Mohawk Industries, Inc.

Good morning. My name is Megan, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mohawk Industries third quarter 2020 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers depart, there will be a question and answer period. If you would like to ask a question during this time, simply press star and the number one on your telephone keypad. To withdraw your question, please press the pound key. Should anyone need assistance at any time during the conference, please press star, then zero, and an operator will assist you. As a reminder, ladies and gentlemen, this conference is being recorded today, Thursday, October 30, 2020. Thank you. I would now like to introduce Mr. Frank Boykin. Mr. Frank Boykin, you may begin your conference.

Thank you, Megan. Good morning, everyone, and welcome to Mohawk Industries' quarterly investor conference call. Today, we'll update you on the company's third quarter results. 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 in the Private Securities Litigation Reform Act of 1995, which are 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 of non-GAAP numbers. For a reconciliation of any non-GAAP to GAAP amounts, please refer to our Form 8K and press release in the Investors section of our website. In addition to Jeff and Chris, joining us today on this call is Jim Brunk, our corporate controller. As we previously disclosed, we received subpoenas from the Department of Justice and the Securities and Exchange Commission related to allegations in a class action lawsuit filed against us. With the assistance of outside legal counsel, our audit committee completed a thorough internal investigation into these allegations of wrongdoing and concluded that they are without merit. We are cooperating fully with the ongoing governmental investigations and will continue to vigorously defend against the lawsuit, which we do not believe has merit. I'll now turn the call over to Jeff for his opening remarks.

Jeff? Thank you, Frank. Our third quarter results significantly exceeded our expectations with sales recovering and operating income substantially increasing from last year's levels. Under continued pandemic conditions, people all over the world are spending more time in their homes and working remotely. Globally, this trend increased investments in home remodeling as well as driving new home purchases. All of our businesses and geographies were stronger due to higher demand and customers increasing inventory in our distribution channels. Flooring rest of the world delivered the strongest results in the quarter, as our Northern European, Russian, and Australian businesses were less impacted by the pandemic. Our global ceramic and flooring North America segments also improved substantially, while being more affected by COVID and postponed commercial projects. Our laminate, LVT, and sheet vinyl outperformed our other categories, and our new plants improved their output and efficiencies. Fluctuations in worldwide exchange rates negatively impacted our EBIT by about $7 million, with declines in most currencies offsetting the strengthening euro. During the period, demand for our products exceeded our production, and inventory declined by about $80 million as we ramped up plants across the world. Our increase in manufacturing in the period was limited by challenges with hiring, training, and capacity. To cover higher operating material logistics costs, we've announced selective price increases in some markets and product categories. We've made significant progress on our previously announced restructuring actions, and are in line with our planned schedule and savings. Though in response to higher demand levels, we have postponed some restructuring projects while we assess future conditions. Our businesses responded to the COVID crisis as our focus has remained on keeping our employees safe. Throughout our offices, operations, and distribution systems, we've implemented procedures that exceed the public health guidelines. We're tracking all identified cases, testing all contacts, and successfully containing the spread within our operations. Throughout the pandemic, our people have collaborated to protect each other and support our customers around the world. Even with our improved performance in the period, our visibility of the future remains very limited. As COVID cases increase, governments may expand restrictions on commerce and reduce stimulus activities. In addition, future consumer spending is uncertain. Business investments remain low, and inventory growth in the channels could change. We continue to monitor health information and market trends to respond to the evolving conditions in our market. In the second quarter, we took advantage of the favorable rate environment to pay off $1.1 billion of short-term debt and pre-fund our future long-term maturities. In the third quarter, We generated about $530 million of cash, bringing our cash balance to $1.2 billion at the end of the period. We will pursue additional investment opportunities, including internal growth, acquisitions, and stock purchases as the pandemic and economies improve. We believe our stock represents an attractive investment, and our Board of Directors recently approved a plan to repurchase $500 million of the company's stock. I'll turn the call over to Frank for a view of our third quarter financials.

