Masco Corp (MAS) — Q2 2017 Earnings Call Transcript

Thank you, Kim, and good morning. Welcome to Masco Corporation’s 2017 Second Quarter Conference Call. With me today are Keith Allman, President and CEO of Masco, and John Sznewajs, Masco’s Vice President and Chief Financial Officer. Our second quarter earnings release and the presentation slides that we will refer to today are available on our website under Investor Relations. Following our remarks, we will open the call for analysts’ questions. Please limit yourself to one question with one follow-up. If we can’t take your question now, please call me directly at 313-792-5500. Our statements today will include our views about our 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 described these risks and uncertainties in our Risk Factors and Other Disclosures in our Form 10-K and our Form 10-Q that we filed with the Securities and Exchange Commission. Our statements will also include non-GAAP financial measures. Our references to operating profit and earnings per share will be as adjusted unless otherwise noted. We reconciled these adjusted measurements to GAAP in our earnings release and presentation slides, which are available on our website under Investor Relations. With that, I’ll now turn the call over to our President and Chief Executive Officer, Keith Allman.

Thank you, Dave. Good morning, everyone, and thank you for joining us today. Please turn to Slide 4. In the second quarter of 2017, we continued executing on our strategic plans. Our top line increased 4%, excluding the impact of currency, driven by strong growth in our Plumbing, Decorative Architectural, and Windows segments. Our operating margin increased 30 basis points to 17.4%, largely driven by the quick turnaround in our North American window business and strong margin performance from our Plumbing segment. We continue to be pleased with our EPS growth and achieved EPS of $0.60 per common share in the quarter. Let me give you some additional insights into the drivers behind each of our segment’s performance, beginning with Plumbing. We had another terrific quarter in the Plumbing segment with solid growth against a very difficult comp from last year. Delta, Hansgrohe, and Watkins each achieved record quarters for both sales and operating profits, once again demonstrating the sustainable competitive advantage of our brands, innovation, and industry-leading positions. In North America, our trade business was particularly strong as we gained share with our high-end Delta and Brizo branded showroom products. Internationally, Hansgrohe continued its global expansion driving significant growth in its focused markets. In our Decorative Architectural segment, our Pro paint sales grew double digits, and we achieved outstanding sales growth from our innovative Liberty Hardware shower door program. In DIY paint, we outperformed the overall DIY market with sales in the quarter matching last year’s. We are positioned to continue to outperform the DIY market with our powerful Behr brand, its outstanding product quality and service ratings, and our strong channel partner, The Home Depot. In our Cabinetry segment, we grew our repair and remodel business despite being up against a difficult double-digit comp. This growth was more than offset by losses in our new construction business as we exited certain low-margin builder accounts. We’re now pivoting towards growth in cabinetry as we described during our recent Investor Day. In the third quarter, KraftMaid, our leading repair and remodel brand, will capitalize on its already strong performance with one of the largest new product launches in the brand’s history. New door styles and decorative accessories will address the growing consumer trend towards transitional style, and new finish options will be expanded to provide designers with a more robust finished palette. We are confident that our growth strategy of new product introductions, customer program alignment, and selective new construction gains will result in growth for 2017 and margin expansions for the full year. In our Windows segment, Milgard, our North American window operation, achieved 10% sales growth and a significant increase in profitability due to its strong brand, market-leading position, and operational improvements. I’m very pleased with this rapid turnaround and as I shared with you last quarter, I remain confident that we will achieve mid-single-digit operating margins for the full year, a substantial improvement over 2016. Demonstrating our commitment to actively managing our portfolio, we completed the divestiture of our Arrow Fastener business, realizing proceeds of $126 million during the quarter. We further strengthened our balance sheet by tendering for some of our higher coupon debt and replacing it with lower coupon, longer maturity debt. We were able to execute this transaction due to the work we have done to vastly improve our credit profile, which allowed us to take advantage of favorable credit markets. We also continued our share repurchase activity in the quarter by buying back 1.2 million shares. And our Board of Directors announced its intention to increase our annual dividend by $0.02 per share beginning in the fourth quarter, showing confidence in our long-term prospects. This is the fourth consecutive year we have increased our dividend. Lastly, on our prior earnings call, we updated our 2017 target for earnings per share to be in the range of $1.90 to $2. Based on our results through the second quarter and our anticipated performance for the second half of the year, we now expect our earnings per share to be in the range of $1.93 to $2, exceeding our target of $1.80 that we set two years ago. Now I’d like to turn the call over to John, who will go over our operational and financial performance in detail. John?

