UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
For the quarterly period ended September 30, 2015
OR
For the transition period from to
Commission file number 1-35166
FORTUNE BRANDS HOME & SECURITY, INC.
(Exact name of Registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
Registrant’s telephone number, including area code: (847) 484-4400
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares outstanding of the registrant’s common stock, par value $0.01 per share, at October 23, 2015 was 159,695,840.
PART I. FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Nine and Three Months Ended September 30, 2015 and 2014
(In millions, except per share amounts)
(Unaudited)
Net sales
Cost of products sold
Selling, general and administrative expenses
Amortization of intangible assets
Restructuring charges
Operating income
Interest expense
Other expense (income), net
Income from continuing operations before income taxes
Income taxes
Income from continuing operations, net of tax
Income (loss) from discontinued operations, net of tax
Net income (loss)
Less: Noncontrolling interests
Net income (loss) attributable to Fortune Brands
Basic earnings per common share
Continuing operations
Discontinued operations
Net income (loss) attributable to Fortune Brands common shareholders
Diluted earnings per common share
Comprehensive income (loss)
See notes to condensed consolidated financial statements.
2
CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions)
Assets
Current assets
Cash and cash equivalents
Accounts receivable, net
Inventories
Other current assets
Current assets of discontinued operations
Total current assets
Property, plant and equipment, net of accumulated depreciation
Goodwill
Other intangible assets, net of accumulated amortization
Other assets
Non-current assets of discontinued operations
Total assets
Liabilities and equity
Current liabilities
Current portion of long-term debt
Accounts payable
Other current liabilities
Current liabilities of discontinued operations
Total current liabilities
Long-term debt
Deferred income taxes
Other non-current liabilities
Non-current liabilities of discontinued operations
Total liabilities
Commitments and contingencies (see Note 17)
Equity
Fortune Brands stockholders’ equity
Common stock(a)
Paid-in capital
Accumulated other comprehensive loss
Retained earnings
Treasury stock
Total Fortune Brands stockholders’ equity
Noncontrolling interests
Total equity
Total liabilities and equity
3
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2015 and 2014
Operating activities
Net income
Non-cash pre-tax expense (income):
Depreciation
Amortization
Stock-based compensation
Recognition of actuarial losses
Amortization of deferred financing costs
Pre-tax loss on sale of discontinued operations
(Income) loss on sale of property, plant and equipment
Changes in assets and liabilities:
Increase in accounts receivable
Increase in inventories
Increase (decrease) in accounts payable
Increase in other assets
Increase (decrease) in accrued expenses and other liabilities
Increase in accrued taxes
Net cash provided by operating activities
Investing activities
Capital expenditures
Proceeds from the disposition of assets
Proceeds from sale of discontinued operations
Cost of acquisitions, net of cash acquired
Other investing activities
Net cash used in investing activities
Financing activities
Decrease in short-term debt, net
Issuance of long-term debt
Repayment of long-term debt
Proceeds from the exercise of stock options
Treasury stock purchases(a)
Excess tax benefit from the exercise of stock-based compensation
Dividends to stockholders(b)
Other financing, net
Net cash provided by (used in) financing activities
Effect of foreign exchange rate changes on cash
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
4
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
Balance at December 31, 2013
Comprehensive income:
Other comprehensive income
Stock options exercised
Tax benefit on exercise of stock options
Tax-related adjustments
Treasury stock purchase
Dividends ($0.36 per common share)
Dividends paid to noncontrolling interests
Balance at September 30, 2014
Balance at December 31, 2014
Dividends ($0.28 per common share)
Balance at September 30, 2015
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
References to “Fortune Brands,” “the Company,” “we,” “our” and “us” refer to Fortune Brands Home & Security, Inc. and its consolidated subsidiaries as a whole, unless the context otherwise requires.
The Company is a leading home and security products company with a portfolio of leading branded products used for residential home repair, remodeling, new construction and security applications.
The condensed consolidated balance sheet as of September 30, 2015, the related condensed consolidated statements of comprehensive income for the nine and three-month periods ended September 30, 2015 and 2014 and the related condensed consolidated statements of cash flows and equity for the nine-month periods ended September 30, 2015 and 2014 are unaudited. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair statement of the financial statements have been included. Interim results may not be indicative of results for a full year.
The condensed consolidated financial statements and notes are presented pursuant to the rules and regulations of the Securities and Exchange Commission and do not contain certain information included in our annual consolidated financial statements and notes. The December 31, 2014 condensed consolidated balance sheet was derived from the audited financial statements, but does not include all disclosures required by U.S. generally accepted accounting principles (“GAAP”). This Quarterly Report on Form 10-Q should be read in conjunction with the audited consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2014.
The condensed consolidated financial statements included in this Quarterly Report on Form 10-Q were derived principally from the consolidated financial statements of the Company. In May 2015, we acquired Norcraft Companies, Inc. (“Norcraft”). The financial results of Norcraft were included in the Company’s condensed consolidated statements of comprehensive income and statements of cash flow beginning in May 2015 and the condensed consolidated balance sheet as of September 30, 2015. On September 10, 2015, we completed the sale of Waterloo Industries, Inc. (“Waterloo”), our tool storage business. Therefore, in accordance with Accounting Standards Codification (“ASC”) requirements, the results of operations of Waterloo through September 9, 2015, were classified and separately stated as discontinued operations in the accompanying condensed consolidated statements of comprehensive income for the nine and three months ended September 30, 2015 and 2014. The assets and liabilities of Waterloo were classified as discontinued operations in the accompanying condensed consolidated balance sheets as of December 31, 2014. In September 2014, we sold all of the shares of stock of Fortune Brands Windows, Inc., our subsidiary that owned and operated the Simonton windows business (“Simonton”). The results of operations of Simonton were classified and separately stated as discontinued operations in the accompanying condensed consolidated statements of comprehensive income for the nine and three months ended September 30, 2014. The cash flows from discontinued operations for the nine months ending September 30, 2015 and 2014 were not separately classified on the accompanying condensed consolidated statements of cash flows. Information on Business Segments was revised to exclude these discontinued operations.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Simplifying Accounting for Measurement-Period Adjustments
In September 2015, the Financial Accounting Standards Board (“FASB”) issued a final standard that eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. Instead, acquirers must recognize measurement-period adjustments during the period in which they determine the amounts, including the effect on earnings of any amounts they would have recorded in previous periods if the accounting had been completed at the acquisition date. The new standard is effective for the annual period beginning January 1, 2016 (calendar year 2016 for Fortune Brands). Early application is permitted, however we elected not to early adopt. We do not expect this standard to have a material effect on our financial statements.
