馬斯科 (MAS) 2009 Q1 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Masco Corporation 2009 first quarter conference call. As a reminder, today's conference is being recorded and simultaneously web cast. If you have not received the press release and supplemental information, they are available on Masco's web site along with today's slide presentation under the Investor Relations section at www.masco.com.

Before we begin management's presentation, the Company wants to direct your attention to the current slide and the note at the end of the earnings release which are cautionary reminders about statements that reflect the Company's views, about future performance and about non-GAAP financial measures. After a brief discussion by management, the call will be open for analysts' questions. If you're unable to get your question during the call, please call the Masco Corporation Investor Relations office at 313-792-5500.

I would now like to turn the call over to Mr. Timothy Wadhams, President and Chief Executive Officer of Masco. Mr. Wadhams, please go ahead, sir.

Thank you, Bill. Good morning and thank all of you for joining us today for Masco's first quarter 2009 earnings call. Joining me are Richard Manoogian, our Executive Chairman, Donny DeMarie, our Executive Vice President and Chief Operating Officer and John Sznewajs, our Chief Financial Officer.

I assume you all have the slide deck. If you would please flip to slide number three. Obviously the quarter was another difficult one. And I would remind folks that from a seasonal standpoint, the first quarter is typically our weakest quarter of the year from a revenue standpoint. We were down 26% in the quarter to $1.8 billion in sales. And we continued to see significant volume declines in both new home construction and home improvement markets both in North America and internationally and also had negative foreign currency impact in terms of sales of about $85 million.

Earnings per share was a loss in the quarter of $0.23 compared to $0.04 of income in the prior year. And we'll talk about EPS in a minute. Working capital was a very significant positive for us. We were able to reduce working capital as a percent of sales defined as receivables plus inventories less payables from 17.3% to 16%. And we significantly enhanced our financial flexibility and I'll move to the next slide.

We did end the quarter with $800 million of cash. If you'll move to slide number four, we'll talk about a couple of items we mentioned on our last call. First, we previously announced this, we did reduce the dividend from a quarterly perspective to $0.075 cents from $0.235. That will save the Company on an annual basis, $240 million. In addition, in April, actually just last week, the Company and its Bank Group at the Company's initiation amended our five-year revolving credit facility. In that process, we reduced the facility from $2 billion to $1.25 billion. And you might remember that $2 billion was in place several years ago when we had a zero coupon debt instrument outstanding and there was a put feature to that. So, we had some extra provision if you will, in the bank agreement to cover that. So, lowering that from $2 billion to $1.25 billion from our perspective was not a significant issue.

Debt to total cap has been increased in terms of the covenant from 60% to 65%. At 3/31, we came in at 58%. I would point out we were in compliance with our covenants as of 3/31. That would be the old covenants. In addition to the improvement from our perspective of the debt to total cap ratio, we also were able to put in place a basket of $500 million that would relate to any potential non-cash related charges or certain non-cash related charges primarily good will and or other intangibles. We're not anticipating any issues at this point in time, but that does give us some extra cushion, if you will, if we should have a good will impairment charge like we did last year at the end of the year.

Given all of that, our current borrowing capacity is the entire line. We do have the ability to draw the entire $1.25 billion. That's a significant improvement from where we were at the end of the first quarter. You might remember as of the beginning of the year, we were in a position where we could only draw $420 million and still comply with the covenants. So, we've been able to effectively triple that. And we feel like that's a very positive outcome for the Company.

One other item I would like to mention on this slide is that we did repurchase 2 million shares of stock in the quarter. I want to make sure there's no confusion. Our share repurchase program continues to be on hold. The repurchase of these shares is really an offset to shares issued for stock awards to our employees. And I would remind folks as I mentioned, we did end the quarter with $800 million of cash. We continue to expect we'll end the year with approximately a billion of cash.

If you flip to slide number five, I mention that we lost $0.23 in the quarter. And that included $0.04 related to rationalization charges, $0.01related to the curtailment of defined benefit plans, we're transitioning from defined benefit pension plans to defined contribution plans. And that will be effective, we're freezing the defined benefit plans effective 1-1-2010. That cost us about $0.01. We also had impairment charges and currency transaction impact in total of about $5 million which - - $5 million which in aggregate is about $0.01. We also, even though we were in a loss position, did have $0.02 of tax expense in the quarter as we mentioned when we provided guidance earlier this year. So hopefully, that gives you a little bit of perspective of what's in the earnings for the quarter.

If you flip to slide number six, from a consolidated basis, I mentioned we were down 26% in sales. And again, that's obviously significantly driven by the declines in volume related to both new home construction and home improvement markets. That comment will be one that I won't repeat going forward. It does apply to segment discussions as well as North America and International. I would point out that our sales to key retailers in the quarter were down 11%. That compares with the fourth quarter decline of a 14% and a full-year 2008 decline of 12%.

We had a loss position from an operating profit standpoint as you can see, $7 million. And again, that's related to the reduction in volume and the under absorption of fixed costs. And also reflects the fact we did have $24 million of rationalization charges in the quarter as compared to 9 million in the prior year.

