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, 2015

Commission file number: 1-5794

Masco Corporation

(Exact name of Registrant as Specified in its Charter)

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

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 September 30, 2015
Common stock, par value $1.00 per share		336,472,115

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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, 2015 and December 31, 2014	1

		Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2015 and 2014	2

		Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2015 and 2014	3

		Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2015 and 2014	4

		Consolidated Statements of Shareholders’ Equity for the Nine Months Ended September 30, 2015 and 2014	5

		Notes to Condensed Consolidated Financial Statements	6-22

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		23-30

Item 4.	Controls and Procedures		31

PART II.	OTHER INFORMATION		32-34

Item 1.	Legal Proceedings

Item 1A.	Risk Factors

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds

Item 6.	Exhibits

	Signature

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MASCO CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

September 30, 2015 and December 31, 2014

(In Millions, Except Share Data)

	September 30,			December 31,
	2015			2014
ASSETS
Current assets:
Cash and cash investments	$	1,279		$	1,379
Short-term bank deposits	255			306
Receivables	1,006			820
Deferred income taxes	177			206
Prepaid expenses and other	74			68
Assets held for sale	—			373
Inventories:
Finished goods	392			361
Raw material	258			251
Work in process	99			100
	749			712
Total current assets	3,540			3,864

Property and equipment, net	1,025			1,046
Goodwill	843			840
Other intangible assets, net	163			142
Other assets	156			200
Assets held for sale	—			1,141
Total assets	$	5,727		$	7,233

LIABILITIES
Current liabilities:
Notes payable	$	6		$	505
Accounts payable	827			721
Accrued liabilities	727			685
Liabilities held for sale	—			300
Total current liabilities	1,560			2,211

Long-term debt	3,418			2,919
Other liabilities	721			768
Liabilities held for sale	—			207
Total liabilities	5,699			6,105
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: 2015 – 331,900,000; 2014 – 345,000,000	332			345
Preferred shares authorized: 1,000,000; issued and outstanding: 2015 – None; 2014 – None	—			—
Paid-in capital	—			—
Retained (deficit) earnings	(332		)	690
Accumulated other comprehensive loss	(159		)	(111		)
Total Masco Corporation’s shareholders’ (deficit) equity	(159		)	924
Noncontrolling interest	187			204
Total equity	28			1,128
Total liabilities and equity	$	5,727		$	7,233

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, 2015 and 2014

(In Millions Except Per Common Share Data)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2015			2014			2015			2014
Net sales	$	1,839		$	1,834		$	5,427		$	5,340
Cost of sales	1,250			1,312			3,706			3,761

Gross profit	589			522			1,721			1,579

Selling, general and administrative expenses	331			341			1,019			1,024

Operating profit	258			181			702			555

Other income (expense), net:
Interest expense	(54		)	(57		)	(171		)	(169		)
Other, net	(6		)	7			(2		)	10
	(60		)	(50		)	(173		)	(159		)
Income from continuing operations before income taxes	198			131			529			396
Income tax (expense) benefit	(77		)	415			(219		)	377
Income from continuing operations	121			546			310			773
Income (loss) from discontinued operations, net	—			10			(1		)	21
Net income	121			556			309			794
Less: Net income attributable to noncontrolling interest	10			13			29			38
Net income attributable to Masco Corporation	$	111		$	543		$	280		$	756

Income per common share attributable to Masco Corporation:
Basic:
Income from continuing operations	$	.33		$	1.49		$	.81		$	2.06
Income (loss) from discontinued operations, net	—			.03			—			.06
Net income	$	.33		$	1.52		$	.81		$	2.12

Diluted:
Income from continuing operations	$	.32		$	1.48		$	.81		$	2.04
Income (loss) from discontinued operations, net	—			.03			—			.06
Net income	$	.32		$	1.51		$	.80		$	2.10

Amounts attributable to Masco Corporation:
Income from continuing operations	$	111		$	533		$	281		$	735
Income (loss) from discontinued operations, net	—			10			(1		)	21
Net income	$	111		$	543		$	280		$	756

See notes to condensed consolidated financial statements.

