Earnings Call: Q2 2019

Jul 25, 2019

Good morning, ladies and gentlemen. Welcome to Masco Corporation's 2019 Second Quarter Conference Call. My name is Amy, and I will be your operator for today's call. As a reminder, today's conference call is being recorded for replay purposes. I will now turn the call over to David Chaika, Vice President, Treasurer and Investor Relations. You may begin. Thank you, Amy, and good morning. Welcome to Masco Corporation's 2019 Q2 conference call. With me today are Keith Allman, President and CEO of Masco and John Snuevais, Masco's Vice President and Chief Financial Officer. Our Q2 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 ks 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. Please turn to Slide 4. Excluding the impact of currency, our top line matched prior year. Growth in North American Plumbing and Decorative Architectural Products was offset by softer sales in International Plumbing, Cabinetry and Windows. We delivered operating profit growth and margin expansion across all segments, resulting in 5% operating profit growth and 100 basis points of margin expansion, despite the flat top line. Our profit growth and margin expansion were achieved through disciplined pricing actions to offset tariffs and other inflation and a continued focus on cost control. Our EPS increased 16% to $0.88 per share. As it relates to tariffs, our near term mitigating action has largely been price. However, we continue to work with our suppliers and internal teams on cost reduction opportunities and have begun moving limited production out of China as a longer term solution. While pricing may have had a temporary impact on volume in the first half of the year, the consumer is still very healthy with unemployment at 50 year lows, incomes continuing to grow, confidence remaining high and home prices continuing to appreciate, all key drivers of repair and remodel activity. Now moving back to this quarter's performance. Let me give you some additional insights into the drivers behind each of our segments performance beginning with Plumbing. North American Plumbing grew 3% in local currency with Delta and Watkins each achieving a record sales quarter. International Plumbing sales decreased 3% in local currency with growth in Germany offset by softer sales in a number of other markets. International Plumbing sales are expected to improve in the second half as comps get easier and many of the new products introduced by Hansgrohe earlier this year begin to hit the market, such as Hansgrohe's Rainfiniti shower product, a modern shower with ultra fine and powder rain shower jets for a truly luxurious showering experience. In our Decorative Architectural segment, sales grew 3% led by high single digit growth in propane and low single digit growth in DIY paint. We were pleased once again to be named the top rated interior paint by a leading independent testing organization. In fact, Bear had 2 products in the top 3 and 3 products ranked in the top 6 reinforcing Behr's position as the quality leader in the U. S. Paint industry. In addition, Behr achieved a 1st place ranking in customer satisfaction for interior paints in the J. D. Power 2019 paint satisfaction survey. These recognitions speak to the strong brand, quality and value proposition of Behr Paint offered exclusively at the Home Depot. In Cabinetry, good cost control and pricing actions contributed to profit growth and strong margin performance despite a soft overall market. We're very pleased with our Menards business now that it has been fully implemented and it is meeting our expectations. Additionally, in the second half of twenty nineteen, we will celebrate Craft Maid's 50th anniversary with the largest introduction of new finishes in Craft Maid's history. New paint and stain colors along with new finish techniques such as weathered and translucent will keep Craftmade at the forefront of industry trends. Turning to windows. Flat sales in North American windows were offset by continued challenging conditions in our U. K. Window operation. Despite these challenges, we achieved profit growth and margin expansion in the 2nd quarter. Aided by continued strong performance and improved mix due to our intrinsic line of vinyl windows in North America launched late in 2018. Now moving to capital allocation in the quarter, we continued our share repurchase activity by repurchasing 4,300,000 shares $167,000,000 bringing our year to date share repurchase total to $289,000,000 Based on the strength of our forecasted cash flows and our strong liquidity position, we intend to deploy approximately $300,000,000 towards share repurchases in the second half of twenty nineteen for a full year total of approximately $600,000,000 This figure does not include any expected proceeds from the divestitures. Our Board of Directors also announced its intention to increase our annual dividend by $0.06 per share to $0.54 per share, a 13% increase beginning in the Q4. This is our 6th consecutive year we have increased our dividend. Maintaining a relevant dividend payout ratio of approximately 20% or greater is an important part of our balanced capital allocation policy. Lastly, are updating our anticipated earnings per share for 2019 to be in the range of $2.62 to $2.72 per share from a previous range of $2.60 to $2.80 per share. I'd also like to give you a brief update on our announcement to pursue the divestitures of our cabinetry and windows operations. We've begun the sales process and feel good about the initial market response to these businesses. As we laid out in our June announcement, we anticipate completing these transactions by the end of the Q1 of 2020, assuming each of these transactions can be completed on acceptable terms and conditions. This transformative step will create a more stable, less cyclical Masco that is focused mainly on lower ticket repair and remodel products. The divestiture of these businesses will also generate healthy cash proceeds from Asco. While the