Simplifying Subsequent Measurement of Inventory
In July 2015, the FASB issued a final standard that simplifies the subsequent measurement of inventory by replacing lower of cost or market test under the current GAAP. Under the current guidance the subsequent measurement of inventory is measured at the lower of cost or market, where “market” may have multiple possible outcomes. The new guidance requires subsequent measurement of inventory at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs to sell (completion, disposal, and transportation). This new standard is effective for the annual period beginning January 1, 2017 (calendar year 2017 for Fortune Brands). Earlier application is permitted, however we elected not to early adopt. We do not expect this standard to have a material effect on our financial statements.
Simplifying the Presentation of Debt Issuance Costs
In April 2015, the FASB issued Accounting Standards Update (“ASU”) 2015-03, “Simplifying the Presentation of Debt Issuance Costs.” This ASU requires debt issuance costs to be presented in the balance sheet as a direct deduction from the carrying value of the associated debt liability, instead of as a deferred charge (i.e., as an asset). This new standard is effective for the annual period beginning after December 15, 2015 (calendar year 2016 for Fortune Brands), and for annual periods and interim periods thereafter. Early adoption is permitted, however we elected not to early adopt. The guidance will be applied on a retrospective basis. The adoption of this ASU will require us to reclassify approximately $3 million of debt issuance costs from a deferred asset to long-term debt as of September 30, 2015.
7
Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern
In August 2014, the FASB issued ASU 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” This ASU provides guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. This amendment is effective for the annual period ending after December 15, 2016 (year-end 2016 for Fortune Brands), and for annual periods and interim periods thereafter. Early application is permitted. We do not expect this standard to have a material effect on our financial statements.
Revenue from Contracts with Customers
In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers.” This ASU clarifies the accounting for revenue arising from contracts with customers and specifies the disclosures that an entity should include in its financial statements. Further, in August 2015, the FASB issued a standard, which clarified that the amendment is effective for the annual reporting period beginning after December 15, 2017 (calendar year 2018 for Fortune Brands), and for annual and interim periods thereafter. We are assessing the impact the adoption of this standard will have on our financial statements.
Supplemental information on our balance sheets is as follows:
Inventories:
Raw materials and supplies
Work in process
Finished products
Total inventories
Property, plant and equipment, gross
Less: accumulated depreciation
Property, plant and equipment, net
8
In May 2015, we completed our tender offer to purchase all of the outstanding shares of common stock of Norcraft, a leading publicly-owned manufacturer of kitchen and bathroom cabinetry, for a total purchase price of $648.6 million in cash. We financed the transaction using cash on hand and borrowings under our existing credit facilities. This transaction is expected to continue to strengthen our overall product offering, round out our regional market penetration and enhance our frameless cabinetry capabilities. Net sales in the nine and three months ended September 30, 2015 were approximately $151 million and $105 million, respectively. Operating income in the nine and three months ended September 30, 2015 was approximately $15 million and $12 million, respectively. The results of operations of Norcraft are included in the Cabinets segment. We incurred $15.1 million and $0.2 million of Norcraft acquisition-related transaction costs in the nine and three months ended September 30, 2015, respectively. The goodwill expected to be deductible for income tax purposes is in the process of being determined.
The following table summarizes the preliminary allocation of the purchase price to the fair value of assets acquired and liabilities assumed as of the date of the acquisition.
Accounts receivable
Property, plant and equipment
Identifiable intangible assets
Deferred tax liabilities
Other liabilities and accruals
Net assets acquired
The preceding purchase price allocation has been determined provisionally and is subject to revision as additional information about the fair value of individual assets and liabilities becomes available. The Company is in the process of finalizing valuations of certain tangible and intangible assets, including tradenames and customer relationships. Any change in the acquisition date fair value of the acquired assets and liabilities will change the amount of the purchase price allocable to goodwill.
Goodwill includes expected sales and cost synergies. Identifiable intangible assets consist of an indefinite-lived tradename of $125 million and customer relationships of $210 million. The useful life of the customer relationships identifiable intangible asset is estimated to be 20 years.
9
The following unaudited pro forma summary presents consolidated financial information as if Norcraft had been acquired on January 1, 2014. The unaudited pro forma financial information is based on historical results of operations and financial position of the Company and Norcraft. The pro forma results include:
The unaudited pro forma financial information does not necessarily represent the results that would have occurred had the acquisition occurred on January 1, 2014. In addition, the unaudited pro forma information should not be deemed to be indicative of future results.
Income from continuing operations
In March 2015, we acquired a cabinets component company for approximately $6 million in cash. A preliminary allocation of the purchase price has been reflected in the financial statements and will be updated as asset and liability valuations are finalized. Final adjustments will reflect the fair value assigned to the assets, including intangible assets, and assumed liabilities.
10
In December 2014, we acquired all of the issued and outstanding shares of capital stock of Anafree Holdings, Inc., the sole owner of Anaheim Manufacturing Company (“Anaheim”), which markets and sells garbage disposals, for $28.9 million in cash. We paid the purchase price using a combination of cash on hand and borrowings under our existing credit facilities. Net sales in the nine and three months ended September 30, 2015 were approximately $23 million and $8 million, respectively, and operating income was not material to the Company. The results of operations of Anaheim are included in the Plumbing segment.
In July 2014, we acquired all of the voting equity of John D. Brush & Co., Inc. (“SentrySafe”) for a purchase price of $116.7 million in cash. The purchase price was funded from our existing credit facilities. This acquisition broadened our product offering of security products. Net sales in the nine and three months ended September 30, 2015 were approximately $101 million and $33 million, respectively, and operating income was not material to the Company. The results of operations of SentrySafe are included in the Security segment.
The 2014 completed acquisitions were not material for the purposes of supplemental disclosure and did not have a material impact on our consolidated financial statements.
In September 2015, we completed the sale of Waterloo for approximately $14 million in cash, subject to certain post-closing adjustments. We recorded a pre-tax loss of $16.9 million as the result of this sale. Transaction and other sale-related costs were approximately $2.7 million. The estimated tax benefit on the sale was $26.5 million with the after-tax gain of $6.9 million recorded within discontinued operations. The estimated tax benefit resulted primarily from a tax loss in excess of the financial reporting loss as a result of prior period nondeductible asset impairments. Waterloo is presented as a discontinued operation in our financial statements beginning December 2014 and through September 9, 2015 in accordance with ASC 205 requirements. Prior to classifying Waterloo as a discontinued operation, it was reported in the Security segment.