If you flip to slide number seven, please, in North America, we were down 24%. And again, that's driven by volume in both of our major markets. And obviously in North America, as you can see on this slide, profits were down from 7.9% of sales to 1.3% of sales. Again, reflecting the significant volume decline and the underabsorption of fixed costs.

If you flip to slide number eight, our International operations were off 31% and that included approximately $74 million or 13% of that decline related to the impact of foreign currency, reflecting the strength of the US dollar primarily against the Euro as well as the British pound. Again, significant volume declines for our European businesses, particularly in the United Kingdom. Profits were down from 9.7% of sales to 3.9% of sales. Again, reflecting the volume decline in the underabsorption of fixed costs.

On slide number nine, this gives you a little bit of perspective in terms of the components of working capital. We talked about the percent to sales earlier. And as you can see, we saw some improvement in both inventory and payables and certainly feel very, very good about the job that our folks are doing from an operating perspective to manage working capital. In the environment we're in, with the significant reduction in sales that we've seen in the fourth quarter of 24% and 26% down in the first quarter, our folks have really stepped up and I think are doing an excellent job of managing the working capital side of the business.

If you flip to slide number ten, I want to walk through the segments real quick. Talk a little bit about cabinets. Cabinets were down 34% in the first quarter. And again, similar situation as I mentioned earlier. Significant volume declines in the major markets. We also had currency impact here of about $18 million which would have contributed to that sales decline. And certainly had underperformance, if you will, or challenge performance in our European businesses. Profits went from 4.7% which was $28 million last year to a loss of $28 million in the quarter. And we did have $9 million of rationalization charges in this segment versus $1 million in the prior year.

If you would flip to slide number 11, in terms of plumbing, our sales were down 26%. And again, significant volume declines both in North America and Europe. And we did have approximately $57 million of negative currency impact related to our Plumbing business which includes $11 million in North America. Profits were down in this segment from 12% to 5% of sales. Again, reflecting the lower volumes and the underabsorptions of fixed costs primarily.

If you flip to slide 12, our Installation and Other Services businesses, this business is pretty much 100% related to new home construction. The sales there were down 35%. Another significant drop in terms of this particular segment. You can see decline in profit, if you will, with small loss to modest loss last year, down to $36 million this year. And a slight increase in systems implementation costs year-over-year as part of that.

If you flip to slide 13, on the brighter side of the business, this is our Decorative Architectural Products segment which includes paints and stains as well as builder's hardware. Sales here were up slightly at 2%. Margins were - - and operating profit was relatively flat and that was driven by nice improvement in the builder's hardware side of the business even though we had lower sales there. We did have some reduced promotional and program-related costs that helped the profitability of this particular segment.

If you flip to slide number 14, other Specialty Products which includes our window offerings in both North America and in the United Kingdom. Again, significant volume declines in both of those markets drove a 32% decline in sales. Profits went from an $8 million profit last year to a $7 million loss in this segment. There is a negative impact in terms of sales here of foreign currency of $10 million. And again, this reflects lower volumes in the underabsorption of fixed costs.

If you flip to slide number 15, this gives you a little bit of a summary of the actions that we have taken from a rationalization standpoint over the course of the first quarter as well as on a total activity basis which goes back a couple of years. And as you saw in the press release, we did incur about $24 million in the quarter. I mentioned that earlier. That compares with $9 million last year in the first quarter. We did close two additional plants and overall, our head count reduction now at this point in time is down 27,000 people which represents about 50% of our North American work force if you go back a little over a couple of years.

We do have, in the appendix, we included a breakdown of the restructuring costs in the first quarter by segment and we also have in there a summary of the 2007 and 2008 numbers. And with that, if you would flip to slide number 16, before I turn it over to Donny, we have spent a lot of time talking about some of the things that we're doing to reposition our cost structure. And I think we continue to make a lot of progress there. Obviously it is a challenging environment. But one of the things we think is important for investors to understand is also the investments that we're making at the same time in the business to position our business for long-term growth and value creation.

And with that, I would like Donny to pick up the presentation. I'll come back when Donny finishes and talk about guidance and then we'll go to Q&A.

Thank you, Tim. Good morning. I would like to talk to you a little bit about what we're doing to really position ourselves to win on the way out of this operating environment. And really have focused our efforts in five areas. First is realigning our cost structure for what is a new paradigm related to demand. And with doing what, we also have to adjust our supply chains to be more efficient at those lower volumes. We're investing in our leadership brands. We're driving innovation and we have a strong focus on cash.

Next slide, slide 17, in our Cabinets and Related Product segments, our key initiatives have been around building our manufacturing capacity to be more flexible. Our North American builder businesses have now adopted a common architecture and we have completed the transformation of the first facility. And our Merillat branded product is now on the common architecture that not only did we go to a common architecture for those productions, but we also have been able to increase the strength of the box. So we feel very good about that.

We have a world-class lean organization on the Builder Cabinet side. We continue to invest in our leadership brands, Quality, Merillat and KraftMaid. We are preparing for the future. We have a major ERP implementation on the Builder Cabinet Group. We have completed our first major milestone of that implementation with our first assembly plant which has been converted. We expect that project to complete second quarter of 2010 on track.