ultimate use of these proceeds will be determined based on the situation and the opportunities at the time of closing of the transactions. Our current plan is that most of the proceeds will be deployed to share repurchases. Now I'd like to turn the call over to John, who will go over our operational and financial performance in detail. John? Thank you, Keith, and good morning, everyone. As Dave mentioned, most of my comments will focus on adjusted performance, excluding the impact of rationalization and other one time items. Turning to Slide 6, sales decreased 1% on a reported basis, but matched prior year in local currency. Foreign currency translation unfavorably impacted our 2nd quarter revenue by approximately $26,000,000 In local currency, North American sales increased 1% in the quarter. This performance was driven by disciplined pricing actions offsetting lower volumes. Currency international sales decreased 4% in the quarter with growth in Germany and Asia more than offset by softness in other regions. Gross margins were 34.5%, up 90 basis points. Our SG and A as a percent of sales decreased 20 basis points to 16.9%, reflecting our continued focus on cost control. We delivered solid bottom line performance as operating income increased 5% to $399,000,000 with operating margins expanding 100 basis points to 17.5%. Our EPS was $0.88 in the quarter, an increase of 16% compared to the Q2 of 2018. And we are updating our annual EPS estimate range to $2.62 to $2.72 per share. This change reflects the softer top line demand we experienced in the first half of the year and the full cost of the tariffs beginning in the middle of Q3 as inventory flows through the system. This EPS estimate range also assumes that tariffs remain at the 25% level, which is an increase from our guidance on our Q1 call, where we assume 10% tariffs for 2019. Turning to Slide 7. Plumbing segment sales decreased 2% on a reported basis. Excluding the impact of currency, sales matched prior year. Foreign currency translation unfavorably impacted this segment sales by approximately $24,000,000 in the quarter. Our North American sales increased 3% in local currency in the Q2 against a tough 6% comp from the Q2 of 2018. This performance was driven by growth at Delta, which achieved another record sales quarter through solid growth with our wholesale customers. Also, as Keith mentioned, our spa business, Watkins Wellness, delivered another record sales quarter, partially due to strong consumer demand for spas with its recently introduced freshwater salt system. Our international plumbing sales decreased 3% in local currency as Hansgrohe's growth in Germany and Asia was more than offset by softness in other regions. The segment's operating profit growth of 2% was driven by pricing actions, partially offset by lower volume. For full year 2019, we now expect plumbing sales growth to be in the 1% to 3% range due to lower volumes we experienced in the first half of the year, particularly in our International Plumbing business, and we continue to expect margins to be similar to 2018. Turning to Slide 8, the decorative architectural products grew 3%. This performance was driven by high single digit growth in Behr's propane initiative and low single digit growth in their DIY business. Positive price and volume in paint were partially offset by lower sales in our lighting and builders hardware businesses compared to prior year as our disciplined pricing actions impacted volumes in the quarter. Operating income in the Q2 grew compared to prior year due to net selling price increases and cost productivity initiatives, partially offset by higher commodity costs. We are pleased with the cost savings we have achieved at Kichler, which were driven by sourcing savings and business process improvements as we implement the Masco operating system. For full year 2019, we now expect Decorative Architectural product sales growth will be in the range of 1% to 3%, including the benefit of the Kichler acquisition due to reduced volumes resulting from the impact of disciplined pricing actions in our lighting and builders hardware business. We also expect operating margins will be in the range of 17% to 18% as we make merchandising investments to enhance consumer shopping experience and incur a greater impact from the tariffs in lighting and builders hardware. These investments in tariffs will have more of an impact in the Q4 than in the Q3. Turning to Slide 9, in the Cabinetry segment, sales decreased 6% in the quarter. This performance was driven by a softer market and excluding the Moores divestiture, a difficult 13% sales comp against the Q2 of 2018, partially offset by price. Segment profitability increased in the quarter by $1,000,000 with margins of 13.5%, representing one of the best profit quarters in this segment in 10 years. We continue to expect full year 2019 sales growth between 0% 3%. However, based on our demonstrated cost control in the first half of the year, we now expect modest margin expansion, and improvement from our prior guidance. Turning to Slide 10, our window segment sales decreased 3%. Foreign currency translation unfavorably impacted this segment sales by approximately $2,000,000 While sales at our North American window business matched prior year, this segment continued to be impacted by market softness at our U. K. Window operation. Segment profitability in the quarter increased $3,000,000 driven by favorable pricing actions and lower spend, partially offset by lower volume. For full year 2019, we now expect sales growth for this segment to decline 1% to 3%, excluding currency due to the performance we experienced in our U. K. Window business. However, we continue to expect modest margin improvement for the full year. And turning to Slide 11, our balance sheet remains strong with net debt to EBITDA at 1.9 times and we ended the quarter with approximately $1,300,000,000 of balance sheet liquidity. Working capital as a percent of sales improved 60 basis points