Masco Corporation (MAS) Q3 2022 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Welcome to Masco Corporation's Third Quarter 2022 Conference Call. My name is Alex. I will be your operator for today's call. As a reminder, today's conference call is being recorded for replay purposes. [Operator Instructions]. I will now turn the call over to David Chaika, Vice President, Treasurer and Investor Relations. You may begin.

Thank you, Alex, and good morning. Welcome to Masco Corporation's 2022 third 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 third quarter earnings release and the presentation slides 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 metrics. Our references to operating profit and earnings per share will be as adjusted, unless otherwise noted. We reconcile these adjusted metrics 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. Please turn to Slide 5. In the third quarter, sales matched prior year with significant pricing actions of 9%, offsetting volume declines of 6% and currency headwinds of 3%. Demand moderated more than expected in the third quarter with most categories experiencing declining volumes year-over-year. Our operating profit was impacted by these lower volumes, higher operational costs and unfavorable foreign currency. Partially offsetting these headwinds, SG&A as a percent of sales improved 110 basis points to 15.6%, as we continue to manage our SG&A and discretionary spending. Operating margin was 15.9% for the quarter and earnings per share was $0.98. Turning to our segments. Plumbing grew 5% in local currency against a 15% comp with 4% growth in North America and 5% growth in international. Our spa business and international plumbing delivered positive volumes for the quarter. International plumbing sales were led by strong growth in China as we continue to gain share. European markets in the quarter were flat in local currency against a double-digit comp in the third quarter of 2021. While incoming orders have moderated in Europe, we saw good demand in several markets such as China, India, and the Middle East, demonstrating the benefit of selling to over 100 countries. We were price/cost positive in the third quarter in plumbing, and we expect that relationship to continue to improve in the fourth quarter as our pricing actions are in place and we continue to anniversary the higher costs from last year. In our Decorative Architectural segment, sales grew 1% led by PRO paint sales, which increased mid-teens against a more than 45% comp in Q3 of 2021, more than offsetting sales decline in DIY paint, lighting and hardware. PRO paint volumes increased low-single digits as we continue to see good demand from PRO paint contractors. We are retaining the significant share gains we have achieved over the past 12 months, and we continue to increase the rollout of additional capabilities and services along with our channel partner to strengthen our value proposition to the PRO painter. This strong performance is a testament to the satisfaction that PRO painters have with our high quality products, competitive PRO offering and our partnership with the Home Depot. We are pleased with our performance in PRO paint and we'll continue to capitalize on the significant growth opportunity. Moving on to the overall demand picture. POS and incoming orders slowed more than expected late in the third quarter across most of our product categories, and we anticipate this slowdown to continue into the fourth quarter. In the third quarter, we also experienced higher operational costs, mostly in plumbing that will continue into the fourth quarter. These operational costs include higher than expected freight and material costs due to persistent inflation, as well as production and absorption inefficiencies associated with changing volume levels. Lastly, the U.S. dollar continues to strengthen, which will result in lower revenue and operating profit dollars than we'd previously forecasted. Because of these dynamics, we are lowering our earnings per share expectation for the year to $3.70 to $3.80, from our previous expectation of $4.15 to $4.25. We are enacting plans to address lower volumes and elevated operational costs. While market conditions are softening, we believe, we are well-positioned to outperform in more challenging times and deliver long-term shareholder value. Our portfolio of lower ticket repair and remodel-oriented products serves both DIY and PRO customers, and we have product, channel, geographic, and price point diversification to provide stability and resilience through a cycle. We've taken significant pricing actions and will continue to recover cost inflation experienced in 2021 and 2022 as certain commodities and cost pulled back from their highs such as copper, zinc, and ocean freight. We continue to invest in our leading brands and innovation to capture share. We have experienced agile management teams that have successfully navigated uncertain economic environments before. And we have a strong balance sheet, cash flow, and liquidity that can be used to our advantage. This confidence in our business is exemplified by the new $2 billion share repurchase authorization approved by our Board of Directors. This authorization is a continuation of our capital allocation strategy. First and foremost, we invest in our business to drive profitable growth; second, maintain a strong investment grade balance sheet; third, pay a relevant dividend with a targeted 30% payout ratio; and fourth, deploy excess free cash flow to share repurchase or bolt-on acquisitions. We have consistently executed on this strategy to drive long-term shareholder value and will continue to do so. I'll now turn the call over to John for additional detail on our third quarter results and full-year outlook. John?

