馬斯科 (MAS) 2013 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to Masco Corporation's third quarter 2013 conference call. My name is Tiffany, and I will be your conference operator for today's call. As a reminder, today's conference is being recorded for replay purposes.

(Operator Instructions)

I will now turn the call over to Vice President of Investor Relations, Maria Duey. Maria, you may begin.

Thank you, Tiffany. And good morning to everyone. Welcome to Masco Corporation's third quarter 2013 earnings conference call. Joining me on our call today are Tim Wadhams, President and CEO of Masco, and John Sznewajs, Masco's Vice President, Treasurer and Chief Financial Officer.

Our third quarter earnings release and the presentation slides that we will refer to during the call are available on the Investor Relations portion on our website. Following our prepared remarks, the call will be open for analyst questions. As a reminder, we would appreciate it if you would limit yourself to one question with one follow-up. If we are unable to take your question during the call, please feel free to call me directly at 313-792-5500.

I would like to remind you that statements in today's presentation will include our views about Masco's future performance, which constitute forward-looking statements. These statements are subject to risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements. We describe these risks and uncertainties in our risk factors and other disclosures in our Form 10-K and our Form 10-Qs that we filed with the Securities and Exchange Commission.

Today's presentation also includes non-GAAP financial measures. We have provided a reconciliation of these adjusted measurements to GAAP on our website at www.Masco.com. With that, I will now turn the call over to our President and Chief Executive Officer, Tim Wadhams. Tim?

Thank you, Maria. And thank all of you for joining us today for Masco's third quarter 2013 earnings call. And if you would please move to slide number 4.

As we have for the last several quarters, Masco's third quarter results showed strong revenue growth and margin expansion compared to the prior year quarter. We continue to execute on the strategic initiatives we laid out at the beginning of the year. As a result, this is the first time since the third quarter of 2007 that we have delivered double-digit operating margins. That outcome was driven by a double-digit increase in top line sales and strong operating leverage. We're very pleased with these results.

Our leadership position in the building products industry and our focused execution against the housing recovery benefited all of our segments this quarter, with all five of our operating segments contributing to our top line growth. In North America, we continue to benefit from increased new home construction activity and improving trends in remodel activity, where we are starting to see an increase in bigger ticket-related items. In addition, the investments we have made in new products and programs have strengthened our business, particularly benefiting our paint and plumbing business. We are seeing the benefit of our strict focus on cost containment, as well as our ongoing commitment to total cost productivity, as evidenced by our incremental margins. Importantly, our installation and cabinetry segments grew both top and bottom line in the quarter, reflecting our strong leverage to a housing recovery and significant improvement compared to last year. Our international sales and profits continue to increase, reflecting the slowly improving economic environment in the Eurozone and a solid performance by our international plumbing and window businesses.

And if you would please turn to slide number 5. As we have communicated in the past, our strategy is focused on four key elements to drive performance. Our commitment and investment to expand our market leadership positions was recognized by one of our major partners, The Home Depot, at its recent supplier partnership meeting. Both Delta and Behr were awarded The Home Depot Partner of the Year award in their respective categories. Both Delta and Behr were also recognized for The Home Depot's top 10 innovations of the year, reflecting the emphasis we place on innovation at Masco. In addition, unrelated, Delta was awarded the EPA WaterSense Partner of the Year. We're extremely proud of Behr and Delta, and congratulate both teams on their recent wins, and thank them for their hard work and dedication.

Our company-wide emphasis on cost control as sales increase is demonstrated by our improvement in gross margins, SG&A leverage and our operating margins. John will discuss that in a couple of minutes, but we're very pleased with that outcome. Our installation segment is capitalizing on improved market dynamics and drove sales in all channels of the business. By remaining focused on profitability, they continue their trend of improving their operating profit.

North American cabinetry is outperforming the new home construction market, and is benefiting from positive trends in remodeling. We had strong growth in the quarter reflecting the stabilization of the business. The team continues to execute on their strategic plan, positioning the business for future profitable growth. Combined, these two segments, cabinets and installation, improved by $41 million of operating profit, compared to the third quarter of 2012.

In addition, we remain committed to strengthening our balance sheet and continue to improve our working capital management. In addition, in August, we retired a $200 million debt maturity with cash on hand. These strategic highlights demonstrate our continued focus on execution, which produced another strong quarterly performance. And if you would please move to slide 6, John Sznewajs, our CFO, will take you through our operating segments from a financial and operational perspective.

Thank you, and good morning, everyone. If you could please turn to slide 7. Due to the improving fundamentals of our business, our momentum accelerated coming out of the second quarter and we delivered another quarter with double-digit sales growth and operating margin expansion. In fact, this was our eighth consecutive quarter of year-over-year sales growth and adjusted operating margin expansion. Sales increased 12%, with North American sales up 13% and international sales up 5% in local currency for the quarter. Currency had an approximate $13 million positive impact in the quarter. And while we experienced strong growth in all channels, volume increases were strongest in our direct to builder channel.