Thank you, Keith, and good morning, everyone. As Dave mentioned, most of my comments will focus on adjusted performance, excluding the impact of rationalization and other one-time items. Turning to Slide 6. Our continued execution drove solid top and bottom-line growth. The second quarter of 2017 was our 23rd consecutive quarter of year-over-year sales and operating profit growth. Excluding the impact of foreign currency, sales increased 4%. Foreign currency translation negatively impacted our second quarter revenue by approximately $23 million as the U.S. dollar strengthened against both the Euro and the British pound. North American sales increased 4% in the quarter due to strong demand from repair and remodeling products across all channels of distribution and across the price continuum as we continue to experience strong consumer demand for our better and best product offerings. As a reminder, repair and remodel activity represents approximately 83% of our total sales. International sales increased 4% in local currency in the quarter as our international Plumbing businesses continue to drive growth. Gross margins expanded approximately 60 basis points compared to the second quarter of last year to 35.8%, largely due to the improvement in our North American Windows business. Our SG&A as a percent of sales increased this quarter by 40 basis points to 18.5% of sales. This slight increase is partly due to the strategic growth investments we’ve made, such as the 200 new Behr hub store employees we hired last year. We will continue to leverage these investments to drive profitable growth. We delivered solid bottom-line performance as operating income increased 4% to $357 million with operating margins expanding 30 basis points to 17.4%, our strongest operating margin in nearly 15 years. Our EPS was $0.60 in the quarter, an improvement of 30% compared to the second quarter of 2016. As a reminder, our results in the second quarter of 2016 included a one-time loss on debt extinguishment of $40 million or approximately $0.08 per share to complete the retirement of debt maturities. Turning to Slide 7. Our Plumbing segment once again delivered outstanding results despite a difficult 9% comp. Segment sales increased 5%, excluding the impact of currency driven by growth in our faucets, showers, and spas. Foreign currency translation negatively impacted this segment’s sales by approximately $16 million in the quarter. Our North American sales grew 4% in the second quarter against a 9% comp as we experienced strong consumer-driven demand for our innovative products and industry-leading brands with wholesale, large retail, and dealer customers. As Keith mentioned, Delta, Hansgrohe, and Watkins each delivered a record quarter of sales and profits. Our international Plumbing sales increased 5% in local currency against an 11% comp as Hansgrohe continues to outperform and benefit from investments in brand, design, and innovation. Additionally, we’re focused on growing key markets as yielding results as they experience strong double-digit growth in China. Operating profit for this segment increased 3% in the quarter driven by incremental volume, which was partially offset by some of our strategic growth investments. Turning to Slide 8. The Decorative Architectural Products segment grew 5%. This performance was driven by another strong double-digit growth of our BEHR PRO business and solid performance of BEHR MARQUEE, our highest price point offering. Liberty Hardware also contributed to the top line performance as it continues to benefit from the expansion and growth of its innovative shower door program. Liberty continues to win new retail programs and was recently awarded an expanded cabinet hardware program, which will be set in the third quarter. As a result of this program win, we anticipate incurring approximately $10 million in program reset costs in the third quarter. Operating income in the second quarter increased 1% driven by increased volume, which was partially offset by an unfavorable price-to-commodity relationship in coatings as we discussed last quarter. Turning to Slide 9. In the Cabinetry segment, excluding the impact of currency, sales declined 3% in the quarter. This is principally due to the exit of certain low-margin builder business in the United States and in the U.K. These actions in aggregate reduced segment sales by approximately $10 million. Foreign currency translation also negatively impacted this segment’s sales by approximately $2 million in the quarter. Starting in Q3, we expect to see year-over-year segment sales growth. Our repair and remodel business continues to perform well in the quarter. KraftMaid had solid performance in the retail and dealer channels, delivering mid-single digit growth through increased volume. This performance was achieved against a tough double-digit comp. Segment profitability declined in the second quarter by $7 million as we experienced a more normalized sales and marketing spend as compared to the second quarter of 2016 and softness in our U.K. Cabinet business. As we look to the third quarter of 2017, we expect to incur incremental costs of approximately $7 million related to new product launches as we continue to enhance KraftMaid’s product assortment and due to the recently announced anti-dumping duties and countervailing tariffs on imported Chinese plywood. We expect the effect of these duties to be temporary as we work to mitigate the impact through supply chain and other initiatives during the remainder of the year. Turning to Slide 10. Excluding the $5 million impact of currency translation, our Windows segment sales increased 7% in the second quarter driven by growth in Milgard, our leading Western U.S. window business, which grew 10% in the quarter. Milgard’s strong growth was due to increased volume, a positive mix shift toward our premium window and door product lines, and favorable pricing. Segment profitability in the quarter increased $20 million over the prior year driven by the lapping of last year’s warranty expense, cost-savings initiatives, and favorable pricing. We are extremely pleased with the rapid progress that Joe and his team have made on Milgard’s turnaround and their improved results delivered in the first half of 2017. We also completed the sale of our Arrow Fastener business at the end of the second quarter. This will reduce second half of 2017 sales and operating profit by $38 million and $8 million, respectively, split roughly evenly between the two quarters. We remain confident in our ability to achieve top-line growth and mid-single-digit margins in the segment for the second half of 2017 and the full year despite the sale of Arrow. And turning to Slide 11. We ended the quarter with approximately $1.1 billion of balance sheet liquidity. Working capital as a percent of sales increased 170 basis points versus the prior year to 15%, principally due to the higher inventory to support our growth in new program wins. We believe we will have this inventory work down to a more normalized level by the end of the year. During the second quarter, we continued our initiative to create shareholder value by repurchasing 1.2 million shares valued at approximately $42 million. And we also took further actions to strengthen our balance sheet by refinancing high coupon debt, thus reducing our interest expense by approximately $3 million per quarter starting in the third quarter. And with that, I’ll now turn the call back over to Keith.