Thank you, Keith, and good morning, everyone. As Dave mentioned, my comments today will focus on adjusted performance, excluding the impact of rationalization and other one-time items. Turning to Slide 7. Sales in the quarter matched prior year and excluding currency grew 3%. Net selling prices increased sales by 9%, partially offset by lower volumes, which decreased sales by 6%. In local currency, North American sales increased 3%. This performance was driven by strong growth in PRO paint as well as in spas. Higher net selling prices increased sales by 11%, partially offset by lower volumes, which decreased sales by 8%. In local currency, international sales increased 5%. Net selling prices increased sales by 4% and higher volumes increased sales by 3%, partially offset by a mixed impact of 1%. Our gross margin of 31.5% was impacted by higher year-over-year operational costs in the quarter. We anticipate that gross margin will continue to face pressure in the fourth quarter, but will improve year-over-year. Our SG&A as a percentage of sales improved 110 basis points to 15.6%. Operating profit in the third quarter was $351 million and operating margin was 15.9%. Operating profit was impacted by lower volumes, higher operational costs and currency partially offset by higher net selling prices. Lastly, our EPS in the quarter was $0.98. Turning to Slide 8. Plumbing sales were flat to prior year. Excluding the impact of currency, segment sales grew 5% against the healthy 15% comp in the third quarter of last year. Pricing contributed 7% to growth and volume decreased sales by 2%. North American sales increased 4% in local currency. This performance was driven by strong spa volumes and pricing actions across the segment partially offset by lower volumes in other product categories. International plumbing sales increased 5% in local currency against an 18% comp from last year. Growth was led by strength in China with most European markets roughly flat versus prior year. Segment operating profit in the third quarter was $220 million, and operating margin was 16.6%. Operating profit was impacted by lower volumes, higher operational costs and currency, partially offset by higher net selling prices. Turning to Slide 9. Decorative Architectural sales increased 1% in the third quarter. Our PRO paint business continues to deliver outstanding performance, with sales up mid-teens against a robust count of over 45% in the third quarter of 2021. We continue to gain share and drive conversion as our PRO paint offering, strong brands and high quality products resonate with PRO customers. Our DIY paint business declined low-single-digits versus prior year, largely as expected. Additionally, our lighting and builders' hardware businesses declined in aggregate mid-single-digits in the quarter. Operating profit was $151 million in the quarter, and operating margin was 17.2%. Operating profit was impacted by lower volumes and higher freight and material costs, partially offset by higher net selling prices. Turning to Slide 10. Our balance sheet is strong with net debt-to-EBITDA at 1.9x. We entered the quarter with approximately $1.5 billion of balance sheet liquidity. Working capital as a percent of sales was 18.5%. Working capital was impacted by higher inventory levels at many of our businesses, cost inflation and delays in receipt and delivery of material. We continue to balance our inventory levels with demand and expect working capital as a percent of sales to be approximately 16.5% at year-end. In the quarter, we also paid down $100 million of the $500 million term loan that we borrowed in the second quarter. Additionally, our Board authorized a new $2 billion share repurchase program effective October 20, 2022, replacing the existing authorization. This action underscores Masco's strong financial position and our Board's confidence in Masco's future. We do not expect further share repurchases this year as we will use our free cash flow to repay the balance of the $500 million term loan that we took out in the second quarter. Turning to Slide 11, let's review our outlook for 2022. Given moderating demand and additional foreign currency headwinds, we now expect our full-year sales growth for Masco to be in the range of 3% to 4% versus our prior guidance of 5% to 7%. We now anticipate full-year operating margins to be approximately 16% given lower volumes and higher operational cost. While we continue to expect year-over-year margin expansion in the fourth quarter, it will be lower than previously anticipated. In our Plumbing segment, we now expect 2022 sales growth to be in the range of 1% to 2%, including foreign currency, versus our previous guidance of 3% to 5%. Given current exchange rates, foreign currency is expected to unfavorably impact Plumbing revenue by approximately 4%. We now anticipate the full-year Plumbing margins will be approximately 16.50%. In our Decorative Architectural segment, we expect 2022 sales to grow in the range of 7% to 8% versus our previous guidance of 9% to 11%. Looking specifically at paint growth for 2022, we currently anticipate our DIY paint sales to increase mid-single-digits and our PRO paint sales to increase strong double-digits. We now expect the full-year Decorative Architectural margin to be approximately 17.50%. This is lower than our previous guidance due to lower than anticipated volumes and higher advertising spend. Finally, as Keith mentioned earlier, our updated 2022 EPS estimate is $3.70 to $3.80. This assumes a 233 million average diluted share count for the year. Additional modeling assumptions for 2022 can be found on Slide 14 in our earnings deck. With that, I would like to open the call for Q&A. Operator?

Thank you. In order to ensure that everyone has a chance to participate, we would like to request that you limit yourselves to asking one question and one follow-up question during the Q&A Session. [Operator Instructions]. Our first question for today comes from Michael Rehaut from JPMorgan. Michael, your line is now open.

Thanks. Good morning, everyone. Appreciate it. I want to focus for a moment on not just, the changing demand backdrop but how you're looking at your own inventory levels as well as inventory levels in the channel. And how much to the extent that you're able to get a sense how much of the change in demand trend that you're expecting in the fourth quarter are being driven by any types of channel inventory, restocking, relative to, consume trend, end-market demand trends and how you think of that perhaps persisting into the first quarter of the year?

