馬斯科 (MAS) 2005 Q1 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Masco Corporation 2005 first quarter conference call. As a reminder, today's conference is being recorded and simultaneously webcast. If you have not received the press release and supplemental information, they are available on Masco's website at www.masco.com.

Statements in the following discussion may include certain forward-looking statements regarding Masco's future sales, earnings growth potential and other developments. Actual results may vary materially because of external factors, such as interest rate fluctuation, changes in consumer spending, and other factors over which management has no control. Additional information about Masco's products, markets, and conditions, which could affect future performance, is contained in the Company's filings with the Securities & Exchange Commission and is available on Masco's website at www.masco.com.

Masco undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. The financial and statistical data referred to in this call is included in the investor packet distributed prior to the conference call and posted on the Company's website at www.masco.com under the Investor Relations section.

In addition, we may refer in this call to non-GAAP financial measures as defined by the SEC's Regulation G. Accordingly, a reconciliation of the differences between such measures and most directly comparable financial measures calculated in accordance with GAAP is included in the investor package.

After a brief discussion by management, the call will be open for analyst questions. If we are unable to get your question during the call, please call the Masco Corporation Investor Relations office at (313)792-6646.

I would now like to turn the conference over to Mr. Richard Manoogian, Chairman and Chief Executive Officer of Masco. Mr. Manoogian, please go ahead.

Thank you, Erica. We reported our first quarter results this morning. Net sales from continuing operations for the first quarter of 2005 increased 6% to a first quarter record of $3 billion, compared with $2.8 billion for the first quarter of 2004.

While sales to the new construction market of installed products and services, assembled cabinets and windows, were particularly strong in the quarter, consumer purchases of paints and stains, plumbing and cabinets, were lower than expected. In total, we were disappointed with our sales and earnings for the quarter, as they came in less than we had expected at the beginning of the year.

We believe that higher energy costs and lower consumer confidence are having a negative impact on consumer spending for certain home improvement products, resulting in our total sales for the quarter being approximately 1 to 2% lower than we had originally thought. And with our high contribution margins, every 1% swing in sales impacts earnings by approximately $0.06 per share on an annual basis.

Total North American sales increased 6%. Since we've had no significant acquisitions during the quarter, virtually all of that 6% was organic growth. International sales increased 5%. In local currencies, International sales increased 1%.

The quarterly comparison for the entire Company was challenging since net sales from increasing -- from continuing operations increased a strong 19% in the first quarter of 2004, compared with 2003. Income from continuing operations for the quarter was 212 million compared with 241 million last year. Earnings from continuing operations were $0.48 per common share, above the Company's guidance of $0.44 to $0.47 per common share, and compared with $0.52 per common share for last year's first quarter.

Results for the first quarter, however, benefited from other income of $0.06 per common share, principally net gains from the sale of financial investments. Given our concern about the economic outlook and its possible impact on the financial markets, we accelerated the liquidation of a portion of our marketable securities portfolio, and thus, realized some gains in the first quarters that might otherwise have been spread throughout the balance of the year.

The first quarter also included tax benefits of $0.02 per common share related to the adjustment of estimated tax accruals, principally for actual tax results of International operations, which offset realized currency translation losses of $0.02 per common share. The first quarter of last year also benefited from other income, principally net gains from the sale of financial investments of $0.07 per common share and income related to the Behr litigation of $0.03 per common share.

The Company previously announced the planned disposition of several European businesses that are not core to our long-term growth strategy. First quarter 2004 results of discontinued operations included an after-tax charge of $0.16 per common share to reflect those businesses expected to be divested at a loss. During the first quarter of 2005, the Company completed the disposition process with the additional sale of two of these businesses, realizing an after-tax net gain of $0.04 per common share, included in discontinued operations. Total net proceeds for the dispositions completed in 2004 and 2005 aggregated $282 million.

As I mentioned earlier, the Company's 2005 first quarter results, seasonally the lowest of the year, were adversely affected by lower than expected consumer spending, impacting sales of certain of our products, product mix, and recent increases in commodity, energy, and freight costs, much of which have not yet been recovered due to the lag in implementing selling price increases to customers. The Company expects that these conditions will continue at least through the second quarter of 2005.

Gross margins for the first quarter were 28.3% compared with 30.3% last year. Operating profit margins as reported were 11.6% for the quarter, compared with 13.8% last year. Excluding income regarding the Behr litigation of 2 million and 21 million in 2005 and 2004 respectively, operating profit margins were 11.5 in the first quarter, compared with 13% in last year's first quarter.

Total SG&A expenses for the quarter as a percent of sales, including general corporate expense, were 16.8% compared with 17.3% in 2004 first quarter. Our general corporate expense was 1.5% of sales in the first quarter compared with 1.3% a year ago. Since we had no significant acquisitions in the quarter, our sales increases were mostly organic.

Our segment sales for the quarter were cabinets and related product sales increasing 8%, plumbing product sales increasing 3%, installation and other services sales increased 10%, decorative architectural product sales were flat, and other specialty product sales increased 7%. Total key retailer sales from continuing operations decreased 2% in the quarter compared with a strong 20% increase in the first quarter of 2004, compared with 2003.

