馬斯科 (MAS) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Masco Corporation 2006 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, 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 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 analyst questions. If we are unable to take your questions during this call, please call the Masco Corporation Investor Relations office at 313-792-5500.

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

Thank you, Melissa. This morning, Masco reported our third quarter results. Year-over-year net sales from continuing operations for the third quarter of 2006 increased 1% to 3.3 billion. North American sales decreased 1% and international sales increased 10%. In local currencies, international sales increased 5% compared with the third quarter of 2005. Our sales growth slowed from the first half of 2006 rate as a result of accelerating declines in housing activity and a moderation in consumer spending in North America.

Sales of builder installation services for non-insulation products in the third quarter were particularly strong with double digit increases. Sales of major faucet brands combined and architectural coatings were up mid single digits. Sales of assembled cabinets were up modestly. Sales of certain other products and services, particularly windows and doors and the installation of insulation, were negatively impacted by the slowdown in new construction and experienced mid single digit declines. Sales of ready-to-assemble cabinets continued their negative trend of recent quarters and declined double digits.

Income from continuing operations, excluding charges, was $236 million or $0.60 per common share compared with 290 million or $0.68 per common share for last year's third quarter. Income from continuing operations, including charges, was 225 million or $0.57 per common share. The Company's third quarter results were adversely affected by accelerating declines in housing activity, a moderation in consumer spending, and increased commodity costs partially offset by profit improvement programs and selling price increases.

In September, 2006, the Company completed the sale of Computerized Security Systems, CSS, which supplies electronic locksets, primarily to hospitality markets in the U.S. CSS had annual sales in 2005 of 73 million and was included in our Other Specialty Products segment. This disposition was completed as a result of our decision that this business unit was not core to the Company's long-term strategy. Total net proceeds from the sale were $91 million. The Company recognized a $51 million pretax net gain, which is included in discontinued operations on the disposition of CSS. This divestiture is consistent with our strategy of simplifying and refining our portfolio of companies. We have now reduced the number of our operating units through consolidations and divestitures from 67 in 2003 to 31 businesses currently.

Operating profit margins as reported were 12.1% for the quarter compared with 13.9% last year. The Company's operating margins were negatively affected by lower than anticipated sales volumes, increased commodity costs and a less favorable product mix.

Segment sales for the quarter as compared with the prior year included Cabinets and Related Product sales declined 4%, largely as a result of declining RTA sales, Plumbing Products sales increased 5%, Installation and Other Services sales increased 1%, Decorative Architectural Product sales increased 5%, and Other Specialty Product sales declined 6%, largely as a result of lower window sales.

Total key retailer sales from continuing operations were flat in the quarter compared to increases of 1% in the 2005 third quarter, 7% in the 2006 first quarter, and 1% in the 2006 second quarter. The Company believes that retail sales in the third quarter of 2006 were negatively impacted by softening consumer demand for larger ticket items.

For the 12 months ended September 30, 2006, and September 30, 2005, return on invested capital as reconciled was 12.9% and 13%, respectively. While the Company remains highly committed to the continued improvement in its return on invested capital, certain current business trends have resulted in a reduction in our anticipated earnings for 2006. As a result, the Company will not achieve its 15% ROIC goal by the end of this year, which we would have met if we had achieved our original forecasted earnings per share per common share for 2006. The Company, however, continues to believe that it will improve its ROIC in future years and that we will achieve our previously stated ROIC goal of 18% by 2010.

Our liquidity and balance sheet continues strong at the end of the third quarter with $870 million of cash and marketable securities and $2 billion in unused bank lines. Debt as a percent of total capitalization was 46% at September 30 and 49% a year ago.

In addition, earlier this month, the Company issued $1 billion of fixed rate, 6.125 notes, 6.125% notes, due 2016 resulting in net proceeds of $988 million. The notes offering was in anticipation of 2007 debt maturities.

The Company has continued its active share repurchase program, and we repurchased approximately 7 million common shares during the third quarter in addition to the 20 million shares repurchased in the first half of 2006. In October, we repurchased an additional 1 million common shares. At the end of this month, we have approximately 37 million shares remaining under our share repurchase authorization. The Company expects to continue to return a minimum of $1 billion annually to shareholders on average over the next several years through dividends and share repurchases as part of our ongoing commitment to value creation. The Company has returned 3.6 billion to shareholders over the last three calendar years including dividends and the repurchase of 97 million common shares. In the first 9 months of 2006, the Company has already returned over $1 billion to shareholders, including 263 million in the third quarter.