Thanks, Mike. This is Keith, I'll take that one. We did see moderating demand POS in the quarter a bit more than we expected. It was fairly broad-based I would say, across categories in terms of incoming orders in POS, which we think is most important. Most categories saw this decline across channel. So broadly speaking, we did see moderating, POS demand on the consumer -- on the customer side across channels and categories. We do expect volumes to be down in both segments for Q4 understanding that Decorative had a 15% comp and Q4 PRO paint, I think, was like 50% comp. So we do expect volumes to be down in the fourth quarter across both of those segments. In spite of this, we do have backlog in some of our business, wellness in particular and we did it as John and I both mentioned we had another solid quarter of PRO paint growth. In terms to your question with regards to inventory and inventories in the channels, I would say that inventories are in pretty decent shape. I wouldn't say that they're overstocks or excessive. Some destocking is occurring across categories and channels for sure. But there's always movement in inventory levels, particularly in changing macroeconomic environments and changing markets like we have, evens out usually around the end of the quarter. We do see some stock de-stocking that happens around quarter-end that we've talked about in the past. So we are not really expecting inventory destocking to be a material impact for us as we think about Q4. So the majority of it we would say is an end market demand driven.

Yes. Mike, maybe a little bit of additional color to give you. I'd say that de-stocking will probably be mostly in the non-paint categories. Paint we manage very closely with the Home Depot. And then with respect to our inventories, as I mentioned here in the third quarter, our inventories were a little bit higher than we would like. But I think their teams are very focused on this in doing a good job of trying to match our inventories with demand. And so as I also referenced in my prepared remarks, I -- we do think, we'll get our working capital as a percent of sales down at year-end to probably more normalized levels at like 16.5% or so.

Great. Thank you for that. I guess, secondly, maybe just shifting to raw materials. If you could just kind of give us a sense of where you were I think on a consolidated basis, if you have by segment, that's obviously also very helpful in terms of price/cost and what the raw material headwinds were during the quarter itself? And looking into 2023 given more recent movements in the various inputs, how should we think about raw materials in terms of where the prices stand today if you think that that could turn into a tailwind?

Okay. Mike, I'll try to answer a couple of questions then, let me try to break that down in and give it -- and give you a sense. In terms of price/cost, I'd say across the enterprise, we are price/cost favorable and across the enterprise as well as in breaking it down to the segments both segments. As we think about raw materials going forward, we have seen some moderation in raw material prices, particularly on the paint side of the business. Copper and zinc have come off, their highs from earlier in the year, but I would remind everyone it takes a couple quarters for that that benefit to flow through and hit our P&L. And so I'd say that we probably aren't experiencing as much of the price/cost favorability as we would've anticipated in the third quarter, given some of the moderating volumes that Keith just talked about. As we think about the go-forward period, we would expect and it's hard -- it's always hard to foreshadow, but we would expect more favorability in price/costs as we go into Q4. And just given our pricing actions that we put in place kind of some of them were mid-year and quite honestly Hansgrohe is going out with price at the beginning of the year as they typically do that there'll be some favorable price/costs as we go into 2023. So I think that covers most of the questions you asked Mike, but if I missed something, let me know.

Hey, John, this is Keith. Let me -- if I can just insert here just a minute. You referenced some commodities that have come down in paint I think you meant plumbing --

I miss spoke, yes.

…when you referenced conferencing, that's obvious, our Plumbing segment.

Yes.

Yes. No, that was great and appreciate that clarification. I think the only element of -- and I apologize, I guess, my multi-part question was just on a net basis for 2023, given where commodity prices are currently, if you would expect raw materials to be a net tailwind on the whole for next year?

Yes. We're not really getting in deep into 2023 here. We'll talk about that next quarter, Mike. But certainly, our expectation would be that we'd see some commodity relief and it's all flowing through our P&L a little slower than we had anticipated because of some of the volume pullback. I would say we expect that to be a tailwind in 2023.

Our next question comes from Adam Baumgarten from Zelman. Please go ahead. Your line is now open.

Hey, thanks for taking my questions. Good morning. Just maybe on paint just given the week DIY activity that you're seeing, are you seeing or expecting, I should say, an increase in promotional activity going forward?

When we think about promotional activity in general, I would say that it's been more muted than in the past. I think given that where the volumes were we have increased our advertising and planned to continue to do that. In terms of promotions overall in the industry, I suspect it'll that, that we'll see a little bit of an uptick in that, but it remains to be seen. Our preference obviously is to compete on brand service and innovation and continue to drive that, that's worked well for us. And I think if we do see increased promotions, it will be more spot promotions, if you will, rather than the - what was traditional pre-pandemic, say, where they were more ingrained into the market more consistent. That's what we're currently seeing.

