馬斯科 (MAS) 2006 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Masco Corporation's 2006 fourth quarter earnings conference call. As a reminder, today's conference is being recorded and simultaneously webcast. If you have not received a press release and supplemental information, they are available on Masco's website at www.masco.com.

Statements in the following discussion may include certain forward-looking statements regarding Masco's future sales, earnings growth potential and other developments. Actual results may vary materially because of external factors such as interest rate fluctuation and changes to the consumer spending and other factors over which management has no control. Additional information about Masco's products, markets and conditions which would 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 include on the investor's package 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 a non-GAAP financial measures as defined by the SEC's Regulation G. Accordingly, a reconciliation of the differences between such measures and the most comparable financial measures calculated in accordance with the GAAP is included in the investor's package.

After a brief discussion by management, the call will be only for analyst questions. If we are unable to get to your question during the call, please call the Masco Corporation Investor Relations office at 313-792-5500.

And at this time, 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.

Thank you, Mark, and happy Valentine's Day to everyone from snowbound Detroit. Joining me today for Masco Corporation's earnings call are Alan Barry, our President and Chief Operating Officer, and Tim Wadhams, our Senior Vice President and Chief Financial Officer.

We reported this morning that net sales from continuing operations for the year 2006 increased 2% to a record $12.8 billion compared with $12.6 billion for 2005. North American sales for the year increased 1% and international sales increased 5%. In local currencies, international sales increased 4%.

Income from continuing operations was $2.22 per common share compared with $2.26 last year. These results exclude the impact of non-cash impairment charges for goodwill and financial assets and costs and charges related to profit improvement programs. Including these charges for 2006, income from continuing operations for the year as reported was $1.15 per common share.

Sales and profit margins for the year were adversely affected by an accelerating decline in the new home construction market in the last six months of the year, a moderation in consumer spending for certain big ticket home improvement items such as cabinets, costs related to profit improvement programs and higher commodity costs, partially offset by profit improvement programs and selling price increases.

Our fourth quarter 2006 net sales from continuing operations declined 6% from last year's $2.9 billion. Masco's North American sales for the fourth quarter declined 10%. International sales increased 17%. In local currencies, international sales increased 7% compared with 2005.

Sales of cabinets, windows and doors and the installation of insulation were particularly weak when compared with the fourth quarter of 2005, primarily due to the accelerating decline in the new home construction market as well as a slowing of sales of certain products at retail in the last six months of 2006.

Sales of major faucet brands combined and architectural coatings increased low to mid single digits.

Excluding the non-cash impairment charges for goodwill and financial investments and cost and charges related to profit improvement programs, income from continuing operations for the 2006 fourth quarter was $0.38 per common share compared with $0.50 per common share for the 2005 fourth quarter. Including the charges, the major amount of which was a good will writedown of our large European RTA business, earnings from continuing operations for the 2006 fourth quarter was a loss of $0.48 per common share.

Segment sales for the fourth quarter were Cabinets and Related Products sales hurt by declining housing starts and lower RTA sales were down 12%. Plumbing Product sales increased 3%. Installation and Other Services sales declined 9% as we continued to gain market share from new product programs as our sales were down less than the housing starts decline of 20%. Decorative Architectural Products sales increased 4% and our Other Specialty Product sales, particularly windows, which were also negatively impacted by housing starts, declined 14%.

Key retailer sales from continuing operations declined 7% in the fourth quarter, were flat in the third quarter and increased 1% and 7% in the second and first quarters of 2006, respectively. The Company believes that retail sales in the last six months of 2006 were negatively impacted by a moderation in consumer spending for certain big ticket home improvement items such as cabinets. For the full-year 2006, key retailer sales were flat compared with 2005.

For the year 2006, operating margins as reported were 8.8% compared with 12.5% in 2005. Operating profit margins as reconciled were 11.8% in 2006 compared with 13.1% last year. Margins were negatively impacted by lower than expected sales and higher commodity costs.

Total SG&A as a percent of sales including general corporate expense were 16.1% in 2006 compared with 15.5% in the 2005 fourth quarter. Higher SG&A expenses in 2006 reflect increased stock-based compensation expense, in part reflecting the adoption of new accounting rules and increased information systems implementation costs and other expenses.

Our general corporate expense was 1.6% of sales in 2006 compared with 1.5% of sales last year. Working capital, defined as accounts receivable and inventories less accounts payable, was 16.1% of sales at the 2006 year-end and 15.9% of sales a year earlier.

Return on invested capital as reconciled was 12.4% in 2006 and 13.4% in 2005. While the Company remains highly committed to the continued improvement in its return on invested capital, due to recent slowing business trends, which resulted in a reduction in earnings in 2006, the Company's return on invested capital did not reach our previous goal of 15% for the year. The Company continues to believe, however, that we can achieve our return on invested capital goal of 18% by the year 2010.

