馬斯科 (MAS) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Masco Corporation 2005 third 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, it will be 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 the interest rate fluctuations, and 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 and 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 on 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 the 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 analysts' questions. If we are unable to get to your question during this call, please call the Masco Corporation Investor Relations office at 313-792-5500. I would now like to turn the call over to Mr. Richard Manoogian, Chairman and Chief Executive Officer of Masco. Mr. Manoogian, please go ahead, sir.

Thank you, Operator. We reported our third quarter results this morning. Net sales from continuing operations for the third quarter of 2005 increased 6% to a record 3.4 billion compared with 3.2 billion for the third quarter of 2004. Sales of assembled cabinets, installation services and windows in North America were particularly strong in the quarter. Total North American sales increased 7%. Since we have had no significant acquisitions during the past year, virtually all of that 7% was organic growth. Net sales in North America benefited from strong housing starts and certain selling price increases.

International sales increased 1% and also 1% in local currencies, reflecting weaker economic conditions in Europe, particularly in the United Kingdom.

Income from continuing operations for the quarter was $262 million and earnings were $0.61 per common share, compared with the Company's guidance of $0.60 to $0.64 per common share, and compared with $0.64 for last year's third quarter. Results for the third quarter of 2005 were reduced by $0.08 per common share net, reflecting impairment charges for certain financial investments, charges for a discontinued product line, and head count reductions related to the Company's Plumbing Product segment and currency transaction gains. Results for the third quarters of 2005 and 2004 benefited from other income of $0.04 per common share and $0.01 per common share, respectively, principally, net gains from financial investments.

Third quarter operating results were actually somewhat better than we expected at the beginning of the quarter. Excluding the $0.08 per common share of net charges, our earnings would have been $0.69 per common share. And if you exclude the gains from the sale of financial investments in both years, our earnings would have been $0.65 per common share compared to the street consensus of $0.62 and $0.63 per common share for the third quarter of last year.

While third quarter 2005 sales and earnings benefited from the strong new construction market and certain selling price increases, our third quarter results were adversely affected by recent additional increases in commodity, energy and freight costs and product mix. While retail demand continued strong for certain high ticket purchases, such as assembled cabinets, demand for certain lower ticket items such as architectural coatings, was softer.

Gross margins were 28.7% in the 2005 third quarter compared with 29.4% in the second quarter of 2005 and 31.2% last year. Operating profit margins as reported were 14% for the quarter, compared with 14.1% in the second quarter of 2005 and 15.5% last year. Margins in the third quarter of 2005 were adversely affected by increases in certain operating expenses, including increased commodity, energy and freight costs, and product mix.

Total SG&A expenses for the quarter as a percent of sales, including general corporate expense, were 14.8% compared with 15.8% a year ago. Our general corporate expense was 1.5% of sales in the third quarter, compared with 1.7% a year ago.

Segment sales for the quarter, as compared with the prior year, included Cabinets and Related Product sales increased 8%. Plumbing Product sales increased 4%. Installation and Other Services sales increased 9%. Decorative Architectural Product sales increased 5%, and Other Specialty Product sales decreased 1%. Other Specialty Products have a relatively higher proportion of European sales and the slowing economic conditions in Europe had a greater and negative impact on this segment than our other businesses.

Total key retailer sales from continuing operations increased 2% in the third quarter, compared with a 10% increase in the second quarter of 2005, a decrease of 2% in the first quarter of 2005, and a 6% increase in the third quarter of last year. The Company's tax rate was 34.5% for the third quarter, and the Company estimates that an effective tax rate for the full year of 2005 should approximate 35%.

Accounts receivable days at the end of the third quarter improved to 49 days compared with 51 days a year ago, inventory days were 47 days compared with 49 days a year ago, and account payable days were 36 days, compared with 38 days a year ago. Working capital, defined as accounts receivable and inventories less accounts payable, improved to 17.7% of the last 12 months of sales from 18.5% a year earlier. For the 12 months ended September 2005 and 2004, return on invested capital has reconciled with 13%. 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 continues strong at the end of the third quarter, with cash in excess of $1.5 billion and $2 billion in unused bank lines. In June of this year, to take advantage of lower interest rates, the Company issued $500 million of 10-year, fixed rate notes which added to our cash position. The Company intends to use a portion of our cash to retire $800 million of notes due in March of 2006. In the third quarter of 2005, the Company also generated an additional $56 million of cash from the sale of financial assets.