Got it. Thanks. And then just on the cost actions you alluded to, any specific areas that you're targeting or maybe just some more color around what the plan is there and which areas of the business will be affected?

Yes. I think when you look at what happens in an environment where there's a quick volume reduction, there's a couple things in the cost side that are impacted. Firstly is on the material side. The costs that we have seen that particularly in plumbing that have backed off a little bit from their highs, take a little bit longer to flow through our P&L because of the lower volumes and that's the case for us. It's taken a little longer than expected, say a quarter or two to flow through the box -- because of their volume. So that's a piece of it. And that really comes with time, we -- as the -- as they roll through the P&L. It also drives absorption issues and variable overhead principally. And as we see where that'll settle in, that, that's going to give us the ability to better dial-in our shift patterns and balance our factory to drive productivity. And this is quite typical when you see rather rapid volume reductions and we're working that. Inbound logistics talking about specific in plumbing that's been timely deliveries can be challenging and drive productivity issues. Frankly, we expected to see a more rapid improvement in that. Things are improving but not to the pace that we thought they would be. So we're continuing to work those down. So in terms of the operational costs that we're currently facing, that gives you a flavor of how we're attacking it. We expect to be through that by the end of Q1. In terms of a more protracted recession if there -- that is there, as John mentioned in his calls, we have an experienced management team that have been through times like this. And our focus, frankly, is to come out of a recession stronger than when we went into it and we were able to demonstrate that in 2008 and 2009 and we're going to demonstrate that again here, but the usual suspects in terms of levers we have around variable costs that we would look to in terms of either delaying spend or cutting back and marketing and advertising, travel, entertainment, those sorts of things. And then of course, there's always fixed cost levers that we could look into. Now, given where our capacity utilization is across our own supply chain, our own factory network, et cetera, and the high-level demand, I don't anticipate that would involve any sorts of reconfiguration of our manufacturing footprint just because of the demand and our expectation for growth, but that gives you few of the levers both short-term and mid-term.

Our next question comes from John Lovallo from UBS. Please go ahead. Your line is now open.

Good morning, guys, and thank you for taking my questions. The first one is on the implied 4Q plumbing margin seems to be implied in sort of the low-to-mid teens versus I think expectations of closer to 20%. It doesn't seem like the sales decline explains this, so just curious if you can give us some more color on what's going on there.

Yes. So John, maybe I'll start and maybe Keith can -- you can chime in on part of this. So if you think at our 4Q plumbing guide for profit, I agree on margins. It does imply some pull down from where we were previously guided. I think there's really two components. One is the volume drop that you talked about. And then the second piece would be the operational costs that we alluded to in our prepared remarks. And some of that relates to higher than -- continued higher than expected freight and material, but then also some of the production inefficiencies with the changing volume levels that that Keith mentioned. So Keith, maybe with that, I'll turn it over to you if you give a little bit more color on that portion of it.

Sure. I would say the biggest piece is the volumes. So we have the FX there that we talked about and the lower volumes. That does a couple things that that give us challenges with regards to cost. And I've talked about this a little bit in my last response. One is the longer time for the lower material costs that we expected to hit our P&L. And then section -- secondly is the absorption issue. So that's a factor. And then John mentioned the elevated freight and in some case -- and labor costs, so that was -- that's an area that and we expected to see more relief in coming into Q4 than we have. So that's -- that's a second challenge. And thirdly, operational inefficiencies, principally in our plumbing area driven by inbound logistics and the reliability and timely of those deliveries that gives us labor efficiencies and challenges in the shop floors that hasn't improved as much as we expected it to. Now it is improving and we continue to take actions to drive that improvement at a faster rate. But as we look at that improvement and paradoxically, while the lower volumes does give us absorption issues. It does give our supply chain some relief. So we're getting after this and the improvements are coming, but they won't be totally behind us until Q1. So that frames up some of the margin challenges and why, while we'll be a little bit better in margin, it's not as good as we had previously guided to.

Okay. Thanks for that. And then the second question is the SG&A leverage was surprising given the sort of flattish top-line. What kind of costs do you guys taking out and how sustainable is that before it begins to impact the business?

Well, I think we're going to end up; this is not a run rate that we'll stay at. We're starting to filter back in SG&A. We've put in little -- we put in more advertising in our paint business. And we're committed to continue to invest in brand service and innovation because that fundamentally is what'll make us as strong as we can be coming out of these sorts of pullbacks or recessions, however you want to think about it. So we're very careful in terms of how we look at SG&A. It is a dial that we have that we can turn that, that we can either delay some growth spend or delay as I mentioned advertising, travel, entertainment, participation in shows, those sorts of things. But we're very careful with it. We're focused on the long-term exiting of this pullback so that we're stronger than we went in as I mentioned.