We did a great job of leveraging our costs in the quarter, as adjusted gross margins expanded 120 basis points, to 28.5%. The strength of our bottom line performance and our commitment to cost control were evident in the quarter, as our SG&A as a percent of sales declined to 18.2%, a 140 basis point improvement, and a terrific outcome and one of our best performances on that metric in many years. As a result, adjusted operating income increased 50% to $222 million, with adjusted operating margins expanding 260 basis points, to 10.3%. As Tim mentioned, our first double-digit operating margin in 6 years. We realized good operating leverage as we delivered 31% incremental margins in the quarter. And our adjusted EPS nearly doubled in the quarter, to $0.27, from $0.14 one year ago.

Turning to slide 8, we can see the components of our operating income improvement in the third quarter. The $59 million increase in net volume mix was driven by solid volume increases in every segment. This growth was partially offset by mix in both our cabinet business, with strong sales growth to production builders, and in our decorative architectural segment, with their successful new programs and expansion into international markets.

Net price commodity improved approximately $15 million in the quarter, largely driven by our cabinets, European plumbing, installation, and US windows businesses, partially offset by an unfavorable price commodity relationship in our paint business. This also reflects the year-over-year impact of our metals hedge, which was $1 million favorable in the quarter. We captured $42 million of profit improvements gross in the quarter, and believe we are on track to realize our full-year profit improvement initiatives gross of $160 million, up $10 million from our prior estimate of $150 million.

If we turn to slide 9, you can see we delivered solid performance in our plumbing segment, as sales increased 11% in the quarter. The strong sales momentum of our North American faucet and toilet businesses, which include our leading brands Delta, Peerless and Brizo, continued in the third quarter. Consumer demand for our innovative new products drove a mid-teens percentage sales growth in the quarter, as we experienced good growth at retail and strong, balanced growth in the trade channel, reflecting our continued investments in the showroom, commercial and multi-family segments of this channel. We were up against a difficult comparison in the quarter, as Q3 2012 benefited from approximately $12 million of load-in related to our retail program wins in the second half of last year. As a reminder, we all face a similar headwind of $12 million in the fourth quarter.

We also experienced mid single digit growth from several of our other North American businesses, such as spas and our rough plumbing business. In following an improved second quarter, our European sales momentum continued, with sales increasing mid single digits in local currency, led by Hansgrohe. Partially offsetting this growth was the exit of the unprofitable trade channel bathing business and lost retail bathing programs. These actions negatively impacted sales by approximately $12 million in the quarter and will total approximately $50 million for 2013.

Year-over-year operating profit increased $43 million, driven by incremental volume, especially in the trade channel, a favorable price commodity relationship, particularly in Europe, favorable currency, and productivity and cost control measures. Recall -- you may recall that 2012's Q3 operating profit was negatively impacted by $10 million due to increased program costs and currency.

Turning to slide 10, you can see our decorative architectural segment enjoyed good growth as new product introductions such as Behr Marquee and Behr DeckOver, which continue to perform well. Increased pro sales in international sales growth drove a 9% revenue increase in the quarter. And as a result, we realized low teens percentage gallon growth in the quarter. Liberty Hardware also continues to contribute to both the top and bottom lines of this segment, as a result of share gains and several new programs in retail. Our efforts to drive gallon growth included $10 million of incremental investment in advertising and promotional expenses, which, when coupled with an unfavorable price/commodity relationship, caused our operating margin to decline in the quarter.

If you turn to slide 11, you can see that our sustained focus on profitable growth in the cabinet segment resulted in improved performance, as we posted a double-digit sales gain in the third quarter, and adjusted operating profit for the second quarter in a row. The environment for cabinetry is improving, as we experienced ongoing strength with our builder accounts and accelerating demand from our remodel customers. All three brands are benefiting from these improved market conditions. These trends led to segment sales increasing 15% in the quarter.

North American cabinet sales, excluding countertops increased 20% in the quarter, reflecting strong direct to builder sales growth and improvements in the dealer and home center channels. We maintained our profitability in North America by improving our adjusted operating results in the quarter by $21 million, reflecting a 62% incremental margin. This improvement was driven by increased volume, cost control, productivity improvements, and lower promotional spending. This was partially offset by higher input costs and negative mix due to increased sales to production builders.

The turn-around plan in North America continues to be on track, and we are profitable in this segment sooner than we anticipated, as a result of our focus on cost containment, improving demand, and actions taken late in 2012. After preparing one of our existing facilities to absorb additional volume, we announced the closure of a component plant in the quarter that was identified as part of our late 2012 footprint consolidation plan.

Turning to slide 12, our installation segment saw sales growth of 19%, which was driven by a 28% increase in residential new construction sales, and to a lesser degree by higher sales volumes in our commercial, retrofit and distribution channels. We experienced strong growth with all builders, but particularly the big builders. In addition to solid top line performance, many different strong execution delivered significantly improved bottom line results, with adjusted operating profit improving by $20 million and adjusted operating margins expanding by 540 basis points. This strong execution was complemented by the continued implementation of a leaner operating model, which was allowing for efficiencies in facilitating growth in new geographies. We anticipate that we will have opened 15 new locations by year end, and expect further greenfield growth in 2014. This segment exhibited strong operating leverage in the quarter, delivering 35% incremental margins despite the impact of rising raw material and labor costs.

