital. We recognize this expense ratably over the shorter of the vesting period of the stock awards, typically five to ten years, or the length of time until the grantee becomes retirement-eligible at age 65. Pre-tax compensation expense for the annual vesting of long-term stock awards was $34 million for 2013.
Stock Options
We grant stock options to key employees. The exercise price equals the market price of our common stock at the grant date. These options generally become exercisable (vest ratably) over five years beginning on the first anniversary from the date of grant and expire no later than ten years after the grant date.
We measure compensation expense for stock options using a Black-Scholes option pricing model. We recognize this compensation expense ratably over the shorter of the vesting period of the stock options, typically five years, or the length of time until the grantee becomes retirement-eligible at age 65. Pre-tax compensation expense for stock options was $13 million for 2013.
We estimated the fair value of stock options at the grant date using a Black-Scholes option pricing model with the following assumptions for 2013: risk-free interest rate – 1.22%, dividend yield – 1.47%, volatility factor – 49.07% and expected option life – six years. For expense calculation purposes, the weighted average grant-date fair value of option shares granted in 2013 was $8.35 per option share.
If we increased our assumptions for the risk-free interest rate and the volatility factor by 50 percent, the expense related to the fair value of stock options granted in 2013 would increase by 42 percent. If we lowered our assumptions for the risk-free interest rate and the volatility factor by 50 percent, the expense related to the fair value of stock options granted in 2013 would decrease by 52 percent.
Employee Retirement Plans
Effective January 1, 2010, we froze all future benefit accruals under substantially all of our domestic qualified and non-qualified defined-benefit pension plans. As a result of this action, the liabilities for these plans were remeasured; in addition, certain assumptions appropriate for on-going plans (e.g., turnover, mortality and compensation increases) have been modified or eliminated for the remeasurement.
Accounting for defined-benefit pension plans involves estimating the cost of benefits to be provided in the future, based upon vested years of service, and attributing those costs over the time period each employee works. We develop our pension costs and obligations from actuarial valuations. Inherent in
these valuations are key assumptions regarding inflation, expected return on plan assets, mortality rates and discount rates for obligations and expenses. We consider current market conditions, including changes in interest rates, in selecting these assumptions. Changes in assumptions used could result in changes to reported pension costs and obligations within our consolidated financial statements.
In December 2013, we increased our discount rate for obligations to an average of 4.40 percent from 3.80 percent. The discount rate for obligations is based upon the expected duration of each defined-benefit pension plan's liabilities matched to the December 31, 2013 Towers Watson Rate Link curve. The discount rates we use for our defined-benefit pension plans ranged from 1.75 percent to 4.80 percent, with the most significant portion of the liabilities having a discount rate for obligations of 4.20 percent or higher. The assumed asset return was primarily 7.25 percent, reflecting the expected long-term return on plan assets.
Our net underfunded amount for our qualified defined-benefit pension plans, which is the difference between the projected benefit obligation and plan assets, decreased to $324 million at December 31, 2013 from $462 million at December 31, 2012, primarily due to increased asset returns, as well as higher rates of return in the bond market in 2013, which decreased our long-term pension liabilities. In accordance with accounting guidance, the underfunded amount has been recognized on our consolidated balance sheets at December 31, 2013 and 2012. Qualified domestic pension plan assets in 2013 had a net gain of 13.6 percent compared to average gains of 12 percent for the InvestorForce Defined Benefit Plan Universe.
Our projected benefit obligation for our unfunded non-qualified defined-benefit pension plans was $163 million at December 31, 2013 compared with $181 million at December 31, 2012. In accordance with accounting guidance, this unfunded amount has been recognized on our consolidated balance sheets at December 31, 2013 and 2012.
At December 31, 2013, we reported a net liability of $487 million, of which $163 million was related to our non-qualified, supplemental retirement plans, which are not subject to the funding requirements of the Pension Protection Act of 2006. In accordance with the Pension Protection Act, the Adjusted Funding Target Attainment Percentage ("AFTAP") for the various defined-benefit pension plans ranges from 74 percent to 82 percent.
We expect pension expense for our qualified defined-benefit pension plans to be $18 million in 2014 compared with $23 million in 2013. If we assumed that the future return on plan assets was one-half percent lower than the assumed asset return and the discount rate decreased by 50 basis points, the 2014 pension expense would increase by $5 million. We expect pension expense for our non-qualified defined-benefit pension plans to be $8 million in 2014 compared with $8 million in 2013.
We anticipate that we will be required to contribute approximately $60 million to $70 million in 2014 to our qualified and non-qualified defined-benefit plans.
Income Taxes
The accounting guidance for income taxes requires that the future realization of deferred tax assets depends on the existence of sufficient taxable income in future periods. Possible sources of taxable income include taxable income in carryback periods, the future reversal of existing taxable temporary differences recorded as a deferred tax liability, tax-planning strategies that generate future income or gains in excess of anticipated losses in the carryforward period and projected future taxable income.
If, based upon all available evidence, both positive and negative, it is more likely than not (more than 50 percent likely) such deferred tax assets will not be realized, a valuation allowance is recorded. Significant weight is given to positive and negative evidence that is objectively verifiable. A company's three-year cumulative loss position is significant negative evidence in considering whether deferred tax assets are realizable and the accounting guidance restricts the amount of reliance we can place on projected taxable income to support the recovery of the deferred tax assets.
In the fourth quarter of 2010, we recorded a $372 million valuation allowance against our U.S. Federal deferred tax assets as a non-cash charge to income tax expense. In reaching this conclusion, we considered the weaker retail sales of certain of our building products and the slower than anticipated recovery in the U.S. housing market which led to U.S. operating losses and significant U.S. goodwill impairment charges, that primarily occurred in the fourth quarter of 2010, causing us to be in a three-year cumulative U.S. loss position.