Yes. Yes. John, I really add to Keith's comments. That's right. I mean as we started looking forward to 2023, I think we're going to be very focused on SG&A just and trying to match that, our investment in SG&A up with what we're seeing from demand in the marketplace. And so to Keith point it's a lever that we can pull, we're on top of it. We're watching this very closely, right? Yes, we did enjoy some better SG&A leverage here in Q3. And it's something that's got our complete focus as we move forward.

Thank you. Our next question comes from Matthew Bouley from Barclays. Please go ahead. Your line is now open.

Good morning, everyone. Thanks for taking the questions. Wanted to ask about the Decorative margins and the guide for Q4. Seems like there's an expectation there for relatively significant, I guess detrimental margin. And Keith, you're alluding to everything around the challenges with a rapid reduction in volumes and perhaps that's the big piece of it. But so just kind of looking at that, that detrimental volume assumption in Q4 what it just to number one, confirm if that's what it is, if that really is what's driving that Q4 guide, and then kind of what's the right way to think about the volume detrimentals longer-term on the assumption that, that we do continue to see kind of weakness in consumer demand. Thank you.

There's a couple of items I'd point to and then John maybe if you want to add some color to it. Clearly the volume moderation is a big piece of it. There's no question about it. And then secondly, I'd remind you when we talk about how we typically perform in price as it relates to commodities, we generally hold our margin dollars. But when you do that that results in margin percent pressure, just by way of example, something like a 10% increase to recover only commodity costs results in almost a 200 basis point reduction in margin. So those two -- the interaction of price versus commodities and the volume reduction of the principle drivers.

Yes, yes, that's right. I think those are the two components. I think that the third principle component of the margin degradation in Q4 Matthew would be the investment that we referenced in marketing and advertising in the segment. It's perhaps more elevated than we would've had experienced a year ago. And so if you take the volume drop, the cost recovery nature of the inflation and the marketing spend, the advertising spend that we reference, those would be the three big components that, that would cause the margin degradation. But as Keith said, I expect that that that investment in marketing and advertising will be largely contained to Q4 and it wouldn't say that that's going to be something we'd bake in longer-term.

Got it. That's very helpful. Thanks for that guys. And then second just kind of shifting to the international business I guess with Hansgrohe, it sounds like I believe you said at the top that that Europe is slowing, whereas you got some of the other geographies where are actually a bit more supportive. I'm just curious if you can expand on that a little bit kind of what are your expectations for how European demand evolves in that business and to what degree can those other geographies continue to offset that? Thanks, guys.

So we delivered a nice quarter internationally in local currency, up 5% as we mentioned. So very pleased with that. Largely driven by Hansgrohe's growth in China as well as several other markets. Hansgrohe has done an outstanding job of positioning that brand and driving it to market leadership in terms of a premium brand in China. We continue to grow there and expect that to continue. European markets are starting to moderate, modest slowdown in incoming orders. Sales overall in Q3 in Europe, I'd say were roughly flat. Again, the broad exposure that we have across many countries that have different economies in Europe is helpful. And that diversification of our risk there is very helpful. I'm glad to have it. So it's clearly seeing a pullback in Europe. But as I said, China, Middle East is doing well for us. As I mentioned in my prepared remarks, we're seeing good growth in India. So I think that diversification as well, more broadly speaking our diversification across price points, our diversification across channels, and of course our geographic diversification both U.S. versus international and then within that international bucket are all helpful for us and why we feel that we are positioned very well to make it through these moderating times.

Yes. Yes. Matthew, maybe a little bit of additional color to frame this up for you. Recall that international sales are approximately 20% of our overall sales. And in that, Europe represents about two-thirds of that international sales and the rest of the world represents about a third. So we're -- Keith has just talked about it and what we referenced, so the two-thirds is roughly flat. The one-third of the business is growing nicely. So I just want to make sure everyone's got that in context, because a lot of people think our international business is solely Europe and it is -- it's much more diversified than that. Due to the good work that the Hansgrohe team has done over the years to expand their sales base across the globe.

Our next question comes from Susan Maklari from Goldman Sachs. Please go ahead. Susan, your line is now open.

Thank you. Good morning, everyone. My first question is dialing in a bit on the consumer. Are you seeing any pushback on pricing from them? And is that in any way impacting some of the moderation in volumes that you're seeing? And how are you thinking about the consumer and their willingness to spend overall?

Well, I think the overall inflation I think is really starting to have an effect on the consumer. Not just in our products, but in everything from energy to food to you name it. So I think that's -- that's all part of it. Having said that, we still in -- we're seeing good order rates moderating a little bit in our spa business. We are starting to come down to chip away at our backlog. I think that's our backlog now is in that 10, 12-week range. So that's down and we're working that down, but we're also seeing some good order patterns. We are not seeing, Susan, a material shift down. I mean oftentimes in times like this in my career, I've seen, for example maybe a little bit of a shift towards private label. But we really haven't seen that at this point. So we do expect, I expect that overall inflation will ultimately have an impact on the consumer and their spending habits. But where we sit right now, I think the consumer is holding up well. They have a good amount of home equity. Unemployment is obviously in a very good spot. So there's a mixed bag out there as it relates to that combination of inflation and how the consumer feels. But we're not seeing mixed down and we're seeing in some parts of our business still strong order rates.

