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FBHS > SEC Filings for FBHS > Form 10-K on 26-Feb-2014All Recent SEC Filings

Show all filings for FORTUNE BRANDS HOME & SECURITY, INC.

Form 10-K for FORTUNE BRANDS HOME & SECURITY, INC.


26-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Introduction

This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is a supplement to the accompanying consolidated financial statements and provides additional information on our business, recent developments, financial condition, liquidity and capital resources, cash flows and results of operations. MD&A is organized as follows:

> Overview: This section provides a general description of our business, and a discussion of management's general outlook about market demand, our competitive position and product innovation, as well as recent developments we believe are important in understanding our results of operations and financial condition or in understanding anticipated future trends.

> Separation from our Former Parent: This section provides a general discussion of our Separation from our Former Parent.

> Basis of Presentation: This section provides a discussion of the basis on which our consolidated financial statements were prepared, including our historical results of operations and adjustments thereto, primarily related to allocations of general corporate expenses from our Former Parent.

> Results of Operations: This section provides an analysis of our results of operations for each of the three years ended December 31, 2013, 2012 and 2011.

> Liquidity and Capital Resources: This section provides a discussion of our financial condition and an analysis of our cash flows for each of the three years ended December 31, 2013, 2012 and 2011. This section also provides a discussion of our contractual obligations, other purchase commitments and customer credit risk that existed at December 31, 2013, as well as a discussion of our ability to fund our future commitments and ongoing operating activities through internal and external sources of capital.

> Critical Accounting Policies and Estimates: This section identifies and summarizes those accounting policies that significantly impact our reported results of operations and financial condition and require significant judgment or estimates on the part of management in their application.

Overview

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 window products and entry door systems, and security and storage products.

For the year ended December 31, 2013, net sales based on country of destination were:

                 (In millions)
                 United States                   $ 3,479.4        84 %
                 Canada                              418.1        10
                 China and other international       259.9         6
                 Total                           $ 4,157.4       100 %

We believe the Company has certain competitive advantages including market-leading brands, a diversified mix of customer 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,


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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 to 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 recovers, we have the potential to generate additional growth from leveraging our cash flows 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 a continued recovery 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.

During the past two years ended December 31, 2013, the Company's net sales have grown at a compounded annual rate of approximately 12% as we benefited from an improving U.S. home products market, share gains, growth in international locations and acquisitions. Operating income has improved from a loss of $15.6 million in 2011 to income of $357.1 million in 2013. Growth in operating income has occurred primarily due to higher sale volumes, a focus on channeling available capacity toward our most profitable sales opportunities, controlling and leveraging our operating expenses, the benefits of productivity improvement programs, and reduced restructuring and impairment charges.

During 2013, the U.S. home products market grew due to both the expansion of both new home construction and repair and remodel activities. We believe new housing construction grew in the high teens (%) in 2013 compared to 2012 and spending for home repair and remodeling increased approximately 5% to 6%. We experienced strengthening in larger ticket repair and remodel activities, which had previously been lagging the overall market, and are particularly impactful to our cabinet and window products. In 2013, operating income increased on the benefit of higher volume from our growth initiatives, improving U.S. home products market conditions and productivity improvements, as well as the benefit of the acquisition of WoodCrafters Home Products Holding, LLC ("WoodCrafters").

In June 2013, our Kitchen & Bath Cabinetry business acquired WoodCrafters, a manufacturer of bathroom vanities and tops, for a purchase price of approximately $302 million, subject to certain post-closing adjustments. We paid the purchase price using a combination of cash on hand and borrowings under our existing credit facilities. The financial results of WoodCrafters are included in the Company's results of operations and cash flows beginning in the third quarter of 2013. This acquisition greatly expanded our offering of bathroom cabinetry products.

During 2012, the market for our products improved over 2011. We believe new housing construction grew over 20% and spending for home repair and remodeling increased approximately 4% to 5%. We


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introduced new product innovations, expanded into adjacent markets and refined our supply chain. In 2012, operating income increased on higher sales volume, productivity improvements, lower recognition of defined benefit plan actuarial losses and lower asset impairment charges.

Separation from Our Former Parent

On September 27, 2011, the board of directors of our Former Parent approved the Separation. The distribution of Home & Security common stock was made on October 3, 2011, with our Former Parent stockholders receiving one share of Home & Security common stock for each share of Former Parent common stock held on September 20, 2011. Following the Separation, our Former Parent changed its name to Beam Inc. and retained no ownership interest in Home & Security. On October 4, 2011, our common stock began trading "regular-way" on the New York Stock Exchange under the ticker symbol "FBHS".