The Company's current results are being adversary affected by the recent accelerating declines in housing activity and a moderation in consumer spending as well as increased commodity costs, partially offset by profit improvement programs and selling price increases. The Company has implemented additional selling price increases in an effort to at least partially offset these commodity cost increases.

While we don't have final results for October, our October sales appear to be down approximately low single digits. New housing construction market, the new housing construction market has declined more rapidly than most people expected and we now estimate that new housing starts will decline by more than 20% during the last three months of 2006 compared with the previous year's period. We expect a continuing softening of incoming orders for building products and services based on a forecasted deeper than expected decline in year-over-year single family housing starts for November and December, resulting in the Company's fourth quarter net sales being down mid single digits compared with the fourth quarter of 2005.

Accordingly, full-year earnings from continuing operations, excluding costs and charges related to profit improvement programs, impairment charges, and any other items, may be closer to $2.20 per common share rather than the Company's most recent guidance of $2.25 to $2.30 per common share. Including costs and charges related to the Company's profit improvement program and impairment charges, earnings from continuing operations may be closer to $1.95 per common share for the full-year 2006.

While some economists believe that the housing market is stabilizing and the downturn is nearing the bottom, others are more pessimistic. Given economic trends in the housing market and excess inventories of unsold existing and new homes, we expect further declines in the rate of single family housing starts in coming months. We estimate that housing starts in 2007 will decline another 12% on top of the 2006 forecasted decline of at least 12%.

While the bottom in housing starts may not be realized until sometime in the first half of 2007, we still think the long-term fundamentals of the housing industry are sound. Masco remains cautiously optimistic that in late 2007 or even as late as 2008, the housing market will begin to rebound depending on when the current excessive inventories of new and existing homes reach more acceptable levels.

While the next few months may be difficult for Masco, the current slowdown is giving us an opportunity to accelerate our investment in future growth by upgrading our IT systems, rolling out new products and services more quickly. We believe that these investments will pay significant dividends once the current housing slowdown is behind us.

We remain committed to our strategy of value creation and are focussed on the simplification on our business model, cash flow generation, improvement on return and invested capital, and the return of cash to shareholders through dividends and share repurchases.

Consistent with this strategy, we will proactively manage the business for difficult economic times in our markets by pursuing a variety of initiatives to offset cost increases and improve operating profit. Initiatives already underway include sourcing programs, restructuring of certain businesses, including consolidations, manufacturing rationalization, head count reductions, and other profit improvement programs. The Company remains committed to its long-term strategy, concentrating on organic growth, cash flow generation, improving return on invested capital, and generating significant returns to shareholders. We continue to drive our growth initiatives, including leveraging installation services, developing new channels of distribution, developing new markets in emerging economies with greater emphasis on new product development.

In addition, as we finalize our budgets and plans for 2007, we are reviewing all capital expenditures, eliminating non-essential costs and developing our plan so that we are prepared if housing starts are down even more dramatically than currently anticipated.

Masco's strength is the cumulative result of our scale, service, distribution, installation, and brand differentiation. We continue to build on the strength of our leading consumer brands, including KraftMaid and Merillat cabinets, Delta, Peerless and Hansgrohe faucets, Behr paint, Milgard windows, and Arrow Fastener products, just to name a few. We believe that by the end of 2007, we will be an even stronger Company than we are today.

Now, I'll be happy to open the question -- the discussion for questions and comments. And joining me are Alan Barry, our President and Chief Operating Officer, and Tim Wadhams, our Chief Financial Officer. Operator, we'd be happy to take questions.

[OPERATOR INSTRUCTIONS] We'll go first to Budd Bugatch with Raymond James.

Good morning, Richard. Good morning, Tim. Good morning, Alan.

Good morning, Budd.

Morning. Looking at just the cabinet segment, I know you're facing the headwinds of the housing market. But cabinets look particularly serious when I look at it. I know RTA was down double digits and that's not a new phenomenon. And if you look the a the draw down of operating profit, either sequentially or year-over-year for a dollar of sales, it's particularly eye-popping. What's going on there? What do you think is the prognosis? Was assembled cabinets as you say, were they up sequentially as well or just year-over-year? A read on what's going on with the whole cabinet segment.