Debt as a percent of total capital at the end of the third quarter was 49% compared with 45% a year ago, partially reflecting the notes that we issued in anticipation of debt retirement in 2006.

The Company has continued its active share repurchase program and repurchased approximately 5 million common shares during the third quarter bringing our nine month total to 23 million common shares repurchased. At the end of September, we had approximately 37 million shares remaining under our share repurchase authorization. In October, the Company repurchased approximately 3 million additional common shares.

The Company continues to expect 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 the first nine months of 2005, the Company has already returned over $1billion to shareholders. In 2004 and 2003, the company returned 2.3 billion in aggregate to shareholders. The Company remains committed to our strategy of value creation and is focussed on the simplification of our business model, cashflow generation, improvement and return on invested capital and the return of cash to shareholders through share repurchases and dividends.

Consistent with this strategy, the Company is pursuing a variety of initiatives to offset cost increases and increase operating profit, including sourcing programs, the restructuring of certain businesses, including consolidations, manufacturing rationalization, head count reductions and other profit improvement programs. As previously disclosed, the Company believes that these initiatives, which began in early 2005, will reduce annual costs by $200 million by the end of 2007. While the Company will incur expenses and charges related to these programs, implementing these initiatives should improve the Company's earnings outlook for 2006 and beyond.

We are also continuing our program of balance sheet simplification. We generated cash of $173 million from the liquidation of financial investments during the first nine months of the year, reducing our total financial assets from approximately 710 million at the end of last year to 520 million at the end of September. In addition, all of our former acquisition share price guarantees have expired. Also, our contingent liability related to our five-year-old executive stock purchase program expired in July with no payments or obligations incurred by the Company.

We are continuing to reduce the number of our operating units through consolidations and divestitures. Two years ago, we had 67 operating units and by the end of this year, we expect that number to be reduced significantly to less than 40 operating units through consolidations and divestitures.

In recent weeks, we have experienced substantial additional commodity cost increases, particularly in our architectural coatings and installation services businesses, most of which are not expected to be offset by selling price increases until the first half of 2006. Because of these added costs, and based on current business trends, the Company anticipates that fourth quarter 2005 earnings from continuing operations will be in a range of $0.48 to $0.52 per common share. And I should add that the fourth quarter is seasonally one of the slowest quarters for the Company of the year.

The Company believes that higher energy costs and recent trends indicating lower consumer confidence and the related slowing in sales of certain retail products will continue. Given these factors, together with recent additional commodity cost increases, the company believes that full year 2005 earnings from continuing operations are expected to be in a range of $2.20 to $2.24 per common share compared with the Company's previous guidance of approximately $2.30 per common share. Our current guidance includes anticipated income from financial investments and excludes any additional costs associated with profit improvement programs and any other items. As far as current business trends are concerned, organic sales growth for October and we believe for the entire 4th quarter, will be in the mid single digits range.

While we are disappointed with our earnings in 2005, which are largely a result of the lag of implementing selling price increases to offset commodity cost increases incurred, we believe well be able to pass the majority of this year's cost increases during the first half of 2006. In addition, we remain committed to our long term value creation program, returning to shareholders $1 billion dollars annually on average through a combination of share repurchases and dividends, and growing sales organically on average 6 to 8% annually. This 6 to 8% growth, when combined with a 4 to 5% annual reduction in share count as a result of our positive high cashflow, and a 2% dividend yield, we believe will result in achieving our goal of double-digit average annual returns for shareholders over the next several years.

Now I'll be happy to open up the discussion for questions and comments. And joining me for the Q & A period are Alan Barry, our Chief Operating Officer, and Tim Wadhams, our Chief Financial Officer. Operator, we'd be happy to take any questions.

[OPERATOR INSTRUCTIONS] We go first to Ivy Zelman with Credit Suisse First Boston.

Good morning, everybody. Richard, thanks for the detail you provided. I guess one of the thoughts going forward on your expectation for recovering some of the cost increases, first question really relates to, are you embedding any further increases, I know, for example, in insulation, there's talk about more increases given the lack of capacity and running flat out. What are your expectations for '06 and realizing some of the major customers out there, key retailers, are actually getting even tougher out there on allowing these types of price increases, I guess the question is, what gives you the confidence you'll be able to recover them if that environment gets even more stringent?

Ivy, as you probably may remember, the last increase we had in insulation up until recently was in January of this year, and that cumulated in a compounded total increase of somewhere around 30%, as I recall. And as you can tell from our margins and our services group, we were beginning to recover those costs and actually had a margin increase in the second and third quarter of this year. We have been hit with a new increase in insulation of 9% effective in November, and that is reflected in our, on our guidance.

