Masco Corporation

Good morning, ladies and gentlemen. Welcome to Masco Corporation's second quarter 2022 conference call. My name is Bailey 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 star then two. I will now turn the call over to David Chaika, Vice President, Treasurer, And Investor Relations, you may now begin.

Thank you, Bailey, and good morning. Welcome to Masco Corporation's 2022 second 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 second quarter earnings release and the presentation slides 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 risk 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 reconcile 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.

Thank you, Dave. Good morning, everyone, and thank you for joining us today. Please turn to slide five. We continue to execute in this challenging environment, and I'm pleased with our performance in the first half of the year. In the second quarter, our top line increased 8% with growth driven by pricing and to a lesser extent volume in both segments. Our operating profit was impacted by higher supply chain costs, planned marketing expense increases, and unfavorable foreign currency. Commodity and other inflation was mid-teens in the quarter, but we expect this to be a peak level as we anniversary inflation that began last year, and we are beginning to see declines in certain input costs in the spot market. Importantly, with our continued pricing actions, we have begun to recover the price-cost lag that we experienced in the back half of 2021. Additionally, we continue to leverage our SG&A as SG&A as a percent of sales improved 90 basis points to 15.3%. These actions contributed to sequential margin improvement of 140 basis points to 17.6% for the quarter. Earnings per share for the quarter was $1.14, which matched prior year's earnings. Turning to our segments, plumbing grew 7% in local currency against a 48% count. with 7% growth in North American plumbing and 8% growth in international plumbing. North American growth was led by our spa business that continues to capitalize on strong demand for its products. International plumbing markets remain solid, with strong growth across Europe and in China during the quarter. In our decorative architectural segment, sales grew 15%, as Bayer continued its strong performance with low teens growth in DIY paint and approximately 40% growth in propane. DIY paint growth was mostly due to price as we continue to see DIY paint volumes normalizing. We expect full-year DIY paint volumes to be in the range of 2019 volumes. Propane volumes remain strong as we continue to gain market share in this market. demonstrating the compelling offering that we have developed along with the Home Depot. I'm also very pleased that for the ninth year in a row, Behr was named the number one rated interior paint by a leading third party testing agency. In addition to the top spot, Behr took all of the top four rankings. This is a testament to the quality and value proposition that bare paint brings to both the DIY and propane markets as paint quality, including ease of application, durability, coverage, and value are extremely important selling points for both the DIY and pro customer. Turning to capital allocation, we repurchased $550 million of our stock during the quarter through open market repurchases and an accelerated stock repurchase transaction. This brought our total share repurchases to over $900 million for 2022, or nearly 7% of our shares outstanding at the beginning of the year. This likely completes our repurchases for the year, as we will use our free cash flow to repay the $500 million term loan we used to fund the ASR. Now let me address what we are seeing in terms of demand in our markets. Largely as expected, demand or actual sellout for many of our products moderated during the second quarter. Across most of our categories, we expect volumes to be down modestly in the second half of the year with growth driven by pricing. On the cost side, certain input costs such as labor and freight remain elevated. Additionally, Labor and freight availability continues to be inconsistent, making it challenging to operate efficiently. Lastly, the U.S. dollar continues to strengthen, resulting in lower operating profit dollars than we forecasted. With these considerations in mind, we are narrowing our earnings per share expectations for the year to be between $4.15 to $4.25 per share from our previous expectations of $4.15 to $4.35. We are closely monitoring market dynamics and will take action if demand falls below our expectations. That said, we believe there are numerous positive structural factors related to housing that will be supportive of increased repair and remodel activity over the next few years, even if there is a short-term economic slowdown. We are on the edge of the large 75 million-person millennial cohort forming households and entering the housing market. 2.7 million more homes will reach the prime remodeling age of 20 to 39 years old over the next three years. The COVID-19 pandemic has clearly increased the desire for more enjoyable living spaces, which has led to increased home demand and remodeling expenditures. And consumers and homeowners have strong balance sheets with more than $2 trillion in savings and home equity values at all-time high. All of these structural forces provide tailwinds for our repair and remodel business. Now I'll turn the call over to John for additional detail on our second quarter results and full year outlook. John?