Yeah, Budd, our entire cabinet segment was down 4%. We talked for a number of quarters about the declining trend in the sales of RTA cabinets, both in this country and in Europe where we have a large RTA operation. If you exclude RTA sales, then our sales of cabinets, assembled cabinets, in this country would have been up modestly. That's a reflection of the fact that we have housing starts down in recent months, 20%, sales of higher ticket items such as cabinets slowing in home centers and when you factor all that in, I think a modest improvement in sales is not a bad number. We analyze our sales, we analyze our sales by market share with the top 20 builders in the country. We continue to gain market share and we think we're gaining market share in most of the channels that we're in. We're not pleased with a modest increase in cabinet sales, assembled sales in this country, but in the present environment, I think that's not that bad a result.

What about the profit performance?

Profit performance was down, margins were down in cabinets, and that was due to several factors. One was we experienced a very substantial increase in costs in particle board, particularly in Europe. Secondly, we have a $100 million expansion underway to build two new plants on the west coast. We're beginning to incur start-up costs in bringing those operations on to stream. So those were probably the main factors that impacted margins in the quarter.

What do we look like for RTA going forward? That trend has continued and looks like it's unabated. I don't think the Mill's Pride [inaudible]. That was done as a pooling if I remember right. And doesn't have a profit -- doesn't have a goodwill associated with it, or am I wrong on that? I know it was --

No, I think that's correct. So we do have our Mill's Pride operation, and we're in the process of coming out with new products for Mill's Pride. We're in the process of using some of those facilities to produce other products, but we've also now experienced a significant slowdown in RTA sales in Europe, and our Tvilum Scanbirk operation there is a fairly large operation. And again, I think those trends are because more and more consumers are upgrading, buying assembled cabinets rather than buying RTA cabinets. So the fact we're in that industry is a problem in terms of we are facing headwinds there.

Okay, and just last two questions. Assembled sequentially, were they up sequentially from second quarter to the third quarter as well as year-over-year modestly?

I don't have that in front of me, but you have to remember that there's seasonal trends that come into play there and I can't tell you offhand. I would just guess we probably were down modestly sequentially, but we can get that number for you if you'd like.

Okay. And last question, just remind me, RTA, is it still around, I thought it was around 20% of the cabinet sales?

We haven't -- we haven't put that number out, but it's a significant amount of sales.

Okay. All right. Thank you very much.

We'll go next to Michael Rehaut with JP Morgan.

Hi, thanks. Just a couple questions. First on, you'd mentioned, Richard, that you still think you gained some share in the assembled cabinet area. And if you just take a step back and to the extent that you can comment on Fortune Brands' results yesterday having high single digit growth in their faucet and cabinet business, you guys had declines of mid single digit in faucets. I'm sorry, mid-single digit growth in faucets and up modestly in cabinets. So, I mean, with that in perspective, do you believe that you're gaining share and if so, if you could provide a little bit more granular detail in terms of where that's occurring?

Yes. First of all, it's hard to compare us to any other particular company for several reasons. First of all, we have, in many cases, different product lines. We have RTA cabinets, a number of our other competitors don't have that. We have international operations. Some of our competitors don't have that. We -- we've also been capacity constrained in our cabinet business. So frankly we haven't been able to take on additional work and we know we lost some work during the course of 2006 as a result of that, which will be alleviated once our new plants come on stream probably in the first quarter of next year. Having said that, I would say that the two companies that are gaining market share in most of their markets are Fortune Brands and Masco. And the companies that are losing market share are many other companies including a number of private companies that you wouldn't be aware of who are losing market share. And we also have some other public companies that in their third quarter comments have talked about declining sales in some of these product categories. So I think both Fortune Brands and Masco continue to gain share at the expense of most other companies in the industry.

The one exception to that I've mentioned in previous calls, we do feel that in faucets we have lost some market share, particularly to low-end imported product from China, particularly in the home centers where they brought in their own house brands. And we have a very active expansion program underway in China. We -- we're in the process of expanding our capability. We now have some 2,000 employees in China as well as a lot of outsourcing. We'll have increased our outsourcing in China this year to about 650 million from 550 million. So all of that should enhance our competitive position even at the lower end.

The only other thing I'll just mention is that in the case of faucets, we exclude accessories in our faucet category. We pick those up in other segments and some of our competitors include accessories in their faucet segments. So, again, you're not comparing apples-to-apples when you compare the two.

Okay. I mean, I think they did kind of break out faucets without accessories.

Under the brand, they sell significant accessories, as well. I think that's included in that number.

They did break it out in the press release, just faucets, branded faucets. But that's okay, I appreciate the explanation. The other question on the cabinet capacity expansion that you're still planning to do over the next 12, 18 months, I was wondering if you could again walk us through the time line and also just kind of explain why you still feel comfortable doing that in the face of an overall slowdown and expectations for demand to go negative or sales to go negative over the next few quarters. Is it that you have -- you're just on this schedule be more costly to push it off or what's the reasoning behind that?