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MASCO CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)

For the Three and Nine Months Ended September 30, 2015 and 2014

(In Millions)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2015			2014			2015			2014
Net income	$	121		$	556		$	309		$	794
Less: Net income attributable to noncontrolling interest	10			13			29			38
Net income attributable to Masco Corporation	$	111		$	543		$	280		$	756

Other comprehensive income (loss), net of tax (see Note L):
Cumulative translation adjustment	(17		)	(73		)	(70		)	(79		)
Interest rate swaps	—			—			1			1
Amortization of pension prior service cost and net loss	4			—			11			6
Other comprehensive income (loss)	(13		)	(73		)	(58		)	(72		)
Less: Other comprehensive income (loss) attributable to noncontrolling interest	(1		)	(18		)	(10		)	(21		)
Other comprehensive income (loss) attributable to Masco Corporation	$	(12	)	$	(55	)	$	(48	)	$	(51	)
Total comprehensive income (loss)	$	108		$	483		$	251		$	722
Less: Total comprehensive income (loss) attributable to the noncontrolling interest	9			(5		)	19			17
Total comprehensive income (loss) attributable to Masco Corporation	$	99		$	488		$	232		$	705

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, 2015 and 2014

(In Millions)

	Nine Months Ended
	September 30,
	2015			2014
CASH FLOWS FROM (FOR) OPERATING ACTIVITIES:
Cash provided by operations	$	581		$	543
Increase in receivables	(245		)	(257		)
Increase in inventories	(41		)	(109		)
Increase in accounts payable and accrued liabilities, net	127			129
Net cash from operating activities	422			306

CASH FLOWS FROM (FOR) FINANCING ACTIVITIES:
Retirement of notes	(500		)	—
Purchase of Company common stock	(407		)	(39		)
Cash dividends paid	(94		)	(86		)
Dividend payment to noncontrolling interest	(36		)	(34		)
Cash distributed to TopBuild Corp.	(63		)	—
Issuance of TopBuild Corp. debt	200			—
Issuance of notes, net of issuance costs	497			—
Increase in debt	2			—
Issuance of Company common stock	2			1
Tax benefit from stock-based compensation	32			—
Payment of debt	(3		)	(2		)
Credit Agreement and other financing costs	(3		)	—
Net cash for financing activities	(373		)	(160		)

CASH FLOWS FROM (FOR) INVESTING ACTIVITIES:
Capital expenditures	(112		)	(82		)
Acquisition of companies, net of cash acquired	(41		)	(2		)
Proceeds from disposition of:
Short-term bank deposits	251			322
Other financial investments	7			13
Property and equipment	13			12
Purchases of:
Short-term bank deposits	(225		)	(297		)
Other, net	(37		)	(26		)
Net cash for investing activities	(144		)	(60		)

Effect of exchange rate changes on cash and cash investments	(9		)	(27		)

CASH AND CASH INVESTMENTS:
(Decrease) increase for the period	(104		)	59
At January 1	1,383			1,223
At September 30	$	1,279		$	1,282

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, 2015 and 2014

(In Millions, Except Per Share Data)

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

Balance, January 1, 2015	$	1,128		$	345		$	—		$	690		$	(111	)	$	204
Total comprehensive income (loss)	251									280			(48		)	19
Shares issued	(9		)	3			(12		)
Shares retired:
Repurchased	(407		)	(15		)	(29		)	(363		)
Surrendered (non-cash)	(18		)	(1		)				(17		)
Cash dividends declared	(94		)							(94		)
Dividend payment to noncontrolling interest	(36		)													(36		)
Separation of TopBuild Corp.	(828		)							(828		)
Stock-based compensation	41						41
Balance, September 30, 2015	$	28		$	332		$	—		$	(332	)	$	(159	)	$	187

See notes to condensed consolidated financial statements.