We continue to expect, however, a significant increase in key retailer sales for the remainder of the year. And I should mention that that decline of 2% in key retailer sales in the first quarter were similar to the flat comparison of sales that we experienced in the fourth quarter of last year.

The Company's tax rate was 32.4% for the first quarter of 2005 compared with 36.3% for the comparable period last year. The lower tax rate was due to the adjustment of estimated tax accruals, principally for actual tax results of International operations. The Company estimates that its effective tax rate for the full year of 2005 should approximate 35%.

We continued to make improvements in working capital management. Accounts receivable days at the end of the first quarter improved to 51 days compared with 53 days a year ago. Inventory days were 50 days compared with 49 days a year ago. And accounts payable days at the first -- at the end of the first quarter improved to 37 days from 36 days a year ago, as we continue to negotiate more favorable supplier turns.

Working capital, defined as accounts receivables and inventories, less accounts payable, improved to 18% of the last 12 months of sales from 18.5% a year before. For the 12 months ended March 31, 2005, return on invested capital as reconciled improved to 12.7% compared with 11.6% a year ago. The Company continues to believe that we will achieve our 15% return on invested capital goal by the end of 2006, and 18% by 2010.

Our liquidity and balance sheet were strong at the end of the first quarter with cash and marketable securities in excess of $1 billion and $2 billion in unused bank lines. In the first quarter of 2005, the Company generated approximately $69 million of cash from the net disposition of financial investments, and $63 million of net cash from the disposition of two European businesses. Debt as a percent of total capital at the end of the first quarter was 46% compared with 47% a year ago.

The Company has continued its active share repurchase program and repurchased approximately 13 million common shares during the first quarter. Our Board of Directors recently authorized the repurchase of up to an additional 50 million shares of common stock, replacing our previous authorization. In April, we repurchased an additional 2 million common shares. At the end of April, we had approximately 45 million shares remaining under our share repurchase authorization.

During the first quarter, our Board of Directors also increased the quarterly dividend by 11% from $0.18 to $0.20 per common share, marking the 47th consecutive year in which dividends have been increased. The Company expects to return a minimum of $1 billion annually to shareholders on average over the next several years through share repurchases and dividends as part of our ongoing commitment to value creation. In 2004 and 2003, the Company returned 2.3 billion in aggregate to shareholders, and in the first quarter of 2005, the Company has already returned an additional $545 million to shareholders through share repurchases and dividends.

In terms of current outlook, the higher commodity costs experienced in late 2004 and early 2005 are having an adverse effect on our first-half results. As we previously disclosed, we expect first half operating margins to be below those of a year ago. The Company is continuing to implement additional price increases for a number of its products, and believes that by the second half of 2005, most of these commodity cost increases should be largely offset. We currently forecast that second half operating margins will be modestly ahead of last year's second half.

While we do not have final April results, we believe that April organic sales growth is running slightly ahead of our first quarter rate. And based on present trends, we expect at least mid-single digit organic growth for the entire second quarter.

Based on these current business trends that I discussed previously, the Company anticipates that second quarter 2005 earnings from continuing operations will be in a range of $0.58 to $0.62 per common share, compared with second quarter earnings of 2004 of $0.65 per common share, which included $0.04 of other income, principally net gains from sale of nonoperating assets.

If higher energy costs and recent trends indicating lower consumer confidence and the related slowing in the sales of certain consumer products continues, the Company believes that full-year results for 2005 may be nearer to the lower end of its previously provided earnings guidance range for continuing operations of $2.40 to $2.50 per common share.

Our current guidance is based on housing starts approximating 2004 levels in 2005, an upward revision from our previous forecast of a 5% decline. No additional share repurchases beyond the 13 million common shares repurchased in the first quarter of 2005, modest margin improvement in the second half of 2005, reflecting selling price increases offsetting higher commodity costs, and anticipated income from the sale of financial investments. The guidance also assumes no further significant commodity cost increases. Effectively, the upward revision in forecasted housing starts was more than offset by a reduction of 1 to 2% in total forecast corporate sales as a result of slower consumer spending.

As you know, our long-term goal is to average 6 to 8% average annual organic growth, double the growth rate of our industry and most of our peers. At the beginning of this year, we expected to be at the higher end of that range. Our new forecast for this year is that our organic growth will be closer to the lower end of that range. But again, still well above most of our peer group of companies.

Now I'd be happy to throw the meeting open to questions. And I'd like to add that Alan Barry, our President and Chief Operating Officer, and Tim Wadhams, our Chief Financial Officer are here with me to answer any of your questions. Operator, could you take any questions?

[OPERATOR INSTRUCTIONS] Our first question comes from Budd Bugatch with Raymond James.

Good morning, Dick. Good morning, Alan -- or afternoon.

Hi, Budd. Afternoon.

Question -- a couple of questions. One, you said that you thought key retailer sales would be up, and I don't remember whether you said significantly, but I think you did, in the second half of the year as the year progresses. Can you give us some comfort as to why you think that?

