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spk07: Good morning, ladies and gentlemen. Welcome to the NASCO third quarter 2020 earnings call. My name is Maria, and I will be your operator for today's call. As a reminder, today's conference call is being recorded for replay purposes. To ask a question, please press star then the number one on your telephone keypad. To withdraw your question, please press the pound key. I will now turn the call over to David Shika, Vice President, Treasurer, and Investor Relations. You may begin.
spk08: Thank you, Maria, and good morning. Welcome to Masco Corporation's 2020 Third Quarter Conference Call. With me today are Keith Allman, President and CEO of Masco, and John Snevice, Masco's Vice President and Chief Financial Officer. Our Third Quarter earnings release and the presentation slides that we will refer to today are available on our website under Investor Relations. Following our remarks, we will open the call for analyst questions. Please limit yourself to one question with one follow-up. If we can't take your question now, please call me directly at 313-792-5500. Our statements today will include our views about our future performance, which constitute forward-looking statements. These statements are subject to risk and uncertainties that could cause our actual results to differ materially from the forward-looking statements. We've described these risks and uncertainties in our risk factors and other disclosures in our Form 10-K and our Form 10-Q that we filed with the Securities and Exchange Commission. Our statements will also include non-GAAP financial metrics. Our references to operating profit and earnings per share will be as adjusted, unless otherwise noted. We've reconciled these adjusted metrics to GAAP in our earnings release and presentation slides, which are available on our website under Investor Relations. With that, I now turn the call over to Keith.
spk14: Thank you, Dave. Good morning, everyone. And thank you for joining us today. I hope you and your families are staying healthy and safe in these difficult times. Please turn to slide four. During the third quarter, demand for our products was extremely strong as consumers continued to reevaluate how they use their homes in the face of ever-changing responses to the pandemic. With more time at home, and more disposable income due to reduced discretionary spending on leisure travel, entertainment, and gas for commuting, to name a few, consumers are investing in their homes. I'm very proud of our strong execution as we met this increased demand and served our customers while maintaining our top priority of employee safety. This resulted in tremendous performance on both our top And bottom lines, sales for the quarter increased 15%, excluding the impact of currency. Operating profit increased $127 million, or 43%, and operating margins expanded 400 basis points to 21.4%. We delivered strong incremental margins, 48%, as a result of our ability to profitably leverage the robust volume growth and to pull the right cost reduction levers. Earnings per share grew 73% to $1.04 per share. Turning to our segments, excluding currency, plumbing sales increased 12%. North American plumbing sales grew 14%, led by extremely strong performance at Delta. which drove greater than 20% growth across each of its retail, e-commerce, and trade channels. Trade sales in North America were particularly strong in the second half of the quarter, with Delta achieving record trade sales in both August and September. Delta was recently recognized as the Home Depot Marketing Partner of the Year. This is an annual award across all of Home Depot's suppliers and speaks to our commitment to partner with our customers to drive growth through innovation, omni-channel expertise, and strategic thought partnership. Our spa business also rebounded nicely in the third quarter and achieved growth, despite still dealing with government limitations on the number of employees in its factories. Record levels of demand and backlog for our spas continued as consumers looked for ways to enhance their at-home living and backyard experience. Our international plumbing business also posted strong growth of 9%, excluding currency, led by growth in Germany and China. While Europe as a whole rebounded in the third quarter, certain markets remained challenged, such as the UK and Spain. In our decorative architectural segment, sales grew an exceptional 19% as we drove growth in all product categories, including paint, bath and cabinet hardware, and lighting. Our DIY paint sales remained very strong in the quarter with growth in the upper 20% range. ProPaint declined mid-single digits, a significant improvement from last quarter. Paint demand has remained robust as it is a simple, economical project that homeowners can do themselves to improve the appearance of their home. Across all of our business units, it was an exceptional quarter. I would like to again thank all of our employees for their tremendous efforts in serving our customers and keeping each other safe. Now, moving into our fourth quarter outlook. we anticipate demand to remain strong and expect fourth quarter sales growth excluding currency to be approximately eight to 10% in both segments. Additionally, we expect fourth quarter operating margins for our plumbing segment to be approximately 19% and operating margins for our decorative segment to be approximately 17%. Together, This would put Masco's operating margin at over 17% for the quarter, a year-over-year expansion of approximately 150 basis points. As it relates to SG&A as a percent of sales, we anticipate further investment in our brands, innovation, and service to ensure we continue to deliver long-term, sustainable value creation. This outlook assumes no further shutdowns of facilities or points of distribution, which is obviously a concern as COVID cases spike in many parts of the United States and the world. Lastly, I'd like to update you on our capital allocation. While there remains uncertainty in the incurred environment, based on our strong balance sheet and liquidity, we do plan on resuming our share repurchase program in the fourth quarter. While the amount of repurchases will be subject to many variables, our initial plan is to deploy approximately $100 million towards repurchases in the core. And finally, there is no change to our thoughts on M&A. We remain active in the M&A market and have the balance sheet and liquidity to execute transactions with the right strategic fit and return during these uncertain times. With that, I'll now turn it over to John for additional details on our third quarter results. John?