Next slide, slide 18. We're very excited to tell you about some of the awards we've won related to [Aileen]. We were one of the ten top places to work by iSixSigma related to SixSigma. We have won a Shingo prize in the past and most recently, the Masco Cabinet Group President, Carol Strauss, has been named the SixSigma CEO of the Year by global SixSigma awards. Karen will be accepting the award on June 24th at the summit in Chicago. So, very, very strong culture of lean within the platform.

Slide 19. Slide 19, you'll see some of our new campaigns we've been running related to KraftMaid. We're really engaging the consumer to understand the design capability of Kraftmaid, they can really personalize the experience to reflect their own personality.

Slide 20. In the Plumbing Products category, our key initiatives are really sourcing and supply chain. As costs change and labor increases, outside of the US, we really need to re-examine our entire cost position and we're doing that. We continue to invest in our leadership brands with Delta and Hansgrohe and Brizo. But we're also focused heavily on innovation in this phase. We're going to talk a little bit more about Diamond Seal on a future slide and also innovation from our point of view can be not only limited to new products but different ways to attack the market.

Slide 21. See a couple of examples on slide 21 of our Delta, see what Delta can do campaign. This campaign was designed to get the consumer to re-engage with the Delta brand to see what the new styles and functions that we have out there.

Slide 22. Our Diamond Seal technology which we have brought out in the Delta-branded product is really two major innovations here. We have a new ceramic cartridge where we have a carbon film between the disks and by doing that, we no longer have to have any lubricant inside of the cartridge so it extends the life of the cartridge. We also have introduced a one piece, what we call a [nano] flex waterway where there's no connector hose required but this also stops water from ever coming into contact with metal, within the faucet. So, we're excited about this innovation.

Slide 23. Our Hansgrohe is not only a design leader in Europe, but it's also a remarkable Company that being able to expand globally. Today, we now are selling the Hansgrohe products in more than 70 markets outside of North America.

Slide 24. On our Installation and Other Services segment, we continue to rationalize our product portfolio focusing on the most profitable products. We're driving innovation with the industry leading green building program, our Environments for Living program and we have partnered with GE to bring the Ecomagination home program to life. But we're also preparing for the future with NERP implementation with Masco Contractor Services that we're in the middle of a full-blown roll-out. That ERP roll-out will complete about this time next year. We're emphasizing more Repair and Remodel through our network of installers. And we continue to open new locations for Service Partners. That's our distribution business within the segment.

Decorative Architectural on slide 25. The key initiatives here are premium paints and stains that we brought out under the NanoGuard Technology. We brought out about a year ago, our Premium Plus Ultra Exterior which has sold extremely well at retail. And we have just introduced and are doing a launch into the Home Depot stores with our Premium Plus Ultra Interior, our Paint and Primer in one. And the picture on 25 is the new end-cap display for that Premium Plus Interior. And we have a new website on Behr to drive additional traffic to the brand. And we have our new Verve lighting control system.

On slide 26, the Verve system changes the way people think about wiring a home because there is no longer a wiring required from the switch to the fixture. The actual switch does not require any form of external energy. The flipping of the switch creates enough energy that can be harvested to send a radio signal to the control panel. We're very excited about this innovation. We think it will change the way homes are being built. We have now shipped our first orders and so this is an exciting time for us with this new product line.

On slide 27, on our Other Specialty Products, our key initiative here was really taking a look at the supply chain and how we serve the markets more efficiently. We have also introduced a new [premia] opening price point product, our Simplicity Window under the Mill Guard brand. We're excited about the opportunity this gives us as builders look to cope with competition from foreclosed homes and lower-priced homes. We think this is the right product at the right time.

I'll close my segment of the presentation with slide 28. We firmly believe at Masco that innovation is the lifeblood of our Company. We have a culture of and a long-standing history of being very innovative. But 2008 was a very, very strong year for us with 30% of our sales coming from products that we've introduced in the prior three years. So, it is a strong statement on our commitment to innovation and we hope that this will continue to go even higher from here.

With that, I'll turn the call over to Tim Wadhams.

Thank you, Donny. I appreciate it. If you please flip to slide 29, we'll talk about our full-year guidance. I would remind everybody that in the environment we're in, providing guidance forecasting business is extraordinarily challenging. But we will update you as to where we see things at this point in time.

We currently see our sales in terms of top line decline down approximately 20% to 25%. That's an increase in the decrease that we're anticipating in sales. Previously in our guidance, we mentioned that we anticipated sales to be down mid to high teens. And obviously down 26% in the first quarter, we - - as we said earlier, expect the first half to be difficult.

We currently see housing starts for the full-year at approximately 550,000. That's at the low end of the range that we provided back in February of 550,000 to 600,000. As a result, we currently anticipate that our loss will be in a range of negative $0.15 to negative $0.35 for the full-year. Previously, our range was approximate breakeven to a $0.30 loss.

We continue to believe that we will generate free cash flow of approximately $300 million and there is a slide in the appendix that provides some detail by the major components of free cash flow on a full-year basis.

Our EPS includes rationalization charges, which we anticipate will be approximately $0.13 a share. That relates to programs that we are already committed to. As we said in the press release, we'll continue to evaluate the business and it is possible that there could be increased rationalization related charges at $0.13 , is an increase from $0.08 that we estimated back in the February call, an increase from $44 million to approximately $70 million for the full-year.