The Company's free cash flow before dividends exceeded $800 million in 2006. For the last four years, the Company's free cash flow aggregated over $4 billion. During 2006, the Company also generated $71 million of cash from the net disposition of financial investments and $160 million from the net disposition of certain businesses. We spent $28 million on bolt-on acquisitions.

The Company had a strong balance sheet at year-end with over $2 billion in cash and marketable securities and continues to have unused bank lines of $2 billion. Debt as a percent of total capital at the end of 2006 was 53% compared with 49% at the end of 2005. In January, 2007, the Company repurchased for cash $825 million of the accreted value of its outstanding zero coupons notes. Had this payment taken place in December, 2006, debt as a percent of total capital would have been 48% at year-end.

For the year 2006, we repurchased 29 million common shares of which 2 million shares were repurchased in the fourth quarter. We have continued our active share repurchase program and repurchased an additional nearly 2 million shares of our common stock thus far in 2007. The Company currently has 34 million common shares remaining under our repurchase authorization. During 2006, the Company returned $1.2 billion to shareholders through share repurchases and dividends. And for the four-year period, 2003 to 2006, the Company has returned $4.8 billion to shareholders through the repurchase of $126 million common shares and dividends.

In terms of current outlook, new home construction has declined dramatically in the last 12 months due to previous excessive speculative buying, rapidly rising home prices in recent years reducing affordability and less attractive mortgage terms. Even with the recent decline in single family housing starts, the inventory of unsold, new homes has increased to unprecedented levels. The uncertainty that homebuilders may cut production even further to reduce this inventory and given the large percentage of Masco sales that go to the new home construction market, combined with the unpredictability of commodity costs, make it very difficult for the Company to provide more precise earnings per common share guidance for 2007.

Also negatively impacting the Company's earnings outlook for 2007, our factory and system implementation start-up costs, charges related to additional profit improvement programs including severance costs from headcount reductions, higher interest expense, a moderation at retail of certain big ticket items, home improvement items such as cabinets, and as yet unrecovered commodity cost increases. Housing starts declined by approximately 13% in 2006 compared with 2005 to 1.8 million units. Late in 2006, the run rate declined further to between approximately 1.5 to 1.6 million units which is more than 20% below the 2005 levels. If housing starts improve from these levels, commodity costs moderate and home improvement retail sales improve, then the Company's earnings per common share could be $1.80 or even higher for 2007.

On the other hand, if housing starts decline even further than current depressed levels as a few observers predict and commodity costs escalate, the Company's earnings per common share for 2007 could decline to $1.50 or less.

Our guidance does not include any share buyback in 2007 which we expect to continue.

The Company expects the low point in its earnings for the year to be in the first quarter, seasonally its lowest quarter, when earnings may decline 50% or more from last year's first quarter earnings of $0.50 per common share when housing starts were very strong. The company currently expects first quarter sales to decline low double digits from last year's strong quarter and full-year sales to decline approximately mid single digits.

The Company remains committed to its long-term strategy, concentrating on organic growth, 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 and emphasizing new product development.

In addition to this strategy, we are proactively managing the business for the current difficult economic times in our markets by pursuing a variety of initiatives to further reduce costs and improve operating profits. Initiatives already underway, including sourcing programs, restructuring of certain businesses including consolidations, manufacturing rationalization and other profit improvement programs.

Recent initiatives to bring costs more in line with current lower demand for our products and services as a result of lower housing starts include a major reduction in hourly and salaried headcount. By the end of the first quarter, we will have lowered Masco's headcount in recent months by over 8,000 people or over 16% of our U.S. work force, including nearly 1,000 salaried personnel. The costs incurred for these programs, including severance, are part of the reason of our lower anticipated first quarter earnings.

Additional cost reduction programs, including corporate expenses, will be implemented in the first half of 2007 to further mitigate the effect of the housing downturn and improve our long-term profitability.

While we are disappointed with the anticipated decline in our earnings for 2007, we consider this an important transitional year. We are bringing on stream additional manufacturing capacity that we believe we will need in future years. We are implementing important systems initiatives. We are introducing a number of new products and expanding our installation service capabilities, and we are implementing a number of profit improvement and cost reduction programs which should enhance our future profit margins. If the economy stays reasonably healthy and housing starts improve in 2008, as we expect, and if commodity cost increases moderate, we believe our earnings per share next year in 2008 should be considerably higher than 2007.

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, Masco, even with the challenges we are facing this year, will be an even stronger Company than we are today.

Now Alan and Tim and I will be happy to open the discussion for any questions that you might have. Operator?

Thank you, sir. The question-and-answer session will be conducted electronically. [OPERATOR INSTRUCTIONS] We'll take as many questions as time permits. Our first question is from Margaret Whelan from UBS.

Good morning, guys.