That's -- a couple of reasons, Budd. First of all, various programs that we have in place with those customers we think are going to result in some significant sales during the year. One of the main reasons is that the comparisons for us get much easier as the year progresses. My recollection is in the first quarter of last year, our key retailer sales were up over 20%. I believe they were up 19% in the second quarter of last year and up only 7% and basically flat in the fourth quarter. So given our current level of sales, we think that for the year as a whole, we will continue to show a significant increase in aggregate. It will be the first quarter, and to a lesser extent the second quarter, that will show the poorest comparisons.

Maybe you can drill down and kind of tell us where some of those gains will come from?

We expect those gains to be pretty much across the board. I think some of the key areas that we're looking for good growth would be paints and stains, which did not have a good quarter the first quarter or a good quarter of the fourth quarter of last year. But again, they had an outstanding performance in the year-ago quarter. So their comparisons will be significantly better than they are currently. And really, I think we'll get it pretty much across the board in most products for the balance of the year.

And plumbing products --?

That is assuming a slowdown in consumer spending. So we look for significant key retailer growth for the balance of the year even with the slowdown that I outlined previously.

Okay. Just let me go two quick areas, other areas. Plumbing did not look particularly good in the quarter, and a little disappointing to my numbers. Can you kind of give us some color as to where that might have happened and were there -- I think the competitor has got some sort of a rollout too in one of the major home centers.

Yes. Our plumbing segment sales were only up about 3% in the quarter. Our faucet sales, which you might be particularly interested in, were up significantly more than the 3%, and that average was brought down by other plumbing product sales being slow. And particularly European plumbing product sales being slow. That segment has a fair amount of European operations in it, which affects the operations, the overall results.

I would say that in aggregate, we feel that we have not lost any market share or SKUs throughout the Company. The one area that we might have had a slight decline in the quarter in market share would have been in faucets. But I should point out that a quarterly faucet market share number is not really a reliable number, because the timing of new product introductions, the rolling out of new products, the timing of price increases, all affect sales in any given quarter.

And in our case, we're going to be introducing a number of new faucet products at the Kitchen and Bath Show in Las Vegas in May. Some of our competitors rolled out their new products at the Home Builders Show early in the year, and we did have a competitor that was rolling out a lot of products into one of our major customer’s pipeline filling during the first quarter that distorted the results. So our results there were a little below the industry, but I think on the average for the year as a whole we'll do very well in terms of maintaining market share.

One last question. Can you follow up on -- give us maybe what significantly that faucet percentage was and can you remind us what percentage of the segment sales faucets might represent and at what rate that grew in the quarter?

We haven't broken those numbers out. But I can just say faucet sales were up quite a bit more than the 3%. The other thing I just might mention is that our margins did not look very good in the first quarter in that plumbing segment. And again, that's because of absorbing a lot of commodity cost increases, which will be offset to a large extent by price increases in the second quarter. But that lower margin number was comparable to what we had in the fourth quarter.

So even though we showed relatively low margins in several segments in the first quarter compared to a year ago, that really was just a continuation of the trend that we were experiencing in the fourth quarter, and we will expect to start seeing some of those margins improve, particularly in the second half.

Okay. Thank you. I'll cede to others. Thank you.

And we'll move next Margaret Whelan with UBS.

Hi, Richard. Hi, everyone. Can you give us a sense maybe by segment of your unit versus your sales growth, just so we can get an idea of the pricing power you're talking about?

Well, I think what we've said previously is that we would expect aggregate price increases in 2005 to be in the low-single digits. And I think that number's still a relatively good number. So, that would apply I think to the first quarter and probably to most of the year as a whole.

Across the board? It's not going to vary by product segment?

It clearly will vary by product segments. We have certain products such as the installation of insulation. And for home builders, there we've seen material cost increases aggregating 40% since the beginning of last year. So it's going to vary by different product categories, but we'd rather not break down our price increases by product categories for competitive and customer reasons.

Okay. I'm just trying to get a sense for how much of it is actually sticking, because your sales came in line with our expectation, but the margins were lighter, and we're just trying to get a sense for how that might change throughout the year?

Well, I think in the terms of -- and I'll ask Alan to add to this, but I think in terms of price increases that we've implemented and ones that we've discussed with customers that will be going out in the next few weeks or few months, we have not had a problem with any of those increases being maintained. Is that fair, Alan?

Once we’ve had a price increase in, it's pretty much stuck.

One thing I might mention to some of the listeners who may not know Masco as well, we do have a strong business with a number of larger customers, major home centers, as well as some of the major builders. And particularly with the home builders, they always ask us not to implement a price increase until they begin the construction of a new home that has not been sold so they can roll the price increase into their selling price. So due to those factors, it often takes us anywhere from three to six months or longer to really implement the price increases that we need to offset commodity cost increases.

And one of the negatives of having done such a good job in bringing our inventories down over recent years is that we have less raw materials, commodities, and component parts in our pipeline to absorb cost increases. So when we ran into a much larger than increases in the recent months, we've had that lag impact on our margins. But we do believe that most of that we will be able to pass on to customers in time.

Okay. And the second question I had is that -- two parts, really. Regarding your outlook today versus a month ago at your Investor Day, it does seem like you're more conservative and cautious on the economy overall.