We continue to anticipate an increase in pension expense over the prior year. That estimate now is about $0.05. I think previously we suggested it might be $0.06. We continue to believe that we will have tax expense not withstanding the fact that we're anticipating a loss for the year of somewhere around $0.04 to $0.06 a share. I would remind everyone that estimating taxes in an environment when you're around breakeven or slight loss is relatively difficult. The tax expense relates to jurisdictions that would include states and/or foreign locations where we have income where we are anticipating to have a loss that would offset the tax expense. So, that gives you a little summary in terms of where we see our guidance.

And with that, Bill, I think we can open up the lines for Q&A.

Thank you, Mr. Wadhams. (Operator Instructions) We'll take our first question from Budd Bugatch at Raymond James.

Good morning, everyone. This is Chad filling in for Budd.

Hi, Chad.

First question, in regards to the reduction in the revenue outlook, we took things down from mid to high teens to down 20 to 25. And housing starts you're assuming are at the low end of the previous range. And key retailer sales in the quarter were actually pretty consistent with what you had talked about for the full-year run rate last quarter. Obviously Q1 sales, I would assume that they were below the internal expectation for the quarter but I guess what really drove the reduction? Are you assuming, is Europe weakening worse? Is there an expectation for retail to get worse in the US? Or are you must adding more conservatism?

No, I wouldn't necessarily say conservatism. This is basically, we built up our forecast from the bottom up. And one thing I would point out is that we currently estimate that foreign translation will cost us about $300 million for the full-year. And we had about $85 million in the first quarter. We're anticipating that we'll have probably the rest of that will be evidenced in the second and third quarter. We had a pretty good hit in the fourth quarter of last year as the dollar started to strengthen.

So, I think, Chad, it reflects that. It reflects just in general, I think, a little bit more slowing. Our first quarter came in a couple percentage points lower than we anticipated when we talked to folks back in February. And that was really across the board, if you will. So, I think that when we think about it, the additional sales decline is pretty much across all of the businesses, both international as well as repair remodel and new home construction.

Ok. And given that reduction to the revenue outlook, I would have anticipated a bigger hit to the EPS outlook. Could you maybe walk us through or help quantify some of the incremental benefits that you expect will offset the deleverage?

Yes. Actually, that's a very good question, Chad. And as we talked in the first quarter, when we provided guidance, we anticipated at that point in time, that we would achieve about $120 million of cost structure improvement over last year. That broke down about $60 million related to savings from some of the actions that we've taken. The other $60 million was related to the relationship between price and commodities and that totaled $120 million roughly. We currently believe that that number is going to be closer to $200 million.

We currently believe that with some of the actions that we took in the first quarter, including a head count reduction at the corporate office, another plant closure in the cabinet business, that the savings that we're expecting this year should approximate $80 million.

I would point out to everybody that we have taken a lot of charges and we've talked about the benefits related to those charges, but the other thing that I think is important for folks to know is that we have had an ongoing focus on productivity, profitability improvement, if you will. Donny talked a little bit about lean principles in the cabinet group. So, there are a lot of other actions that take place within the Company whether it is material science related or a variety of areas where we obviously attempt to improve our operations on a day in, day out basis. So, we're currently anticipating about $80 million in terms of savings.

We currently anticipate that the relationship between price and commodities will generate about $120 million in terms of improvement over the prior year. I would point out that from a price standpoint, that is not anticipating any significant, additional improvement in price across the board. Most of the price increases that we have been pursuing are in place. There are a few that we will continue to pursue. And again, we don't get specific by customer or by product line there. But I would say that a lot of that relates to the anniversary of price and also the expectation that we'll see commodity prices decline. And that price commodity relationship does have implications to all of our segments.

In terms - - and just to give you a little perspective where we see those benefits resulting. We would guess out of the $200 million, that about 35% to 40% would relate to our Plumbing segment. Most of that is related to the relationship between price and commodity. We also expect in that segment to see some savings from a cost reduction standpoint in the back half of the year and a lot of that relates to our European operations.

You might remember that we did have a fair number of charges late last year related to Europe. We also think that about 20% to 25% of the $200 million would relate to our installation business. And again, most of that would relate to savings actions which would affect the back half of the year. Obviously you're aware, we've closed a number of branches, have had significant head count reductions in that business. We would expect to see the benefits of that flow through the last latter part of this year.

In addition, in terms of savings, cabinets, the corporate office, our other specialty segment, would represent about 10% of the $200 million each. And that would be the same for our Decorative Architectural Products Group. Savings, the cabs corporate and other more on the savings side as opposed to the price commodity relationship and a little bit of both in terms of our decorative architectural products. The commodities we're talking about include energy, natural gas, brass, petroleum-based products including resins for windows as well as glass. And in the first quarter, we estimate we might see about $20 to $30 million of benefit from activity in the first quarter.

I'm giving you a long answer here, Chad but hopefully this is helpful to others. We've seen positive signs in the numbers. Our SG&A spending has been down now pretty significantly, the last two quarters. We were down $64 million in the fourth quarter of 2008. Down another $60 million in the first quarter of 2009 in terms of total SG&A spend. I think you probably saw that our general corporate number was down from $43 million in the first quarter to $33 million this year.