versus prior year to 16.5%. For the full year, we now expect working capital as a percent of sales to be slightly higher as compared to our 2018 result of 14%. During the Q2, we continued our focus on shareholder value creation by repurchasing 4,300,000 shares valued at approximately $167,000,000 And as Keith mentioned, our Board of Directors has announced its intent to increase our annual dividend by 13% to $0.54 per share starting in the 4th quarter, demonstrating the Board's confidence in our future performance and cash flows. And with that, I'll turn the call back over to Keith. Thank you, John. It's been a dynamic start to 2019 and I'm proud of how our teams have responded to the market conditions and challenges to generate profit growth and margin expansion across all segments in the Q2. As I mentioned earlier, the fundamentals of our industry remain strong. Demographic should drive household formation and housing for years to come as the large millennial generation has begun to form households. Home price appreciation, which has a strong correlation with repair and remodel spending, remains strong at nearly 4% year over year. Existing annual home turnover remains at a healthy overall level of 5,300,000 units. Age of housing stock continues to increase as 65% of the U. S. Housing stock is now 30 years old or older. And older homes have more repair and remodel spending per home than newer ones. Consumer confidence and real wage growth remain high as consumers benefit from a healthy economy and declining mortgage rates could spur additional mortgage refinancing, which will put more disposable income in consumers' pockets. Against these strong fundamentals, we will continue to deploy our strong cash flow with a disciplined and balanced approach to investing in our current businesses, dividends, share repurchases and acquisitions with the right fit and return to create value for our shareholders. Lastly, I hope to see you all at our Investor Day on September 17th in New York City. With that, we'll open the call for Q and A. Thank you. In order to ensure that everyone has a chance to participate, we would like to request that you limit yourself to asking Your first question comes from the line of Stephen Kim with Evercore ISI. Stephen, your line is open. Thanks very much guys. Good job in a tough environment. I wanted to ask a little bit about the plumbing business. Just I want to make sure that I got a couple of pieces accurate. Last year, you had an impact from Delta's ERP, which if I remember, created a pull forward effect. And I'm thinking that probably was a benefit to North America business, North America Plumbing of about 150 basis points this quarter and that was sort of in this 3% North America. I just want to make sure that that's the right way to think about it. And as you more broadly as you are lowering the sales guide in Plumbing by a couple of 100 basis points. How much of that reduction would you say is attributable to North America versus the international? You're right, Stephen. We did have in 2,008 a pull ahead of about $10,000,000 from Q2 into Q1 due to the ERP launch at Delta. Despite that pull forward last year, Plumbing still had a great Q2 in 2018. I think the segment was up about 6% excluding FX. So it was a pretty tough comp for us in the quarter. In terms of how we think about the volume going forward in plumbing, I think there's a couple of key drivers. Certainly, there's a little bit of softness in international. While we did have good growth in the core market of Germany, there were some other markets internationally that were soft. Italy was particularly soft. There was some softness in Turkey and a little bit of softness in Latin America. So that's a component of how we're thinking about the remainder of the year. And the other is price elasticity as it relates to some of our tariff pricing. We've been very effective in getting a price out in the market in relationship to tariffs to equalize that cost impact as we talked about last quarter. And we have seen some elasticity as it relates to volume, particularly when we think about the lower price point, which tends to be a little bit more sensitive and we've also seen some elasticity around threshold prices for various products. So when you think about the volume and going forward in plumbing, I think international and pricing is a piece of that. But we're quite pleased with how we did this quarter against the tough comp. Yes, Stephen. The only thing I would supplement Keith's comments with is, of the 2 international in pricing, I'd say international price is a heavier weight to the impacts going forward than pricing. And John, was that a general comment across the whole business or was that just in plumbing? And I guess as a part of that question also as you had mentioned, I believe in one of your segments, I think it was Deckard that the elasticity effect was going to be greater in 4Q than 3Q. So I guess my general question is elasticity, what you just mentioned about that reducing your guidance versus the international weakness, how much is it for the company as a whole? And is it are you going to see more of that in 4Q than 3Q? Yes. No, Stephen, my comment was specific to Plumbing. That said, you've broadened out the question with your follow-up. And I wouldn't say that there's a dramatic impact. I think that my I guess my comment stands at face value that in Decorative Arc, there'll be more of an impact in the Q4 as the tariffs and the related inventory starts to flow through our system. Just to add a little bit of color, Stephen, in terms of the European volume, we are seeing a little bit of overall market softness in the UK that we talked about and that would be in the windows. Yes. Okay. Thank you very much guys. Your next question comes from the line of Michael Rehaut with JPMorgan. Michael, your line is open. Thanks. Good morning, everyone. First question, I just wanted to get a little more detail maybe on the Kichler acquisition and integration. And