Well, I think, Margaret, you may remember that probably for at least two quarters, if not longer, I've been saying that I think that there is a slowdown in consumer spending, and I had quantified it as somewhere around a 2 to 3% decline in overall consumer spending. But we hadn't seen an impact as much into our product areas and into some of our markets. So whether that's a delayed effect or whether the slowdown in consumer spending is accelerating, I can't tell you. But bottom line, we're running at about a 1 to 2% lower rate of sales overall, as much as 5% on the consumer product side, than we had expected as recently as three to six months ago.

Okay.

Or even a few months ago.

Okay. And the last question, you said in your prepared comments that you -- your average return to shareholders would be $1 billion. Do you find the stock very attractive here or attractive or what do you think the outlook will be, because it seems like you're halfway there already.

Well, the $1 billion return to shareholders I should mention is an average number. There may be times when market factors and other conditions can result in higher or lower. I think you could probably tell from the fact we repurchased 13 million shares in the first quarter and 2 million in April that with our share price even lower, we would see that, if anything, as a more attractive opportunity to repurchase shares. So we don't want to make a forecast of how much we might do in any given year, but I would say that we obviously consider current share prices very attractive from a share buyback standpoint.

Has the M&A opportunity backlog changed at all?

We continue to look at a lot of companies, but we have nothing in the pipeline in terms of acquisitions other than relatively small branch acquisitions or bolt-on acquisitions in our services business, some of our other businesses. So from a cash flow need, we continue even with the lower guidance of earnings, expect to generate about $1 billion of free cash flow before dividends this year. And we're doing some divestitures on top of that, we're liquidating our marketable securities portfolio on top of that.

So even with returning 500 million to shareholders in the first quarter, we ended the quarter with over $1 billion in cash and marketable securities. And we're getting close to the high point in our working capital needs in terms of the springtime. So I think all that tells you that we have plenty of resources to continue an aggressive buyback program.

Going forward.

Going forward.

Okay. Thanks very much.

And next we'll go to Michael Rehaut with J.P. Morgan.

Hi. Good afternoon.

Good afternoon.

A couple questions here. First, on the sales growth outlook, you had mentioned earlier that you expect the key retailer sales growth to accelerate due to easier comps. Considering that and also the fact that overall, I would think that your first quarter at 6% is just like key retailers, being influenced by the toughest comp of the year Company-wide, is there any reason not to think that, like your key retailer sales, your overall corporate sales growth should accelerate over the next couple of quarters?

You have to also factor in what housing might do during that time period, and we're assuming some leveling off or possibly modest slowing down of housing during the course of the year. But you are right. If we had had organic growth of a shade under 6% in the first quarter, I would expect that that number might be modestly higher than that for the balance of the year.

Okay. And if housing, more or less, stays where it is, given the easier comps, like you're already seeing in April, you would expect, as you said, that modest acceleration at minimum to continue?

Right. But we're trying to be conservative. Because we feel there is a slowdown in consumer spending and we want to try to allow for that and anticipate it in our projections.

Okay. Also, just to drill down here on the margins, with plumbing down about 260 bips year-over-year, is that part of the price increases that you're looking for in the second quarter? And where would you expect that to trend over the year, particularly as you get more savings from the outsourcing of components from China?

We -- we have mentioned in the past that our plumbing segment does include a number of European operations, and it does include a number of lower margin businesses in Europe. And also I should mention that as we increase some of our manufacturing in China, we're beginning to sell faucets in this country now in under the Peerless brand manufactured in China. And some of those products have lower margins than some of our other products. So all that tends to influence our total plumbing margins.

Having said that, the margins in the fourth quarter and first quarter of this year are below what we were running in the first half of last year, and I would expect that our margins will get back somewhere between current margins and our former margins of a year ago. But I can't tell you that we'll recover it all.

Okay.

One of the things that I should emphasize is that, as you know, we're putting greater focus on absolute improvement in profits, and as a result, as long as we generate higher return on invested capital, in some cases, like selling imported faucets, we might have lower operating margins but higher absolute profits and higher return on investments. So you may see our overall margins, once we get back up, trend a little bit lower over time as we see more opportunities to expand our profits at a faster rate, but perhaps at a lower margin.

Okay. One last question. On the installation margins, I noticed that the decline year-over-year actually narrowed from the fourth quarter to the first quarter. And I just wanted your comments if the price increases that you've been implementing or continue to implement continue to get -- stay on track in terms of your outlook to, perhaps, reach by the second quarter or third quarter flat year-over-year type comparison.

Yes. With the price increases that we have in motion in that sector of our business, again, I think that we'll continue working that during the second quarter. And as we said before, we expect the second half to see some margin improvement in that, assuming that we aren't faced with any more cost increases than we've already had. And at this point, we're not aware of any and don't anticipate any additional cost increases.

I think on our last call, we mentioned that we had -- we had gone and made some good progress offsetting the cost increases we had early in 2004, but we were surprised by some additional cost increases we experienced in insulation, in our install product categories, and in our paints and stain ingredients categories, and those are the additional costs that we have to roll out price increases in the first half of this year to offset.

Since then, we haven't seen significant additional cost increases. And I could be wrong, but my expectation is that I think we'll see some leveling off in overall commodity cost increases, maybe even an improvement later in the year. We're not factoring any improvement in our forecast. But at least in recent months we haven't seen any escalation of costs.