During 2012 and 2011, objective and verifiable negative evidence, such as U.S. operating losses and significant impairment charges for U.S. goodwill in 2011 and other intangible assets, continued to outweigh positive evidence necessary to reduce the valuation allowance. As a result, we recorded increases of $65 million and $89 million in the valuation allowance related to our U.S. Federal deferred tax assets as a non-cash charge to income tax expense in 2012 and 2011, respectively.
A return to sustainable profitability in the U.S. is required before we would change our judgment regarding the need for a valuation allowance against our deferred tax assets.
Although the recent strengthening in new home construction activity has resulted in profitability in the Company's U.S. operations in 2013, we continue to record a full valuation allowance against the U.S. Federal deferred tax assets as the Company remained in a three-year cumulative loss position throughout 2013.
It is reasonably possible that the continued improvements in our U.S. operations could result in the objective positive evidence necessary to warrant the reversal of all or a portion of the valuation allowance, up to approximately $550 million, as early as the second half of 2014. Until such time, the profits from our U.S. operations will be offset by the net operating loss carryforward resulting in a lower U.S. effective tax rate.
The $175 million and $203 million of deferred tax assets at December 31, 2013 and 2012, respectively, for which there is no valuation allowance recorded, are anticipated to be realized through the future reversal of existing taxable temporary differences recorded as deferred tax liabilities.
Should we determine that we would not be able to realize our remaining deferred tax assets in the future, an adjustment to the valuation allowance would be recorded in the period such determination is made. The need to maintain a valuation allowance against deferred tax assets may cause greater volatility in our effective tax rate.
The current accounting guidance allows the recognition of only those income tax positions that have a greater than 50 percent likelihood of being sustained upon examination by the taxing authorities. We believe that there is an increased potential for volatility in our effective tax rate because this threshold allows changes in the income tax environment and the inherent complexities of income tax law in a substantial number of jurisdictions to affect the computation of our liability for uncertain tax positions to a greater extent.
While we believe we have adequately provided for our uncertain tax positions, amounts asserted by taxing authorities could vary from our liability for uncertain tax positions. Accordingly, additional provisions for tax-related matters, including interest and penalties, could be recorded in income tax expense in the period revised estimates are made or the underlying matters are settled or otherwise resolved.
Other Commitments and Contingencies
Warranty. At the time of sale, we accrue a warranty liability for the estimated cost to provide products, parts or services to repair or replace products in satisfaction of warranty obligations. Our estimate of costs to service our warranty obligations is based upon the information available and includes a number of factors such as the warranty coverage, the warranty period, historical experience specific to the nature, frequency and average cost to service the claim, along with product manufacturing metrics and industry and demographic trends.
Certain factors and related assumptions in determining our warranty liability involve judgments and estimates and are sensitive to changes in the aforementioned factors. We believe that the warranty accrual is appropriate; however, actual claims incurred could differ from the original estimates thereby requiring adjustments to previously established accruals.
A majority of our business is at the consumer retail level through home centers and major retailers. A consumer may return a product to a retail outlet that is a warranty return. However, certain retail outlets do not distinguish between warranty and other types of returns when they claim a return deduction from us. Our revenue recognition policy takes into account this type of return when recognizing revenue, and deductions are recorded at the time of sale.
We are subject to lawsuits and pending or asserted claims in the ordinary course of our business. Liabilities and costs associated with these matters require estimates and judgments based upon our professional knowledge and experience and that of our legal counsel. When estimates of our exposure for lawsuits and pending or asserted claims meet the criteria for recognition under accounting guidance, amounts are recorded as charges to earnings. The ultimate resolution of these exposures may differ due to subsequent developments. See Note U to our consolidated financial statements for information regarding certain of our legal proceedings.
Corporate Development Strategy
Our business strategy includes expanding our product leadership and implementing lean principles and product process improvements across our business units. Going forward, we expect to maintain a balanced growth strategy with emphasis on cash flow, organic growth with fewer acquisitions and growth through new product development and greenfield locations related to certain Installation and Other Services businesses.
As part of our strategic planning, we continue to review all of our businesses to determine which businesses may not be core to our long-term growth strategy.
In early February 2013, we determined that our Danish ready-to-assemble cabinet business was no longer core to our long-term growth strategy and, accordingly, we embarked on a plan for disposition. We completed the disposition of our Danish cabinet business and a related Danish holding company in December 2013.
See Note B to the consolidated financial statements for more information.
Liquidity and Capital Resources
Historically, we have largely funded our growth through cash provided by our operations, long-term bank debt and the issuance of notes in the financial markets, and by the issuance of our common stock, including issuances for certain mergers and acquisitions.
Maintaining high levels of liquidity and focusing on cash generation are among our financial strategies. Our total debt as a percent of total capitalization was 82 percent and 87 percent at December 31, 2013 and 2012, respectively.
On March 28, 2013, the Company entered into a Credit Agreement (the "Credit Agreement") with a bank group, with an aggregate commitment of $1.25 billion and a maturity date of March 28, 2018. Upon entry into the Credit Agreement, the Company's credit agreement dated as of June 21, 2010, as amended, with an aggregate commitment of $1.25 billion, was terminated.
The Credit Agreement contains financial covenants requiring the Company to maintain (A) a maximum debt to total capitalization ratio, as adjusted for certain items, of 65 percent, and (B) a minimum interest coverage ratio, as adjusted for certain items, equal to or greater than 2.5 to 1.0. The debt to total
capitalization ratio allows the add-back, if incurred, of up to the first $250 million of certain non-cash charges, including goodwill and other intangible asset impairment charges, occurring from and after January 1, 2012 that would negatively impact shareholders' equity.
At December 31, 2013, we had additional borrowing capacity, subject to availability, of up to $1.2 billion. Alternatively, at December 31, 2013, we could absorb a reduction to shareholders' equity of approximately $770 million and remain in compliance with the debt to total capitalization covenant. We were in compliance with all Credit Agreement covenants and we had no borrowings under the Credit Agreement at December 31, 2013.