The other thing I would point out is that we did see an improvement in our decremental margin, our decremental margin decline in the first quarter versus the fourth quarter. You might remember last year I think a decremental margin for the full-year at about 34%. That number was closer to 26% in the first quarter of 2009. So, I think that's certainly evidence that we're seeing some improvement and we also, we're only down 190 basis points in gross margin in the first quarter compared to last year's first quarter. The fourth quarter we were down 400 basis points. If you compare first quarter gross margin with fourth quarter, we were actually up 190 basis points. I think that gives little bit of perspective in terms of where we see that $200 million showing up over the course of the year. And again, I would point out that much of that is anticipated in the second half of the year.

Well, that's very helpful. Thank you very much. Good luck on the year.

Thank you.

We'll take our next question from Peter Lisnic at Robert W. Baird.

Good morning, everyone.

Hey, Pete.

I guess first question, Donny, maybe you could talk a little bit about the plumbing supply chain initiatives. I'm just trying to get an understanding of the breadth and the scope there. We've gone from looking at the supply chain and looking at overseas and low cost countries and now it sounds like the labor equation has changed. Just trying to figure out how significant is the work that you have to do there relative to the undertaking that you have in cabinets, for example.

Yes. I would be happy to make a few comments. Pete, right now, we're in the process of two things going on on the plumbing supply chain, primarily talking about our North American operations. One is we have a significant conversion to our Diamond Seal Technology which has changed that - - we're going from a ball valve to a ceramic cartridge and really a metal body and a connector hose to a one piece NanoFlex waterway. So, that changes dramatically as we convert more and more of the Delta products to DST which is internal for Diamond Seal Technology.

The second thing we're looking at on the Delta is more really along our opening price point product. Exactly what is the right supply chain to do that in a way that drives the lowest total cost and doesn't impact the quality or the ability to proliferate that brand into the appropriate retailers here in North America.

We started that work, Pete. It is not complete. Hopefully we are going to talk a little bit about investment conference we're going to have later in the year. Hopefully we can update you at that point. I will tell you that our opinion, the cost - - the price cost changes have been pretty dramatic and we think that you will see some pretty significant changes in the way under which we source those products.

Yes, Pete, one thing we could point out there that Donny alluded to is we've got the flexibility to really take advantage of whatever the most cost-effective approach is with some of the capabilities that we have in the Far East. So, it gives us the opportunity to manufacture here or there, depending on things like freight, labor cost, et cetera.

Ok. Great. And then just as the second time I heard the migration to opening price points. Window business and now plumbing. Is there a broader strategic shift or is that an underpenetrated opportunity for you as you look across the portfolio of businesses?

I think it is both, Pete. As we look across, our view of what happens on the way back out is that we think for very significant period of time that if you look at new home construction, we're going to be competing with the lower home prices which will force, really, our builder customers to de-content.

We also have consumers who we believe coming out of this will be more conservative in the way that they purchase. And when we look at some of our opening price point products, especially on the window side, where MillGuard has been positioned as a mid to high branded product, really didn't have a way to penetrate that market without discounting a product that we didn't believe was appropriate to discount.

So, simplicity for us does two things. It is an opening price point on the MillGuard product but also protects our MillGuard branded product from further discounting. On the plumbing side, we really have a wonderful opportunity with our Peerless product to continue to penetrate the opening price point. So, you'll see us get more aggressive with really trying to use that to attack the opening price points.

Excellent. That's very helpful. Thank you.

Thanks, Pete.

Our next question comes from Dan Oppenheim at Credit Suisse.

Thanks very much. Similar question there. There is a lot of talk about terms of investing in leadership brands, also less favorable product mix impacting the profits. Can you talk about how much of the margins were impacted by trading down and then as you're investing in the - - you think about the - - investing in the leadership brand, how much was going there versus the new products. And if we think about sales activity in 2010, how much will we see coming from investment products that are coming out now (inaudible)

Well, I think first part of your question, Dan, related to where we've seen mixed related issues in the quarter. And that would include in cabinets where we have seen a migration to lower price points and then with certain offerings in Europe, at a little bit lower mix in terms of just channel, if you will.

In addition, in plumbing, we had a little less rich mix primarily because some of the project work that Hansgrohe has been able to win in the Middle East had slowed down in the first quarter. We do understand that that is picking up in terms of opportunity for us going forward. So, we're encouraged by that. But we did have a little less exposure there.

In the other specialty segment, I think on the window side, I don't know that we had a mixed issue related to that. I think it will probably be primarily in the cabs and plumbing. Donny, are there any other segment you're aware of where we had any tradedown?

No, I think we have to be careful that the mix can be more than just tradedown. For example, if you look at installation services where the average home size has come down dramatically, that also creates, in our - - an unfavorable mix as housing starts come down and they start to be smaller, it impacts our take per unit as well. I think we're just seeing the overall less demand, smaller homes, opening price point products is just becoming a bigger issue.

The other thing, Dan, too, that we should mention is in our distribution business. We've seen a shift to a lot more roofing-related material which tends to have a little bit lower margin as well. There are some examples sprinkled throughout the business. Dan, could you repeat the other part of your question, please?