you kind of pointed to some good progress in terms of some, I believe from the cost side. Just wanted to get a sense also from the top line, and I apologize if I missed this earlier, how you're thinking about their performance this quarter given some of the challenges around tariffs as you've highlighted before? How you're thinking about the top line performance for the year for Kichler? And on the bottom line, if there's any ability to kind of be a little more granular, if possible, on what you're achieving from a cost savings standpoint, from a cost synergy standpoint, and how you think about the margins in that business going forward? Good morning, Michael. From a tariff perspective, I'm very pleased with how the team has performed. We set out to make sure that the cost increases from the tariffs were made up by either improvements in overall cost productivity and supply chain changes and of course in pricing. And we've done all of that. The majority of the labor without a doubt has been on the pricing side and the team has done a very good job in getting that pricing into the market. In terms of our activities to drive margin improvements, we continue to work hard really across all fronts as it relates to business process improvements that we're working on with the Masco Operating System, certainly with productivity and sourcing improvements and we have begun some initial while not a big number at this point, but we have begun some initial movement of product out of China as a longer term mitigant. With regard to growth in 2019, as I said last quarter, growth is going to be challenged for us. We are off to a slow start. The team has been very disciplined around pricing and programs as we've talked about, and that's going to affect the volume coming into 2019. Overall, when we look longer term, we believe that lighting is a good business and it should grow similar and consistent with the remodel market over the long term and we're working hard to get back to that pace. In the call. But with the decline, the top line decline in the quarter, If you could just kind of review some of the factors there and was that decline a surprise relative to your expectations and relative to the industry backdrop? And how should we think about growth in the back half of the year? No, I think it's consistent with how we thought this business is going to perform. As I mentioned on the call, we were up against a 13% comp in the Q2 of last year when you exclude the divestitures of Moores. So that was a component. A lot of price has been put in the market to offset tariffs and we talked about that in past calls. So it really is performing as we thought it would. And we're pleased with the margin performance in this segment given the environment. Great. Thanks so much. Your next question comes from the line of Michael Wood with Nomura Instinet. Michael, your line is open. Hi, good morning. I was hoping you can give some more color on the international weakness that you pointed out. To what extent is the acceleration that decline there due to destocking? And is price discipline holding in some of those European markets? The price is holding, yes. Not a lot of destocking that we really saw. John, was there? No, no. Not that was all in the Q1, not in the Q2. I would say it's generally speaking, it's more around some specific markets that are a little softer than we expected. Certainly, we're seeing some softness in the UK and our window operation. And as I have mentioned on the call, there's some markets over in Europe and Latin America that are a little softer than we had thought. And it was nice to see the propane accelerate from I think it was low single digits in 1Q to high single digits here in 2Q. Is that a more normal pace of growth that you'd expect going forward in that pro business in terms of where it is now from a maturity standpoint? Or can you continue to accelerate that? No, that's as expected. We're pleased with our pro growth. We're going to continue to expand our capabilities and we're confident that we're going to continue to grow above the market and we think we're doing that. Great. Thank you. Your next question comes from the line of John Lovallo with Bank of America. John, your line is open. Hey, guys. Thank you for taking my questions. The first one on Kichler, I guess, are you comfortable at this point that the personnel changes that you've gone through are pretty much behind you? And then along those same lines, if I recall correctly, Home Depot sells largely private label lighting, I think it's their Hampton Bay. Is there an opportunity for you guys to get more Kichler product into Home Depot? I'm very pleased with the team. We have a new leader in place down there that is a high performer that has been in a number of positions at Masco with increasing responsibility in each stop along the way, whether it was from Investor Relations to the retail cabinet sales and a nice win that she put together with Menards, which as I mentioned on my prepared remarks that that program is performing well and as expected and that was a very good win. She ran overall sales for cabinetry and that she did a great job there. And then on her extended team, again, very confident in that. We've made some significant changes and brought in professionals that I interact with on a regular basis and I couldn't be more happy with how that team is shaped up. In terms of opportunities across the broader lighting market, I think, there are several across multiple channels. And we have importantly a brand that is one of the few brands in the industry that in fact is successful across multiple channels. It has an outstanding assortment across price points and as I just mentioned across the channels. So we're going after growth really across the board in cabinetry or excuse me, in lighting. Okay. Thanks for that, Keith. And then as a follow-up, can you guys give just a little bit more color on the merchandising investments that you mentioned in Decorative