Mohawk Industries, Inc.

Good morning. My name is Jesse, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Mohawk Industries third quarter 2019 earnings conference call. All lines are in place on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you'd like to ask a question during this time, simply press star, then the number one on your telephone keypad. To withdraw your question, please press the pound key. Should anyone need assistance at any time during this conference, please press star, then zero, and an operator will assist you. As a reminder, ladies and gentlemen, this conference is being recorded today, Friday, October 25th, 2019. Thank you. I'd now like to introduce Mr. Ken Hielskamp. Mr. Hielskamp, you may begin your conference.

Thank you. Good morning, everyone, and welcome to the Mohawk Industries Quarterly Investor Conference Call. Today, we'll update you on the company's third quarter results for 2019 and provide guidance for the fourth quarter. I'd like to remind everyone that our press release and statements that we make during this call may include forward-looking statements. as defined by the Private Securities Litigation Reform Act of 1995, subject to various risks and uncertainties, including but not limited to those set forth in our press release and our periodic filings with the Securities and Exchange Commission. This call may include discussion on non-GAAP numbers. For a reconciliation of any non-GAAP to GAAP amounts, please refer to our Form 8-K and the press release in the investor section of our website. The key speakers today are Jeff Lorberbaum, Chairman and Chief Executive Officer, Chris Wellborn, Chief Operating Officer, and Glenn Landau, Chief Financial Officer. I'll now turn the call over to Jeff for his opening remarks. Jeff?

Thank you, Ken. Our third quarter operating results were in line with our expectations, though we're not satisfied with our performance. Our sales were $2.5 billion, roughly flat as reported on a constant basis. Our adjusted operating income for the period was $250 million, or 10% of sales. Compared to the prior year, the US dollar strengthened, creating a $35 million impact on our translated revenues. As anticipated, our US businesses presented the greatest challenges during the period, given soft retail demand, the impact of LVT, a stronger dollar, and excess ceramic inventories in the industry. Lower interest rates in the US are positively impacting housing starts and home sales, and many believe this could be the beginning of an improving housing market. During the period, duties on imported ceramic tile were increased by an additional 104%, which will largely stop shipments coming into the market. Trends in our other major markets weakened, creating a more competitive environment. In most regions, significant political and trade uncertainties are affecting consumer confidence and spendings. In response to economic concerns, central banks in many countries are lowering interest rates to stimulate growth. We expect the present conditions to persist in the near term, and we'll further adjust our strategies as needed. We're progressing on the initiatives to improve our business, with the most significant of these being aligning the ceramic production with demand in the US, realigning our North American carpet operations, optimizing our LVT manufacturing, and ramping up our new plans. In addition, we're entering new product categories, introducing innovative product extensions, and optimizing our recent acquisitions. We are investing in more sales personnel and marketing to increase our penetration in new and existing products. We continue to streamline our operations to enhance efficiencies, and we are leveraging automation and process enhancements to lower our costs. Our free cash flow for the quarter is up year over year, and our balance sheet remain strong. Since the beginning of the third quarter, we purchased over 740,000 shares for approximately $91 million under our stock purchase program. For a review of our financial performance during the period, I'll turn the call over to Glenn.

