Edgar Filing: MASCO CORP /DE/

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014

Commission file number: 1-5794

Masco Corporation

(Exact name of Registrant as Specified in its Charter)

Delaware		38-1794485
(State or Other Jurisdiction of Incorporation)		(IRS Employer Identification No.)

21001 Van Born Road, Taylor, Michigan		48180
(Address of Principal Executive Offices)		(Zip Code)

(313) 274-7400

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x		Accelerated filer o

Non-accelerated filer o		Smaller reporting company o
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class		Shares Outstanding at October 21, 2014
Common stock, par value $1.00 per share		356,260,200

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MASCO CORPORATION

INDEX

		Page No.

PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited):

	Condensed Consolidated Balance Sheets – as at September 30, 2014 and December 31, 2013	1

	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2014 and 2013	2

	Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2014 and 2013	3

	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013	4

	Consolidated Statements of Shareholders’ Equity for the Nine Months Ended September 30, 2014 and 2013	5

	Notes to Condensed Consolidated Financial Statements	6-23

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24-30

Item 4.	Controls and Procedures	31

PART II.	OTHER INFORMATION	32-34

Item 1.	Legal Proceedings

Item 1A.	Risk Factors

Item 6.	Exhibits

	Signature

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MASCO CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

September 30, 2014 and December 31, 2013

(In Millions, Except Share Data)

	September 30,		December 31,
	2014		2013
ASSETS
Current assets:
Cash and cash investments	$	1,282	$	1,223
Short-term bank deposits	275		321
Receivables	1,229		1,004
Prepaid expenses and other	353		155
Inventories:
Finished goods	459		398
Raw material	289		268
Work in process	114		99
	862		765
Total current assets	4,001		3,468
Property and equipment, net	1,153		1,252
Goodwill	1,891		1,903
Other intangible assets, net	147		149
Other assets	181		185
Total assets	$	7,373	$	6,957

LIABILITIES
Current liabilities:
Notes payable	$	505	$	6
Accounts payable	1,020		902
Accrued liabilities	890		874
Total current liabilities	2,415		1,782
Long-term debt	2,919		3,421
Deferred income taxes and other	681		967
Total liabilities	6,015		6,170

Commitments and contingencies

EQUITY

Masco Corporation’s shareholders’ equity:
Common shares, par value $1 per share Authorized shares: 1,400,000,000; issued and outstanding: 2014 – 349,900,000; 2013 – 349,500,000	350		349
Preferred shares authorized: 1,000,000; issued and outstanding: 2014 – None; 2013 – None	—		—
Paid-in capital	17		16
Retained earnings	716		79
Accumulated other comprehensive income	64		115
Total Masco Corporation’s shareholders’ equity	1,147		559
Noncontrolling interest	211		228
Total equity	1,358		787
Total liabilities and equity	$	7,373	$	6,957

See notes to condensed consolidated financial statements.

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MASCO CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

For the Three and Nine Months Ended September 30, 2014 and 2013

(In Millions, Except Per Common Share Data)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013

Net sales	$	2,232		$	2,150		$	6,457		$	6,175
Cost of sales	1,621			1,543			4,638			4,451
Gross profit	611			607			1,819			1,724
Selling, general and administrative expenses	409			395			1,225			1,192
Operating profit	202			212			594			532
Other income (expense), net:
Interest expense	(57		)	(58		)	(169		)	(178		)
Other, net	7			6			10			23
	(50		)	(52		)	(159		)	(155		)
Income from continuing operations before income taxes	152			160			435			377
Income tax benefit (expense)	403			(38		)	361			(91		)
Income from continuing operations	555			122			796			286
Income (loss) from discontinued operations	1			(2		)	(2		)	(16		)
Net income	556			120			794			270
Less: Net income attributable to noncontrolling interest	13			11			38			30
Net income attributable to Masco Corporation	$	543		$	109		$	756		$	240

Income per common share attributable to Masco Corporation:
Basic:
Income from continuing operations	$	1.52		$	.31		$	2.12		$	.72
Loss from discontinued operations	—			(.01		)	(.01		)	(.04		)
Net income	$	1.52		$	.31		$	2.12		$	.67
Diluted:
Income from continuing operations	$	1.51		$	.31		$	2.11		$	.71
Loss from discontinued operations	—			(.01		)	(.01		)	(.04		)
Net income	$	1.51		$	.30		$	2.10		$	.67
Amounts attributable to Masco Corporation:
Income from continuing operations	$	542		$	111		$	758		$	256
Income (loss) from discontinued operations	1			(2		)	(2		)	(16		)
Net income	$	543		$	109		$	756		$	240

See notes to condensed consolidated financial statements.