On August 15, 2013, the Company repurchased and retired all of its $200 million, 7.125% Notes on the scheduled retirement date.
We had cash, cash investments and short-term bank deposits of approximately $1.5 billion at December 31, 2013. Our cash and cash investments consist of overnight interest bearing money market demand and time deposit accounts, money market mutual funds containing government securities and treasury obligations. While we attempt to diversify these investments in a prudent manner to minimize risk, it is possible that future changes in the financial markets could affect the security or availability of these investments.
Of the $1.5 billion and the $1.4 billion of cash, cash investments and short-term bank deposits we held at December 31, 2013 and 2012, respectively, $622 million and $572 million, respectively, is held in our foreign subsidiaries. If these funds were needed for our operations in the U.S., their repatriation into the U.S. may result in additional U.S. income taxes or foreign withholding taxes. The amount of such taxes is dependent on the income tax laws and circumstances at the time of distribution.
We have maintained investments in available-for-sale and marketable securities and a number of private equity funds, principally as part of our tax planning strategies, as any gains enhance the utilization of any current and future capital tax losses. Since we have significantly reduced our capital tax losses in part by generating capital gains from investments and other sources, we have and will continue to reduce our investments in long-term financial assets.
We utilize derivative and hedging instruments to manage our exposure to currency fluctuations, primarily related to the European euro and the U.S. dollar; commodity cost fluctuations, primarily zinc and copper; and interest rate fluctuations, primarily related to debt issuances. We review our hedging program, derivative positions and overall risk management on a regular basis.
During 2013, we paid quarterly dividends of $.075 per common share.
Our working capital ratio was 1.9 to 1 and 1.7 to 1 at December 31, 2013 and 2012, respectively. The increase in the working capital ratio is primarily due to the payment of $200 million of 7.125% Notes in August 2013, which were included in current liabilities at December 31, 2012.
Cash Flows
Significant sources and (uses) of cash in the past three years are summarized as follows, in millions:
| 2013 | 2012 | 2011 | ||||||||
| Net cash from operating activities | $ | 645 | $ | 281 | $ | 239 | ||||
| Retirement of notes | (200 | ) | (791 | ) | (58 | ) | ||||
| Issuance of notes, net of issuance costs | — | 396 | — | |||||||
| Payment for settlement of swaps | — | (25 | ) | — | ||||||
| Proceeds from disposition of: | ||||||||||
| Businesses, net of cash disposed | 17 | 9 | — | |||||||
| Property and equipment | 27 | 67 | 24 | |||||||
| Proceeds from financial investments, net | 15 | 40 | 94 | |||||||
| Cash dividends paid | (107 | ) | (107 | ) | (107 | ) | ||||
| Capital expenditures | (126 | ) | (119 | ) | (151 | ) | ||||
| Purchase of Company common stock | (35 | ) | (8 | ) | (30 | ) | ||||
| Decrease in debt, net | (2 | ) | (1 | ) | (5 | ) | ||||
| Dividends paid to noncontrolling interest | (34 | ) | (40 | ) | (18 | ) | ||||
| Proceeds (purchases) of short-term bank deposits, net | 2 | (2 | ) | (23 | ) | |||||
| Acquisition of businesses, net of cash acquired | (7 | ) | — | (10 | ) | |||||
| Effect of exchange rates on cash and cash investments | (3 | ) | 11 | (8 | ) | |||||
| Other, net | (9 | ) | (24 | ) | (19 | ) | ||||
| | | | | | | | | | | |
| Cash increase (decrease) | $ | 183 | $ | (313 | ) | $ | (72 | ) | ||
| | | | | | | | | | | |
| | | | | | | | | | | |
Net cash provided by operations of $645 million consisted primarily of net income adjusted for non-cash and certain other items, including depreciation and amortization expense of $186 million, a $42 million net change in deferred taxes and other non-cash items, including stock-based compensation expense and amortization expense related to in-store displays.
We continue to emphasize balance sheet management, including working capital management and cash flow generation. Days sales in accounts receivable were 46 days and 47 days, respectively, at December 31, 2013 and 2012, and days sales in inventories were 49 days and 52 days at December 31, 2013 and 2012. Accounts payable days were 67 days at December 31, 2013 and 66 days at December 31, 2012. Working capital (defined as accounts receivable and inventories less accounts payable) as a percent of sales was 10.6 percent at December 31, 2013 and 12.1 percent at December 31, 2012.
Net cash used for financing activities was $382 million, primarily due to the retirement of $200 million of 7.125% Notes due August 15, 2013, $107 million for cash dividends paid, $34 million for dividends paid to noncontrolling interest and $35 million for the acquisition of our common stock to generally offset the dilutive impact of long-term stock awards granted in 2013.
At December 31, 2013, we had remaining authorization from our Board of Directors to repurchase up to an additional 22.6 million shares of our common stock in open-market transactions or otherwise. We believe that our present cash balance and cash flows from operations are sufficient to fund our near-term working capital and other investment needs. We believe that our longer-term working capital and other general corporate requirements will be satisfied through cash flows from operations and, to the extent necessary, from bank borrowings and future financial market activities. Consistent with past practice, we anticipate repurchasing shares in 2014 to offset any dilution from long-term stock awards granted or stock options exercised as part of our compensation programs.
Net cash used for investing activities was $77 million, and included $126 million for capital expenditures. Cash provided by investing activities included primarily $27 million of net proceeds from the disposition of property and equipment, $17 million from the disposition of businesses, net and $15 million
from the net sale of financial investments. Investing activities also include net proceeds from the sale of short-term bank deposits of $2 million.