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MASCO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

A. ACCOUNTING POLICIES

In our opinion, the accompanying unaudited condensed consolidated financial statements contain all adjustments, of a normal recurring nature, necessary to present fairly our financial position as at September 30, 2015, our results of operations and comprehensive income (loss) for the three months and nine months ended September 30, 2015 and 2014 and cash flows and changes in shareholders’ equity for the nine months ended September 30, 2015 and 2014. The condensed consolidated balance sheet at December 31, 2014 was derived from audited financial statements.

Reclassification: Certain prior year amounts have been reclassified to conform to the 2015 presentation in the condensed consolidated financial statements. In our condensed consolidated statements of cash flows, the cash flows from discontinued operations are not separately stated.

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 us for annual periods beginning January 1, 2018. We are currently evaluating the impact the adoption of this new standard will have on our results of operations.

In April 2014, the FASB issued Accounting Standards Update 2014-08 (“ASU 2014-08”) “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. On January 1, 2015, we adopted ASU 2014-08. The adoption of the new standard did not have an impact on our financial position or results of operations.

In February 2015, the FASB issued Accounting Standards Update 2015-02 (“ASU 2015-02”) “Consolidation (Topic 810) — Amendments to the Consolidations Analysis,” which modifies certain aspects of both the variable interest and voting models. ASU 2015-02 is effective for us for annual periods beginning January 1, 2016. We are currently evaluating the impact the adoption of this new standard will have on our financial position or results of operations.

In April 2015, the FASB issued Accounting Standards Update 2015-03 (“ASU 2015-03”) “Interest — Imputation of Interest (Subtopic 835-30) — Simplifying the Presentation of Debt Issuance Costs,” that requires that all costs incurred to issue debt be presented in the balance sheet as a direct deduction from the carrying value of the debt. In August 2015, the FASB amended ASU 2015-03 to clarify that debt issuance costs related to line-of-credit arrangements may be classified as an asset. ASU 2015-03 is effective for us for annual periods beginning January 1, 2016. We do not expect that the adoption of the new standard will have a material impact on our financial position.

B. DISCONTINUED OPERATIONS

The presentation of discontinued operations includes a component or group of components that we have or intend to dispose of, and represents a strategic shift that has (or will have) a major effect on our operations and financial results. For spin off transactions, discontinued operations treatment is appropriate following the completion of the spin off.

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MASCO CORPORATION

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

Note B — continued:

On September 30, 2014, we announced a plan to spin off 100 percent of our Installation and Other Services businesses into an independent, publicly-traded company named TopBuild Corp. (“TopBuild”) through a tax-free distribution of the stock of TopBuild to our stockholders. We initiated the spin off as TopBuild was no longer considered core to our long-term growth strategy in branded building products. On June 30, 2015, immediately prior to the effective time of the spin off, TopBuild paid a cash distribution to us of $200 million using the proceeds of its new debt financing arrangement. This transaction was reported as a financing activity in the condensed consolidated statements of cash flows.

We have accounted for the spin off of TopBuild as a discontinued operation. (Losses) gains from this discontinued operation were included in income (loss) from discontinued operations, net, in the condensed consolidated statements of operations.

The major classes of line items constituting pre-tax (loss) profit of discontinued operations, in millions:

	Three Months Ended						Nine Months Ended
	September 30						September 30
	2015			2014			2015			2014
Net sales	$	—		$	398		$	762		$	1,117
Cost of sales	—			309			603			877
Gross profit	—			89			159			240
Selling, general and administrative expenses	—			68			148			201
Income from discontinued operations	$	—		$	21		$	11		$	39
(Loss) gain on disposal of discontinued operations, net (1)	(1		)	1			(1		)	(2		)
(Loss) income before income tax	(1		)	22			10			37
Income tax benefit (expense) (2)	1			(12		)	(11		)	(16		)
Income (loss) from discontinued operations, net	$	—		$	10		$	(1	)	$	21

(1) Included in (loss) gain on disposal of discontinued operations, net in 2014 are additional costs and charges related to the 2013 sale of Tvilum.