Thank you, John. We had a very productive second quarter. Our businesses continue to perform well. We executed our strategies. And we are well-positioned across our segments to achieve higher growth in the second half of 2017. We completed the divestiture of Arrow Fastener and improved our capital structure with our debt transactions. We moved our corporate headquarters into a new building, downsizing from 415,000 square feet to 90,000 square feet. This new modern headquarters will facilitate our culture of collaboration, continuous improvement, and execution. And lastly, we had a very well-attended Investor Day with nearly 300 participants and had thoughtful discussions about our strategy and the demand drivers underlying our industry. And we committed to a $2.50 earnings-per-share target for 2019. Fundamentals driving our business are strong, and the strategy we laid out two years ago and reiterated this quarter at our Investor Day is working. We remain committed to investing behind our brands for growth; developing innovative products to ensure we maintain our must-have position with our customers; focusing on operational excellence through our continued deployment of the Masco operating system; and finally, balancing our capital allocation between acquisitions with the right strategic fit and return, share buybacks, and dividends. Our operational execution, coupled with our strong balance sheet and liquidity position, provides us with multiple levers to continue to drive shareholder value and outperform the industry. With that, we’ll open the call for Q&A.

Hey guys. Thanks for taking my questions. First question is, Sherwin and PPG both talked about, in the paint division, weakness in exterior and then also a little softness in DIY. Do you think that your performance in the quarter could represent some share gains? And also along those lines, what is your mix of exterior versus interior?

John, I’ll answer the first part of that question. No doubt in our mind that we gained share. In terms of specifically exterior, we had a very solid quarter with exterior paint, and we grew that business. So no question there was a share gain there. And then, we matched our sales this quarter in DIY versus prior year’s second quarter, which unquestionably shows us that we’re gaining share there as well as we continue to outperform the DIY market. And we intend to continue to do that. We’ve got the Behr brand with the leading product quality in the space. We have the leading customer service with regards to JD Powers. We’re investing a significant amount of resources together with our channel partner, The Home Depot, to train and ensure that we have that shopping experience consistently delivered. So we like our progress. We think we’re gaining share without question. And we’re continuing to invest in order to continue to do that.

And John, just to address your second question about interior versus exterior sales. While we don’t break that out specifically, I can give you some guidance and that is generally, interior sales far outpace exterior sales, at least in our business.

That's encouraging. For my second question, regarding the $10 million in paint spending you mentioned for the third quarter, is that an additional amount or should we view it as neutral compared to the $10 million from last year?

So this will all hit in the third quarter, John. It's paint and is part of the Liberty Hardware program reset that we're implementing. Compared to the third quarter of last year, it will be incremental.

John, I’d like to follow up on your last question. Can you summarize your investment costs for the third quarter, particularly what's incremental compared to last year, and whether there will be any follow-on in the fourth quarter? Additionally, are these charges included in your projected range of $1.93 to $2?

Yes, Stephen. So the way I look at it is pretty simple, yes. In terms of these charges in the $1.93 to $2, yes, they are. So the way I think about it is you have $10 million in the Decorative Architectural segment for Liberty, you’ve got the $8 million hit in the second half of the year for the Arrow profit that, given the divestiture, then we’ve got the incremental $7 million in the Cabinet segment for the launch costs as well as the incremental tariffs. So in aggregate, approximately $25 million. Favorably offsetting those charges is the $3 million per quarter of interest expense, so call that roughly $19 million to $20 million of headwinds in the second half that are included in our guidance for the $1.93 to $2 which equates to roughly $0.04 a share.

Great. That’s perfect. That’s what was I was looking for. And then, I guess more broadly, can you all talk about what you’re seeing on the raw material inflation front, whether you’re getting the offsets, and I know you’re typically able to get it a lot easier in Plumbing. But are you able to get it moving forward on paint also? And just where you’re seeing the pressure points for the raw materials?

Steven, as you know, we’ve got a track record. Over time, and there are some leads and lags with regards to supply chain activity that we do to mitigate cost increases and price and those sorts of things, so there are some ebbs and flows. But over the long haul, we’re able to maintain a flush position between price and commodities over time. In terms of what we’re experiencing as we look forward in this year, we have experienced some inflation in TiO2 and Decorative Architectural business that began to impact us in 2016. And that will continue into the first half of (indiscernible)—excuse me, second half. We also have some pressures in resin-related costs mainly driven by methyl methacrylate and that supply input. Copper and zinc are both up year-over-year, and we’re working with various cost-outs and price increases there. And then we talked about the recently announced anti-dumping tariffs related to Chinese plywood. So we’re working very closely with our suppliers. We’re driving those costs down. And for the full year, we expect as a company to continue to have margin expansion.

This is Chris Counihan on for Susan. I was wondering if you guys could speak on the current health of the M&A pipeline, kind of what the level of activity you guys are seeing out there and what you’re thinking about potential opportunities?

Yes, Chris. Our pipeline continues to be healthy, both in terms of its size and the movement that we have going through it. We’re spending a lot of time across the organization on cultivation, and we’ve also moved deals through the pipeline that we’re talking quite seriously about. So I would say overall, the pipeline is very healthy. We continue to see pretty robust valuations, but oftentimes there’s good growth that goes with some of those more robust multiples. So we’re looking at it very patiently. We have to have the right strategic fit, first and foremost. And secondly, we need to drive a return on invested capital that exceeds our WAC, risk-adjusted. So we’re working very hard at it. The volume is good. The valuations still are a little higher than what we would see typically. And we’re being patient, we’re being strategic, and we’re going to make sure that we drive return on invested capital.

Okay. Great. And then going back to Cabinets. I was wondering if you guys could talk about the current mix shift you guys are seeing, and when do you think you expect that benefit to hit. Would it be in 3Q, 4Q in regards to exiting that lower-margin business? And if you guys could just give us a little outlook on that, that’d be great.

Yes, Chris. We think largely that the builder-direct business and the builder-oriented businesses that we’ve been purposefully exiting over the course of the last 4 to 6 quarters is largely behind us now. Could there be a little bit of spillover into the third quarter? Clearly, there could be just a touch. But we really do think that starting now, here in the third quarter of 2017, we should begin to see that segment reposition itself from one that’s been contracting to one that’s going to start to grow.

Chris, as John mentioned, we do have significant investment planned in new product introductions coming forward, and we have the hit that will take largely in Q3 on the countervailing duties and tariffs associated with Chinese plywood. But we do have, and continue to have, solid drop down on our incremental volume. And when we look at the productivity improvements that we’re driving, the benefits of the incremental volume, we believe we will continue to expand margins for the full year.

Hi, thanks for taking my questions. Just to follow on, on Cabinets, and those last comments about growth resuming in the third quarter, I think may just need a clarification on some of the comments around the full year. Is it growth will resume and be positive for the second half? Or do you expect an acceleration to the extent that it will actually drive full year growth as well?

We expect single-digit growth for the year.

Okay. That's helpful. Shifting to the paint side, given the program cost you've mentioned on the hardware side, can you help us understand the revenue opportunity as you reset and pursue this business?

Well, we’re not going to disclose the revenue of the program win. We’ll let our customer do that. But I’ll tell you, we do have an outstanding shower door program that’s performing very well, and we’ve had a significant Cabinet hardware win that will continue to drive growth and is a very solid program for us.

Looks like the turnaround in your Windows business is definitely in good shape at this point. Just curious, do you have enough bandwidth to kind of support the growth you’re seeing? And would that have any bottlenecks on operations and profitability down the road?

Our capacity is in good shape. As we’ve talked about, there is a tight labor market up there in the Pacific Northwest and in California. We don’t expect that to magically free up. So it’s tight on the labor side. But I will tell you that we’ve had significant productivity improvements. So that the requirement for that labor has gone down quite materially. And the turnover profile that we generally see, and it’s fairly consistent across all our businesses, is that the turnover happens in the people that are hired recently. So while the turnover is tough, it tends to churn on the folks that are less than 90 days. And when you have the type of productivity improvements that we’ve made, that really takes out the need, and thus, the significant impact on the turnover. As we see some mix shifts, there’ll be certain pieces of equipment that maybe are strained a little more than others, but by and large, we’re well prepared to support the growth. We’ve had good growth this quarter. I mean, really solid growth this quarter. And very pleased with how our lead time and fill rates have continued to remain consistent and really industry-leading, and that’s the value prop for Milgard windows in the West Coast. And that’s in part why we have been able to really bounce back as quickly as we have. We’ve got a great dealer network out on the West Coast. And when we deliver on our promise to them, they deliver on their promise to us to go after growth. So I think it’s early in the turnaround. But I like what I’m seeing, and we’re in good shape.

Got you. And I guess for paint, I mean, you guys have clearly outperformed your peers both on DIY. But the Pro initiative has been a nice source of growth, and it’s been impressive you’ve been able to kind of keep your margins intact because it’s supposed to be a lower-margin business. Just curious, how much more runway do you have? And can you sustain this level of growth going forward the next few years?

We are dedicated to maintaining our double-digit growth and have experienced this for several consecutive quarters. Our ongoing investments are not based on hope; they are yielding results. We recently expanded our hub store presence and are refining that model, assessing its performance, and providing training. This has evolved into a model that can be franchised further. We offer competitive pricing and terms with our Pro Rewards program and collaborate effectively with The Home Depot. I've mentioned our top-ranked products, highlighting their importance for Pros to access jobs across regions. I take pride in our regional sales representatives and hub store employees and the excellent service they provide. Our data clearly indicates that we are excelling in service, saving Pros both time and money. We offer a convenient one-stop shopping experience with bundled purchases alongside our partner, Home Depot. Therefore, we plan to continue achieving double-digit growth.

John, I'm not sure if this is clear, but regarding the increase in the lower end of the guidance, it seems that the negative impact from Arrow and the positive from the debt refinance cancel each other out. So what are you all feeling more optimistic about compared to three months ago?

I think you see the fundamental growth in that business over the course of the first half of the year. And what we’re seeing and hearing from our customers, Scott, gives us the confidence. We’re hearing about good showroom traffic at our Cabinet dealers and our Plumbing wholesalers and Plumbing showrooms. So we’re seeing good demand, continuing good demand in our paint business. So all that combined, I think gives us the confidence to raise that lower end of the range.

Okay. Cool. And then just a couple of quick ones on the model. Anything unusual in the corporate line that’s stepped up this quarter with the relocation? And then just tied to that, John, the buybacks? It was the weakest in some time, and the guidance to get to $400 million to $500 million implies a pretty sharp step-up. So just wanted to get your comfort with that level?

Yes. A couple of things, Scott. Maybe on the corporate expense side, we are up a little bit this quarter, probably due to the stock compensation expenses, the share price rises, obviously, that hits us a little bit harder in the corporate expense side. So that was the principal driver there. That said, we still think we’re going to be in approximately $100 million for the full year. And in terms of the share repurchase activity, there are a number of things going on. Obviously, we had our Investor Day and you were there, and we had the debt transactions going on. So we were out of the market a little bit more around in some of those events than we would typically have been in a normal quarter. That said, we still have our guidance out there for the $400 million to $500 million for this year. And as we’ve discussed in the past, we’ll be opportunistic about how we buy back those shares. And so yes, I would look for slightly stronger activity as we go into the third quarter and beyond.

Nice turnaround in Windows, very impressive. And it’s coming in ahead of expectations. I think Joe gets a raise. What’s driving this big turnaround here? And can you give me a margin walkthrough year-end or into ‘18 a little bit? I mean, this was kind of something I was not a fan of. Quite honestly, I thought it was a subpar business, and I was wrong. You guys have really crushed it. So what’s driving this operationally? And how do you see this kind of playing out? I’m not really looking for color about the quarter, but more about what you’re doing strategically.

Yes, Bob. I told you to hang in there. I’m glad you did. Really, it gets back to something I touched on earlier with the brand and the dealer network. So when we deliver on our promise, that dealer network really responds because it tends to be kind of quoted business, right? There is a quick lead time there between when the quote is needed and when we deliver the product. So when we’re at the ready with our Milgard value proposition, it’s easy business to flip our way. So that’s a huge fundamental strategic point of view that I have of why I like this business so much; is that we have a strong share position to begin with. And we have a strong value prop. So when we can deliver that, it really just creates momentum, and we’re able to outgrow the market. So that’s number one. And then secondly, the Masco Operating System is really driving productivity improvements, and we’re getting more effective at deploying it. So taking some price where we need to, to make sure that we’re driving volume into our more profitable segments of business, driving productivity, variable and fixed cost productivity, focusing, as I said, on that R&R dealer business, which is more profitable. So it’s a combination of really well-positioned strategically to build off a strong base of market share with pretty good productivity.

Got it. So that’s very convincing. So it sounds like the trajectory is going to continue to have a lot of positive momentum. I’m excited for that business. I wanted to ask John on Cabinets. I’m trying to understand kind of the back half of the year in terms of profitability. You’re guiding towards some incremental spending but you’re looking for margins to continue rising. And I think the implication is that the incrementals in the core Cabinet business on the legacy piece have to be really high to get that margin guide in the context of higher spending. Am I thinking about this the right way? Or how should we be thinking about profitability in that business? There’s obviously a couple of cross currents in there. I was hoping you could unravel that.

Yes, Bob. Regarding the margin profile of the business, we have very strong incremental margins. This is true not just for our core business, but also for the repair and remodel sectors, which are performing well. Additionally, the builder business we are exploring for the future has great potential. We typically expect this segment to deliver around 35% incremental margins on sales, which positions us well. Looking back at 2016, we experienced strong margins in the first half, with around 10.5% in Q1 and about 14% in Q2 due to similar spending. However, margins decreased slightly in the latter half of the year, landing around 8% to 8.5% in Q3 and Q4. As we consider the comparisons we face from the second half of last year and the current business trajectory, particularly the points Keith mentioned about both revenue growth and margin expansion this year for this segment, we feel confident in our ability to achieve these goals.

Even though you’re investing incremental spend in the business just because you have the weak comp in 2H, is that the right way to think about it?

That’s the right way to think about it, Bob.

Thank you. And congratulations on a nice quarter as well. Can you talk a little bit about some of the variables of you being able to achieve double-digit margins within your Windows business by year-end ‘18? And if there is a shot at achieving double-digit margins for the entire year of ‘18?

Long term, as we talked about on our Investor Day, we’re targeting 3% to 5% growth and 10% to 13% margins. In terms of this year, we’re expecting mid-single digit growth, if you exclude Arrow, and mid-single-digit margins. So as I think about ‘18, I think we should be able to continue to drive towards that long-term Investor Day guidance. Whether we get there a little quicker or it’s right down the middle, that takes us a couple of years to get there. But I would think about it kind of with those brackets.

Yes, Alex. To provide you with a bit more detail on that, a significant part of it relates to volume and what we anticipate for 2018. We are very pleased with the progress we have made in 2017. If we achieve higher volumes, that will certainly help. However, we will still face some ERP headwind as we move into 2018, which is why we expect to continue spending around $3 million to $4 million per quarter on ERP in the upcoming year. This could somewhat limit net margin expansion. Nevertheless, once that challenge is behind us, I believe we have a solid path to reach double-digit margins.

They really weren’t added in the quarter. They were added last year, there were 100, but they weren’t in last year, Q2. So the 100 incremental is what we’re reflecting. So we have a total of 200 hub stores, roughly speaking. Of the first 100 have been in there, what, John, a couple of years?

About 1.5 years.

1.5 years and then about 0.5 year for the other 100. And as I mentioned, we’re focused with our Masco operating system to codify time and territory planning and how to execute sales calls. And we’re really driving a regimentation of execution to make this as productive as we can.

This is Neal on for Mike. I guess, continuing on paint. Obviously, you had continued double-digit growth, which is impressive for BEHR PRO, but how are some of the smaller DIY initiatives trending?

I’m sorry, Neal, you broke up. You had asked about DIY, but I wasn’t clear on the question. Could you repeat it?

Yes. Just some of those smaller DIY initiatives. How are those trending?

We’ve implemented significant DIY initiatives, including the introduction of a new color center, adding in-store sales representatives, and focusing on training to develop our BEHR MARQUEE paint, along with establishing clear product positioning in the aisle. This effort has been a collaborative process with our partner, The Home Depot. By clarifying our product tiers of good, better, and best, and consistently enhancing our service offerings, we recognize that there isn’t a single factor responsible for our success. Instead, it’s a blend of a strong partnership, a reputable brand, high quality, excellent service, and a customer experience anchored in clear positioning. All these elements have contributed to our ability to consistently outperform the market.

Okay. That’s helpful. And I guess going back to Plumbing margins. Obviously, you’ve been successful offsetting raw materials with price. Do you think you’ve got a little bit ahead of commodity increase? Or I guess, what are you doing right?

Yes, Neal. I’d say we probably did, in the first quarter in particular we got a little bit ahead of raw material with price. That said, in my prepared remarks and I think Keith referred to as well, we had a little bit of pricing headwinds in the second quarter. And just given where the commodities are we anticipate probably some very modest inflation going into the second half of the year. But nothing that we’re too concerned about.

The team does a great job leveraging fixed overhead. So we continue to see good drop-down on incremental volume. And at the base of the success of this platform is the brands, customer innovation, and the strong channel relationships that we have. So those have been following us a while. No, this has not been something that we just flipped the switch, this has been over a period of three, four years that we’ve really been building the momentum here.

And Neal, I misspoke just a second ago. I said price headwinds, I meant commodity headwinds.

You cited some showroom traffic being improved in Cabinets. So I’m just curious if you could opine on what you think is explaining the lull in the second quarter industry sales in Cabinets?

We think that our repair, remodel top line growth of kind of mid-single digits is right in line with industry growth and if not, a little bit better. We didn’t really see a lot of choppiness that the industry may have implied in our business. And we had pretty consistent performance through the quarter, Mike. So we’re really pleased with how the KraftMaid brand is performing, and we’re really excited about this new launch that Keith described a little while ago. So we think there’s opportunity for continued steady growth in our repair/remodel side of our Cabinet business.

Great. And could you also give us some color in terms of what type of growth you saw out of the builder hardware business this quarter?

A big chunk of that growth was driven by our new shower door program, which, incremental stepwise growth as we went from the West Coast to up to the Rockies and then into the Plains and now full national coverage with that shower door program with Depot. And then as we’ve talked, we’ve also got a nice win in Cabinet hardware coming up in the second half of the year here. So really solid performance by the builders’ hardware team down at Liberty.

So in paint, you mentioned price/commodity pressure, but the margins were pretty nice at 21.5%. So I was just wondering if you could put those, that comment into context. Are you laying that out as a potential pressure for second half? Just trying to understand that against the pretty good margin you had.

Yes. I think, Nishu, that the TiO2 will really come through in the back half, so we are expecting some margin pressure from that. We have approximately $10 million of new program reset costs that we talked about that are in that segment. And again, these investments that we make are ahead of the growth oftentimes, and we have to earn our way into that leverage. So as you think about the full year in this segment, we expect to be in the mid-single digits driven by volume, and we may see some modest margin erosion.

Recall, Nishu, that the second half, or I’m sorry, the second quarter all margins were at about 21%. They were down from the second quarter of last year, so we did start to see some of that commodity headwind hit the segment in the second quarter. And to Keith’s point, we’ll probably feel a little bit more margin pressure in the second half of the year.

Got it, got it. Okay. The divestitures from a modeling perspective, there was the $5 million impact that you had cited of divesting some of the Cabinet lines in 2Q. I think you mentioned, John, that it might be a little bit in 3Q. And then on Arrow, the $38 million. Should we expect something similar for the first half of ‘18 in terms of the $38 million and $8 million? Or is there some seasonality that would make that higher or lower?

Yes, Nishu. It’s going to be roughly equivalent in the first half of ‘18, so that’s good catch. I should have probably mentioned that in my remarks. So yes, that will be the waterfall effect of the remaining piece of the over-divestiture. And just to be clear, on the Cabinet piece, there’s no divestitures per se. But rather, we are deliberately walking away from some low-margin builder business, both domestically as well as internationally. And so that’s the impact. Yes, it was about, as I mentioned, about $10 million of impact in the second quarter. And could there be a little bit of spillover into the third quarter? Yes, there could be, but we don’t anticipate very much.

Most of my questions have been addressed, but I would like to clarify the breakdown you provided, which I believe amounts to about $25 million, and netting out the $6 million in interest expenses, we see approximately $19 million in adjustment issues. I am curious how much of that was expected when you first shared your guidance. From what I can gather, it seems like the hardware win and possibly the refinancing were not anticipated, but perhaps the Arrow divestiture was considered. I'm trying to understand which elements were additional to your previous guidance.

So Stephen, when we provided the guidance of $1.90 to $2, we did not factor in the Liberty reset costs. Some of the Cabinet launch expenses were included in our forecast, but the plywood tariffs were unpredictable at that time. Those tariffs account for a significant portion of the $7 million. The Arrow divestiture was in progress, though it wasn't widely discussed at that time, so it wasn't specifically mentioned for the interest savings. You could argue that Keith and I were aware of the planned divestiture of Arrow, but likely the market was not. The Arrow situation had a major impact on our guidance of $1.90 to $2.

Okay. So that basically is another $0.03, $0.035 that the lower end of your guide...

Yes, that’s right. $0.035, $0.04.

Yes, I wanted to clarify that. That looks good, and I just want to be sure. When you discussed Milgard, I believe you touched on it partially. However, regarding the margin turnaround, I was expecting more sales growth rather than just cutting costs in the short term. You mentioned that sales rebounded quickly because dealers responded once Milgard was able to fulfill its commitments. Could you provide a bit more detail on that? Specifically, I want to ensure there wasn’t a timing issue or any catch-up sales that contributed to this quarter’s growth, or if, as Bob mentioned earlier, this momentum in sales is something we can anticipate in the future.

Yes. There really wasn’t a one-time windfall that drove that. It was broadly spread across multiple dealers up and down the West Coast. I think maybe the recent bad weather might have created some pent-up demand. But overall, it’s been pretty steady. That’s a good part of the country right now, and it’s a growth market for us. So I would expect that type of success to continue. There was, however, some currency effect, wasn’t there, John?

There was a currency effect. Additionally, we have been considering the Arrow divestiture for the second half of the year. Nonetheless, we still believe that Milgard can experience solid growth, likely with slightly easier comparisons. Keep in mind, we encountered an ERP issue in the second quarter of last year, which probably had a small impact on our revenue. However, we feel very confident about what Joe and the team have built regarding the Milgard brand and how quickly they've restored sales. Therefore, we believe there is significant growth potential ahead. We are noticing strong demand among our customers, including both our dealer customers and the major retailers in the Western U.S. We are currently seeing good demand from both segments.

This is Jake on for Keith. Just wanted to touch on the Cabinet business real quick. In regards to the UK business, was that driven just by the existing businesses or was there any other type of weakness that we’re seeing there?

Yes. The performance was similar to that of the U.S. business, but there was some weakness. We're observing a degree of softness across the U.K., particularly with the election taking place during the quarter and increased discussions around Brexit. This has led to some consumers in the U.K. pulling back. However, it doesn't significantly impact our business, so we aren't overly worried about it.

Just want to ask about KraftMaid, the new product introduction in Q3. Is that going to come with more promotion in the channel? Or I guess more broadly, how would you describe that promotional channel overall in Cabinets?

The retail promotional environment is slightly elevated year-over-year, but in comparison to Q2 of last year, it is consistent with the latter half of 2016 and 2017. I believe it will maintain that level. There are no specific promotions tied to new product launches; instead, we are focusing on direct interactions with our designers and dealer partners to share product knowledge and sales strategies for our new offerings as opposed to increasing promotional expenses.

Okay. Great. My second question is about Plumbing. There has been strong growth despite challenging comparisons. I want to confirm that there are no load-ins or one-time program items that contributed to that impressive number.

There was a bit of load-in related to new products being placed on store shelves. However, I don’t believe it was significant or anything material that we need to highlight.

We’d like to thank everyone for your interest in Masco Corporation and that concludes today’s call.