Okay. And then turning to the balance sheet, can you talk a little bit about the ability to work down the working capital? How you're thinking about that is perhaps a source of funds in the upcoming quarters? And then, any thoughts in general around capital allocation? You talked about paying down that term loan in the fourth quarter, but how are you thinking about leverage and buybacks and all the different opportunities in general?

Yes, sure, Susan. In terms of how we're thinking about working capital, if you think about the seasonality of the business, generally the way the business operates is the first call it five, six months of the year we're a cash consumer, just given the seasonal build, typically that takes place of inventory for the summer selling season, the spring selling season, and the like. And then right around mid-year, we turn into a much more of a cash generation as this working capital comes in. And typically, you see this greatest source of cash generation in the fourth quarter as both inventories and receivables kind of bleed down just due to the seasonal -- natural seasonal slowdown that we -- the business enjoys. And then obviously right around the first of the year, then it begins to flip back. And so I would don't expect any changes to that seasonality over the course of the coming months and quarters. In terms of focus in the business on this absolutely the businesses are focused on it. It's part of our variable compensation scheme, where working capital generation is. And so yes, I would tell you the teams across the enterprise are very much focused on doing the right thing in driving working capital, lower for the business. At the same time, I would tell you, given my longer-term experience with the business in software economic environments, working capital generally is a source of cash generation, if volumes were to decline. And so is -- if depending on how the economy rolls out over the course of the coming quarters, I would anticipate that to be a benefit for the organization. Now, flipping to your second part of your question about broader capital allocation, I don't think our views on capital allocation have changed dramatically. Keith articulated our capital allocation strategy, and I'll just repeat it for everyone's benefit. One, first and foremost is to invest in the business because that is our highest return investment, either growth capital and/or maintenance capital with the business. And so those are naturally done and we -- I'll remind everyone that's generally the light touch. It's about 2%, 2.5% of sales. So not a significant draw upon our cash generation. The second piece is to maintain a strong balance sheet. We've done so over the years and we've done a very diligent job of making certain that we take advantage of the capital mark -- debt capital markets when there's attractive periods. We did so with 2021 very, very effectively. And earlier this year we did the $500 million term loan to pull forward our share repurchase activity. And we have a very strong commitment to live within our means. And so we would anticipate continuing to pay down that, that term loan fully as we foreshadowed back in May and June when we took that on, that we would be very disciplined about how we approach it. And so I don't think that is going to change whatsoever. We are committed to the dividend because we think an organization of our size, our quality should be paying a dividend and the 30% payout ratio we think is the right level to payout for our industry and our organization. And then, lastly, because of the significant cash flow generation that we enjoy, you're able to redeploy that the excess to either share repurchases and/or M&A. And I would say that, that both of those activities will continue. We continue to look at what is the right or the best return that we get on that excess cash that we generate. And if we can find highly attractive both on M&A targets for either our paint or our plumbing business, we would like to do that because we've got great franchises in both businesses, whether it's domestically with the Delta team or whether it's internationally with the Hansgrohe team or the Behr team here. We would gladly invest behind them to continue to grow their business. And whether that's product line acquisition, channel access, geographic acquisition, we look at anything along those lines to support those business to continue growth. But to the extent, we can't find those types of acquisitions. We're happy to redeploy our excess capital to share repurchases. And so I think we've been a very effective stewards of our capital allocation program over the years. And I think we'll continue to do so. So, Keith, I don't know if there's anything else you want to add?

All right. Maybe just some specific context on working capital. Business are focused on that as John mentioned its part of our variable compensation scheme. And I would estimate that we'd finish the year in that 16.5% range.

Great. Thank you for all the color and good luck with everything.

Thank you.

Our next question comes from Mike Dahl from RBC Capital Markets. Your line is now open. Please go ahead.

Hi, thanks for taking my questions. Keith, my first question is just around kind of the rate of change in what you're seeing in underlying market conditions, because at least our sense was that for a while the quarter things were probably okay, but then looking at where you ended up in the quarter and now with the guidance implies, it seems like things may have shifted pretty quickly late, like very late in the quarter. So maybe can you speak to just the cadence and how quickly conditions changed as you've kind of gone through the September and into October? And also what does that really mean in terms of your visibility even into year-end let alone beginning of next year?

