Masco Corporation

Good morning, ladies and gentlemen. Welcome to Masco Corporation's third quarter 2022 conference call. My name is Alex and I'll 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 two. I'll now turn the call over to David Chiker, Vice President, Treasurer and Investor Relations. You may begin.

Thank you, Alex, and good morning. Welcome to Masco Corporation's 2022 Third Quarter Conference Call. With me today are Keith Allman, President and CEO of Masco, and John Snubice, Masco's Vice President and Chief Financial Officer. Our third 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 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 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. In the third quarter, Sales matched prior year with significant pricing actions of 9%, offsetting volume declines of 6% and currency headwinds of 3%. Demand moderated more than expected in the third quarter, with most categories experiencing declining volumes year over year. Our operating profit was impacted by these lower volumes, higher operational costs, and unfavorable foreign currency. Partially offsetting these headwinds, SG&A as a percent of sales improved 110 basis points to 15.6% as we continued to manage our SG&A and discretionary spending. Operating margin was 15.9% for the quarter, and earnings per share was 98 cents. Turning to our segments, plumbing grew 5% in local currency against a 15% comp with 4% growth in North America and 5% growth in international. Our spa business and international plumbing delivered positive volumes for the quarter. International plumbing sales were led by strong growth in China as we continue to gain share. European markets in the quarter were flat in local currency against a double digit comp in the third quarter of 2021. While incoming orders have moderated in Europe, we saw good demand in several markets, such as China, India, and the Middle East, demonstrating the benefit of selling to over 100 countries. We were price-cost positive in the third quarter in plumbing, and we expect that relationship to continue to improve in the fourth quarter, as our pricing actions are in place and we continue to anniversary the higher costs from last year. In our decorative architectural segment, sales grew 1% led by propane sales, which increased mid-teens against a more than 45% top in Q3 of 2021. More than offsetting sales declined to DIY paint, lighting, and hardware. Propane volumes increased low single digits as we continue to see good demand from propane contractors. We are retaining the significant share gains we have achieved over the past 12 months, and we continue to increase the rollout of additional capabilities and services, along with our channel partner, to strengthen our value proposition to the propainter. This strong performance is a testament to the satisfaction that propainters have with our high-quality products, competitive pro offering, and our partnership with the Home Depot. We are pleased with our performance in propane and will continue to capitalize on the significant growth opportunity. Moving on to the overall demand picture, POS and incoming orders slowed more than expected late in the third quarter across most of our product categories, and we anticipate this slowdown to continue into the fourth quarter. In the third quarter, we also experienced higher operational costs, mostly in plumbing, that will continue into the fourth quarter. These operational costs include higher than expected freight and material costs due to persistent inflation, as well as production and absorption inefficiencies associated with changing volume levels. Lastly, the U.S. dollar continues to strengthen, which will result in lower revenue and operating profit dollars than we previously forecasted. Because of these dynamics, We are lowering our earnings per share expectation for the year to $3.70 to $3.80 from our previous expectation of $4.15 to $4.25. We are enacting plans to address lower volumes and elevated operational costs. While market conditions are softening, we believe we are well positioned to outperform in more challenging times and deliver long-term shareholder value. Our portfolio of lower ticket repair and remodel oriented products serves both DIY and pro customers, and we have product, channel, geographic, and price point diversification to provide stability and resilience through a cycle. We've taken significant pricing actions and will continue to recover cost inflation experienced in 2021 and 2022 as certain commodities and costs pull back from their highs, such as copper, zinc, and ocean freight. We continue to invest in our leading brands and innovation to capture share. We have experienced, agile management teams that have successfully navigated uncertain economic environments before, and we have a strong balance sheet, cash flow, and liquidity that can be used to our advantage. This confidence in our business is exemplified by the new two billion dollar share repurchase authorization approved by our board of directors this authorization is a continuation of our capital allocation strategy first and foremost reinvest in our business to drive profitable growth second maintain a strong investment grade balance sheet third pay a relevant dividend with a targeted 30 payout ratio and fourth Deploy excess free cash flow to share repurchase or bolt-on acquisitions. We have consistently executed on this strategy to drive