In addition, in September 2014, we sold the Simonton windows business for $130 million in cash. Simonton is presented as a discontinued operation in the Company’s financial statements in accordance with ASC requirements. The 2014 year-to-date and third quarter loss in discontinued operations included a loss on sale of the business of $111.8 million.
The following table summarizes the results of discontinued operations for the nine and three months ended September 30, 2015 and 2014. The nine and three months ended September 30, 2015 consist of Waterloo only, however comparable periods in 2014 include both Waterloo and Simonton.
11
Loss from discontinued operations before income taxes
The following table summarizes the major classes of assets and liabilities of Waterloo, which is reflected as a discontinued operation on the consolidated balance sheet as of December 31, 2014:
Other non-current assets
12
We had goodwill of $1,800.8 million and $1,467.8 million as of September 30, 2015 and December 31, 2014, respectively. The $333.0 million increase was primarily due to the acquisition of Norcraft, partially offset by other acquisition-related adjustments. The change in the net carrying amount of goodwill by segment was as follows:
Goodwill at December 31, 2014 (a)
Year-to-date translation adjustments
Acquisition-related adjustments
Goodwill at September 30, 2015 (a)
We also had identifiable intangible assets, principally tradenames, of $982.2 million and $656.5 million, net of accumulated amortization, as of September 30, 2015 and December 31, 2014, respectively. The $337.5 million increase in gross identifiable intangible assets was primarily due to the acquisitions of Norcraft and Anaheim.
The gross carrying value and accumulated amortization by class of identifiable intangible assets as of September 30, 2015 and December 31, 2014 were as follows:
Indefinite-lived tradenames
Amortizable intangible assets
Tradenames
Customer and contractual relationships
Patents/proprietary technology
Total
Total identifiable intangibles
13
Amortizable identifiable intangible assets, principally tradenames and customer relationships, are subject to amortization over their estimated useful life, ranging from 5 to 30 years, based on the assessment of a number of factors that may impact useful life. These factors include historical tradename performance with respect to consumer name recognition, geographic market presence, market share, plans for ongoing tradename support and promotion, customer attrition rates, and other relevant factors.
In the first nine months of 2015, no events or circumstances occurred that would have required us to perform interim impairment tests of goodwill or indefinite-lived intangible assets.
In June 2015, we issued $900 million of unsecured senior notes (“Senior Notes”) in a registered public offering. The Senior Notes consist of two tranches: $400 million of five-year notes due 2020 with a coupon of 3% and $500 million of ten-year notes due 2025 with a coupon of 4%. We used the proceeds from the Senior Notes offering to pay down our revolving credit facility and for general purposes. On September 30, 2015, the outstanding amount of the Senior Notes, net of underwriting commissions and price discounts, was $891.4 million.
We have a $975 million committed revolving credit facility, as well as a term loan in the initial amount of $525 million, both of which expire in July 2018. Both facilities can be used for general corporate purposes. On September 30, 2015 and December 31, 2014, our outstanding borrowings under the revolving credit facility were zero and $145.0 million, respectively; the amounts outstanding under the term loan were $450.0 million and $525.0 million, respectively. At September 30, 2015 and December 31, 2014, the current portion of long-term debt was $3.8 million and $26.3 million, respectively. The interest rates under all of these facilities are variable based on LIBOR at the time of the borrowing and the Company’s leverage as measured by a debt to Adjusted EBITDA ratio. Based upon the Company’s debt to Adjusted EBITDA ratio at September 30, 2015, the Company’s borrowing rate could range from LIBOR + 1.0% to LIBOR + 2.0%. At September 30, 2015, we were in compliance with all covenants under these facilities.
We currently have uncommitted bank lines of credit in China, which provide for unsecured borrowings for working capital of up to $25.7 million in aggregate, of which zero was outstanding, as of September 30, 2015 and December 31, 2014. The weighted-average interest rates on these borrowings were zero and 8.2% in the nine-month periods ended September 30, 2015 and 2014, respectively. The weighted-average interest rates on these borrowings were zero and 12.2% in the three-month periods ended September 30, 2015 and 2014, respectively.
14
We do not enter into financial instruments for trading or speculative purposes. We principally use financial instruments to reduce the impact of changes in foreign currency exchange rates and commodities used as raw materials in our products. The principal derivative financial instruments we enter into on a routine basis are foreign exchange contracts. Derivative financial instruments are recorded at fair value. The counterparties to derivative contracts are major financial institutions. Management currently believes that the risk of incurring material losses is unlikely and that the losses, if any, would be immaterial to the Company. In addition, from time to time, we enter into commodity swaps.
Our primary foreign currency hedge contracts pertain to the Canadian dollar, the Mexican peso and the Chinese yuan. The gross U.S. dollar equivalent notional amount of all foreign currency derivative hedges outstanding at September 30, 2015 was $204.9 million, representing a net settlement receivable of $2.9 million. Based on foreign exchange rates as of September 30, 2015, we estimate that $1.2 million of net foreign currency derivative gains included in other comprehensive income as of September 30, 2015 will be reclassified to earnings within the next twelve months.
The fair values of derivative instruments on the consolidated balance sheets as of September 30, 2015 and December 31, 2014 were:
Location
Foreign exchange contracts
Net investment hedges
Liabilities
15
The effects of derivative financial instruments on the statements of comprehensive income for the nine and three months ended September 30, 2015 and 2014 were:
Type of hedge
Cash flow
Fair value
Other expense, net
The effective portion of cash flow hedges recognized in other comprehensive income were net gains of $4.4 million and zero in the nine months ended September 30, 2015 and 2014, respectively. The effective portion of cash flow hedges recognized in other comprehensive income were net gains of $2.4 million and $2.9 million in the three months ended September 30, 2015 and 2014, respectively. In the nine and three months ended September 30, 2015 and 2014, the ineffective portion of cash flow hedges recognized in other expense, net, was insignificant.
ASC requirements for Fair Value Measurements and Disclosures establish a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels. Level 1 inputs, the highest priority, are quoted prices in active markets for identical assets or liabilities. Level 2 inputs reflect inputs other than quoted prices included in level 1 that are either observable directly or through corroboration with observable market data. Level 3 inputs are unobservable inputs, due to little or no market activity for the asset or liability, such as internally-developed valuation models. We do not have any assets or liabilities measured at fair value on a recurring basis that are level 3.