Thank you, Keith, and good morning, everyone. As Dave mentioned, my comments today will focus on adjusted performance, excluding the impact of rationalization and other one-time items. Turning to slide seven, we delivered another strong quarter with sales increasing 8% against a robust 24% comp. Net selling prices increased sales by 10%. The higher volumes increased sales by 1%. These were partially offset by an unfavorable currency impact of 3%. Sales grew 11 percent, excluding the impact of currency. In local currency, North American sales increased 11 percent. This performance was driven by strong growth in DIY and propane, as well as spas, faucets, and showers. The main drivers of this growth were increased net selling prices, which increased sales by 10 percent, and higher sales volumes, which increased sales by 1 percent. In local currency, International sales increased 8 percent, or 11 percent, excluding divestitures. Net selling prices increased sales by 7 percent, and higher volumes increased sales by 4 percent. A gross margin of 33 percent was impacted by a higher year-over-year commodity and logistics cost in the quarter. We anticipate the gross margin will continue to face pressure in the third quarter, with year-over-year improvement expected in the fourth quarter. Our SG&A as a percentage of sales improved 90 basis points to 15.3 percent due to operating leverage and continued cost discipline across their businesses. Operating profit in the second quarter was $414 million, and operating margin was 17.6 percent, sequential improvement of 140 basis points. Operating profit was impacted by higher supply chain costs, marketing, and currency. partially offset by higher net selling prices and incremental volume. Our EPS of $1.14 in the quarter matched the second quarter of 2021. Turning to slide eight, plumbing growth was 7 percent in local currency against a robust 48 percent comp in the second quarter of last year. Segment sales grew 8 percent, excluding the net impacts of currency, acquisitions, and divestitures. Pricing contributed 7% to growth and volume contributed 1%. North American sales increased 7% in the local currency. This performance was led by Watkins Wellness as they continue to capitalize on the trends toward wellness and outdoor living. Delta also contributed to increased sales in the quarter as they delivered growth against a double-digit comp. International plumbing sales increased 8% in local currency or 11 percent excluding divestitures. Hansgrohe grew sales across almost all their markets, with their key markets of Germany, China, France, and the U.K. continuing to drive exceptional results. Segment operating profit in the second quarter was $238 million, and operating margin was 17.3 percent. Operating profit was impacted by higher supply chain costs, marketing, and currency, partially offset by higher net selling prices. Turning to slide nine, decorative architectural sales increased 15 percent for the second quarter. Our propane business delivered another outstanding quarter, with growth of approximately 40 percent as our propane offering and high-quality products continue to gain share with the pro customer. With our strong operational execution and continued investment, We are demonstrating our ability to retain and grow our penetration with the pro customer. Our DIY business sales grew low teens. However, DIY volumes normalized in the second quarter. We now anticipate second half DIY paint sales to decline modestly. Operating profit was $198 million in the quarter, up $10 million, or 5%. And operating margin was 20.2%. This performance was driven by higher net selling prices and incremental volume, partially offset by higher commodity and supply chain costs and marketing. Turning to slide 10, our balance sheet is strong, with net debt to EBITDA at 1.9 times, even with the additional $500 million we borrowed to fund the accelerated share repurchase transaction we executed during the quarter. We ended the quarter with approximately $1.4 billion of balance sheet liquidity. Working capital as a percent of sales was 18.9%. Working capital was impacted by higher inventory levels to meet demand of our customers, cost inflation, and delays in receipt and delivery of material. Through focused execution, we continue to balance our inventory levels with demand. We expect working capital as a percent of sales be approximately 16.5% at year end. We also continued our focus on shareholder value creation by deploying $550 million to share repurchases during the second quarter. Year to date, we have deployed approximately $914 million to share repurchases and retired approximately 16.6 million shares, or almost 7% of our shares outstanding at the beginning of the year. We do not expect further share repurchases this year, as we will use the free cash flow in the second half to repay the $500 million term loan. Finally, turning to slide 11, let's review our outlook for 2022. Given moderating demand and additional foreign currency headwinds, we now expect four-year sales growth for MASCO to be in the range of 5% to 7% versus our previous guidance of 6% to 10%. Due to lower sales volume and higher supply chain costs, We now anticipate full-year operating margins to be approximately 17%. While we do anticipate margin expansion in the second half of the year, this will be weighted to the fourth quarter. In our plumbing segment, we now expect 2022 sales growth to be in the range of 3% to 5%, including foreign currency, versus our previous guidance of 3% to 7%. Given current exchange rate, foreign currency is expected to unfavorably impact plumbing revenue by approximately 3% or $165 million. We now anticipate full-year plumbing margins will be approximately 18%, lower from previous guidance due to higher supply chain inefficiencies and slightly lower volume assumptions. In our decorative architectural segment, we expect 2022 sales to grow in the range of 90% to 11%, versus our previous guidance of 10 to 14%. Looking specifically at paint growth for 2022, we currently anticipate our DIY paint sales to increase mid-single digits and our propane sales to increase strong double digits. We now expect full-year decorative architectural margin to be approximately 18%. As we previously discussed, in this segment, pricing actions typically only recover the dollar amount of inflation. As a result, all else equal, operating profit dollars remain neutral from cost recovery pricing actions that result in margin compression. Finally, as Keith mentioned earlier, our updated 2022 EPS estimate is $4.15 to $4.25, which represents 14% EPS growth at the midpoint of the range. This assumes a $233 million average diluted share count for the year. Additional modeling assumptions for 2022 can be found on slide 14 in our earnings deck. With that, I would like to open the call for Q&A. Operator?

Thank you. If you would like to ask a question, please press star followed by 1 on your telephone keypad. 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 this Q&A session. Our first question today comes from the line of Stephen Kim from Evercore ISI. Please go ahead. Your line is now open.