Good morning, Margaret.

Happy Valentine's to you.

Yes, you too.

Thank you, and so here is my first question. I'm looking at how much your business has changed over the last three or four years since you've started reducing the number of operating units, I think from 70 to 35 or something in that magnitude, and I'm wondering if maybe you can give us an idea of what normalized margins are going to be by business segment because it is hard for us to know since there has been so much change in the units, and then relative to the current -- what's a normalized margin when you might get there relative to the current pace?

Well, Margaret, you're right that in the last two, three years, we've been very active at simplifying the Company, both operationally and financially. We have reduced our operating units from 69 to approximately 31 units currently and we've re-organized the Company into five global platforms to get better synergy and cooperation among our business units and we're very optimistic as to what's going to result from all that activity. It is very difficult for us to give you a number in terms of what margins can be with all the changes that are going on and the difficult economic environment that we're in but we have said in the past that we do expect, excluding product mix, in other words, we have certain segments that have higher margins than other segments and excluding the impact of that differentiation, that our goal is to get our operating margins back to the levels that we had two, three years ago and we think we'll be in a better position to give you a lot more accurate forecast on that come 2008 but we think that we'll be on the road towards recovering those margins next year.

It would seem to me though that as you've divested underperforming businesses that maybe the margins should exceed those three years ago, no?

Well, I think what we've said in the past is that it partly will depend on mix and we also assume there's always going to be competitive pressure. There is always going to be pressure from the fact that we deal with a lot of large customers whether they're large homebuilders or large home centers so that what we normally would expect to see improved margins from our long-term goal, some of that's going to be given back to customers in the form of promotions and other things that enhance our growth.

I think the key also is that, as a Company, we're focusing a lot less on operating margins and focusing much more on return on assets and related to that, return on invested capital. And that's why we feel that our goal of getting to 18% return on invested capital by 2010 from current levels of around 12%, 13% is the more important goal that we're striving for and because of those high returns that come from that kind of return on invested capital, we think that enhances our ability to create more value to shareholders through share buybacks and dividends as well as organic growth.

Okay. I agree with that, and so margins are a little loose at the moment maybe in 2008 and you have a lot of financial capacity and so the plan is to continue to shrink the balance sheet? Is that it?

Not necessarily shrink the balance sheet but throw off a lot of positive cash flow from our operations because of relatively high margins and therefore be able to return a fair portion of that to shareholders.

But assuming that the margins don't go above the '02-'03 level, despite all of the changes you've made and the charges you've taken, how are you going to get better return if you don't improve the asset turns?

Well, basically we're going to be increasing the earnings on a relatively flat asset base. We've maintained our asset base fairly level over the last three years while growing the business and improving profitability. So bottom line, we increase the earnings and if we keep the asset base the same, that should result in higher returns.

Okay. All right. Thank you, guys. I'll see you next week.

Hey, thank you.

Our next question is from Budd Bugatch with Raymond James.

Good morning.

Good morning, Budd.

Just if you could, maybe give us some quantification of some of the impacts that you've talked about for inside of the expectations for this year. You talked about a fair amount of severance and I wondered whether or not how much of that -- what's the number that affects this year?

Yes, we are -- as I mentioned in my comments, we are undertaking a major headcount reductions both of hourly and salaried people. That has been underway since late in '06 and obviously going on in first quarter of this year and we expect to do more of that as well as reduce other costs. We also have other costs that we're incurring this year. We're going to be incurring about $35 million of planned start-up costs in our new cabinet facilities out west because of the fact we had to refinance our zero coupon bonds which had a relatively low rate of interest with higher interest rates. That is going to cost us about $0.04 a share. We obviously will be incurring significant severance costs related to the headcount reductions. We're implementing a number of systems technologies throughout the Company that have significant costs related to those as well. So the earnings guidance that we've given, the $1.50 to $1.80, which assumes a broad range of housing starts below 1.5 million units or up to 1.7 million units, also includes all of those other charges that I mentioned within those numbers. So, those in many cases are one-time expenses and we would expect a fair number of those to be behind us as 2008 unfolds.

I just want to make sure I understand how those costs will unfold during the year. The $35 million in plant start-ups, is that evenly spread through the year?

I would say that that will be more weighted in the first half of the year because we will be putting additional work into those plants as the year progresses, as we spread out some of the work that made -- was formerly made in other facilities that should be made on the west coast so that should reduce the cost there as the year progresses. The severance cost would also largely be impacted in the first half of the year as well.

And you didn't quantify that for us, Rich.

No, we haven't, we haven't put a number on that. We haven't completed all the programs. We haven't made all of the announcements so we just don't feel we're in a position to put that number out yet.

And the zero coupon or the $0.04 a share, is that a continuing item because the -- ?

That's the one item that would be continuing because the new debt replacing the old debt is long-term debt.