Well, several things. First of all, that was a decision that was made well over a year ago in a different business environment. Secondly, even if we had the capacity, we're incurring a lot of extra expenses and inefficiencies by producing product in the midwest and shipping it all the way to the west coast, which results not only in extra cost shortages, but also poor service to the customers. So we feel we needed that expansion on the retail side and on the new construction side. Now in hindsight, would we have delayed it 6 or 12 months if we had known today what we knew then. We might have, but when we analyze it, to delay that expansion would have cost as much as going ahead with it. And we are comfortable based on the trends we've had and the continued market share gains we expect in future years that we will need that capacity in the next year or two. And one of the things that we always try to do is keep ahead of our customers in terms of capacity and frankly, we fell down in 2005 and 2006 where demand was stronger than we expected and we disappointed some customers in terms of availability and delivery. So we want to make sure that doesn't happen in the future and while we may incur some short-term additional costs, we think within a year or two that capacity will be certainly needed.

So can you give us any numbers associated with that in terms of what the fill rates were in the midwest or -- actually I'm sorry, in the west, without these plants that you have scheduled coming on, and an idea what the extra costs are that you're incurring that may go away in '07 or in '08 as you get this online?

Well, I would tell you that there was significant additional business that we could have had in '05 and '06 if we had had the additional capacity. So we needed the capacity and we feel we will need it in the future, but you're right, we will incur some additional costs bringing that onstream, but I don't think that will be a major element in terms of our '07 results.

Yes, Mike, what we had said in the past is that we were incurring anywhere up to about 2 million a month in terms of additional freight related costs. You might recall that from previous conversations. And we also indicated that our delivery times had stretched out a little bit. One of the things that we do very well is fill very quickly, in terms of our builder cabinets particularly, and we did see some stretching out in terms of time, again, when things were very heated up in 2005.

Part of our job is to keep ahead of our customers. During 2006, we went from delivery times that we consider satisfactory of a few days to 5 or 6 weeks. And it's up to us to make sure that we stay ahead of our customers and we can't always anticipate short-term trends, but in the long run, we know we'll need that capacity.

Great. Thank you.

We'll go next to Margaret Whelan with UBS.

Good morning, it's actually Susan for Margaret.

Yes. Hi, Susan.

Wanted to focus a little bit on your corporate expense line. It's up about 100% over the last few years. Can you just let us know when we can expect this to come down and maybe what the trends we should be looking for there are?

Yes, I think you're probably referring to SG&A. Our general corporate expense has been relatively flat, if not coming down a little bit. But SG&A did go up about 100 basis points in the quarter, and I would say that was more timing than anything else. If you look at our 9 months SG&A numbers, it's not that far off from the previous year. And we do have stock incentive programs that we implement. This year, those programs, because of timing of board meetings and other factors, happened in the third quarter. Last year as I recall, they happened in the second quarter. And in the material that we've provided, we are now expensing $100 million a year of stock based compensation, and that is up 25 million just from last year so all of that is coming out of the earnings that we report and a significant portion of that flows through SG&A.

I think, Susan, you might be looking at the general corporate expense. That runs about 50 million, I think a quarter, approximately. And what's happened there are two things. Richard mentioned stock based compensation, which has increased and is part of that category. The other thing that's in there when you go back to prior periods, prior to 2004, we've had significant increase in compliance related costs. 2004 costs for Sarbanes-Oxley compliance were up, I believe, 35 million over 2003, and that approximate dollar amount has continued in '05 and '06. We were down a little bit in '05, I think maybe 6 or 7 million, as I recall. But those are the two primary reasons why that has gone from about 1% of sales to about 1.5 or 1.6% of sales.

If you can politic your local representatives in Congress to change the Sarbanes-Oxley laws, you'll see that number come down.

Okay. So we should basically be expecting it to stay around that $200 million level?

Yes. I would expect at this point that that's probably a reasonably good run rate based on what we know today.

Okay. Thank you.

We'll go next to Kenneth Zener with Merrill Lynch.

Good morning.

Morning.

Richard, your comments on housing recovering as late as 2008 is a very sober outlook. Can you describe why you think your business, the margins, wouldn't decline worse than they did in 2001 when housing was flat? That's one of the real issues that I struggle with with your Company.