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MASCO CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

For the Three and Nine Months Ended September 30, 2014 and 2013

(In Millions)

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2014			2013		2014			2013

Net income	$	556		$	120	$	794		$	270
Less: Net income attributable to noncontrolling interest	13			11		38			30
Net income attributable to Masco Corporation	$	543		$	109	$	756		$	240

Other comprehensive income, net of tax (see Note K):
Cumulative translation adjustment	(73		)	37		(79		)	11
Interest rate swaps	—			—		1			1
Unrecognized pension prior service cost and net loss	—			5		6			14
Other comprehensive (loss) income	(73		)	42		(72		)	26
Less: Other comprehensive (loss) income attributable to noncontrolling interest	(18		)	8		(21		)	4

Other comprehensive (loss) income attributable to Masco Corporation	$	(55	)	$	34	$	(51	)	$	22

Total comprehensive income	$	483		$	162	$	722		$	296
Less: Total comprehensive (loss) income attributable to the noncontrolling interest	(5		)	19		17			34

Total comprehensive income attributable to Masco Corporation	$	488		$	143	$	705		$	262

See notes to condensed consolidated financial statements.

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MASCO CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

For the Nine Months Ended September 30, 2014 and 2013

(In Millions)

	Nine Months Ended
	September 30,
	2014			2013

CASH FLOWS FROM (FOR) OPERATING ACTIVITIES:
Cash provided by operations	$	543		$	489
Increase in receivables	(257		)	(302		)
Increase in inventories	(109		)	(40		)
Increase in accounts payable and accrued liabilities, net	129			203
Net cash from operating activities	306			350

CASH FLOWS FROM (FOR) FINANCING ACTIVITIES:
Cash dividends paid	(86		)	(81		)
Dividend payment to noncontrolling interest	(34		)	(34		)
Purchase of Company common stock	(39		)	(35		)
Credit Agreement costs	—			(4		)
Issuance of Company common stock	1			—
Retirement of Notes	—			(200		)
Payment of debt, net	(2		)	(2		)
Net cash for financing activities	(160		)	(356		)

CASH FLOWS FROM (FOR) INVESTING ACTIVITIES:
Capital expenditures	(82		)	(88		)
Acquisition of companies, net of cash acquired	(2		)	(5		)
Proceeds from disposition of:
Other financial investments	13			13
Short-term bank deposits	322			309
Businesses	—			—
Property and equipment	12			24
Purchases of:
Other financial investments	—			—
Short-term bank deposits	(297		)	(269		)
Other, net	(26		)	(5		)
Net cash for investing activities	(60		)	(21		)
Effect of exchange rate changes on cash and cash investments	(27		)	(2		)

CASH AND CASH INVESTMENTS:
Increase (decrease) for the period	59			(29		)
At January 1	1,223			1,040
At September 30	$	1,282		$	1,011

See notes to condensed consolidated financial statements.

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MASCO CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Unaudited)

For The Nine Months Ended September 30, 2014 and 2013

(In Millions)

										(Accumulated			Accumulated
				Common						Deficit)			Other
				Shares			Paid-In			Retained			Comprehensive			Noncontrolling
	Total			($1 par value)			Capital			Earnings			Income			Interest

Balance, January 1, 2013	$	534		$	349		$	16		$	(102	)	$	59		$	212
Total comprehensive income	296									240			22			34
Shares issued	—			3			(3		)
Shares retired:
Repurchased	(35		)	(2		)	(11		)	(22		)
Surrendered (non-cash)	(20		)	(1		)	(19		)
Cash dividends declared	(81		)				(14		)	(67		)
Dividend payment to noncontrolling interest	(34		)													(34		)
Stock-based compensation	39						39
Balance, September 30, 2013	$	699		$	349		$	8		$	49		$	81		$	212

Balance, January 1, 2014	$	787		$	349		$	16		$	79		$	115		$	228
Total comprehensive income (loss)	722									756			(51		)	17
Shares issued	(5		)	3			(8		)
Shares retired:
Repurchased	(39		)	(2		)	(9		)	(28		)
Surrendered (non-cash)	(15		)				(15		)
Cash dividends declared	(91		)							(91		)
Dividend payment to noncontrolling interest	(34		)													(34		)
Stock-based compensation	33						33
Balance, September 30, 2014	$	1,358		$	350		$	17		$	716		$	64		$	211

See notes to consolidated financial statements.