Wondering if you think about the margins first, how much - - good to get that clarity in terms of how much of the margin was coming from the - -

That would be tough for us to quantify, Dan. I would say that when you look at our numbers and you look at the significant declines in those groups we're down 30%, 35% on a couple of them. Most of the margin decline is tied to the significant volume reductions. That's not to say there isn't some impact from mix. But again, I think that just in terms of thinking about it, I think more about the volume side of the business.

Great. Second one, wondering if we could look out to 2010 or just thinking about where you are now, what percentage of your sales activity would you say would be the leadership brands and where do you see that shifting? How much of a shift do we expect there?

In terms of - - well we have very strong brands across almost every one of our segments. I would think that next year that we would continue - - I'm anticipating next year is going to be better than this year. And so I would expect that we ought to see some improvement across the board whether it's KraftMaid, Merillat, the Quality Brands and our Cabinet Group, Hansgrohe, Delta Faucets, as well as Behr which continues to take Share and MillGuard. I would expect all of those to continue to do well next year.

Thanks very much.

Our next question comes from Michael Rehaut at JPMorgan.

Thanks, good morning.

Good morning, Mike.

Appreciate the detail on some of the benefits by segment. That was very helpful. First question on the free cash flow forecast that you provided later, I think on page 38. I just wanted to know, you have other non-cash of 145. I was wondering if you could go into more detail on that. And also if you are considering perhaps taking another shot at the dividends to lower that and if there are any other areas of potential upside either through asset sales or the like to bolster the cash generation this year and next. Certainly perhaps to make things more increase some flexibility in front of the 2012 maturity.

Yes, in the other non-cash, Mike, what we have in there is we have stock-based compensation. We also have minority interest as well as deferred income taxes make up the 145. There is also probably a little bit of non-cash charges that would flow through that line item. So, that's what comprises that.

Your second question on the dividend. No, at this point in time, we are not thinking about or considering any reduction in the dividend. We did that very thoughtfully, I think, back in the early part of this year. And as we mentioned to folks, we certainly feel like on an annual basis, $105 million is something we can handle given we continue to anticipate having good cash generation capability.

In terms of upside to the free cash flow forecast, I do think there is a little bit of upside here. There is a possibility that CapEx could come in a little bit below what we're looking at here at $170 million. There is also certainly the possibility we'll do a little better on the working capital side.

We have incentives in place across the Company from a working capital management standpoint, balance sheet management standpoint, and as you can tell from the first quarter, I think this is one of the first times we have had a significant reduction in the first quarter versus the prior year. Typically those have run pretty consistently. You can see from that that the guys are getting after it. I would say that we've got a little bit of upside here. And I would guess that it might be $20, $25 million max.

Ok. Appreciate that. Second question, just on going back to some of the restructuring actions. Over the past 12 months, in particular, talking about the cabinets one of the thoughts given out was that you didn't want to cut too much so that once you get out of the down part of the cycle, you will be able to capture all of the upside potential. But there was talk of keeping overall capacity to a potential housing start number of, I remember hearing it, like at $1.8 million type of upside scenario. Given that that probably is pretty far out at this point, what are your thoughts in terms of where is your cabinet capacity in terms of total upside or that that upcycle start number capacity? Given that we're kind of at this trough where we might be at this depressed level for an extended period of time,what further actions or how are you thinking about that business in terms of taking a more aggressive right size?

Thanks, Mike. It is Donny. On the cabinet side, I think it is important to think about cabinets as being a very integrated supply chain. And to really attack that cost, you have to delayer the interdependency so that you can get further after it. We started that by really understanding what those interdependencies were and then what did we have to do so we could eliminate some of the relationships so we can continue to drive further costs out? We've done that on the builder cabinet side related to the common architecture. As that rolls out, that gives us further options.

We also have talked about a more normal housing market and to create our manufacturing capability to serve a housing market in the 1.2 to 1.8 range and wanted to believe that we could optimize our cost position within that range of housing starts. Today, obviously, that appears to be further out.

We still have confidence that the housing market will return to that range given the demographics and the demand drivers. But so we're looking at cost. If you look at what we did, we mothballed two of our facilities, our West Jordan facility and our Ocala facility because we felt both of those would be needed in a more normal market. We have continued to take costs out and we'll do so and as we continue to complete the ERP implementations and some of the things we're doing on the common architecture, it really gives us further ability to try to continue drive costs out of the business.

One thing I would mention, Mike, Donny mentioned mothballing those two plants. That currently costs us about $14, $15 million on an annual basis. And I think about $12 of that is depreciation. Most of it is non-cash. But we certainly think that that makes sense for the longer haul. As Donny indicated .

One last one if I could on the installation services. Last quarter, excluding the charges, you had a slight profit this quarter. You slipped back probably the biggest negative number to date. Any thoughts in terms of maybe more drastic action? I understood that earlier you were trying to reduce some of the product portfolio and get out some of the money losers, so to speak. What should we expect from that segment over the next few quarters?