Thanks very much, guys. Appreciate it. I was curious if you could talk a little bit about the – I know you gave a lot of info there – Hopefully I got it all down right. But when you talked about in the DeckArc segment, I believe Paint, you said you expected second half volume to decline modestly. I just wanted to see if you could give us a sense for, was that inclusive of the pro business? Maybe you could just review that, what your volume specific outlook is within Paint and maybe breaking out DIY versus pro, just so we're clear.

Sure, Steve. As you think about demand, like we said, we saw strong demand in the quarter. As we think about going forward, DIY versus pro, you might expect we've had some strong comps in the pro side of the business. We're starting to face some pretty significant comps in Q3. I think our pro comp against Q3 of last year is like 45% growth. So While we still anticipate growth in the back half of the year, obviously we won't be posting the strong comps that we've posted the last three or four quarters. As we think about our DIY business, we do think our DIY business will be up in the back half of the year. That said, it'll be driven by price with volumes declining in the back half of the year. Okay.

So you think DIY volume will be up?

Will be down. Yeah, down probably double digits, low double digits, Steve.

What would be down double digits? Sorry, I spoke over you.

Yeah, DIY paint volumes will be down low double digits in the second half of the year.

Okay, that's what I needed. Okay, great. Thank you for that. Appreciate it. And then when you look at the plumbing business, can you give us a sense, just housekeeping-wise, what was the FX and the acquisition divestiture impact on sales in the quarter? And when you're looking forward in that business, do you anticipate that you will be able to more than cover your cost inflation in that business, or should we simply be looking for – just recovering the cost dollar for dollar in the back half of the plumbing business. And as we look into 2023, I know we're not giving guidance on that. However, would it be reasonable to think that with the movements we're seeing in commodities and perhaps a little stickiness in price, that we might actually see some positive carryover effects in 2023?

Stephen, it's Keith. Typically, we do recover... With price in this segment, we do recover margin as well. And you're exactly right. If there is a pullback in commodities, we would expect that to be a tailwind for us.

Yeah, Steve, and maybe you had a question in the beginning. I think the first part of your question had to do with revenue and the impact of acquisitions and FX. And, you know, roughly speaking, these are kind of rough numbers. FX is roughly 2%, and acquisition is 1%.

Perfect. Thank you so much.

Thank you. The next question today comes from the line of Matthew Booley from Barclays. Please go ahead. Your line is now open.

Hey, good morning, everyone. Thank you for taking the questions. I think you mentioned at the top, speaking around sellout, that sellout moderated in the quarter. I guess, number one, could you kind of speak to the comparison of sort of sell in and sell through there through the quarter and you know part two really what i'm getting at is we think about the second half guide um you know was that basically your view of sellout or you know or is there any assumption around additional uh inventory destocking there thank you yeah we did we did uh catch up on our channel inventory a little bit uh here year to date through the second quarter

And I think that was planned, and we did that to help improve our service to the customer and to the consumer. In terms of the forward look as it relates to our guide, we're really not anticipating inventory fluctuations to have much impact on that.

Got it. Okay, thank you for that, Keith. Second one, it sounded like on the international business and Hans Grohe – Strong trends there, you know, ex-investitures and currency. I guess looking forward, clearly a lot of concern around, you know, energy costs in Europe and Germany specifically. I guess, could you sort of speak to your assumptions around the second half in the international business, both on the energy side and sort of the, you know, the knock-on effects to the European consumer there? Thank you.

Well, you know, we certainly are in no position to make an overall crystal ball, call it a economic call in Europe. But I will tell you that we continue to see strong demand, particularly in key markets for Hansgrohe. Central Germany, China continues to perform very well for us, France, the UK, etc. So we're counting on continued good solid growth from Europe and our performance is quite strong. With regard to the overall energy, the team has done a really good job and we've secured the majority of our energy requirements from renewable energy for this year and going into next year. We're working hard to convert and have converted the majority of our equipment from natural gas to other sources of energy in terms of powering that equipment. That said, if there was a significant shutdown or constriction of energy flow into it, that would be an issue that we'd have to manage, and that would be challenging. But in terms of the proactive actions that we're taking, I feel confident about the work that the team has done. They've done a good job.

Maybe just a couple other comments in addition to Keith's comments. We are assuming higher energy input costs in the back half of the year, just given what's taken place. So we feel, you know, we need to make sure that's baked into the guide.

Great. Well, thanks, John. Thanks, Keith. Good luck, guys.

Thank you. The next question today comes from Mike Dahl from RBC Capital. Please go ahead. Your line is now open.

Thanks. Good morning. Just a couple of follow-ups here. In terms of The second half guide and the comments or the implied volumes for the second half, this relates a little to Matt's question, but can you talk about how those volume expectations compare to where you exited 2Q? I know you talked about moderation through the quarter. Are you assuming similar levels of declines as you have most recently seen, or are you embedding greater declines in the back half of the year than what you've just experienced maybe over the past month or so.

Yeah, I'd say, Mike, as we look at it, we think things have kind of stabilized here, and we think the trends as we exited the quarter are going to be consistent with the back half of the year, as best we can tell at this point.