Thank you, Jeff. Sales for the quarter were $2,575,000,000, or up 2% as reported and on a constant basis, with the rest of the world segment performing best. As a note for next quarter, our sales will be impacted by two more days compared to the previous year. Our gross margin was 27.4% as reported, or 28.3% excluding charges, increasing from 27.8% last year. The year-over-year increase was driven primarily by higher volume, productivity, and lower inflation, partially offset by price mix. The actual amounts of these items will be included in the 10-Q filed later today. Our SG&A as reported was $443 million, or 17.2% of sales, or 16.9% versus 17.8% in the prior year, both excluding charges. This was primarily impacted by favorable productivity of $21 million. Our restructuring charges were $32 million for the quarter, of which $6 million was cashed. All of our restructuring and other savings are on track with our original plans. Our operating margin excluding charges was 11.5%, improving from 9.9% last year. The increase was driven by stronger volume, productivity, and declining raw materials, partially offset by unfavorable price and mix. Interest expense was $15 million, and we expect interest next quarter to be approximately 16 million. Our income tax rate was at 17% this year compared to 18% last year. We expect the fourth quarter to be approximately 5% and then returning to historical levels ranging from 20 to 21% next year. Our earnings per share excluding charges was $3.26, up 18% from last year. Turning to the segments. In the global ceramics segment, sales were $911 million, down 1% as reported, with business up almost 2% on a constant basis. The nine US businesses turned in our best performances in this segment. Our operating margin, excluding charges, was 10.3%, up 110 basis points compared to the 9.2% last year. Our increase was from productivity and volume partially offset by unfavorable price mix. In the flooring North American segment, sales were $982 million, down 2% as reported, with growth in all major categories except the more profitable commercial end market, which remains challenging with postponed projects and slower office and hospitality. Operating margin excluding charges was 8.2% compared to 8.7% last year. The decrease in earnings was driven by lower margin and price mix, partially offset by favorable productivity and lower inflation. In the floor and rest of world segment, sales were $681 million, up 13% as reported, and increased by almost 10% on a constant basis. A lower exposure to our commercial end markets, along with a larger presence in Northern Europe, supported strong top line growth in this segment. Our operating margin excluding charges was 19.3%. That's up 480 basis points from 14.5% last year. The main drivers were higher volume, favorable productivity, and lower raw materials, partially offset by unfavorable price mix. In the corporate and eliminations segment, the operating loss excluding charges was $10 million. We expect the total year to come in at a loss of about $40 million. Then jumping to the balance sheet, our receivables ended the quarter at $1,711,000,000. Our day sales outstanding improved to 56 from 61 days last year. Our inventories ended the quarter at $1,842,000,000 and dropped almost 500 million or 21% from last year as all businesses saw significant reductions in inventory with production lagging sales. Our inventory days were at 100 versus 127 days last year. Fixed assets at the end of the quarter were $4,405,000,000 and included capital expenditures during the quarter of $69 million, and depreciation and amortization of $151 million. We estimate the annual capital expenditures to be about $420 million, with DNA estimated at $595 million. And finally, the balance sheet and cash flow remains strong, with total debt of $2.6 billion, total cash and short-term investments of almost $1.2 billion, and leverage at 1.1 times to adjusted EBITDA. I'll now turn the call over to Chris to provide segment details of our third quarter performance. Chris?