Thank you, Jeff, and good morning, everyone. Moving right into our financial performance and year-over-year bridges, As Jeff shared, third quarter total company net sales were $2.5 billion, roughly flat on a constant basis compared to prior year or down 1% as reported. Year-to-date total company net sales are up 2.8% on a constant basis and flat as reported through the third quarter. Organic growth in legacy businesses was down 2.5% in the third quarter on a constant basis, bringing our year-to-date legacy growth down 1.6% versus the first three quarters of 2018. In terms of earnings, the company's adjusted operating income was $250 million in the third quarter, or 9.9% of sales. This is off 242 basis points from the third quarter last year, largely due to weaker ceramic volume as expected. With that said, the company's year-over-year decline in margins improved modestly on a sequential basis by 15 basis points, which represents now three consecutive quarters of improvement. Bridging from the prior year third quarter, adjusted operating earnings were impacted by one lower overall volume of $16 million, largely in flooring North America and global ceramic, and associated market-related shutdown costs of $9 million, all in our global ceramic segment to match our supply with our demand in order to manage our inventories in the U.S. An increase of inflation of about $19 million due to higher wages and benefits partially offset by lower raw materials. An erosion in price mix of $15 million, largely in our flooring rest of the world segment, as input costs have eased. And $10 million higher spending in SG&A and other due to investments in sales and talent and marketing to drive sales, including product rollout initiatives and new start-ups. Moving to the positive offsets, productivity, including lower startup costs, swung positive by $8 million versus last year due to better utilization and non-repeating one-time costs. Lastly, FX translation impact was unfavorable by approximately $3 million. Still at the enterprise level, SG&A per net sales across the enterprise was 17.8%, excluding unusual items. Special and unusual items in the quarter, consisted of approximately $10 million in restructuring and integration costs impacting operating income, primarily in flooring North America, of which most was cash, and $65 million, or $43 million after tax, write-down of our investment in a Chinese supplier in the other income line as a consequence of the September ruling by the U.S. Commerce Department imposing an incremental 104% countervailing duty on ceramic title. effectively stopping Mohawk purchases from this Chinese entity, with this partial offset by about $8 million due to transactional effects in other income for a total special and unusual items of $66 million before tax. Back to our restructuring and integration for the full year, we expect to complete the $94 million as previously disclosed this year, plus a further $15 to $25 million, some of which may fall into 2020. And as we shared last quarter, the cash component of the restructuring of approximately $30 to $35 million should be recovered in about a year as lower costs. Adjusted EBITDA was $398 million, or 15.8% before interest expense of $9 million, which was flat with last year. The effective tax rate for the quarter was 18.3%, and it's expected to move into a range of 17% to 19% in the fourth quarter, driving full-year guidance down to the 19% to 20% range. Finally, adjusted net earnings per share was $2.75 in the quarter, down from $3.29, or 16%, versus last year. Turning now to the segments, global ceramics delivered sales of $916 million, an increase of 4.3% on a constant basis versus last year, or 3.5% as reported. Operating income on an adjusted basis was 86 million or 9.3% of net sales, down from 13.4% margin last year, primarily due to weaker demand and higher U.S. inventories associated with duties. Compared to last year, inflation was 18 million higher, driven by higher material costs and wages. Volume was softer by 11 million, inclusive of 9 million in downtime. Sales and marketing costs were up $8 million, and price mix slipped $2 million, all of this partially offset by improved productivity and lower startup costs of $6 million. FX was neutral in the quarter. In the flooring North American segment, the business showed better overall performance with sales of $1 billion, down 4.4% versus last year, as continued weakness in soft surfaces were partially offset by solid laminate performance and continued significant growth in LVT. Adjusted operating income improved for the second quarter in a row sequentially as flooring North America earned $84 million or 8.4% of net sales in the third quarter, cutting the year-over-year deficit $20 million versus $47 million in the second quarter. Compared to last year, volume accounted for the majority of the deficit, down $17 million versus last year, and inflation the rest off a net $7 million with improved raw material costs partially offsetting higher wages and benefits. Turning positive, price mix improved $4 million and productivity less reduced startup cost was also positive. Moving to flooring rest of the world, the segment had sales of $601 million, up 2.5% versus last year on a constant basis, but down 1.9% as reported, with legacy sales holding at 0.4% on a constant basis. Adjusted operating income came in at $89 million, or 14.8% in the quarter, off 100 basis points versus last year in a competitive environment. Compared to last year, the business continues to manage well in a more difficult environment supported by solid LVT, laminate, and insulation performance. The primary headwind in the quarter was an erosion of price mix of $17 million, largely offset by relief and overall inflation of $10 million by lower input costs, and modest improvements in volume and productivity totaling $4 million. Additionally, investments in sales and product marketing were $2 million higher in the quarter, and FX translation was unfavorable by $3 million. Finally, at the corporate level, expenses and eliminations drove an operating loss of $9 million, with the full-year estimate holding in a range of $35 to $40 million. Speaking now to the balance sheet, receivables entered the quarter at $1.8 billion, with day sales outstanding up due to changes in geographic and channel mix. Inventories entered the quarter at approximately $2.3 billion, or 126 days. Flat with the prior quarter and higher year over year by $124 million due to the ramp-up of new investments, acquisitions, and increased source products. Fixed costs for the quarter ended at $4.6 billion, down $100 million compared to the prior quarter, on capital expenditures of $125 million in the period, lower than depreciation, which was $145 million, and in line with plans. For the full year, CapEx, we are on track to spend about $575 million, which is depreciation, up to $595 million, depending on timing. Total debt was $2.8 billion at the end of the quarter, down $300 million since exiting the second quarter, with leverage declining to 1.7 times debt to adjusted EBITDA. We also closed our effort to renew our credit revolver for the full $1.8 billion for five years, plus two automatic one-year extensions. So wrapping up, the balance sheet is strong and getting stronger with free cash flow of $286 million in the quarter, totaling $572 million year to date, giving us line of sight to our expected solid cash year in addition to at $700 plus million. With that, Chris, I'll turn it over to you.