long-term shareholder value and will continue to do so. I'll now turn the call over to John for additional detail on our third 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, sales on the quarter matched prior year, and excluding currency grew 3%. Net selling prices increased sales by 9%, partially offset by lower volumes, which decreased sales by 6%. In local currency, North American sales increased 3%, This performance was driven by strong growth in propane as well as in spas. Higher net selling prices increased sales by 11%, partially offset by lower volumes, which decreased sales by 8%. In local currency, international sales increased 5%. Net selling prices increased sales by 4%, and higher volumes increased sales by 3%. partially offset by a mixed impact of 1%. Our gross margin of 31.5% was impacted by higher year-over-year operational costs in the quarter. We anticipate the gross margin will continue to face pressure in the fourth quarter, but will improve year-over-year. Our SG&A as a percentage of sales improved 110 basis points to 15.6%. Operating profit in the third quarter was $351 million and operating margin was 15.9%. Operating profit was impacted by lower volumes, higher operational costs, and currency, partially offset by higher net selling prices. Lastly, our EPS in the quarter was 98 cents. Turning to slide eight, plumbing sales were flat to prior year. Excluding the impact of currency, segment sales grew 5% against a healthy 15% count in the third quarter of last year. Pricing contributed 7% to growth, and volume decreased sales by 2%. North American sales increased 4% in local currency. This performance was driven by strong SPA volumes and pricing actions across the segment, partially offset by lower volumes in other product categories. International plumbing sales increased 5% in local currency against an 18% comp from last year. Growth was led by strength in China, with most European markets roughly flat versus prior year. Second operating profit in the third quarter was $220 million, and operating margin was 16.6%. Operating profit was impacted by lower volumes, higher operational costs and currency, partially offset by higher net selling prices. Turning to slide nine, decorative architectural sales increased 1% in the third quarter. Our propane business continues to deliver outstanding performance with sales up mid-teens against a robust count of over 45% in the third quarter of 2021. We continue to gain share and drive conversion as our propane offering, strong brands, and high quality products resonate with pro customers. Our DIY paint business declined low single digits versus prior year, largely as expected. Additionally, our lighting and builders hardware businesses declined, in aggregate, mid-single digits in the quarter. Operating profit was $151 million in the quarter, and operating margin was 17.2%. Operating profit was impacted by lower volumes and higher freight and material costs, partially offset by higher net selling prices. Turning to slide 10, our balance sheet is strong with net debt to EBITDA at 1.9 times. We ended the quarter with approximately $1.5 billion of balance sheet liquidity. Working capital as a percent of sales was 18.5%. Working capital was impacted by higher inventory levels at many of our businesses, cost inflation, and delays in receipt and delivery of material. We continue to balance our inventory levels with demand and expect working capital as a percent of sales to be approximately 16.5% at year end. In the quarter, we also paid down $100 million of the $500 million term loan that we borrowed in the second quarter. Additionally, our Board authorized a new $2 billion share repurchase program effective October 20, 2022, replacing the existing authorization. This action underscores MASCO's strong financial position and our board's confidence in MASCO's future. We do not expect further share repurchases this year as we will use our free cash flow to repay the balance of the $500 million term loan that we took out in the second quarter. Turning to slide 11, let's review our outlook for 2022. Given moderating demand and additional foreign currency headwinds, We now expect our full year sales growth for MASCO to be in the range of 3% to 4% versus our prior guidance of 5% to 7%. We now anticipate full year operating margins to be approximately 16% given lower volumes and higher operational costs. While we continue to expect year-over-year margin expansion in the fourth quarter, it will be lower than previously anticipated. In our plumbing segment, We now expect 2022 sales growth to be in the range of 1% to 2%, including foreign currency, versus our previous guidance of 3% to 5%. Given current exchange rates, foreign currency is expected to unfavorably impact plumbing revenue by approximately 4%. We now anticipate the full-year plumbing margins will be approximately 16.5%. In our decorative architectural segment, We expect 2022 sales to grow in the range of 7% to 8% versus our previous guidance of 9% to 11% per spend. 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 the full-year decorative architectural margin to be approximately 17.5%. This is lower than our previous guidance due to lower than anticipated volumes and higher advertising spend. Finally, as Keith mentioned earlier, our updated 2022 EPS estimate is $3.70 to $3.80. 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'd like to open the call for Q&A. Operator?