Thank you, Frank. For the quarter, our global ceramic segment sales increased 2% on a constant days and currency basis. Our operating income grew 11% with a margin of 10% excluding restructuring costs compared to last year. All of our ceramic businesses improved substantially in the third quarter, with low inventories limiting both our sales and service. The residential sector experienced a more significant rebound in the period, while commercial demand remained sluggish. Most of our plants have stepped up to run all of their capacity to meet present demand and increase inventories in the fourth quarter. Overall demand was solid, but our visibility is hampered by COVID. The sustainability of residential sales growth and postponed commercial projects. In the U.S., we are seeing increased traffic in our showrooms and galleries, as well as our customers' retail shops. We have shifted sales focus from commercial to new home construction, which is expected to increase through next year. Commercial sales improved from the prior period, but are still lagging. Our inventories decreased slightly during the quarter, even as we increased our production levels. We have announced price increases to cover higher freight and operations costs. Our quartz countertop plan is performing as planned, and we are increasing our higher-style collections to improve our mix. Our restructuring initiatives are being executed as we planned. We have closed two tile manufacturing facilities and consolidated distribution points. We've also reduced SG&A and labor costs and discontinued lower-performing products. Our Mexican ceramic business is experiencing many of the same trends as the US. Our plants in Mexico are operating year capacity to reduce order backlogs, running shorter production quantities, and optimizing our SKU offering. To replace higher end imports, we are manufacturing new porcelain collections in larger sizes. We are expanding our sales footprint with exclusive Daltal branded shops being opened by our customers. Our Brazilian ceramic business had its best quarter in its history with significant growth in both domestic and export markets. We are presently operating at full capacity and allocating production as consumer demand increase and inventories are rebalanced. To offset rising inflation, we have announced a price increase that will go into effect later this year. We are continuing our investments to upgrade our Brazilian assets, create higher value products, and reduce our costs. Our European ceramic business delivered strong results in the period as residential sales improved and inventories in the channel are replenished. Our performance was hindered by substantial reduction in higher value commercial category and lower exports for projects around the world. We achieved higher manufacturing levels by reducing the traditional August shutdown periods. As production rose during the period, our service improved and we will continue to increase inventories to enhance our service. Increased pricing pressures during the period were offset by higher volumes and productivity, lower inputs and SG&A leverage. Our major markets in Europe are increasing restrictions due to recent spikes in COVID cases, which could impact future demand. Our Russian ceramic business recovered and is performing better than last year. even with the political crisis in the Eurasian Union lowering our exports. The growth was driven by our strong results in the new construction channel and company-owned retail stores. Like our other businesses, low inventories constrained our sales in the period. Our new sanitary ware plant is operating as planned and will support our premium strategy with products that coordinate with other offerings. During the quarter, our Flooring North America segment sales decreased approximately 2% as reported, with operating income margin exceeding 8%, excluding restructuring charges. The segment's performance improved substantially from the prior period due to improving residential sales. Revenue in the quarter were limited by our low inventory levels and difficulties increasing production due to staffing shortages and higher employee absentee rates. Commercial demand improved from the prior period but remains weak, with the hospitality, retail, and office impacted the most. Inventories in the period continued to fall, though we expect them to increase through the end of the year. As our production aligns with demand, our service levels are improving. Our restructuring programs are progressing and achieving the expected cost savings in manufacturing, logistics, and SG&A. Our residential carpet business improved from the prior period, with retail remodeling performing best. Our polyester products are outperforming other fiber categories, which is impacting our mix and average selling price. As we progressed through the period, we achieved higher manufacturing rates, which improved our productivity and cost. Increased overtime and shorter runs improved our service, but raised our production cost. To cover higher costs, we are implementing price increases in the market. Our rug sales increased as consumers used them as an easy way to update their home decor. In the period, we are allocating our rug production as demand increased and retailers restocked their inventories. Commercial flooring remains depressed as businesses reduce remodeling and postpone construction projects. While our commercial sales improved from the deep second quarter decline, we anticipate a slower recovery in the sector. During the period, laminate had strong growth with expanding distribution and sales in all channels. The beauty of our waterproof laminate collections are attracting more consumer interest and has enhanced our mix. Even with our laminate operations running at full capacity, we are unable to satisfy demand and have postponed our new product introductions. To increase our laminate production, and provide new features, we are installing a new line that should begin production in the fourth quarter of next year. We have reduced our commodity wood manufacturing and are repurposing our operations to produce premium wood collections with unique features. Sales of our residential LVT collections continue to expand at a rapid pace, with rigid products increasing in their share and our new product launches improving our mix. To compensate for higher tariffs on source collections, we implemented price increases in the period. We are continuing to make significant progress in our U.S. manufacturing facilities. Output is increasing, although some of our productivity initiatives fell behind schedule due to COVID-related interruptions and travel from Europe. We have recently relocated European engineers to the U.S. to implement enhanced LVT processes that are being used in our Belgian operations. Our sheet vinyl collections continue to take market share, and our costs in the category improve due to greater efficiencies. For the quarter, our flooring rest of world segment sales increased approximately 13% as reported. The segment's operating income grew 56%, with a margin of 19% as reported. During the period, the segment outperformed in all of its geographies as home sales and remodeling expanded, with people spending more time at home and reducing other discretionary spending. Our inventories remained low in all product categories as order rates exceeded our increasing production levels. To meet higher consumer demand, our plants took less time off in the August vacation period to maximize production levels and service. With higher service and lower marketing expenditures, we leveraged our SG&A costs across the business. Our flooring rest of the world segment has less participation in commercial end markets that more negatively affected our other two segments. Our laminate sales growth was limited by manufacturing capacity in Europe. We began shipping laminate from Russia to support higher demand in Europe. Our strong brands and industry-leading innovations continue to attract the consumer, and our differentiated products are improving our mix. We postponed new product launches and reduced our marketing and promotional activities in the period. During the quarter, sales of our LBT collections grew the most as our production levels, efficiencies, and cost improved as we anticipated. We expect our productivity and cost to continue improving as we expand the utilization of our operations and enhance our material yields and efficiencies. The rigid LBT category is also growing faster in Europe, and we will be adding a weekend shift to support the increased demand. In the fourth quarter, we will begin shipping our next generation of rigid LBT products with new features that will strengthen our market position. Our sheet vinyl provides the best flooring value in the market, and our sales increased as our retail customers reopened. Higher production volumes positively impacted our costs and better leveraged our SG&A. Our Russian sheet vinyl plant performed well with higher utilization and margins. We are adding another shift in the plant to satisfy our expanding business. We completed the consolidation of our wood manufacturing operations in Malaysia and significantly reduced our costs. We have improved our output, allowing us to satisfy increasing demand. We are gradually lowering our material costs through our initiatives to vertically integrate. Our insulation products rebounded with increased volumes after our markets reopened. Even though our selling prices have declined, our margins remain strong as material costs were lower as well. Our raw material costs are now rising, and we have announced price increases to compensate. Our board's business benefited from strong demand, improved product mix, and lower material prices. We also reduced our costs with the investments we made in expanding our glue manufacturing and new energy plants. Our Australia and New Zealand business performed very well with strong sales growth, improved product margins, and the success of our updated product offering. The company is well positioned with its strong branding in both carpet and hard surface. With that, I'll return the call to Jeff.