The carrying value and fair value of debt as of September 30, 2015 and December 31, 2014 were as follows:
Revolving credit facility
Term loan, including current portion
Senior Notes, net of underwriting commissions and price discounts
16
The estimated fair value of our term loan and the current portion thereof is determined primarily using broker quotes, which are level 2 inputs. The estimated fair value of our Senior Notes is determined by using quoted market prices of our debt securities, which are level 1 inputs.
Assets and liabilities measured at fair value on a recurring basis as of September 30, 2015 and December 31, 2014 were as follows:
Derivative financial instruments (level 2)
Deferred compensation program assets (level 1)
Total accumulated other comprehensive loss consists of net income and other changes in business equity from transactions and other events from sources other than shareholders. It includes currency translation gains and losses, unrealized gains and losses from derivative instruments designated as cash flow hedges, and defined benefit plan adjustments. The components of and changes in accumulated other comprehensive loss, net of tax, were as follows:
Amounts classified into accumulated other comprehensive loss
Amounts reclassified from accumulated other comprehensive loss
Net current-period other comprehensive loss
17
The reclassifications out of accumulated other comprehensive loss for the nine and three months ended September 30, 2015 and 2014 were as follows:
Details about Accumulated Other ComprehensiveLoss Components
Affected Line Item in
the Statement of
Comprehensive
Income
Cumulative translation adjustments
Gains on cash flow hedges
Commodity contracts
Total before tax
Tax expense
Net of tax
Defined benefit plan items
Recognition of prior service credits
(a)
Recognition of prior service costs in discontinued operations
(b)
Recognition of actuarial losses in discontinued operations
Total reclassifications for the period
18
Gains (losses) on cash flow hedges
19
The components of net periodic benefit cost for pension and postretirement benefits for the nine and three months ended September 30, 2015 and 2014 were as follows:
Service cost
Interest cost
Expected return on plan assets
Recognition of prior service costs (credits)
Recognition of actuarial losses (gains)
Net periodic benefit cost (income)
In the third quarter of 2015, we recognized actuarial losses of $6.1 million related to the sale of the Waterloo tool storage business in discontinued operations in addition to the $2.8 million of actuarial losses reflected above.
In the first quarter of 2014, we communicated our decision to amend certain postretirement benefits to reduce health benefits for certain current and retired employees. The impact of these changes was a reduction in accrued retiree benefit plan liabilities of $15.3 million and we recorded actuarial losses of $0.6 million and prior service credits of $3.5 million in the first quarter of 2014. Liability reductions from these plan amendments are recorded as amortization of prior service cost in net income in accordance with accounting requirements. See Note 10, “Accumulated Other Comprehensive Loss,” for information on the impact on accumulated other comprehensive loss.
20
The effective income tax rates for the nine months ended September 30, 2015 and 2014 were 34.0% and 31.5%, respectively. The effective income tax rate for 2015 was unfavorably impacted by the tax cost related to the final settlement of a federal income tax audit covering the 2010 and nine months ended September 30, 2011 tax years, non-deductible acquisition costs and incremental state taxes associated with the Norcraft acquisition, and restructuring charges for which the Company cannot recognize a tax benefit. The effective income tax rate for 2014 was favorably impacted by the release of valuation allowances related to state net operating loss carryforwards and tax benefits related to stock-based compensation.
The effective income tax rates for the three months ended September 30, 2015 and 2014 were 32.8% and 33.4%, respectively. The effective income tax rate for third quarter of 2015 was favorably impacted by adjustments to prior year income tax estimates upon the filing of the Company’s 2014 federal income tax return.
It is reasonably possible that, within the next 12 months, total unrecognized tax benefits may decrease in the range of $3 million to $7 million, primarily as a result of the conclusion of pending U.S. federal, state and foreign income tax proceedings.
We generally record warranty expense at the time of sale. We offer our customers various warranty terms based on the type of product that is sold. Warranty expense is determined based on historic claim experience and the nature of the product category. The following table summarizes activity related to our product warranty liability for the nine months ended September 30, 2015 and 2014, respectively.
Reserve balance at January 1,
Provision for warranties issued
Settlements made (in cash or in kind)
Acquisitions
Reserve balance at September 30,
21
Net sales and operating income for the nine and three months ended September 30, 2015 and 2014 by segment were as follows:
Net Sales
Cabinets
Plumbing
Doors
Security
Operating Income
Less: Corporate expenses
Corporate expenses
General and administrative expense
Defined benefit plan income
Norcraft transaction costs(a)
Total Corporate expenses
22
23
Pre-tax restructuring and other charges for the nine and three months ended September 30, 2015 and 2014 are shown below.
Corporate
Restructuring and other charges in the first nine months of 2015 related to severance costs to relocate a plumbing facility in China and severance costs and accelerated depreciation to relocate a manufacturing facility within our Security segment, as well as severance costs in the Security segment and Corporate.
Restructuring and other charges in the first nine months of 2014 primarily results from severance charges in our Corporate and Security segment, partially offset by a benefit from release of a foreign currency gain associated with the dissolution of a foreign entity in the Plumbing segment.
24
Restructuring and other charges in the third quarter of 2015 primarily resulted from severance charges and accelerated depreciation to relocate a manufacturing facility within our Security segment. Restructuring and other charges in the third quarter of 2014 primarily resulted from severance charges.
Reconciliation of Restructuring Liability
Workforce reduction costs
Asset disposals
Contract termination costs
Other
25
The computations of earnings per common share were as follows:
Less: Noncontrolling interest
Income from continuing operations for EPS
Income (loss) from discontinued operations
Earnings per common share
Basic
Net income (loss) attributable to Fortune Brands common stockholders
Diluted
Basic average shares outstanding
Stock-based awards
Diluted average shares outstanding
Antidilutive stock-based awards excluded from weighted-average number of shares outstanding for diluted earnings per share
26
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Concluded)
Litigation
We are defendants in lawsuits associated with the normal conduct of our businesses and operations. It is not possible to predict the outcome of the pending actions, and, as with any litigation, it is possible that these actions could be decided unfavorably to the Company. The Company believes that there are meritorious defenses to these actions and that these actions will not have a material adverse effect upon our results of operations, cash flows or financial condition, and where appropriate, these actions are being vigorously contested.