Architectural? Yes. So as I mentioned, we're enhancing some of the in store displays, John, here in the back half of twenty nineteen. So, yes, mostly and that will be in the paint category. And so the Bayer team is going to get those in place here in the 3rd Q4. Okay. Thanks, guys. Your next question comes from the line of Keith Hughes with SunTrust. Keith, your line is open. Thank you. Within Decorative Architectural Products, as you look at the second half of the year, will the to get to the guidance you've established, will the trends remain the same of pro up high single digits, DIY low and I assume down at Lighting and Builders Hardware, is there some sort of rate change is going to occur? Yes, Keith. I think that's the general pattern that we expect to see in the back half of the year. The one thing I would ask you to remember is in the Q4 of last year, we had a fairly significant pull forward of about $20,000,000 related to our paint business. And so that we don't expect that to reoccur. And so that will be a little bit of a top line headwind going into Q4. So just want to make sure you recall that. And also in Lighting or in Kichler, when do you think you will fully offset the impacts of the tariff? Is that currently where we are? Or there's still some things to be worked out? I think in terms of our pricing actions and the cost, I think we've got it in place at this point. Now the in terms of the cost reductions that we're executing against. So when you look across price and some of our productivity improvements, I think we've handled that. Now in terms of the cost of the products coming in, I would expect that in the Q3 and Q4, we will start to see those costs hit our P and L as it flows through our inventory. Okay. Thank you. Your next question comes from the line of Truman Patterson with Wells Fargo. Truman, your line is open. Hi, good morning guys. Nice quarter in a pretty challenging environment. So first, I wanted to look at your EPS guidance. You guys walked down the mid point just very modestly by a few cents. Could you walk us through the drivers of this? And were there any offsets to the upside? And could you also give us what amount of share repurchase is included in guidance? Is it the 600,000,000 dollars Yes, Truman. So a couple of questions in there. As we look at the puts and takes in terms of the revised guidance, I'd say, the first one was the trends that we have seen in the 1st part of the year. And we laid out pretty clearly, I think, our sales expectations and margin expectations for each of those segments. So that reflects is reflected. The other piece to recall is, we did increase our view as to where tariffs were. In our last call, in the Q1 call, we thought tariffs would be at 10%. And now we think we're going to be at 25%. So those are the 2 principal components in there. In terms of the share count, the share count really is reflective of where we purchased through today. It doesn't take into account that, but we do have $600,000,000 that we're anticipating as Keith mentioned in his remarks for the full year. Okay. Okay. Thanks for that. And then thinking about the China tariffs and some of your plumbing competitor supply chains, Couple of the larger guys and then some of the smaller competitors, do the majority of them source through China as well? And do you think the industry is kind of on an even playing field with China tariffs jumping to 25%? Yes. It really depends. There's different competitors that we have across different price points. Sorry, I was meaning faucets. So even with faucets, there's some private label competitors that sometimes come up against us in the low end, which would have more of an impact. But on balance, we think we are in good competitive footing as it relates to our exposure to China tariffs. So, Usha, I just want to clarify a remark I made a minute ago. Our guidance does include the impact of all $600,000,000 of share repurchase. Okay, thanks. Your next question comes from the line of Matthew Bouley with Barclays. Matthew, your line is open. Hi, good morning. Thank you for taking my questions. I wanted to ask back on the margin strength in Cabinets specifically. I think John you mentioned some strong cost control there and you guys highlighted the pricing actions as well. So just more color on that. Which channels are you taking price? To what degree did price relative to cost control drive that margin? And anything you're seeing on the promotional side with the customers as well would be helpful? Thank you. Sure. On the promotional side, we've not seen we've seen pretty consistent promotional activity across the various channels in the 2nd quarter. So not a significant increase or decrease in any of the promotional activity. In terms of price versus cost, all of the 2, I'd say price was a little bit of a heavier weight than the cost side, but both had a pretty good impact on the quarter because a lot of parts that were coming in, they come in and offshore are facing tariffs. So we saw pricing across the industry put in place. Perfect. That's helpful. And then just secondly, I wanted to ask what you guys are seeing on inventory levels at your customers in North America. You had previously talked to seeing some restocking back in April. How did that progress through the quarter and into July? Do you see any room for any further re stocking? Thank you. Matthew, we really didn't see much in the way of inventory fluctuations in the Q2, call it normal. There was some, as you mentioned, some destocking in Plumbing in Q1, but that seems to have normalized and orders to us were more in line with their sales out to the consumer. So we are anticipating some inventory adjustments in the back half of twenty nineteen, I would say, as is somewhat normal and those adjustments are contemplated in our guidance. All right. Thank you very much. Your next question comes from the line of Megan McGrath with Buckingham Research. Megan, your line is open. Good morning. Thanks for taking my