Turning to slide 13, our other specialty products segment saw sales increase 13% in the quarter, yielding another strong quarter driven by our North American window sales increase of mid-teens percent. This growth was due to higher sales in both the new home construction channel and replacement window markets.

As Europe shows initial signs of economic stability, our UK-based window business produced positive volume increases in the low-teens percent, driven by continued growth in trade and retail channels and the success of our small composite door acquisition earlier this year. The segment's adjusted operating profits were flat in the quarter compared to the third quarter of 2012, despite the increased sales. This is primarily due to the negative mix and several miscellaneous costs, including the initial costs of implementing a new ERP system at our Milgard window business. Our estimate at this time is that the ERP implementation costs will be approximately $2 million to $3 million in each of the next several years.

And then turning to slide 14, you can see, as Tim mentioned earlier, that we retired $200 million of debt with our August maturity, and that our working capital as a percent of sales increased -- or improved significantly, down to 12.1% in the quarter, compared to 14.8% in the third quarter of last year. Also, at the table at the bottom of the chart, you can see that our liquidity, both our cash and cash investments, and our short-term bank deposits, aggregate $1.3 billion. I should point out that since January 2012, we have reduced total debt by $600 million, while our total liquidity has improved by about $200 million. With that, I will turn the call back over to Tim and his thoughts on our outlook.

Thank you, John. And if you would please move to slide 16. Our success in the third quarter reflects our commitment to executing on the priorities we identified at the beginning of the year. Our installation and cabinet businesses are continuing to deliver results from their focused execution against improving market dynamics. The previous actions that they have taken to improve their business will continue to deliver benefits going forward. And as John just mentioned, we reduced our debt in August and do not have any maturities in 2014.

Our commitment to innovation, new products and programs, and strategic growth initiatives, is producing results and augmenting market growth, as indicated by our third quarter performance. We continue to manage costs aggressively, and are on target to achieve approximately $160 million of profit improvements for the year. We are very encouraged by our third quarter performance and continued progress against our priorities, and we want to thank all of our employees, worldwide, for their ongoing efforts to drive Masco's performance.

And if you would please move to slide 17, just a couple of quick comments before we go to Q&A. The underlying fundamentals of our business remain strong, as evidenced by another quarter of sales growth and margin expansion. We expect that the positive trends in new home construction and home improvement in North America will continue. Having said that, we recognize that there are macroeconomic factors that will challenge us going forward, including the velocity of the US recovery and global economic uncertainty. Despite these macroeconomic factors, we are positioned to continue profitable growth and value creation for our shareholders.

Our size, scale and strong liquidity allow us to rapidly respond to increased demand and new home construction. Our focus on strengthening our brands through consumer-driven innovative solutions for our customers and consumers is driving share gains in the repair/remodel channel, furthering our strategic relationships with key customers. And our emphasis on cost control and process improvement enables us to convert increased volume with strong operating leverage to improve margins and returns.

We feel very good about our year to date results, and are particularly pleased with our third quarter performance. We will push to close the year with a strong fourth quarter, and are off to a solid start, with October sales looking to be up high single digits percent. We are excited about the future, and believe that Masco is positioned for improved operating performance in 2014 and beyond. And with that, Tiffany, we will open up the lines for Q&A.

(Operator Instructions)

Your first question comes from the line of Dennis McGill with Zelman and Associates. Your line is open.

The first one, you noted, within decorative architectural on the gallon side, low-teens percentage growth there. But there is, as you noted, new products, some load-ins on some business that you've won. Can you maybe separate what you think is apples-to-apples growth versus some of the market share? Or new product growth that is embedded in that low-teens percentage?

In terms of the gallon share increase, Dennis?

Yes. In other words, what did same store gallons go up? And then what would the new product introductions and/or market share placement --

I don't have that level of detail, but the new products, particularly the DeckOver product, had a very strong quarter for us. But as we have indicated, gallon growth has been an area of focus for both us and The Home Depot. And certainly felt good about that outcome in the quarter, and did see growth in other areas of the business, but the new products drove a lot of that.

So is that a load-in effect, or is that the success of the (multiple speakers) --

No, I wouldn't call it a load-in effect, Dennis. We got most of that product in in the second quarter, as I recall. I think most of that was done -- in fact, I am sure that was done in the second quarter. So that was all incremental.

Okay. Thanks. The second one would be just within the cabinets business. There are several moving parts, it seems, from the pricing standpoint, with price announcements being announced across the industry. And then you also have the Chinese plywood dynamic on the raw materials side. So can you talk more broadly about the moving parts between price, raw materials, and then promotional activity?

Sure, Dennis. It is John. There is a couple of things that -- to your point, that impact the segment. So in terms of promotional activity, we have seen promotional activity down pretty significantly compared to this time last year.