Environmental
Compliance with federal, state and local laws regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, did not have a material effect on capital expenditures, earnings or the competitive position of Fortune Brands during the nine months ended September 30, 2015 and 2014. We are involved in remediation activities to clean up hazardous wastes as required by federal and state laws. Liabilities for remediation costs of each site are based on our best estimate of undiscounted future costs, excluding possible insurance recoveries or recoveries from other third parties. We believe compliance with current environmental protection laws (before taking into account estimated recoveries from third parties) will not have a material adverse effect upon our results of operations, cash flows or financial condition. Uncertainties about the status of laws, regulations, technology and information related to individual sites make it difficult to develop estimates of environmental remediation exposures.
27
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and the notes thereto, which are included in this report, as well as our audited consolidated financial statements for the year ended December 31, 2014, which are included in our Annual Report on Form 10-K for the year ended December 31, 2014.
This discussion contains forward-looking statements that are made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended (the “Exchange Act”), regarding business strategies, market potential, future financial performance, pension contributions, impact of acquisitions and other matters. Statements preceded by, followed by or that otherwise include the words “believes,” “expects,” “anticipates,” “intends,” “projects,” “estimates,” “plans” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” “may” and “could” are generally forward-looking in nature. The forward-looking statements are not historical facts, but rather are based on expectations, estimates, assumptions and projections about our industry, business and future financial results, based on information available at the time this report is filed with the Securities and Exchange Commission, or with respect to any document incorporated by reference, available as of the time such document was prepared. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including but not limited to: (i) our reliance on the North American home improvement, repair and new home construction activity levels, (ii) the North American and global economies, (iii) risk associated with entering into potential strategic acquisitions and integrating acquired property, (iv) our ability to remain competitive, innovative and protect our intellectual property, (v) our reliance on key customers and suppliers, (vi) the cost and availability associated with our supply chains and the availability of raw materials, (vii) risk of increases in our postretirement benefit-related costs and funding requirements, (viii) compliance with tax, environmental and federal, state and international laws and industry regulatory standards and (ix) the risk of doing business internationally. These and other factors are discussed in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2014. We undertake no obligation to, and expressly disclaim any such obligation to, update or clarify any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events, new information or changes to future results over time or otherwise, except as required by law.
OVERVIEW
References to “Fortune Brands,” “the Company,” “we,” “our” and “us” refer to Fortune Brands Home & Security, Inc. and its consolidated subsidiaries as a whole, unless the context otherwise requires. The Company is a leader in home and security products focused on the design, manufacture and sale of market-leading branded products in the following categories: kitchen and bath cabinetry, plumbing and accessories, entry door systems and security products.
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OVERVIEW (Continued)
We believe the Company has certain competitive advantages including market-leading brands, a diversified mix of channels, and lean and flexible supply chains, as well as a tradition of strong innovation and customer service. We are focused on outperforming our markets in growth, profitability and returns in order to drive increased shareholder value. We believe the Company’s track record reflects the long-term attractiveness and potential of our categories and our leading brands. As consumer demand and the housing market grow, we expect the benefits of operating leverage and strategic spending will help us continue to achieve profitable organic growth.
We believe our most attractive opportunities are to invest in profitable organic growth initiatives. We also believe that as the market recovers, we have the potential to generate additional growth from leveraging our cash flow and balance sheet strength by pursuing accretive strategic acquisitions and joint ventures, and returning cash to shareholders through a combination of dividends and common stock 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 midst of a multi-year recovery. A continued recovery will largely depend on consumer confidence, employment, home prices, stable mortgage rates 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, changes in foreign exchange, and promotional activity among our competitors. We strive to offset the potential unfavorable impact of these items with productivity initiatives and price increases.
In September 2015, we completed the sale of Waterloo Industries, Inc. (“Waterloo”) for approximately $14 million in cash, subject to certain post-closing adjustments. We recorded a pre-tax loss of $16.9 million as the result of this sale. Transaction and other sale related costs were approximately $2.7 million. The related estimated tax benefit on the sale was $26.5 million with the after-tax gain of $6.9 million recorded within discontinued operations. The estimated tax benefit resulted primarily from a tax loss in excess of the financial reporting loss as a result of prior period nondeductible asset impairments. Prior to classifying Waterloo as a discontinued operation, it was reported in the Security segment.
In June 2015, we issued $900 million of unsecured senior notes (“Senior Notes”) in a registered public offering. The Senior Notes consist of two tranches: $400 million of five-year notes due 2020 with a coupon of 3% and $500 million of ten-year notes due 2025 with a coupon of 4%. We used the proceeds from the Senior Notes offering to pay down our revolving credit facility and for general purposes.
In May 2015, we acquired Norcraft Companies, Inc. (“Norcraft”), a leading publicly-owned manufacturer of kitchen and bathroom cabinetry, for a total purchase price of $648.6 million. Pursuant to the agreement, we acquired all outstanding shares of Norcraft for $25.50 per share of common stock in cash. We financed the transaction using cash on hand and borrowings under our existing credit facilities. This acquisition is expected to strengthen our overall product offering, round out our regional market penetration and enhance our frameless cabinetry capabilities. The financial results of Norcraft were included in the Company’s results of operations and cash flows beginning in May 2015.
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In March 2015, we acquired a cabinets component company for approximately $6 million in cash. The financial results were included in the Company’s results of operations and cash flows beginning in March of 2015.
In December 2014, we acquired Anaheim Manufacturing Company (“Anaheim”), which markets and sells garbage disposals, for $28.9 million in cash. The financial results of Anaheim were included in the Company’s results of operations and cash flows beginning in January of 2015. In July 2014, we acquired John D. Brush & Co., Inc. (“SentrySafe”), a leading manufacturer of home safes, for a purchase price of $116.7 million in cash. The financial results of SentrySafe were included in the Company’s results of operations and cash flows beginning in August of 2014. The purchase prices were funded from cash on hand and our existing credit facilities.
In September 2014, we sold all the shares of stock of Fortune Brands Windows, Inc., our subsidiary that owned and operated the Simonton windows business (“Simonton”) for $130 million in cash. The results of these operations were classified and separately stated as discontinued operations in the consolidated financial statements.
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RESULTS OF OPERATIONS
Nine Months Ended September 30, 2015 Compared To Nine Months Ended September 30, 2014
The following discussion of consolidated results of operations and segment results refers to the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014. Consolidated results of operations should be read in conjunction with segment results of operations.