question. A couple of questions just on the overall market. In terms of paint, some of our channel checks we heard from sales folks at all sorts of different retailers that they were seeing a little bit of mixing down maybe to more mid price point versus higher price point. Curious to see if you saw that as well at all in your either your DIY or pro business? Overall, I'd say the market was a bit challenged in Q2 with some tough weather. So I think that affected us. I think when you look at the market and how we performed with our pro business up high single digits and DIY up low single digits, We think we held our own to possibly maybe gaining a little. Admittedly, it's hard to pinpoint with precision the size of the market in a particular quarter. We didn't see a whole lot of mix fluctuations in paint. And I think if you broaden that your question out if I may into broader Masco as it relates to mix, we don't really see mix as being material one way or another as either favorable or unfavorable as we look forward to the remainder of the year. Okay, great. And then just a quick follow-up on your comments around sourcing and moving things out of China. Do you feel like you are finished with that process or is there more to come assuming that tariffs stay where they are? Is there more to come on that front? I think if we think about it from a perspective of tariffs staying where they are and staying with some sort of permanency, I would say that there's more to come. We're taking and we're being very careful as we move products out and resource to other low cost countries. Careful in that we want to make sure that we're ensuring our delivery excellence and our quality excellence. And there is some variability in fact to whether or not that 25% will indeed stick for some extended period of time. So we're being cautious and we have moved some doubt. But I think long term, when you look at the impact of these tariffs and some of the pricing that we've put into the market that long term this will be absorbed by the consumer. And we still believe in a very healthy R and R market. Great. Thanks. Your next question comes from the line of Justin Speer with Zelman and Associates. Justin, your line is open. Thanks, guys. Good morning. I wanted to spend a little bit of time on your guidance and keeping in mind that the tariff situation is incremental headwind and then that's balanced against raw materials that are favorable. So I wanted to see if we could maybe you could help us unpack what the incremental headwind from the tariff is discreetly, if you can walk through the discrete costs to the business from the tariff step up and then counterbalance that against the raw materials. Because when you look at the range, just the back half margin range to the high and low end of your guidance implies a fairly wide range of outcomes for margins. So just trying to give us some context on how you get to that guidance in view of all those moving parts? I'll talk a little bit, Justin, this is Keith, to the commodities. I think some of the commodities in our basket have indeed moderated year over year. Copper and zinc and plumbing started to moderate in the back half of twenty eighteen and remain below what I would say the peak prices we saw in the first half of twenty eighteen. So that will a little bit of a benefit for us in the second half. TiO2 and resins, both still are up year over year, probably peaked here in Q2, should be flat sequentially in the second half, but still up year over year. So not expecting significant inflation or deflation in paint raws as we sit today. In cabinets, plywood remains elevated, but distribution and logistics have come down a little bit, still up year over year. So obviously, we're continuing to work with our suppliers and our cost productivity and all those types of improvement opportunities. But when we look at the commodity inputs, we're really not seeing a material benefit or a headwind as we think about 2019. And just maybe I'll take the tariff component of that. As we've articulated before, the tariffs are based on what we know today are roughly impacts $600,000,000 of our cost of goods sold or roughly $150,000,000 impact. Obviously, the way we're pursuing, Keith mentioned earlier that we're pursuing price to offset tariffs. Obviously, we're getting price recovery from that. So that action in and of itself limits margin expansion. As a matter of fact, oftentimes that has a slightly dilutive effect to margins. And so maybe that weighs in on your calculation. And then just thinking about these moving pieces, you mentioned the $600,000,000 of COGS today that are sourced from China. If we were to fast forward 6 to 12 months from now, what do you think your footprint looks like? Not anticipating a significant change in that over that time period. As I mentioned, we're moving some products out. We've in sourced some back to the United States. We've taken some to the other low cost countries, but it's going to take some time for us to ramp that up. Our focus really is on keeping our delivery and quality excellence up with our consumer and our customers. Just pulling this all together, as you think about the back half and the setup, clearly the revenue trend is softer, margin trends may be a little bit better. But if you could give us some context on what how you're thinking about that downside the downside, I guess elements to I guess, risk elements to get to the downside versus maybe upside of your range, where you see the most risk and maybe the opportunity? I think from a top line risk, there's a lot of volatility that's out there with the consumer as it relates to what's going on geopolitically, what could potentially happen with trade and everything that we're all quite aware of. So I would say, if something happens from a consumer perspective or from a broader confidence, I think that could be an issue that could take it to the downside. Having said that, as I've went through a couple of times on this call and in