Thank you. In order to ensure that everyone has a chance to participate, we would like to request that you limit yourselves to asking one question and one follow-up question during the Q&A session. To ask a question, please press star and the number one on your telephone keypad. To withdraw your question, please press star and two. Our first question for today comes from Michael Reholt from JP Morgan. Michael, your line is now open.

Thanks. Good morning, everyone. Appreciate it. Wanted to focus for a moment on not just, you know, the changing demand backdrop, but how you're looking at your own inventory levels as well as inventory levels in the channel. And, you know, how much to the extent that you're able to get a sense, how much of the change in demand trends that you're expecting in the fourth quarter are being driven by any types of channel inventory, destocking relative to, you know, consumer trends, you know, and market demand trends. And, you know, how you think of that perhaps persisting into the first quarter of the year.

Thanks, Mike. This is Keith. I'll take that one. We did see moderating demand, POS, in the quarter a bit more than we expected. It was fairly broad-based, I would say, across categories in terms of incoming orders and POS, which we think is most important. Most categories saw this decline across channels. So broadly speaking, we did see moderating POS demand on the customer side across channels and categories. We do expect volumes to be down in both segments for Q4, understanding that decorative had a 15% comp and Q4 propane I think was like 50% comp. So we do expect volumes to be down in the fourth quarter across both those segments. In spite of this, we do have backlogs in some of our business, wellness in particular. And we did, as John and I both mentioned, we had another solid quarter of propane growth. In terms of your question with regards to inventory and inventories in the channels, I would say that inventories are in pretty decent shape. I wouldn't say that they're overstocked or excessive. Some destocking is occurring across categories and channels, for sure. But there's always movement in inventory levels, particularly in changing macroeconomic environments and changing markets like we have. Evens out usually around the end of the quarter. We do see some stock destocking that happens around quarter end that we've talked about in the past. So we are not really expecting inventory destocking to be a material impact for us as we think about Q4. we would say is an in-market demand-driven.

Yeah, Mike, maybe a little bit of additional color to give you. I'd say that destocking will probably be mostly in the non-paint categories. Paint we manage very closely with the Home Depot. And then with respect to our inventories, as I mentioned, here in the third quarter, our inventories were a little bit higher than we would like, but I think their teams are very focused on this and doing a good job of trying to match our inventories with demand. And so, as I also referenced in my prepared remarks, we do think we'll get our working capital as a percent of sales down at year end to probably more normalized levels at like 16.5% or so.

Great. No, thank you for that. I guess, secondly, maybe just shifting to raw materials, if you could just kind of give us a sense of where you were, I think, on a consolidated basis. If you have by segment, that's obviously also very helpful in terms of price cost and what the raw material headwinds were during the quarter itself. And looking into 2023, given more recent movements in the various inputs, how should we think about raw materials in terms of where the prices stand today, if you think that that could turn into a tailwind.

Okay, Mike. I'll try to get a couple questions in. Let me try to break that down and give you a sense. In terms of price-cost, you know, I'd say across the enterprise, we have price-cost favorable across the enterprise as well as in, you know, breaking it down into segments, both segments. TAB, You know, as we think about raw materials going forward, we have seen some moderation in raw material prices, particularly. TAB, On the pain side of the business, you know copper and zinc have come off their highs from earlier in the year, but I remind everyone that takes a couple quarters for that that benefit to flow through and hit our p&l and so. TAB, You know i'd say that we probably aren't experiencing as much of the price cost favorability as we would have anticipated in the third quarter, given some of the moderating volumes. that Keith just talked about. You know, as we think about the go-forward period, we would expect, you know, and it's always hard to foreshadow, but we would expect, you know, more favorability in price costs as we go into Q4. And just given our pricing actions that we put in place, kind of some of them were mid-year, and quite honestly, Hansgrohe is going out with price at the beginning of the year, as they typically do.

um that there'll be some favorable price costs as we go into uh 2023. so i think that covers um most of the questions you asked mike but if i missed something let me know hey john this is keith let me if i can just uh uh insert here just a minute you you referenced some uh commodities that have come down in pain i think you meant uh uh plumbing yeah when you reference conferencing that's obvious segment

Yeah, no, that was great and appreciate that clarification. I think the only element of, and I apologize, I guess my multi-part question was just on a net basis for 2023, given where commodity prices are currently, if you would expect raw materials to be a net tailwind on the whole for next year.

Yeah, we're not really getting in deep into 23 here. We'll talk about that. next quarter, Mike, but certainly our expectation would be that we'd see some commodity relief, and it's flowing through our P&L a little slower than we had anticipated because of some of the volume pullback. I would say we expect that to be a tailwind in 23.

Thanks so much.

Our next question comes from Adam Bomegarten from Zellman. Please go ahead. Your line is now open.

Hey, thanks for taking my questions. Good morning. Just maybe on paint, just given the week DIY activity that you're seeing, are you seeing or expecting, I should say, an increase in promotional activity going forward?

When we think about promotional activity in general, I would say that it's It's been more muted than in the past, I think, given where the volumes were. We have increased our advertising and plan to continue to do that. In terms of promotions overall in the industry, I suspect that we'll see a little bit of an uptick in that. remains to be seen. Our preference, obviously, is to compete on brand service and innovation and continue to drive that. That's worked well for us. And I think if we do see increased promotions, it will be more spot promotions, if you will, rather than what was traditional pre-pandemic, say, where they were more ingrained into the market, more consistent. And that's what we're currently seeing.

Got it. Thanks. And then Just on the cost actions you alluded to, any specific areas that you're targeting or maybe just some more color around what the plan is there and which areas of the business will be affected?