In terms of raw material pricing, we have seen some of the input costs go up during the course of 2013. And we did implement price earlier in the year to offset some of those costs. But to your point, the Chinese tariff that was announced in the third quarter did impact us by about $2 million negatively in the quarter. And we have announced price increases to offset some of those -- that action specifically, later in the fourth quarter.

And just a quick follow-up on that. Are you seeing competitors match or announce similar price increases?

We have not seen -- I haven't followed all of our competitors, but there has been -- we have heard of other pricing actions taking place.

Okay. Thank you, guys.

Your next question comes from the line of Robert Wetenhall with RBC Capital Markets. Your line is open.

Hi, this is Desi filling in for Bob. Thanks for taking my question. When looking at the paint segment, I want to see if you can provide some color on the long-term strategy for that business? You mentioned a few quarters now, you've wanted to drive down growth. So with sales up 8.5%, but profit declining by $3 million, I wanted to see that you can think about the trajectory for promotional spending and profit growth in the business?

We certainly have indicated in the past, Desi, the desire to want to grow gallons, and we did indicate earlier this year that we anticipated there could be some investment that would help us drive that. So from a longer-term strategy standpoint, that is certainly where we expect to be going forward.

As we have indicated, we are willing to invest behind that. We did have about $10 million of additional advertising and promotion in the quarter. And that obviously had an impact on the margin. But I think if you look at the margin on a year to date basis, I think we are slightly above last year, maybe 50 basis points above last year, at 18% plus.

And certainly would, as we think about growth going forward, whether that is with the pro, whether it is part of the international strategy, as we indicated in the past, we expect that to have a very high return, but potentially some negative impact on margins. And we have also said that we still expect those returns on sales to be very strong. So that has been consistent. And that's really the way we see that developing going forward.

Yes. And then in the cabinet segment, you rolled out some new products in the quarter, and are getting greater traction with the customers, particularly in the dealer channel. Can you talk about the success of those new products so far?

Rates, Desi, is the [firmest] benefit. We did launch some new product under the Merillat brand earlier in the third quarter. Now I tell you that, since that was launched early in September, it is tough to tell what kind of traction those are gaining, since they are just hitting the dealer showrooms at this point. I think we can probably give you a better update in 2014, when we have had more experience with those products.

Okay. Thank you.

Your next question comes from the line of David Goldberg with UBS. Your line is open.

Good morning, it is actually Susan for David. You guys noted that you're definitely seeing some improvement in the repair/remodel side of things. Can you just give us a little more detail on maybe what exactly you're seeing there, and what is driving that? Are you having to increase promotions or incentives in any way? And is it at -- you noted that it is at a slightly higher price point, and maybe just what you think is encouraging about that?

Yes, what is encouraging there, Susan, is some increases we saw -- we have seen -- we mentioned on the second quarter call that we started to see some trends in terms of pickup that is related to both windows and cabinets. And I think that, as we think about price points, our KraftMaid brand, which is semi custom, was up low double digits in the quarter.

And we also experienced sales in the dealer channel, up low double digits. And I think that those two facts, from our perspective, certainly would tend to reinforce, and certainly indicate, that we are seeing a little bit of movement from a price point standpoint, as well as additional activity in the dealer channel. Both of those would tend to point towards more activity from a remodel standpoint.

Okay. And then even as we get into a seasonally slower period in the fourth quarter, do you think that you will somewhat buck those trends, given that we're in the early days of this, and that it is just starting to come back?

The fourth quarter is seasonally usually a little bit slower, and remodel activity in the fourth quarter, because of the holidays and the time of year, tends to be a little bit lower. Having said that, I don't see anything, as we look out, that would suggest that remodel is not going to be relatively strong going into the season next year, if you will. And so we are certainly optimistic as we look ahead.

Okay. Great. Thank you.

Thank you.

Your next question comes from the line of Philip Ng with Jefferies. Your line is open.

Morning, guys. You mentioned October sales were up high single digits. Is that an indication that demand, the velocity of the recoveries is decelerating a little bit, or just too early to call?

No, I wouldn't say that at all, Phil. In fact, if you recall, last year's October for us was up mid teens. So we had a very, very strong October last year, and we are up high single digits against that, or we appear to be. Obviously, we've got a couple more days left in the month, but we look to be up high single digits. So no, I wouldn't say that by any means.

Got you. And on the mix dynamic in your cabinets business, I appreciate that you're gaining share on the builder side, which I guess is a negative mix. But on the flip side, you're seeing a pickup in R&R and the dealer side. Should that mix dynamic turn positive going forward? Or how should we think about that dynamic?

I think over time, we typically tend to be about 60% R&R, 40% new home in a more normal kind of environment. Obviously, we're not in a normal environment at this point in time. But I would expect that we would see our sales at least tilt towards more repair/remodel activity as time goes on.

Okay. And just one last question on the paint business. During the quarter, you guys obviously made some investments on promotions for the rollout of some of your new products, that $10 million, should that reverse going into Q4? Or should it stay at an elevated level in the short term?

I wouldn't expect it to be at the $10 million in the fourth quarter, but there could be some incremental promotional-related expense.

Okay. Thanks, guys. Good luck on the quarter.

Thank you.

Your next question comes from the line of Michael Rehaut with JPMorgan. Your line is open.

Thanks. Good morning, everyone.

Good morning, Mike.

First question, on the cabinets. You had really great acceleration of year-over-year top line growth there, and mentioned that it was across all channels. But I was wanting to get a little bit more granularity if possible, in terms of the builder, dealer and retail, which, if you could walk through the magnitude of growth for each, and give us any sense of margin impact? It appears that the negative mix by the builder channel maybe had a little bit of a suppressing effect, but which channel is the most profitable? And understanding that right now, I guess you're still building out your dealer channel as well.

Mike, it is John. In terms of growth rates by the various channels, which you would expect did take place in the quarter, so our direct to builder was up a little bit better than lagged -- 90 day lag to housing starts, so up high 20s, low 30s percentage. As Tim mentioned, the dealer channel was up double digits percent, as was the home center channels, in addition.

So good strength, the cost, the remodel channels, as Tim alluded to earlier. We really haven't broken down our margin -- our profitability by segment at all -- or by channel, I should say. Though I would point out to you that our Kraftmaid product offering, which has a greater opportunity to be upgraded due to additional features and design elements, probably does carry a little bit stronger margin profile than our direct to builder offering.

Great. And just going back to the decorative architectural. I know there has been a bunch of questions there. But just trying to understand, and I think we have talked about this on previous calls, in terms of the longer term margin profile of the business. Historically, it has been plus or minus around 20%, and now you have had a couple of quarters of promotional spend. I remember back in -- a few years ago, where there was a three or four quarter major upgrade, I believe, in Home Depot, where you were putting in a lot of displays. I think they were even computerized, and there is a big investment there. And that really did yield a lot of, I would say, longer term benefit, in terms of the relationship.

This feels a little bit different this quarter and last, where -- what I'm trying to get a sense of is, is the promotional spend here more of just a shorter term, perhaps even just cost of doing business with Home Depot, where you're trying to drive volume and take advantage of the season? Or are there longer term benefits in terms of the volume growth that you saw in the last couple of quarters? Going back a few years ago, when you put in the displays, et cetera. There was more of a longer term impact there. It feels like this is more of a shorter term seasonal impact, and maybe you could tell me if I'm on to that, or is that accurate or fair, or how to think about that?

Yes, I would think -- I would say that is somewhat inaccurate, Mike. You're right about the timing of the color centers. That was 2003 that we put those in. And those is have been upgraded since then. And that was a long-term investment by us. But everything we do, basically, is in large part driven for the longer term.

The penetration of the Pro, for example, that we have worked on over the course of the last couple, three or four years, is certainly longer term opportunity for us. The move into international, we picked up the Mexican business from Home Depot earlier this year. We talked about that. Those are both efforts that are really driven on the longer haul.

As we continue to innovate and bring out products, that cycle continues over time, and has been evidenced by our paint, primer in one, along with the DeckOver product, the Marquee product. So we continue to be longer-term focused in that segment, and certainly we will continue to look at it that way. We think we've got great opportunity with the Pro. We think we've got opportunities from an international perspective. So from that standpoint, certainly believe that there is a lot of upside for us over the longer term.

So just -- I appreciate that, Tim, and following that, in terms of the increased advertising and promotions, how does that fit into -- do those increased advertising and promotions fit into those Pro and Mexico initiatives? Or are they there to support some of your more new recent products? Or how does it (multiple speakers) --

Actually, all of the above, Mike. And basically, when we're promoting, or when Home Depot is promoting, generally speaking, that is to attract people to different opportunities, but we've got a variety of products that that applies to. So I think, generally speaking, that is pretty much across the board.

Okay. Thank you.

Okay, thanks, Mike.

Your next question comes from the line of Garik Shmois with Longbow Research. Your line is open.

Question on the installation division. If the pace of the housing recovery slows, how is that going to impact how you view the business over the next 12 months? Can you -- you mentioned branch openings being planned for next year. Can you flex that up or down, depending on the pace of the housing recovery?

Yes, absolutely we can flex that, and it really does not have any bearing -- if there is a little pause here, obviously there was an interest rate spike, and a little bit of reaction to that a couple, three months ago. But from our perspective, that is a pause, or could be a pause. We have not seen any impact on our business necessarily, because of the 90 to 120 day lag.

But as we look ahead, we are very confident, very comfortable that we ought to continue to see growth on the new home side. Our sense is 150,000 to 200,000 starts a year for the next couple, three years on the upside. So I wouldn't necessarily see anything that might transpire here as anything other than temporary.

Okay. Thanks. And then you mentioned $2 million to $3 million in costs for the ERP implementation in windows. Was most of that in the third quarter? Just trying to figure out what the impact was recently.

Yes, it was a little bit more than half that in the third quarter. There will be some more expense in the fourth quarter this year. And then Garik, going forward, for the next couple of years, it will be $2 million to $3 million each year. And we try to give you a sense as to, in which quarter that will fall out as we incur the costs.

Sure. Thanks so much.

Your next question comes from the line of Mike Wood with Macquarie Capital. Your line is open.

Just a quick question on Hansgrohe. How much is that still a drag, in terms of the impact on new market expansion, on plumbing margins?

There is very little mix impact from that particular business at this point in time. We do have a little bit of mix related to some of the new products. So the source and sell toilet that we have mentioned previously, which has a little bit lower margin, but obviously, a nice return.

Okay. And then just kind of a little higher level. In the past, you've talked about 13% plumbing margins mid cycle, and you are past that in this quarter. It seems like mix is improving in Hansgrohe. Is there an update you can give us as mix normalizes?

No, I don't think I would necessarily back away from what we have said. Obviously, we had a very, very good quarter in plumbing, and we're really proud of that. No question about it. All of our teams did a nice job there. If you look at it year to date, we are at about 13.5%, I think on a year to date basis. So I think that guidance for your modeling going forward is probably in the right spot. I mean obviously, we will work hard to do better than that, but I think that 13%-ish is probably pretty -- a pretty good number to use.

Great. Thanks a lot.

Thank you.

Your next question comes from the line of George Staphos with Bank of America Merrill Lynch. Your line is open.

Hi, everyone. Good morning.

Good morning, George.

Congratulations on the progress so far this year. My first question is on cabinets. Obviously, you have seen a nice rebound in profitability given the low stepping off point. You have done a lot of work to restructure the business.

From here on out, what are the two most important initiatives for you to further improve your margin and profitability in the segment? Or is it really now just, you like where you're at, you like your product portfolio and your cost position, and you're just waiting on the volume improvement from here? And I had a follow-on.

George, I think as we look at our cabinet business, I think there is a couple of things that we are focused on here. One is continue to drive innovation. And that is reflected in the product launches that we have under the Merillat brand that are coming out to market, really starting in the third quarter. And that will continue all the way into the first quarter of 2014. And then some differentiated product based on our dealer channels. Also looking to improve the customer experience across the organization as part of our cabinet offering.

So those are critical items. And then on top of that, as you would imagine, always focused on our cost position and trying to get our productivities and efficiencies up. And that is evidenced by the fact that we took out a component plant that I referenced in the prepared remarks. So always looking at our footprint. Obviously, volume is going to help. And -- but we're not waiting just solely for volume to come in order to drive the improvements in this operation.

Okay. Thanks. And in decorative arch, and specifically within paints, you obviously mentioned that gallons was up low teens, and that is terrific. Is it possible to discuss what the revenue growth was within paints in the quarter? Was it a bit better than the overall gallonage, because perhaps some of the new products have a higher price point? Or perhaps was there a negative mix effect that we should be aware of? Is there any kind of color you can give us around that? Thank you.

Yes, I don't think there was any significant mix impact, George, in terms of anything that would have been negative. We did talk a little bit about the DeckOver product, which was launched along with some of the promotional costs to support that. But don't know that we had any negative mix.

So revenue would have grown more than gallonage?

No, revenue was a little bit below gallon growth. And as you saw, we did have a negative price commodity relationship in the segment in that quarter.

Okay. Thanks. I will turn it over.

Thank you.

Thanks, George.

Your next question comes from the line of Nishu Sood with Deutsche Bank. Your line is open.

Thanks. In the cabinets and installation services division, you folks had targeted those, I think, mid last year. And you have made some nice progress in terms of stabilizing and turning the profitability positive in those divisions. What are you targeting for each of those divisions for longer term margins? So what can we expect as the recovery goes on here?

Sure, Nishu. As we roll out both -- if you think about the incremental margins or contribution margins of those businesses, they vary a little bit by business. So the cabinet business generally runs at 30%, maybe a little bit north of that, as time rolls out. And then our installation segment would run at about a 25% incremental margin or so on a mid cycle basis.

So as you think about those businesses, and depending on what you believe is mid cycle, definitely we believe both of those businesses can get back to double digit operating profit margin area, probably low double digit margin for the installation business. Maybe a little bit better than that. Maybe low teens for the cabinet business, depending in how much volume comes back in the form of the volume. Obviously, the more semi-custom offering that comes back probably is a greater opportunity for enhanced margin.

Great. Thanks. That's very helpful. And second question I wanted to ask. A couple of the earlier questions have already referenced this, but I just wanted to revisit it. The soft patch that we have seen in housing, and in remodeling as well, some people -- some of your peers have noted some slowdown recently.

You mentioned the high single digits for October did not show -- because of the tough comp, did not really show any impact from this soft patch or slowdown that some others have noted. But that it may come in the next couple of months. So I just wanted to get the overall take-away here. Because of the lag between starts and when your revenues show up, is it something that may come up in the next couple of months? Or have you not seen the slowdown, as some of your peers have?

As we indicated, we haven't at this point seen any measurable impact. It is possible that there could be a little bit of impact late this quarter, early next quarter. But again, it gets a little murky, I think, Nishu, with the lag start issue. Typically we run about 90 days. That has been extended in certain cases, with some of the mix of multi-family, for example, some of the labor constraints. So I think we will just have to wait and see how that plays through.

But again, I would remind folks that we don't see that anything other than as temporary if, in fact, it does hit us at some point. Our sense is that new home construction, when you look at the fundamentals, household formation, demographics, et cetera, certainly we expect that to be strong over the course of the next 2 to 3 years.

Okay. Thanks a lot.

Thank you.

Your next question comes from the line of Dan Oppenheim with Credit Suisse. Your line is open.

Hi, thanks. This is actually Mike Dahl on for Dan. I wanted to ask about thoughts on the balance sheet here. I think you have made some progress, and as you noted, there is no real maturities, I guess, until mid 2015 at this point. How are you thinking about free cash flow use, maybe as it relates to dividend, acquisitions, or further debt reduction?

Sure, Mike. Let me walk you through that. So to your point, we have had great cash flow generation this year so far, really pleased with the efforts on behalf of everyone on the team. So as we think about our capital allocation priorities, I think they're in this order of priority, right? Obviously first and foremost, always invest in the business. Whether it is through capital requirements to continue to grow our businesses, or to fund innovation or international expansion. We have seen good evidence of the success of all of those efforts here in this quarter.

After that, I would tell you in the near term, probably look to pay down some debt in the next several years. So as we mentioned, or you referenced, we've got $500 million coming due in 2015, and $1 billion maturity in '16. And so I think what we will look to do, between that aggregate of $1.5 billion of maturities, that we will look to pay down somewhere between $300 million and $500 million of those two maturities. And we will figure out exactly how we will do that when we get closer to the maturity dates.

Then following that, I would look -- I would guide you to think about small tuck-in acquisitions for us. So I do not imagine a sixth or seventh product line for us, but rather something that we can fold into one of existing operations. And we have got some great examples of how we've done that over the course of the last several years. And one would be, we integrated a small spa business into our Watkins unit in 2011, and had tremendous success growing that business, just by pushing that product offering through our distribution network.

Similarly, I referenced in my prepared remarks to the fact that we have had good success with our composite door acquisition in the UK. Again, a similar theme there, where we have been able to quickly expand that business by offering that product through our existing distribution channel. Then after that, after debt repayment and small acquisitions, then we would like to do more shareholder friendly activity, whether it is share repurchases or dividend increases. And we will figure that out as we are get in a better position. But for now, those are our capital allocation priorities.

Thanks. That's very helpful. And then just as a follow-on, given the relative size of the windows business, and your desire to expand beyond what historically had been the focus, is that an area of appetite for tuck-in acquisitions as well?

That business has done a nice job of expanding geographically. They have entered the Texas market recently. They entered western Canada in the last year, 18 months or so. And so to the extent that there is a complimentary tuck-in acquisition that makes sense for the geographic footprint, that would be something we may consider.

Okay. Thank you.

Your next question comes from the line of Nick Coppola with Thompson Research Group. Your line is open.

Good morning.

Good morning, Nick.

There was an earlier question about growth rates between direct to builder, dealer, and retailer. But if you were to drill down into just cabinets, within the cabinets segment, I see there is growth in all channels, but what are the relative growth rates look like?

Nick, the question was asked prior. I was responding to specifically the cabinet business.

Okay. So I guess the alternate question would be, what did it look like across the entire company?

Because we have got varying growth rates depending on the segments, I can give you a little bit of guidance, and you can see it in the overall segment results. Obviously, new home construction was strong, as evidenced by my commentary on both cabinets in our installation business, where our installation contracting business for residential new construction was up high 20%s, in line with housing starts lagging 90 days.

Across a number of our businesses that deal with the dealer network, so we referenced cabinetry, already, but we experienced a very strong performance to our wholesale customers in plumbing, and as well as our window dealers in our window segment. Not much -- we saw some increase in our pro business in paint, but again, it is a relatively small business compared to our very large retail business in paint.

Then other than that, retail sales were strong. That is evidenced by the fact that we were up 9% or so in our paint business, which is our strongest retail facing business.

That makes sense. And then talking about decorative architectural, even adjusting for the $10 million of incremental ad spend that you folks have been talking about, you're still not at the typical leverage, and it looks like the balance is that price/commodity piece. So what are you seeing in the price of raw materials? I hear there was a previous belief that the worst is behind us for titanium dioxide and propylene, but how should we be thinking about that going forward?

TiO2 has been relatively stable, but we have seen a little of a tick-up in resins, which affect both paint as well as the window related business.

Okay. And any expectations, in terms of looking forward?

(multiple speakers) No, Ti02 has been relatively stable for a while. Obviously, I think there is some signaling from the suppliers that as demand starts to pick up, that we could see a little bit of movement there. But at this point, that hasn't happened yet. But as demand picks up, I think the probability of that happening is pretty high.

Okay. All right. Thanks for taking my questions.

Thanks, Nick.

Your next question comes from the line of Sam Darkatsh with Raymond James. Your line is open.

Good morning, Tim, John, how are you?

Good morning, Sam. We're good.