Thanks, Chris. We entered the fourth quarter with improved sales and margin trends and have a solid order backlog across the enterprise. Residential remodeling and new home construction are forecasted to remain strong as the pandemic has transformed our living spaces into schools and offices and as participation in other activities has fallen. The fourth quarter is slower for our industry to the normal seasonality and we expect lower growth in channel inventory levels. Our higher margin commercial channels will continue to be slow with completed projects likely to outpace new starts. We anticipate service improving with our inventories rising as production levels exceed sales. We are implementing our restructuring plans and are on track to reduce costs as expected. Our visibility continues to be limited by many uncertainties, including how government restrictions and demand will evolve. Assuming the current economic trends continue, we anticipate our fourth quarter EPS to be $2.75 to $2.87, with a non-recurring tax rate of approximately 5% for the period. Our business has responded effectively to the COVID crisis, changing government restrictions, and varying market conditions. Residential remodeling and new construction are expected to improve next year. The commercial business should increase from its present low levels as economies recover going forward. Our strong balance sheet cash generation liquidity will allow us to move from a defensive posture to a more aggressive growth strategy. With that, we'll be glad to take your questions.

Ladies and gentlemen, at this time, if you would like to ask a question, please press star and number one on your telephone keypad. Management requests that you limit yourself to one question and one follow-up. Your first question comes from Stephen Kim with Evercore ISI. Your line is open.

Thanks very much, guys. Thanks for all the info, and congrats on the good results. I wanted to first ask a question regarding your share repurchase and your comments earlier about litigation, the litigation. There have been a lot of questions we've been getting from investors about if and when the company would step up its share repurchase activity, which you did address in today's release. And meanwhile, at the same time, there were some important changes, it looks like, to the language around the recent lawsuit in your press release. I'm wondering, is there any reason to think that there might be a relationship between the board's conclusion of its internal investigation and the board's authorization of a share buyback?

Hey, good morning, Steve. This is Frank. That is a good question, and I'd like to make a couple of points, I think, about that. First, last quarter, we stated that the Audit Committee's investigation was substantially complete. This quarter, we added to our statement that the investigation is complete and that the Audit Committee has concluded that the allegations are without merit. I think the second point regarding the authorization You know, the board's decision to authorize an additional $500 million for stock purchases is clearly an indication of their view of the value of our stock. But I also think it's an indication of the improved clarity on our position in the class action lawsuit.

Yeah, that's encouraging. It makes sense. Okay, great. My next question relates to primarily Flooring North America and North American Ceramics. You indicated that you paused the restructuring as well, and it seemed like there were two main reasons for pausing the restructuring, one, because demand's surging, and two, because your inventories need to be rebuilt. So what I'm trying to understand is how big of a factor the inventory rebuild is. So let's say resi-demand stays as strong as it is now. Let's say it just stays really strong. When do you think your inventories would get back to a comfortable level? Is that going to be like, do you think you can do it in 4Q or do you think it's going to spill over into 1Q of next year? And once the inventories are in good shape and current demand, if it stays the same, would you be happy with your present capacity or would you likely restart your restructuring program to reduce your capacity further in that situation?

So what we said was we'd postpone some of it. We actually reduced the cost of the restructuring by about $10 million, and I think the amount of savings by the same $10 million is it. At this point, we haven't concluded. It's only a limited portion of the total. At this point, we have already executed about 25% of the savings through the third quarter. As we said before, we expect about 15% $15 to $20 million a period going forward on a continuous basis. So we haven't changed the strategy on restructuring and cutting costs out of the business. It was just a limited portion of it. On the inventories, we're going to continue increasing the inventories between the fourth quarter and first quarter. And it's all dependent on how we see the demand evolving and the business changing as we go through. and we'll keep adjusting the inventories up and down, we expect to be in reasonable shape coming out of the first quarter for the rest of the year. And in some cases where we have capacity limitations, you'll see us increasing inventories in the slower periods to take us through the peak periods in the middle of the year.

Yeah, that makes sense. Thanks a lot, Jeff. Appreciate it.

Your next question is from Tim Rogers with Baird. Your line is open.

Yeah. Hey, guys. I just want to echo. Nice job and, you know, in the quarter and the guidance here. You know, maybe just in my question, two things. So, the first is on residential versus commercial, is there any way to parse out how residential performs, you know, from a growth perspective versus commercial in North America? and then maybe what the margin differential between the two business lines is?

Let's just give you a higher level view of it. The commercial business is somewhere about 20% to 25% of our total business. In that, we have parts of the business that have very little and parts that have significant. The most significant pieces are in U.S. carpet, U.S. ceramic, and our European ceramic have a much larger piece of the commercial businesses. All the commercial businesses are down substantially. Existing projects are being completed, and new ones are more limited coming forward. We're anticipating a slow recovery over time, with next year being better, but it could take multiple years to get back to where it was as we go through it.

Okay. Is it fair to say commercial down?

The one other thing, Tim, I would like you to emphasize there, too, is with commercial down as it is, it is a much higher margin business than the residential side.

Okay. And then I guess on LVT, is there any way to frame kind of where the rigid LVT margins in Europe are today? Are they in line with other lowering product margins in Europe and just trying to get a sense of, you know, the types of improvement that we've seen in Europe just given, you know, it still seems like there's improvement opportunities in the North American business.