I think when you look at what happens in an environment where there's a quick volume reduction, there's a couple of things on the cost side that are impacted. Firstly, it's on the material side. The cost that we have seen that particularly in plumbing that have backed off a little bit from their highs, take a little bit longer to flow through our P&L because of the lower volumes. And that's the case for us. It's taken a little longer than expected, say a quarter or two to flow through because of that volume. So that's a piece of it. And that really comes with time as they roll through the P&L. It also drives absorption issues and variable overhead principally. And as we see where that will settle in, that's going to give us the ability to better dial in our shift patterns and balance our factory to drive productivity. And this is quite typical when you see rather rapid volume reductions, and we're working that. Inbound logistics, talking about specific in plumbing, that's been timely deliveries. can be challenging and drive productivity issues. Frankly, we expected to see a more rapid improvement in that. Things are improving, but not to the pace that we thought they would be. So we're continuing to work those down. So in terms of the operational costs that we're currently facing, that gives you a flavor of how we're attacking it. We expect to be through that by the end of Q1. In terms of a more protracted recession, if that is there, as John mentioned in his calls, we have an experienced management team that have been through times like this and our focus frankly is to come out of a recession stronger than when we went into it and we were able to demonstrate that in oh wait no nine and we're going to demonstrate that again here but the usual suspects in terms of levers we have around variable costs that we would look to in terms of either delaying spend or cutting back and marketing and advertising travel entertainment those sorts of things And then, of course, there's always fixed cost levers that we could look into. Now, given where our capacity utilization is across our own supply chain, our own factory network, et cetera, and the high-level demand, I don't anticipate that would involve any sorts of reconfiguration of our manufacturing footprint just because of the demand and our expectation for growth. But that gives you a few of the levers, both short-term and mid-term.

Great. Thanks, Keith. Appreciate it.

Our next question comes from John Lavallo from UBS. Please go ahead. Your line is now open.

Good morning, guys, and thank you for taking my questions. The first one is on the implied 4Q plumbing margin. It seems to be implied in sort of the low to mid-teens versus, I think, expectations of closer to 20%. It doesn't seem like the sales decline explains this. So just curious if you can give us some more color on what's going on there.

Yeah. So, John, maybe I'll start and maybe Keith can chime in on part of this. So if you look at our 4Q plumbing guide for profit, I agree on margins, it does imply some pull down from where we were previously guided. I think there's really two components to it. is the volume drop that you talked about, and then the second piece would be the operational costs that we alluded to in our prepared remarks. Some of that relates to continued higher than expected freight and material, but then also some of the production inefficiencies with the changing volume levels that Keith mentioned. With that, I'll turn it over to you to give a little bit more color on that portion of it.

Sure. I would say the biggest piece is the volume. We have the FX there that we talked about and the lower volumes that does a couple things that give us challenges with regards to cost. I've talked about this a little bit in my last response. One is the longer time for the lower material cost that we expected to hit our P&L. Secondly is the absorption issue. That's a factor. Uh, John mentioned the elevated freight, uh, and in some cases in labor costs. So that was, that's an area that we expected to see more relief in coming into Q4 than we have. Uh, so that's, that's the second challenge. And then thirdly, operational inefficiencies principally in our plumbing area driven by, um, inbound logistics and the reliability and timely of those deliveries that gives us labor efficiencies. and challenges in the shop floors. That hasn't improved as much as we expected it to. Now, it is improving, and we continue to take actions to drive that improvement at a faster rate. But as we look at that improvement, and paradoxically, while the lower volumes does give us absorption issues, it does give our supply chain some relief. So we're getting after this, and the improvements are coming, but they won't be totally behind us until Q1. So that frames up some of the margin challenges and why. While we'll be a little bit better in margin, it's not as good as we had previously guided to.

Okay, thanks for that. And then the second question is the SG&A leverage was surprising given the sort of flattish top line. What kind of costs do you guys take now and how sustainable is that before it begins to impact the business?

Well, I think we're going to end up, this is not a run rate that we'll stay at. We're starting to filter back in SG&A. We've put in more advertising in our paint business. And we're committed to continue to invest in brand service and innovation because that fundamentally is what will make us as strong as we can be coming out of these sorts of pullbacks or recessions, however you want to think about it. So we're very careful in terms of how we look at SG&A. It is a dial that we have that we can turn, that we can either delay some growth spend or delay, as I mentioned, advertising, travel, entertainment, participation in shows, those sorts of things. But we're very careful with it. We're focused on the long-term exiting of this pullback so that we're stronger than we went in, as I mentioned.

Yeah, John, I really add to Keith's comments. That's right. I mean, as we start looking forward to 2023, You know, I think we're going to be very focused on SG&A just, you know, and trying to match that, you know, our investment in SG&A up with what we're seeing from demand in the marketplace. And so to Keith's point, it's a lever that we can pull. We're on top of it. We're watching this very closely. You're right. Yeah, we did enjoy some better SG&A leverage here in Q3, and it's something that's got our complete focus as we move forward.

Thank you, guys.

Thank you. Our next question comes from Matthew Boley from Barclays. Please go ahead. Your line is now open.