We invest in automating our manufacturing operations to increase our productivity, improve customer service and support new product innovation. Capital expenditures for 2013 were $126 million, compared with $119 million for 2012 and $151 million for 2011. For 2014, capital expenditures, excluding any potential 2014 acquisitions, are expected to be approximately $200 million. Depreciation and amortization expense for 2013 totaled $186 million, compared with $214 million for 2012 and $263 million for 2011, including accelerated depreciation of $13 million, $28 million and $52 million in 2013, 2012 and 2011, respectively. For 2014, depreciation and amortization expense, excluding any potential 2014 acquisitions, is expected to be approximately $175 million. Amortization expense totaled $11 million, $12 million and $17 million in 2013, 2012 and 2011, respectively.
Costs of environmental responsibilities and compliance with existing environmental laws and regulations have not had, nor do we expect them to have, a material effect on our capital expenditures, financial position or results of operations.
Consolidated Results of Operations
We report our financial results in accordance with GAAP in the United States. However, we believe that certain non-GAAP performance measures and ratios, used in managing the business, may provide users of this financial information with additional meaningful comparisons between current results and results in prior periods. Non-GAAP performance measures and ratios should be viewed in addition to, and not as an alternative for, our reported results.
Sales and Operations
Net sales for 2013 were $8.2 billion, which increased nine percent compared with 2012. Excluding results from the acquisition of a small U.K. door business and the favorable effect of currency translation, net sales increased eight percent compared with 2012. The following table reconciles reported net sales to net sales excluding acquisitions and the effect of currency translation, in millions:
| Twelve Months Ended December 31 | |||||||
| 2013 | 2012 | ||||||
| Net sales, as reported | $ | 8,173 | $ | 7,495 | |||
| – Acquisitions | (16 | ) | — | ||||
| | | | | | | | |
| Net sales, excluding acquisitions | 8,157 | 7,495 | |||||
| – Currency translation | (28 | ) | — | ||||
| | | | | | | | |
| Net sales, excluding acquisitions and the effect of currency | $ | 8,129 | $ | 7,495 | |||
| | | | | | | | |
| | | | | | | | |
Net sales for 2013 were positively affected by increased sales volume of North American cabinets (such increase in cabinets was partially offset by a less favorable product mix) installation and other services, plumbing products, paints and stains, builders' hardware and windows, which, in aggregate, increased sales by approximately seven percent compared to 2012. Net sales of International plumbing products and cabinets also increased sales by one percent compared to 2012. Net sales for 2013 were also positively affected by selling prices, which increased sales by approximately one percent. Net sales for 2013 were negatively affected by lower selling prices of paints and stains.
Net sales for 2012 were positively affected by increased sales volume of installed products, North American plumbing products, paints and stains, builders' hardware and windows, which, in aggregate, increased sales by approximately four percent compared to 2011. Net sales for 2012 were also positively
affected by selling price increases, which increased sales by approximately three percent. Net sales for 2012 were negatively affected by the planned exit of certain cabinet and window product lines in certain geographic areas. A stronger U.S. dollar decreased sales by one percent compared to 2011.
Our gross profit margins were 27.6 percent, 26.1 percent and 24.9 percent in 2013, 2012 and 2011, respectively. The 2013 gross profit margin reflects a more favorable relationship between selling prices and commodity costs as well as increased sales volume. The 2012 gross profit margin reflects a more favorable relationship between selling prices and commodity costs as well as increased sales volume. Both 2013 and 2012 reflect the benefits associated with business rationalizations and other cost savings initiatives.
Selling, general and administrative expenses as a percent of sales were 19.4 percent in 2013 compared with 20.5 percent in 2012 and 21.5 percent in 2011. Selling, general and administrative expenses as a percent of sales in 2013 and 2012 reflect increased sales volume and lower business rationalization costs. Both 2013 and 2012 also reflect the benefits associated with our business rationalizations and other cost savings initiatives.
Operating profit (loss) in 2013, 2012 and 2011 includes $48 million, $75 million and $111 million, respectively, of costs and charges related to business rationalizations and other cost savings initiatives. Operating profit (loss) in 2012 and 2011 includes $42 million and $450 million, respectively, of impairment charges for goodwill and other intangible assets. Operating profit (loss) in 2012 and 2011 includes $77 million and $9 million, respectively, of net charges for litigation settlements. Operating profit (loss) in 2012 includes $8 million of net gains related to fixed asset sales. Operating profit (loss) margins, as reported, were 8.2 percent, 4.0 percent and (3.0) percent in 2013, 2012 and 2011, respectively. Operating profit margins, excluding the items above, were 8.8 percent, 6.5 percent and 5.0 percent in 2013, 2012 and 2011, respectively.
Operating margins in 2013 and 2012 were positively affected by a more favorable relationship between selling prices and commodity costs, increased sales volume and the benefits associated with business rationalizations and other cost savings initiatives.
Other Income (Expense), Net
Other, net, for 2013 included gains of $11 million from financial investments, net. Other, net, for 2013 also included realized foreign currency losses of $18 million and other miscellaneous items.
In 2013, in conjunction with the transaction to sell our Danish ready-to-assemble cabinet business (included in discontinued operations), we also disposed of a related Danish holding company. This disposition triggered the settlement of loans, which resulted in the recognition of $18 million of currency translation expense, which is included in other income (expense) from continuing operations in the statement of operations.
Other, net, for 2012 included net gains of $24 million from financial investments. During 2012, we recognized non-cash, pre-tax impairment charges aggregating $2 million for an investment in a private equity fund. Other, net, for 2012 also included realized foreign currency losses of $2 million and other miscellaneous items.
During 2011, we recognized gains of $41 million related to the sale of TriMas common stock. We also recognized gains of $32 million related to distributions from private equity funds.
Other, net, for 2011 also included realized foreign currency losses of $5 million and other miscellaneous items.
Interest expense was $235 million in 2013 and $254 million in each of 2012 and 2011.