Make sure I understand. You paid off the 825 of the accretive zeros?

Right, and we were paying the equivalent of about 3% on those notes and we replaced them with the equivalent of 6% on the new notes.

And the level of the new notes is also 825? Did you refinance it dollar for dollar?

We issued $1 billion worth of new notes in '06 but we also have $600 million of additional debt coming due in '07 so part of that additional funds would go toward some of that debt retirement.

But that debt was on the balance sheet at the end of the year then. Everything you've done so far is -- the only thing that's not on the balance sheet was the 825 repayment, right?

That's right. Correct. That's correct.

So everything else will flow.

We might possibly do some additional debt during the course of the year to refinance some of that additional debt coming due.

And that $600 million comes due later in this year?

We have $300 million that comes due in March and $300 million comes due in the fall.

Okay. A couple of other questions. I was hoping you would define the word "considerably" for us in terms of a number. I think you said --

Which sentence was the considerable in?

Considerably higher, I think was --

Oh, I think, well, several things. One, we clearly have a large contribution margin so increased sales have a major impact on Masco so if next year, the economy stays healthy, and we see a recovery in housing starts and that translates into more sales of cabinets and faucets and whatever, that should result in nice incremental margins.

Secondly, we won't have a number of those costs that I mentioned that are hitting us in '07 and '08 and thirdly, all of the programs that we've been working on for the last two, three years in terms of cost reductions and other things should be helping results in 2008 and on top of that, particularly if housing slows this year, I would hope that we might see some further moderation in commodity costs later in 2007 going into 2008 and that's a very big number for us. We still have several hundred million dollars of unrecovered commodity cost increases that we will be rolling out some price increases in '07 but even with those, we won't have recovered all of the cost increases. So if we see commodity costs come down, that should have a significant impact on us later in '07 and particularly in '08.

So let me just make sure I kind of -- we put this in perspective. If, in fact, revenues in '08 are modestly higher or say 5% higher than they were -- than they will be in '07, will you be able to get back to a -- the same earnings level that you had in this year, in '06, or do you think you'll be above that?

Are you talking about on per share basis?

That's correct.

Yes, I don't think I would want to make a forecast on that, Budd, but I know you're a good analyst and you'll put pen to paper and probably come up with a number. I also forgot to mention that we also will have additional share buyback in '07 and '08 and additional cash flow generation which could be invested in acquisitions and other things so come '08, again if the economy stays relatively healthy, housing has at least a modest recovery, there are a lot of positive things that should be going for Masco that I think will result in much better performance next year.

Okay. Just a couple of other quick questions. Can you quantify the amount of financial investments on the balance sheet at the end of the year?

Yes, it would be about $380 million, Budd.

Okay. And also, Tim, the other question I had --

About 20% of that Budd, would be marketable securities.

And like we said, our goal is to liquefy all those financial assets or virtually all those financial assets over a reasonable period of time.

And I don't think you've addressed this but maybe you have and I missed it. Do you still intend to return $1 billion a year to shareholders in the form of dividend and stock repurchase?

Yes, our financial goals haven't changed. We hope to continue returning, on average, $1 billion to shareholders through share buyback and dividends. We've said that that could vary year to year depending on cash flow and other things. One thing I should mention, we did generate $800 million of cash flow in 2006 even with our lower earnings. And if earnings go down in 2007 as we've indicated, we would still expect our cash flow to stay at approximately the same level. And the reason for that is we expect capital expenditures to be down about $100 million in 2007 and with slower sales, our working capital needs would also be down by about $100 million so as a result of that, even if we hit earnings in that guidance that I've given, the lower earnings, our cash flow should be about the same as 2006. So in that environment, we should be able to maintain a fairly active level of share repurchase and dividend activity.

We've also said in the past that on average, we think our divestitures will approximate our acquisitions which are going to be bolt-on acquisitions to our existing platforms so in that environment again, we should throw off a lot of positive cash that we can return to shareholders.

So the CapEx for 2006, did that wind up at 380? I don't know that I saw that number.

Yes, 388, Budd, and we would expect in '07 to be around $300 million.

About 300 million and evenly spread, Tim?

Evenly spread? We've got a little bit continuing in the cabinet area. But generally, no major programs so I think the capital allocation there, the allocation of the CapEx would be spread across the different businesses, yes.

Okay, thanks. I'll get back in the queue if I've got some more questions. I do have some more, but I'll get back.

Yes, thank you, Budd.

Our next question is from Michael Rehaut from JP Morgan.

Hi, good morning.

Yes, Michael, how are you?

Good, good. I was wondering first, just to dot a couple Is, cross a couple Ts, if we could just hit on the overview of the charges and benefits that you've seen in '05 and in '06 and now looking into '07 in terms of the restructuring programs.