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MASCO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

A. In the opinion of the Company, the accompanying unaudited condensed consolidated financial statements contain all adjustments, of a normal recurring nature, necessary to present fairly its financial position as at September 30, 2014 and the results of operations for the three months and nine months ended September 30, 2014 and 2013 and cash flows for the nine months ended September 30, 2014 and 2013. The condensed consolidated balance sheet at December 31, 2013 was derived from audited financial statements.

Recently Issued Accounting Pronouncements. In May 2014, the Financial Accounting Standards Board (FASB) issued a new standard for revenue recognition, Accounting Standards Codification 606 (ASC 606). The purpose of ASC 606 is to provide a single, comprehensive revenue recognition model for all contracts with customers to improve comparability across industries. ASC 606 is effective for the Company for annual periods beginning January 1, 2017. The Company is currently evaluating the impact the adoption of this new standard will have on its results of operations.

In April 2014, the FASB issued Accounting Standards Update 2014-8 (ASU 2014-8), “Reporting of Discontinued Operations and Disclosure of Disposals of Components of an Entity,” which changes the criteria for determining which disposals can be presented as discontinued operations and modifies the related disclosure requirements. ASU 2014-8 is effective for the Company beginning January 1, 2015, with early adoption allowed for new disposals not previously classified as discontinued operations.

Revision of Previously Issued Financial Statements. During the first quarter ended March 31, 2014, the Company identified an error in the accounting for certain of its investments in private equity limited partnership funds. The investments were inappropriately accounted for under the cost basis versus the equity method. The impact of the error was to under report the investment value (included in other assets on the consolidated balance sheets) and to over (under) state equity investment earnings (loss) (included in other income (expense), net in the consolidated statements of operations). We have revised our three-month and nine-month periods ended September 30, 2013 consolidated statement of operations and prior year consolidated balance sheet in these financial statements to reflect the investment accounted for as an equity investment. Retained earnings and other comprehensive income were adjusted for the changes in net income. Other historic periods will be revised, as detailed below, in our future filings. This error is not considered material to any prior period financial statement.

This revision has no effect on our consolidated statement of cash flows.

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MASCO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

Note A — continued:

The following table presents the impact of the revisions on the Company’s previously issued full-year consolidated statement of operations (in millions):

	Year ended December 31,
	2013			2012			2011

Other income (expense), net
As reported	$	(239	)	$	(229	)	$	(177	)
Correction	16			—			9
As revised	$	(223	)	$	(229	)	$	(168	)

Income (loss) from continuing operations, before income taxes
As reported	$	434		$	73		$	(392	)
Correction	16			—			9
As revised	$	450		$	73		$	(383	)

Income (loss) from continuing operations
As reported	$	323		$	(18	)	$	(352	)
Correction	16			—			9
As revised	$	339		$	(18	)	$	(343	)

Net income (loss)
As reported	$	313		$	(79	)	$	(533	)
Correction	16			—			9
As revised	$	329		$	(79	)	$	(524	)

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MASCO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

Note A — concluded:

The following table presents the impact of the revisions on the Company’s previously issued quarterly consolidated statements of operations (in millions):

	Three Months Ended												Three Months Ended
	Dec. 31			Sep. 30			June 30			Mar. 31			Dec. 31			Sep. 30			June 30			Mar. 31
	2013												2012
Other income (expense), net
As reported	$	(71	)	$	(58	)	$	(57	)	$	(53	)	$	(57	)	$	(57	)	$	(66	)	$	(49	)
Correction	3			6			1			6			4			7			(2		)	(9		)
As revised	$	(68	)	$	(52	)	$	(56	)	$	(47	)	$	(53	)	$	(50	)	$	(68	)	$	(58	)