Thank you, Glenn. In our global ceramic segment, our businesses around the world are under pressure caused by slowing economies. Excess industry capacities are creating more pricing and margin pressures. In most of our markets, commercial is outperforming retail as consumers are postponing purchases. In U.S., ceramic retailers are promoting lower price points, consumer shifting to LBT, and inventories remain high in the channel. During the quarter, the U.S. imposed increased tariffs on Chinese imports, and further anti-dumping duties are anticipated. At these levels, U.S. ceramic purchases will be shifted to manufacturers around the world and should benefit Mohawk and other domestic manufacturers. The excess inventories created by the tariffs will take time to be absorbed in the channel. We expect the U.S. ceramic market to remain soft in the near term, and we are taking actions to improve our sales and costs. We are expanding our offering of stone looks and polished dials, and we are introducing additional value collections. We are adding more salespeople in major markets to increase our participation in commercial projects. We are rolling out new online processes to make our customer ordering and pickup faster and easier. To complement our ceramic offering, we are selling dowel tile LVT for commercial applications and will introduce residential LVT collections. We are initiating a limited launch of our new easy installation ceramic tile, and we will expand more broadly at the beginning of the year. This patented system cuts the installation time in half with limited expertise and we are receiving positive feedback as we demonstrate the benefits. We are developing new markets for our porcelain roofing and thick landscape tiles, which over time will create new sales channels for our business. Our new countertop plant in Tennessee is ramping up. Processes and formulations are being refined and new products are being created. Utilizing state-of-the-art robotics, we have begun manufacturing premium countertops that will improve our sales and mix. We are presently staffed to operate three shifts and will expand production further next year. We have outperformed the Mexican ceramic industry by expanding our product offering and growing our customer base. We are hiring additional architectural reps to increase our commercial sales and enhancing our collections with premium porcelain, large sizes, and new wall tile products. We are supporting stores exclusively carrying Delta products and expanding our trucking fleet to improve service and cost. The Brazilian market is showing some signs of recovery, and we have outpaced the market with our premium brand and offering. We have a strong position in the new construction market, which is outperforming residential remodeling. We are replacing an old ceramic line with new porcelain production that is more efficient and will produce larger sizes when operational early next year. To meet present capacity needs, We have also restarted two previously idle lines. The European ceramic industry has slowed with the overall economies and lower exports to other regions. Excess industry capacity and inflation is compressing margins as we are selling more lower value tile, which reduced our mix. Commercial is outperforming residential, and we are leveraging our comprehensive offering, expanding our specification team, and adding showrooms in major cities to grow. Declining consumer confidence is impacting discretionary spending and is compressing the retail remodeling channels. Our commercial technical tile, porcelain slabs, and outdoor products are gaining traction and strengthening our higher value offerings. We are reinforcing our leading design with larger porcelain slabs for walls, print and registration that delivers more realistic visuals, and slip-resistant tiles for commercial applications. Our Russian ceramic business is the market leader and is gaining share due to our national distribution system, owned and franchised stores, and project specification teams. Our technology, design, and scale give us the foremost position in the premium category as well as a cost advantage. To complement our tile business, we are constructing a small sanitary ware plant that should be operational in the first quarter next year. In our Flooring North America segment, our margins have improved compared to the prior quarter due to increased sales, lower material cost, and operational initiatives, partially offset by lower product mix and inflation in labor. The business has been reorganized by product category to enhance our sales, product, and operational strategies and execution. By volume, carpet steel represents by far the largest category in the North American flooring market, though it's losing share to hard surfaces. Polyester carpets continue to gain share in the soft market, which has reduced our overall product mix. We have completed the expansion of our recycled polyester fiber to support continued growth in the category. We have expanded our offering of multicolored and patterned carpet as consumer preferences shift from solid colors. We are preparing our new residential introductions earlier this fall so they can be in the market sooner next year. The realignment of our residential carpet manufacturing will be largely complete in the fourth quarter and will improve our cost, quality, and service. We are aligning our operations for lower residential carpet volumes and utilizing our best assets. We have closed higher cost extrusion and dyeing assets and consolidated yarn and tufting production. We have increased automation and upgraded assets to improve our backing and yarn costs. Beyond asset rationalization, we have enhanced our continuous improvement processes to increase efficiencies and process controls. Our commercial business continues to outperform with carpet tile and LBT growing fastest. We are expanding our sales organization and increasing our carpet tile manufacturing. We have broadened our carpet tile offering with new pattern technology with unique visuals and value alternatives. We are launching more flexible LVT options for commercial that provides acoustic advantages and are more comfortable underfoot. During the period, LVT sales outperformed the other categories with demand remaining strong. Our LVT operations continue to improve production, volume, speeds, and cost. One of our LVT lines is specialized on rigid products while the other is producing flexible products, with each providing unique features for different requirements. In September, we set a record for rigid production levels, and the flexible line is now running at comparable speeds to our European operations. Our rigid LBT line is focused on the production of SPC, which is the fastest growing category today. We continue to transfer operational improvements that have been executed in Europe to increase throughput and introduce additional features. We have specific ongoing actions that will further increase our output and lower our costs through the first quarter. To utilize our increasing production, we are introducing new products and features under our best brands for both retail and commercial markets. Our manufactured sheet vinyl sales continue to grow as we broaden our offering and expand our position in the multifamily and home center channels. We expanded our waterproof laminate offering and use our premium laminate collections is extending throughout the home in the remodeling and new construction channels. Our redwood collection is providing a desirable alternative for both LVT and natural wood with its superior scratch and dent resistance, state-of-the-art visuals, and greater value. We have developed proprietary technologies so that our laminate better replicates real wood and has superior water resistance. To support our laminate business, we are upgrading our HDF manufacturing to increase our capacity and improve our cost. In a slower environment, our flooring rest of world segment delivers solid results driven by product innovation, cost improvements, new businesses, and acquisitions. Our new LVT, sheet vinyl, laminate, and carpeted tile operations are making progress in reaching our expected levels. In laminate, we outperformed the market as our new premium products with waterproof features gained momentum and improved our mix. We have introduced a signature collection which sets the standard for the most realistic visuals and we're adding our waterproof technology to most of our products. We have further increased our direct distribution footprint with the acquisition of our Eastern European distributor. Our direct distribution strategy positions us closer to our customers and provides them with greater service and value. Our Russian laminate expansion is operating at expected levels and our sales are growing as we expand our customer base. As our LVT production increases, we are expanding our product offering and sales to grow all segments of the market. In rigid, we are introducing new collections with embossed and registration to utilize our increasing capacity. We continue to enhance our line speeds, yields, and formulations to improve our cost position. This process will continue into next year when we anticipate achieving our planned production rates and costs. To increase our distribution, we are offering retailers fashionable products with better value, service, and inventory turns to enhance their results. Our sheet vinyl business is performing stronger as our new Russian plan expands sales and volume increases. The new plan has freed up capacity in Europe so we can expand our offering and customer base. Our insulation business is performing well. with volumes at historically high levels. Our margins remain good, even though pricing has declined, along with lower material costs. Our panel business has slowed, reducing our pricing and volume, partially offset by mixed and lower materials. To further improve our costs this year, we are expanding our internal glue production. Next year, we will increase our use of recycled wood and start up a new plant that generates energy from waste wood. In Australia and New Zealand, The integration of our acquisition is largely complete. While the regional economies have softened, interest rates have been reduced, and there are some signs of an improving housing market. To increase our market share, we are upgrading our hard and soft surface product offerings. We are investing to expand our retail distribution and commercial carpet tile production. We have completed the closing of high-cost assets in Australia, which will benefit our results moving forward. With that, I return the call to you, Jeff.