Basis of Presentation

The consolidated financial statements included in this Annual Report on Form 10-K have been derived from the accounts of the Company and its majority-owned subsidiaries. Prior to the Separation, the Company was a wholly-owned subsidiary of our Former Parent. Our financial statements from periods prior to the Separation were derived from the historical results of operations and the historical basis of assets and liabilities and include allocations of certain corporate expenses of our Former Parent incurred directly by our Former Parent totaling $23.4 million in the first nine months of 2011. These allocated expenses include costs associated with legal, finance, treasury, accounting, internal audit and general management services and are included in "Corporate" in the accompanying segment information. Management believes that the assumptions and methodologies underlying the allocation of these general corporate expenses are reasonable. However, such expenses may not be indicative of the actual level of expense that would have been incurred by the Company if it had operated as an independent company during such period. The consolidated financial statements included in this Annual Report on Form 10-K for periods prior to the Separation may not necessarily reflect what the Company's results of operations, financial condition and cash flows would have been had the Company been a stand-alone company during such pre-Separation periods.


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Results of Operations

The following discussion of both consolidated results of operations and segment results of operations refers to the year ended December 31, 2013 compared to the year ended December 31, 2012, and the year ended December 31, 2012 compared to the year ended December 31, 2011. The discussion of consolidated results of operations should be read in conjunction with the discussion of segment results of operations and our financial statements and notes thereto included in this Annual Report on Form 10-K.

Years Ended December 31, 2013, 2012 and 2011



(In millions)                           2013       % change             2012       % change           2011
Net Sales:
Kitchen & Bath Cabinetry           $ 1,642.2           23.8 %      $ 1,326.6            5.6 %    $ 1,256.3
Plumbing & Accessories               1,287.0           16.9          1,100.7           14.3          962.8
Advanced Material Windows &
Door Systems                           657.8           12.0            587.2            6.2          552.9
Security & Storage                     570.4           (1.1 )          576.6            3.6          556.6
Total Home & Security              $ 4,157.4           15.8 %      $ 3,591.1            7.9 %    $ 3,328.6
Operating Income (Loss):
Kitchen & Bath Cabinetry           $    97.1          373.7 %      $    20.5          259.6 %    $     5.7
Plumbing & Accessories                 228.3           34.9            169.2           22.6          138.0
Advanced Material Windows &
Door Systems                            14.4         1540.0             (1.0 )         99.0         (101.2 )
Security & Storage                      90.4           19.9             75.4           20.4           62.6
Corporate(a)                           (73.1 )         28.6           (102.4 )         15.2         (120.7 )
Total Home & Security              $   357.1          120.8 %      $   161.7         1136.5 %    $   (15.6 )

(a) Corporate expenses include the components of defined benefit plan expense other than service cost which totaled (income) expense of $(4.9) million, $38.7 million and $74.2 million for the years ended December 31, 2013, 2012 and 2011, respectively. There are no amounts that represent the elimination or reversal of transactions between reportable segments. Corporate expenses in 2011 prior to the Separation also include allocations of certain Former Parent general corporate expenses incurred directly by our Former Parent. These allocated expenses include costs associated with legal, finance, treasury, accounting, internal audit and general management services.

Certain items had a significant impact on our results in 2013, 2012 and 2011. These included the WoodCrafters acquisition, asset impairment charges, defined benefit plan recognition of actuarial losses and gains, restructuring and other charges and the impact of changes in foreign currency exchange rates.

In 2013, financial results included:

> the impact of the WoodCrafters acquisition, which added approximately $115 million of net sales,

> asset impairment charges in our Kitchen & Bath Cabinetry segment of $21.2 million ($13.8 after tax) associated with the abandonment of certain internal use software,

> defined benefit plan recognition of actuarial losses, recorded in the Corporate segment, of $5.2 million ($3.3 million after tax) compared to $42.2 million ($26.2 million after tax) in 2012. This change was primarily due to a higher than expected increase in pension plan assets and higher discount rates in 2013, as well as lower postretirement liabilities due to plan amendments to reduce health benefits. The 2012 actuarial loss was principally due to both decreasing discount rates and actual returns on plan assets that were lower than our expected return,

> restructuring and other charges of $5.1 million before tax ($3.6 million), primarily associated with supply chain initiatives and


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> the impact of foreign exchange, which had an unfavorable impact compared to 2012, of approximately $7 million on net sales and approximately $1 million on operating income and net income. The effects of foreign exchange on the Company's results are principally associated with movements in the Canadian dollar.