The LVT in Europe is operating much better. It's positively contributing to our results. The margins are not as high as the average of our business. We have specific actions on a continuing basis to continue to lower the cost, and we expect the productivity and cost to further improve. In Europe, which is ahead of the U.S., we're actually bringing to market new innovative features to keep us ahead of the marketplace, and they're going in the market now. In the U.S., as we've said, it's behind the other one by three to four months. We just recently brought engineers over which we had trouble getting them to get in the United States. So we'd had them here earlier. And they're in the plants, updating the pieces to align with it. I left out in Europe that we're in the process of adding a weekend shift to it to fill the increasing demand on the rigid products over there. And the US is following behind and we think we're going to get to where we need to go.

Okay. Okay, well, nice job on the results, and good luck on the rest of you here.

Thanks.

Your next question is from Sam Darkatash with Raymond James. Your line is open.

Good morning, Jeff, Frank, Chris. How are you?

Perfect. Good morning.

Terrific. Two quick questions, if I might, on the fourth quarter specifically. It looks like your guidance implies a far more mild margin expansion year on year in the fourth quarter than what you saw in the third quarter. I'm trying to figure beyond conservancy why that might be the case, knowing that you're getting incremental pricing, that your production is going to be higher, that you have restructuring savings coming in. Why might we not see as much of a margin expansion in the fourth quarter as we did in the third?

In the third quarter, compared to the last year, we had our European businesses ran a lot of the capacity through the vacation period, so our cost structures were lower and on a relative basis to each other as we go through. At the same time in the third quarter, we cut back on a huge amount of our marketing activities and our costs, where the capacity is where they are, and we're going to have to normalize the marketing expenses and pieces in the fourth quarter going forward. On a forward basis, when you look at the sales, it looks like residential will continue to be good, but you're listening to all the things about COVID. We're not sure what's going to happen with COVID and how it's going to impact our business. So far with the European businesses, It appears that our customers are going to stay open, and they're considered essential, but, I mean, it's changing by the day. So that's good at the moment, but we can't tell what's going to happen. Our commercial businesses, we really don't know if they've bottomed yet or not. You have the old projects that were put in place are coming to completion, and they're completing. The new ones are slower coming up, and it's really hard to determine how they're going to all balance out together as we go through the fourth quarter. So in our estimate, we're trying to reflect all of those considerations.

Helpful. Second question, if I might, Frank. Back to the envelope, I'm getting fourth quarter free cash flow somewhere in the break-even to somewhat positive area, I guess depending on the inventory ramp. Is that a fair – representation of how you see free cash flow in the quarter?

Yeah, I think it's going to be in that range.

Okay, thank you. Be well, stay safe. Have a terrific weekend.

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

Hi, thanks for taking my questions and the details so far. I have two questions on foreign North America specifically. The first, I'm curious if it's possible for 3Q, you know, you went through a lot of the moving pieces and talked about still seeing the strength in LVT, which is obviously consistent with the market. Your overall foreign North America sales were down 2%. Excluding LVT, what were foreign North America sales?

We don't give out the information at that level. I can tell you that our sales were limited in all the product categories by our capacities and production levels. With the $500 million of inventory that's been taken out of the whole business is that we usually go into the third quarter with higher inventories and reduce them. So all the categories, the sales were limited by that. In the carpet one specifically, With the whole industry in the same area, the whole industry picked up. The whole industry had let the workforce decline because nobody could see where it is. So there's a huge pressure on the workforce in getting it staffed back up. And then the training and hiring impacted it significantly. So the business in Florida, North America, had more restrictions on it than many of the other businesses. We are... a long way down where we'd like to be, but we're still having training, absenteeism, COVID, you know, still impacts. We're protecting the people inside the business, but when they come in with it, we then have to let people go home and the absenteeism goes up. So protecting all the people is impacting our ability to raise the production rates as high as we would have liked to have them.

And I would just add, too, Mike, that the single biggest headwind we had on sales in Floating Wealth America was commercial, as Jeff had talked about before. And on the margins. Yeah.

Right. Okay. Thanks. That's helpful. And that kind of ties into my next question. Just given the headwinds that you're still seeing in commercial, and hopefully those are bottoming, but with the puts and takes there, within your fourth quarter guide, do you anticipate foreign North America sales to be positive or still under pressure?

We're expecting more of the same.

Okay. Thank you.

Your next question is from Keith Hughes with Choice Securities. Your line is open.

Thank you. Two questions. One back to the foreign North America. As you look at your LVT growth, in the segment. Do you think you're at a point now where you're growing at the market? I know you've been underperforming for a while.

I think that we're growing with the market. The numbers are really hard to get by because the numbers are based on the imports and the imports have been so erratic. We have the same thing in ceramic. You can't take the imported volumes and assume that reflects what's going on in the marketplace, so it's really hard to estimate the sales at this point, both for anything that's imported.

That was my second question. The import numbers are erratic and particularly high, too. Do you think that indicates LVT ramping its growth back up from some more limited growth in 2019, or is there just an inventory build ahead of this price increase?

It's hard to tell. One is that the base continues to get bigger. the growth rate is not going to grow at the same rate it has been, and the growth rate is going to slow. And I think it's still going to grow, but just at a lower growth rate.

Okay, second question, or third question, I guess. Within price mix and ceramic, you called out the negative in the discussion, and it's been negative for some time. What's Some of this emergence of residential growth and some pricing you talked about, is that something that could flip to the positive in the near term?

Well, Keith, typically residential pricing would be less than commercial pricing. So I wouldn't expect help on pricing. Secondly, so far with the imports coming in, the pricing has been under pressure on those two. So I wouldn't expect a whole lot of help from pricing. We are taking a price increase to offset transportation and other costs. But generally, I don't think the shift to residential is going to help us.

The countries where the imported ceramics are coming from, most of the countries, their exchange rates have weakened in the past six months, which isn't helping things.

Okay, thank you.

Your next question is from Eric Bossard with Cleveland Research. Your line is open.

Thank you. On the U.S. tile business, kind of the conversation you just had, I'd love to get a little bit more sense of where this goes from here. And specifically with less commercial volume, it seems like that would create some excess capacity in the industry. What's going on with currency seems like it could create a more aggressive pricing environment. and I understand your need to take price to offset cost, but as we look forward for the next six or nine months, it seems like it could be a more competitive environment for pricing or for share. Am I missing something or am I looking at this wrong in the U.S. tile business?

Well, I think the tile business is going to remain competitive in the United States. As you may already know, we have implemented restructuring initiatives that that are being executed as planned. In North America, we've closed two manufacturing facilities and consolidated distribution points, and we've reduced SG&A manufacturing and also lower-performing products. So I think we'll be in an environment where pricing is competitive, but we are reducing our costs at the same time.

Okay. Are others, I guess, just a follow-on within this, is the rest of the industry putting through price increases as well, or what's the trend across the industry in terms of pricing?

Really, we don't know at this point. We do know that the average price of imports have declined and that we have recently implemented or in the process of implementing a price increase, but we don't know yet about the other competitors.

The price increase is basically focused on the freight. If you look around the country, the freight rates are going up dramatically. The transportation systems are tight. And so all the costs of everybody who's moving anything are going to go up, not only us.

That's helpful. Thank you.

Your next question is from Phil Ning with Jefferies. Your line is open.

Hey, good morning, everyone. Congrats on a solid quarter. You know, outside of the commercial piece, you know, in the U.S., your international business seems to have snapped back much faster versus U.S., so just trying to get a better sense. You know, it sounds like that's partly due to labor and maybe just lack of inventory. Should we expect that catch-up dynamic playing out the next few quarters as your operations improve here?

The question, give me the... I'm not sure we heard the question real well on our end, so can you go through it one more time, please?

Yeah, should we... Yeah, no problem. It sounds like, it looks like your results in international did much better than the U.S. Just trying to understand why international saw a quicker snapback. It sounds like it's partly due to labor inventory, lack of that in the U.S. Can you... Expand on that and do you expect that catch-up dynamic to play out as well in the U.S. next few quarters?

The first part of it is that the regions that they end, the majority of our businesses are in Northern Europe, which perform better. Second is they have a much higher percentage of residential sales, so they didn't have the same impact on the commercial volume and commercial margins And the commercial margins in our businesses are higher than our residential businesses, so they also suffer. At the same time, we had the LVT performance over there is better. We have a new plant in Russia that turned profitable and is doing well. We're increasing the shifts in both LVT and sheet vinyl layer to satisfy demand. And then we also had the occurrence in our Australian business that the Australian business also performed really well. And we think a lot of it's because of pent-up demand, and we were better positioned than our competitors in the marketplace.

Got it. That's helpful, Jeff. And then from a LVT standpoint in the U.S., any way to help us understand, give us some landmarks to look at going forward in terms of where you are in terms of that evolution of being profitable, any color on that? where your capitalization levels are for the U.S. lines, and where are you with that evolution on improving your mix?

We think we're about three to four, maybe five months behind the European ones. The European businesses are all profitable, and so the reason we're bringing over the people is to catch up. In addition, in Europe, they're one step ahead of us with new products and innovations in the marketplace, so their mix is a little higher. which we'll be introducing here as we catch up to them.

Okay. Should we expect you getting closer to profitable early next year if you kind of close that three to four month gap?

I think so.

Okay. Thanks a lot. Appreciate the call.

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

Hi. Thank you for taking my questions today. Our understanding from an industry standpoint of use and approval with American business that the time off around Thanksgiving and the Christmas holidays this year is shorter than it had been in previous years. Could you discuss how you're approaching time off around those two holidays this year, compare against what was happening last year? And final point with that, given COVID and different ways you have to operate, also discuss how you approach potential multiple shifts. Thank you.

So first, the holidays do fall on different timeframes. So one is it could have a positive impact on the volume due to the timing. On the business shifts and the closures of the holidays, they're all around the inventories and service levels are required. We can increase or decrease them within some limits based on the business volume. and get volunteers to work through some of the holidays if they, usually there's a group that can. So if we need more capacity in our projections, we can increase the utilization of the plants and keep running them to raise inventories if we think we need to.

Well, maybe more directly, are you taking less time off this year around the holidays versus last year?

Well, to tell you the truth, we don't know how demand is going to be over the next two months with COVID. And so we're leaving everything flexible because we have no idea what's going to happen to the volume at this minute. And we're working almost week to week trying to anticipate what's happening. But we don't know if governments are going to restrict us more or not restrict us more. And we don't know how the consumer is going to react. So we're producing as necessary.

The other side of that, too, is, as we've said several times, our inventories are below where they need to be, and we're running production as hard as we can to try to get caught up.

But we're looking at it now all the way through the first quarter of the pieces and trying to see how the thing works. And at the same time, we're trying to estimate next year's requirements, which is really hard to do.

Yes, so I totally appreciate that. I was thinking all of you, if you were able to do that, would you? Okay, I guess that backdrop, assuming that you can continue, is it your assumption based on if demand remains as is right now with your current production levels? Just to be clear, do you believe you'll be able to meet sufficient by the end of Q1 with current production levels, or is it the type of thing that would require a longer time period to catch up.

We're going to catch up by the end of the year, the demand pieces, we believe. But the inventories is the question. What level will they get to and where they are? And it's all dependent on how strong the demand is through November and December relative to our production rates. And we're not sure. Normally, seasonally, it falls off. And we're expecting our inventories to go up in both the fourth quarter and the first quarter to get them to where we want them to be for next year. And then we're going to keep adjusting the strategy based on how we see the consumers reacting in COVID.

Okay, great. Thank you very much.

Your next question is from Susan McClary with Goldman Sachs. Your line is open.

Thank you. Good morning, everyone, and congratulations on a good quarter. My first question is, you know, going back to Europe, can you talk a little bit about some of the shutdowns that we're starting to see go into effect in some of those countries and how you're thinking about any differences there relative to what we saw back in the spring, in March and April, and maybe, you know, how you could react differently this time around relative to back then?

To begin with, it's too early for us to feel. At this point, the cases have gone up, but we haven't seen any impact in either our demand relative to the new changes or to limitations they're putting on us. At the moment, they are limiting more social activities. They're limiting what time people go to bed, how they go out at night. They're limiting bars and restaurants. And so up to this point, we haven't seen it. So we're going to have to see how restricted do they get and what, if any, impact it's going to have on us.

We went through this last time, too, Susan, with the definition of essential businesses, both in the U.S. and over in Europe, you know, back in March, April, and May. And we're going through the same exercise now. But so far, we're considered to be essential businesses.

Okay. All right. That's helpful. Thank you. And then my next question is, you know, you mentioned that you are starting to see some inflation, obviously, in your input cost. Can you give us some idea of, you know, the magnitude of that inflation and how we should be thinking about it as we get into next year?

It's different by product, by category. I think as we ran through the earlier description, what you heard was we were raising prices in a number of categories. I'll try to run through some of them. U.S. ceramic mostly based on freight, Brazilian ceramic, U.S. carpet, U.S. LVT, European sheet with vinyl and LVT with vinyl costs going up, and European insulation with the raw materials there. So all those are in process of being enacted. The Oil prices are really difficult to predict, so how they're going to react and where they're going to go, we're going to have to follow them. There's also the supply and demand of the various places in between. So in vinyl in Europe, there's a really tight supply of it, so the prices are going up. So it's really hard to predict how all the supply and demands are going to work out, and we're reacting as appropriately.

Okay, thank you. Good luck.

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

Hey, guys. Thank you for fitting me in here. Maybe starting, Frank, with SG&A. On a dollar basis in the second quarter, it was down year over year. I'm just curious, you know, the sustainability of that given some of the cost containment. and productivity, you know, efforts on one side and then the increased marketing expense, hiring, et cetera, on the other side. I mean, should we see that begin to increase on a year-over-year basis, the dollar amount of SG&A?

Right now, as Jeff said, that we did pull back in the third quarter on marketing expenses and that we have to begin to normalize that in the fourth quarter. but we continue to see benefits from our restructuring plans as well, which will help lower that cost.

Okay. And then maybe just on global ceramic, you guys mentioned a shift in sales focus towards residential buildings. I'm just curious what that actually involves. I mean, is that simply repositioning people or hiring new people, or is it just saying, hey, look, we need you guys to focus more on this part of the business, and maybe you can just walk us through that?

Well, what's happened, as the commercials flowed down, we've taken resources out of that business, and at the same time, we've added resources in the residential business, both on the remodeling and the new construction. Okay. And I think that residential business looks like it's got some legs on it for, you know, several months into next year and maybe beyond. Commercial, we think, will come back. But for right now, there's not been a whole lot of projects started. And so we've pulled back in that area.

Thanks, Chris.

Thank you.

Your next question is from Matthew Bully with Barclays. Your line is open.

Hey, thank you for taking the questions. The rest of world margin of 19%, can you maybe unpack a little bit what drove that margin strength? And I guess, you know, to what degree was that helped by, I think you mentioned producing a little more during August, the vacation period than you typically do. Just trying to understand what the profitability of that business should look like on a more normalized basis. Thank you.