Couple of just fine-tuning questions here. First off, installation in the quarter actually is now tracking housing starts lagged by a quarter, which has not been the case for a number of reasons in the past. And I also noticed that Owens Corning had an 8% installation growth, and yours is considerably higher, at nearly 20%. Should we expect now that your installation business should be tracking starts lagged by a quarter, or was there some sort of a one-off impetus to growth in this quarter, perhaps that might not be -- should not be sustained?

As I take a look at -- and we have been trying to break this out in every quarter for the last several quarters, that our installation sales to residential new construction have pretty much, for the last several quarters, mirrored housing starts lagged 90 days now. I will tell you what, we are seeing a little bit differently in the marketplace is, it seems that lag times for the big builders are getting back to a more normalized rate than they have been historically. We're still seeing expanded or lengthier lead times, is with the regional or custom builders. Those seem to be running in the 5 month to 6 month lag time as opposed to the 90 day lag time.

Okay. And then my last question, a follow-up regarding your plumbing margin commentary today, where you mentioned that 13% might be a good number to assume for the year. That suggests a fairly significant step-down, sequentially.

No, I didn't say for the year, Sam. I think the question was going forward over the longer term. I did not -- that was not a suggestion for the full year.

Okay. So then how -- you're doing a 15% now. How sustainable is that near term?

We don't generally predict margins, Sam, but obviously this year has been a good year in plumbing. I think what we are really seeing is the benefit from some of the growth initiative spend that hit margins a little bit over the course of the last couple of years. So in terms of looking ahead, we continue to be pretty optimistic about the way returns will flow coming forward.

Are there any seasonable aspects to the plumbing margins at all, Q3 over Q4?

There are seasonal issues that affect the top line. And usually, the Q4 to Q1 time frame for us tends to be a little bit slower.

And last question, if I could. Could you remind us what the year-over-year comparisons are in November and December versus what you -- the difficult comparison you saw in October?

Well, Sam, I don't have the --

We were mid single digits in both November and December last year, Sam.

Thank you much.

Okay. Thank you. We have time, Tiffany, for one more question.

Your last question comes from the line of Stephen Kim with Barclays. Your line is open.

Hi, it is Steve Kim from Barclays. Thanks. By the way, first of all, good job on the quarter. And most of my questions have been answered, but I guess my first question relates to fine tuning on the cabinet side. We talked about the fact -- or you talked about the fact that there were about $2 million of headwinds from the Chinese plywood issue. You talked about the fact that the builder market was a benefit to you this quarter, outstripping the growth, because it was so strong in the dealer.

I guess I'm curious as to what we can look forward to in the fourth quarter? Because the pricing action you referenced, it sounds like it is not coming in until the end of the fourth quarter. The plywood tariff sounds like it really hit at the end of the third quarter. So we got a little bit of a gap here where we could float. I'm curious as to how we should be thinking about the cost dynamic in cabinets, relative to what we saw, that $2 million we saw in the third quarter? What we think we can might be able to see, or we should be thinking about in the fourth quarter?

Yes, Steve, I think your commentary hit it pretty good, that there will be a little bit of a lag in the fourth quarter as a result of pricing not going in until late in the quarter.

So following up on that, I just want to make sure we are modeling things correctly. I totally hear you about the hiccup in builder starts being a temporary phenomenon, I agree with that. Definitely understand the longer term focus of the business, and the trajectory being solid -- solidly upward. At the same time, I just want to make sure that if there is any hiccups along the way, like in fourth quarter, that we're properly thinking about them.

So you had an extremely strong incremental margin in the third quarter here in cabinets. Would it be your expectation that the incremental margin would likely come back down to a more sustainable, more normal type level in 4Q in cabinets? And then just if I could touch on -- tack on to that. Are there any other unusual items that we should be thinking about in the fourth quarter, like any timing and promotional issues, that you know about? Or tax issues, or shipping days? I'm just trying to think -- making sure there is nothing based on the sidelines that we're not thinking about that we should be.

Yes, Stephen, in terms of -- I think you had a number of questions embedded in there. But in order to try to get at, I think, the general theme of your commentary, incremental margins in the third quarter were very strong, though we have experienced very strong incremental margins in the segment all year long.

Yes.

So feel pretty good about the incremental margins that the team is delivering in cabinetry. Secondly, you had a series of comments or questions with respect to the fourth quarter and how things look. I think the big question mark we have there is the remodeling. If -- to the extent that remodeling continues the trends that we've seen, that is favorable to our incremental margins and our margin profile going forward. So to the extent we continue to show strength in remodeling, could that help offset some of the negative impact of the Chinese tariff in the fourth quarter? Yes, that could be the case.

I think --

Okay. Great. Thanks.

I would think about that, Steve, is that whatever you think the third quarter looks like, if you use an approximate 30% incremental margin across the company, that is probably going to get you pretty close to whatever drop we will have for profitability.

Thanks very much, guys.

Thank you. And Tiffany, we are winding up here, but I want to thank everybody for their participation today, and have a good rest of the day. Thank you.

This concludes today's conference call. You may now disconnect.