Yes, Mike. I think we're doing all of the right things there. They continue to address their costs. There are some additional ERP-related charges in the quarter versus last year but they're really doing all of the right things. If you look at their decline in revenue versus their decline in profit, you'll see how aggressive they've been at being able to get after their cost structure. And trying to deal with a market where permits were down again year-over-year, quarter-over-quarter, north of 40% with a revenue decline of only 30%, 35%. You also could make a strong argument that they're gaining share because within that number, also also exiting some products that we no longer believe are profitable and we're dealing with smaller home sizes.

So, the key for me in that segment is to continue to take the cost basis down, continue to minimize our operating losses because on the way back up, I think we're going to be in a much stronger cost position as well as a stronger share position to really capitalize on the way back up. So, we're excited about the opportunity within that segment and to continue to do the things that we're doing.

We also mentioned that we have challenged that group, that leadership team, to get more active in the retrofit market. And we have been very active with understanding how the money is going to roll out into the - - the incentive money into that segment and with our basis in Building Science and Environments for Living, we think that that's a great play. And I also think you see a little bit of our commitment to that segment with the two new Greenfield locations that we've opened at Service Partners that continue to expand our distribution base. So, although a challenging environment for installation services that, at this level of housing starts, we think it is a pretty bright future.

Mike, this is Richard. If I can make one comment on your question of excess capacity. As you know, this cycle, I've been through a lot of cycles over 50 years, has been worse than any other ones we've seen, both in the sense of depth of the decline, unprecedented levels as well as the scope of the decline affecting home improvement, new construction, a lot of things which often were countercyclical to one another. But historically, Masco has gained market share more rapidly during economic declines than in normal economic environments.

One other thing that I think is going to be different in this cycle is in this cycle, unlike other ones, in previous cycles, we saw very little change in the competitive environment across the board among our competitors. I think in this cycle, because of the depth and the severity of the cycle, we're going to see competitors go out of business, capacity be reduced, so that I will be surprised if we don't gain even more market share in this cycle than we have in past cycles which is another reason why having that excess capacity might well be a competitive advantage to us down the road.

Great. Thanks.

Thanks, Mike.

Our next question comes from David Goldberg from UBS.

Thanks, good morning, guys.

Good morning, David.

The first question, I wanted to get a little bit deeper into some of the changes at MCS and specifically the move toward maybe taking on some more repair remodel work. And the question is really how that affects the operating leverage in the business. And what kind of margin you can generate in that on repair remodel activity relative to new home construction where you might be doing multiple steps in the process?

Ok. Yes, on the MCS side, as we said, we really focused on narrowing down that product portfolio to those products where we think we have the greatest scale to be able to generate the highest level of profits. The other thing that's real important with MCS is we went through the ERP roll-out and implementation but eliminating that - those number of products reduces the variability on the complexity which drives a tremendous amount of cost out for that organization as a whole.

So, as we started looking at the 40 different products, there wasn't the velocity and the majority of those products to create any type of scale or efficiencies. And what it was doing was really creating a lot of cost and complexity throughout the organization. We think we'll an stronger Company and a more profitable Company with less products and we'll go after a higher share of the products we remain in.

On the retrofit side, we have created a separate organization called Masco Home Services to really become the front end of the consumer. That organization will do the lead generation, they'll do the interaction with the consumer and Masco Contractor Services will become a subcontractor to Masco Home Services. What we understand very well is Masco Contractor Services does things in scale but does not interface with consumers. So we created a separate organization to do the consumer interface and to interact with both the local and state governments in accessing the incentive funds that are available for retrofit applications. So, we feel really, really good about that.

And I would mention that the Environment for Living Program is also a part of the Masco Home Services so that as we continue to expand our industry-leading building program, that same building science that we're using to make more homes, new homes more efficient is the exact same tool that we need to improve the performance of existing homes. So, those employees that have been going on new homes to make them more efficient for our builder customers are now going on existing homes and creating a list of those type of activities that need to take place to make the existing home more efficient. We think we have the right plan to go to market. We think it leverages our cost structure very well, but also provides what we think is a tremendous experience for the consumer as they interact with an organization that is focused 100% on delivering quality experience for them.

Donny, if I can make sure I understand though, the Masco business does 12 products in the construction process. Right? And sells 12 products or however you want to think about it. I would guess Masco home services would be a lot fewer products and maybe one at a time since it is a retrofit business. What I'm trying to understand is what's the profitability of doing it on a [one off] basis versus something where you're installing multiple products at the same time.

Right. I think what you have to realize is on the MCS side, even though it is multiple products going into the home, they all happen within a construction schedule meaning they happen on the day under which they're scheduled to occur. So, although we may do four or five products, they may not be sequential in nature and their dependency is based upon the product that occurs before them, being completed so the next one occurs.

The scale for MCS is really the strength of that organization is by being able to do so many homes and being able to leverage that purchasing power to then deliver across more than any one builder, any one community or multiple communities, but to really take in the total demand on those products.

On the Masco Home Services side, you're right. A lot of that work is going to be weather stripping, air sealing, sealing of ducts, reinsulation. Where we'll create the scale is really leveraging MCS to do the retrofit insulation where we already have the equipment, the machinery and the product and inventory. The actual consumer interface where we'll be doing the testing and the caulking and the weather stripping will be done by the folks that currently do the work for the builder community in the Environments for Living program as we go out and do the energy audit.