Yes, we had a major cost reduction profit improvement program that we announced two, I think it was about two years ago, and we spelled out the benefits and the costs of that to shareholders over that time period. We have achieved a major portion of the savings that we expected from that program but unfortunately, the unrecovered commodity cost increases that we've absorbed have eaten up a large amount, if not all, of those savings. So the new programs that I've discussed, the costs reduction, headcount reduction, some of the other things that I've talked about, are an entirely new program and we would expect to implement additional programs during '07 to reduce costs even further than that initial program.

Yes, Mike, more specifically, when we came in to 2007, we had estimated that we would incur about $70 million of restructuring related costs or profit improvement related costs primarily related to the Plumbing platform, as you may recall, and that included the closure of one of our plants. We actually came in at about $39 million related to Plumbing which was pretty much where we were in the -- at the end of nine months. I think we had like $3, $4 million, maybe in the fourth quarter. We also had about $8 million related to Cabinets. The decline from the $70 million to the $39 million related to Plumbing relates to a plant that we originally assumed that we would close which we actually were able to sell. So that's why we ended up with much less expense, if you will, in the fourth quarter.

And what were the associated savings with those programs that you saw in '06 and what do you expect to get from those in '07?

I think, Mike, when we put that information together back in the spring, I think we were estimating about $60 million of savings in the 2006 year and I believe that we pretty much track that, as I recall. I haven't seen the final tally on that or don't remember the exact numbers but I know we were on track for that late in the year so my guess is we hit that. A lot of that relates to sourcing and there might have been a little bit of a deduct there because of brass costs because a lot of the sourcing that we're doing is in the Plumbing area. A lot of that was going to China. And of course, they had some issues with raw material cost as well as we did here in the States so we might have come in a little bit under maybe the $60 million that we had targeted for that reason.

Also because you sold the unit?

I'm sorry.

Also because you sold the units so you didn't have the costs associated with that unit but --

Oh, yes. That's what I meant. In terms of the reason why we didn't hit the $70 million number, because we sold the business, we did not have what would have been about an additional $20 million of charges.

And none of that would have affected the reported earnings we had excluding the charges on items so that didn't flow through the 222 or the $0.38 in the fourth quarter. Mike, maybe for the benefit of the listeners because as I mentioned, we've undertaken a lot of cost reduction programs but it hasn't shown up yet in margins because of the commodity cost increases, I might run through what we've seen in the way of material cost increases.

In previous calls, we've mentioned that our commodity costs in 2005 went up $250 million over and above what we had recovered in price increases, and in early 2006, commodity costs went up an additional $200 million. That was $450 million of increases. We implemented $350 million of price increases during -- spread out during the first half of 2006 and those increases have held very well in terms of customer acceptance. But since then, we reported in our last call that we had seen commodity costs go up another $150 to $200 million in late '06. Since we've seen a little tapering off of some commodities such as copper, that $150 to $200 million now is probably around $150 million. So when you add the $150 million to the $450 I mentioned earlier, that says that our commodity costs in the last three years have gone up $600 million of which we've only recovered $350 million in price increases. We are implementing additional price increases in '07 but there is still a significant lag and gap from what we've incurred in costs versus what we've recovered in pricing and that's why if, if we see commodity cost increases taper off, we should get a major benefit from that because we don't expect to pass that back to customers because we never got it back from them in the first place.

Okay. And going back to '07, you mentioned that you have $35 million of the start-up costs but you're not willing at this point to give a number on the additional restructuring or severance costs and those types of charges?

We're -- we're just really implementing a lot of those programs and we will share that information with investors but we're just not prepared to do it at the present time.

And the $70 million of incremental savings in '07, is that something that you still expect to achieve?

That would be true, Mike, with the exception of what I mentioned earlier relative to some of the brass costs because again, a lot of that is sourcing and we have seen some material cost increases. We are -- we do have a benefit there but it might be a little bit less than the $70 that we originally anticipated because of the significant increase in raw materials.

Yes, I would add to that also that although we've achieved, if nothing, if anything, exceeded our outsourcing goals, we achieved over $700 million of outsourcing in '06 which was ahead of our goal. We have not yet achieved all of the profit savings that we expected from that outsourcing. We would normally expect about 25% to 30% cost savings from outsourcing but because of the major transfer and logistics of converting a lot of that work from existing operations in this country to offshore bases and all of the costs related to implementing those new programs, we've really gotten only a small portion of that cost savings yet but we still feel pretty comfortable that we're going to be getting it but it will probably be coming more in '07 and particularly in '08 than it has in the past.

Okay, and I appreciate it. Last question, just to focus on the Decorative Architectural segment. It's actually been a pretty solid bright spot this year and you did 18% margins in the quarter excluding the impairment charges, low, mid single digit organic growth. What's your outlook for '07 in that segment and maybe you could talk about how you were able to keep up a solid sales pace and good margins in that business?