Morning, everyone. Thanks for taking the questions. I wanted to ask about the decorative margins and the guide for Q4. It seems like there's an expectation there for relatively significant, I guess, decremental margin. And Keith, you're alluding to everything around the challenges with a rapid reduction in volumes, and perhaps that's a big piece of it. But so just kind of looking at that decremental volume assumption in Q4, you know, just to number one, confirm if that's what it is, if that really is what's driving that Q4 guide, and then kind of what's the right way to think about the volume decrementals, you know, longer term, you know, on the assumption that we do continue to see kind of weakness in consumer demand. Thank you.

There's a couple items I'd point you to, and then, John, maybe if you want to add some color to it. Clearly, the volume moderation is a big piece of it. There's no question about it. And then, secondly, I'd remind you, when we talk about how we typically perform in price as it relates to commodities, we generally hold our margin dollars, but when you do that, that results in margin percent pressure, just by way of example, something like a 10% increase to recover only commodity costs results in almost a 200 basis point reduction in margin. So those two, the interaction of price versus commodities and the volume reduction of the principal drivers.

Yeah, that's right. I think those are the two components. I think the third principal component of the margin degradation in EQ4, Matthew, would be the investment that we referenced in marketing and advertising in the segment. It's perhaps more elevated than we would have experienced a year ago. And so, you know, if you take the volume drop, you know, the cost recovery nature of the inflation and the marketing spend, the advertising spend that we referenced, those would be the three big components that would cause the margin degradation that you see. That said, you know, I expect that that investment in marketing and advertising will be largely contained to Q4. And it wouldn't say that that's going to be something that we'd bake in longer term.

Got it. That's very helpful. Thanks for that, guys. And then second, just kind of shifting to the international business, I guess with Hans Grohe, it sounds like I believe you said at the top that Europe is slowing, whereas you've got some of the other geographies where we're actually a bit more supportive I'm just curious if you can expand on that a little bit. What are your expectations for how European demand evolves in that business, and to what degree can those other geographies continue to offset that? Thanks, guys.

We delivered a nice quarter internationally in local currency, up 5%, as we mentioned, so very pleased with that. Largely driven by Hans Grohe's growth in China, as well as several other markets. Hansgrohe has done an outstanding job of positioning that brand and driving it to market leadership in terms of the premium brand in China. We continue to grow there and expect that to continue. European markets are starting to moderate. Modest slowdown in incoming orders. Sales overall in Q3 in Europe I'd say were roughly flat. The broad exposure that we have across many countries that have different economies than Europe is helpful, and that diversification of our risk there is very helpful. I'm glad to have it. So it's clearly seeing a pullback in Europe. But as I said, China and Middle East is doing well for us. As I mentioned in my prepared remarks, we're seeing good growth in India. So I think that diversification as well, more broadly speaking, Our diversification across price points, our diversification across channels, and of course our geographic diversification, both U.S. versus international and then within that international bucket are all helpful for us and why we feel that we are positioned very well to make it through these moderating times.

Yeah, Matthew, maybe a little bit of additional color to frame this up for you. Recall that international sales are approximately 20% of our overall sales. And in that, Europe represents about two-thirds of that international sales, and the rest of the world represents about a third. So what Keith has just talked about and what we've referenced, so the two-thirds is roughly flat. The one-third of the business is growing nicely. So I just want to make sure everyone's got that in context, because a lot of people think our international business is solely Europe, and it's much more diversified than that. due to the good work that the Hansgrohe team has done over the years to expand their sales base across the globe.

Great. Thanks, John. Thanks, Keith.

Our next question comes from Susan McClary from Goldman Sachs. Please go ahead, Susan. Your line is now open. Thank you.

Good morning, everyone. My first question is dialing in a bit on the consumer. Are you seeing any pushback on pricing from them? And is that in any way impacting some of the moderation and volumes that you're seeing? And how are you thinking about the consumer and their willingness to spend overall?

Well, I think the overall inflation, I think, is really starting to have an effect on the consumer, not just in our products, but in everything from energy to food to you name it. So I think that's all part of it. Having said that, we're seeing good order rates moderating a little bit in our spa business. We are starting to come down to chip away at our backlog. I think that our backlog now is in that 10-12 week range. So that's down and we're working that down. But we're also seeing some good order patterns. We are not seeing, Susan, a material shift down. I mean, oftentimes in times like this in my career, I've seen, for example, maybe a little bit of a shift towards private label, but we really haven't seen that at this point. So we do expect, I expect that overall inflation will ultimately have an impact on the consumer and their spending habits. But where we sit right now, I think the consumer is holding up well. They have a good amount of home equity. Unemployment is obviously in a very good spot. So there's a mixed bag out there as it relates to that combination of inflation and how the consumer feels. But we're not seeing a mixed down, and we're seeing in some parts of our business still strong order rates.