The other areas that we're really getting very high cost increases from, largely relate to refinery problems in the Louisiana and Gulf area. We've had a number of our suppliers in the past month or two declare force majure. We had one siding supplier to our services businesses overnight raise prices 15%,. We're seeing a lot of the ingredients and components of petrochemical based that go into architectural coatings being raised in the high single to low double digit rates so we have experienced in recent weeks and months, a very substantial increase in rates, cost commodity rates. We think we've reflected all of that in the guidance that we've given for the fourth quarter, and just personally, I would be surprised if we're not getting close to a peak in what we're seeing in terms of commodity cost increases, but I've been wrong on that up to now this year, so take that forecast for what you would like.

In terms of your second question, based on the relationships we have with all of our customers and based on our past experience, we believe that we will be able to pass on the majority of the cost increases that we have experienced to date through the supply -- through the customer chain, but it might take us one or two quarters of 2006 to implement all those increases.

And assuming right now as you look out in '06 obviously, you haven't provided us guidance on '06, but you are expecting the margins will rebound with recovering some of that price?

We're behind. Our margins this year are down about 150 basis points and you can attribute virtually all of that decline to these cost increases and the lag in implementing pricing. So if we see a leveling off of commodity costs, let alone a decrease, possible decrease in costs, and we're able to implement the price increases that I've outlined during the first half, I would certainly expect to see an improvement in our margins in the second half of 2006.

Okay. One more question related to your performance in plumbing. The overall margins were up an impressive 130 basis points. Looking at that, I assume that's due to the restructuring, and if that is correct, how much more improvement do you expect to realize in the fourth quarter and have you guys even contemplated getting rid of more further European businesses, divesting other European businesses?

You're right in that we did have an improvement in Plumbing Products. The data that we reported showed margins in Plumbing Products going down slightly from 13.1 to 12.8, but you're probably adding back in the charges that we took, which does come out of the plumbing segment, and when you add that back, margins went up to 14.3% compared to 13.1 in the second quarter and 13% a year ago, and I think that reflects partly a product mix. We had some strong sales of some of our higher end faucet products but also we have undertaken a number of cost reduction initiatives throughout our Plumbing Products group, and I think some of these benefits are beginning to show through in some of our numbers. Small thus far, but we're encouraged by the trends that we're seeing.

Okay. Thanks, Richard.

We go next to Margaret Whalen with UBS.

Good morning.

Good morning, Margaret.

Just in terms of the operating units getting it done closer to 40 -- dollar volume of sales. Have you given up this year in doing so?

Well, we do expect our operating units to be down to less than 40. My recollection in total, we've divested 8 companies, I believe.

Well, 13, if you go back to a couple years ago.

If you start with the 67, we've had 13 divestitures, and the rest would be a result of consolidation of existing businesses where we've eliminated independent companies and combined them with other businesses. We expect to continue doing that. We have a very aggressive program of looking at where else can we do consolidations, where else can we do divestitures of companies that just don't fit into our long term strategic goals, and that may include both Europe and in this country. But again, I think many of those will be relatively smaller business units.

I'm just trying to get a sense of the dollar volume of sales you would have lost in '05 versus '04 because -- divestitures were significant?

Margaret, this is Tim. Everything is reported on a continuing operation basis.

Okay.

So the discontinued ops data would include that information and I think there's a schedule in the package that shows the sales activity for those businesses. But you do have apples and apples comparing '05 and '04 in an extending operations basis.

That's what I wanted to clarify. And then in terms of the margins being flat sequentially, I guess you are benefiting from the cost cutting. Do you have a sense for how much of the changes you made are permanent now and what the margin improvement was because of those?

We have very active cost reduction programs already underway in virtually all of our business units and we probably have major cost reduction programs underway in maybe 20 or so of our business units. I think you're only beginning to see the benefits of many of those changes, and I think a great many of those benefits will really start flowing through in '06. In '05, even though in some cases we've had cost reductions, we've also incurred expenses in those operations as part of those consolidations and other actions, which have masked the benefits. So a lot of the benefits I think will show up next year. I should just add that small charges are -- I shouldn't say small charges, but the charges we did announce in the third quarter, the $12 million related to head count reductions in one operation, product discontinues in another, we expect those actions alone will result in about a $4 to $5 million savings in 2006, so we have a lot of other similar programs in the works and under plan, and we think it will be significant.

Okay. And the last question I have is on your insulation business. Recognizing the pricing went up again, and last quarter. Are you actually getting more supply volume from your vendors?

The allocation -- the insulation material, as we've talked in past calls, is still on allocation, and we continue to expect that situation tightness will ease up some time in the next quarter or two, but it's still on allocation, and, therefore, we're unable to enter into additional contracts which we think we can enter into with some of the large builders because we can't get enough material to fulfill those contracts.

The allocation has not changed?

It's still on allocation.

Okay. Thanks, we'll see you tomorrow.

Okay.

We go next to Budd Bugatch with Raymond James.

Hi, Richard. Hi, Tim. Hi, Alan. Good morning, I just have a couple questions. Key retailers you were up against had a bit of an easier comparison. I realize you had the volume pulled forward from this quarter into the previous quarter. Next quarter you're up against a 0% or a flat comparison on key retailer, how should we think about that going forward? What do you think the revenue gain could be in fourth quarter?

Well, you're right in that there was a little distortion in the second to third quarter. We had about 20 to 30 million of paint sales that happened in June that really were for a July 4th promotion. So key retailer sales in the third quarter, if you take that out, would have been closer to 4% versus the 2% we reported. I'd rather not make a forecast right now on key retailer sales for the fourth quarter, largely because our customers are very sensitive to our making any forecasts on prospective business.

You had said in the past that you had some programs that could certainly get you back into positive territory, is that still the case? Are those programs still in place and improving?

We have a number of programs in a lot of our different divisions but we are net positive with our key retailer sales in all the quarters other than the first quarter of this year. So I would expect that we expect to continue generating positive retail growth in the future quarters.

And higher than it was in the third?

I'd rather not make a forecast on that one.

Okay. When you look at the differential going from last year to this year in revenues, we've got the currency going the wrong way this quarter just modestly, and acquisitions are pretty much offsetting that. How would you separate the differential between units and pricing? What do you think you realized in price in the third quarter?

We've said before, and I think this is still true, that if you were to take the Company as a whole, I would estimate that pricing probably contributes low single digits to our sales increases for the third quarter and for most of the year to date.

Do you think that will go higher in the fourth quarter? Do you think as you get more and more of the grab of -- or take hold of the pricing that you've put in place?

I don't think that will change that much in the fourth quarter, because a lot of the pricing will have to implement reflecting these new increases won't happen until the first and second quarter of next year.

Okay. Do you have any feeling right now, Tim, as to where foreign exchange might be for the fourth quarter if rates don't change very much? Especially Europe, right?

Probably a negative impact, Budd, looking at it versus last year. I think last year the foreign exchange for the fourth quarter was around 125, maybe even slightly higher than that, maybe 126, 127, and obviously, right now we're running around 121 for the euro. So I would guess there will be a negative impact in the fourth quarter from a foreign currency standpoint.

This quarter was negative 4 million. Can you put a number on that --

Well, I think our sales over there in the fourth quarter, you know, you have a pretty good feel, roughly, we're doing about 2 billion plus, 2.2 billion. I'm going to guess it's going to be quite a bit higher than the 4 million in terms of that kind of delta.

Okay. And then my last area of questioning is on the profit improvement plans, you took a $12 million charge in plumbing, do we have a similar in the fourth quarter or is there -- do we look forward to that to be called out when you report fourth quarter?

We're actively looking at a lot of different programs and decisions. And -- none of that is in our guidance because we haven't made any final decisions related to any of those costs or programs, but I think we just want to give a head's up that there may be additional charges, but if there are, there will be costs related to them. On the other hand, we're also working on additional divestitures and it's possible if we have some of those, those may represent gains in the quarter too, so there's a lot of activity, and we just don't know yet, because a lot of those haven't matured. The reason we don't give more information on that, besides the fact that a lot of those are being implemented, we have a lot of questions involving plants, people, customers, product lines, so we would hope to give more information on that in a lot more detail probably when we announce our year end results. I think we'll give a lot more information as to what's underway and what the net cost savings of different programs might be.

The action you've taken so far in plumbing has no residual effect in the fourth quarter, you've already announced some things? Does that have any -- you have to account for that now on a more current basis than you used to be able to do. Does that have any residual or carry over effect?

Besides the charges that we've announced, we are incurring, just in the normal course of operations, additional costs related to implementing some of these programs. So some of that is offsetting some of the benefits we're already getting, but I think as time goes on, you'll see more of the benefits and less of the cost absorption.

Okay. All right. Thank you. Good luck on the quarter.