Great. And one last question here, and then I'll get off. Any comments on sell-through at the retail channel? Would you say that they were comparable to the sell-in, and particularly, I'm thinking about the key retailers here, the large home centers.

Based on whatever information we have and some retailers share that information with us and some do not, we don't think there's any build up of inventory if that's really the concern you have in the trade channels. We think we're in pretty good shape from a trade channel inventory standpoint.

Great. Thanks a lot.

Next we'll move to Stephen Kim with Smith Barney.

Thanks very much. I was wondering if we could circle back to the sales numbers again, not to beat a dead horse here, but I was wondering if we might not be making a little bit too much of the easing comps in the back half of the year in light of the fact that, you're right, definitely the key retailer comps diminished significantly from first quarter to fourth quarter last year. But the year before that it was the exact opposite trend, where they strengthened dramatically up until the fourth quarter.

So I guess what I'm saying is, on a year-over-year basis your comps get easier, but sort of on a blended two-year basis they don't really seem to be getting that much easier. Is there something other than just the way the technicals work, that you're planning on or seeing that you can talk about more specifically, maybe in paints, perhaps.

Well, you almost have to go -- and you're absolutely right, you almost have to go product by product, and we did have very strong sales of paints and stains in the first and second quarter of last year. And we can make some fairly good projections on those working with customers on promotions and incentives and other basis, and we do think we'll have a nice increase in overall paint and stain sales for the year. But a difficult first quarter comparison.

So if you go through the analysis that we have, I think we're pretty comfortable that unless something changes dramatically in the economy, that we will show a significant pickup in key retailer sale comparisons for the balance of the year versus the first quarter, and to a lesser extent, the second quarter.

Okay. Obviously, you had your easiest one year-over-year comp in the fourth quarter. Are you sort of anticipating that you're going to see the fourth quarter sales improvement be sort of the lion's share of the back half or do you think it's going to be clearly visible in 3Q as well?

No. I think you'll see it in the third quarter, as well.

Okay. Great.

Seasonally -- seasonally, the second and third quarters are the key quarters for us in most of our product lines.

Right. Okay. Second question related to the corporate expense and the interest expense. I was wondering if you could maybe give some indication of where you think those numbers might go. Because they were a little different from what we expected here in this quarter.

Steve, did you mentioned interest expense?

I did. Interest and corporate.

In the interest expense I think it was 59 million for the quarter. There's a couple million dollars in there related to fees associated with the zero coupon exchange that we did. That would be nonrecurring. But we are a little bit higher than you might have expected primarily from the standpoint of less benefit from the swap we entered into a couple years ago in terms of the debt that does float related to that swap. So I would think the 57 net of the two that I mentioned, we would probably be around 225 to 228 in terms of interest for the entire year, assuming that rates stay relatively constant.

Okay.

Having said that, in the general corp. area, we were about, I think, 1.5 versus 1.3 last year. And you might remember the comment, we talked a little bit about that on the fourth quarter call, and that's about what we anticipated for the first quarter. We're up just a little bit, I think, just a couple million dollars in outside fees, most of which is related to the Sarbanes-Oxley-related costs that are slightly higher in our first quarter this year than they were last year. But that explains most of that change.

I had something slightly different in my notes for corporate. I had a slight decline from 4Q levels, which was much higher. It was running more like 2% of sales and like 60 million. So just so I'm clear on your outlook --

We are substantially down. I think the numbers was 60 million in the fourth quarter down to 40 -- what, 49?

Yes. I was surprised by how much you were down, actually, I thought it would have been less than that.

Well, we had mentioned last year in the second half that we had both in the third and fourth quarter some unusual timing, if you will, relative to some professional fees that were outside the Sarbanes-Oxley cost and that was the reason we ran up a little bit in the third and fourth quarter last year.

Our Sarbanes costs are still running pretty close to a year-ago levels and we expect that to continue and then begin perhaps tapering off modestly in the second half or late in the year.

Just so I'm clear, you're looking for about 1.5% of sales or whatever on corporate for the year, you think?

Yes. I'd say 1.4 to 1.5, Steve, as I remember from our fourth quarter conversation, but I think we should be in that category relative to sales.

Okay. Also in your release you said tax rate you expect for the full year somewhere around 35%, obviously you were a lot lower than that this quarter. Are you suggesting that you're going to be higher than 35% in the back half of the year?

Slightly higher than 35. But we should average 35 for the year.

Okay. So you meant that specifically. Great. I guess I had just one last question, and that relates to the commodity costs that you're experiencing outside of insulation. You certainly shared a lot with respect to that particular product. But can you talk a little bit more about what commodity cost inflation you're experiencing in other segments? Is there any particular one that really stands out that we should be focusing on in addition to inflation?

I think it's the ones that we’ve probably talked about before. Copper, which certainly has an impact on our plumbing group, we saw that increase in I think it was the major part of that increase in the second and third quarters of last year. Still working our way through that, but it hasn't gone up any higher. It kind of hit the $1.50 a pound range and has stayed in that general area. The TIO 2 and resins, we saw some increases there, last part of last year, as well as early this year. And again, we continue to work our way through that. But other than those major things, I think everything else is pretty well leveled off from the increases that we saw the first half of last year.