(2) The unusual relationship between income tax expense and income before income tax for the nine months ended September 30, 2015 resulted primarily from certain non-deductible transaction costs related to the spin off of TopBuild.

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MASCO CORPORATION

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

Note B — concluded:

The carrying amount of major classes of assets and liabilities included as part of the TopBuild discontinued operations, in millions:

	December 31,
	2014
Cash	$	4
Receivables	220
Inventories	107
Deferred income taxes	38
Prepaid expenses and other	4
Property and equipment, net	93
Goodwill	1,044
Other intangible assets, net	3
Other assets	1
Total assets classified as held for sale	$	1,514
Accounts payable	$	229
Accrued liabilities	71
Other liabilities	40
Deferred income taxes	167
Total liabilities classified as held for sale	$	507

Other selected financial information for TopBuild during the period owned by us, were as follows, in millions:

	Nine Months Ended
	Sep. 30,		Sep. 30,
	2015		2014

Depreciation and amortization	$	6	$	19
Capital expenditures	$	7	$	9

In conjunction with the spin off, we have entered into a Transition Services Agreement with TopBuild to provide TopBuild administrative services subsequent to the separation. The fees for services rendered under the Transition Services Agreement are not expected to be material to our results of operations.

C. ACQUISITIONS

In the second quarter of 2015, we acquired a U.K. window business for approximately $16 million in cash in the Other Specialty Products segment. This acquisition will support our U.K. window business’ growth strategy by expanding its product offerings into timber-alternative windows and doors.

In the first quarter of 2015, we acquired an aquatic fitness business for approximately $25 million in cash in the Plumbing Products segment. This acquisition will allow our spa business to expand its wellness products platform, open new channels of distribution and access a new customer base.

These acquisitions are not material to us. The results of these acquisitions are included in the condensed consolidated financial statements from the date of their respective acquisition.

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MASCO CORPORATION

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

D. GOODWILL AND OTHER INTANGIBLE ASSETS

The changes in the carrying amount of goodwill for the nine months ended September 30, 2015, by segment, were as follows, in millions:

	Gross Goodwill		Accumulated			Net Goodwill
	At		Impairment			At
	Sep. 30, 2015		Losses			Sep. 30, 2015
Cabinets and Related Products	$	240	$	(59	)	$	181
Plumbing Products	528		(340		)	188
Decorative Architectural Products	294		(75		)	219
Other Specialty Products	989		(734		)	255
Total	$	2,051	$	(1,208	)	$	843

	Gross Goodwill		Accumulated			Net Goodwill							Net Goodwill
	At		Impairment			At							At
	Dec. 31, 2014		Losses			Dec. 31, 2014		Acquisitions		Other(A)			Sep. 30, 2015
Cabinets and Related Products	$	240	$	(59	)	$	181	$	—	$	—		$	181
Plumbing Products	531		(340		)	191		8		(11		)	188
Decorative Architectural Products	294		(75		)	219		—		—			219
Other Specialty Products	983		(734		)	249		6		—			255
Total	$	2,048	$	(1,208	)	$	840	$	14	$	(11	)	$	843

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

Other indefinite-lived intangible assets were $137 million and $130 million at September 30, 2015 and December 31, 2014, respectively, and principally included registered trademarks. The carrying value of our definite-lived intangible assets was $26 million (net of accumulated amortization of $49 million) at September 30, 2015 and $12 million (net of accumulated amortization of $48 million) at December 31, 2014, and principally included customer relationships. As a result of our 2015 acquisitions, other indefinite-lived intangible assets and definite-lived intangible assets increased by $7 million and $17 million, respectively, as of the acquisition dates.

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MASCO CORPORATION

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

E. DEPRECIATION AND AMORTIZATION

Depreciation and amortization expense, including discontinued operations, was $100 million and $125 million for the nine months ended September 30, 2015 and 2014, respectively. Depreciation and amortization expense included accelerated depreciation (relating to business rationalization initiatives) of $1 million for the nine months ended September 30, 2014.

As a result of business rationalization initiatives, at September 30, 2014, we decided to sell two facilities within our Cabinets and Related Products segment. At September 30, 2014, the net book value of those facilities was approximately $10 million. In the third quarter of 2014, we 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.

F. FAIR VALUE OF FINANCIAL INVESTMENTS

We have maintained investments in available-for-sale securities, equity method investments 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 tax capital losses. Financial investments included in other assets were as follows, in millions:

	September 30,		December 31,
	2015		2014
Auction rate securities	$	22	$	22
Total recurring investments	22		22

Equity method investments	13		11
Private equity funds	12		14
Other investments	3		3

Total	$	50	$	50

Recurring Fair Value Measurements. The fair value of the auction rate securities held by us 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.

Our 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, 2015 and December 31, 2014.

Non-Recurring Fair Value Measurements. During the three months and nine months ended September 30, 2015 and 2014, we 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 these investments.

We did not have any transfers between Level 1 and Level 2 financial assets in the nine months ended September 30, 2015 or 2014.

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MASCO CORPORATION

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

Note F — concluded:

Realized Gains (Losses). Income 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,
	2015		2014		2015		2014
Realized gains from private equity funds	$	1	$	—	$	5	$	4
Equity investment income (loss), net	—		—		2		(2		)
Total income from financial investments, net	$	1	$	—	$	7	$	2

Fair Value of Debt. The fair value of our 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 us for debt with similar terms and remaining maturities. The aggregate estimated market value of short-term and long-term debt at September 30, 2015 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, 2014 was approximately $3.7 billion, compared with the aggregate carrying value of $3.4 billion.

G. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

We are exposed to global market risk as part of our normal daily business activities. To manage these risks, we enter into various derivative contracts. These contracts include interest rate swap agreements, foreign currency contracts and metals contracts intended to hedge our exposure to copper and zinc. We review our hedging program, derivative positions and overall risk management on a regular basis.

Interest Rate Swap Agreements. In March 2012, in connection with the issuance of $400 million of debt, we terminated the interest rate swap hedge relationships that we had entered into in August 2011. These interest rate swaps were designated as cash flow hedges and effectively fixed interest rates on the forecasted debt issuance to variable rates based on 3-month LIBOR. Upon termination, the ineffective portion of the cash flow hedges of approximately $2 million loss was recognized in our consolidated statement of operations in other, net. The remaining loss of approximately $23 million from the termination of these swaps is being amortized as an increase to interest expense over the remaining term of the debt, through March 2022.

Foreign Currency Contracts. Our 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, we, including certain of our European operations, entered into foreign currency forward contracts and foreign currency exchange contracts.

Gains (losses) related to foreign currency forward and exchange contracts are recorded in our condensed consolidated statements of operations in other, net within other income (expense), net. In the event that the counterparties fail to meet the terms of the foreign currency forward contracts, our 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 G — concluded:

Metals Contracts. We have entered into several contracts to manage our exposure to increases in the price of copper and zinc. Gains (losses) related to these contracts are recorded in our condensed consolidated statements of operations in cost of sales.

The pre-tax (losses) gains included in our condensed consolidated statements of operations are as follows, in millions:

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2015			2014		2015			2014
Foreign currency contracts
Exchange contracts	$	—		$	5	$	3		$	2
Forward contracts	1			1		(3		)	—
Metal contracts	(9		)	—		(14		)	—
Interest rate swaps	—			—		(1		)	(1		)
Total (loss) gain	$	(8	)	$	6	$	(15	)	$	1

We present our derivatives, net by counterparty due to the right of offset under master netting arrangements in the condensed consolidated balance sheets. The notional amounts being hedged and the fair value of those derivative instruments are as follows, in millions:

	At September 30, 2015
	Notional
	Amount		Balance Sheet
Foreign currency contracts
Exchange contracts	$	28
Receivables			$	1
Forward contracts	35
Accrued liabilities			(3		)

Metals contracts	67
Accrued liabilities			(9		)
Other liabilities			(2		)

	At December 31, 2014
	Notional
	Amount		Balance Sheet
Foreign currency contracts
Exchange contracts	$	55
Receivables			$	6
Forward contracts	79
Other assets			2
Accrued liabilities			(1		)

Metals contracts	70
Accrued liabilities			(2		)

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

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

H. WARRANTY LIABILITY

Changes in our warranty liability were as follows, in millions:

	Nine Months Ended			Twelve Months Ended
	September 30, 2015			December 31, 2014

Balance at January 1	$	135		$	124
Accruals for warranties issued during the period	39			51
Accruals related to pre-existing warranties	8			11
Settlements made (in cash or kind) during the period	(36		)	(46		)
Other, net (including currency translation)	(3		)	(5		)
Balance at end of period	$	143		$	135

I. DEBT

On June 15, 2015, we repaid and retired all of our $500 million, 4.8% Notes on the scheduled retirement date.

On March 24, 2015, we issued $500 million of 4.45% Notes due April 1, 2025. These Notes are senior indebtedness and are redeemable at our option.

On March 28, 2013, we 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. On May 29, 2015 and August 28, 2015, we amended the Credit Agreement with the bank group (the “Amended Credit Agreement”). The Amended Credit Agreement reduces the aggregate commitment to $750 million and extends the maturity date to May 29, 2020. Under the Amended Credit Agreement, at our request and subject to certain conditions, we can increase the aggregate commitment up to an additional $375 million with the current bank group or new lenders.

The Amended Credit Agreement provides for an unsecured revolving credit facility available to us and one of our foreign subsidiaries, in U.S. dollars, European euros and certain other currencies. Borrowings under the revolver denominated in euros are limited to $500 million, equivalent. We can also borrow swingline loans up to $75 million and obtain letters of credit of up to $100 million; any outstanding letters of credit under the Amended Credit Agreement reduce our borrowing capacity. At September 30, 2015, we had $42 million of outstanding standby letters of credit.

Revolving credit loans bear interest under the Amended Credit Agreement, at our option, at (A) a rate per annum equal to the greater of (i) the prime rate, (ii) the Federal Funds effective rate plus 0.50% and (iii) LIBOR plus 1.0% (the “Alternative Base Rate”); plus an applicable margin based upon our then-applicable corporate credit ratings; or (B) LIBOR plus an applicable margin based upon our then-applicable corporate credit ratings. The foreign currency revolving credit loans bear interest at a rate equal to LIBOR plus an applicable margin based upon our then-applicable corporate credit ratings.

The Amended Credit Agreement contains financial covenants requiring us to maintain (A) a maximum net leverage ratio, as adjusted for certain items, of 4.0 to 1.0, and (B) a minimum interest coverage ratio, as adjusted for certain items, equal to or greater than 2.5 to 1.0.

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

Note I — concluded:

In order for us to borrow under the Amended Credit Agreement, there must not be any default in our covenants in the Amended 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 our representations and warranties in the Amended 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, 2014, in each case, no material ERISA or environmental non-compliance, and no material tax deficiency). We were in compliance with all covenants and no borrowings have been made at September 30, 2015.

J. STOCK-BASED COMPENSATION

Our 2014 Long Term Stock Incentive Plan (the “2014 Plan”) provides for the issuance of stock-based incentives in various forms to our employees and non-employee Directors. At September 30, 2015, 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,
	2015		2014		2015		2014
Long-term stock awards	$	6	$	6	$	19	$	27
Stock options	1		1		5		3
Phantom stock awards and stock appreciation rights	—		3		6		4
Total	$	7	$	10	$	30	$	34

Income tax benefit (37 percent tax rate – before valuation allowance)	$	3	$	4	$	11	$	13

Long-Term Stock Awards. Long-term stock awards are granted to our key employees and non-employee Directors and do not cause net share dilution inasmuch as we continue the practice of repurchasing and retiring an equal number of shares in the open market. We granted 719,546 shares of long-term stock awards in the nine months ended September 30, 2015.

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

Note J — continued:

Our long-term stock award activity was as follows, shares in millions:

	Nine Months Ended
	September 30,
	2015		2014
Unvested stock award shares at January 1	6		8
Weighted average grant date fair value	$	18	$	17

Stock award shares granted	1		1
Weighted average grant date fair value	$	26	$	22

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	$	18	$	16

Forfeitures upon spin off (A)	1		—
Weighted average grant date fair value	$	20	$	—

Modification upon spin off (B)	1		—

Unvested stock award shares at September 30	5		6
Weighted average grant date fair value	$	17	$	18

(A) In connection with the spin off of TopBuild, TopBuild employees forfeited their outstanding Masco equity awards.

(B) Subsequent to the separation of TopBuild, we modified our outstanding equity awards to employees and non-employee directors such that all individuals received an equivalent fair value both before and after the separation. The modification to the outstanding stock awards was made pursuant to existing anti-dilution provisions in our 2014 Plan and 2005 Long Term Incentive Plan.

At September 30, 2015 and 2014, there was $47 million and $68 million of total unrecognized compensation expense related to unvested stock awards, respectively; such awards had a weighted average remaining vesting period of three years in both 2015 and 2014.

The total market value (at the vesting date) of stock award shares which vested during the nine months ended September 30, 2015 and 2014 was $54 million and $50 million, respectively.

Stock Options. Stock options are granted to our 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 10 years after the grant date.

We granted 452,380 of stock option shares in the nine months ended September 30, 2015 with a grant date exercise price approximating $26 per share. In the first nine months of 2015, 3,150,790 stock option shares were forfeited (including options that expired unexercised).

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

Note J — continued:

Our stock option activity was as follows, shares in millions:

	Nine Months Ended
	September 30,
	2015		2014
Option shares outstanding, January 1	18		24
Weighted average exercise price	$	21	$	22

Option shares granted	—		—
Weighted average exercise price	$	26	$	22

Option shares exercised	3		2
Aggregate intrinsic value on date of exercise (A)	$	32 million	$	17 million
Weighted average exercise price	$	17	$	16

Option shares forfeited	3		3
Weighted average exercise price	$	29	$	28

Forfeitures upon spin off (B)	—		—
Weighted average exercise price	$	19	$	—

Modification upon spin off (C)	2		—

Option shares outstanding, September 30	14		19
Weighted average exercise price	$	17	$	21
Weighted average remaining option term (in years)	4		4

Option shares vested and expected to vest, September 30	14		19
Weighted average exercise price	$	17	$	21
Aggregate intrinsic value (A)	$	111 million	$	102 million
Weighted average remaining option term (in years)	4		4

Option shares exercisable (vested), September 30	12		16
Weighted average exercise price	$	18	$	22
Aggregate intrinsic value (A)	$	96 million	$	80 million
Weighted average remaining option term (in years)	3		3

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

(B) In connection with the spin off of TopBuild, TopBuild employees forfeited their outstanding Masco equity awards.

(C) Subsequent to the separation of TopBuild, we modified our outstanding equity awards to employees and non-employee directors such that all individuals received an equivalent fair value both before and after the separation. The modification to the outstanding options was made pursuant to existing anti-dilution provisions in our 2014 Plan and 2005 Long Term Incentive Plan.

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MASCO CORPORATION

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

Note J — concluded:

At September 30, 2015 and 2014, there were $6 million and $7 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 2 years at both September 30, 2015 and 2014.

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,
	2015			2014
Weighted average grant date fair value	$	9.67		$	9.53
Risk-free interest rate	1.75		%	1.91		%
Dividend yield	1.32		%	1.34		%
Volatility factor	42.00		%	49.00		%
Expected option life	6 years			6 years

K. EMPLOYEE RETIREMENT PLANS

Net periodic pension cost for our defined-benefit pension plans was as follows, in millions:

	Three Months Ended September 30,
	2015					2014
	Qualified			Non-Qualified		Qualified			Non-Qualified
Service cost	$	—		$	—	$	1		$	—
Interest cost	13			1		12			2
Expected return on plan assets	(12		)	—		(11		)	—
Amortization of net loss	5			1		2			1
Net periodic pension cost	$	6		$	2	$	4		$	3

	Nine Months Ended September 30,
	2015					2014
	Qualified			Non-Qualified		Qualified			Non-Qualified
Service cost	$	2		$	—	$	3		$	—
Interest cost	36			5		38			6
Expected return on plan assets	(35		)	—		(35		)	—
Amortization of net loss	14			2		8			1
Net periodic pension cost	$	17		$	7	$	14		$	7

We participate in one regional multi-employer pension plan, principally related to one of our manufacturing companies; the plan is not considered significant to us.

Effective January 1, 2010, we froze all future benefit accruals under substantially all of our domestic qualified and non-qualified defined benefit pension plans. Future benefit accruals related to our foreign non-qualified plans were frozen several years ago.

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

L. RECLASSIFICATIONS FROM ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME

The reclassifications from accumulated other comprehensive (loss) income to the condensed consolidated statements of operations were as follows, in millions:

	Amount Reclassified
Accumulated Other	Three Months						Nine Months
Comprehensive	Ended Sep. 30,						Ended Sep. 30,						Statement of
(Loss) Income	2015			2014			2015			2014			Operations Line Item
Amortization of defined benefit pension:
Actuarial losses, net	$	6		$	3		$	16		$	9		Selling, general & administrative expenses
Tax (benefit)	(2		)	(3		)	(5		)	(3		)
Net of tax	$	4		$	—		$	11		$	6

Interest rate swaps	$	—		$	—		$	1		$	1		Interest expense
Tax (benefit) expense	—			—			—			—
Net of tax	$	—		$	—		$	1		$	1

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

M. SEGMENT INFORMATION

Information by segment and geographic area was as follows, in millions:

	Three Months Ended September 30,										Nine Months Ended September 30,
	2015		2014		2015			2014			2015		2014		2015			2014
	Net Sales(A)				Operating Profit (Loss)						Net Sales(A)				Operating Profit (Loss)
Our operations by segment were:
Cabinets and Related Products	$	253	$	266	$	21		$	(35	)	$	771	$	756	$	32		$	(55	)
Plumbing Products	853		855		137			141			2,495		2,504		386			399
Decorative Architectural Products	527		523		102			91			1,600		1,560		318			280
Other Specialty Products	206		190		23			20			561		520		50			39
Total	$	1,839	$	1,834	$	283		$	217		$	5,427	$	5,340	$	786		$	663
Our operations by geographic area were:
North America	$	1,462	$	1,420	$	234		$	162		$	4,298	$	4,100	$	645		$	494
International, principally Europe	377		414		49			55			1,129		1,240		141			169
Total	$	1,839	$	1,834	283			217			$	5,427	$	5,340	786			663
General corporate expense, net					(25		)	(36		)					(84		)	(108		)
Operating profit					258			181							702			555
Other income (expense), net					(60		)	(50		)					(173		)	(159		)
Income from continuing operations before income taxes					$	198		$	131						$	529		$	396

(A) Inter-segment sales were not material.

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

N. SEVERANCE COSTS

We recorded charges related to severance of $1 million and $8 million for the three and nine months ended September 30, 2015, respectively, and $13 million and $23 million for the three and nine months ended September 30, 2014, respectively. Such charges are principally reflected in the condensed consolidated statements of operations in selling, general and administrative expenses. For the three months and nine months ended September 30, 2014, we recorded $13 million and $20 million, respectively, of severance costs related to corporate office actions, which are included in general corporate expense, net.

O. OTHER INCOME (EXPENSE), NET

Other, net, which is included in other income (expense), net, was as follows, in millions:

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2015			2014		2015			2014

Income from cash and cash investments	$	1		$	1	$	2		$	2
Income from financial investments, net (Note F)	1			—		7			2
Foreign currency transaction (losses) gains	(8		)	5		(13		)	5
Other items, net	—			1		2			1
Total other, net	$	(6	)