Thank you. We see the present market conditions continuing, and we are taking actions to better position our business for the future. We're investing more in sales and marketing to expand placement of our products and increase the utilization of our new plants. Our new greenfield projects will progress as sales and costs improve. Our LVT productions improving and increased distribution will follow. Our US and European ceramic businesses are being impacted by lower market demand, and we are reducing inventory levels, expanding product offerings, and entering new categories. The restructuring of our U.S. carpet operations will be substantially complete this year and will benefit our costs next year. Taking this into account, our EPS guidance for the fourth quarter is $2.13 to $2.23, excluding one-time charges. We will adapt our business strategies to the future circumstances as required. Next year, our business will benefit from our new products, higher utilization of our startups, and cost reductions we have taken in 2019. Our results and balance sheet should improve with strong cash generation to take advantage of future opportunities. We have a strong global management team, and they are focused on enhancing our results and optimizing our long-term profitability. With that, we'll be glad to take your questions.

Ladies and gentlemen, at this time, if you'd like to ask a question, please press star to the number one on your telephone keypad. Management requests that you allume yourself to one question. If you have additional questions, you may re-enter the key by again, pressing star one on your telephone keypad. Your first question comes from the line of John Ball with Stiefel. Your line is open.

Thank you. Good morning. And I wanted to focus on the North American revenue performance, which I think was down just a little over 4% in the quarter versus the prior quarter, second quarter, where it was down 7%. Is there any way you could give some more detail on sort of what drove that in terms of You know, was carpet down about similarly, I guess. And then also, you know, where we sit today in terms of sourced LVT sales versus produced. And I appreciate the record comment of rigid production, but I'm not sure how to quantify that. Thank you.

The carpet industry remains under pressure and is losing share. The industry declined about 7% in units with commercial outperforming residential pieces. We see housing sales and remodeling could improve as we go forward. The other businesses, the laminate business is doing well as we introduce new products that are going into different markets and satisfying all the different market and acting as an alternative to the other waterproof products in the category. The LVT continues to increase as the sales goes up. As the production goes up, we're increasing new products into the marketplace with different visuals and performance features, which will help us more next year than immediately as we go through. We think the throughput of the plant is going to keep going up, and we're aligning new customers to use it next year as we go forward.

Jeff, on laminate, I thought I heard in there a particle board expansion. Was I right? Is that in the U.S. or in Europe? I've been worried a little about the U.S. laminate production rates, and it sounds like it's reasonably strong.

The U.S., it's an HDF board, which we make the core products in. We have exceeded the capacities of the plants, so we are upgrading them in order to increase the throughput and lower the cost to support the business.

John, just to also comment that premium laminate is growing as an alternative for wood and LBT while the lower end laminate is declining. The technologies we use that make it very realistic as an alternative to wood. It has superior visuals, scratch resistance, water resistance, so we're doing quite well.

And then lastly, quickly, Chris, so what can you see or discern in terms of industry ceramic inventory in the United States? Where do we sit? Is that getting I appreciate you won't see a benefit until we get into 2020, but is there any improvement?

Yeah, I think it's a good idea to first explain the difference between our company and the industry, but let's answer your question first, the industry. We don't really know exactly what the inventory level shows. We only see import volume, not the actual inventory. What we know is that this year, the Chinese inventory spiked in front of these tariffs, and our customers are telling us that they have a lot of inventory. Going forward, that will be an opportunity for us. As those Chinese inventories deplete, we have options to replace those with our internal production, and we have a very short supply chain, which should put us in a good position as the industry inventories deplete.

Thank you, and good luck.

Thank you. Your next question comes from Steven Kim with Evercore ISI. Your line is open.

Thanks very much, guys. Appreciate it. Encouraging signs, you know, particularly in Florida and North America. I just wanted to make a comment as well as a question. My comment both about making permanent adjustments in capacity. First, a comment. You've been implementing what I would call a formalized restructuring program in carpet this year, and you've given a lot of qualitative commentary about the rationale and the actions you're taking. But unlike, you know, we get with a lot of other public companies restructuring plans, the street hasn't had a set of quarterly numbers to model with and track your progress. Thank you. We lost you for a minute. Oh, I apologize for that. I guess what I was saying is that we don't get from you a good sense of, in this carpet restructuring, what the ultimate annualized savings opportunity is and how much should land in what quarter. And I think if you could do that, I think it would really help investors with the medium to longer-term opportunity prognosis or making that projection. And so in a related way, my question is in ceramic. What would you need to see, Chris, with respect to your assessment or your ability to assess the supply-demand in the industry to embark on a restructuring program in ceramic where you take out some older capacity to accelerate the inventory decline, much like what you are currently doing in carpet?

Okay, yeah, I can answer that. So this is what we have going on. In our global ceramic industry, Generally, we have slower economic conditions and greater competition in the market. If you look at the U.S., it's mostly impacted by LBT growth, excess inventory from tariffs, and a stronger dollar. And if you look at Europe, it's impacted more by a slowing economy and lower exports to other regions. And in that environment, as you know, which we expect to remain for some time, we have actions to reduce our inventories, and that contributes to the favorable cash flow that you see. Now, going forward, we're taking a lot of actions to improve our business. We're adding salespeople while we're continuing to reduce our internal costs. We're introducing products that are alternatives for imports. We're introducing, pioneering really, new easy installation tile, roofing, and outdoor products. And what we're looking for then is we've got our inventories in good shape. We will by the end of the year. We're about to ramp up with all these new products, salespeople, and we have an opportunity to take share from these imports. And I think as you go through the year, our hope is that these things kick in and that we are able to use our capacity.

Got it. So we really shouldn't be expecting a significant restructuring where you're taking capacity out because you think your inventories are going to be pretty much in good shape by the end of the year.

That's very encouraging. Yeah, our inventories will be in good shape and we think we have opportunities to grow the business.

Yeah, that's very encouraging. Appreciate it. If I could just follow on in terms of LVT in Europe, you made some comments about how when we went down there recently, Jeff, I think you mentioned that 90% of the market over there in LVT is actually flex LVT, not rigid LVT. And I just wanted to clarify from your press release, it sounded almost like you could make more rigid product over there than you can sell, and so you're increasing your sales force over there. So that was a little surprising, because it sounds almost like that means that when you started making the facility, building the line, that since that time, the market for rigid in Europe grew slower than you thought, while in the U.S., obviously, the market's grown way faster for rigid. So just wondering if you could clarify that.

Yeah, the market in Europe is still primarily flexible, and there's click and non-click. The RIDGID is a relatively limited share of the total market, but we think it's going to grow quickly. Our equipment that we put in will make either or as you go through. So we're introducing new products in RIDGID and we're going to try to push the market to sell more RIDGID as we go, but our equipment will make both. The other side is the marketplace is also selling much less of it. It has about half the market share in Europe it does in the U.S., and the growth rate is less than half also. So the markets are nothing alike.

Got it. Thanks very much for that. Appreciate it.

Thank you. Again, we ask that you please limit yourself to one question. Your next question comes from Michael Reholt with J.P. Morgan. Your line is open.

Thanks. Good morning, everyone. First, I just wanted to hit on just trying to get a sense of progress with LVT. Obviously, you mentioned some encouraging factoids about the September production of RIDGID and also matching the European production. When you look at the incremental lines that you put together over the last year and as they've been ramping, where would you peg the capacity utilization of those lines given the progress that you've highlighted so far on your press release today and your comments? Should we think about the capacity utilization? Of the two lines in the U.S. and Europe, are we talking about you know, 75% or greater? And similarly, from a margin standpoint, how should we think about where you, you know, what margins that production is producing? You know, is it still below average or if it's at a higher level of capacity utilization, is it more in line with the corporate average?

And you have to separate U.S. and Europe into different pieces. The US business is utilizing all the capacity as it's running now. And as it speeds up, we have avenues to use it as well as to substitute other product categories we have as it ramps up. In Europe, we don't source any products. So as it ramps up, we have to build the sales for it in front of it, and you have to put the products in the marketplace. So in Europe, we're going to get ahead of the production rate. We're going to get ahead of the sales rate, and it's going to have to catch up in the interim. And the costs, none of the costs are where we want them, because we don't have the throughputs and the material formulations where we want them. And we've said we have ongoing programs week to week, and it will go into next in the first to next year, and we expect to hit our targeted cost structure sometime as we go into next year. The other part is the mix on the products. And the product mix, you start out with selling the products to use the capacity, and then over time, you try to move the product mix up by selling higher value products, which takes time in the marketplace.

Okay. That's helpful. I appreciate that, Jeff. And I guess just one other one, if I could squeeze one in, please, on the price mix. I believe you said that it kind of netted out roughly neutral, maybe just a slight headwind year over year. I wanted to get a sense of sequentially how you're looking at price mix, how it went from 2Q to 3Q in each of the segments, and if that's still kind of a moving target, and, you know, obviously there's been some slippage there. I was hoping if you could address each of the segments directionally, sequentially, you know, where price mix, particularly mix, has trended in 3Q and how you see that playing out for the rest of the year.

Listen, in general, all the businesses, the price mix is declining as the volume and the different categories are under pressure, and as people, as as our customers tend to use price to attract consumers on one hand, and on the other, as we tend to sell more lower-value products to utilize the plants higher. So they're all going lower.

All I'd add to that is that for the enterprise, it's lower, like Jeff says, $15 million. But that's largely imploring the rest of the world, but that's with a lot of input costs easing. So I think offline we could bridge that quarter by segment, but the theme is essentially that, is that there's a competitive marketplace out there.

Thank you.

Your next question comes from Phil Ng with Jefferies. Your line is open.

Hey, guys. In the last 18 months or so, you've obviously had a lot of headwinds, whether it's drawn-down production with the downdraft in demand, price costs, and startup costs. you know, way on profitability. When you kind of look out to 2020, do you expect these headwinds to moderate and some of the self-help initiatives kind of kick in and drop through to the bottom line where margins could actually be up year to year next year? Just be helpful to kind of tie all that together.

The market in general, as we keep talking about, is under pressure and we keep aligning the businesses with the markets. As we look forward, You see us investing more in sales and marketing to increase our share both in existing products as well as to get these new factories up and running. The positive pieces are the North American restructuring is going to start benefiting the business next year. The LVT lines will be operating more efficiently. These other plants we're talking about will start adding value versus being a drag on the pieces. You know, the marketplace will have to keep reacting to whatever happens.

Got it. And just one last one. Chris, I believe on the call you mentioned that you expect your inventory on ceramics to be in pretty good shape by the end of the year. If that's the case, you know, obviously the back half of this year you've had a big drag on production curtailment for ceramics. Should that be kind of like a neutral event when we think about early next year then?

Well, I think as we go into next year, we've got all these things to drive our business, and how we utilize that capacity will really depend on how fast they ramp up.

Okay. Thanks a lot. Appreciate the call.

Your next question comes from Michael Wood with Nomura InstantNet. Your line is open.

Hi, good morning. I wanted to shift gears to carpet, particularly in nylon. I'm curious how small that's become as a portion of your mix in carpet. And can you scale operations in nylon specifically enough to achieve the required returns that you have?

The nylon part of the business has declined in residential. And we have another category that we compete against nylon with we call SmartStrand. which is made out of tri-exta. Both of those things compete in the higher end of the business. And we have a much larger business in tri-exta than we do in nylon in the residential category. On the commercial side, you have the nylon makes up the majority of it and still does and isn't changing.

Got it. Okay. And could you also just talk briefly about how you're running promotions in ceramics? in terms of how that would actually phase out once the inventory gets worked down. Thanks.

Well, what we're doing in ceramic, in some cases, we're running promotions with, or I won't even call, we value engineered products to go after builder business where they were previously using LVT. So that's one product that we have offered. We also have products aimed at getting the product, the Chinese product, that will stop coming into the United States. So those are the two main areas.

Your next question comes from Keith Hughes with SunTrust. Your line is open.

Thank you. Questions in ceramic. I think you'd said it was $18 million of higher input cost in the quarter. We've seen that for now, a couple quarters now. Specifically, what product or what inputs are driving that up?

Well, in particular, in South America and in Europe, we had higher costs for energy is for one.

And then also the material, you're in a global marketplace. In the different places around the world, there's inflation in energy and there's inflation in raw materials still occurring in most of the markets.

And if we look back at 2018, ceramic incurred about $100 million of higher inputs. Was it the same sort of things or was it different last year?

Mainly the input cost globally, like Jeff said, has been in energy, materials, labor, in several areas.

And one more on the material costs in ceramics. In some cases, there's trucking costs that have also gone up to move the stuff to the plans, which has also impacted the material costs. Okay.

And I guess final question for Chris. You know, you've been in this industry for a long time. This is going to be two years of just tremendous input cost inflation. Have you ever seen anything like this before?

Well, I think the thing that, as Jeff mentioned, one of the costs that really ramped up last year was the transportation cost. That was a significant cost increase, and also the material cost. You had both of those.

Okay. Thank you.

Your next question comes from Truman Patterson with Wells Fargo. Your line is open.

Hi. Good morning, everybody. First, just wanted to touch on your fourth quarter EPS guidance. Backing into it, it looks like that implies your operating profit is going to decline about 20% year over year on much easier comps in the second quarter. So it seems to me that operations look like they're going to take another step back in the fourth quarter. Could you just maybe walk us through what the largest buckets of what's causing this? In that, it also appears that I hear the improvement in LVT North America and making some capacity rationalization, but it seems like implied in that guidance that North America margins might even take a step back as well in the fourth quarter? Just hoping you can help me wrap my arms around this.

Yeah, I mean, I think the message here, and this is Glenn, is essentially the fourth quarter is playing out as we expected. The dynamics in the fourth quarter are the same as the dynamics in the third quarter. And the biggest is in ceramics, in volume. and ultimately that and the downtime we're taking against that volume to manage our inventories in the U.S. So those are the two key buckets that build that guidance. There's really no more new issues. It's just a seasonally different quarter and a different amount of days, and from there, you know, fill in the blanks.

Okay, okay, gotcha, and thanks for that. digging into North America a little bit more. You know, they bumped up margins, bumped up 200 bps sequentially. If you look historically, that looks kind of in line to maybe a little bit below the normal improvement. You know, if you look at a couple years, it looks like, you know, margins are backsliding a little bit further. You're mentioning positives in the North America, you know, carpet restructuring that should benefit 2020. You've got better LVT manufacturing. We've also been hearing in channel checks there's still some excess inventory. There's some increased promotional activity, capacity rationalization. I'm really thinking when you roll all the puts and takes up, should we expect third quarter margins to really be the floor? and we can ramp up and improve through 2020? Or do you expect, you know, the pressures to kind of more than offset, you know, the positives and possibly a flat to down margins?

Yeah, I would think this year is over. We're talking about 2020 right now. I think the fourth quarter is transitional. The dynamics are the same. It's the fourth quarter. But certainly, as we've outlined, you know, we're going to have a tailwind in the things we can control in Florida and North America, and LBT will turn profitable, as Jeff said. We'll get the benefits from restructuring, and outside of economic conditions, there is a tailwind to improve margins from where they are today.

Okay, thank you.

Your next question comes from Tim Wadges with Baird. Your line is open.

Yeah. Hey, everybody. Good morning. Just maybe shifting gears to the cash flow statement. I guess first, any sense for what preliminarily CapEx might look like in 2020? And I guess secondarily, how are you kind of thinking about just kind of using or kind of utilizing just some of the increased free cash flow that you should generate in the back half of this year and into 2020? Just wondering, you probably won't pay down debt, you've done a couple of acquisitions, but is there an increased emphasis on potentially using some of that cash to buy back stock?

The CapEx next year will be less than depreciation. The biggest part of it is going to be spent on projects that have good paybacks and reducing our costs in each piece with limited risk in them. And we think we have a number of those identified and able to do. On the stock buyback, we are going to complete the stock purchases over time, as we have said, and we haven't made any plans to add to it. We'll decide that in the future when we get there.

Your next question comes from Justin Spear with Zellman & Associates. Your line is open.

Good morning, guys. Thank you. I just wanted to take a look under the hood at flooring rest of the world and the global ceramic business. You've touched on quite a bit, but we have these softer international market conditions. Can you give us a sense for how you see profitability trending in those segments as we look into the fourth quarter, particularly in the 2020, given what you're doing in terms of productivity and given what you see, is the flooring rest of the world business has been pretty sound, a little weaker into the third quarter. but just give us a good sense for how you view that business casting into 2020.

So when you look at the flooring rest of the world, the European economy is slowing a little, but each of those countries and markets are different, and our businesses are performing well in each of them. Our investment in innovation, cost, and new businesses are enhancing our results, and we're well positioned in each of those categories. Laminate, LVT, and sheet vinyl are performing the best, and our new operations are making progress. That would be on the flooring rest of the world. And on the ceramic side, I think it's just like we talked about. So far, Europe's been affected by a slowing economy, particularly Italy, Germany. And also, the European ceramic business has been impacted by lower exports to other regions. Now, in that context, we're managing our business well. Commercial is doing better. And just like in the U.S., we're increasing our sales organization and new showrooms. And we're also selling more mid- and low-end product to increase sales. So we're doing a lot, but we think the economies will still be relatively weak.

Okay. In terms of line of sight and the inventory management, I feel good about the direction. I feel good about some of the investments you're doing to kind of rev up growth, but I'm still trying to get a sense for do you think that flooring rest of the world margins, and I know it's doing relatively well, but in view of if trends remain soft as they are, do you think margins will be stable with where they're casting this year as we think about next year?

You have also these new projects coming on. You have LVT that the line's going to change from a drag to a positive. You have the Russian sheet vinyl plant has come up, and it's going to flip to a positive. You have the laminate businesses, which we put investments in a while, that they're running well and using the capacities. And we have put more capacity in Russia And it's doing okay. But there are drags from the economy. So you have the economy drags on one side, and you have the various positive things we're doing on the other. We'll have to see how they all balance out.

Excellent. Excellent. And then lastly, kind of a line of questioning on flooring North America. I know you source LVT, and we know you're bringing up your internal production, but you're still sourcing quite a bit of LVT from what I understand. We have the tariffs in place. Just thinking about the implication of the tariff on that source product on your North American margins this year and potentially the next year, and in terms of that business, looking separately after that at price mix, input costs, and productivity, what was that in the quarter and what's expected going forward?

I'll just make one comment on the tariffs. For North America, it's not been – nearly the issue that we had in ceramic. Ceramic, the tariffs are 130%. In North America, they were 25%, some of which was discounted back. So I don't think the tariffs have been such a big impact.

It's been an impact, but not as great. You have the Chinese currency got weaker and the suppliers absorbed a portion of it as you go through. And we're in the same position as the rest of the market. And there's also you know, production moving, trying to move to other places to be made. So we're in the same boat as everybody else.

Okay. And then just in terms of the price mix, input cost and productivity in Florida and North America, can you relay what those were in the quarter and what's expected going forward?

As I said earlier, price mix turned positive. and productivity factoring startup costs also were positive. So, yeah, we have the volume challenges, but from a mixed standpoint, it was the biggest driver, keeping the overall segment across the categories in a flat to positive mode of about $4 million.

Excellent. Thank you, guys. Really appreciate it.

Your next question comes from Mike Dahl with RBC Capital Markets. Your line is open.

Hi, thanks for taking my questions. First question is really focused on the European environment and one of your competitors earlier this week talked about how they were seeing excess Chinese LVT capacity and how that was starting to appear in Europe and cause some disruption in Europe as that entered the market. Can you comment to what extent you've seen LVT imports into Europe pick up and have an impact on your business?

LVT from China has increased as the market has increased. We believe we're positioned to compete against it. In Europe, we're manufacturing all of the product we're selling, and as our new line comes up and our costs come down, we think that we can offer retailers or buyers of the product competitive products with much shorter lead times and more flexibility. And we think we can increase our position in the marketplace.

Okay, got it. My second question, two parts on ceramic. The first is just a little more color on the impairment on the Chinese asset post the anti-dumping ruling. Can you just talk about how much... how much you were importing through that business and whether or not there's a go-forward impact on how we should think about sales and margins in the ceramic segment as that's been impaired and potentially redirected. And the second part is bigger picture around ceramic. I know you talked about the inventory levels. specifically to the Chinese ceramic. But, you know, as you've had the anti-dumping go into effect, you know, what have you seen in terms of import activity from other countries taking that place? And how do you stack up competitively compared to that?

Okay. So, firstly, the investment that we wrote off is something that we've had since 2010. It's a factory where we brought – imported product, and that has slowly decreased over time. And that production can be brought into our U.S. factories. So that's the only story about that investment. The Chinese inventories, they spiked. As those tariffs were about ready to be implemented, the last wave, let's say, of Chinese inventory was brought into the system, and that'll slowly work its way down. Now, what'll happen is that source of supply will get replaced by U.S. manufacturers will be part of it, but it'll also impact Brazil, Turkey, India. And right now, that's being made a little easier because the dollar is so strong. But we should benefit, us and U.S. manufacturers should benefit from some of it.