Okay. Thanks very much.

And now we'll take a question from Ivy Zelman with CSFB.

Wow. Good afternoon, I'm at the back of the bus. If you talk about your raw material costs, I think one of the surprises was your architectural margins overall not being down more. My first question is related to the contracts that you have today that might be reflective of lower raw material prices than might be coming your way and, therefore, that's why your costs were not higher in this quarter.

And also, in light of some retail price increases we've seen at Home Depot in the 5 to 6% range, why would we -- or are you getting those price increases or are they not reflective of your products and maybe just the overall segment margins or segment prices, but not your particular products.

I think, Ivy, the first question you had was on the services businesses.

No, no, no. Not on the services. I'm talking about raw materials related to the paint business with respect to contracts that are currently still -- you're benefiting from contracts that have lower raw material prices.

Oh, we -- that was true for part of 2004. Like a lot of companies, we had some contracts that were yearly contracts, so we benefited from arrangements that were made even in 2003, early 2004. And a number of those contracts ran out, particularly, as you say, on titanium dioxide, so that we then had to roll out a price increase to offset the expiration of those contracts. But I think what Alan was referring to is even after that we saw some additional cost increases, particularly on things that were petrochemical based, and some of those came in higher than we expected and that was what was having a negative impact on the first and second quarter of this year.

So the first quarter, the margin's down only a 100+ basis points reflects the benefit of getting price?

No. Which category are you talking about?

I'm still on paint. I'm still on paint.

Decorative architectural.

There are other products -- there are other products in that category. So -- and a lot of those would be hardware, brass-related, somebody -- by the way, somebody asked me about China earlier, and I forgot to answer that. We are continuing to increase our outsourcing to China. We exceeded 450 million last year and we'll be over 550 million this year. So that's 100 million pickup and we do save about 20, 30% on that pickup. So that offsets some of the cost increases that we've talked about. But their cost increases exceed that. So we picked up a number of things in pricing, but we haven't picked up some of the more recent cost increases.

So in terms of pricing on a go-forward basis, you still expect to realize further price increases within the paint segment.

Yes or some are just in the process of being rolled out now.

Okay. And just sort of looking at a big picture --?

I don't want to limit that to any single product category, Ivy, though I'd love to tell you that, but we have an understanding with customers for competitive and other reasons that we won't identify individual product categories in terms of pricing changes.

Okay. Richard, you made some comments that your housing forecast looks a little bit more bullish with the housing starts roughly flat compared to your previous guidance which was incorporating a 5% decline, correct, in 2005?

Right.

It feels like I'm a little bit confused because here you are telling us the consumer is slowing, and you're seeing that as a result in your key retailer sales and you're concerned about the consumer slowing, but yet housing remains gangbusters. So is it possible that your sales are not slowing at retail, but in fact, you're seeing just a deceleration from an above normalized growth rate or above a normalized growth rate? Because it's certainly a huge disconnect between the segments of your business that pertain to new construction, which obviously consumers are buying homes, as opposed to the key retailers?

Our initial forecast for the year included a down 5% housing starts. And as you may remember, every one 1% swing in housing starts changes our earnings by $0.02 a share up or down. So when we revised our guidance to flat housing starts, which I might mention is the most recent forecast made by the National Association of Home Builders, that should have added $0.10 a share to our earnings. On the other hand, every 1% swing in home improvement product sales, consumer sales, impacts our earnings by about $0.04 a share.

So basically, at the beginning of this year, we expected consumer product sales to be approximately low double digits, around 10, 11%. We're now saying that we think consumer sales this year are going to come in about 5% lower than we had projected at the beginning of the year. So the $0.10 gain in earnings from housing starts is more than offset by a $0.20 decline in consumer product sales and that's why we dropped $0.10 from the high end of our guidance of 2.50 down to 2.40.

Richard, I get the math. I'm not asking about the math. I'm asking why you're saying the consumer is slowing at retail, but yet the housing activity continues to be robust. Don't you see that as a disconnect? Oil prices are going up affecting consumers that they can't buy faucets or cabinets or paint, but they can afford a house.

You're a better judge of that, you would have to tell me why --.

Well, I'm curious what you think.

Well, why are housing starts staying so strong? I think the reason for that is, to a large extent, housing starts are driven by interest rates and the ability to get good favorable long-term financing, and those who can afford high -- other than starter homes, are still in the marketplace for homes. Perhaps that's in anticipation of rates getting worse later. But we haven't seen a slowdown in housing starts. And also, from a standpoint of affecting Masco, there's always a significant lag because the products that we make typically go in a home three to six months after the home is started. So now that we're in May, we can make a pretty good projection on our sales of products to new construction for the balance of the year, even if housing starts were to fall off later in the year.

So do you think, in respect to that comment, that starter homes you're starting to see weakness in housing starts?

No. What I’ve said is that I think higher energy prices tend to impact lower income people more than others, thus far in the cycle. And that's why we have seen it in things like paint. And I would say that if you're at the lower income, you're more apt to be in a starter home. And I would think if interest rates continue to go up, energy prices continue to stay high, that's bound to have more of an impact on lower-income home purchasers than higher-income home buyers.