Income (loss) from continuing operations, before income taxes
As reported	$	70		$	154		$	131		$	79		$	(26	)	$	51		$	(12	)	$	60
Correction	3			6			1			6			4			7			(2		)	(9		)
As revised	$	73		$	160		$	132		$	85		$	(22	)	$	58		$	(14	)	$	51

Income (loss) from continuing operations
As reported	$	50		$	116		$	92		$	65		$	(63	)	$	35		$	(43	)	$	53
Correction	3			6			1			6			4			7			(2		)	(9		)
As revised	$	53		$	122		$	93		$	71		$	(59	)	$	42		$	(45	)	$	44

Net income (loss)
As reported	$	56		$	114		$	87		$	56		$	(80	)	$	24		$	(67	)	$	44
Correction	3			6			1			6			4			7			(2		)	(9		)
As revised	$	59		$	120		$	88		$	62		$	(76	)	$	31		$	(69	)	$	35

The following table presents the impact of the revisions on the Company’s previously issued consolidated balance sheets (in millions):

	As of
	Dec. 31		Sep. 30		June 30		Mar. 31		As of
	2013								Dec. 31, 2012

Other assets
As reported	$	161	$	166	$	173	$	182	$	184
Correction	24		21		15		14		8
As revised	$	185	$	187	$	188	$	196	$	192

Total assets
As reported	$	6,933	$	7,059	$	7,062	$	6,779	$	6,875
Correction	24		21		15		14		8
As revised	$	6,957	$	7,080	$	7,077	$	6,793	$	6,883

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MASCO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

B. In the first quarter of 2013, the Company determined that Tvilum, its Danish ready-to-assemble cabinet business, was no longer core to its long-term growth strategy and, accordingly, the Company embarked on a plan for disposition. The disposition of Tvilum was completed in the fourth quarter of 2013. The Company has accounted for this business as a discontinued operation.

Selected financial information for the discontinued operations, during the period owned by the Company, was as follows, in millions:

	Three Months Ended			Nine Months Ended
	September 30, 2013			September 30, 2013

Net Sales	$	75		$	194

Operating loss from discontinued operations	$	—		$	(8	)
Impairment of assets	—			(10		)
Loss on disposal of discontinued operations, net	(2		)	(2		)
Loss before income tax	(2		)	(20		)
Income tax benefit	—			(4		)
Loss from discontinued operations, net	$	(2	)	$	(16	)

During the first quarter of 2013, the Company estimated the fair value of the business held for sale, using unobservable inputs (Level 3). After considering the deferred gains reported in Accumulated Other Comprehensive Income, the Company recorded an impairment of $10 million in the first quarter of 2013.

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MASCO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

C. The changes in the carrying amount of goodwill for the nine months ended September 30, 2014, by segment, were as follows, in millions:

	Gross Goodwill		Accumulated			Net Goodwill
	At		Impairment			At
	Sep. 30, 2014		Losses			Sep. 30, 2014
Cabinets and Related Products	$	240	$	(59	)	$	181
Plumbing Products	538		(340		)	198
Installation and Other Services	1,806		(762		)	1,044
Decorative Architectural Products	294		(75		)	219
Other Specialty Products	983		(734		)	249
Total	$	3,861	$	(1,970	)	$	1,891

	Gross Goodwill		Accumulated			Net Goodwill					Net Goodwill
	At		Impairment			At					At
	Dec. 31, 2013		Losses			Dec. 31, 2013		Other(A)			Sep. 30, 2014
Cabinets and Related Products	$	240	$	(59	)	$	181	$	—		$	181
Plumbing Products	550		(340		)	210		(12		)	198
Installation and Other Services	1,806		(762		)	1,044		—			1,044
Decorative Architectural Products	294		(75		)	219		—			219
Other Specialty Products	983		(734		)	249		—			249
Total	$	3,873	$	(1,970	)	$	1,903	$	(12	)	$	1,891

(A) Other principally includes the effect of foreign currency translation.

Other indefinite-lived intangible assets were $132 million and $133 million at September 30, 2014 and December 31, 2013, respectively, and principally included registered trademarks. The carrying value of the Company’s definite-lived intangible assets was $15 million (net of accumulated amortization of $65 million) at September 30, 2014 and $16 million (net of accumulated amortization of $62 million) at December 31, 2013, and principally included customer relationships and non-compete agreements.