Let me just amplify our analysis of the housing market, and this is just our view on it. Obviously, there are a lot of other people who have different perspectives. As you probably know, the inventories that have been reported of unsold, new homes are reported at about 550,000 units. A normal number would probably be 300 to 350,000 units. But that number, which indicates an excess there of about 250,000 units, that number, however, does not include cancellations. So if somebody cancels a new home order and that home goes back to the home builder, that's not picked up in that number, which is, as you know, a significant number. On top of that, existing home inventories of unsold homes has gone up by 1 million units in the past year to about 3.1 million units. A portion of those are new homes that were bought by speculators who now are trying to sell them and never moved into those homes. So when you add all that together, we come up with an excess -- an excess of 300,000 to 400,000 or more homes, new homes, that we think are still out there that have to be sold and we think that housing starts have to decline enough to absorb that 300,000, 400,000 or more units. And to do that, I would not be surprised if in some month in the next few months, we don't see 1.5 million, 1.6 million housing units in an individual month, because that's a lot of inventory to absorb. That affects us because with incremental margins, any business we lose or don't get results in about a 35% loss of contribution margin which obviously has an impact on our profit margins. I would say that any decline we have in profit margins is due to increasing costs on the commodity side, not because of any price reductions that we're giving to customers. We obviously are asked by customers to help them on pricing. We sit down and work with them and if we can come up with something where they benefit and we benefit as well, through additional volume, additional markets, we'll work with customers, but thus far, any change you've seen in our margins have really been driven by commodity costs and loss of volume, not due to any pricing reductions that we're doing because of economic conditions.

Okay. So if we haven't had the slowdown in the volume, meaning absorption yet, why wouldn't that kind of pick up? For instance, in windows, that's the one category where new construction declines have already been impacted given its early stage use in the house. Why won't that be flowing over into cabinets and plumbing in the next, call it, 3 to 5 months?

Well, I'm not saying that if the volumes come in lower because of even lower housing starts, that doesn't affect profit margins. You could do your own calculation as to what you think housing will decline, translate that into product sales for us, take a 35% contribution margin and you probably would come up with somewhat lower margins as a result.

Thank you very much.

We'll go next to Nishu Sood with Deutsche Bank.

Thanks, good morning.

Morning.

I wanted to ask about the non-insulation part of the Installation Services, which I think you said was up double digits in terms of sales. Now I just wanted to understand a little bit better what's driving that. Is that the traditional categories you've been in like cabinets or fireplaces? Or is that -- ?

That really includes about 20 different product lines, including cabinets, fireplaces, gutters, windows, many other product categories. And the reason that's growing so rapidly is that in the case of insulation, we are already the largest national producer or installer of insulation in the housing industry. So given our large market share, additional market share gains there are more difficult. And what we've said is that in the average home that we work in and we now have some 17,000 individuals working in new construction installation,9 ,000 trucks on the road, 350 branches and service centers, so we have a major capability that we're rolling out additional products nationally. We're averaging in the homes we do work in, and we have a team of Masco people now in over half of all the homes built in this country, we're averaging about $3,000 per home. If you start going down the list of the volume, dollar volume added of these additional products, I left painting out, for instance, in that list I gave you initially. We are now rolling out a painting capability nationally, and because of the slowdown, we're accelerating that rollout because we have the availability of people to do that with. If we just paint a home, that's an incremental $4,000 on top of the 3,000 we're currently averaging. So we think there's a very large upside growth opportunity in non-insulation products a and we see that growing double digits as far out as we can see in a normal housing environment, and the fact we're up double digits in a very bad housing environment in the third quarter gives you some indication of the growth potential there.

Are we seeing some effects due to the fact the insulation is earlier cycle in terms of the construction cycle and perhaps the other products are later cycle?

Well, there's a certain amount of that. It depends. It varies really by product line to product line. Windows would come in early, some other products would come in early. Insulation might be more in the middle, Alan, would you say?

Before middle, but it's --

So a little before the middle. Cabinets would come in later. So clearly some product lines feel the impact a little later than others. But I would just point out that we've seen a fairly significant housing decline now for four or five months, it isn't just the last month or two. But you're right that there may be some additional impact from that. But we think that our opportunity there is still very significant on the upside and is more a function of our rolling out and training people and getting the skill sets into our various branches and entering into additional national contracts with big builders. We've also talked that we've been limited in our past growth by a shortage of insulation. We've been on allocation, and insulation is still on allocation, but we are now beginning to get all the material we want and need. And as a result of that, we would expect to enter into additional national contracts with some of the top 20 home builders that would get us not only insulation business, but some of the other diversified products that you're mentioning.