The margins on that side of the business are actually really good because what you have is the opportunity to create that experience, but you also have a significant payback. Because if you look at how inefficient the homes are, we're able to do work in these homes to improve the efficiency of the home so the consumer is a compelling value for them, and given some of the incentive offset to really invest in their home and get a significant payback on their future utility costs.

Then just a quick follow-up question. I was wondering if you could talk about the sensitivity of your cash flow estimate to the starts number. And what I'm really trying to understand is let's say -- I know everybody thinks that this downturn is going to last longer and certainly it will. Let's say we start to accelerate a little bit. Can you keep the working capital reduction down to the point that you can generate more free cash flow because starts are going up and because the business is getting better? Or does it require you to start building the working capital again?

David, if business starts to pick up which obviously we anticipate at some point here, we will have to replenish working capital. There is no question about that. Now, the question is how much we'll have to do? And with our folks as focused as they have been, I think we can do a very good job of managing that. One of the big challenges for us as we drive lean principles and continuous improvement into the business, can we eliminate some capital expenditures? Can we improve our processes? We're doing some (inaudible) work around process improvement as well as shop four] stuff. We think there will be opportunities to do a better job but there's no question that as we come back out of this, we'll have to put more money into working capital.

Ok, thank you.

Thank you.

We'll go next to Ken Zenner at MacQuarry.

Hello. Just wanted to go back to the change in the forecast in the earnings you laid out. The change in sales, with FX I think was $200 million is what you thought it was going to be in January. Now, it is roughly 300 so that's about 1%. s It looks like all of the changes basically related to remodeling. Is that correct?

No. I think there's some impact related to international operations beyond foreign exchange as well as on the new home side.

Over in Europe is what you're saying?

Yes. The new home side in North America as well.

Right. It seems like you only took it from the 550 to 600 range to 550. That's why I was focusing on the remodeling dropping off so much.

It's a slight drop. Yes. There's no question. But there's still some implication there.

Then how - - relative to the decline obviously and the remodeling demand. How do you think inventories are at the retail level?

Not aware of any significant issues. If anything, maybe a little on the lower side. They've been managing inventory, but we haven't necessarily seen any issues in our product lines that have been either helpful or hurtful.

Ok. Then I guess because you're expected savings now, you talked about this 120 number moving up to about $200 million.

Right.

So, a $80 million change. It seemed like $60 of that was related to pricing commodities. Is that correct?

Yes.

How do you think, since the cost savings I get, you're obviously restructuring but since the majority of that was really tied to commodities that were beyond your control. How do you think of the risk of that benefit being mitigated in terms of pricing as other manufacturers would also get that benefit? Thank you.

I think there's certainly some risk to those numbers but I would like to think that those are positive situations if, in fact we are in a situation where we might trade price for volume, Yes, you have to make those decisions on the fly and there will be discussions like that. But I think what we're really reflecting there is probably a little lower corporate discount to what our business units anticipated a little earlier in the year. So, we've got more visibility now than we did six weeks in mid February and do feel comfortable that we should be able to deliver those numbers late this year.

So, when you're talking pricing, you're talking about in terms of discounts, that's actually discounts you would have expected to give to the customers?

No. No. We're talking about price - - when we talk about price commodity relationship, what we're talking about is the relationship going forward compared to where we were last year where we had I think three segments, cabinets, decorative architectural as well as I believe other specialty and a little bit in plumbing where material cost was up. And as I mentioned, there have been some price increases implemented that we'll anniversary this year.

Thank you.

Thank you. Operator, I think we'll cut it off there in terms of questions. As the operator mentioned, as Bill mentioned earlier, we can certainly handle any calls that you might want to send in later on. We'll be available all day.

I would like to have you move to slide number 31, if you would please in your deck. And I would like to thank all of you for joining us today.

We continue to aggressively manage our cost structure and have worked very hard over the last several quarters to offset the impact of the current economic environment on our business. Although we expect market conditions in the near-term to be very challenging, we continue to be confident that the long-term fundamentals for the new home construction and home improvement markets are positive. That confidence is buoyed by the dedication and energy of the Masco team.

And we believe we've made significant progress transforming business models to enhance manufacturing flexibility, better understanding of our customer and ultimately end consumer's total experience with our products, working to enhance the quality and sustainability of our products and services, driving continuous improvement and lean principles in everything we do, ensuring that our pipeline for innovative new products and services is robust and continuing to invest in the development in opportunities of our employees worldwide that are making all of this happen.

While forecasting is fraught with risks, we are also encouraged, maybe cautiously optimistic is a better term, that we are seeing positive signs in the economy. Government stimulus and liquidity programs are in place and seem to be working. Mortgage rates are at all--time lows. Refi activity has increased. Affordability has improved. And importantly, consumer confidence has picked up. And we believe that we're seeing signs that housing and home improvement markets appear to be bottoming or, at least, they're not getting worse at this point in time.

There is a lot of energy at Masco and we will share with you this fall, at our investor conference on September 17th. Please hold that date and we will review with you how we are positioning Masco to win. Thank you very much.

And again, that does conclude today's conference call. Thank you for your participation.