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MASCO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

D. Depreciation and amortization expense, including discontinued operations, was $125 million and $143 million, including accelerated depreciation (relating to business rationalization initiatives) of $1 million and $12 million for the nine months ended September 30, 2014 and 2013, respectively.

As a result of business rationalization initiatives, at September 30, 2014, the Company decided to sell two facilities within its Cabinets and Related Products segment. At September 30, 2014, the net book value of those facilities was approximately $10 million, included in property and equipment, net in the condensed consolidated balance sheet as of September 30, 2014. In the third quarter of 2014, the Company recorded a charge of $28 million, included in cost of goods sold in the condensed consolidated statement of operations, to reflect the estimated fair value of those facilities. Fair value was estimated using a market approach (Level 3 input), considering the estimated fair values for other comparable facilities in the areas where the facilities are located.

E. The Company has maintained investments in available-for-sale securities and a number of private equity funds, principally as part of its tax planning strategies, as any gains enhance the utilization of any current and future tax capital losses. Financial investments included in other assets were as follows, in millions:

	September 30,		December 31,
	2014		2013
Equity method investments	$	61	$	70
Total equity method investments	61		70

Auction rate securities	22		22
Total recurring investments	22		22

Private equity funds	15		18
Other investments	4		3
Total non-recurring investments	19		21

Total	$	102	$	113

The Company did not have any transfers between Level 1 and Level 2 financial assets in the three months or nine months ended September 30, 2014 or 2013.

Equity Method Investments. Investments in private equity fund partnerships, joint ventures and less than majority-owned subsidiaries in which we have significant influence are accounted for under the equity method. Our consolidated statements of operations include the Company’s proportionate share of the net income or (loss) of our equity method investees. When we record our proportionate share of net income (loss), it increases (decreases) our equity income in our consolidated statement of operations and our carrying value of that investment on our consolidated balance sheet.

Recurring Fair Value Measurements. The fair value of the auction rate securities held by the Company have been estimated, on a recurring basis, using a discounted cash flow model (Level 3 input). The significant inputs in the discounted cash flow model used to value the auction rate securities include: expected maturity of auction rate securities, discount rate used to determine the present value of expected cash flows and the assumptions for credit defaults, since the auction rate securities are backed by credit default swap agreements.

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MASCO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

Note E — concluded:

The Company’s investments in auction rate securities included cost basis of $19 million and pre-tax unrealized gains of $3 million and had a recorded basis of $22 million at both September 30, 2014 and December 31, 2013.

Non-Recurring Fair Value Measurements. During the three months and nine months ended September 30, 2014 and 2013, the Company did not measure any financial investments at fair value on a non-recurring basis, as there was no other-than-temporary decline in the estimated value of private equity funds.

Realized Gains (Losses) and Impairment Charges. Income (loss) from financial investments, net, included in other, net, within other income (expense), net, was as follows, in millions:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2014		2013		2014			2013
Realized gains from private equity funds	$	—	$	—	$	4		$	7
Equity investment (loss) income, net	—		6		(2		)	13
Income from other investments, net	—		—		—			1
Total income from financial investments	$	—	$	6	$	2		$	21

Fair Value of Debt. The fair value of the Company’s short-term and long-term fixed-rate debt instruments is based principally upon modeled market prices for the same or similar issues or the current rates available to the Company for debt with similar terms and remaining maturities. The aggregate estimated market value of short-term and long-term debt at September 30, 2014 was approximately $3.7 billion, compared with the aggregate carrying value of $3.4 billion. The aggregate estimated market value of short-term and long-term debt at December 31, 2013 was approximately $3.7 billion, compared with the aggregate carrying value of $3.4 billion.

F. The Company is exposed to global market risk as part of its normal daily business activities. To manage these risks, the Company enters into various derivative contracts. These contracts include interest rate swap agreements, foreign currency exchange contracts and metals contracts intended to hedge the Company’s exposure to copper and zinc. The Company reviews its hedging program, derivative positions and overall risk management on a regular basis.

Foreign Currency Contracts. The Company’s net cash inflows and outflows exposed to the risk of changes in foreign currency exchange rates arise from the sale of products in countries other than the manufacturing source, foreign currency denominated supplier payments, debt and other payables, and investments in subsidiaries. To mitigate this risk during the year, the Company, including certain European operations, enters into foreign currency forward contracts and foreign currency exchange contracts.

Gains (losses) related to foreign currency forward and exchange contracts are recorded in the Company’s condensed consolidated statements of operations in other income (expense), net. In the event that the counterparties fail to meet the terms of the foreign currency forward contracts, the Company’s exposure is limited to the aggregate foreign currency rate differential with such institutions.

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MASCO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

Note F — concluded:

Metals Contracts. The Company has entered into several contracts to manage its exposure to increases in the price of copper and zinc. (Losses) gains related to these contracts are recorded in the Company’s condensed consolidated statements of operations in cost of sales.

The pre-tax (losses) gains included in the Company’s condensed consolidated statements of operations is as follows, in millions:

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2014		2013			2014		2013
Foreign Currency Contracts
Exchange Contracts	$	5	$	(4	)	$	2	$	3
Forward Contracts	1		(1		)	—		1
Metal Contracts	—		3			—		(6		)

Total gain (loss)	$	6	$	(2	)	$	2	$	(2	)

The Company presents its derivatives, net by counterparty due to the right of offset under master netting arrangements in current assets or current liabilities in the condensed consolidated balance sheet. The notional amounts being hedged and the fair value of those derivative instruments, on a gross basis, are as follows, in millions:

	At September 30, 2014
	Notional
	Amount		Assets		Liabilities
Foreign Currency Contracts
Exchange Contracts	$	76
Current assets			$	4	$	—
Forward Contracts
Current assets	64		1		—

Metals Contracts
Current assets	61		2		2
Total			$	7	$	2

	At December 31, 2013
	Notional
	Amount		Assets		Liabilities
Foreign Currency Contracts
Exchange Contracts	$	53
Current liabilities			$	—	$	2
Forward Contracts	88
Current liabilities			—		1

Metals Contracts	48
Current liabilities			—		2

Total			$	—	$	5

The fair value of all metals and foreign currency derivative contracts is estimated on a recurring basis, using Level 2 inputs (significant other observable inputs).

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MASCO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

G. Changes in the Company’s warranty liability were as follows, in millions:

	Nine Months Ended			Twelve Months Ended
	September 30, 2014			December 31, 2013
Balance at January 1	$	124		$	118
Accruals for warranties issued during the period	36			42
Accruals related to pre-existing warranties	6			6
Settlements made (in cash or kind) during the period	(35		)	(42		)
Other, net	(3		)	—
Balance at end of period	$	128		$	124

H. 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.

Based on the limitations of the debt to total capitalization ratio covenant in the Credit Agreement, at September 30, 2014, the Company had additional borrowing capacity, subject to availability, of up to $1.2 billion. Additionally, at September 30, 2014, the Company could absorb a reduction to shareholders’ equity of approximately $859 million and remain in compliance with the debt to total capitalization covenant.

In order for the Company to borrow under the Credit Agreement, there must not be any default in the Company’s covenants in the Credit Agreement (i.e., in addition to the two financial covenants, principally limitations on subsidiary debt, negative pledge restrictions, legal compliance requirements and maintenance of properties and insurance) and the Company’s representations and warranties in the Credit Agreement must be true in all material respects on the date of borrowing (i.e., principally no material adverse change or litigation likely to result in a material adverse change, since December 31, 2012, in each case, no material ERISA or environmental non-compliance and no material tax deficiency). The Company was in compliance with all covenants and no borrowings have been made at September 30, 2014.

I. The Company’s 2014 Long Term Stock Incentive Plan (and the prior plan that it replaced) provides for the issuance of stock-based incentives in various forms to employees and non-employee Directors of the Company. At September 30, 2014, outstanding stock-based incentives were in the form of long-term stock awards, stock options, phantom stock awards and stock appreciation rights. Pre-tax compensation expense and the related income tax benefit for these stock-based incentives were as follows, in millions:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2014		2013		2014		2013
Long-term stock awards	$	7	$	7	$	30	$	27
Stock options	1		2		3		12
Phantom stock awards and stock appreciation rights	3		3		4		6
Total	$	11	$	12	$	37	$	45

Income tax benefit (37 percent tax rate - before valuation allowance)	$	4	$	5	$	14	$	17

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MASCO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

Note I - continued:

Long-Term Stock Awards. Long-term stock awards are granted to key employees and non-employee Directors of the Company and do not cause net share dilution inasmuch as the Company continues the practice of repurchasing and retiring an equal number of shares in the open market. The Company granted 1,680,220 shares of long-term stock awards in the nine months ended September 30, 2014.