We go next to Dana Richardson with Argus Research.

Good morning, I was wondering you could clarify your comments about the adverse effect of product mix had. It sounded to me like you said your higher end stuff had more demand and your lower stuff was a little softer, so that would indicate that that would have been a positive effect, presumably?

You're right on that. As a matter of fact, in a number of our product lines, such as some faucets and in our cabinet businesses, we've seen a trend of people buying more features and higher price product than lower, so the product mix I was referring to really had to do within segments. As an example, we've often discussed that in our installation businesses, we are rapidly increasing our sales of non-insulation products. And those products have less profit margin to them than the installation of insulation. So as the mix of different products within a group changes, that might bring down our average margins for the segment. It doesn't mean we're seeing a trend down of people buying lesser products. The one exception that I would point out, we've said in the past, we are losing some market share in faucets to imported product which is lower price points. But as far as domestic manufactured product, we feel we're gaining, we're maintaining our market share in the domestic manufactured products.

Okay. That's very enlightening. I was also wondering why you didn't include the effective share repurchases in your guidance since you've already bought back 3 million shares in this quarter?

Normally we would exclude any impact of additional future share repurchases and guidance. The reason we didn't mention that is because you have to take a weighted average and as you get down to the last 2, 3 months of the year, any share repurchases you do in that time period would have a relatively small effect on 2005 because it only represents 10, 20% of your year, but would have a full impact on 2006.

Okay. Thank you very much.

We go next to Lorraine Maikis with Merrill Lynch.

Thank you, good morning. Can you quantify the impact of commodity prices on your margins in the quarter?

It's hard to give you an exact number. I think the best indication I can give, because we're talking about hundreds of product lines all around the world, and in scores of businesses, but I think that 150 basis point decline we had in margin, I would say you could assume that that is pretty much a number of what our commodity cost increases were in the quarter that were not offset with price increases.

Okay, and then just looking into 2006, I know the abatement of some of these commodity price increases will help your margins. Can you just talk about the impact of a slowing housing market and how you expect to offset that on the margin line?

We haven't seen a slowing in the housing industry, but assuming the industry were to decline 5 to 10% and some of us have been forecasting that for years and we've been wrong. What we said this year, and I think it would also be true next year, if the housing industry declined 5 to 10% next year, we would still expect our sales to the new construction market to increase because of market share gains, and because of the fact that we have significant additional business and we would expect to enter into significant new contracts with homebuilders to supply additional products and services, so we would look for our sales to grow unless there was a very dramatic decline in housing starts to that sector.

Okay. And then finally, could you just talk a little bit about the price increase process with some of your larger customers? In the past, when commodity prices have rebounded or come back down as we expect them to do in 2006, have they been a little bit harder on passing through your price increases from '05 or is that set in stone already?

I would love to have that experience to find out what it's like when commodity costs come down. But what we've said in the past is that with some of our retail customers, it's not unusual to take two to three quarters or a couple quarters, one to two quarters, to try to implement price increases, because you have to explain why they're permanent, then you have to work in increases to timing that, based on various catalogues, promotions and other factors that are already programmed. In the case of home builders, we've said that it's often two to three quarters to implement a price increase because the builders typically give us a price increase on a home we haven't sold already, where we can roll it into the selling price, and because demand has been so strong, they've sold a larger proportion of homes even before they begin construction. So the lag is widened out from historical levels.

Conversely, another point I should mention too is that I think we've done an excellent job in terms of working capital in the Company, and you can see from the data I gave you that we've reduced inventory down to 49 days. Well, the negative of that, we used to have 70, 80 days of inventory, the negative is, that gives us one or two months less of cushion when commodity costs are up to absorb it through existing inventory, so we feel the impact sooner. Now if commodity costs come down and I hope you're right that in '06 they might actually turn the other direction, then if anything, we would get the benefits sooner because again of the small inventories we have. And I would say that we should get the benefit of some of that commodity cost decline, but at some point, if it comes down and stays down, then I think our customers would also expect that they would get the benefit of that decline and price reductions.

Okay. Thank you.

We go next to Michael Rehaut with J.P. Morgan.

A couple questions, first on the key retailers, you mentioned you thought was impacted a couple a percent by paint. But still it's a pretty sharp falloff from the second quarter, and I was wondering if you could point to any other factors that might have driven that deceleration. For instance, any comment on inventories at some of the bigger home centers?

I don't think there's any issues related to inventories. I think you have to be careful putting too much weight on any one quarter swing in sales to home centers. I mentioned earlier we were down 2% in the first quarter, then up 10 in the second quarter and then up 2 in the third. Some of that just has to do with seasonality. Some of that has to do with timing of promotions. And also, I would point out that whenever our sales change with a retailer, when we had a 2% decline on the first quarter, we actually had very strong organic growth. All that meant was that sales were going through other channels, and perhaps we were selling more product through kitchen distributors and dealers than retailers. So it can vary quite a bit, and I'm not sure that it's necessarily a function of dramatic changes taking place.

Now, having said all of that, what we have been saying for a while now is that we do think higher energy prices related to gasoline and upcoming heating oil costs are taking money out of consumer's pockets, and particularly with lower income individuals who might be earning 30,40, $50,000 a year, the loss of 500, 1,000 or $2,000 is all after tax dollars and that means they have to cut spending somewhere. And we think in lower ticket items such as paint, we think we're feeling some effect from that, where people who have higher incomes and can afford to put in new kitchens are less impacted by the energy situation and probably haven't changed their spending habits. So you really have a dichotomy between high-priced point products and lower-priced point products.

Okay. Next question on the financial investments, you had some impairments this quarter and you've talked about starting -- you continued to pare down the -- on the balance sheet. Where would you expect that 520 at the end of the quarter to be by the end of the year or by end of '06?

Well, of the 520, only about $100 million now is marketable securities. So frankly -- and our goal is to reduce that to virtually zero over time. As that number shrinks from what it was a few years ago, the chances of additional write-offs in that category become less and less. And what we've said is that our goal is to take that entire 500 million and reduce it or eliminate it over a 2 to 3 to 4 year period. The several hundred million, 250 million, of equity funds we have, we don't control the timing of those disposals and some of the other investments that we have, we don't control the timing of those, but our goal is to materially reduce those over the next two to three years.

Okay. And lastly, you mentioned, given the expectation of the price increases, that you're planning to do, that you would hope to get a margin expansion the second half of '06. How should we think about the first half of '06? Would you continue to expect further margin contraction or maybe just more of a flatter type of performance?

I guess you'd have to tell me what happens to commodity costs during that time period, but I think it's just hard for us to forecast that in the next couple quarters, I would expect putting aside seasonal trends, that our margins probably will stay at the current levels roughly down 150 basis points from where they've been and then start recovering in the second half of '06.

When you say stay at the current levels, you mean on an absolute basis the levels that we're at right now?

Adjusted for seasonality. In other words, normally, our margins would be lower in the first and fourth quarters because of the lower sales volumes we have in those months and then you also have to watch out for the seasonality of certain products. We sell more paint in the second and third quarter than we do in the first and fourth, so excluding seasonal type factors, I would think that we probably will hold pretty close to present margins which are still down from where they were a year ago, and then start recovering sometime in the second quarter or second half of next year.

Okay. So then when you say seasonality you're referring to more of a down -- at least in the first quarter as well?

Yes. I don't remember our normal fourth quarter margins, but my recollection is fourth quarter margins are normally lower than third quarter on a seasonal basis.

All right. Okay. Thank you.

We go next to Larry Horan with Janney Montgomery Scott.

Your question -- for instance, you talked a lot about the low end consumer, et cetera, in terms of that weakness in that area, how are RTA cabinets doing?

RTA cabinets is probably one of the weakest product lines that we have. And by the way, I should mention that even with that slowdown in consumer spending, we're still seeing positive sales in terms of comparisons on our architectural coatings year-over-year. It's just the rate of growth is less than it has been. In the case of RTA, that's another area that gets impacted by lower income consumers, but we've also seen over the last year or two, a secular change in RTA where that business has just come down because of the improving quality and price points of assembled cabinets. The gap between RTA and assembled cabinets has shrunk where people have traded up from RTA to assembled cabinets. You raise a good point and one thing I should mention, if you take Europe and RTA out of our Cabinet sector, our assembled cabinets in North America were up well over low double-digits. So we had a very strong growth in assembled cabinets in North America. The other thing I should mention is the weakness I talked about in RTA cabinets is really in North America, where we've seen a significant decline. Our RTA business in Europe where the sector in total continues to grow, continues to grow very nicely in our European operations, so in that area we continue to show growth.

Okay. In paint sales, did you have any volume increases over a year ago?

Yes.

Okay. Thanks. That's all I have.

We go next to Keith Hughes with Suntrust Robinson Humphrey.

You mentioned earlier the push down in the number of operating units. Once you hit this goal of 40 or under over the next couple years, will you continue to pare that down even more?

Yes. 40 wasn't necessarily a goal. It was the point that we've gotten down to. We don't have a number in mind. What we're really looking at doing is just analyzing every company in the portfolio and seeing if there's a reason to keep them relative to their product line, and their performance, or if there's an opportunity to do any more consolidations.

So there will be more work done on this over the next couple years?

That's correct.

If you look at the number of units you have now, how many of them are on common systems platforms? Just rough guess is fine.

I don't know. We standardized around two systems about 2.5 years ago. And we have not forced any of our companies that were on other systems to make the change. But what we're doing is as a company is making a change, we're limiting what the options are going forward. We've just recently, in September, brought a new CIO on board and we're focusing now on narrowing that down hopefully to one operating system, but again that will take a period of time to get to.

Okay. Final question, you had mentioned earlier, market share in plumbing in relation to imported products, have you see a bigger impact there in the big box or in the wholesale channel?

The big impact would be primarily in the big box area.

Thank you.

The trade generally tends not to be as anxious to switch to imported products, so with plumbers and tradespeople, there's a strong demand for domestic product.

Thank you.

We go next to Stephen Kim with Citigroup.

Thanks. Richard, I know you had mentioned with respect to talking about the profitability initiatives, that you were a little reluctant to include in the fourth quarter guidance a provision or an allocation for that, because there was going to be some possible divestiture that obviously hasn't happened yet, and there may be some specifics related to plant closings and head count and so forth that you probably didn't want to get into. I guess I wanted to understand, though, is it in your mind if you accomplish what you want to accomplish in the fourth quarter with respect to those things, do you expect that those things might generally wash out together so that, you know, the net effect would be fairly minimal? Or is there some way that you can maybe avoid giving specifics but just give us a sort of a bottom line sense for what -- at least the costs might be, less, not including the divestitures?

Yes, Stephen, it wasn't really with the idea that one might wash the other out. All I've said is that there may be charges and expenses. There also may be gains related to divestitures and they may fall in different quarters. It's under accounting rules we haven't made final decisions in a number of these areas, and we can't expense or charge the decision until that decision is made. And as you probably know, there are also changes in accounting where even if you make some decisions, there are some expenses that you can't take as a charge, you have to just flow through expenses as you incur them. So when you're doing this in dozens of operations, it just becomes a very complex issue as to what is going to happen when, so we're not trying to dodge anything, it's just that there's a lot going on, and when we're able to provide more information, we certainly want to provide it.

Sure. I guess I'm just sensing that for many investors, one of the key issues is that they would love to see, a little greater clarity regarding some of the bottom line impacts from this productivity initiative, as it may flow out in the first half of '06, the back half of '06. Let me ask the question this way. As you look out over what you want to accomplish over the next 12 months, are there any things that you can point to that might enable you to run through these programs at a more accelerated rate than, perhaps you had earlier thought or thought about nine months ago? Or was there anything you've seen developing that would lead you to believe it would be a little more back end weighted meaning not until late '06 or '07 that you're actually going to be able to take some of these actions?

I think one of the things we've said in the last couple of calls is that since we've swung to a platform strategy, that platform strategy has been evolving more rapidly and better than we originally expected and, therefore, a number of these initiatives and we're creating new initiatives because of the platform strategies are happening sooner than expected so the fact that we expect these to happen sooner is only partially related to cost increase. A lot of it is because of the success we've had in the platforms, and in terms of when they might happen, I will answer this two ways. One, we consider this a never-ending process, not only what are we going to do the next year or two, but this is part of our culture going forward to keep looking for cost reductions. But related to the current programs, I think that you will see most of the charges and expenses sooner than later and then the benefits would start flowing through. We don't expect the majority of those actions to be in the latter part of the time period.

Okay. And I guess in particular what I'm trying to ascertain is when you think that the costs or the expenses versus the benefits might actually start reaching the break even point, where you actually might start retrieving a net benefit. Do you perceive that sometime in the first part of '06 too?

I would be very surprised if sometime in 2006 we don't have more of the expenses behind us and more of the benefits flowing through.

I just want to make sure that that was a direct answer to my question. I'm talking about that what you may expense in a given quarter might be equal to what you actually receive in benefits for that quarter.

I think -- maybe I'm -- I thought I was answering what you had asked. I think sometime in 2006 in quarters going forward, I would expect the benefits to outweigh the costs.