Net sales increased $380.7 million, or 13%. The increase was due to the benefit of the acquisitions of SentrySafe, Norcraft and Anaheim (approximately $254 million in aggregate), higher sales volume primarily from the continuing improvement in U.S. market conditions for home products, price increases to help mitigate cumulative raw material cost increases and favorable mix. The impact of foreign exchange was unfavorable by approximately $47 million.
Cost of products sold increased $244.0 million, or 12%, due to the impact of the acquisitions of SentrySafe, Norcraft and Anaheim (approximately $167 million in aggregate), higher sales volume and investments to support increased manufacturing capacity and long-term growth initiatives, partially offset by the benefit of productivity improvements.
Selling, general and administrative expenses increased $87.9 million, or 13%, due to the impact of the acquisitions of SentrySafe, Norcraft and Anaheim (approximately $60 million in aggregate), $15.1 million of Norcraft transaction costs, higher employee-related costs, and planned increases in strategic spending to support increased capacity and long-term growth initiatives.
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RESULTS OF OPERATIONS (Continued)
Amortization of intangible assets increased $5.8 million due to the acquisitions of Norcraft, SentrySafe and Anaheim.
Restructuring charges of $12.6 million in the nine months ended September 30, 2015 primarily related to severance costs to relocate a plumbing facility in China, restructuring charges to relocate a manufacturing facility, and severance within our Security segment and the Corporate office. Restructuring charges in the nine months ended September 30, 2014 were $1.1 million.
Operating income increased $31.5 million. Operating income benefited from price increases to help mitigate cumulative raw material cost increases, higher sales volume, productivity improvements and the impact of acquisitions, partially offset by investments to support manufacturing capacity increases for long-term growth, $15.1 million of Norcraft transaction costs and $14.7 million of higher restructuring and other charges.
Interest expense increased $13.3 million to $20.5 million due to higher average borrowings and higher average interest rates.
Other expense (income), net, was expense of $3.7 million in the nine months ended September 30, 2015, compared to zero in the nine months ended September 30, 2014. The change was due to unfavorable foreign currency adjustments.
Noncontrolling interest was $0.3 million and $0.9 million in the nine months ended September 30, 2015 and 2014, respectively.
Net income from continuing operations
Net income from continuing operations was $218.9 million in the nine months ended September 30, 2015 compared to $217.1 million in the nine months ended September 30, 2014.
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The income (loss) from discontinued operations was $8.6 million and $(103.2) million in the nine months ended September 30, 2015 and 2014, respectively. The discontinued operations for the nine months ended September 30, 2015 consist of the results of operations of Waterloo and the gain associated with the sale of the business. The discontinued operations for the nine months ended September 30, 2014 also include the results of operations of Simonton and the loss associated with the sale of Simonton in third quarter of 2014 of $111.8 million.
Results By Segment
Net sales increased $233.9 million, or 18%, due to the benefit of the Norcraft acquisition (approximately $151 million), higher sales volume including the impact of new product introductions, favorable mix and the benefit of price increases to help mitigate cumulative raw material cost increases. These benefits were partially offset by approximately $17 million of unfavorable foreign exchange.
Operating income increased $29.6 million, or 29%, due to price increases to help mitigate cumulative raw material cost increases, productivity improvements, higher sales volume and a $15.5 million benefit from the acquisition of Norcraft, net of a $2.0 million charge related to an inventory purchase accounting adjustment to fair value. These benefits were partially offset by investments to support manufacturing capacity increases for long-term growth, higher employee-related costs, higher wood related raw material costs and costs associated with new product introductions.
Net sales increased $60.1 million, or 6%, due to higher sales volume in the U.S. driven by improving U.S. market conditions, the acquisition of Anaheim (approximately $23 million), price increases to help mitigate cumulative raw material cost increases and approximately $10 million in higher sales in Canada. These benefits were partially offset by unfavorable foreign exchange of approximately $20 million and higher sales rebates.
Operating income increased $12.0 million, or 6%, on higher sales volume, price increases to help mitigate cumulative raw material cost increases. Operating income was unfavorably impacted by higher sales rebates, $8.1 million of higher restructuring and other charges primarily related to severance costs to relocate a facility in China and approximately $8 million of unfavorable foreign exchange.
Net sales increased $20.1 million, or 7%, due to higher sales volume driven primarily by improved conditions in the U.S. home products market, price increases to help mitigate cumulative raw material cost increases and favorable mix.
Operating income increased $9.0 million, or 41%, due to price increases to help mitigate cumulative raw material cost increases, higher sales volume and productivity improvements, as well as approximately $2 million of favorable foreign exchange. These factors were partially offset by an unfavorable comparison to the reversal of a bad debt reserve in 2014.
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Results By Segment (Continued)
Net sales increased $66.6 million, or 19%, due primarily to the impact of the acquisition of SentrySafe (approximately $80 million), partially offset by unfavorable foreign exchange (approximately $10 million) and lower international sales volume.
Operating income decreased $0.3 million, or 1%. Operating income was favorably impacted by the acquisition of SentrySafe and lower employee-related costs, offset by an increase of $7.1 million of restructuring and other charges primarily to relocate a manufacturing facility and unfavorable foreign exchange of approximately $3 million.
Corporate expenses increased $18.8 million predominantly due to $15.1 million of transaction costs associated with the Norcraft acquisition.
Defined benefit plan recognition of actuarial losses
In future periods the Company may record, in the Corporate segment, material expense or income associated with actuarial gains and losses arising from periodic remeasurement of our liabilities for defined benefit plans. At a minimum the Company will remeasure its defined benefit plan liabilities in the fourth quarter of each year. Remeasurements due to plan amendments and settlements may also occur in interim periods during the year. Remeasurement of these liabilities attributable to updating our liability discount rates and expected return on assets may, in particular, result in material income or expense recognition.
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Three Months Ended September 30, 2015 Compared To Three Months Ended September 30, 2014
The following discussion of consolidated results of operations and segment results refers to the three months ended September 30, 2015 compared to the three months ended September 30, 2014. Consolidated results of operations should be read in conjunction with segment results of operations.
Net sales increased $181.1 million, or 17%. The increase was due to the benefit of the acquisitions of Norcraft, SentrySafe and Anaheim (approximately $125 million in aggregate), higher sales volume primarily from the continuing improvement in U.S. market conditions for home products, price increases to help mitigate cumulative raw material cost increases and favorable mix. The impact of foreign exchange was unfavorable by approximately $21 million.
Cost of products sold increased $114.6 million, or 17%, due to the impact of the acquisitions of Norcraft, SentrySafe and Anaheim (approximately $83 million in aggregate) and higher sales volume.
Selling, general and administrative expenses increased $30.8 million, or 13%, due to the impact of the acquisitions of Norcraft, SentrySafe and Anaheim (approximately $25 million in aggregate) and higher employee-related costs.
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Amortization of intangible assets increased $3.3 million due to the acquisitions of Norcraft and Anaheim.
Restructuring charges of $1.8 million in the three months ended September 30, 2015 primarily related to severance costs to relocate a manufacturing facility within our Security segment. Restructuring charges in the three months ended September 30, 2014 were $0.2 million.
Operating income increased $30.8 million, or 24%. Operating income benefited from higher sales volume, price increases to help mitigate cumulative raw material cost increases, productivity improvements and the impact of the acquisitions of Norcraft, SentrySafe and Anaheim (approximately $13 million). These benefits were partially offset by higher employee related costs of $10.3 million, investments to support manufacturing capacity increases for long-term growth, higher sales rebates, unfavorable mix and $3.7 million of higher restructuring and other charges.
Interest expense increased $7.9 million to $11.1 million due to higher average borrowings as well as higher average interest rates resulting from our bond issuance in June 2015.
Other expense (income), net, was $0.5 million expense in the three months ended September 30, 2015 compared to income of $(0.5) million in the three months ended September 30, 2014. The change was due to unfavorable foreign currency adjustments.
Noncontrolling interests was $0.3 million and $0.2 million in the three months ended September 30, 2015 and 2014, respectively.
Net income from continuing operations was $100.0 million in the three months ended September 30, 2015 compared to $84.5 million in the three months ended September 30, 2014. The increase of $15.5 million was due to a higher operating income, partially offset by lower effective income tax rate and higher interest expense.
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The income from discontinued operations was $7.8 million in the three months ended September 30, 2015 compared to a loss from discontinued operations of $(105.4) million in the three months ended September 30, 2014. The discontinued operations for the three months ended September 30, 2015 consisted of the results of operations of Waterloo and the gain associated with the sale of the business. The net loss from discontinued operations for the three months ended September 30, 2014 included a $111.8 million loss on the sale of Simonton.
Net sales increased $150.7 million, or 33%, due to the benefit of the Norcraft acquisition (approximately $105 million), higher sales volume including the impact of new product introductions and the benefit of price increases to help mitigate cumulative raw material cost increases, partially offset by approximately $7 million of unfavorable foreign exchange.
Operating income increased $27.7 million, or 76%, due to higher sales volume, the benefit of approximately $12 million from the acquisition of Norcraft, price increases to help mitigate cumulative raw material cost increases and productivity improvements. These benefits were partially offset by higher employee-related costs and costs associated with investments to support manufacturing capacity increases for long-term growth.
Net sales increased $18.5 million, or 5%, due to higher sales volume in the U.S. driven by improving market conditions including the introduction of new products, the acquisition of Anaheim (approximately $8 million), price increases to help mitigate cumulative raw material cost increases, and higher international sales. These benefits were partially offset by higher sales rebates in 2015 and unfavorable foreign exchange of approximately $9 million.
Operating income increased $5.1 million, or 7%, due to higher sales volume and price increases to help mitigate cumulative raw material cost increases. Operating income was unfavorably impacted by higher sales rebates and approximately $3 million of foreign exchange rate.
Net sales increased $9.4 million, or 8%, due to higher sales volume driven primarily by improved conditions in the U.S. home products market, price increases to help mitigate cumulative raw material cost increases and favorable mix.
Operating income increased $4.6 million, or 38%, due to higher sales volume and price increases to help mitigate cumulative raw material cost increases.
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Net sales increased $2.5 million, or 2%, due primarily to the impact of the acquisition of SentrySafe (approximately $12 million), offset by lower international volume and approximately $4 million of unfavorable foreign exchange.
Operating income decreased $3.6 million, or 18%, primarily due to an increase of $3.9 million of restructuring and other charges mainly to relocate a manufacturing facility and lower sales volume. Operating income was favorably impacted by lower employee-related costs.
Corporate expenses increased $3.0 million predominantly as a result of higher employee related costs due to increases in actuarial losses related to changes in defined benefit plan demographic data.
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LIQUIDITY AND CAPITAL RESOURCES
Our primary liquidity needs are to support working capital requirements, fund capital expenditures and service indebtedness, as well as to finance acquisitions, repurchase shares of our common stock and pay dividends to stockholders, as deemed appropriate. Our principal sources of liquidity have been cash on hand, cash flows from operating activities, availability under our credit facilities and debt issuances in capital markets. Our operating income is generated by our subsidiaries. There are no legal restrictions on the ability of our subsidiaries to pay dividends or make other distributions to Fortune Brands. In December 2014, our Board of Directors increased the quarterly cash dividend by 17% to $0.14 per share of our outstanding common stock. Our Board of Directors will continue to evaluate dividend payment opportunities on a quarterly basis. There can be no assurance as to when and it future dividends will be paid, and at what level, because the payment of dividends is dependent on our financial condition, results of operations, cash flows, capital requirements and other factors deemed relevant by our Board of Directors.
In the first nine months of 2015, we repurchased 762,954 shares of our outstanding common stock under the Company’s share repurchase program for $36.0 million. As of September 30, 2015, the Company’s total remaining share repurchase authorization under the Company’s repurchase programs was $263.5 million. The share repurchase programs do not obligate the Company to repurchase any specific dollar amount or number of shares and may be suspended or discontinued at any time.
We periodically review our portfolio of brands and evaluate potential strategic transactions to increase shareholder value. However, we cannot predict whether or when we may enter into acquisitions, joint ventures or dispositions, make any purchases of shares of our common stock under our share repurchase programs, or pay dividends, or what impact any such transactions could have on our results of operations, cash flows or financial condition, whether as a result of the issuance of debt or equity securities, or otherwise. Our cash flows from operations, borrowing availability and overall liquidity are subject to certain risks and uncertainties, including those described in the section of our Annual Report on Form 10-K for the year-ended December 31, 2014 entitled “Item 1A. Risk Factors.”
Acquisitions and divestitures in 2015 and 2014 included:
In June 2015, we issued $900 million of Senior Notes in a registered public offering. The Senior Notes consist of two tranches: $400 million of five-year notes due 2020 with a coupon of 3% and $500 million of ten-year notes due 2025 with a coupon of 4%. We used the proceeds from the Senior Notes offering to pay down our revolving credit facility and for general purposes. On September 30, 2015, the outstanding amount of the Senior Notes, net of underwriting commissions and price discounts, was $891.4 million.
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We also have a $975 million committed revolving credit facility, as well as a term loan in the initial amount of $525 million, both of which expire in July 2018. Both facilities can be used for general corporate purposes. On September 30, 2015 and December 31, 2014, our outstanding borrowings under the revolving credit facility were zero and $145.0 million, respectively; the amounts outstanding under term loan were $450.0 million and $525.0 million, respectively. Issuance of long-term debt in 2015 on the statement of cash flows includes borrowings under the revolving credit facility that were repaid when the Senior Notes were issued. The interest rates under all of these facilities are variable based on LIBOR at the time of the borrowing and the Company’s leverage as measured by a debt to Adjusted EBITDA ratio. Based upon the Company’s debt to Adjusted EBITDA ratio at September 30, 2015, the Company’s borrowing rate could range from LIBOR + 1.0% to LIBOR + 2.0%. At September 30, 2015, we were in compliance with all covenants under these facilities.
On September 30, 2015, we had cash and cash equivalents of $350.6 million, of which $202.4 million was held at non-U.S. subsidiaries. We manage our global cash requirements considering (i) available funds among the subsidiaries through which we conduct business, (ii) the geographic location of our liquidity needs, and (iii) the cost to access international cash balances. The undistributed earnings of foreign subsidiaries are considered indefinitely reinvested. If these funds were needed for our operations in the U.S., the repatriation of non-U.S. cash balances from certain subsidiaries could have adverse tax consequences as we may be required to pay and record income tax expense on those funds to the extent they were previously considered indefinitely reinvested.
Our operating cash flows are significantly impacted by the seasonality of our business. We typically generate our operating cash flow in the third and fourth quarters of each year. We use operating cash in the first half of the year, particularly in the first quarter.
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Cash Flows
Below is a summary of cash flows for the nine months ended September 30, 2015 and 2014.
Net cash provided by operating activities was $264.1 million in the nine months ended September 30, 2015 compared to $110.2 million in the nine months ended September 30, 2014. The increase in cash provided of $153.9 million was primarily due to lower incentive compensation and customer program payments in the first quarter of 2015 compared to 2014.
Net cash used in investing activities was $725.0 million in the nine months ended September 30, 2015 compared to $77.6 million in the nine months ended September 30, 2014. The increase of $647.4 million was primarily due to the impact of Norcraft acquisition.
Net cash provided by financing activities was $630.5 million in the nine months ended September 30, 2015 compared to net cash used in financing activities of $97.3 million in the nine months ended September 30, 2014. The increase in cash provided of $727.8 million was primarily due to higher net borrowings of $341.6 million and lower share repurchases in 2015 compared to 2014 ($395.7 million decrease), partially offset by an increase in dividends in 2015 compared to 2014 ($8.6 million increase).
The cash flows related to discontinued operations are combined with cash flows from continuing operations within each category on the statements of cash flows.
Pension Plans
In 2015, we expect to make pension contributions of approximately $5 million. For the foreseeable future, we believe that we have sufficient liquidity to meet the minimum funding that may be required by the Pension Protection Act of 2006.
Foreign Exchange
We have investments in various foreign countries, principally Canada, Mexico, China and France. Therefore, changes in the value of the related currencies affect our financial statements when translated into U.S. dollars.
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RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2015, the FASB issued a final standard that simplifies the subsequent measurement of inventory by replacing lower of cost or market test under the current GAAP. Under the current guidance the subsequent measurement of inventory is measured at the lower of cost or market, where “market” may have multiple possible outcomes. The new guidance requires subsequent measurement of inventory at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs to sell (completion, disposal, and transportation). This new standard is effective for the annual period beginning January 1, 2017. Earlier application is permitted, however we elected not to early adopt. We do not expect this standard to have a material effect on our financial statements.
In April 2015, the FASB issued Accounting Standards Update (“ASU”) 2015-03, “Simplifying the Presentation of Debt Issuance Costs.” This ASU requires debt issuance costs to be presented in the balance sheet as a direct deduction from the carrying value of the associated debt liability, instead of as a deferred charge (i.e., as an asset). This new standard is effective for the annual period beginning after December 15, 2015 (calendar year 2016 for Fortune Brands), and for annual periods and interim periods thereafter. Early adoption is permitted. The guidance will be applied on a retrospective basis. The adoption of this ASU will require us to reclassify approximately $3 million of debt issuance costs from a deferred asset to long-term debt as of September 30, 2015.
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There have been no material changes in the information provided in the section entitled “Quantitative and Qualitative Disclosures about Market Risk” in our Annual Report on Form 10-K for the year ended December 31, 2014.
The Company’s management has evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.
There have not been any changes in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter ended September 30, 2015 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company is in the process of reviewing the internal control structure of acquired businesses and, if necessary, will make appropriate changes as we incorporate our controls and procedures into those recently acquired businesses.
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PART II. OTHER INFORMATION
The Company is a defendant in lawsuits associated with the normal conduct of its businesses and operations. It is not possible to predict the outcome of the pending actions, and, as with any litigation, it is possible that these actions could be decided unfavorably to the Company. The Company believes that there are meritorious defenses to these actions and that these actions will not have a material adverse effect upon the Company’s results of operations, cash flows or financial condition, and, where appropriate, these actions are being vigorously contested.
We are subject to laws and regulations relating to protection of the environment. It is not possible to quantify with certainty the potential impact of actions relating to environmental matters, particularly remediation and other compliance efforts that our subsidiaries may undertake in the future. We believe, however, compliance with current environmental protection laws (before taking into account estimated recoveries from third parties) will not have a material adverse effect upon our results of operations, cash flows or financial condition.
There have been no material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014 in the section entitled “Risk Factors.”
Below are the repurchases of common stock by the Company or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) for the three months ended September 30, 2015:
Issuer Purchases of Equity Securities
Three Months Ended September 30, 2015
July 1 – July 31
August 1 – August 30
September 1 – September 30
Authorization and announcement date
June 2, 2014
September 30, 2014
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ E. Lee Wyatt, Jr.
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EXHIBIT INDEX
Exhibit