Okay, and just switching gears to the cabinet side. Assembled cabinets which you said were up slightly, can you just break that down for us a little bit more? How was that in the new construction channel versus the remodeling channel?

We haven't broken that out, but I would say if you take the cabinet industry generally, you probably have 60, 65% would be replacement remodeling and maybe 35, 40% new construction. Alan, would that be a ballpark?

Probably pretty close.

I could be off a few percent, but it would be somewhere in that range.

Okay. So --

I should qualify that. When you have strong housing markets, maybe the percentage goes up some from that number and in weak markets, it might come down some from that market.

No, I was asking more in in terms of your performance. I would imagine that if it was up slightly overall that the new construction channel for you was probably weaker than the remodeling channel.

Well, actually we gained market share in the new construction market. But we can't always give you a precise number on that because we also sell to kitchen dealers and sometimes those dealers will install in new construction. Sometimes they'll do home repair and remodeling work. So it's hard for us to have a precise number on that.

Okay. Thanks a lot.

We'll go next to Keith Hughes with Suntrust.

Thank you. You talked early in the call about some more pricing action being taken. Can you tell me specifically what segments and how's that going to fare in what seems like a worsening environment for volume?

We continue to experience a lot of commodity cost increase. We've talked in the past that in 2005, we had $250 million of unrecovered cost increases, not offset by price increases. And as we entered 2006, we had an additional 200 million, so that was an aggregate of 400 million cost increases coming into this year that we had not offset with price increases. We undertook an aggressive price increasing program in the first half of this year, during the first six months, and we've, during that time period implemented about $350 million of price increases. That would have been spread out throughout the first six months. So that still left 100 million of unrecovered costs. Now since the first of the year, we've seen copper prices go up 50%. Zinc prices just hit an all-time high last week. They're up 120% since the beginning of this year. Particle board has gone up significantly. So on top of all of those cost increases, we've probably experienced on an annual basis, another 150, maybe 200 million, of cost increases in new commodity cost pressure. Those were offsetting with additional, at least partially offsetting, with additional cost increases we're rolling out in the second half of this year and some of those price increases don't even take effect until early 2007. So one reason why you've seen our margins under pressure is really a combination of sales volume being less than expected as well as a new wave of material increases that we've been absorbing in the last few quarters that are beginning to impact margins. Until we have offsetting pricing increases.

Now, given that we're in a weakening environment, how is that going to be received by your wholesale distributors and home centers and building customers?

I would say that the 350 million I mentioned to you already has been implemented and most of the other increases that we're working on, we expect to get those into effect. Because remember, even with those increases, we're still not recovering all of our cost increases. Now, the one thing that would be very helpful to us in 2007 is if commodity cost increases back off. And I've been forecasting that now for a while and I've been totally wrong on that so you've got to take any forecast I give with a grain of salt, but I would just be surprised with car production dropping, truck production will be dropping in '07, with housing starts dropping, all of those industries are major users of copper, zinc, brass, steel. It's just hard to imagine that that shouldn't take the heat out of the acceleration of commodity costs and not result in a decline in commodity costs. But I've been wrong so far, so you can take that, that forecast for what it's worth.

Final question. Some of your competitors in the installed services business have had to take some goodwill writeoffs on some businesses that have been acquired. Do you anticipate anything like that near term?

Well, we as a matter of practice always look at all of our businesses in the fourth quarter from the standpoint of goodwill impairment. But that's unrelated to any economic trends that are happening out there. We view that on a long-term cash flow basis. I would just mention, though, now that you bring it up, that we have said that we're not going to be doing any major acquisitions. But on the other hand, we are looking at a number of bolt-on opportunities for us in existing platforms and businesses. And in this economic environment, I would be surprised if in our installation businesses we don't have some acquisition bolt-on opportunities that may be attractive to us that normally wouldn't be attractive to us. So I think you might see some pick-up there rather than slowdown.

All right. Thank you.

We'll go next to Stephen Kim with Citigroup.

Thanks. Can you hear me?

Steve, we can barely hear you.

Hello?

Yes, that's better.

Hi, sorry about that. My first question related to the faucet margins and seasonality that you might be experiencing there. Typically, the faucet margins look like they decline a little bit, excluding all sort of extraneous charges and so forth as you go from 3Q to 4Q, I was just wondering whether or not if you could talk about excluding the factors of any restructuring charges, what you would expect the sort of the core margin within plumbing products to do as you head into fourth quarter?