The Company’s long-term stock award activity was as follows, shares in millions:

	Nine Months Ended
	September 30,
	2014		2013
Unvested stock award shares at January 1	8		8
Weighted average grant date fair value	$	17	$	16

Stock award shares granted	1		2
Weighted average grant date fair value	$	22	$	20

Stock award shares vested	2		2
Weighted average grant date fair value	$	17	$	17

Stock award shares forfeited	1		—
Weighted average grant date fair value	$	16	$	17

Unvested stock award shares at September 30	6		8
Weighted average grant date fair value	$	18	$	17

At September 30, 2014 and 2013, there was $68 million and $76 million of total unrecognized compensation expense related to unvested stock awards; such awards had a weighted average remaining vesting period of three years in both 2014 and 2013.

The total market value (at the vesting date) of stock award shares which vested during the nine months ended September 30, 2014 and 2013 was $50 million and $38 million, respectively.

Stock Options. Stock options are granted to key employees of the Company. The exercise price equals the market price of the Company’s common stock at the grant date.

The Company granted 332,750 of stock option shares in the nine months ended September 30, 2014 with a grant date exercise price approximating $22 per share. In the first nine months of 2014, 3,640,670 stock option shares were forfeited (including options that expired unexercised).

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MASCO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

Note I - continued:

The Company’s stock option activity was as follows, shares in millions:

	Nine Months Ended
	September 30,
	2014		2013
Option shares outstanding, January 1	24		30
Weighted average exercise price	$	22	$	21

Option shares granted, including restoration options	—		1
Weighted average exercise price	$	22	$	20

Option shares exercised	2		3
Aggregate intrinsic value on date of exercise (A)	$	17 million	$	22 million
Weighted average exercise price	$	16	$	12

Option shares forfeited	3		1
Weighted average exercise price	$	28	$	23

Option shares outstanding, September 30	19		27
Weighted average exercise price	$	21	$	22
Weighted average remaining option term (in years)	4		4

Option shares vested and expected to vest, September 30	19		27
Weighted average exercise price	$	21	$	22
Aggregate intrinsic value (A)	$	102 million	$	91 million
Weighted average remaining option term (in years)	4		4

Option shares exercisable (vested), September 30	16		22
Weighted average exercise price	$	22	$	24
Aggregate intrinsic value (A)	$	80 million	$	51 million
Weighted average remaining option term (in years)	3		3

(A) Aggregate intrinsic value is calculated using the Company’s stock price at each respective date, less the exercise price (grant date price) multiplied by the number of shares.

At September 30, 2014 and 2013, there was $7 million and $10 million, respectively, of unrecognized compensation expense (using the Black-Scholes option pricing model at the grant date) related to unvested stock options; such options had a weighted average remaining vesting period of two years at both September 30, 2014 and 2013.

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MASCO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

Note I - concluded:

The weighted average grant date fair value of option shares granted and the assumptions used to estimate those values using a Black-Scholes option pricing model were as follows:

	Nine Months Ended
	September 30,
	2014			2013
Weighted average grant date fair value	$	9.53		$	8.35
Risk-free interest rate	1.91		%	1.22		%
Dividend yield	1.34		%	1.47		%
Volatility factor	49.00		%	49.07		%
Expected option life	6 years			6 years

J. Net periodic pension cost for the Company’s defined-benefit pension plans was as follows, in millions:

	Three Months Ended September 30,
	2014					2013
	Qualified			Non-Qualified		Qualified			Non-Qualified
Service cost	$	1		$	—	$	1		$	—
Interest cost	12			2		10			2
Expected return on plan assets	(11		)	—		(10		)	—
Amortization of net loss	2			1		4			1
Net periodic pension cost	$	4		$	3	5			3

	Nine Months Ended September 30,
	2014					2013
	Qualified			Non-Qualified		Qualified			Non-Qualified
Service cost	$	3		$	—	$	3		$	—
Interest cost	38			6		32			5
Expected return on plan assets	(35		)	—		(30		)	—
Amortization of net loss	8			1		12			2
Net periodic pension cost	$	14		$	7	$	17