Got it. Okay. And then my second question is around the inflation dynamics. And I talked about kind of 15% high level, but this is the peak. Can you split that out between your segments? Because it seems fairly clear if we look at some of the plumbing inputs to Steve's question, you know, that there could be a relief on the horizon there, maybe a little stickier on on the paint side, but just if you could give us a little more color on the difference in inflation trends between the two segments and potential timeline for relief as you see it.

Sure, I'm happy to do that. So as you indicated, we have experienced a fair amount of inflation obviously all year and starting actually in the midpoint of 2021. But as you said, you know, and we said earlier, we think we've hit a high point As we look at our cost basket across the various segments, we have seen some input costs back off their highs from earlier in the year. You know, obviously copper and zinc, which go into our plumbing products, have begun to decrease. That impact, it takes about two quarters or six months to flow to an impact or financial statement. So if you consider the timing of the inflation that we experience now, the timing of the decline in some of the commodity prices, that's not going to have much of an impact here in 2022. That will be much more of an impact in the first part of 2023. So that could provide a tailwind as we go into 2023. You know, other parts of the inflation basket, though, are beginning to moderate as well. You know, ocean freight was something we talked about quite extensively on prior calls. We're starting to see that begin to moderate. That said, you know, fuel costs, you know, will probably offset a portion of that because, you know, over the road trucking continues to be high. And certain other components of our inputs like packaging and pallets all continue to remain high. On the paint side of our business, we are seeing paint input costs be stickier and still face some upward pressure. Specifically, we're seeing that is TIO2 in other inputs. And so we're closely monitoring that. And, you know, if we have to take additional pricing actions to offset any of this inflation, we will do so, you know, as evidenced by the fact that we put through 10% price in the second quarter. So, you know, we think, you know, we are in good position. We're slightly, you know, price cost positive for the second quarter. So we're set up well, but we'll continue to monitor the situation and we'll react accordingly with additional price if need be.

That's very helpful. Thanks, John.

Thank you. The next question for today comes from the line of John Lovallo from UBS. Please go ahead. Your line is now open.

Good morning, guys, and thank you for taking my questions as well. The first one is maybe just a point of clarification. Did you say that the DIY volumes in the quarter were actually flat, which would be, you know, a very good outcome versus your peers? And if so, what do you think were the biggest drivers of that on a relative basis?

Yeah, DIY volumes for the quarter. We're relatively flat, yeah. John, did you have a second?

Yeah, I'm here.

John, did you have a second question?

Yeah, I'm sorry. I didn't hear my answer. You said that, no, I missed it. They're relatively flat?

Cell in.

I remember it was greater than sellout in the quarter. So, yeah, they were – yeah. So I hope that answers your question. I'm uncertain.

Okay, yeah. I was just curious because that is better than some of what your competitors are saying, and I was just curious if you thought – what was kind of the differentiating factor there?

Yeah, I think part of it, John, is, you know, if you compare our results against the second quarter last year, second quarter last year, we had relatively soft performance in DIY because of the Texas freeze. And so as you think about the year-over-year comparison, we are catching up on that. And so that's why we had better sell in than sell out in the second quarter.

Okay. Thank you.

And second question.

Go ahead. Revenues. When you look at revenue in Dec Arc and the growth in second quarter, it was roughly 80% price and about 20% volume. And then when you look at that volume, we're relatively flat in DIY.

Got it. Okay. And then in terms of just any inflation or any pressures, are you seeing any trade down for consumers in either of your segments? Yes.

Not really. It's been pretty stable. We've worked hard to reduce the impact of movement along the assortment from the lower price to the higher price and from pro to DIY, for example. There still exists some impact of mix as we see that kind of movement, but we really haven't. We haven't seen evidence of a trade down when we look across the volume of our big ticket items like spas, for example. We continue to see strong demand there, strong backlog of about 25 weeks remaining, which is greater than we would typically see in a normalized environment. In China, where we have really a focus on the higher-end products, that Hansgrohe sees there with a good growth in China, and that continues despite the market slowdown. That popped back very nicely, so we're seeing good demand there. And we are seeing good demand on the lower end of our assortment. So overall, I have not seen evidence of a significant trade-down, and we don't expect any as we move forward through the year.

Okay. Thanks, guys. Thank you.

The next question today comes from the line of Susan McClary from Goldman Sachs. Please go ahead. Your line is now open.

Good morning, everyone. My first question is, you know, building off of John's question there, as you take a step back, can you talk a bit about the overall state of the consumer, how it changed during the quarter, what their willingness to spend is on housing, and are you seeing any signs of elasticity as the pricing continues to come through across the product categories?

Well, we did see some moderation of demand, and we are seeing some signals of slowdown as we look at the various leading indicators, if you will, like website searches and those sorts of things that we watch closely. And there was... moderation that I would say well we don't break down specific in quarter trends I would say that mid quarter we saw a moderation and then it's been fairly flat since then and it's consistent across our categories and for the specific categories fairly consistent across the channel so overall I think a consistent moderation of demand now there's some categories for us that have bucked that trend we talked about propane sales that was very strong, our spa sales that we felt were very strong, and international continues to perform very well for us. But faucets and showers, hardware lighting, DIY paint, I would say we have seen a moderation of demand. As I said, that happened kind of mid-quarter and then has been flattish coming through the rest of the quarter. We expect volumes to be down modestly in the second half. maybe a little less in plumbing, a little bit more in decorative. And I'll remind you that plumbing had, I think it was a 16% comp in Q3, and decorative had a 15% comp. So you can factor that in as you think about the segments on a quarterly basis.