spk09: Thank you, Keith, and good morning, everyone. As Dave mentioned, most of my comments will focus on adjusted performance, excluding the impact of rationalization and other one-time items. Turning to slide six, we had an outstanding quarter as sales increased a robust 15% excluding currencies. foreign currency translation favorably impacted our third quarter revenue by approximately $13 million. In local currency, North American sales in the third quarter increased 16%. This exceptional performance was mainly driven by strong volume growth in our DIY paint and North American plumbing businesses. In local currency, International sales rebounded nicely from last quarter and increased 9% over prior year, driven by increased volume. Gross margin was 38% in the quarter, up 210 basis points, driven by increased volume and cost leverage. Our SG&A as a percent of sales decreased 200 basis points to 16.5% as a result of fixed cost leverage and our continued focus on cost containment. operating income was $425 million, up $127 million, or 43% from last year, with operating margins expanding 400 basis points to 21.4%. Our EPS was $1.04, an increase of 73% compared to the third quarter of 2019. Company-wide incremental margins for the quarter were a strong 48% due to operating leverage on the exceptional volume our continued focus on cost control, and a relatively benign commodity environment. While this tremendous performance is a testament to Masco's operating leverage and commitment to cost control, we also recognize the need to invest in our brands, service, and innovation to fuel our growth and plan to fund such investments in future quarters. While uncertainty remains and precise forecasting is a challenge, we do anticipate continued solid consumer demand in the fourth quarter. We expect sales growth, excluding currency, of 8 to 10 percent with approximately 150 basis points of margin expansion from Q4 of 2019. Uncertainties such as the effect of government stimulus programs and the impact of the virus on the overall health of the economy and consumer could impact demand in the market and our expected results. Additionally, it is important to note that our Q4 expectations assume no further closures of our manufacturing plants or points of distribution related to COVID-19. Turning to slide seven, plumbing grew 12% excluding the impact of currency. Foreign currency translation favorably impacted this segment's sales by approximately $13 million in the quarter. North American sales increased 14% in local currency, led by Delta. The strong growth we experienced at the end of the second quarter in our trade, retail, and e-commerce channels continued in the third quarter, driven by robust consumer demand and some inventory restocking. While manufacturing in our spa business improved compared to the second quarter, Watkins continued to operate at less than 100% capacity, due to ongoing government mandated employee limitations in our Mexican facilities. Despite these challenges, Watkins grew in the third quarter and they continue to experience very strong demand for their products, resulting in a record backlog. International plumbing sales increased 9% in local currency. Hansgrohe drove low double-digit growth in both Germany and China, with lower growth in other European countries. This growth was partially offset by continued declines in other countries, including the UK and Spain, where the economies have been slower to recover. Operating profit was $271 million, up $83 million, or 44% from prior year, with margins expanding 510 basis points to 23.8%. The strong incremental margin of 61% was driven by higher volume, cost productivity initiatives, in a favorable price-cost relationship. Turning to the fourth quarter, we anticipate sales excluding currency to be up 8% to 10% with margins of approximately 19% up 150 basis points from prior year. Turning to slide eight, decorative architectural grew 19% for the third quarter. This outstanding performance was driven by high teams growth in our paint business with strong high 20% growth in our DIY paint, partially offset by a mid single digit decline in propane. The continued resurgence in DIY paint and some inventory restocking drove this performance. We remained well positioned with Bayer's compelling quality and value proposition to capitalize on this shift in consumer behavior. While propane demand declined in the third quarter, we saw a nice improvement from Q2 and sequential improvement through the quarter. Our builders hardware business also contributed to the segment's results as they delivered exceptional growth across product categories and benefited from strong consumer demand and new program wins. Additionally, our lighting business continued to improve, achieving growth over prior years. Operating profit increased in the quarter by 34%, driven by incremental volume and continued cost control, partially offset by an unfavorable price-cost relationship. Turning to the fourth quarter, we expect a strong demand for paint to continue and anticipate segment sales growth of 8% to 10%, with operating margins of approximately 17%, up approximately 70 basis points from prior year. At the same time, we anticipate a price-cost headwind and a more normalized level of investment in the fourth quarter. And turning to slide nine, we continue to strengthen our balance sheet with net debt to EBITDA at 1.1 times as we end of the quarter, with approximately $2.3 billion of balance sheet liquidity, which includes full availability of our $1 billion revolver. Working capital as a percent of sales improved 70 basis points versus prior year to 16.4% due to lower inventory levels and an improvement in accounts payable, largely resulting from working capital improvements at Kichler. It is important to note that our GAAP-reported net cash from operations of $573 million to the nine months ended September 30th reflects the cash taxes paid on the sale of our cabinetry business. Excluding the impact of approximately $192 million of cash taxes paid on the gain on the sale of our cabinetry business, our year-to-date adjusted net cash flow operations is approximately $765 million, with free cash flow of approximately $690 million. This is consistent with our expectation of 100% free cash flow conversion this year. A reconciliation can be found in the appendix of this deck. During the third quarter, we also successfully refinanced our 2021 debt maturity at historically low rates, which will result in approximately $4 million of annualized interest expense savings. Lastly, as Keith mentioned, we plan to reinstate our share buyback activity in the fourth quarter. We currently intend to deploy approximately $100 million to share repurchases in the fourth quarter, subject to market conditions. And with that, I'll turn the call back over to Keith.