I mentioned earlier that some of the biggest increases we've experienced have been in copper, zinc, and brass, and those really are primarily impacting our plumbing businesses so any margin decline you're seeing there, other than due to charges, is related to commodity cost increases, but we are rolling out and have rolled out price increases. And we are doing more outsourcing in plumbing than probably any other industry. So we continue to believe that from a long run standpoint, we can generate low double digits margins in our plumbing business going forward. But there's a transition period of transferring that work and outsourcing it. And during that transition, if anything, we incur extra costs. We right now are carrying extra inventories because of the shipping of product from China due to the inefficiencies of all that transferring of work. We have a lot of air freight costs to maintain service to our customers. So even on the long run, we'll have significant savings. In the short run, it may cost us more than it saves us and that shows up in margins.

I guess I was thinking the plumbing margins were about 10.5 if you sort of add back the restructuring charges that you sustained third quarter.

That's correct, but we would consider that to be an unacceptable run rate in terms of the future.

Sort of a low water mark, perhaps?

As I say, we would expect to have low double digits which to me would be higher than 10.5.

Got it. Now in the fourth quarter, however, you've talked about the need to take additional restructuring charge, which you had previously announced. I just wanted to understand which divisions those charges might be spread over. If I have -- if I have my numbers right, looks like we got about $18 million still left to come in the fourth quarter. I was thinking that might all show up in plumbing. Would that -- can you give us a sense of where that might be spread?

Yes, Steve. That would be consistent with what we said at the beginning of the year. We do have some charges as you're aware in the cabinet business in the third and second quarters. But any incremental charges that we incur would, based on what we know today, would generally be in the plumbing sector.

In the old days, you could set up a charge ahead of time for all of these anticipated expenses. Under present accounting rules, you have to incur those costs as they happen so we have to expense them as they occur.

Got it. Okay. And in terms of the seasonality question on margins, I guess my question -- the answer that you gave, I guess, from my question on seasonality in the plumbing business, what that you don't really see a seasonal factor affecting the margins there. How about in other -- your other categories, let's say installation services. We've also noticed some tendency in the fourth quarter to have some down tick there.

Yes, you're right on plumbing. Other than the fact that Company-wide, our first and fourth quarters are normally our lowest sales quarters and probably as a result have typically lower margins. As an example, paint is something that's strong in the second and third quarters, less in the first and fourth quarters, so that would influence overall corporate margins.

Yes, and for the plumbing business in the fourth quarter, certainly it would seem like that would play a role. How about the installation services business? Do you have a similar phenomenon that you anticipate there?

Yes, that's pretty much the same thing. From a seasonality viewpoint, the first and fourth quarters would be our slowest. Second and third, the strongest. When you look at, that certainly is somewhat weather related. Builders try and get the houses closed in the third quarter before the bad weather sets in. And it's again, it's much more regional. The northeast, there's very little construction that's taking place in the winter months. So we look at the first and the fourth quarters as our slowest period there, as well.

Okay. And then lastly, you made a mention, you made a comment about margins being hurt by less favorable product mix. I was just wondering if you could just elaborate on that a little bit more.

Yes. One example of that would be we've often said that in our installed products, non-insulation products have typically lower margins than insulation installation. So as that increases rapidly and insulation sales have anything declined a little bit, that has an impact on margins.

Okay. Outside the Installation -- ?

I should mention, though, that even though that reduces margins, the return on assets is very high.

Sure.

As we do incremental business, we get 80, 100% return on assets in that business, so we're focusing more on return on assets, return on invested capital, than we are on profit margins on sales.

Are you seeing any tendency to have a less favorable product mix outside of the Installation Services business?

Well, you know as long as we're doing building products, I think you have a certain amount of seasonality in the nature of some of those products. It's not in a big swing. I think we'll always have that first and fourth quarter being lower volume than other quarters.

Okay. Great, thanks very much.

We'll go next to Steven Fockens with Lehman Brothers.

Hey, good morning, guys.

Morning.

Just two questions. First, Richard, on the fourth quarter outlook, to get to your guidance on down mid single digit sales but also what I think is the earnings guidance, looks like possibly 300 basis point or so contraction in margins. A is that correct, and B is that more fixed cost absorption, input cost pressure, capacity additions or something else?

Steve, we -- I can't necessarily comment on the margin compression. Are you comparing margins when you make that comment to the fourth quarter of last year or -- ?

Yes, year-over-year.

Well, we would expect with a sales decline of 5%, as Richard mentioned earlier, you've got about a 35% contribution margin per se. So if you factor that into the mix, definitely there'll be some impact on margin. I haven't calculated what the detriment might be. So I wouldn't comment on your 300 basis points.

Fair enough. I would guess that's purely the volume related. And I assume if you have cost pressures, you've got to take that into account?

Right. There would be some issues relative to commodity. As Richard mentioned, brass-related costs have been very significant in plumbing. And we're in the process of trying to implement some price increases to offset a portion of that. We probably won't see a lot of benefit from that until early next year.

Fair enough and thanks for the color on that. And then just secondly, what have you seen in terms of reaction of sales volume to higher prices? I should say any evidence of consumer trading down as you've tried to recover some of your input costs through price increases?

I don't think we've seen any of that trend because of price increases. What we have seen is some trending down of consumers due to economic conditions. So we've seen some people trading down and not buying higher ticket items. Some quarters ago, we talked about how when our energy prices were high, we thought that was affecting lower income consumers and affecting our paint business. Now in the present economic environment, it seems like higher income individuals are contracting their business whether that's due to declining housing values or what the motivation might be. And that's resulting in slower cabinet sales than we experienced earlier in the year. But that's different than trending down from one product line to a lower level priced product line. They're just deferring the purchase rather than trading down.

Okay. Great, thanks very much.

Maybe, Operator, we have time for one more question.

We'll take our last question from Ivy Zelman with Credit Suisse.

Good morning, guys. With respect to that question that person just asked, just to elaborate a little bit. Richard, you've always explained to me that with a 1% decline in sales, it would translate with the contribution margin to roughly $0.02 to the bottom line.

That would be now closer to $0.025 because of the fact we bought shares back and have fewer shares outstanding.

Right. But then the math doesn't really work.

That's only on new construction. In other words, a 1% decline in sales of new construction products typically results in about a $0.025 decline in profit, earnings per share.

Okay. Well, it's a helpful rule of thumb if we actually knew within each segment what was new construction exactly because I'm looking at your guidance for the fourth quarter and it would look much more significant, the hit to profitability implying that there's a lot more going on than just the 35% contribution margin, which we've always thought was not a linear relationship as you've described. Have you factored any price concessions into your expectations -- ?

No, there are no price concessions in there, but what's included in that is one, the decline in housing starts during the fourth quarter, secondly, the continuing slowing of consumer spending and, third,and importantly, the increasing commodity costs that we're absorbing during the -- during the fourth quarter. And on top of that, we do have, as I mentioned earlier, some planned start-up costs. We're rolling out additional products in our services businesses. That incurs an upfront cost to do that. We're putting in new technology information systems in a number of operations. So a lot of different things are impacting the numbers. And I don't want to make it sound like housing alone is impacting those fourth quarter margins. All of those factors will impact them.

Okay, and just to follow-up on that. You said that you expect consumer spending to also slow in the fourth quarter. I don't know if anyone asked the question about your retail sales being up only -- or flat or 1% increase for the quarter. Can you talk about what's happening at retail and what your guidance implies for the fourth quarter with respect to retail, inventory levels at retail? What's going on there and what are you incorporating in your guidance with respect to consumer spending?

Well, that slowed down, we felt we saw in the third quarter already. So we're just expecting a continuation of that trend. We're not necessarily forecasting a significant change from that present trend.

Is that an area where you could be wrong and there could be further downside or what's your confidence level that that trend be maintained?

When it comes to macro economic conditions, again, your judgment is as good as mine, maybe even better, as to what consumer spending will be or what housing starts will be.

Okay. Thank you.

Just to summarize, in the third quarter of 2006, Masco increased sales 1% to 3.3 billion with a 1% decline in North America and a 10% increase international sales. We returned $263 million to shareholders through dividends and the repurchase of 7 million common shares during the quarter, and we ended the quarter with 870 million of cash and marketable securities. We continue to simplify our organizational structure and the platform synergies that we have developed are driving synergy and leveraging opportunities. So even during these challenging housing market conditions, we remain focussed and committed to continuing to execute our strategy of further simplifying the Company, investing to grow our businesses organically, aggressively managing our business unit portfolio, improving our balance sheet and return on invested capital, generating superior cash flow, and returning cash to shareholders through dividends and share repurchases. As we continue to develop and execute our strategic plan, we expect to emerge from the current downturn as a stronger Company due to the efforts and dedication of our over 60,000 employees worldwide. And we firmly believe that our strategy, together with our leadership products, brands, services, multiple distribution channels and price points, position Masco to deliver long-term value for our shareholders. And we certainly thank all of you for your interest and taking the time to be on this call today. Thank you.

Once again, that does conclude today's call. We do appreciate your participation and you may now disconnect.