Okay. And then turning to the balance sheet, can you talk a little bit about the ability to work down the working capital, how you're thinking about that as perhaps a source of funds in the upcoming quarters, and then any thoughts in general around capital allocation? You talked about paying down that term loan in the fourth quarter, but how are you thinking about leverage and buybacks and all the different opportunities in general?

Yeah, sure, Susan. In terms of you know, how we're thinking about working capital. You know, if you think about the seasonality of the business, generally the way the business operates is the first call at five, six months of the year, where a cash consumer, just given the seasonal bill, typically that takes place in an inventory for the summer selling season, the spring selling season and the like, and then right around mid year, we turn into a cat, you know, much more of a cash generation as, as working capital comes in. And typically you see this greatest source of cash generation in the fourth quarter, Bill Meyers, WPE Co-Chair, There's both inventories and receivables kind of bleed down just through the seasonal natural seasonal slow down that we, the business enjoys and then obviously right on the first year, then it begins to flip back and so Bill Meyers, WPE Co-Chair, You know, I don't expect any changes to that seasonality. Bill Meyers, WPE Co-Chair, Over the course of the coming months and quarters in terms of focus in the business on this, you know, absolutely the businesses are focused on it as part of our variable compensation scheme, what working capital generation is. And so, you know, I would tell you the teams across the enterprise are very much focused on doing the right thing and driving working capital lower for the business. At the same time, you know, I would tell you, given my longer term experience with the business, in softer economic environments, working capital generally is a source of cash generation. if volumes were to decline. Depending on how the economy rolls out over the course of the coming quarters, I would anticipate that to be a benefit for the organization. Now, flipping to your second part of your question about broader capital allocation, I don't think our views on capital allocation have changed dramatically. Keith articulated our capital allocation strategy, and I'll just repeat it for everyone's benefit. You know, one first and foremost is to invest in the business because that is our highest return investment, you know, either growth capital and or maintenance capital with the business. And so, you know, those, you know, those are naturally done. And I'll remind everyone that's generally the light touch. It's about two, two and a half percent of sales. So not a significant draw upon our cash generation. The second piece is to maintain, you know, a strong balance sheet. You know, we've done so over the years and we've done a very diligent job of of making certain that we take advantage of the debt capital markets when there's attractive periods. We did so in 2021 very effectively. And earlier this year, we did the $500 million term loan to pull forward our share repurchase activity. And we have a very strong commitment to live within our means. And so we would anticipate continuing to pay down that term loan fully as we foreshadowed back in May and June when we took that on, that we would be very disciplined about how we approach it. And so I don't think that is going to change whatsoever. We are committed to the dividend because we think an organization of our size, our quality, should be paying a dividend. And the 30% payout ratio we think is the right level to pay out for our industry and our organization. And then lastly, because of the significant cash flow generation that we enjoy, you're able to redeploy the excess to either share repurchases and or M&A. And I would say that both of those activities will continue. We continue to look at what is the right or the best return that we get on that excess cash that we generate. And if we can find highly attractive cash bolt-on M&A targets for either our paint or our plumbing business, we would like to do that because we've got great franchises in both businesses, whether it's domestically with the Delta team or whether it's internationally with the Hansgrohe team or the Bayer team here. We would gladly invest behind them to continue to grow their business, and whether that's product line acquisition, channel access, geographic acquisition, we look at anything along those lines to support those businesses continue to grow. But to the extent we can't find those types of acquisitions, we're happy to redeploy our excess capital to the share repurchases. And so I think we've been a very effective stewards of our capital allocation program over the years, and I think we'll continue to do so. So Keith, I don't know if there's anything else you want to add?

All right. Maybe just some specific context on working capital. Businesses are focused on that, as John mentioned. It's part of our variable compensation scheme, and I would estimate that we'd finish the year in that 16.5% range.

Great. Thank you for all the color and good luck with everything.

Thank you.

Our next question comes from Mike Dahl from RBC Capital Market. Your line is now open. Please go ahead.

Hi. Thanks for taking my questions. Keith, my first question is just around the rate of change in what you're seeing in underlying market conditions because, you know, at least our sense, was that for a lot of the corridor things were probably okay but then looking at you know where you ended up in the corridor and now what the guidance implies it seems like things may have shifted pretty quickly at least like very late in the corridor so maybe can you speak to just you know the cadence and how quickly conditions changed as you've kind of gone through September and into October and also what does that really mean in terms of your visibility even into, you know, year end, let alone, you know, beginning of next year?

Yeah, I would say that the slowdown really became apparent, as you mentioned, in September, so it was late in the quarter. While it's early in October, I guess it's not so early in October now, we're three weeks into October. factored that what we're seeing into October into our guide. So our best view of where the year is going to finish out is obviously incorporated into the guide based on that. We've seen some softening in DIY paint demand that we've talked about to give you a little bit of context on that and the overall slowdown, if you will, has been, as I mentioned, pretty broad-based. It wasn't like there was one particular part of the country or one particular channel or one particular type of product, while I would say, obviously, that we're still continuing to do quite well in pro, and we're working through and have good demand in our SPA backlog. So it did happen late in the quarter, and I'd say it's been fairly consistent since then, and what we're seeing in October and is incorporated into our guide.