You see what, you know, maybe one thing I would add to Keith's comments is, you know, as we look at the consumer, the consumer continues to look healthy to us. You know, we continue to see strong balance sheets. You know, home equity continues to look good in this. In terms of your question about elasticity, if you think about our portfolio of low-ticket repair model products, consumers have the flexibility to buy our products, and a lot of our products are for break-fix purposes. And so we're not seeing the consumer bend as a result of the higher prices that they're feeling in the market, at least for our products.

Okay, that's very helpful, Culler. I guess as a follow-up, you know, as we do think about the macro environment shifting, are there any early steps you're taking to prepare the business or what are the things that you're watching for to indicate that you may need to make some underlying changes in terms of perhaps cost structures or those kinds of things looking out?

At the end of the day, ultimately, it would be demand for us. And that would be the trigger for us to implement our contingency plans. And that's really a part of our ongoing business planning process. And this is something that we all have experience in dealing with. And it's part of what we do. So pullbacks on certainly variable costs and discretionary costs that we could execute in the SG&A fund, for example, and throttling back costs. growth investments or hires and looking at that variable cost. And depending on the depth of it, as we've proven the ability to do, we could get into the fixed costs as well. So we have contingency plans in place, and we watch leading indicators. I mentioned website traffic. We have deep access and relationships in the channel as it relates to consumer tickets, et cetera. And we watch those leading indicators. But fundamentally, we don't. We wouldn't execute cost outs on a leading-end educator. We'd wait to see where the demand goes, and we're very keenly watching that and, as part of our standard process, meeting on a regular basis with the businesses to review their contingency planning. So this is, you know, this certainly is an area where we have experience and it's part of our business, and that's fundamentally how we're looking at it. Having said that, the portfolio as we reconfigured it, what John mentioned with the break-fix component and with the fact that it's lower ticket and they're high bang for the buck, coupled with the fundamental shifts that we've seen in terms of how people buy products for their home and how they view their home, we feel good about the long-term aspects of our portfolio.

Okay, thank you very much. Good luck with everything.

Thank you. The next question today comes from the line of Deepa Rakhavan from Wells Fargo Securities. Please go ahead. Your line is now open.

Good morning, everyone. Thanks for taking my question. The first question is on price cost. You mentioned you are slightly price-cost positive in the quarter. Is it true across both the segments? I'm interested in plumbing comments specifically because it doesn't look like price fully offset into quarter headwinds from higher costs.

Yeah, Deepa. We were slightly price-cost positive across both segments, both plumbing and I think the thing that you might focus on a little bit more is we did have some operational inefficiencies in the second quarter in plumbing. And as Keith referenced in his prepared remarks, specifically we had some shipping and some labor inefficiencies in the second quarter that probably would have created more of a headwind for the plumbing segment.

Deepa, are you there?

Oh, hey. Sorry. I was on mute. I apologize for that. Just a follow-up. Can you talk through some metrics that might have positively surprised you or negatively surprised you in the quarter? I think I'm looking at the magnitude of change that possibly surprised you and if that changes in the second half of the year?

We continue to perform well in Europe.

I wouldn't say so much that that's a surprise, but we've watched that performance develop and that was good to see for our franchise to be able to grow like we did in Europe and China. I think that was very solid. We've talked about now for a number of quarters about how we're working very hard to drive stickiness into the propane demand. It's evidenced by our continued growth and share gain in that part of our business that the team is doing an outstanding job together with our channel partner to really take advantage of the opportunity that we had with our supply chain excellence when we had an opportunity to acquire a share wallet of some new customers to really show them what that bear paint can do. And we've had positive response there. So I think our continued growth in Europe and our continued stickiness and demonstrated capability to keep our business that we're gaining in the pro is a couple positive aspects of the quarter for sure.

I'd say on the negative side, the operational inefficiencies that I just mentioned in plumbing were probably – a bit more persistent than we'd expected. I mean, it's been a very dynamic environment, as you well know, you know, in the last couple quarters. And we thought we would see some improvement, and obviously we didn't see an improvement in the second quarter, the improvement that we'd anticipated. And quite honestly, we probably expect some of those inefficiencies to carry over into the third quarter in the plumbing segment. So it'll be, you know, continue to be a bit of a headwind for that segment as we go into the third quarter. But we do think things get better as we roll into the fourth quarter.

Thanks much for the call. Very helpful. Good luck.

Thank you. The next question today comes from the line of Keith Hughes from Truist. Please go ahead. Your line is now open.

Thank you. Questions on international plumbing. Strong numbers in the quarter. You've highlighted it in the prepared statement. There's been a lot of fear around Europe. What could be coming? Are you getting any indications that this pace of business could fall off in the second half of the year, given some of their energy pressure and various other things going on in the continent.