Okay, thank you.

Your next question comes from Matthew Boily with Parklaze. Your line is open.

Hi, thank you for taking my questions. You know, you mentioned kind of seeing those signs of the residential market improving in the U.S. You know, how should we think about how that might flow into your business timing-wise? And if you could remind us maybe which product categories, obviously carpet, ceramic tile, on the home builder side where you might see kind of the greater benefits of an improving housing market in the U.S.? Thank you.

What we said was in the last few months, as you guys get the numbers, we've seen an improvement in the housing sales, and improving in the housing sales should benefit us. If you look at new home sales, flooring is the last thing that's put in before the house is complete. So if it takes nine to 12 months to build a house or 18 months, The flooring is the last thing that's put in it. The different categories, all the different categories are used in the homes as you go through. We're seeing increases in all the different hard surfaces are used in, carpets used in it. So if it goes up, it should positively impact all of the pieces.

Okay, understood. And then just back to LVT in the U.S. again. I think you mentioned, Jeff, that you've got some visibility to reduce costs in Q1, and you kind of also mentioned hitting the targeted cost structure at some point next year. Can you just elaborate a little bit on that or, you know, around the timeline to turning a profit in that plant and, you know, what type of margin you can actually do with the LVT in the U.S.? Thank you.

What we said is that next year we think that we'll turn a profit in it. We haven't put it by the quarter. In addition, as the piece, as our manufacturing improves, it has to flow through the inventory so the cost improvements show up about four months later in the cost sheets as you go through. We expect all through the year for it to keep improving and then Even further beyond that, we would expect the cost structures to continue to improve incrementally, and then over time you change the mix in the business. To get the business to align, you have to sell it at whatever prices you need to to get it into the marketplace quickly, and then over time you upgrade the mix, which will take more than next year as we do it as we go forward.

Okay, understood. Thanks a lot.

Your next question comes from John Lovallo with Bank of America. Your line is open.

Hey, guys. Thank you for fitting me in here. Can you just help us think about the magnitude of the sales and marketing investment that you're making to expand the placement of your products? And, you know, should we expect this to kind of ramp sequentially as we head through 2020?

We're putting in all the different businesses, as you've heard, we're putting more salespeople on and we're trying to be more aggressive in the marketplaces as we go through so there's a spike in it. We're going to continue to monitor it, and if we get the positive results, we'll continue spending at those levels. If we don't, we'll adjust the strategy and get it in line.

Okay. And then maybe finally, what percentage of your ceramic offerings today are what you would consider to be value-oriented and And where do you think this percentage could go over the next year or two?

You know, we have price points up and down the spectrum in ceramic. And I wouldn't overemphasize these lower price points. We're in selected situations where we have opportunities. We're targeting it because we are underutilized in our assets. But overall, it's not a huge piece of our production.

No, but it will get bigger, and it will impact the margins. And we're doing the same thing in Europe, is that we're being more aggressive. As the industries slow down, we participate more in lower-value products. So it does impact the mix.

Got it. Thanks, guys.

Your next question comes from Catherine Thompson with Thompson Research. Your line is open.

Hi, thank you for taking my question today. On carpets in the U.S., last year was somewhat flattish down a little bit, and the overall industry expectation was the worst is behind, and the industry context with whom we've spoken have been very surprised by just taking such a bigger leg down this year. I wanted to get your thoughts on that dynamic and what realistically are your expectations looking beyond just the next couple of quarters, but What could the next be as we look two to three years down the road?

If you look at the flooring market in the United States, historically it's grown greater than GDP through the cycle. And I don't know what would have changed it that flooring would not grow slightly more than GDP over time as if.

I was talking about carpet. Carpet's not been growing as fast. I'm talking about a specific category, not overall flooring.

I'm sorry.

So we're talking about a secular change.

Carpet has been decreasing, and we don't see it changing at the moment. What we believe is that the LVT at some point is going to plateau out. We believe that it's probably slowing somewhat at this point from where it was, and it will plateau, and then things will go back to,

some sort of growth rate that's more leveled over the piece but it's not going to stop tomorrow yeah so just once again just to follow up to see if i can clarify carpet is taking a bigger step down this year while every lvt has been growing at a pretty steady rate what do you think the percentage reasonably carpet should be two to three years down the line as we look at this broad mix

I don't have a number to give you. You can make up one as well. I don't have a number.

Okay. On transportation, obviously there's been just a shortage of drivers. It's been a thorn in the side for so many industries in construction and manufacturing. What are you doing to ensure – the ability to keep drivers and to get some stability in that labor force and the long-term cost for that?

We have done a few things. One is that we have increased our internal trucking fleet in order to move a greater percentage of our products. We think that we offer, we've been able to staff our positions because of the consistency of the routes and the ability for people to make money. So we've done better than the market in general to support our own trucking fleets, and we've taken a larger percentage of it than has been going in the open market as the costs have increased.

Okay, thanks.

That is all the time that we have for questions. I turn the call back to Mr. Lorberbaum for any closing remarks.

We appreciate everybody joining us. We have a lot of actions we're taking to improve the business and our results. We think we have a lot of opportunities as we look going forward, and we appreciate you being on the call with us. Have a good weekend.

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