Right. But your customer that buys Behr is not a low-income customer.

I think to a large extent they are.

You do. Okay. All right. One final question with respect to your comments. I just want to understand back to the insulation services in terms of realizing price. I think I wrote here in my notes that you said that builders ask you to not raise prices and wait until they've completed homes that have yet to have been sold.

No. They basically they ask us not to give them a price increase on a home that they've already sold at a fixed price. And as you know, many home builders now, because of the strong demand, often don't even start a home until they've sold it. So the stretch in lag period gets out to six to nine months in some cases.

Okay. Great. Thank you, Richard.

And we'll move next to Keith Hughes with Robinson Humphrey.

Yes. You mentioned acquisitions a little bit earlier. You've done a lot of work of divestitures and rationalizing some of the work you did in the '90s. Is there going to come a time soon when you think you'll be more active in the acquisition market? Or is that a far second in terms of use of capital to share repurchase.

I think what we've said in a number of instances that our strategy going forward is to build on the platforms we have in place, and we can see some bolt-on acquisitions, but they'll be relatively small in perspective to what we've done historically.

So there's no change in that strategy.

There's no change in that strategy.

Okay. And on your -- your discussion of your contracts with the home builders, particularly in insulation, if those prices do remain flat, will there still be a process of getting new pricing in over the next twelve months, can it be that long in order to implement that or would it be shorter?

I think it will be shorter. We've said before that we expect by the end of the second quarter that we should be pretty much caught up with our price increases.

Okay. Thank you.

Next we'll take a question from Timothy Jones with Wasserman & Associates.

Hi, Richard. Can you hear me?

Yes. Go ahead.

Okay. First question is, you brought your consumer sales down from 10 to 11% to 5 to 6%, correct?

That's right.

And what were consumer sales up last year?

Our organic -- I think it was up 10, 11% -- our organic growth, I believe Company-wide was low-double digits last year.

And what percentage of your total sales is the consumer -- would you consider the consumer --?

We're referring to the 60% of our business that's non-new construction. And in fairness, that also includes European operations. And I should mention that we've also seen a significant slowdown in Europe in the last month or two.

You know what? Germany and France have unemployment rates of 13 -- 12, 13% near the 1932 levels.

That's right. And it seems like things have gotten worse there in recent weeks.

I haven't seen it turn around for the last ten years. And one last thing. You said that the price of -- the two things that affect demand, incremental demand, introductions of new models for the faucets and price increases.

No. I was only referring to the faucet segment of our business, which is more affected by items such as that.

Yes. You said you were going to raise prices again in faucets soon and --?

No. I didn't say that. We've already implemented some selective price increases on faucets, and they're already in place.

So the introduction comes in in the next couple months.

Right.

Okay. Thank you very much.

We'll move next to Steve Fockens with Lehman Brothers.

Hey, guys, just a couple questions. Following up on an earlier one regarding retail demand, inventory that paint was perhaps hit by tough comps and you're showing faucet sales that were much stronger than overall segment, and in effect if that segment if you to even in the quarter lose a little share, it would seem to say that faucets overall as a category were quite strong. Is it really a demand issue --?

(multiple speakers) Faucets go to new construction as well.

Okay. So the strength in faucet sales in that segment was really on the new construction side?

I would say our faucet sales to new construction were probably stronger than they were to retail.

But if --?

We don't always have that information because in the case of faucets, we often sell faucets to wholesalers, and wholesalers may turn around and sell them either to new builders or to retailers. And we can't always track the end demand.

Fair enough. Fair enough. Let's put it this way. If you think what you saw in the first quarter was something of a softer retail demand or consumer demand issue, why would you feel comfortable with much stronger key retailer sales as the year goes on? Or is that purely a comps issue and it's being offset by softness in retail demand in other channels?

It's partly a comp issue. It's also a question of new product introductions, added programs we're working with on the retailers, a wide variety of programs.

Or put another way, if you think that retail demand is sort of soft now and maybe doesn't get markedly stronger, is it fair to say you expect your key retailer sales in the next three quarters to be above your overall Company sales expectations?

I would say probably closer in line with them.

Okay. Fair enough. One other question on pricing sticking. Have you had any customers that would say to you, okay, we'll pass it through for now, but that's the most we're going to take or no more of this. And are you seeing any evidence that end consumers, the actual person buying the stuff in the store, is unwilling to accept these price increases?

We haven't had any customers that have said they'll take this increase and no others. But with large customers, what you have to do is justify the increase. And we have to sit down with them and show them where the cost increases came from. And as long as they're legitimate cost increases that we're absorbing, we're finding more receptivity to passing those on to customers. To my knowledge, the increases, when they come out the retail end are not that large, and I don't think to -- we've seen any impact from price increases in terms of impacting end demand.

Now, there may be questions of people are doing less refinancing of mortgages, does that give them less spendable income, other factors that aren't directly tied to prices that may be affecting consumer spending. But the kinds of increases we've seen on the consumer side are relatively small and I don't think are having an impact from a pricing standpoint.