As I talked a little bit earlier, Keith, it's a dynamic environment, and we don't have a crystal ball. So we're focused on being fleet of foot and watching and being ready to make adjustments if there was some sort of significant economic changes. And it's a dynamic environment for sure. But we are not seeing that currently. And we're not seeing that reflected in a trade down. And we continue to see good robust demand through Europe. And we are taking the contingency plans and putting those in place in terms of conversion, as I mentioned, from natural gas to other sources of energy. We've procured the majority of our energy through 23 from renewable sources. So the team's doing a good job to prepare for and address the current challenges in terms of seeing indications of what might happen going forward. We're working hard to be ready for what might happen, but we are not seeing any indications of a turndown in Europe at this point.

And Keith, you know, the other thing I would add to Keith's comments is if you think about Hans Grohe, A good portion of the revenue comes from project sales. Think about hospitality or hotels going up. A lot of that takes place in countries outside of Europe. That's Asia, that's the Middle East. There's a good fundamental baseline of demand there. We do serve projects in Europe. Even when the consumer market turns down, these projects continue. They have to be finished. That will provide some basis of support for Hansgrohe going forward.

Okay. Thank you.

Thank you. The next question today comes from the line of David McGregor from Longbow Research. Please go ahead. Your line is now open. Yes, good morning, everyone.

You talked about the gross profit margins and the fact that they're going to be under a little more pressure in 3Q and that would expect to improve a little more in 4Q. I wonder if you could just unpack that a little for us and talk about some of the puts and takes that are behind those dynamics.

Yes, certainly. There's a couple things that are happening there, David. One is we talked about the cost recovery element of our decorative architectural business where we the COOP, the dollar cost of the inflation. And so obviously, you know, we talked about and we've talked historically about a 5% inflationary increase has about 100 basis point impact on our margins in the segment. And if you think about the fact that we mentioned we had mid-teens inflationary impact in the second quarter, you know, that's a big contributor to some of the gross margin pressure that we're feeling. On top of that, the second thing that would be impacting would be the lower volumes that we're foreshadowing. So those two, I think, are the two big things that are impacting our gross margins in the second half. Okay.

Okay, that's helpful. And then just as a follow-up, I guess, given the fact that the macro seems to be softening up here a little bit, I'm just wondering to what extent you're seeing your channel partners tapping the brakes on replenishing inventories. I'm just wondering if you can talk about what you're seeing right now in terms of channel inventory levels and what you're expecting in terms of fluctuations around that over the next two to three quarters.

It's really a mixed bag. In some cases, we're still a little light on where we'd like to have our channel inventories. For the most part, we've caught up and I think the inventories... are in pretty good shape as we work to get inventory in place to better serve the customer and to meet the requirements. A little bit of a pull down, you know, in not atypical as some of our bigger plumbing wholesale customers approach their fiscal year end or fiscal quarter end, that there'll be some pullback in inventory. So there's a little bit of pullback, I would say, in plumbing wholesale, but by and large, I think it's fairly stable. Thanks very much.

Thank you. The next question today comes from the line of Adam Baumgarten from Zellman. Please go ahead. Your line is now open.

Hey, good morning, everyone. I guess maybe starting in paint, just given the slower DIY outlook in the second half, do you expect promotional activity to pick up in any meaningful way?

You know, that really is a decision. of our channel partner. I mean, we obviously are together in that, in the discussions and the strategy around it. In some cases, based on our partnership, we'll choose to participate in that and help fund some of that. But as we sit right now, I would not expect material change in the promotion levels. But again, that's a choice of our customer.

Okay, got it. And then just switching gears to plumbing, just maybe if you could give us some color around the order patterns or showroom traffic that you're seeing in the spa business?

Well, that continues to be robust.

Really, our backlogs, as I mentioned, are around 25 weeks and staying there. The orders have been pretty consistent. Haven't seen a material movement up or down there. So I would say consistent through the quarter.

Got it. Thanks a lot.

Thank you. The next question today comes from Phil Ng from Jefferies. Please go ahead. Your line is now open.

Hey, guys. I guess if demand does soften a bit, what are some of the levers that you guys are talking about in the contingency plan perhaps for next year? And then when we think about decremental margins in that softer demand environment, how should we think about that, John? And then do you anticipate pricing holding in that environment?

So, you know, Phil, as you're thinking about our contingency plans, they're taking a couple different, you know, flavors, right? I mean, depending on the extent of the softening of demand, some things you do is simple belt timing. You pull back on open head, you know, open head count requests, pull back on advertising, travel, entertainment, things like that. If the decline is more persistent and deeper and longer than you expect, then you have to look at the structural aspects of the business. You have to take out headcount, reduce shifts, things like that. And so we'll see how this plays out. In terms of our decremental margins, they should be fairly consistent with our incremental margins, which are kind of in that 25%, 30% range. We may not have that perfect alignment there. The first quarter of a decline, you can't always get the cost out as quickly as volumes decline, but We're going to try to marry those up as best we can. The one thing that may be helpful as we go into, you know, if there is a recession, you know, typically input costs decline, so that could be a little bit of an offset to some of those decremental margins. So, you know, that's the way we think about it. Keith, I don't know if there's anything else you'd like to add.

Yeah, I talked about the fixed and variable component of the cost plans that we have in place, and it really depends. So I think we've hit on that pretty good.

Cool. And in pricing, in that environment?

Pricing in that environment? I think it depends, again, on what we're seeing in the marketplace. In a rare instance, in a recession, if commodities were to inflate, we'd have to push through pricing. We do have, you know, by segment, it varies. We typically don't give back a lot of pricing on the plumbing side of our business. Obviously, if there was deflation in inputs, we've got that cost recovery on an inflationary reverses itself in that environment. And actually, that's when you start to see margins expand in our decorative architectural segment.

Gotcha. That's really helpful. And then on plumbing, if I heard you correctly... Keith, it sounded like China was still quite strong. Certainly, that part of the world is seeing a lot of COVID lockdowns. I've been impressed that it's held up so well. Any color on how you're managing through that and how you're thinking about that business in the back half?

I think you nailed it. That was a real solid performance for us in China, particularly given the shutdown period that was there in the quarter. I think it really gets back to a combination of three things. We're executing very well. The team there has been a real nice bright spot for us. And so good folks there that are focused on growth, no matter what is thrown at them. And the shutdown was significant. Secondly, we are focused on the higher end segment, and we believe we're the share leader in that premium segment. And that tends to have less volatility and I think more consistency. And then thirdly, when you look at Where we're selling to in terms of end use, it's primarily, as John mentioned, into project business or in hotels or in multifamily, et cetera, which has the ability to jump right back after that shutdown, more so than, say, if we were into the lower price point that depended more on retail traffic. So those three things combined have really come together to give us a very nice story in China.

Okay, super. Thank you.

Thank you. The next question today comes from the line of Garrick Schmoitz from Loop Capital. Please go ahead. Your line is now open.

Oh, hi. Thanks for taking my question. Higher level question for me. Just want to unpack the comment that DIY paint volumes are coming back down to 2019 levels. And I'm just wondering if you're you're thinking at this point that 2019 is the baseline, uh, for that business, you know, just given, you know, on one hand you've got strong demographic trends, but on the other hand, you had a big surge in DIY demand during the pandemic. So just a little bit higher level and just kind of what the right market baseline could be for that business.

Yeah, I think that's, that's exactly how we're thinking about it. You know, we had, uh, tremendous DIY demand as the pandemic hit and folks put more of a focus on their home and had more time. And then we've seen some shift as the pandemic restrictions lessened with a move towards pro. And we're very happy with how our pro business has been able to take advantage of that with respect to capacity and supply chain performance, but also keep that as it relates to quality and service and having a good value proposition for the pros and the stickiness of that share that we gain. So when we look going forward with the millennials coming in and forming houses, and we know that they're DIYers and they're DIYers for multiple projects based on our research, not just one and done, so to speak. So I think that's a very, you know, the impact of COVID as it relates to how those DIYers view their home and invest in their home and the equities that they've developed in their home and their savings accounts that we think for the next couple years for sure that the DIY volume is going to have some nice tailwinds because of those structural factors. So, yes, we're looking at kind of the, you know, great growth during the pandemic. We've come back now to, let's say, a 2019 level in terms of volume, and we see this is the jump-off point for further growth in DIY.

Great, that's helpful. I wanted to follow up on capital allocation. I guess I'll take that question. You're focused on paying off the term loan in the second half of the year, so you'll pause on repurchases, but what does that mean for M&A moving forward? Does that take a pause as well, just given the debt pay down that's coming in?

No, here, continuing to look at M&A, we continue to have our teams cultivate potential acquisition candidates. Though you might expect in this environment where things get a little choppy, there are fewer candidates for sale. That said, I balance you to set up. We are in a position to execute on strategic M&A if the right candidates were to emerge in this environment.

Understood. Thanks for the help.

Thank you. The next question today comes from the line of Kenneth Sena from KeyBank. Please go ahead. Your line is now open.

Good morning. Hey, Ken. Good morning.

Hey.

Good morning.

Look, I don't want to get on page. There's two questions I have. If you're talking about – I think it was DIY – 21 versus 19, could you just maybe say, if that's accurate, is that your total pain volumes? And then could you maybe just level set, like, you know, how you're thinking about that same comment, you know, first half of this year versus the second half, just so we can see kind of how that seasonality and all this COVID stuff is working through, if you have that. But I think the bigger question I can ask is, you know, you guys, Sherwin, it's not a yin or yang situation because there's a lot of small regional competitors, in my view, that are ceding share. So can you really kind of maybe talk about where you are today versus 2019? And, you know, your pro initiative, it's not – it doesn't have to be coming from Sherwin. There's a bunch of private, smaller regional companies that are, you know, ceding that share. Can you maybe just give us a little context around – that because obviously as you guys had raw material availability, you gained share because people came and now they're staying with you. I think sometimes the dialogue is just between two data points rather than the broader picture. Please, thank you.

We're focused on our business and on the targeted customers that we have where our value proposition works the best as part of our partnership with the Home Depot. And, you know, it's challenging, as I've consistently talked about, in terms of quarter-to-quarter market size determination with any kind of accuracy. But when you look at our growth rates, particularly with pro, there's no question that we're gaining share in pro. And we've done it now for two, three quarters in a row and demonstrated, I think, some stickiness. With regards to competition, we have very strong competition in that segment. I think it makes us better, very respectful of them. With regards to where our volume is coming from, I really don't have an answer for that. We know we're outgrowing the market. We're gaining share. You're exactly right. There's regional competitors throughout the country. But we're really focused on how we can best serve our customer. And while we understand market sizing is difficult on a quarter-to-quarter basis, I think it's pretty clear we're gaining share and feel good about the business now. And then moving forward, the structural aspects of DIY that we talked about, the fact that we are relatively low share in pro, and we're demonstrating the ability to grow together with our channel partners. So that's how we do it.

Thank you. Thank you.

The next question today comes from the line of Rafe Jadvisich from Bank of America. Please go ahead. Your line is now open.

Hi. Good morning. Thanks for taking my question. First, as you look at your CapEx investments for 2022, are you adjusting any of your capacity expansion plans to reflect the moderating demand or changing macro environment?

No. When you look at the major projects we have and where they're focused, say European plumbing business, our spa business, this is investments that will start to – begin to ramp up in 2023 and won't reach full capacity until after that. So while we're certainly aware and are keenly watching what's happening in the short term here as it relates to a potential slowdown or a pullback, and we have contingency plans in place that we talked about, and we have an experience base in our leadership team that has operated in this environment several times, so we're confident in that. We're also confident in the fundamentals of our low-ticket DIY repair and remodel and the pro aspect of our business for the long term. And it has strong fundamentals and strong correlations to what we think are positive tailwinds. So, no, we're not going to pull back on these important capacity increases for us because where they are, what business they're in, what geography they're in, the confidence we have overall in the long term of our business. So no change to that.

The only thing I would add to Keith's good comments is that we're a high-cash flow generating company, and the amount of dollars that we allocate to CapEx is relatively light compared to our free cash flow. So we have the free cash flow to fund these without really pulling back on any other investments that we need to make across the business.

And in most cases where we look at this capital, they're stepwise where we can begin to capacitize, say, the new factory with various amounts of equipment and staffing. So it's not an all or nothing thing as it relates to the total investment. But we have no plans right now to pull back on our capacity, capex rather.

Okay, that makes sense. And then the guidance implies an improvement in the plumbing margins in the second half of the year versus the first half. Can you just maybe help us understand how much of that is lower inflation on the metal side versus additional price realization or additional price hikes that you've announced in the first half of the year?

Yeah, Rafe, you know, as I think about it, you know, the improvement, you know, the back half of the year in plumbing is going to be your Q3, you know, margins, my guess would be very similar to Q2s and Q4 will improve significantly compared to Q4 of last year. So, you know, I think the fundamental difference is the improvement in performance in the fourth quarter. Relative to the fourth quarter of last year, the pricing, the improvement in commodity position really will not be much of an impact in the back half of the year. That's really going to be a 2023 event, just given the length of our supply chains and the fact that it takes about two quarters for that benefit to flow to and hit our P&L.

Okay, that's really helpful. Thank you.

Thank you. Our final question today comes from the line of Mike Rehout from J.P. Morgan. Please go ahead. Your line is now open.

Hi. Good morning, guys. Doug Wardlaw from Mike. I was just wondering if you guys could give more color on the supply chain currently. I know you guys have mentioned earlier that you believe inflation has peaked, so I'm just wondering in terms of the supply chain moving forward and maybe comparing it to earlier in the year and parts of last year, you know, where you guys see yourself in terms of that battle?

I think, you know, when we think about it in terms of pricing, we have, we're seeing, as John mentioned in an earlier question, we are seeing some pullbacks, Jay, in brass and copper and zinc and that sort of thing. But we're also seeing some pressure in other spots of the business, TIO2, specialty chemicals. in our paint business. So we are still very attuned to the relationship to the commodity inbound pricing and the pricing that we need to have for our customers. And we're staying keenly aware of that. Where the supply chain has, frankly, is a little tougher than we expected this quarter when we were sitting here a quarter ago thinking about it is in terms of labor costs and freight costs. But importantly, beyond the cost of it, it's really the availability of those two aspects of our input. And when you have freight that is less predictable, the delivery times, as I think we're all seeing, even our personal lives, where the delivery times of inbound product is not as reliable, the fill rates, the lead times are more challenged. that puts a challenge to the rhythm of manufacturing and to the rhythm of our supply chain. And we did see that in plumbing this past quarter. So I think that's really what I would highlight that has changed.

Thank you, guys. Good luck.

Thanks.

Thank you. This concludes today's Masco Corporation second quarter 2022 conference call. Thank you all for your participation. You may now disconnect your lines.