Income (Loss) and Earnings (Loss) Per Common Share from Continuing Operations (Attributable to Masco Corporation)
Income and diluted income per common share from continuing operations for 2013 were $282 million and $.78 per common share, respectively. (Loss) and diluted (loss) per common share from continuing operations for 2012 were $(53) million and $(.16) per common share, respectively. (Loss) and diluted (loss) per common share from continuing operations for 2011 were $(394) million and $(1.14) per common share, respectively. (Loss) from continuing operations for 2012 included non-cash, pre-tax impairment charges for other intangible assets of $42 million ($27 million or $.08 per common share, after tax). (Loss) from continuing operations for 2011 included non-cash, pre-tax impairment charges for goodwill and other intangible assets of $450 million ($291 million or $.84 per common share, after tax).
Our effective tax rate for the income (loss) from continuing operations was a 26 percent tax expense, a 125 percent tax expense, and a 10 percent tax benefit in 2013, 2012 and 2011, respectively. Compared to our normalized effective tax rate of 36 percent, the variance in the effective tax rate in 2013, 2012 and 2011 is due primarily to changes in the U.S. Federal valuation allowance and reversal of an accrual for uncertain tax positions.
Outlook for the Company
We continue to make progress on our strategic initiatives, which include expanding our product leadership positions, reducing our costs, improving our Installation and Cabinet segments and strengthening our balance sheet. In 2014, we expect new home construction and repair and remodel activity to show continued improvement in North American and internationally. Our focus will be to continue to maximize the benefits of this activity and maintain the positive momentum. We are well positioned to grow our key brands and to gain share in our channels in 2014. Our emphasis will remain on developing our pipeline of innovation, improving our enterprise leverage, driving a high performance culture and focusing on continuous improvement across all our operating segments.
We believe and are confident that the long-term fundamentals for new home construction and home improvement activity continue to be positive. We believe that our strong financial position, together with our current strategy of investing in leadership brands, including KRAFTMAID and MERILLAT cabinets, DELTA and HANSGROHE faucets, BEHR paint and MILGARD windows, our continued focus on innovation and our commitment to lean principles, will allow us to drive long-term growth and create value for our shareholders.
Business Segment and Geographic Area Results
The following table sets forth our net sales and operating profit (loss) information by business segment and geographic area, dollars in millions.
| Percent Change | ||||||||||||||||
| 2013 | 2012 | 2011 | 2013 vs. 2012 | 2012 vs. 2011 | ||||||||||||
| Net Sales: | ||||||||||||||||
| Cabinets and Related Products | $ | 1,014 | $ | 939 | $ | 934 | 8 | % | 1 | % | ||||||
| Plumbing Products | 3,183 | 2,955 | 2,913 | 8 | % | 1 | % | |||||||||
| Installation and Other Services | 1,412 | 1,209 | 1,077 | 17 | % | 12 | % | |||||||||
| Decorative Architectural Products | 1,927 | 1,818 | 1,670 | 6 | % | 9 | % | |||||||||
| Other Specialty Products | 637 | 574 | 576 | 11 | % | — | % | |||||||||
| | | | | | | | | | | | | | | | | |
| Total | $ | 8,173 | $ | 7,495 | $ | 7,170 | 9 | % | 5 | % | ||||||
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| North America | $ | 6,634 | $ | 6,046 | $ | 5,669 | 10 | % | 7 | % | ||||||
| International, principally Europe | 1,539 | 1,449 | 1,501 | 6 | % | (3 | )% | |||||||||
| | | | | | | | | | | | | | | | | |
| Total | $ | 8,173 | $ | 7,495 | $ | 7,170 | 9 | % | 5 | % | ||||||
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| 2013 | 2012 | 2012 (B) | 2011 | 2011 (B) | ||||||||||||
| Operating Profit (Loss): (A) | ||||||||||||||||
| Cabinets and Related Products | $ | (10 | ) | $ | (89 | ) | $ | (89 | ) | $ | (126 | ) | $ | (126 | ) | |
| Plumbing Products | 394 | 307 | 307 | 322 | 323 | |||||||||||
| Installation and Other Services | 37 | (19 | ) | (19 | ) | (79 | ) | (79 | ) | |||||||
| Decorative Architectural Products | 351 | 329 | 329 | 196 | 271 | |||||||||||
| Other Specialty Products | 35 | (31 | ) | 11 | (401 | ) | (27 | ) | ||||||||
| | | | | | | | | | | | | | | | | |
| Total | $ | 807 | $ | 497 | $ | 539 | $ | (88 | ) | $ | 362 | |||||
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| North America | $ | 649 | $ | 360 | $ | 402 | $ | (259 | ) | $ | 191 | |||||
| International, principally Europe | 158 | 137 | 137 | 171 | 171 | |||||||||||
| | | | | | | | | | | | | | | | | |
| Total | 807 | 497 | 539 | (88 | ) | 362 | ||||||||||
| General corporate expense, net | (134 | ) | (126 | ) | (126 | ) | (118 | ) | (118 | ) | ||||||
| Charge for litigation settlements, net | — | (77 | ) | (77 | ) | (9 | ) | (9 | ) | |||||||
| Gain from sales of fixed assets, net | — | 8 | 8 | — | — | |||||||||||
| | | | | | | | | | | | | | | | | |
| Total operating profit (loss) | $ | 673 | $ | 302 | $ | 344 | $ | (215 | ) | $ | 235 | |||||
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| 2013 | 2012 | 2012 (B) | 2011 | 2011 (B) | ||||||||||||
| Operating Profit (Loss) Margin: (A) | ||||||||||||||||
| Cabinets and Related Products | (1.0 | )% | (9.5 | )% | (9.5 | )% | (13.5 | )% | (13.5 | )% | ||||||
| Plumbing Products | 12.4 | % | 10.4 | % | 10.4 | % | 11.1 | % | 11.1 | % | ||||||
| Installation and Other Services | 2.6 | % | (1.6 | )% | (1.6 | )% | (7.3 | )% | (7.3 | )% | ||||||
| Decorative Architectural Products | 18.2 | % | 18.1 | % | 18.1 | % | 11.7 | % | 16.2 | % | ||||||
| Other Specialty Products | 5.5 | % | (5.4 | )% | 1.9 | % | (69.6 | )% | (4.7 | )% | ||||||
| North America | 9.8 | % | 6.0 | % | 6.6 | % | (4.6 | )% | 3.4 | % | ||||||
| International, principally Europe | 10.3 | % | 9.5 | % | 9.5 | % | 11.4 | % | 11.4 | % | ||||||
| Total | 9.9 | % | 6.6 | % | 7.2 | % | (1.2 | )% | 5.0 | % | ||||||
| Total operating profit (loss) margin, as reported | 8.2 | % | 4.0 | % | N/A | (3.0 | )% | N/A |
(A)
Before general corporate expense, net, gain from sales of fixed assets, net and charge for litigation settlements, net; see Note P to the consolidated financial statements.