Got it. Okay, thanks. And my follow-up question, just specifically around this elevated spend in DEC-ARC, I guess what I'm wondering is, you know, was this kind of a preplanned spend and the impact that it's having is just larger because the volumes haven't come through as expected, or is this a newer program that, you know, where the spend is being put in place to effectively stem even greater declines versus, you know, what you're currently seeing? Just a little more elaboration on what exactly this is, why it's in place as volumes are falling more meaningfully would be helpful.

You know, as John mentioned, in terms of SG&A being something that we watch carefully and we make calls based on the most appropriate use of that. So I would say it's a little bit more accelerated than we have originally planned. If you watch any kind of sports TV, you've seen our ads for Bear Paint, for Dynasty specifically. It's a great product, and we think that when we look at that advertising spend versus the benefit that we get from that, and that is the right thing to do. So it's something that we look at and tweak as we see different demand characteristics and what we think would be the best bang for our buck in terms of what and how we advertise and how much. As John mentioned, I wouldn't model that into ongoing at the levels that we did in Q three here and plan to do in Q4 into the full year. And we'll talk more about 2023 next quarter and give you much more color on how we feel about our brand spend, et cetera, at that point.

Mike, the other point I might comment on, in addition to what Keith just said, is if you take a look at the spend year over year, it's up. So fourth quarter of last year was a relatively muted spend. And it's higher this year. And I think that's probably the more significant component of it is the year-over-year compare.

Okay. Thank you.

Our next question comes from Truman Patterson from Wolf Research. Please go ahead. Your line is now open.

Hey. Good morning, everyone, and thanks for taking my questions. First, I just wanted to touch on the plumbing and paint margin guides in the fourth quarter. You all have gone through a variety of items already for both segments, but I was wondering if there was also a component of pricing that was previously announced that either wasn't as robust or realized as you all had previously expected in either segment.

No. No, it's really the things that we've already talked about in terms of, you know, and principally across both segments, it's the reduced volume that obviously has issues in plumbing in terms of overhead absorption, but mainly the drop down on the incremental revenue from that volume. FX is a factor. We've had some operational issues that we're working through in plumbing that will be behind us by the end of Q1 that we've talked about. But price realization has been very solid for us.

Okay. And then just thinking your propane segment, the share gains over the past year, two years, I'm trying to understand if this is a bit more of a kind of general jack-of-all-trades type pro that you've gained or whether a decent portion of the success has been drawing in converting, you know, what we'll call traditional paint-dedicated pros into Home Depot. And then finally, embedded in the fourth quarter guidance, does that actually assume that pro paint volumes will decline year over year on that tough comp?

Yeah, I think it's probably a little bit of a decline when you talk volumes year over year because of that, but it'll be – modest decline in volumes. We've had good volume growth this quarter that we just finished and propane is performing very well for us. Let's call it mid-teens growth against I think our comp last year Q3 was like 45% and we continue to get data and we watch this very carefully in terms of stickiness of the share gain that We've got both with new customers, and to your point, it's a combination with the smaller painters or the more paint-focused professionals who are painting. We're getting some of that demand as well, and recent data on our net promoter score is very strong. So I feel very good about what the Bayer team has done in terms of what we committed to, which is to keep this... Share gain going and you know the experience they're particular in our research are referencing the experience with our product The kid the probe the programs that we have for pros and of course the partnership and how the Home Depot is servicing That that general segment so our confidence is reflected in the outlook and while yeah, there'll be a modest volume but when you look against the cop in terms of gallons and Um, we, we feel we are doing a very good job of maintaining the share as we committed to.

Yes. Remember, but the only thing I'd add is, you know, we're kind of in a period of some really tough comps on the pro side. We've got 45% in Q3, 50% in Q4, I think north of 50% in Q1. So, you know, we've, the bear team is just a terrific job at executing and taking this share. But, you know, as you, you know, you, you go up against these enormous comps, you know, it's, it's always tough to. to post even higher charts on top of that.

Okay. All right. Thank you all, and good luck in the coming quarter. Thank you.

Our next question comes from Phil Ning from Jefferies. Your line is now open. Please go ahead.

Hey, guys. Your 4Q guide, any color on the implied volume declines by segment and any early read on how we should think about 2023 by regions or businesses? Because it seems like, you know, the pro side of things and small is still holding up quite well. Any color would be helpful.