prior calls, we think the consumer is in pretty good shape. So we're not anticipating that. Thank you, guys. Your next question comes from the line of Mike Dahl with RBC Capital Markets. Mike, your line is open. Hi. Thanks for taking my questions. I wanted to ask first, just I guess, Keith, going back to the paint comments you just made around price costs and not necessarily expecting significant deflation. But if I kind of parse out the commentary between Kichler headwinds and then the overall margin performance. It seems like the core coatings margins have been quite strong. So I guess what do you attribute that to? Is it really just pricing actions and volume? And if you look at your full year guide embedded in that guide, is there an expectation that coatings margins are up year on year? Thanks. When we think about the margins in Q2, we're very pleased with the cost productivity improvements we're making. I called out Kichler. They continue to do a very good job both from a variable cost perspective as well as on the sourcing side. The second half impact of tariffs in lighting and hardware are going to be are going to start to flow through midway into the Q3. So that's a factor that I ask you to think about as well. But fundamentally, our productivity and our movements are reflected in that margin range that we have in that 17% to 18% range. Yes. I guess, Mike, as you think about it, we've had pretty good strong performance in our pro businesses, as well as our DIY business for the full year. So I think we've had good margins, but we're not going to break them out for the full year. Okay, understood. Second question, Keith, you've kind of mentioned the different potential initiatives around shifting supply chain over time. I think in the past, you've talked specifically around the relative low cost of shifting some assembly in plumbing stateside where that can be one solution that's relatively low CapEx for you. Is that an initiative that you've begun to pursue at that point? Or is that still in the bucket of kind of wait and see how this all plays out? We have in sourced some assembly back, but just a little bit at this point. Again, this is a very dynamic environment. And what's included and not included moving forward, I think is still in play. So this is a game of where we're moving slowly and carefully. And as I said, we're driving cost out and in some cases cost sharing with some of our suppliers. We're driving value engineering and productivity improvements. And of course, we're getting price. And we're going to be very careful that we protect the customer as we move through this, and that's our focus. Okay. Thank you. Your next question comes from the line of Phil Ng with Jefferies. Phil, your line is open. Hey guys. You should be getting a pretty decent amount of proceeds from the divestitures. Curious how quickly will you use the buybacks potentially for buybacks? And at this point of the cycle, how are you thinking about M and A? And are there any pockets that really stand out? Do you need a 3rd leg to kind of continue to drive the growth story in your business going forward? Yes, Phil. In terms of procedure, right, we do expect some significant proceeds. But as Keith mentioned in his prepared remarks, while we anticipate at this time using the proceeds from the divestitures for share repurchases. It's going to be facts and circumstances dependent upon what's happening at the time that we actually receive the proceeds. So it's hard to give you a great deal of specificity as to how quickly we may redeploy those proceeds to share repurchases. The second part of your question again was? I think it was I could jump in here, John. With regards to how we're looking at our M and A funnel and whether or not we need, I think, Phil, is your word a Would you like to add a 3rd leg, if you will, to keep the growth story going. We don't believe we do, no. And we're looking at all options in the building products case building product space in our funnel. But clearly, our focus is closer to the core. We think we have very strong businesses in paint and plumbing and that's where our focus is. And I would suspect M and A activity to be more along those areas. Not saying no to other opportunities, but clearly our focus is closer to the core. Got it. Given the margin expansion you saw in 2Q, you're guiding to flat margins for the full year. I assume that part of that is just the tariffs kicking in more fully. I'm just wondering, have you implemented all the price increases you need, at this juncture for the full 25%? And is there any risk that margins in the Q4 would be flattish or potentially down just given the full impact? Thanks a lot. You're right, Phil. The impact of tariff costs as it rolls through our inventory will be more strongly felt in the second half. With regards to pricing, we do think we've got our pricing in place and where it needs to be. Yes. Phil, with respect to margins, recall again, I mentioned this earlier in response to I think Keith's question, that we had some pull forward of sales out of Q1 of this year into Q4 of last year, which probably created a bit of a stronger margin than which you would typically see seasonally in the Q4 of 2018. And so margins could be flat to slightly down in Q4 given that dynamic that we experienced last year. Got it. Thanks a lot. Your next question comes from the line of Ken Zener with KeyBanc. Ken, your line is open. Good morning, gentlemen. Good morning, Ken. Good morning, Ken. Just checking. Keith, you mentioned in Plumbing in regard that was useful. In Plumbing, in regards to the entry price point, which in the U. S, so separate from the international, You mentioned that the entry price point was actually the somewhat weaker category because of the pricing. And you mentioned this term threshold pricing. Are you suggesting that the elasticity on the delta, let's say, big box is actually will deter demand if you take $45 or $50 faucet up to $58 Is that where you're seeing the largest impact of pricing, this is a challenge this is a challenge and it's relatively new territory and that a typical data analytics around elasticity involve a static environment where you move a price on a SKU and you say if it goes up, you raise price 1%, the volume goes down 3% or something of that sort. So the data and the analytics is really in a more static environment. This is anything but static. We have a significant amount of price changes that's gone into the cost changes that have gone into the market and we have variable responses in the competitive aisle, if you will, around how much of that gets put by retailers into the market. So it's not static. So we are seeing a more elastic demand curve for opening price point products and that certainly stands to reason as you think about sensitivity and the total cost and what people are willing to spend when they're at the low end versus the high end. Conversely, we're not seeing a significant as significant, nearly a significant amount of elasticity in some of our higher end products. We mentioned a record quarter in our spa business, for example. That's not a low end product and it's discretionary. So the elasticity is hitting us a little bit more on the opening price point. What I mean by threshold pricing is pricing that's around a certain number where it makes a more of a material difference in volume and customer perception than say is necessarily warranted by the flat out percent of the price increase. So on certain products, a $199.99 is the threshold price. So if there's an increase over that threshold of 2%, that's going to affect you more than if it was an increase of 2%, say going from $80 up. So that's what I meant by threshold pricing. Hope that helps. It does. For the variable variability of the market, were you referring to the variability of how retailers were accepting your price? Or was it the variability of how your competitors were responding to tariffs? Thank you. Just the variability of what we're seeing in the channel and the consumer pricing in the market. Thank you. Your next question comes from the line of Steven Ramsey with Thompson Research. Steven, your line is open. Good morning. I guess to start with the guidance to make sure I understand, what gives you the confidence to raise the low end slightly while lowering the top end a bit more? Is the high end volume related in the low end better margins or maybe unpack that and if it's a certain segment that is coming in with better margins maybe than expected? Yes. I would say, I think you yes, that's the answer to the question. It is better volumes and slightly lower volumes in margins are kind of how we got there. As you may recall, as you break it down by segment, we did raise the margin expectation for a couple of for the Cabinets segment. And so that has definitely an impact on it. But your lead in actually was the answer to the question. Great. And then thinking on capital allocation, a couple of questions there. Why not raise the dividend at a more modest pace when the buyback is more accretive to EPS growth per share? And then can you maybe talk to what CapEx might look like once the sales are completed? Yes, sure. With respect to the dividend, I think one of the things that we mentioned on our prepared remarks is part of our capital allocation policy is to keep our dividend payout ratio roughly 20%, maybe slightly out lower, slightly higher, but in that 20% zip code. And so the reason we raised it to $0.54 this time around was to make certain that we keep that payout ratio of nearly 20% intact. And so that's kind of the thought behind that. In terms of the CapEx post divestitures, I'd say we're probably in that 2.5% of sales range. So not significantly different from where we're at today. Excellent. Thank you. Gentlemen, your final question comes from the line of Eric Bosshard with Cleveland Research. Eric, your line is open. Curious as we think about 2020 in Kichler, what you're excited about and what the upside scenario might be for that business as we think about 2020 beyond? I think new products has really got me jazzed and the team that we talked about before which goes across not only new products, but also our human resource function, our supply chain function, etcetera. So we've got a very good team and we've got a nice focus on new product introductions. And as I mentioned, we have the luxury of having one of the few brands that competes across all of the channels. So we have opportunities with the new team and with our product assortment across the online channel and across retail and across our dealers. And certainly continuing to apply our Masco operating system and getting that more ingrained in that business will yield improvements without a doubt. And then secondly, just clarity within the guidance, is there anything different in the sales outlook in the back half? Is that regional or by business that you would call out where you feel different than you did 90 or 180 days ago? Well, I guess, Eric, there's a couple of areas where we adjusted our sales expectations. But international is probably the one area that is coming in softer than we had expected. And so that has an impact on what we put out for our plumbing guidance and the like. So I think that's the one area that would probably be the one difference versus where we were at the end of the Q1. I would say that while certainly a little bit softer in international, I do like the trends that I'm seeing in our decorative segment, North American Plumbing coming out of Q2. Strong backlog in our spa business points to a healthy consumer on the high end. We think that's a nice barometer for consumer spending. And then just in general, as I'm kicking around in the markets, we're getting good reports from customers across our product categories. So I like the trends that we saw in Q2. Great. Thank you. This concludes today's conference call. On behalf of Masco Corporation, thank you for today's participation. You may now disconnect.