Well, I can take that. In Q3, our volume was higher as the economy rebounded in all areas. We had higher productivity with volume, and as you mentioned, we had lower vacation stops. We had lower material cost, but that was offset by price mix. LBT and Russian sheet improved performance. In Australia and New Zealand, we were better due to increased volume from deferred purchases. Q4 will be lower margins due to seasonality, higher cost, and additional marketing investments.

Got it. Thank you for that. The second one is the language you mentioned around pivoting to more aggressive growth. I guess in light of the improving balance sheet. Could you discuss kind of if there have been any areas that you felt constrained on from an investment perspective and kind of what's on the, I guess, the wish list?

I think you have to back up a little. The last six months, I mean, all focus has been on surviving an unknown future and trying to manage day-to-day, changing the strategies almost week-to-week And so anything about future investments were put on hold. Any looking at acquisitions was put away. So we've gone through this period and we didn't know what the demand and cash flows were going to be like. So at this point, we're getting comfortable that the business has improved significantly and we have to go back and start looking at alternatives and pieces. And today, we still have a constriction on on capital expenses, where we postpone things that we think are good projects. And we have to decide what next year is going to look like and how aggressively to approach it. And then we are restarting at this point looking at alternatives to grow the business, go into new product categories and potential acquisitions. But we're just starting to do that as the business is starting to normalize.

Got it. Thanks for the details.

Your next question is for Michael Rahut with JP Morgan. Your line is open.

Thanks. Good morning, everyone, and I guess right now it's the afternoon. Congrats on the results. First, I just wanted to get a sense, if possible, you know, you had mentioned inventory build during the third quarter. and just wanted to get a sense for, you know, what that contributed to the overall sales growth and if there were any segments where there were, you know, larger, where it contributed more than others.

Is the question a third quarter or the fourth quarter?

Well, you know, both if I can be so bold, but I'll settle for what the – contribution was in the third quarter, if you could give me on a relative basis. I know that you said for 4Q, there'll be less of a contribution from inventory growth, but just love to hear your thoughts on, again, what roughly was the percent sales growth contribution from the inventory restocking? Okay.

You know, Mike, I think... First is in the third quarter, the inventory of the whole business actually went down $80 million. So the inventory has declined in the third quarter, even with all our efforts. Now, as we went through the period, the production rates increased as we went through the period. And with that, we still have a lot of costs with training people, absenteeism, COVID... across the different businesses, so we expect those things to get better going forward, but as the cases in the communities go up, we'll have to see what happens. Jeff.

Just to make sure we understood your question.

Yeah, I'm not referring to the inventory decline at your own business. What I was referring to, and maybe I'm misunderstanding it, but what I thought you had said in the prepared remarks was that in the sales into the channel, there was some inventory restocking by your customers as demand rebounded as well. And so if that was the case, not what your own inventory balances did, but what the sales into the channel did, you know, if you have any sense of what contribution to sales growth the inventory restocking by your customers was?

We don't have perfect views into it. We know that coming out of the second quarter, just like the rest of us, that they all reduced their inventories not knowing what was going to happen. And they came into the third period with low inventories. The sales improved in most of them. And so... They tried to increase the – one is they tried to satisfy the demand, and they've tried to get some of the inventories up in their own places. We think they're still low in most of the channel, but we're not sure because we have very poor views of what's going on through it. We know that in specific instances with some large customers, we know we have not been able to supply them the volume they wanted to increase their inventories. And we think there's going to be, in those parts, some inventory increases. Now, what we can't tell is, because we don't have the view, is what's going to happen, which is why another piece in the demand, which we're uncomfortable with, we can't tell if some of it was to increase inventories and that they will reduce the orders as they get further in the period because it won't help them if it doesn't get there in time. So there's a lot of moving parts in this thing that we really don't have good views of.

I appreciate that. Thank you, Jeff. I guess, secondly, just going back to the share repurchase plan for a moment, I just want to understand, and, you know, is this more of just a general authorization thing? to be, you know, implemented over time? Or is this, you know, it sounded slightly different in terms of the language that this was something that maybe would be happening more immediately and, you know, over a shorter time period. And if that's the case, you know, perhaps what type of time period are you looking at?

Well, it's a general authorization. I think that was one of the descriptions you used. This is a general authorization for us to increase the amount of shares we can buy by up to another $500 million. So this is going to allow us to invest in our stock because we believe it's a good value going forward. And so we'll continue to look at different investment alternatives, including this one, capital expenditures and acquisitions, just like we said earlier.

Okay, great. Thank you.

I would now like to turn the call back over to Mr. Loeberbaum for closing remarks.

We're responding to the COVID crisis as required. As you can tell, our forward visibility is poor, and we're going to have to keep reacting to it. The actions that we've been taking should improve our results next year, both in cutting costs and improving our sales performance. the commercial businesses we expect next year to continue to improve, and our balance sheet is strong and will support moving to a more aggressive growth strategy. We appreciate the time you've taken to be with us. Thank you very much.

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