Yeah, in terms of, you know, volumes, Phil, you know, I'd say... overall um you know you know volumes you know you know as you think about volumes um for q4 you know i'd say um you know we talked about you know kind of low single digit volume declines in plumbing in q3 and say you know that um may be even more significant in q4 just given the way we're seeing things uh right now and then on the decorative architectural side um know the implied guide you know for q3 was that you know volumes on the diy side we're down um double digits and so if you take that into consideration with what keith just covered about a modest protocol you can kind of read through what the volume declines might be in q4 perhaps slow double digits in deck arcs okay and then for for next year is that like a good product you know Yeah, we're not given 2023 guidance just yet, but we'll give that out on our Q4 call.

Gotcha. And then your margins, which you've addressed here, a little light in the fourth quarter. And some of these issues, you're going to flush out by one Q. You know, rods have started to fall as well as ocean freight containers. Any color, when you start seeing that flow through more meaningfully and with some of the cost out programs, Is that enough to kind of offset potential volume declines where your margins could potentially hold next year?

You know, as we look at, you know, the volume decline filling, I remind everyone, as we think about our deck amount of volumes, they generally run in the 30% range enterprise-wide, maybe a little bit higher than that in the plumbing side, a little bit lower than that in the deck arc side. And so as you think about, you know, volume declines, that's going to have, you know, an impact on profitability. Phil Kleisler- That says, you know, to your point is we, as we get through some of these higher raw material costs that are as they start flowing through and hitting our PML that should be an offset will be a one for one offset probably Phil Kleisler- It's hard to tell at this point, but probably a little bit of margin had been there.

Phil Kleisler- Okay. Phil Kleisler- I'm sorry, Phil. Go ahead. that raw material benefit, you start seeing it more early 1Q, and I think, John, you mentioned the bigger drop-off, I think, was Deckard, and maybe Keith kind of corrected you, is it more plumbing? I just wanted to flesh out, you know, the potential impact and the timing of some of that stuff.

Phil, are you looking for the potential impact of tailwind from raw material prices flowing through our P&L and comparing that to potential headwinds of volume in 2023?

Keith, I appreciate your problem, and I can go to that level of detail, but I'm just trying to gauge, with RAS falling, when does that flow through? Is that an early 1Q event? And I think, John, you mentioned you're seeing a bigger drop-off potentially in pain. Was that really more in plumbing? I just want to flush that out in terms of potential outflip on RAS just for timing, and would the second consider a bigger benefit?

we should start to see a flow-through fill in Q1, and it's plumbing. Okay.

All right. Thanks a lot.

Our next question comes from Stephen Kim from Evercore ISI. Your line is now open. Please go ahead.

Yeah, thanks very much, guys. Appreciate all the color you provided so far. I was wondering if you could talk a little bit about whether you're seeing any meaningful mix impacts across the business, plumbing, paint, you know, international, U.S., that are worth calling out. And then, in addition, any plans to adjust staffing or capacity in light of what you've seen? And what would you be monitoring in order to, you know, make, you know, a move there in terms of, you know, capacity or staffing?

In terms of mixed impact, we haven't really seen one, or are we expecting one? When we look across, for example, in China, where we had such a strong performance in Hansgrohe, that's a premium brand, and that's where we stand there, and that continues to do well. We monitor that, but we really aren't seeing anything. Dynasty is doing very well for us, which is in the high end. Our showroom products in Delta are performing well, so no real impact. In terms of staffing, of course, we look to maintain our labor productivity numbers, and we focus our businesses on our decrementals in times like this. And staffing is a piece of it, and so that's capacity in the sense of a short-term capacity in terms of matching staffing. We match our inventories to our demand levels. As I mentioned earlier in the call, At this point where we expect our growth to be mid to long term, I wouldn't suspect that we'd be looking at any brick and mortar. We're carefully evaluating the timing of our capital and our expansion projects to make sure that we continue to drive strong return on invested capital, but our plan is to continue to go forward with those as well.

That's very helpful. And then just generally on a related note, you talked about the abruptness of the decline that came upon us all. And I guess my thought, my question is how you're thinking about if there's any implications for what the recovery may be. Do you think it's possible that the recovery could be similarly abrupt or is based on what you're seeing is your view that the recovery would be sort of typical or even perhaps more protracted? Just kind of curious as to whether you think there's any thing to be implied from the abruptness of the onset of the weakness.

Yeah, I think it's a little premature to prognosticate on the steepness of the recovery based on where we are at this point. I think when we look at the overall savings rate of the consumer, the health as it relates to the overall structure of our industry with the age of stock, with millennials coming into the repair and remodel and specifically into the DIY market. When you look at our coverage, we call it a 50-50 mix roughly in our overall enterprise between pro and DIY. The price point coverage is geographic. Certainly, I think we're positioned to fare better than most as it relates to coming out of this, and that's how we're driving the business.

Great. Appreciate it. Thanks very much, guys.

I'd like to thank everyone for joining us on the call this morning and for your continued interest in MASCO. This concludes today's call. Thank you.

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines.