Masco Corp (MAS) — Q4 2018 Earnings Call Transcript

Thank you, Jack, and good morning. Welcome to Masco Corporation's 2018 fourth quarter and full year conference call. With me today are Keith Allman, President and CEO of Masco; and John Sznewajs, Masco's Vice President and Chief Financial Officer. Fourth 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 analyst 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 describe 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 reconcile 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 Keith.

Thank you, Dave. Good morning, everyone, and thank you for joining us today. I’ll begin with some brief comments on our fourth quarter before I turn to our full year results and conclude with the thoughts on 2019. In the fourth quarter, our top line increased 11%, excluding the impact of currency, driven by strong growth in our North American Plumbing operations, the benefit of our Kichler acquisition, and strong growth in paint. Excluding the impact of currency, acquisitions and divestitures, sales grew 5%. Operating profit grew $58 million or 23%, due to an increase of volume, continued cost control, and improved price realization. As a result, operating margins for the quarter expanded 150 basis points to 15.4%. Our earnings per share increased 56% due to improved operating earnings, a lower tax rate, and a lower share count. We repurchased 9.6 million shares for $300 million in the quarter, a significant increase in our repurchase activity compared to prior quarters. We were pleased with our fourth quarter performance. For the full year of 2018, we overcame significant inflation and delivered strong sales, operating profit and EPS growth for the full year. This growth was driven by solid consumer demand, healthy end markets and our continued focus on executing our growth and capital allocation strategies to deliver shareholder value. Sales for 2018 increased 9%. Excluding the impact of currency acquisitions and divestitures, sales grew 5%. This growth was driven by record sales years for five of our business units, Behr Paint, Delta Faucet, Hansgrohe, Watkins Wellness and Liberty Hardware. Operating profit grew 6% despite significant inflationary headwinds demonstrating our ability to manage our costs and successfully implement price to offset raw material and other inflation. Earnings per share increased 29% in 2018 due to a lower tax rate of 25%, increased operating earnings, lower share count and lower interest expense. Turning to our segments. Plumbing continued its strong performance in 2018. Delta gained share with its Brizo brand and showrooms, its opening price point Peerless brand at retail, and we saw strength across all channels of distribution, including wholesale, retail and e-commerce. Notably, Delta achieved a record year and successfully implemented a companywide ERP system. Hansgrohe's success was driven by growth in China and Germany offsetting softer conditions in certain other countries. Watkins, our leading spa business, had an outstanding year with strong performance in its core dealer network and retail channel, and healthy sales of these aquatic fitness systems. In our Decorative Architectural Products segment, the acquisition of Kichler Lighting early in the year significantly increased sales. We've integrated Kichler into our Masco Enterprise, and we'll continue to drive value in 2019 by leveraging Kichler's product portfolio with existing and new customers realizing further operational improvements and optimizing its brand and go-to-market capabilities. Our propane initiative grew high single-digits for the full year, and we continue to invest in this large opportunity along with our partner, The Home Depot. Propane now represents about 25% of our coatings revenue, and we expect to continue to drive high single-digit growth in the propane market in 2019. In the DIY market, we are well positioned with the leading brand, the highest quality products and a great team of people and expect to continue to outgrow the DIY market in 2019. In Cabinetry, we've returned to top line growth in 2018 with strong 7% growth, excluding the divestiture of Moores. Our repair and remodel cabinet business grew double-digits in 2018, aided significantly by our new program win with Menards. This growth, together with our business shift over the past several years, has resulted in 70% of our sales in this segment now driven by the repair and remodel market, up from approximately 60% two years ago. In our Windows business, sales grew 1% for the full year, excluding currency and our divestiture of Arrow Fastener. We achieved mid-single digit growth in our U.S. business, while our UK business was challenged with lower demand. We took action in the UK to restructure and right size our operations during the year to match the current level of demand. From an overall Masco perspective, our strong growth generated over $800 million of free cash flow for a more than 100% free cash flow conversion rate. Strong cash flow is a hallmark of Masco, enabling us to drive shareholder value through reinvesting in the business, selectively pursuing acquisitions with the right fit and return, and returning cash to shareholders through share repurchases and dividends. We deployed nearly $1.5 billion of capital during the year consistent with our balanced capital allocation strategy. We returned $654 million to shareholders through share repurchases, redeployed $549 million for the acquisition of Kichler Lighting and we increased our dividend for the fifth consecutive year all while reducing debt by $106 million. With this debt reduction and continued earnings growth, we finished 2018 with a very strong balance sheet. Our net debt to EBITDA at year-end was approximately 1.7 times. Before turning to 2019, I'd like to thank our more than 26,000 employees, here in North America and across the globe for all of their efforts to help make 2018 another successful year for Masco. Now turning to 2019. I'd like to share with you our view of the markets for the year. Consistent with many industry forecasters, we expect the repair and remodel market to grow in the mid single-digit range in 2019, though slower than the rate of growth in 2018. For new construction, we are assuming a low single-digit growth rate due to labor constraints and affordability concerns, understanding that recent declines in mortgage rates could help alleviate some of the affordability pressure. For our international markets, principally Europe, we're expecting a low single-digit growth environment. With regards to tariffs, our assumption is that the list three tariffs will increase to 25% on March 1st. We've previously shared with you that the impact of these tariffs on Masco is less than the raw material and other inflation we effectively dealt with in 2018. As a reminder, the 25% tariffs represent approximately $150 million of annual inflation or approximately 2.7% of cost of goods sold. However, it remains to be seen what the impact these subsequent price increases will have on consumer demand. Based on these assumptions, we expect sales growth in the range of 3% to 5%, excluding currency, margins to be similar to 2018 as we've offset tariffs with supply chain initiatives, other internal productivity measures and price, and earnings per share to be in the range of $2.60 to $2.80. With our strong balance sheet, we will continue our balanced capital allocation strategy, and intend to deploy approximately $600 million towards share repurchases in 2019.

Thank you, Keith, and good morning, everyone. As Dave mentioned, most of my comments will focus on adjusted performance, excluding the impact of rationalization charges, inventory step-up related to purchase accounting for the Kichler acquisition and other one-time items. We've finished the year strong. Fourth quarter sales increased 10% or 11% in local currency. Excluding acquisitions and divestitures, sales increased 4% or 5% local currency. Currency translation unfavorably impacted sales in the quarter by approximately $19 million. Local currency in North American sales increased 14% in the quarter or 6%, excluding acquisitions and divestitures. Local currency international sales matched prior year in the quarter and increased 2%, excluding our divestiture of Moores in the fourth quarter of 2017. SG&A as a percent of sales decreased to 190 basis points to 16.9% in the fourth quarter to leverage on volume, lower promotional spend and cost containment. We delivered solid bottom-line performance as operating income increased 23% in the quarter and margins expanded 150 basis points to 15.4%. For the fourth quarter, our EPS increased 56% to $0.64. I would like to note this performance was calculated based on a normalized tax rate of 25% versus a previously guided 26% tax rate. This change in our tax rate was driven by the issuance of recent IRS regulatory guidance regarding certain provisions of the new tax code. Due to this change, we have provided restated adjusted EPS numbers each quarter of 2018 in the appendix on Slide 23. Fourth quarter EPS was favorably impacted more than expected by approximately $0.05 consisting of approximately $0.03 benefit from the pull-forward of sales in the Plumbing and Decorative segments, $0.01 due to the lower normalized tax rate of 25% and $0.01 due to the gain in asset sale in the Decorative segment. Turning to the full year 2018, sales increased 9%. Excluding the acquisitions and divestitures, full year sales increased 5%. Currency translation favorably impacted the full year results by $47 million. In local currency, North American sales increased 11% for the full year or 6%, excluding acquisitions in the Arrow divestiture. Our North American teams executed well, driving solid revenue growth as our strong brands, innovative products, and broad product assortment continue to resonate with designers and consumers. In local currency, international sales declined 2% for the full year or increased 1%, excluding the Moores divestiture. While we experienced some international market softness in 2018, mainly in the UK, our international Hansgrohe plumbing business continued to drive growth. Our SG&A, as a percent of sales, decreased 90 basis points to 17.7% for the full year, as we continue to leverage our volume and control our costs. Full year operating income increased $67 million or 6% as operating margins up 15.1%. Lastly, our EPS increased 29% to $2.50 for the full year. Compared to our prior 2018 EPS guidance, the $2.50 in EPS includes the aggregate $0.04 EPS benefit of the sales pull-forward and again the sale of the building in Q4 and a $0.03 full year EPS benefit from a normalized tax rate of 25%, down from our previously guided 26% tax rate. Our adjusted EPS calculation will continue to assume a 25% normalized tax rate for 2019.

Turning to Slide 8, our Plumbing segment had a strong finish to the year as sales in the quarter increased 6%, excluding the impact of currency. This was driven by strong growth in our faucet, shower and spa businesses. The fourth quarter benefited from approximately $10 million of pull-forward sales from Q1 of 2019, while currency negatively impacted sales by approximately $16 million in the quarter. North American sales increased 8% in local currency as we experienced strong demand from our wholesale, retail, dealer, and e-commerce customers. Additionally, our spa business continued to outperform by achieving a record fourth quarter with these innovative new products and industry leading brands. Our international sales in the fourth quarter grew 3% in local currency, rebounding from the stocks third quarter. Hansgrohe's focus on key markets drove this performance as they experienced strong growth in Germany and China. Operating profit in the quarter increased 11%, due to incremental volume, lower spending and a neutral price-cost relationship. Turning to the full year 2018, sales increased 6% in local currency. This strong growth was driven by record years at Delta, Hansgrohe and Watkins. North American sales grew 8% in local currency as we experienced strong growth across all channels and price points during the year. Our international plumbing sales increased 2% in local currency as Hansgrohe's performance continued to benefit from their investments in brand, design and innovation. Full year operating profit grew 3% due to volume growth, partially offset by the price-cost lag we experienced in the first three quarters of the year, mix and other expenses such as ERP spending. For 2019, we expect the plumbing segment sales growth to be in the 3% to 5% range, excluding currency with margins similar to 2018 as we implement price to offset the impact of the proposed tariffs. Also, given year-end currency exchange rates, we expect 2019 revenue will be unfavorably impacted by approximately $65 million, principally in the first and second quarters. This unfavorable currency exchange results in a negative EPS impact of approximately $0.01 per quarter in each of Q1 and Q2, 2019. In addition, depreciation and amortization in this segment will approximate $20 million per quarter due to increased capital investments in 2018. We also anticipate an additional $5 million of expense in Q1 as we will be exhibiting at ISH, a large biennial European plumbing trade show.

Turning to Slide 9, the Decorative Architectural Products segment grew 30% in the fourth quarter. Excluding the acquisition of Kichler, sales grew 8%, as we experienced strong double-digit growth in our core DIY products, and high single-digit growth in Pro. Behr's strong DIY performance was aided by approximately $20 million of sales pulled forward from Q1, 2019, due to increased year-end customer purchases to achieve incentives. Operating income increased 42% in the quarter aided by the Kichler acquisition, increased volume and improvement in the price-cost relationship, cost control, and a $4 million gain on the sale of a building. Full year sales grew 20%. Excluding the acquisition of Kichler, sales grew 5%. The solid performance was driven by our Behr Pro initiative as we achieved high-single-digit growth and continued to grow share with the Pro. While this Pro growth is slightly lower than our previously guided double-digit growth expectations, we are pleased with this performance considering the slowdown in the overall coatings market. Together with The Home Depot, we will continue to invest in and capitalize on the significant growth opportunity. The solid sales growth in 2018 was also attributable to Liberty Hardware's continued share gains from successful new product introductions and program wins in the retail channel. Full year operating income increased 13%, principally due to the acquisition of Kichler and improving in the price-cost relationship and lower spending. For Q1, 2019, we expect the segment's operating margins to be down approximately 200 basis points. This margin erosion in Q1 is driven by the $20 million of sales pull-forward into Q4, 2018, both sequential and year-over-year commodity inflation, additional investment in our propane initiative, the full quarter impact of Kichler and an increase in depreciation and amortization to approximately $12 million per quarter. For the full year 2019, we expect sales growth in this segment to be in the 4% to 6% range, including the benefit of approximately two months from the Kichler acquisition and operating margins to be between 17% and 18%.