Yes, I might mention that that's an example of what I think Masco can do once commodity costs level off. We suffered in commodity -- in that segment in 2005 when we had the escalation of energy-related commodity costs because of the hurricanes and so the margin recovery in 2006 was really just recovering back to some of our historic margins after the very difficult 2005. But because those commodities have not risen significantly in 2006, you can see that we had a nice, consistent pattern of good returns during the year.

On the other hand, that tends to be impacted by consumer spending in low ticket items and what we had said early in 2006 when energy prices, gas prices rose to $3.00 a gallon, we did see a slowdown in paint sales. Once energy prices returned to $2.00, $2.25, $2.50 a gallon, we saw some pickup again in paint business. So, currently, the shortfall we're seeing at retail is not at low ticket items like paint. It is more at high ticket items like cabinets where obviously housing prices and consumers taking less money out of their homes is impacting the bigger expenditure for a kitchen remodeling and bathroom remodeling.

Thank you.

And our next question is from Ivy Zelman with Credit Suisse.

Good morning, guys.

Good morning, Ivy.

To focus in a little bit on the MCS group, understanding that housing starts are weak, can you talk a little bit about the competition that we know has gotten a little bit more aggressive on gaining share and willing to come in at significantly lower margins than your segment is generating? In fact, some we've talked to are willing to come in at half of where you are and understanding the competitive landscape and realizing that business is weak. How do you keep from margins getting cut in half in this business when others are willing to do it at that level?

Well, I'll answer that maybe a little bit more generally. I would say obviously whenever you have a significant economic downturn such as the housing industry, there is always the question of price reduction, either because customers are demanding it or competitors are offering price concessions to fill factories or keep workers working. Having said that, I would say if you take Masco as a whole, we've seen very little margin decline because of price reduction. We have walked away from some work that was bid on at lower prices by other people but generally speaking, our margins from the standpoint of pricing have held fairly well. That's not to say again, there isn't pricing competition and in some categories and some products but thus far, we haven't seen that as a major factor.

What really impacted margins in the contractor services in the fourth quarter and I'm sure will impact them in the first quarter of this year is, of course, the sharp falloff in volume of new construction although I mentioned earlier, their sales were only down 9% where housing starts were down 20%. But on the other hand, the biggest decline we've seen there is in the installation of insulation which is one of our higher margin businesses and on the other hand, we continue to grow quite rapidly in other product installed categories but those typically are at somewhat lower margins. That, combined with the fact that we're implementing major technology systems updates throughout the contractor services at significant cost in the fourth quarter and throughout '07, you will see some lower margins there but those are driven more by the items I've mentioned than they are by competition although again, I don't want to de-emphasize that there isn't competition out there aggressive on price.

I'll also add that another driver in margins, we've continued to roll out our paint initiative at contractor services. We're in 40 branches, I believe, by the end of '06. We expect to be in 80, I think, by the end of '07 and there is significant start-up costs related to that in terms of equipment and people until the volume ramps up to support those costs.

I appreciate it. Thank you for the answer. I think the one thing I would like to follow up on that is that you have been relatively optimistic that you wouldn't have to give any concession you said at a dinner I hosted about a year ago in terms of ability to offer product brass and in place of losing some business in insulation, you wouldn't have to take it on price. You might take it up in other products and that portfolio approach was going to mitigate pressure and that you didn't think there would be any margin pressure and here you are realizing now that margins in fact with volume lower does, in fact, have a negative impact. I mean builders are telling us, Richard, that you're giving them concessions. So maybe it is not the 10% they're asking for and maybe it is not just in MCS and maybe you can give us -- some sense of what the total concessions that you are giving.

Well, I think, Ivy, at the same dinner, what I said was and back then, we didn't see the sharp decline in the housing at the time but what I did say back then was when we do give concessions, we get something back for them. In other words, if a builder insists on concessions or asks for concessions, then we go to them and say look, if you'll do this for us, if you'll give us additional work, additional products, then we will give you additional concessions. We've done that through the history of the Company, both at retail and at homebuilders, and that's how we often grow the business. So I'm sure I would never have said never because I never say never to anything. But having said that, I think that we have good trade-offs when we do give concessions.

Alan, you want to make a comment?

Ivy, our proposition on Masco Contractor Services has always been the total cost that we can provide to the builder on all the services that we deliver. A competitor can always come in with a lower unit cost on a given particular individual item. But we pride ourselves on the fact that the total cost that we provide for our services to the builder is a far lower cost than anybody else that we're competing with out there in the industry.

I would just add to that, Ivy, that we were down 9% in the fourth quarter. I would guess we will be down more than 9% in the first quarter of this year in contractor services but that number will still be less than what the housing industry is declining so my math tells me that means we're gaining share, not losing it.

If you looked at the business in sort of a year and a half from now, two years from now when business may not be as tough on the top line, given that there is distributors and business, other companies in the same line of business that are operating at much thinner margins, would you say that this is a single margin business for you or are you optimistic that you'll get margins back up even with a better sales environment?

Are you talking about contractor services?

Yes.

No, I think our goal is to continue that over time, once we get into a normal environment, we should be back in low double digits margins in that business. But again, even more important than the margins, what we focus on is return on assets and in that business, we have a very high return on assets.

Okay and then switching gears, Richard, just to Plumbing. One of the things people wondered about obviously is American Standard is getting out of the Plumbing business or trying to sell it. Historically, you've only bought companies that were actually very excellent companies and that you didn't have to fix up and is that something that you would say you're still going to stick to?

Well, I would answer that a couple of ways. One, American Standard is -- a large part of their Plumbing business is ceramics and as we've talked to investors over many years, we haven't found a good way to get into ceramics that meets the criteria that we have in terms of profitability and return on assets. So we don't comment on any individual situation, acquisition or divestiture, before it happens but what we have said in the past is we know all the companies that are out there and we don't know of any company in the $1 billion plus range that we think would make an attractive fit with Masco where the returns would justify the investment versus putting that money to work in our own businesses and smaller bolt-on acquisitions and in share buyback and recapitalization activities.

I guess put another way, do you buy -- will you buy companies that need to be fixed up?

Well, if it is a bolt-on acquisition and it immediately goes into another business, where you're really buying a product line, that's different. We don't buy turnaround companies because we think we can turn them around. Our past success on that hasn't been very good. I think we're very good at running good businesses. I'm not sure we're very good at running bad businesses.

Terrific. Thanks, Richard.

And our next question is from Kenneth Zener from Merrill Lynch.

Good morning.

Good morning.

Please avoid fixtures, Richard. [ LAUGHTER ]

You've been there, huh?

Yes, I'm just wondering, some of the earlier questions, based on the margin declines that you had in 2001 when we were in a recession and housing was down, starts down 5%, you did follow with the 300 basis point recovery in '02 which was very solid. But housing right now is at best a steady state. Do you think -- I mean the margin upside in the business is similar notwithstanding the actual margin level, given the run-ups that we've had the last five years in terms of housing activity pricing and these types of things?

Yes, it is not easy to compare us with what happened back then. Our product mix has changed. We're much more active in new housing today than we were then. My recollection is we had a number of one-time things that negatively impacted us in that downturn which enabled us to have a bigger recovery on the upside. Conversely, as I've said earlier, that we have a number of things that are costing us this year that I think will actually enhance our profitability long-term even though they hurt our profit margins this year. So I think we continue to think we can show a significant improvement in profit margins in a reasonable economic environment in 2008 and beyond but it is up to us to prove that.

Right. Thank you for that comment. And looking at the specialty sales where segments -- sales were down materially, I'm just trying to understand. I know windows is a very big part of that business.

Yes, windows is a -- a big portion of that business and our window business is particularly concentrated in California where housing starts are down more than the national average so we've seen a major falloff in the industry there.

Right. I think about 60% of that business is new. So if 40% is remodeling, why didn't remodeling kind of carry more water in the quarter?

On the window business?

Correct.

I would just say that we've seen in California, a falloff in both remodeling and new construction.

And then I guess that leads to my third question, appreciate that, which is if you could comment on the level of remodeling that it will play as a counter cyclical effect on new construction which is, I think, a long-held belief that remodeling picks up if housing is kind of declining and there's been significant changes, I think, this cycle relative to the early '90s whether it's home pre-buying, shifts to higher end product, equity extraction. Could you comment on that?

You're absolutely right. Historically and we've been through many cycles, there was only one other cycle that I can remember in 40, 50 years, where home improvement did not actually accelerate its growth when new home construction declined. And that one time was back when interest rates were running at 16%, 18% and everything slowed down. So what's different this time is really an unusual situation and I would have to attribute it to several factors. I think one, we've seen a sharp falloff in individuals pulling money out of their homes into home equity loans. The annual run rate on that, I think, is down from $800 billion to $300 billion.

Secondly, the concern of the value of homes, I think some consumers have deferred their renovation work in kitchens and bathrooms until a later date. So this cycle is different in the sense of we have not seen the pickup in home improvement that we've seen in past cycles of housing downturn. Having said that, I would just say that I think the fundamental driver in terms of demographics, housing be a good investment, lifestyles, all really should and continue to enhance and there are plenty of studies that would indicate this, continue to enhance home improvement spending over the long-term and I think what we're going through is a relatively short cycle of slowdown in that area and I will be very surprised if, by 2008, we don't start seeing an improvement in home improvement sales.

So you're expecting flat remodeling, just to be clear?

Our guidance for this year assumes a relatively flat home improvement sales on the retail side.

Thank you.