(B)
Excluding impairment charges for goodwill and other intangible assets. The 2012 impairment charge for other intangible assets was as follows: Other Specialty Products – $42 million. The 2011 impairment charges for goodwill and other intangible assets were as follows: Plumbing Products – $1 million; Decorative Architectural Products – $75 million; and Other Specialty Products – $374 million.
Business Segment Results Discussion
Changes in operating profit margins in the following Business Segment and Geographic Area Results discussion exclude general corporate expense, net, charge for litigation settlements, net, gain from sales of fixed assets, net, and impairment charges for goodwill and other intangible assets in 2013, 2012 and 2011, as applicable.
Business Rationalizations and Other Initiatives
During the severe and prolonged downturn in our markets we took several actions focused on the strategic rationalization of our businesses, including business consolidations, plant closures, headcount reductions and other cost savings initiatives. For the years ended December 31, 2013, 2012 and 2011, we incurred net pre-tax costs and charges related to these initiatives of $48 million, $75 million and $111 million, respectively.
We continue to realize the benefits of our business rationalization and continuous improvement initiatives across the enterprise and expect to identify additional opportunities to improve our business operations. We do not anticipate that any costs and charges related to our ongoing commitment to continuous improvement will be as significant as they have been.
During 2013, our North American cabinet business continued to incur costs and charges of $11 million related to the closure of a cabinet components facility and additional severance. Our Plumbing Products segment incurred costs of $16 million related to a plant consolidation and severance in our bathing systems business in North America. Finally, we incurred $21 million of costs and charges across our business units related to other cost savings initiatives.
In early February 2013, we determined that our Danish ready-to-assemble cabinet business was no longer core to our long-term growth strategy and, accordingly we embarked on a plan for disposition. This business unit had 2012 sales of approximately $250 million and an operating loss of approximately $30 million. The Company completed the disposition of this business and a related Danish holding company in December 2013.
During 2012, our North American cabinet business continued to incur costs and charges of $33 million related to the closure of its countertop manufacturing facility (as a result of our strategic change to a sourcing model for countertops), the closure of a cabinet components facility and additional headcount reductions. Our Plumbing Products segment incurred costs of $25 million related to a plant closure and severance in our bathing systems business in North America and a plant closure and severance in Spain. We also incurred $14 million in costs related to severance actions at our corporate office. Finally, we incurred $3 million of costs and charges across our business units related to other cost savings initiatives.
During 2011, we took several actions with our North American cabinet and window businesses to exit product lines and close facilities. We also incurred charges in our builder's hardware business and our Installation and Other Services segment. We incurred costs and charges of $111 million related to these and other actions. Also during 2011, we decided to dispose of several non-core businesses in the Installation and Other Services segment. These businesses were related to commercial drywall installation, millwork and framing, and were classified as discontinued operations for all periods. During 2012, we sold all of these businesses, for net proceeds of $7 million.
Based on current plans, we anticipate costs and charges related to our business rationalizations and other initiatives to approximate $10 million in 2014. We continue to evaluate our businesses and may implement additional rationalization programs based on changes in our markets which could result in further costs and charges.
Cabinets and Related Products
Sales
Net sales of Cabinets and Related Products in 2013 increased primarily due to increased sales volume of North American and International operations and increased selling prices in North America which, in the aggregate, increased net sales by 14 percent compared to 2012. Such increases were partially offset by a less favorable product mix in North America, which reduced sales in this segment by six percent.
Net sales in this segment in 2012 increased primarily due to increased sales volume of North American operations and by increased selling prices, which increased sales by one percent compared to 2011.
Net sales in this segment in 2011 were negatively affected by lower sales volumes of North American cabinets and the planned exit of North American ready-to-assemble and other non-core in-stock assembled cabinet product lines, particle board and door product lines.
Operating Results
Operating margins in the Cabinets and Related Products segment in 2013 were positively affected by lower business rationalization expenses and the benefits associated with such expenses incurred in prior years. Operating margins were also positively affected by a more favorable relationship between selling prices and commodity costs, as well as increased sales volume and the related absorption of fixed costs. Such increases were partially offset by a less favorable product mix.
Operating margins in this segment in 2012 were positively affected by lower business rationalization expenses and the benefits associated with such expenses incurred in prior years.
Operating margins in this segment in 2011 were positively affected by lower business rationalization expenses and the benefits associated with such expenses, including benefits related to the integration of the North American cabinet businesses. Such increases were partially offset by a less favorable relationship between selling prices and commodity costs, aggressive promotional activity and lower sales volume and the related under-absorption of fixed costs.
Plumbing Products
Sales
Net sales of Plumbing Products increased in 2013 primarily due to increased sales volume and increased selling prices, which, in aggregate, increased sales by eight percent compared to 2012. A weaker U.S. dollar increased sales by one percent in 2013 compared to 2012. Such increases were partially offset by the loss of a portion of our bath products business.