Does that mean basically the retailers are willing to accept -- they're eating the price increases you're passing on to them?

No. I think in most cases they're passing them on to consumers. What I'm saying is that a manufacturer can be absorbing substantial percentage increases in raw materials and commodities, but since those represent only a portion of the total cost --

Right. Okay. Okay.

-- it doesn't come out a big number on the other end.

Okay. Fair enough. Thanks.

We'll hear next from Shomo Sadukin with Brentwood Partners.

Yes. A couple of questions. The first one is in terms of the plumbing products business that you guys are in. Is any of the margin decline that you're seeing, is it purely due to cost increases on the commodities side or could there also be something else going on in terms of competitor introductions or foreign competition that's affecting profitability there?

I think I mentioned in my earlier comments that we are even introducing some imported products that have lower margins that we manufacture in China. So I think in the plumbing segment, we are more subject to global competition than probably any other segment that we have in the Company, and, therefore, there could be some gradual additional pressure on the margins coming from foreign competition.

Okay. The second question is, when I look at sort of your targets that are out there, long term for return on invested capital, you guys have a big slug of goodwill on your books. And that doesn't grow, obviously, as quickly as with your working capital and with your PP&E. So it seems to me that the return on invested capital targets that you have out there should be actually very easy to hit, even if you sort of don't produce stellar results, you should be able to get to the 15% next year and then the 18% down the road.

Am I right in that assessment, that these are sort of pretty easy targets and you're being conservative? Because it seems like if you just -- goodwill doesn't grow and you just sort of make the numbers going forward and don't do anything special, you miss the numbers and don't do that much special you make the 18%.

I might answer that and I'll ask Tim if he has any comments. But I don't think people in our organization would call it easy. They're working very hard to achieve those numbers. But I think what you might be getting to is that even if our margins were to decline or our sales were to go up a little slower than we've indicated, those would have relatively small impact on the total cash flow that we're generating, and, therefore, we think we can get to the numbers that we've outlined, whether the economy is up or down a few percentage points, and whether our margins are up or down 100 basis points won't be the swing factor in achieving those goals.

Yes. I think that's accurate. And I -- we set that 15% goal back in 2003, and it was a five-year goal at the time when we were around 10, 10.5% in terms of ROIC. So, we certainly didn't consider that a slam dunk. We did accelerate the goal. We look at it as a continuous improvement opportunity and one that we're clearly focused on. But, again, we're confident we can achieve those goals, but certainly don't look at them as slam dunks.

Okay. And the last thing is over time, you guys have been running with quite a bit of excess cash and also, there's that investment portfolio which is -- which you're liquidating as well on your balance sheet. And it’s just a lot of excess liquidity. Is that something that you would want to draw down in a sense to buy back shares? Because it doesn't seem to be -- at least maybe I'm not understanding correctly. But it doesn't seem from the outside that you have to keep $1 billion of cash on your balance sheet to run the business. You can run the business without that, especially with the strength of your free cash flow. So could you use that to buy back shares, would you be willing to use that to buy back shares?

You're right in that we had over 900 million of cash at the end of March. We had about 200 million of marketable securities, 150 to 200 million of marketable securities and we have about 400 million of other long-term financial assets. And what we've said is that our goal is to run down our marketable securities in a relatively short order. The longer term financial assets might take three, four, five years to totally liquidate. But the goal is to liquidate virtually all of those financial assets.

So when you add that to the cash we have and the cash flow we'll be generating, we actually could do even better than probably $1 billion a year and still maintain a pretty healthy balance sheet and cash position. What we've said is that it's nice to have that flexibility and that just allows us to be more aggressive in unforeseen circumstances if there are bad economic markets or financial markets we might actually accelerate the path and pace and use those resources more aggressively. So we think it just gives us a lot of flexibility.

So would you be willing to draw that cash down to -- bring the cash balance, let's say, to half of what it is or maybe even a couple hundred million dollars to buy back shares. Is that something -- if the price got low enough that you would consider.

What we said in some of our investor presentations is that in adverse circumstances, we would put those resources to use even faster.

Okay. Thank you, guys. Appreciate it.

And we'll take our next question from Keith Hughes with Robinson Humphrey.

My question's been answered, thank you.

Operator, I think we should probably bring it to an end. I know everybody wants to see what the Federal Reserve's going to be doing in a few minutes. I might just add that we are clearly disappointed with our first quarter results. We still think that we'll have a relatively good year even though less than we originally expected.

And I think one of the important things is to emphasize that we're continuing on the long-term value creation program that we've outlined in the last few years and particularly at our most recent investor meeting that we had a month ago. And in that program, we've said that we think we can average 6 to 8% organic growth annually, double those of the industry in our peer group, generate approximately at least $1 billion a year on average cash flow, and if we use that to buy back, put $1 billion back to shareholders through repurchases and dividends, we think the 6 to 8% plus the buyback -- plus the dividend should enable us to return 12 to 15% on average to shareholders regardless of what we might do in any given year. And we continue committed to that as a long-term program and we think that over time that should result in significant shareholder value creation. So I just want to emphasize that we continue to be committed to that program.

And thank you for taking the time to be with us today.

That does conclude today's conference. We thank you for your participation. Have a great day.