spk14: Thank you, John. The COVID-19 pandemic continues to impact our business as consumers re-evaluate their living environments. The house is no longer just a place for shelter. It has become the office, the restaurant, the classroom, the gym, and the entertainment center. And we are capitalizing on these changing needs with our leading products by providing an affordable way for homeowners to discover better living possibilities and to enhance how they interact with their homes. At our Investor Day a little more than a year ago, we committed to between $2.80 and $3 earnings per share in 2021. I'm very proud of the entire MASCO team and pleased to say that we will achieve and likely exceed this range a full year earlier than planned. And while it is a bit early to provide a definitive outlook for 2021, we believe that the strong consumer trend of an increased investment in their homes will continue in 2021 and support growth for our products. The changes we have made to MASCO over the past few years, our culture of execution, and our commitment to continue to invest in brand, innovation, and service to support our customers positions us well to drive long-term growth and value creation in this ever-changing market. With that, I'll now open up the call for questions. Maria?
spk07: Thank you. In order to ensure that everyone has a chance to participate, we would like to request that you limit yourself to asking one question and one follow-up question during the Q&A session. To ask a question, please press star then the number one on your telephone keypad. To withdraw your question, press the pound key. Our first question comes from the line of Matthew Boley of Barclays.
spk03: Matthew Boley Good morning. Congrats on the results and thank you for taking the questions. I wanted to start out with a question around the, I guess, longer-term margin. You know, Keith, you just mentioned the investor day. And the thing about how to guide this year is kind of setting up on the margin side to come in above the ranges you had given in both segments. And I also hear you around some intentions around investing for growth. So, we think about 2021 is the idea that that you're going to sort of intentionally bring those margins back into the long-term range or you know is there a potential that you can kind of remain above those long-term ranges for an extended period here thank you matthew when you think about our margin targets for 2021 that we set up at the investor day
spk14: we need to remember that that was based on a significantly lower volume expectations for 20 to 21. i think we had plumbing in that 18 to 18 and a half range deco was 17 and a half to 18 and overall masco just shy of 17 and as i said this guidance was based on a low volume outlook and um you know as we've talked along this call and another calls we leverage volume very nicely so there's lots of variables And we'll continue to invest in our brands, innovation and service, like we talked about. And that will certainly be somewhat of a headwind, if you would, to margin expansion. But with strong R&R fundamentals and increased volume, I would think that we would be able to exceed those targets and margins that we talk about at our investor day in 2021.
spk03: Okay, understood. Secondly, maybe zeroing in on the 4Q margin guide and plumbing. You know, just given where you kind of ended Q3, complying a bit of a step down sequentially that's larger than typical for Q4. So is there anything in that Q3 plumbing margin that is, I don't know, I guess unsustainable or one time in nature that might drive that type of step down? Thank you.
spk14: There's a couple of things that are interacting as we think about plumbing in the fourth quarter. Recall that once the pandemic hit, we very swiftly enacted significant cost-cutting measures as we were in the throes of assessing what exactly the impact was going to be on liquidity, on cash flow, et cetera, and on demand. And we demonstrated, I believe, with our third quarter results, that our demand has remained robust. So now as we move into the fourth quarter, we do expect to see some increased production costs, certainly overtime, higher bonuses, higher volume rebates. Probably we'll have some additional, a little bit of additional air freight as we continue to balance out inventories in our supply chain and keep up with strong demand. Commodities will be a little bit less favorable as we look forward. And we do anticipate, as I talked about, bringing back some additional investment spent to make sure that we are going to win in the recovery. We talked about investment in brands and advertising and marketing, continued and increased investment in innovation. So that's the dynamic that we're looking at as we think about margins. Q4, really pretty similar for the other segment as well, but definitely for plumbing.
spk03: Okay. Thanks, Keith.
spk07: Our next question comes from the line of John Lovallo of Bank of America.
spk15: Hey, guys. Thank you for taking my questions as well. Maybe starting off just with Kichler, just wondering if you can give us an update on how the performance was in the quarter with a very strong segment performance.
spk14: They did a great job. Really impressed with the team down there. Continued to execute, I would say, better than planned, you know, at or better than planned. So we achieved growth. That was very solid. And the team's doing a good job on plan.
spk15: Okay. And then, you know, maybe just going back to the plumbing margin, the 23.8 in the quarter, you know, it sounds like there's going to be some increased investment coming forward, which makes a lot of sense. But, you know, how much of that was constrained investment in the quarter. Was it was it was that a factor or was it just the other factors that you talked about?
spk14: When you say constrained investments, John, how much did we have a reduction of investment in Q2? Is that what you're asking?
spk09: Yeah, John, maybe I'll take this one, you know, in terms of yeah, I mean, if you think about our performance in the third quarter in plumbing, yeah, as we exited Q2, one of the things that Keith mentioned, we really clamped down on expenses at the start of the pandemic, and we kept them constrained going into the third quarter. And so as you think about, you know, typical expenses that we might be running, particularly in the SGN area, right, a lot less travel and entertainment, right, because virtually we're not having our teams travel very much. Things like promotional expense were down significantly in the quarter. Things like trade shows that we would typically attend were all down in the quarter. And so that led probably to a little bit better margin expansion on top of the benefits we enjoyed with the operating leverage in Q3. And so as Keith mentioned, as we roll from Q3 into Q4, We're trying to contain our expenses as best we can, but we have to appropriately reinvest to grow the business. And so we are viewing the fact that we may need to layer some of those costs back in as we go into Q4.
spk07: Our next question comes from the line of Mike Dahl of RBC Capital Markets.
spk13: Hi, thanks for taking my questions. Nice results. Keith, John, you mentioned in remarks and in response to one of the questions, you know, some of the input costs potentially creeping up and also freight. I think, you know, as we think about global recovery and also potential vaccine distribution next year, there's certainly some thought that we could see further acceleration in some of the freight pressures and and also some re-acceleration in inputs. I guess, can you give us any more color when you're thinking about that 4Q margin? How much of an impact are you already seeing, and what are your thoughts as we head into 21 around inputs and freight?
spk09: Yeah, sure, Mike. It's John. You know, in terms of your commodity costs, yeah, certainly in Q3, you did have some benefit. Of the drivers of our margin expansion in Q3, I'd say volume and cost productivity were much bigger drivers of our Q3 performance and obviously commodity influence. Looking forward, as you think about our plumbing and you think about the base metals, copper and zinc, they did help us and provided us a little bit of tailwind in the third quarter. But recall that we've seen copper and zinc start to increase, particularly in the second quarter, and I think, as we've said before on other calls, it takes about two quarters for raw material inflation to flow through, particularly the base, you know, the copper and zinc, before it hits our P&L. And so that will be a little bit less of a tailwind, a little bit more of a headwind as we go into Q4. You know, as it relates to the input costs for paint, you know, our price-commodity relationship was a bit of a headwind in the quarter. And we expect that to increase a little bit as we go into the fourth quarter. Resident prices have started to rise up a little bit because oil has risen over the course of the year. So that's where we're looking. TIO2, I would say, has remained relatively stable, not a lot of up or down movements there. So as we go into the fourth quarter, we expect that to continue to be stable. As part of your question, I think, Mike, you also mentioned freight. And we haven't seen a lot of freight cost pressure yet. And, you know, I would remind everyone that, you know, distribution and logistics costs as a percent of sales for us is relatively low. So even though if we saw significant spikes in distribution logistics, that wouldn't be much of an impact. So, you know, what we are seeing a little bit of tightness is on just supply of freight in trucks. And so that's something we're keeping an eye on. That said, you know, I think, you know, we and our teams have always done a great job of handling inflation, whether it's, you know, our general inflation that we experience or commodity-based inflation. And so, you know, we'll handle it accordingly. You know, we'll do it like we've always done. We'll, you know, continue to drive our cost productivity initiatives. We'll continue to work with our suppliers to push back on them. And we'll also, you know, enact pricing if that's required.
spk13: Great. Thanks for that. That's really helpful. My second question is clearly a great recovery in plumbing, both in North America and in the international. Just wondering, you know, I think with Europe, some of the some of the rising cases of probably you know, been at least a few weeks ahead of what we've seen in the U.S., and there have been some local restrictions that have probably gotten a little bit tighter there. Can you talk about just whether you're seeing any of those impact your European plumbing business at this point in the fourth quarter relative to the recovery in the third quarter?
spk14: Well, I'll take this one, Mike. Germany, which, as you know, is Hansgrohe's largest market, And China, which is also a very large market for us, each drove low double-digit growth in the third quarter. So we did see good growth. We also saw growth, but to a lesser extent, in other European countries, Italy, the Netherlands, for example. But as I said in my remarks, there were also other countries such as the U.K. and Spain that have been slower to recover. So when we think about Europe in the third quarter, it was good. It was robust for us. As it relates to the fourth quarter, we're watching very closely what happens. And, yes, you're right, there has been some tightening. And they're doing it in a little bit different way than we are here. They tend to be more metropolitan area focused, meaning they're being more pinpointed. in the types of restrictions that they're employing, whether it's cutting the time in certain cities that restaurants can be open or closing certain types of venues like cinemas, movie theaters, et cetera, on a city-by-city basis. So they're being more surgical. And I think just like around the world, there's more experience in how to work through this. So it remains to be seen what the ultimate impact will be. But I think what we've what we've demonstrated is that we have the ability to be agile, if you will, and to very closely monitor the situations and pull the cost levers appropriately if needed. So right now we're really watching, particularly over in Europe. Thanks, Keith.
spk13: Good luck in the quarter.
spk07: Thank you. Our next question comes from one of Adam Bobgartner of Credit Suisse.
spk02: Hey, guys. Good morning. Thanks for taking my questions. Can you give us a sense for how much customer restocking added to growth across both businesses? You did mention that in both segments.
spk09: Yeah, Adam, as you might expect, as we exited the second quarter, because of the strong demand that we were experiencing at the end of Q2, inventories were relatively low in the channels. And as you think about the growth drivers for the third quarter being volume and and inventory restocking, I would tell you that volume was by far the much more significant driver of growth. Inventory restocking was a relatively light impact in the quarter.
spk02: Okay, got it. Thanks. And then just looking at 4Q paint or decorative guidance, what are you assuming for DIY and pro-growth in that guidance?
spk09: You know, as we look, you know, we think demand for paint will continue to be strong as we go into the fourth quarter. You know, we indicated we're forecasting 8% to 10% sales growth in Q4. And, again, I think we're going to see continued strong demand on the DIY side and muted but more in improving demand on the pro side of our business. So, yeah. I would remind everyone, though, we've got a bit of a tough comp going in pain as we go into the fourth quarter. As you may recall, in our fourth quarter last year, we experienced about $20 million of sales pulled forward in the fourth quarter of last year. And so that will be a bit of a comp headwind for us as we go into Q4.
spk02: Great. Thanks, guys.
spk07: Our next question comes from one of Susan McLaurie of Goldman Sachs.
spk05: Susan, you may be on mute.
spk09: Susan, are you there? I'm sorry about that.
spk06: That was my fault. Sorry. My first question is just talking about, you know, you obviously mentioned you're restarting the share repurchase program, which I think is a good sign of your confidence in the outlook and what you're seeing. Can you talk a little bit about, you know, maybe any potential to exceed that $100 million or how we should think about this starting to kind of layer back in and you getting back to the level that you've seen in the past couple of years?
spk09: Sure, Susan. As we indicated, both Keith and I indicated in our prepared remarks, we're right now targeting around $100 million per share repurchases in the quarter. I think as we both indicated, there's a lot of variables that go into the decision, what drives our share repurchase activity. It's going to be subject to market conditions to the extent that we see a pullback in the shares. We'll be probably a little bit more opportunistic like we were earlier this year. when we repurchase $600 million worth of our shares for less than $40 per share. So to the extent we see greater share pullback, we'll probably be a little bit more aggressive to the extent we see the share price run high. We'll probably continue to devote that $100 million, but probably not much more than that. Again, it's going to be a bit of a judgment call as we work our way through the quarter.
spk06: okay all right that sounds good and then you know just following up there you um can you give us a little color on kichler and perhaps some of the trends that you're seeing there and especially given some of those cost-cutting efforts how we should expect that to start to come through as we look to 2021. lighting is a a relatively less expensive purchase that you can create some pop and a new look in your house so much like
spk14: many of our products, which are in that sweet spot of the price point and bang for the buck, if you will, we also saw that in lighting. So we saw good growth across our channels, and Kichler participated in that growth. As we said, Kichler grew. And as I mentioned before to an earlier question, we're on plan, maybe even a little bit ahead of plan, and I'm pleased with how the The team is performing, and our objective was to position Kichler for growth next year, and we had growth this past quarter. So I like what I'm seeing.
spk06: Okay, great. Thank you both.
spk07: Our next question comes from the line of Truman Patterson of Wells Fargo.
spk04: Hi, good morning, everyone, and thanks for taking my question. First, among the two segments, could you just go through how demand trended throughout the quarter and how it either ended in September or October even? And just for clarity, the exit rate seems like all of your businesses were positive on a year-over-year basis in 3Q, but are they still trending that way?
spk14: As we spoke a little bit, Truman, in the prepared remarks, Delta had a record last couple months of the quarter, so nice acceleration through the quarter, and that's fairly consistent with the plumbing segment in general. It had good, solid, somewhat consistent growth over in Europe in plumbing. In the DIY space, excuse me, in paint and then decorative in general, pretty consistent. It was strong going in and remained strong going through. So that gives you a little bit of color on the in-quarter kind of dynamics.
spk04: Okay, thank you for that. And then, you know, not necessarily in paint or faucets, but in other building product categories, we've heard of some supply chain issues or, you know, capacity issues and filling the robust demand. Are you all seeing that in paint and faucets specifically, or do you have any capacity issues? And then on the flip side, you know, it seems like there's a little bit of inventory build in your channels. Do you think that, you know, there's more to come that, you know, your retailers especially need to build additional inventory? And how are you thinking about, you know, your own inventory levels over the winter? Are you looking to build up a little bit more than you normally do?
spk14: Right now, Truman, we're managing through with our current capacity. Typically, we would use the slower months in the beginning of the year and early Q2 to build inventory. We didn't have that luxury due to restrictions and uncertainty and everything that was going on at that point. Now, we do have plans to selectively add some capacity where we need it. We talked a little bit about the resurgence and the increase in demand of one-gallon filling one-gallon paint due to the tremendous shift over to DIY, where the DIYers tend to buy more ones than fives. So we had to buy and purchase some additional capacity in one-gallon filling lines, that sort of thing. So there's some spot capacity in certain types of machinery where we've had to add, but really there's – been no significant capacity issues. At some point, we're likely going to increase capacity in certain areas, but not an immediate horizon. In terms of the inventory position in the channels, I would say that inventory is probably a little bit light for where we would like to see it and where our channel partners would like to see it. So, may see a little bit of inventory fill as we move through the year.
spk09: Yeah, one thing I'd add to Keith's comments is that, you know, I would like to take this time to acknowledge our supply chain teams. They have done just a fantastic job of reacting to the increased robust demand that we've been experiencing in the third quarter. And whether it's our supply chain teams internally, our folks in our plants across the portfolio, or whether it's our suppliers, everyone has acted coordinated in a coordinated fashion to really drive this growth. And so we're really pleased with how the team has responded this quarter.
spk04: Thank you all, and good luck on the upcoming quarter.
spk07: Our next question comes from one of Keith Hughes of Trist.
spk01: Thank you. Question on Watkins. Sounds like you're still having some production issues. Do you have any sort of feel for when that will get back to full production and alleviate some of the backlog you discussed earlier?
spk09: Again, the Watkins team is working day and night to deliver and fulfill on demand. When the Mexican government releases the restrictions, it's tough to tell. I mean, we don't have any good insight as to when that's going to take place. But the Watkins team is running hard and fulfilling as best they can and You know, they, like I said, in my prepared remarks, you know, they drove growth in the quarter despite some of these restrictions. And so we're really pleased with how the Wycombe team is delivering here in Q3 and Q4.
spk01: And second question on propane. You had talked about it sounds like in the fourth quarter you expected to get a little bit better than what we saw in the third. Why is that? Is that something to do with your retail partner or is that something more in the markets?
spk09: I think, Keith, it's just continued progress in the trends that we've been seeing. You know, as you might expect, in Q2, we saw a lot of pullback on consumers allowing paint contractors to come in their homes. And we've seen, you know, a steady improvement since Q2. And actually through Q3, we saw a sequential improvement each month through the quarter in our propane sales. And so, you know, based on what we're experiencing, you know, we think that that trend could continue here as we go into Q4.
spk14: A lot of variabilities there, Keith. You know, what happens to the virus and what happens to the consumer psyche as it relates to pros being allowed in your home, the fact that in the late year it moves more towards the interior. So there's a lot of variables that we have to think about. Okay, thank you.
spk07: Our next question comes from one of Michael Rio of J.P. Morgan.
spk11: Thanks. Good morning, everyone, and congrats on the results. Thank you. First question, I just wanted to circle back a little bit to understanding some of the sequential trends that you're expecting in the businesses on the top line, on the sales side, in plumbing and decorative. And when you think about the expected still very strong growth rates for a little bit of a decel in plumbing from roughly 13% to 8% to 9%, just trying to get a sense of what's driving that, if it's if all of that is perhaps the absence of the inventory restocking that you referred to earlier, or if there's other things at hand. And similarly, in decorative, I believe you had said earlier that you observed relatively consistent trends during 3Q. So again, just trying to understand the decel trend into 4Q, and I know, John, you had referred to somewhat of a tougher comp, but, you know, I'm also looking at 3Q19 growing at 5%, 6%, and 4Q19 down 3%. So I just wanted to try and better understand, you know, what's driving that as well.
spk09: Yeah, Mike, as you think about, you know, the transition of the growth from Q3 to Q4, that's sequential. You know, first of all, you know, we had extremely strong demand in Q3. which drove, you know, really good results. And as you said, we expect demand to continue to be good as we go into Q4. But as you know, forecasting in this current environment is a little bit of a challenge. And it's hard to say, you know, what impact the virus might have on our Q4 results. And, you know, there may be a little bit of a dose of conservatism in that guide as well as we, you know, as we're trying to dial things into the third quarter or the fourth quarter, I should say. You know, so, you know, from my perspective, you know, we had 12% growth in plumbing in the third quarter. You know, we're looking at 8% to 10% growth. So I don't view that as significant deceleration as we go into the fourth quarter. That said, you know, third quarter did have some inventory restocking in it. And so we're probably thinking there's probably a little less inventory restocking as we go into Q4. We'll see how that plays out. On the decorative architectural side, to the point you made in your question, the pull forward definitely has an impact, we think, on our Q4 revenue growth rates because we're currently not expecting that type of activity to recur here in the fourth quarter of 2020. I'd also say that, you know, Liberty Hardware, which is one of the smaller businesses in the segment, had a terrific quarter, full stop. I mean, you know, they had a really, really strong quarter. And, you know, as we go – and they also had a load-in here in the third quarter due to a program win they had at one of their retail customers. And so we don't expect that activity to recur. And similarly – to the plumbing segment. You know, Mike, we talked about a little bit of inventory restocking in Q3. You know, we don't expect that same level of inventory restocking to take place in Q4. So, you know, as we pull it all together, yeah, you know, the transition or the growth rates from Q3 to Q4 are a little bit more muted in Q4. That said, we think 8% to 10% growth in this environment is still quite strong, and coincidentally with 150 basis points of margin expansion, that, we think, represents a very good quarter.
spk11: No, no, absolutely. And no, I appreciate that. Thank you. I guess secondly, you know, on the margin side, obviously it's great to see the reinvestment in the business. And, you know, when you're talking about the margins that you're generating, that strategy makes perfect sense in terms of, you know, trying to, you know, maintain those high margins and reinvest for the top line. Yeah. you know obviously that's baked into your fortune guidance uh how should we think about you know 21 um in this regard and you know when when keith you talked about before you know perhaps being able to maintain a margin above your long-term targets uh is that with reinvestment spend kind of kicking up or um you know how do you see that factor impacting profitability? Is that something where it could be a 50 or 100-bit type of investment, or the levels could still stay above those long-term targets with a higher reinvestment rate?
spk14: My comment, again, it's too early to call 2021, and we'll talk more about that Next quarter, we do expect growth in 2021. We think that the fundamentals of the consumer, when you look at what really drives our business, that is it's configured now, it significantly swings on home price appreciation, housing turnover. And you look at those numbers, you know, we're looking at, let's call it 5% home price appreciation in 2021. you know, 6.5 million of existing home sales. So, those are big numbers. Now, those aren't sustainable numbers, but that certainly gives us a lot of confidence going into 2021. So, my comments about continuing to grow and driving margin expansion, that's how we think here. You know, we always want to grow above market and we want to continue to expand margins. So, Our increased investments were factored into my thinking and my comments that I made there. Now, I will say that when you think about the optimum spend for value creation, I'm not going to sit here and say that 16.5% SG&A is the optimum. It's more than that. and we're going to continue to drive long-term, mid- and long-term value creation. So there will be an increase in SG&A. It's not sustainable at 16.5 because that's not the right thing to do to drive value creation. So we're going to increase those investments, but we also are very carefully watching these cost reduction levers we have and how much we increase. because we don't know, no one knows, where this virus is going to go over the coming months. But as we learn more, we're going to maintain our commitment to the future.
spk07: Our next question comes from one of Stephen Kim of Evercore ISI.
spk05: Thanks very much, guys. Yeah, I had two questions for you, both kind of related to the virus issue. because you're getting a lot of good information in other areas. And obviously I'm not asking you to predict the future, but if we take it from a negative perspective, I'm curious as to what you think, what you're anticipating the effects might be on your business if we were to go through another wave of shutdowns, kind of like what we did earlier on. I would imagine it's going to be a little bit different this time. And you talked about some differences between the U.S. and Europe in the terms of the way that we handled it the first time. How do you imagine the effects may be a little different, in particular as it relates to your business? I'm thinking, do you think inventories would hold more stable through a shutdown wave, for instance? And are there other impacts that are important for us to consider for your business if we were to tighten up again?
spk14: You know, that's a – That's a crystal ball kind of question, and I wish I had one. The way we think about what could happen, either positive or negative, kind of turns on a couple things. One is the discretionary spend. So is the discretionary spend of the consumer going to continue to be at a rather high level now as it relates to reduction in spend in other areas like entertainment and going out, et cetera? And what could potentially happen if there was a reduction or no stimulus, if the virus got worse, those sorts of more downside scenarios? scenarios. So where does the discretionary spend go? Is there more or less discretionary spend? And the second component is what share of wallet of the consumer is going to be spent on the home? Obviously, we've seen a significant spike in that share of wallet being spent on the home. And will that continue? I don't think it's probably prudent to think that. This is going to stay at these elevated levels in perpetuity Probably would revert back to the mean but at the same time we do believe that there has been some structural changes To the DIY market and you know we talked about last quarter some of our own research, and I've certainly talked to other people in the industry and our channel partners in terms of some of their research and And you simply can't deny that the millennials have entered in and entered in big into DIY. And, you know, that is earlier than we expected. We expected it, but it's earlier. So that could be, could represent a structural expanding of the DIY pie, if you will. So I don't have a crystal ball answer for you, but those are three things that we're thinking about as we evaluate positive and potentially negative scenarios.
spk09: And, Stephen, I guess maybe my own color on that. I mean, I think, like Keith said, I think consumer demand will be there. I mean, you know, as we saw what happened in the spring as we worked through the pandemic, you know, the consumer was there and they were spending and they were investing in their home. And, like Keith said, given the trends that we're seeing and given the research that we've seen, you know, we think consumer demand will be there. You know, the thing that we've got to keep our eye on, like, because we're still contending with our Watkins operation, is what happens to production. and, you know, if the shutdown affects any of our facilities. And so that's the one thing we've got to keep in the back of our mind as well.
spk05: Yeah, fair point. Next question relates – actually, it's kind of a flip scenario. Let's say sometime in the next foreseeable future we actually get a vaccine and we get a more rapid reopening or a reopening that's on the more rapid side, let's say, a more positive, like, bullish outcome. One of the foreseeable things that a lot of folks are talking about now for your business, and of course you've addressed it before, is that you might see a slowdown in DIY paint because you had a little bit of pull forward maybe. And so in particular, I suppose with DeckArc, I'm curious if you could address what areas – Are there areas where you're doing some contingency planning today ahead of a potential slowdown in the event of a vaccine? And what are the operational challenges that you could reasonably foresee? And what would your action plan look like? I'm not asking for a lot of specifics here, but just generally, what are the areas of your business that you're anticipating you may need to pull a lever for? If you could give us some insight into how you're thinking about that.
spk14: I think it would probably be mainly on discretionary spending. I really wouldn't see significant structural cost reductions. You know, when you think about where our brick and mortar capacity is and how it's lined up, we're in pretty good shape there. We had good utilization going into the pandemic, and we have outstanding utilization now. So I think, you know, on the upside scenario, we could see a potential investment in some capacity down the road. We obviously work very hard to get more out of the assets that we have, do better with what we have sort of thing in terms of efficiency and how we use our assets. And then the downside, we would flex down on the discretionary. That's kind of how I would see it.
spk09: Yeah, Stephen, maybe the way I would approach it is, you know, we've got a great investment in our pro franchise and if a vaccine to your little description were to come true or come through faster, I think we could double down on our pro investment and grow that business faster than we've been growing it in the last several years. I mean, we've experienced double-digit growth in our propane business historically, and if the consumer decides not to paint their homes anymore and they want pros to do it, we'll be right there with our channel partner to meet that demand. So I think That's the way I would position the business going forward if your scenario were to emerge.
spk05: Great. Thanks a lot, guys. Appreciate it.
spk07: Our next question comes from one of Garrick Schmoes of Loop Capital.
spk00: Hi, thanks. I just wanted to follow up on a comment you just made just around capacity. Just with the step up in demand, it sounds like there's a pretty solid outlook into 2020. are you from having to perhaps add some capacity, whether it's plumbing or paint?
spk09: I'll talk first. Maybe Keith can add some color afterwards. So our teams have done a great job of driving efficiency within our facilities such that, Garrick, we don't need to add any brick-and-mortar capacity in the near term. You know, we are, as Keith mentioned earlier, we are investing a little bit in our one-gallon capacity in the pain side because that's where the demand has been the strongest over the course of the last couple quarters. That said, if demand, you know, continues to go at the current pace that it is, you know, I would estimate that we might need to expand some of our facilities probably in the 22 or 23 timeframe. You know, it's not going to definitely be a 21 investment. But that might be the soonest that we have to do it. We'll have to see how the demand plays out over the course of the next couple of quarters.
spk00: Okay, thanks. Just had a quick question on plumbing. You called out good growth across the board, retail, e-commerce. It sounded particularly bullish just on what you're seeing in trade in August and September. So just kind of wondering what is driving the acceleration in the trade channel and what the outlook is there. Thanks and congratulations.
spk14: I think consumers were becoming more comfortable and feeling more safe to go into plumbing showrooms and to go into those areas of the trade channel that they really shut down for a while. They literally shut down and then shut down in the sense of not being comfortable going in them. So I think the consumer engaging with that part of the channel as it relates to showrooms was a big plus. And we're very strong in the showrooms. So that fed right into our sweet spot. So I think that That was a big component of it. Also, to a degree, the consumer is a little bit more comfortable with having plumbers in their home. And there's a component of repair where when something like that breaks, it has to be fixed. So whether it's a washer, dryer, or in our case, a faucet or a shower system. So I think those are the dynamics that drove the trade.
spk07: Our next question comes from one of Tim Lowes of Baird.
spk10: Hey, guys. Nice job. Thanks for squeezing me in. I just had one question really about promotions. And, you know, just curious kind of what you're hearing as your customers think about 21 around promotions at this point. Do you think things revert back to maybe a normal promotional type of environment, or do you think there's some incremental kind of investment or catch-up investment that your customers might ask of you next year?
spk09: You know, Tim, it's the time of year where we're typically working through the promotional cadence for the subsequent year. And as we think about it right now, you know, the promotional cadence is driven by our retail partners. We don't necessarily drive that. We work with them in how our participation will play out. um but you know our our guess at this point is you know they're going to be thoughtful about it like they were this year to the extent that um uh the virus is more muted i would to your point i would expect to see a more normal cadence of promotional activity to the extent that there's a more aggressive um virus out there and they want to limit consumers going into their stores they may pull back on that so it's It's hard to determine right now exactly how it's going to play out for 21, but, you know, we're going to work very closely with our channel partners to figure out how we can best and most effectively participate in whatever promotion they decide to run. Okay. Okay, great.
spk10: Good luck on the rest of your year, guys. Thanks.
spk09: Operator, is there one more question?
spk07: And, ladies and gentlemen, our final question will come from Juan Asilin of Jefferies.
spk12: Hey, guys. John, thanks for just squeezing me in here. Just one really quick one. you know good to see uh propane recover uh when we look out to 2021 you got some pretty tough cops on the diy side so i'm just curious do you have enough momentum on the pro side and kitchler or maybe we have this stronger growth across the board in diy where you see uh deco actually being up next year from a growth standpoint phil the keith here um it's too early to call 21 as i said
spk14: We do expect growth in 21, and we have a strong consumer. We have a strong brand. We have the best service. When you talk about our DIY paint, we have a great channel partner. So we would, and we always do, invest and drive our teams for growth, and that's how we're thinking about it. So take care, Phil. Thank you to everyone for participating in the call. I really appreciate it. Please stay safe, and we will talk to you next quarter. Thank you.
spk07: Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect.
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