Net sales in this segment increased in 2012 primarily due to increased sales volume of North American operations and increased selling prices, which, in aggregate, increased sales by approximately five percent compared to 2011. Lower sales volume of international operations decreased sales in this segment by one percent from 2011. A stronger U.S. dollar decreased sales by three percent in 2012 compared to 2011.
Net sales in this segment in 2011 were positively affected by increased selling prices and increased sales volume in North America and International.
Operating Results
Operating margins in the Plumbing Products segment in 2013 were positively affected by increased sales volume and a more favorable relationship between selling prices and commodity costs (including the impact of the metal hedge contracts), partially offset by a less favorable product mix.
Operating margins in this segment in 2012 were negatively affected by lower sales volume and a less favorable product mix principally related to international operations. Such declines more than offset increased North American sales volume and a more favorable relationship between selling prices and commodity costs.
Operating margins in this segment in 2011 were negatively affected by a less favorable relationship between selling prices and commodity costs, a less favorable product mix and increased expenses related to growth initiatives which offset the benefits associated with business rationalizations and other cost savings initiatives.
Installation and Other Services
Sales
Net sales in the Installation and Other Services segment increased in 2013 primarily due to increased sales volume related to a higher level of activity in the new home construction market, as well as increased selling prices. Net sales were also positively affected by increased retrofit and commercial sales.
Net sales in this segment increased in 2012 primarily due to increased sales volume related to a higher level of activity in the new home construction market and increased commercial sales.
Net sales in this segment in 2011 were positively affected by increased distribution sales, increased selling prices and increased retrofit and commercial sales. Such increases were partially offset by lower sales volume of installed products related to the decline in the new home construction market.
Operating Results
Operating margins in the Installation and Other Services segment in 2013 were positively affected by increased sales volume and the related absorption of fixed costs, as well as the benefits associated with business rationalizations and other cost savings initiatives. Operating margins were also positively affected by a more favorable relationship between selling prices and commodity costs.
Operating margins in this segment in 2012 were positively affected by increased sales volume and the related absorption of fixed costs, as well as the benefits associated with business rationalizations and other cost savings initiatives.
Operating margins in this segment in 2011 were positively affected by increased sales volume, the benefits associated with business rationalizations and other cost savings initiatives and a more favorable relationship between selling prices and commodity costs.
Decorative Architectural Products
Sales
Net sales of Decorative Architectural Products increased in 2013, primarily due to increased sales volume of paints and stains and builders' hardware, partially offset by lower selling prices of paints and stains.
Net sales in this segment increased in 2012, primarily due to increased selling prices of paints and stains, as well as increased sales volume of paints and stains and builders' hardware.
Net sales in this segment in 2011 were negatively affected by lower sales volume of paints and stains and builders' hardware, partially offset by increased selling prices of paints and stains.
Operating Results
Operating margins in the Decorative Architectural Products segment in 2013 reflect the benefits of increased sales volume of paints and stains and builders' hardware. Such benefits were partially offset by a less favorable relationship between selling prices and commodity costs and increased promotional and advertising costs.
Operating margins in this segment in 2012 reflect a more favorable product mix, a more favorable relationship between selling prices and commodity costs related to paints and stains and lower program costs related to builders' hardware.
Operating margins in this segment in 2011 were negatively affected by a less favorable relationship between selling prices and commodity costs related to paints and stains and increased expenses related to growth initiatives. This segment was also negatively affected by increased business rationalization expenses related to the exit of a builders' hardware product line.
Other Specialty Products
Sales
Net sales of Other Specialty Products increased in 2013 primarily due to increased sales volume, increased selling prices and a more favorable product mix of windows in North America, which in the aggregate increased sales by eleven percent compared to 2012. Such increases were partially offset by lower sales volume and lower selling prices of staple gun tackers and other fastening tools.
Net sales in this segment were flat in 2012 primarily due to increased sales volume of windows in Western markets in the U.S., a more favorable product mix and increased selling prices which were offset by lower sales volume of North American windows resulting from the exit of certain markets.
Net sales in this segment in 2011 were negatively affected by lower sales volume of windows in North America (due to the expiration of the energy tax credit in 2010) and the U.K., partially offset by increased selling prices and increased sales related to new product introductions and geographic expansion.
Operating Results
Operating margins in the Other Specialty Products segment in 2013 reflect increased sales volume and the related absorption of fixed costs, as well as a more favorable relationship between selling prices and commodity costs. This segment also reflects the benefits associated with the business rationalizations and other cost savings initiatives. Such positive results were partially offset by lower sales volume and lower selling prices of staple gun tackers and other fastening tools.
Operating results in the Other Specialty Products segment in 2012 were positively affected by the benefits associated with business rationalizations and other cost savings initiatives, lower business rationalization costs and a more favorable relationship between selling prices and commodity costs. These items more than offset the increased warranty expense of $12 million.
Operating margins in this segment in 2011 were negatively affected by increased business rationalization expenses, lower sales volume and increased product launch and geographic expansion costs. Such decreases offset a more favorable relationship between selling prices and commodity costs and the benefits associated with business rationalizations and other cost savings initiatives.
Geographic Area Results Discussion
North America
Sales
North American net sales in 2013 were positively impacted by increased sales volume of installation and other services, plumbing products, paints and stains, windows, cabinets (such increase in cabinets was partially offset by a less favorable product mix), and builders' hardware which, in the aggregate, increased sales by approximately nine percent compared to 2012. Net sales were also positively affected by increased selling prices of cabinets, installation and other services and windows, which increased sales by approximately two percent compared to 2012. Such increases were partially offset by lower selling prices of paints and stains.