Our next question --

Maybe time for one more question, Operator.

Thank you, sir. Our final question will be from Nishu Sood from Deutsche Bank.

Thanks. Just wanted to follow up on Ken's question there on remodeling. Just talk about the trends as they're reflected in your data. Obviously the microdata as Ken was mentioning, showing that if the remodeling holding up a bit better than new construction. Now in your data, Cabinets, you obviously mentioned have seen some contraction, consumers pulling away from the big ticket purchases. But if you look at some of the other categories like Plumbing, in particular, it didn't seem to show that. So what's your sense overall there?

I think I referred earlier to higher ticket items seem to have been more impacted in terms of a slowdown at retail than lower ticket items. Faucets would probably be somewhere in the middle. And then again, you have to then separate that. We have a lot of new products. We have a lot of new programs. We're going to be introducing a number of new cabinet programs at retail which we think will have some significant growth opportunities for us in 2007. So when you put all that together, we're assuming that this year will be relatively flat on the retail side but you should also remember that you have to look at the seasonal factors and the annualization. We had a very strong first half of growth in home improvement in '06. We had a relatively weak second half. So the second half of 2007, our comparisons are going to be much easier. So I wouldn't be surprised if we don't show perhaps some negative sales on the retail side in the first half of '07 and then positive growth in the second half.

Also, I should just mention in the faucet case, our Hansgrohe operation has just done an outstanding job in terms of product development, innovation, marketing, and global marketing of their product worldwide. And a lot of our growth in faucets is coming in Europe and their efforts internationally over and above what we're doing domestically in this country so they've been a big factor in terms of our strong faucet performance in the recent quarter.

Yes, in the recent quarter, so what would the difference be in terms of the sales growth Europe versus the U.S. in the Plumbing division?

We don't give that out but I would say that faucet sales increased more in Europe than they did in this country. Now, that's also helped by currencies but even if you exclude currencies, they've just done an outstanding job, particularly in penetrating some of the emerging markets around the world.

Oh, so actually we're up still in the U.S.

I don't have that number in front of me so I can't give you that for sure. But if it wasn't up, it would be close to it.

Okay and on the writedown of the goodwill on the Tvilum-Scanbirk operation in Europe, I know you had mentioned in the past couple of quarters, slowing sales in the RTA business in Europe as consumers shifted, I think, more to the higher end cabinets. Can you just talk about your change in thinking that led you to see that as probably a somewhat permanent shift and what prompted you to take the write-off in goodwill this quarter?

Well, basically, Nishu, as you know, we have to look at our goodwill every year and we do that in the fourth quarter unless there's some other event that might trigger the need to take a look and that view is a discounted cash flow approach. And in this particular situation, given the changes that have taken place there in terms of supply related to raw materials, the ability to price and offset that, what we really determined in the fourth quarter was that the change was more of a permanent nature structural going forward. I would point out that in 2005, that business did well both on the top line and in terms of margins. We were relatively strong in the first part of 2006 but we did see a pretty dramatic change. And as a result of what is kind of a quantified or mechanical test, if you will, that's really where we got to the numbers looking at a forecast for future activity, from the top line standpoint, which was more limited in terms of growth and also what we believed was a more permanent decrease in margins.

Okay, and final, just quick housekeeping question. Did you mention the tax rate obviously was a lower because of the change in legislation? What do you expect that to be going forward?

We indicated, I think in the material we sent out, that we did have a lower fourth quarter tax rate and that had some impact on the full year tax rate in 2006 but we would expect in 2007 to be back at a 35% to 36% tax rate.

Okay. Thanks a lot.

Thank you.

I might just mention one additional item as part of our wrap-up. I would like to just mention that we do have a number of senior executives who have ten-year stock options expiring this spring. And as a result, you may see some executive selling or turning in of Masco stock to fund these option exercises and related tax expenses so whenever we think there's going to be a number of those, we like to give you a heads up because it really doesn't relate to Masco and its outlook but it is more driven by expiration.

So just maybe to summarize our results in 2006, our sales increased 2% to $12.8 billion. We generated over $800 million of free cash flow before dividends. We returned $1.2 billion of cash to shareholders through the repurchase of 29 million shares and dividends which were increased for the 48th consecutive year. We continue to simplify our organization structure. The platform strategies we developed are driving synergy and leveraging opportunities. We have a number of initiatives to reduce -- we implemented a number of initiatives to reduce costs and improve future profitability and we continue to believe that we can achieve our goal of 18% return on invested capital by 2010. We believe that our growth strategy, together with our leadership products and brands and multiple distribution channels and price points, position Masco to deliver long-term value for our shareholders. And in addition, I certainly would be remiss not to thank and appreciate the efforts and dedications of our over 50,000 worldwide employees who are helping us to achieve these long-term goals. Thank you for taking the time to be with us.

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