Okay. Good. Great. I appreciate that. Last question relates to Other Specialty. I remember you had talked about the European operation being a bit of a drag and I guess I was wondering, was there any particular product category that maybe felt also some pressure there? Maybe the fastenings business or something. I was wondering there was anything else in there that might stand out.

I referred in the case of the Other Specialty Products that we had particular softness in the UK. We have a window business in the UK, and a heating business in the continent. Those two were particularly weak in the third quarter of this year, and that -- they were down significant in terms of percentage declines over the year before. And that brought the group down in total.

Okay. Great, thanks very much.

We go next to Shaumo Sadhukhan with Basswood Partners.

Hi. My question is do you have any cost increases that you think you may not be able to pass through? You know, even with a six-month lag or longer lag?

Well, that's covering a lot of territory, but I think what we're saying is that we expect the majority of the cost increases we're incurring we will be able to pass through, and bottom line, we're seeing we expect to get back a good portion of the margin decline that we've experienced, but I can't tell you we'll get it all back.

Can you just talk about some of the areas in which you may not be able to pass through and explain why?

It really comes down to competition, negotiating with customers. Are the cost increases permanent in the eyes of the customer or not? So it covers a lot of areas and we're talking about some fairly substantial cost increases to try to pass through in a short period of time, so it's always more difficult to pass cost increases on than it is to try to achieve cost reductions within your own businesses.

Right. So I guess one of the questions that I sort of have is, the home building industry, you know, they're sort of -- if you listen to their conference calls or you talk to their management teams, one of the things they consistently say is, if housing were to fall off, then we would go back to our suppliers and try to sort of squeeze them to make up some of the margins that we would lose if housing starts went down. I'm wondering what you believe your ability to withstand that might be if there was a situation like that?

Well, frankly, housing -- home builders have been very aggressive on purchasing for the past year or two, and we've walked away from some significant product business just because our margins got down to where we weren't interested in that business. But the majority of our business now with homebuilders is through our Services group. And there we are providing such value in terms of solutions, logistics and other areas, soft dollars as well as hard dollars, where the savings are fairly significant to the home builder, and our competition in terms of any company being able to do that on a national scale is very limited. So I don't think that's really an issue in the products and services that we're providing in terms of the majority of those products and services with homebuilders.

Okay. Thanks, guys.

I believe we have time for one more question.

Our final question comes from Mark Koznarek with Midwest Research.

Good morning, gentlemen. In regards to cabinets and faucets, did you guys see a difference in sales between the home center channel and the dealer channel? I guess in essence was one stronger than the other?

In the third quarter?

Yes.

Alan, I think in the case of cabinets, we were pretty strong in all channels?

Cabinets was very strong in all channels. In the case of faucets, one of the problems in identification is, the new construction market, the way we go to market there are through wholesalers and we don't have a good handle, there isn't good information available on how much of that goes to the repair remodeling market and how much of that goes to the new construction market.

And as I -- There may even be some retailers who sell product to small home builders through retailers.

Okay. Can you review which segments have been and will be most impacted by the cost pressures that you've highlighted and then also which segments or categories should we expect to see price increases in the mass retail channel?

I would say in terms of the most recent serious increases we've seen in recent weeks, a lot of which are hurricane related, and that's really impacted the refineries, those components impact our architectural coatings business the most. And windows as well that have resin material related to them. The other one we mentioned was insulation which is an increase and that's a combination of natural gas prices being higher as well as energy costs being higher. And then I also mentioned copper going up, although the increase there is less than the first two.

So should we see paint price increases going through in the mass retail channel then shortly?

I don't want to comment about any individual price increases, but all I'm saying if we've seen a significant increase in paint costs.

Okay. You guys highlighted organic growth, 6 to 8% for the fourth quarter.

I didn't say the 4th quarter. We said that we averaged, we expect to continue averaging on an annual basis 6 to 8% in any given quarter, we may be higher than that number, we may be lower, and our present forecast for the fourth quarter was mid single digits.

Any color on how that's going to break out between the categories?

Between our segments? I would expect you won't see a lot of change from what we showed in the third quarter just directionally. In other words, we expect cabinets to continue strong, we expect windows to continue strong, we expect our service businesses to continue strong, and those might have a higher percent growth rate than some of our other categories.

And international probably weak.

And international on the other hand would continue to be weak, as well as the currency impact.

Okay. Thank you.

Okay. Thank you, operator, and we appreciate all of you taking the time to be with us, and we look forward to talking to you again in a few months. Thank you very much.

That concludes today's conference call. Thank you for your participation. You may now disconnect.