In 2012, financial results included:

> defined benefit plan recognition of actuarial losses, recorded in the Corporate segment, of $42.2 million ($26.2 million after tax) compared to losses of $80.0 million ($49.9 million after tax) in 2011, primarily due to a decrease in the discount rate used to value our pension and other postretirement obligations,

> asset impairment charges of $15.8 million ($9.7 million after tax) associated with the tradenames in the Advanced Material Windows & Door Systems segment ($9.9 million before tax) and the Kitchen & Bath Cabinetry segment ($5.9 million before tax). These charges were primarily the result of an increase in our market-participant cost of capital discount rates. One tradename in the Kitchen & Bath Cabinetry segment was also impacted by reduced revenue growth expectations for high-end discretionary cabinet purchases developed during our annual planning process that was completed in the fourth quarter in 2012,

> restructuring and other charges of $10.0 million before tax ($6.6 million after tax), primarily associated with cabinet manufacturing facility closures and

> the impact of foreign exchange, which had an unfavorable impact compared to 2011, of approximately $5 million on both net sales and operating income and approximately $3 million on net income. The effects of foreign exchange on the Company's results are principally associated with movements in the Canadian dollar and the Euro.

In 2011, financial results included:

> defined benefit plan recognition of actuarial losses, recorded in the Corporate segment, of $80.0 million ($49.9 million after tax) compared to gains of $3.5 million ($2.2 million after tax) in 2010, primarily due to a decrease in the discount rate as well as a lower than expected rate of return on pension plan assets,

> asset impairment charges of $90.0 million before tax ($55.3 million after tax) associated with the tradenames in the Advanced Material Windows & Door Systems segment, primarily as the result of reduced revenue growth and profit margin expectations associated with our Simonton tradename. Our revenue and profit margin expectations were lowered based upon the results of our annual planning process that was completed in the fourth quarter of 2011 and included consideration of our actual fourth quarter 2011 results, including lower 2011 sales due to the expiration of U.S. tax incentives for purchases of energy-efficient home products, as well as our projection of the recovery of the U.S. home products market,

> restructuring and other charges of $20.0 million before tax ($12.5 million after tax) associated with cabinet and window manufacturing facility closures,

> business separation costs of $2.4 million and

> the impact of foreign exchange, which had a favorable impact compared to 2010, of approximately $20 million on net sales, approximately $5 million on operating income and approximately $1 million on net income. The effects of foreign exchange on the Company's results are principally associated with movements in the Canadian dollar.


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2013 Compared to 2012

Total Home & Security

Net Sales

Net sales increased $566.3 million, or 16%. The increase was due to higher sales volume, primarily from improved U.S. market conditions for home products, and new product introductions, as well as a benefit of approximately $115 million from the acquisition of WoodCrafters. Net sales also benefited from price increases that helped mitigate raw material cost increases.

Cost of products sold

Cost of products sold increased $297.5 million, or 12%, due to higher sales volume and the impact of the WoodCrafters acquisition, partially offset by the benefit of productivity improvements, including cost savings from previously announced restructuring actions. Cost of products sold also benefited from lower expense from actuarial losses related to defined benefit plans ($2.7 million in 2013 compared to $14.2 million in 2012).

Selling, general and administrative expenses

Selling, general and administrative expenses increased $66.2 million, or 7%, due to higher volume-related expenses and planned increases in strategic spending to support growth initiatives that included approximately $16 million of higher advertising spending. Administrative expenses also increased due to higher consulting expenses and acquisition-related transaction expenses. Selling, general and administrative expenses benefited from lower expense from actuarial losses related to defined benefit plans ($2.5 million in 2013 compared to $28.0 million in 2012).

Amortization of intangible assets

Amortization of intangible assets increased $2.1 million due to $2.9 million of amortization of identifiable intangible assets associated with the WoodCrafters acquisition, partially offset by the absence of expense for an identifiable intangible asset that was fully amortized in the second quarter of 2012.

Restructuring charges

Restructuring charges of $4.2 million and $4.5 million in 2013 and 2012, respectively, were related to supply chain initiatives.

Asset impairment charges

At the end of the third quarter of 2013, our Kitchen and Bath Cabinetry segment completed an evaluation of its information technology strategy. The evaluation considered opportunities arising from the improving U.S. home market conditions. As a result of this evaluation, the segment abandoned certain software developed for internal use in order to redirect financial resources toward developing more flexible systems that provide industry leading content for consumers and more advanced tools for designers to deliver a superior purchasing experience for their customers. The abandonment of this internal use software resulted in a pre-tax impairment charge of $21.2 million, which was recorded in operating income and reduced property, plant and equipment, and will not materially impact current or future cash flow or future operating income.

In the fourth quarter of 2012, we recorded asset impairment charges of $15.8 million related to indefinite-lived tradenames in the Advanced Material Windows & Door Systems and Kitchen & Bath Cabinetry segments.


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Operating income (loss)

Operating income increased $195.4 million, or 121%, primarily due to higher sales volume from our growth initiatives and improving U.S. home products market conditions, as well as the acquisition of WoodCrafters. In addition, the following items had a significant impact on operating income trends:

                                                                   Increase/(decrease)
   (In millions)                             2013       2012       In operating income
   Defined benefit plan actuarial losses   $  5.2     $ 42.2     $                37.0
   Asset impairment charges                  21.2       15.8                      (5.4 )
   Restructuring and other charges            5.1       10.0                       4.9

Interest expense

Interest expense decreased $1.5 million due to lower average interest rates and external borrowings.

Other expense (income), net

Other expense (income), net, was expense of $5.0 million in 2013, compared to income of $1.0 million in 2012. The change of $6.0 million was primarily due to a second quarter 2013 impairment charge of $6.2 million pertaining to a cost method investment.

Income taxes

The effective income tax rates for 2013 and 2012 were 33.1% and 22.3%, respectively. The effective income tax rate for 2013 was unfavorably impacted by an increase in the valuation allowance related to an impairment charge of a cost method investment for which we cannot presently record an income tax benefit. The effective income tax rate in 2013 was favorably impacted by $3.0 million of deferred tax benefits associated with the enacted repeal of the Mexican Business Flat Tax, under the 2014 Mexican Tax Reform Package and the extension of the U.S. research and development credit under The American Taxpayer Relief Act of 2012. The effective income tax rate was also favorably impacted by an increased benefit attributable to domestic production activities. The effective income tax rate in 2012 was favorably impacted by a tax benefit related to the final settlement of a U.S. federal income tax audit covering the 2008 to 2009 years and a decrease in valuation allowance due to certain reorganization actions among our foreign subsidiaries. The effective income tax rate in 2012 was unfavorably impacted by an income tax expense on foreign dividends.

Net income (loss) attributable to Home & Security

Net income attributable to Home & Security was $229.7 million in 2013 compared to $118.7 million in 2012. The increase of $111.0 million was primarily due to higher operating income, partially offset by the impact of the higher effective income tax rate and an increase in other expense (income), net.

Results By Segment

Kitchen & Bath Cabinetry

Net sales increased $315.6 million, or 24%, due to higher sales volume, primarily from improved U.S. market conditions in both new construction and repair and remodel activity, and new product introductions. Net sales also benefited from the acquisition of WoodCrafters (approximately $115 million), price increases that helped mitigate raw material cost increases and improving product mix from repair and remodel growth.


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Operating income increased $76.6 million to $97.1 million due to higher sales volume. Operating income benefited from productivity improvements, including cost savings from previously announced restructuring actions, improving product mix from repair and remodel growth, reduced promotional costs and price increases, as well as the impact of the acquisition of WoodCrafters. Restructuring and other charges decreased by $11.3 million due to the absence in 2013 of the 2012 restructuring action to close our Martinsville, Virginia cabinet manufacturing facility. Operating income was unfavorably impacted by an asset impairment charge of $21.2 million (compared to $5.9 million in 2012), increased costs for raw materials (wood-related), capacity ramp-up costs and higher compensation expense.

At the end of the third quarter of 2013, the Kitchen and Bath Cabinetry segment completed an evaluation of its information technology strategy. The evaluation considered opportunities arising from improving U.S. home market conditions. As a result of this evaluation, the segment abandoned certain software developed for internal use in order to redirect financial resources toward developing more flexible systems that provided industry leading content for consumers and more advanced tools for designers to deliver a superior purchasing experience for their customers. The abandonment of this internal use software resulted in a pre-tax impairment charge of $21.2 million, which was recorded in operating income and reduced property, plant and equipment, and will not materially impact current or future cash flow or future operating income.

Plumbing & Accessories

Net sales increased $186.3 million, or 17%, due to higher sales volume in the U.S. driven primarily by higher new construction housing starts and improving repair and remodel market conditions, and new product introductions, as well as approximately $37 million of higher international sales, primarily in China where we expanded our distributor-owned network and our direct-to-builder effort and improved performance of the existing Moen stores. Net sales also benefited from price increases that helped mitigate raw material cost increases.

Operating income increased $59.1 million, or 35%, due to higher sales volume. The impact of productivity improvements was partially offset by approximately $14 million of higher planned spending on advertising and brand support.

Advanced Material Windows & Door Systems

Net sales increased $70.6 million, or 12%. Net sales of door systems grew $50.0 million, or 16%, due to higher sales volume driven primarily by improved conditions in the U.S. home products market and distribution expansion. Net sales of window products increased $20.6 million, or 8%, due to improving conditions in the repair and remodel portion of the U.S. home products market.

Operating income increased $15.4 million to $14.4 million due to the benefit of higher sales, the absence of $9.9 million in tradename impairment charges in 2012 and favorable mix. These benefits were partially offset by higher compensation-related expenses and marketing costs, the absence in 2013 of a 2012 $3.5 million gain on the disposition of property and $2.0 million of income attributable to a reduction of a contingent consideration liability related to an acquisition.

Security & Storage

Net sales decreased $6.2 million, or 1%. Net sales of security products increased $16.8 million, or 4%, due to new product introductions and higher U.S. retail and international sales. Net sales of storage products were down $23.0 . . .

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