Turning to Slide 10, in the Cabinetry segment, excluding the Moores divestiture, sales increased 4% in the fourth quarter and 7% for the full year. This solid performance was driven by our industry leading brands as we experienced double-digit growth in our repair and remodel business in 2018. The Cardell program at Menards is performing well, and we are pleased with its first year performance. In addition, our new home construction business matched 2017. Segment profitability declined $1 million in the quarter and declined $8 million for the full year. The fourth quarter performance was driven by increased logistics costs and mix as we discussed in our third quarter call. Full year profitability was also impacted by logistics costs and mix in addition to the ramp-up costs related to the Menards win. In 2019, we expect flat to low single-digit sales growth due to lower demand in the cabinet market and expect segment margins will remain similar to 2018.

Turning to Slide 11. In our Windows segment, sales decreased 1% in the fourth quarter and declined 2% for the full year. Excluding the sale of Arrow Fastener in the second quarter of 2017 and FX, sales increased 1% for the full year. This performance was driven by Milgard, a leading Western U.S. window business, which grew low-single digits in the quarter, and mid-single digits for the full year. Milgard's growth received a favorable pricing and a positive mix shift toward our premium window and door products. This growth was partially offset by our UK window operation, which continues to experience market softness. Segment profitability in the fourth quarter increased to $4 million, but decreased $16 million for the full year, fourth quarter profit due to favorable price costs and mix. Full year performance was primarily driven by restructuring actions taken in the UK and the increase in Milgard's warranty-related costs and inefficiencies in both the North American and UK operations. In the first quarter of 2019, we will be implementing the ERP system in Milgard's largest California facility. As a result, we expect a modest operating loss due to lower volumes in the incremental ERP costs in the first quarter. For the full year, we expect low single-digit sales growth for this segment, excluding currency with modest margin improvement. Turning to Slide 12, our year-end balance sheet was strong with approximately $600 million of balance sheet liquidity as well as full availability of our $750 million revolving credit facility. Working capital, as a percent of sales, finished the year at 14%. While slightly higher due to the acquisition of Kichler, this performance continues to be some of the best results in the industry. During 2018, we repurchased 18.6 million shares for approximately $654 million, and we increased our quarterly dividend by 14% to $0.12 per share. We took further action in 2018 to strengthen our balance sheet by reducing debt by $106 million. In addition, we now hold an investment-grade credit rating as Standard & Poor's, Fitch and Moody's. Going into 2019, our disciplined capital allocation strategy is unchanged. We continue to prioritize investments in our businesses to drive organic growth. We'll balance acquisitions with the right strategic fit and returns with share repurchases, and we will maintain an appropriate dividend. We expect to deploy another $600 million for share repurchases in 2019 subject to market conditions. We are assuming a 290 million average share count for 2019. We generated $830 million of free cash flow in 2018, and expect to sustain a better than 100% free cash flow conversion rate in 2019.

Lastly, as Keith mentioned earlier, our 2019 EPS estimate is $2.60 to $2.80 per share. I provided a lot of detail on our 2019 expected performance for each segment during my prepared remarks. Please see slides 27 and 28 in the appendix of our earnings deck for a list of these assumptions. With that, I'll turn the call back over to Keith. Thank you, John. Looking at 2019, while we believe that growth may moderate in 2019, the fundamentals of our business and our core repair and remodel markets are healthy. Consumer confidence and wages are growing. This increases our consumers' willingness to invest in their home. Home prices continue to appreciate. This is highly correlated with repair and remodel spending. The age of the housing stock is increasing with 50 million owned homes greater than 30-years-old. This drives increased remodeling spending. Household formations have steadily increased throughout 2018, driven by the millennial demographic. This trend is projected to continue fueling housing demand for the next decade. With our continued focus on executing our strategy, including investing in our leading brands, innovation leadership and operational excellence coupled with our strong balance sheet and liquidity position, we will continue to create shareholder value. With that, we’ll now open up the line for Q&A.

The 8% growth we saw in North America Plumbing, I was wondering if you could maybe expand on that a little bit. And I'm just thinking of your Analyst Day in the past, where you looked at faucets and shower-heads, non-decorative and other wellness. I just want to see how much dispersion there was between those different end markets. If you can do that for the quarter and for the year just so we can get a sense of how those different initiatives are working.

When you look at our North American Plumbing market growth of 8%, we're very pleased with that. And we believe that that growth is higher than the overall market. So we think we're taking a share there. So we feel good about that. When you think about our international plumbing business, that's an extremely diverse set of demand spread over 135 countries, and it's difficult to really nail down the market growth with that kind of aggregation. But when you look at how Hansgrohe is performing, particularly in Central Europe, we're happy with that. So when you look across the Plumbing group's overall performance and where that growth was driven, there was some good geographic dispersion, which we are pleased with. And then when you look further as it relates to price point, we had some very good growth in the opening price point, driven the way we wanted driven meaning we launched new products to specifically address that price point of the Peerless brand. For example, we're seeing very good sales in our Beijing, toward those categories, which tend to be more opening or entry price points. But we also saw strong growth in our high-end brands of Axor and Brizo for Delta and Hansgrohe respectively. And we saw very good growth as we talked in our prepared remarks in our spa business and our hot tub business. So we're seeing strong dispersed growth across both geographies, price points, and across our full continuum of the portfolio. So we feel good about the growth and feel good about 2019 in that segment.

And then I was just looking at the DIY paint seems to grow. I mean, we grew low-double-digits. Was that including the pull-forward? Because I mean, I think there was some other commentary from some other producers about it being kind of challenging. And it seems like you didn't have the issue if you can spend on that? Thank you very much.

Yes, Ken. It's John. First of all, the low-double-digit growth rate does reflect or include the $20 million of sales that were pulled forward out of the first quarter into the fourth quarter. So that does help aid growth rate a little bit. That said, we do think that the overall coatings market in 2018 just grew a little bit. And so we do feel like we've probably picked up a little bit of share gain on the DIY side, not a ton. If you look at our overall growth rate for the full year, it was definitely low single-digit, so a little bit of tailwind there in the fourth quarter, but for the full year low single-digit growth.

The first question I had was regarding your sales growth outlook for 2019, which is projected at 3% to 5%. It seems that you have been implementing several initiatives to gain market share in areas like propane and your expansion in plumbing. However, it looks like the 3% to 5% growth forecast aligns more closely with your market growth assumptions. If that's the case, I would like to know how you view the opportunities for market share gains in 2019 and whether that is considered in your outlook.

Yes, Mike, one of the things that did impact our guidance for the full year on the top line the 3% to 5% is the fact that we did have some of that pull-forward sales that impacted the fourth quarter. So that $30 million, we would have typically anticipated hitting into 2019 was pulled forward into 2018. But if you consider the markets that we are in both the R&R market, which is growing kind of mid single-digit in the 4% to 6% range and kind of low single-digits for both new Construction and International, and if you consider the fact that, in particular our Decorative Architectural segment, we've got growing low single-digits. If you put that all together, there is some share gain baked in there. So we do think we're growing ahead of markets, but overall the markets are slowing a little bit for 2019. So I hope that captures the essence of your question.

Mike, we are identifying promising opportunities to continue gaining market share in our propane segment. We have strong momentum in Plumbing, and we anticipate that this will persist. Additionally, we feel confident about our aisle service product and brand in the DIY space, even though the market may be somewhat weaker. We expect it to remain softer heading into 2019, which is why we have share gain considered in our strategy.

I guess, secondly, you mentioned that the list three 25% tariffs are baked into your outlook for the year, your EPS guidance. Just wanted to clarify that it still represents $150 million of incremental headwinds, and more broadly if you could just remind us of the overall outlook for incremental raw material and tariff inflation in 2019, and how you expect to offset that between if it’s possible to break it down between price productivity and whatever other offsets you have?

That $150 million impact is the correct figure, and we've discussed it previously. There are several factors at play and potential variations in the situation. It's essential to view this as a dynamic scenario. As we gain more clarity over time, we will update you accordingly. Regarding ROCE, tariffs undoubtedly pose the most significant uncertainty for 2019. Our forecast assumes that the tariffs will rise to 25% in March. When we consider other major commodities, like copper and zinc in Plumbing, prices began to stabilize in the latter half of 2018, and we expect this trend to continue into 2019, potentially providing a slight benefit as the year progresses. In coatings, while TiO2 prices have eased somewhat, we are still facing considerable pricing pressures in resins. The situation with plywood distribution and logistics remains high but appears to be stabilizing. We believe they will stay at their current levels. To tackle these challenges, we're implementing significant changes and making decisions related to our supply chain. For instance, we've redirected over $30 million of plywood purchases within our cabinet business to address countervailing duties and tariffs. That's just one example of our efforts. We're also focusing on value engineering and cost reduction, improving productivity, exploring opportunities in lower-cost countries, and considering price adjustments. We've shown our capability to effectively manage all these aspects.

First question, I just wanted to ask for some more color on the DIY gallon growth, do you have any point of sale trend that you could share with us in the fourth quarter? It looks like, as you mentioned, you outperformed the market. And if you could provide some more color in terms of what's driving some of that relative strength.

So Mike, we really can't provide insights on point of sale since that's not within our scope. However, the decline in growth appeared to be relatively stable, showing low single-digit figures in the fourth quarter. Overall, we feel positive about this. This situation involves both the Pro and DIY segments. The Pro side continues to grow, while DIY has experienced a bit of sluggishness, which has been evident throughout 2018. So this isn't new information.

I believe several factors are driving the growth in the DIY sector. There isn't just one main reason. A significant contributor is our strong partnership with The Home Depot and our efforts to convert foot traffic into cash-paying sales. The Behr brand is highly recognized in the DIY market. Our service levels, both in-store and for delivery, are exceptionally strong. This combination of a well-regarded brand, excellent service, and a consistent flow of innovation is key to our success in the DIY segment.

Some other building product companies that have reported have experienced some destocking in the fourth quarter, particularly in Europe and U.S. retail. Did you observe that in any of your segments?

There's always fluctuation with inventories at our customers. We did see a little bit of destocking in Plumbing wholesale, where we've had tremendous success. And that did slow down in that channel a little bit in the Q4. So that was a little bit of destocking there. But then, we also had significant pull-ahead volume, which would obviously equate to restocking. We talked about that $30 million impact over and across Paint and Plumbing. So really we did not see what I would characterize as any material destocking in our channels.

I'm wondering if you could talk a little bit about if there was any impact on margins this quarter that might have come from pushing price to offset tariffs, and then we have the tariff delays. So if there's any lag there, that caused a little bit of margin hell in there. And then, understanding that’s pretty uncertain, if tariffs don’t materialize or things turn out to be better than we hoped for, can you speak to the elasticity of pricing that you might have for some of those price increases that you're putting through?

Sure, Scott. As it relates to the impact in the quarter due to pricing related tariffs on margin specifically to your question, when you recall that what we're trying to do and what we're pursuing with price when we pursue price to offset the tariff impact is just to recover the dollar amount of the tariff. So there's not an incremental margin on as a result of the tariff pricing that we're putting into place, if anything, because we're only recovering the dollar value of the tariff is actually a slight potential for margin to decline because of that. So, really no margin benefit there. I forget the second part of the question.

In terms of elasticity, it's really challenging to determine due to the current environment. Typically, our elastic studies and information are based on a stable environment where a specific product line either increases or decreases. However, given the broad-based inflation across our markets, it's hard to pinpoint specifics. We do anticipate a pullback in demand in the categories that are impacted.

I had a couple questions. One, just the broader corporate level SG&A, the management in the quarter was excellent. And I just want to understand which of that is temporal in nature? And how to think about SG&A as a percentage of revenues on a go-forward basis embedded in your guidance?

A portion of the favorable results in SG&A this year is related to the gain on sale in the DAP segment, which amounted to about $4 million. Additionally, we had some previous investments in the fourth quarter of 2017 associated with significant resets and program wins in decorative hardware with Liberty in the shower program, making for an easier comparison. We maintained good cost control throughout the year and deferred some investments into 2019 to address inflationary pressures. In 2019, we anticipate that total SG&A for the company will rise slightly from 2018 as we resume some of the investments that were postponed. We will continue to invest strategically for growth, including increased marketing spending in Plumbing and additional hires in Deco to support the pro initiative.

Okay. And then the next question is a two-part question, particularly as it pertains to the Plumbing business, you're looking for flat margins there included a 25% tariff. First question is do you already have the price in hand for that 25% tariff? And the second question is how do margins for that business flex around a more sanguine R&R market backdrop? Was that low-single or flat as opposed to your 5% view? And how do they look under a 10% or no tariffs scenario?

We do not have pricing information for the 25%. We have had extensive discussions and pricing adjustments for the 10%. We believe that with the combination of pricing and cost reductions we've implemented, we are in a solid position regarding the 10%. However, more discussions will definitely be necessary. If the tariff rises to 25%, could you please repeat the second part of your question? So, Justin, as I think about that assuming that commodities are constant. So let's put that in and there is really, I mean, commodity impact. I would say that we should see some modest margin expansion just given our leverage on incremental volume. And so that should help us out. And to the extent that the tariffs don't go into effect, and that has a good impact or a favorable impact on consumer demand, we would typically see incremental margins off of volume in this segment kind of in that high 20% to 30% range. So we should see some, again, some modest margin expansion in that scenario as well. It had a bit of an impact due to the 25% tariffs. As I mentioned earlier, we'll only experience the dollar impact of that recovery from all these tariffs. This could potentially create a slight headwind to margins in that situation, Justin.

I wanted to ask about the expected moderation in demand that you're incorporating into your 2019 forecast. On the housing side, it's clear there are indicators that housing has slowed down, and I assume you anticipate this will start affecting some of your businesses in the next quarter or two. Regarding the R&R side, have you already seen the assumed slowdown in the fourth quarter, or is this just a prediction based on the decline in new housing?

We did see a little bit of a slowdown in Q4. I think in our coatings business, we saw it a little bit. I talked a little bit about our Plumbing business in the trade and wholesale. So there’s a little bit of slowness there.

And I'd also say that we saw a little bit of slowdown in our cabinets and to a degree, Windows business. We grew low single-digits for the fourth quarter, and Windows, we are in mid single-digits for the full year there.

In terms of cabinets and other specialty products, the margin turnaround indicates a return to low single-digit revenue growth, which is promising given their higher exposure to new construction. However, we are anticipating flat margins for the year due to limited tariffs impact and lower commodity costs. So, when can we expect to see further improvement in the margins for these two businesses?

When you look at cabinets, we had a full year margin north of 9%. And when you compare that to the competition, we think we're doing pretty good there. We've got certainly some good dropdown that can come from that. We also experienced some inflation in plywood that we've dealt with. There's still little bit more of that that could be a drag on margins. In terms of our Windows business, we've got ERP spending that we're going to continue to make into the quarter, which our experience shows us will have an impact on both the top line as well as the actual expense of that ERP system. So when you combine those things together, that's what's really led to our guidance as it relates to margin.

I wanted to follow up on the cabinet discussion. Menards, you mentioned it would be running at an annualized rate of around $80 million by the end of this year or last year. I'm assuming you recognized about half of that in 2018. If that's accurate, it would imply that Menards alone could contribute approximately 400 basis points to your sales next year. However, you've guided for zero to three. I'm curious if you could share what you’re observing in the market environment that affects that guidance and whether there are any specific regional or price point factors influencing the sales environment negatively.

So, Stephen, regarding the Menards business, while we can't disclose specific customer sales, you are correct that it operates on a run rate. We started basically in March, and just based on Kichler alone, it would impact margins negatively since Kichler's margins are below the average in the segment. Additionally, Q1 is typically a weaker quarter for Kichler, which will affect the segment's performance in Q1 and is reflected in our guidance and remarks related to margins in that segment.

Very happy. We continue to build out the team down in Kichler has an outstanding leader that's demonstrated performance across the number of our businesses and a number of functions. As I interact with the dealerships and get more exposure to our customers, I'm really seeing a strong brand and seeing an opportunity for us to bring some of our operational skills and some of our purchasing power to that area. We have an outstanding ability and opportunity to bring e-business capabilities to that business. So we're very happy with Kichler acquisition, and we're going to continue to drive performance throughout the year. Understanding that given the full year or full quarter ownership of Kichler and the fact that Q1 is a seasonally weaker quarter that will be a little bit of margin drag in the segment.

Yeah, Mike, or maybe just to add on to Keith's comments just a bit. If you think about how we look at the lighting business and when we talked about when we acquired the business, we don't see the fundamental market for lighting shifting dramatically from when we initially talked about. It should grow kind of at the same rate as the overall R&R market kind of in that mid-single digit 4% to 6% range, as you might call it. That said you raised the point about the tariffs and the tariff impacts, because that have a little bit of a headwind on that. Yes, they could, without a doubt. So something we need to look at and see how the tariffs actually roll-out and see how that plays.

Hey, thank you for taking my questions. I just wanted to follow up on the discussion earlier around how you would kind of flex margins depending on different market assumptions, because you gave a point estimate for both Plumbing and Cabinets margins in 2019 in light of obviously a lot of moving pieces around tariffs and commodities. So I guess just what gives you confidence in such precise estimates? And then would you be able to kind of give, I guess, some more specific range or bracket around those margin estimates? Thank you.

I believe the clarity comes from our ability to identify the pull forward, which is a significant advantage. We aimed to provide more details in those segments due to numerous variables. Historically, we understand how those businesses function and how Kichler impacts a seasonally slower period. Additionally, we own it for three out of three months, rather than just one out of three months. This was straightforward math, and we wanted to ensure we addressed it. This way, we can be more accurate for specific quarters. Regarding additional details, we have shared what we are ready to disclose about our margin performance for the year. As for the impact of tariffs, which is a crucial factor in this discussion, if those tariffs were to be removed, it would push us toward the higher end of our range. We'll keep it at that and will provide further details as we gain more certainty regarding the figures and timelines.

And then just the margin guidance specifically for Decorative, understanding the larger impacts in the first quarter, it still suggest that you're expecting a lower margin year-over-year from the second quarter to the fourth quarter. So is there any additional color on why that maybe in light of oil prices obviously moving lower. I guess how much of that would be the Kichler headwind from tariffs is mix of pro, a meaningful part of that just any additional color on why the conservatism on margins there? Thank you.

Kichler is a big mover there which we already talked about. We do expect some price commodity headwind in the first half of '19. We are going to continue to invest in hub stores and pro reps and recall that we don't anniversary our 2018 pro rep additions until the third quarter. So when you look at Kichler, you look at what we expect to be commodity headwinds particularly in the resin area that will be facing early in the year. We look at our growth investments in hub stores and pro reps and the fact that we don't anniversary some of those additions we made in '18 to late in the year. Those are combined to put our guidance in that 17% to 18% range.

I would like to add that our depreciation and amortization in the segment will be higher compared to our historical experience. This will create some margin pressure, but it is unlikely to affect our EBITDA at all.

My first question is just around, you've done a fair amount of work on the working capital side over the last year or so. How much more do you think you can do there and how should we think about that potentially adding to some of the cash generation that you expect?

Certainly. So we have been working on working capital and thank you for noticing the fact that we've been working on it indeed. The businesses have been working hard at it. It has actually elevated a little bit from where we've been historically, a large part of that has to do with the Kichler acquisition as they carry a higher working capital than most of our business historically. That said, we are working with the Kichler team. We know they know that they see opportunities to reduce the working capital in their business. So there could be a little bit of a tailwind for us going forward. And as you may know, we have all of our businesses focused on working capital. So while we are happy with what we've posted so far, we always strive to get better than within where we've been. So I think there's an opportunity to grind out a little bit better working capital as we go into 2019. That said, the one thing that will be a bit of a headwind for us in working capital is the tariffs because the tariffs, you have to pay the government in a very short period of time. I believe it's seven days and so that will impact our working capital a little bit as we go into 2019. Okay. And then my next question is just now that Kichler is integrated, how are you thinking about M&A going forward? Can you give us any color on what you've been seeing in terms of the pipeline there?

We have not changed our strategy in M&A, our pipeline remains solid. We're focused on identifying spaces, if you will, that we think have good fundamental growth and tailwinds and good pricing power and then we identify specific targets and then start our cultivation activity and we have a pipeline process and I'm pleased with the level of the pipeline, we really are not changing our strategy. We have a strong balance sheet that affords us the ability to do the kind of deals that we want to do as well as allocate capital on a balanced approach toward share repurchases, dividends, and of course we are going to continue to fund our brand and innovation in our existing core business. So we like what we're seeing and we're going to continue to drive it and when we are ready to announce a deal, we'll do that.