North American net sales in 2012 were positively impacted by increased sales volume of installation and other services, plumbing products, paints and stains, builders' hardware and windows, which, in the aggregate, increased sales by approximately four percent compared to 2011. Net sales were also positively affected by increased selling prices of plumbing products and paints and stains, which increased sales by approximately three percent compared to 2011.
North American net sales in 2011 were negatively impacted by lower sales volume of cabinets, including the planned exit of certain product lines, paints and stains, builders' hardware and windows, partially offset by increased selling prices of plumbing products and paints and stains.
Operating Results
Operating margins from North American operations in 2013 were positively affected by increased sales volume and the related absorption of fixed costs, as well as a more favorable relationship between selling prices and commodity costs. North American operations were also positively affected by lower business rationalization expenses and the benefits associated with business rationalization and other cost savings initiatives.
Operating margins from North American operations in 2012 were positively affected by a more favorable relationship between selling prices and commodity costs, lower business rationalization expenses and the benefits associated with business rationalization and other cost savings initiatives which, in aggregate, increased operating margins by three percentage points.
Operating margins from North American operations in 2011 were positively affected by lower business rationalization expenses and the benefits associated with business rationalization and other cost savings initiatives. Such increases offset the negative impact of lower sales volume and the related under-absorption of fixed costs and a less favorable relationship between selling prices and commodity costs.
International, Principally Europe
Sales
Net sales from international operations in 2013 increased four percent in local currencies compared to 2012, primarily due to increased sales volume of international plumbing products and cabinets and increased selling prices for International plumbing products. A weaker U.S. dollar increased International net sales by two percent in 2013 compared to 2012.
Net sales from international operations in 2012 increased three percent in local currencies compared to 2011, primarily due to increased selling prices, partially offset by lower sales volume of international plumbing products, cabinets and windows. A stronger U.S. dollar decreased International net sales by seven percent in 2012 compared to 2011.
Net sales from international operations in 2011 were positively affected by increased sales volume and increased selling prices of International plumbing products, offset by lower sales volume of International cabinets.
Operating Results
Operating margins from international operations in 2013 were positively affected by a more favorable relationship between selling prices and commodity costs, primarily related to international plumbing products and the benefits associated with business rationalizations and other cost savings initiatives, partially offset by a less favorable product mix.
Operating margins from international operations in 2012 were negatively affected by a less favorable product mix, partially offset by a more favorable relationship between selling prices and commodity costs, primarily related to international plumbing products, the benefits associated with business rationalizations and other cost savings initiatives.
Operating margins from international operations in 2011 were negatively affected by a less favorable product mix and a less favorable relationship between selling prices and commodity costs, offset by the benefits associated with business rationalizations and other cost savings initiatives.
Other Matters
Commitments and Contingencies
Litigation
Information regarding our legal proceedings is set forth in Note U to the consolidated financial statements, which is incorporated herein by reference.
Other Commitments
With respect to our investments in private equity funds, we had, at December 31, 2013, commitments to contribute up to $14 million of additional capital to such funds, representing our aggregate capital commitment to such funds less capital contributions made to date. We are contractually obligated to make additional capital contributions to these private equity funds upon receipt of a capital call from the private equity fund. We have no control over when or if the capital calls will occur. Capital calls are funded in cash and generally result in an increase in the carrying value of our investment in the private equity fund when paid.
We enter into contracts, which include reasonable and customary indemnifications that are standard for the industries in which we operate. Such indemnifications include claims made against builders by homeowners for issues relating to our products and workmanship. In conjunction with divestitures and other transactions, we occasionally provide reasonable and customary indemnifications relating to various items, including: the enforceability of trademarks; legal and environmental issues; and provisions for sales returns. We have never had to pay a material amount related to these indemnifications, and we evaluate the probability that amounts may be incurred and we appropriately record an estimated liability when probable.
Recently Issued Accounting Pronouncements. On January 1, 2013, we adopted new accounting guidance requiring disclosure of amounts reclassified from accumulated other comprehensive income. The adoption of this new guidance did not have an impact on our financial position or our results of operations.
Contractual Obligations
The following table provides payment obligations related to current contracts at December 31, 2013, in millions:
| Payments Due by Period | |||||||||||||||||||
| Less than 1 Year | 1 - 3 Years | 3 - 5 Years | More than 5 Years | Other (D) | Total | ||||||||||||||
| Debt (A) | $ | 6 | $ | 1,803 | $ | 116 | $ | 1,502 | $ | — | $ | 3,427 | |||||||
| Interest (A) | 212 | 485 | 206 | 526 | — | 1,429 | |||||||||||||
| Operating leases | 62 | 99 | 27 | 73 | — | 261 | |||||||||||||
| Currently payable income taxes | 32 | — | — | — | — | 32 | |||||||||||||
| Private equity funds (B) | 7 | 7 | — | — | — | 14 | |||||||||||||
| Purchase commitments (C) | 272 | 6 | — | — | — | 278 | |||||||||||||
| Uncertain tax positions, including interest and penalties (D) | — | — | — | — | 59 | 59 | |||||||||||||
| | | | | | | | | | | | | | | | | | | | |
| Total | $ | 591 | $ | 2,400 | $ | 349 | $ | 2,101 | $ | 59 | $ | 5,500 | |||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
(A)
We assumed that all debt would be held to maturity.
(B)
There is no schedule for the capital commitments to the private equity funds; such allocation was estimated.
(C)
Excludes contracts that do not require volume commitments and open or pending purchase orders.
(D)
Due to the high degree of uncertainty regarding the timing of future cash outflows associated with uncertain tax positions, we are unable to make a reasonable estimate for the period beyond the next year in which cash settlements may occur with applicable tax authorities.
Refer to Note M of our financial statements for defined-benefit plan obligations.
Previous: Item 6. Selected Financial Data. · Next: Item 7A. Quantitative and Qualitative Disclosures about Market Risk.