Yes. I would say that the slowdown really became apparent as you mentioned in September. So it was late in the quarter. The -- while it's early in October, I guess it's not so early in October now, now we're three -- call it three weeks into October. We're -- we've factored that what we're seeing into October into our guide. So our best view of where the year is going to finish out is obviously incorporated into the guide based on that. We've seen some softening in DIY paint demand that we've talked about to give you a little bit of context in that. And the overall slowdown, if you will, has been, as I mentioned, pretty broad-based. It wasn't like there was one particular part of the country or one particular channel or one particular type of product. While I would say obviously that we're still continuing to do quite well in PRO and we're working through and have good demand in our spa backlog. So it did happen late in the quarter. And I'd say it's been that, that it's been fairly consistent since then and what we're seeing in October is incorporated into our guide.

Got it. Okay. Thanks. And my follow-up question just specifically around the -- this elevated spend in Dec Arc, I guess what I'm wondering is, was this kind of a pre-planned spend and the impact that it's having is just larger because the volumes haven't come through as expected? Or is this a newer program that where the spend is being put in place to effectively spend even greater declines versus what you're currently seeing? Just a little more collaboration on what exactly this is, why it's in place, while what as volumes are falling you more meaningfully would be helpful.

We're -- we -- as John mentioned in terms of SG&A being something that we watched carefully and we make calls based on the most appropriate use of that. So I would say it's a little bit more accelerated than we have originally planned. If you watch any kind of sports TVs, our ads on for Behr paint for DYNASTY specifically, it's a great product. And we think that when we look at that advertising spend versus the benefit that we get from that, and that is the right thing to do. So it's something that we look at and tweak as we see different demand characteristics and what we think would be the best bang for our buck in terms of what and how we advertise and how much, as John mentioned, I wouldn't model that into ongoing at that -- at the levels that we did in Q3 here and plan to do in Q4 into the full-year. And we'll talk more about 2023 next quarter and give you much more color on how we feel about our brand spend, et cetera, at that point.

Yes. Mike, the other point I might comment on, in addition what Keith just said is, if you take a look at the spend year-over-year, it's up, right? So fourth quarter of last year was a relatively muted spend. So it's -- well and it's higher this year, and I think that's probably the more significant component of it is compare -- is the year-over-year compare.

Our next question comes from Truman Patterson from Wolfe Research. Please go ahead. Your line is now open.

Hey, good morning, everyone, and thanks for taking my questions. First, I just wanted to touch on the plumbing and paint up margin guides in the fourth quarter. You all have gone through a variety of items already for both segments, but I was wondering if there was also a component of pricing that was previously announced that either wasn't as robust or realized as you all had previously expected in either segment?

No.

No.

No. It's really the things that we've already talked about in terms of and principally across both segments, it's the reduced volume that obviously has issues in plumbing in terms of overhead absorption and -- but mainly the dropdown on incremental revenue from that volume FX is a factor. We've had some operational issues that we're working through in plumbing and will be behind us by the end of Q1 that we've talked about, but price realization has been a very solid for us.

Okay. And then just thinking your PRO paint segment, the share gains over the past year, two years, I'm trying to understand if this is a bit more of a kind of general jack of all trades type PRO that you've gained or whether a decent portion of the success has been drawing in converting what we'll call traditional paint dedicated PROs into Home Depot and then, finally embedded in the fourth quarter guidance. Does that actually assume that PRO paint volumes will decline year-over-year on that tough comp?

Yes. I think it probably a little bit of a decline when you talk volumes year-over-year because of that, but it'll be modest -- modest decline in volumes. We've had good volume growth this quarter that we just finished. And PRO paint is performing very well for us. We let's call it mid-teens growth against that. I think our comp last year, Q3 was like 45%. And we continued to get data and we watched this very carefully in terms of stickiness of the share gain that we've got both with new customers and to your point, it's a combination with the smaller painters or the more paint focused professionals who are painting, we're getting some of that demand as well. And recent data on our net perform -- net promoter score is very strong. So feel very good about what the Behr team has done in terms of what we committed to, which is to keep this share gain going. And the experience their particular in our research are referencing the experience with our product, the programs that we have for PROs and of course, the partnership and how the Home Depot is servicing that that general segment. So our confidence is reflected in the outlook. And while, yes, it'll be a modest volume, but when you look against the comp in terms of gallons, we feel we are doing a very good job of maintaining the share as we committed to.

Yes. Truman, but the only thing I'd add is, we're kind of in a period of some really tough comps on the PRO side. We have 45% in Q3, 50% in Q4, I think north of 50% in Q1. So we've -- the Behr team is just a terrific job at executing and taking this share. But as you go up against these enormous comps, it's always tough to post even higher charts on top of that.

Okay. All right. Thank you all and good luck in the coming quarter.

Thank you.

Our next question comes from Phil Ng from Jefferies. Your line is now open. Please go ahead.

Hey guys, your 4Q guide, any color on the implied volume declines by segment and any early read on how we should think about 2023 by regions or businesses. It seems like the PRO side of things and spa still holding up quite well. Any color would be helpful.

Yes. And in terms of volumes Phil, I'd say overall, volumes -- as you think about volumes for Q4, I'd say we talked about kind of low-single-digit volume declines in plumbing in Q3 and I'd say that maybe even more significant in Q4 just given the way we're seeing things right now. And then on the Decorative Architectural side, the implied guide for Q3 was that -- volumes on the DIY side were down double-digits. And so if you take that into consideration with what Keith just covered about a modest protocol, you can kind of read through what the volume declines might be in Q4, perhaps low double-digit in Dec Arc.

Okay. And then for next year is that like [indiscernible]

Again, Keith referenced, we're not giving -- so yes, we're not given 2023 guidance just yet, but we'll give that out at our Q4 call.

Got you. And then, your margins I mean, which you addressed here a little light in the fourth quarter and some of these issues you're going to flush out by 1Q raws are staring to fall as well as ocean freight containers. Any color when you start seeing that flow through more meaningfully and with some of the cost out programs, is that enough to kind of offset potential volume declines where your margins could potentially hold next year?

As we look at the volume decline Phil, I remind everyone, if we think about our detrimental volumes, it generally run in the 30% range enterprise wide, maybe a little bit higher than that in the plumbing side, a little bit lower than that on the Dec Arc side. And so as you think about volume declines that's going to have a -- an impact on profitability. That said, to your point is we -- as we get through some of these higher raw material costs that are as they start flowing through and hitting our P&L that should be at offset, will be a one for one offset probably it's hard to tell at this point, but probably a little bit of margin headwind there.

Okay. And you start seeing that early next year, just want to get --

I'm sorry, Phil, go ahead.

That raw material benefit, you start seeing it more early 1Q and I think, John, you mentioned the bigger drop off I think was Dec Arc and maybe Keith kind of corrected you. Is it more plumbing? I just want to flush out the potential impact and the timing of some of that stuff.

Phil, are you looking for the potential impact of tailwind from raw material prices flowing to -- to our P&L and comparing that to the potential headwinds of volume in 2023?

Keith, I appreciate your problem. Now I go to that level of detail, but I'm just trying to gauge with raws falling, when does that flow through? Is that an early 1Q event? And I think John, you mentioned you seeing a bigger drop off potentially in paint, was that really more in plumbing, just want flush that out in terms of potential uplift on lower volume just from a timing and would segment could see a bigger benefit.

We should start to see a flow through Phil in Q1 and its plumbing.

Yes.

Our next question comes from Stephen Kim from Evercore ISI. Your line is now open. Please go ahead.

Yes. Thanks very much guys. Appreciate all the color you provided so far. I was wondering if you could talk a little bit about whether you're seeing any meaningful mix impacts across the business plumbing, paint, international U.S. that are worth calling out. And then in addition, any plans to adjust staffing or capacity in light of what you've seen and what would you be monitoring in order to make a move there in terms of capacity or staff?

Yes. In terms of mixed impacts, we haven't really seen one or are we expecting one. When we look across, for example, in China where we had such strong performance in Hansgrohe that's premium brand and that's where we stand there and that continues to do well. We know -- well, we monitor that, but we really aren't seeing anything. DYNASTY is doing very well for us, which is in the high end, our showroom products in Delta are performing well so no real impact. In terms of staffing of course, we look to maintain our labor productivity numbers and we focus our businesses on our detrimental in times like this. And staffing is a piece of it. And so that's capacity in the sense of a short-term capacity, in terms of matching staffing. We match our inventories to our demand levels. As I mentioned in earlier in the call at this point, where we expect our growth to be mid to long-term I wouldn't suspect that we'd be looking at any brick-and-mortar and we're carefully evaluating our -- the timing of our capital and our expansion projects to make sure that we continue to drive strong return on invested capital, but our plan is to continue to go forward with those as well.

Okay. That's very helpful. And then just generally on a related note, you talked about the abruptness of the decline that, that that came upon us all. And I guess my thought -- my question is how you're thinking about if there's any implications for what the recovery may be, do you think it's possible that the recovery could be similarly abrupt or is based on what you're -- or based on what you're seeing is your view that the recovery would be sort of typical or even perhaps more protracted? Just kind of curious as to whether you think there's anything to be implied from the abruptness of the onset of the weakness?

Yes. I think it's a little premature to prognosticate on the steepness of the recovery based on where we are at this point. I think when we look at the overall savings rate of the consumer, the health as it relates to the overall structure of our industry with the age of stock with millennials coming into the repair and remodel, and specifically into the DIY market, when you look at our coverage, we call it a 50:50 mix roughly in our overall enterprise between PRO and DIY. The price point coverage is geographic. Certainly I think we're positioned to fare better than most as it relates to coming out of this and that's how we're driving the business.

I'd like to thank everyone for joining us on the call to this morning and for your continued interest in Masco. This concludes today's call. Thank you.

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines.