Good morning, everyone. My name is Jamie, and I'll be your conference operator today. At this time, I would like to welcome everyone to Mohawk Industries Third Quarter 2022 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. As a reminder, ladies and gentlemen, this conference is being recorded today, Friday, October 28, 2022. Thank you. At this time, I'd like to introduce Mr. James Brunk, Mr. Brunk, you may begin your conference.

Thank you, Jamie. Good morning, everyone, and welcome to Mohawk Industries quarterly investor call. Joining me on today’s call are Jeff Lorberbaum, Chairman and Chief Executive Officer; and Chris Wellborn, President and Chief Operating Officer. Today, we’ll update you on the company’s third quarter 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 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 8-K and press release in the Investors section of our website. I’ll now turn the call over to Jeff for his opening comments. Jeff?

Mohawk's third quarter sales increased to $2.9 billion, up 3.6% as reported or approximately 8.3% on a constant basis, primarily from price increases and strength in the commercial sector. Our sales in the quarter were weaker than we anticipated, as sales in the retail channel softened across all regions and product categories. The strengthening dollar also negatively impacted our translated sales for the quarter by $117 million or 4.1%. Our operating income declined as lower volume resulted in higher unabsorbed costs and material energy and transportation inflation impacted our results. Our global organization responded to the economic challenges with additional actions to optimize cost, productivity and inventory levels. There are substantial differences in the economic conditions affecting our various global markets and product categories. Our businesses in Europe have been impacted more than others, due to the unprecedented energy crisis and high inflation that has slowed the region's economy. Recently, spot gas prices in Europe have fallen drastically, though future prices have not correspondingly declined. Our costs have continued to rise and our pricing in Europe has not kept up with recent material and energy inflation, which has compressed our margins. The Italian government provided energy subsidies during the third quarter and additional actions from both the European Union and individual countries are being discussed. The high cost of energy has forced European consumers to concentrate on necessities and defer discretionary purchases. Our sales and margins in the market will remain under pressure until the region overcomes these challenges. These postponed purchases will increase demand when the economy rebounds and enhance our results. The US is being more impacted by higher overall inflation and mortgage rates that have risen from below 3% to approximately 7%. The residential market, which is the most significant part of our business is expected to decline further before we see an inflection point. Remodeling has slowed, and our product mix has been impacted as consumers trade down to options that better fit their budgets. It is estimated that the US has a housing deficit of five million units and more than half of US homes are over 50 years old. Remodeling investments are expected to grow long-term as US housing stock ages and families with low mortgages choose to remain in their homes. Up until this point, our other geographies have been less impacted by inflation and higher interest rates. Our selling prices in those regions are better aligned with our costs and their margins remain strong even with their economy slowing. While we manage through the current conditions, we're also investing in our businesses for the long-term. We're expanding our capacity and growing product categories, including LVT, laminate, quartz countertops and premium ceramic and insulation. These projects should satisfy strengthening demand as our markets recover. We have recently completed a number of smaller acquisitions that will enhance our product offering and leverage our existing market positions. In Europe, these include a sheet vinyl business, a mezzanine flooring company and a wood veneer plant. In the US, we acquired a non-woven flooring producer and a flooring accessories company. We're awaiting government approval of our Vitromex acquisition, which combined with our legacy business will make us the number two ceramic producer in Mexico. Our strong balance sheet provides us with additional opportunities to enhance our business. We recently published our 13th Annual Environmental, Social, and Governance report which highlights how doing what's right for the people and the planet is also benefiting our business. Our sustainable products excite both residential and commercial customers and our bottom line is enhanced by increasing recycled content, reducing waste and lowering our water and energy consumption. Now Jim will review our third quarter financial performance.

Thank you, Jeff. Sales for the quarter were just over $2.9 billion. That's a 3.6% increase as reported or 8.3% on a constant basis due to the favorable impact of price and product mix, partially offset by declining volume and unfavorable FX. Gross margin for the quarter, as reported, was 24.5%, and excluding one-time items, was 25.6% versus 29.8% in the prior year. The year-over-year margin decrease is due to lower demand, increasing temporary manufacturing shutdowns, lower sales volume and FX headwinds, partially offset by productivity and pricing and mix, which successfully offset the increased year-over-year inflation impact. The actual detailed amounts of these items will be included in our MD&A of the 10-Q, which we filed after the call. SG&A as reported, was 17.9% of sales and 16.3% excluding one-time items. And the adjusted absolute dollar expense was slightly favorable due to the impact of FX and cost containment actions, partially offset by inflation and price and mix. Operating margin as reported was a negative 17.3%, but excluding charges was 9.3% as the company's current market capitalization along with challenging economic conditions and higher discount rates resulted in a non-cash goodwill and trade name impairment charge of $696 million in the quarter. The 9.3% operating margin, excluding charges, is a 350 basis points decrease versus prior year, primarily driven by higher inflation; temporary plant shutdowns, which accounted for $55 million of the decrease in operating income and lower volumes, which accounted for $45 million of the decrease in operating income, partially offset by favorable price and mix and productivity gains along with net FX. Interest expense for the quarter was $14 million, in line with prior year, reflecting the full benefit of paying off the 2021 Eurobond late in the fourth quarter of 2021. Our non-GAAP tax rate was 17.9% for Q3 versus 21.4% in the prior year. We expect the Q4 tax rate to be approximately 20%, bringing the full year 2022 rate to approximately 21%. That leads us to an earnings per share, excluding charges, of $3.34. Now turning to the segments. In Global Ceramic, sales were just shy of $1.1 billion. That's a 9.8% increase as reported or 12.4% on a constant basis. Favorable pricing and mix initiatives more than compensated for the volume declines in the quarter, the sales growth was led by Europe, US and Brazil. Operating income, excluding charges, was $132 million, increasing approximately 11% versus the prior year, and adjusted operating margin improved 20 basis points to 12.1% due to strong price and mix actions, which offset higher year-over-year inflation, productivity gains, and net favorable FX, partially offset by lower volumes. In Flooring North America, sales were just under $1.1 billion as well. That's a 3.7% increase year-over-year as reported. The growth in commercial, laminate, and resilient offset weakness in residential carpet and rugs. Similar to Q2, excluding the decline in the major retailers rug demand, the reduction of that demand, net sales increased approximately 8% versus prior year. Operating margin, excluding charges, was 8%, equating to a 340 basis point decline versus prior year, due to the higher inflation, which was nearly offset by price and mix initiatives, temporary plant shutdowns, and lower sales volumes, partially offset by productivity gains. And finally, Flooring Rest of the World, with sales of $731 million, that's a decrease of 4.8% as reported, but an increase of 9.4% on a constant basis, with price and mix actions driving solid growth in panels, Oceania and the insulation businesses. Operating margin, excluding charges, was 8.5%, a significant decrease versus prior year. The primary drivers of the decline were higher inflation, partially offset by the price and mix actions, temporary plant shutdowns, and related unfavorable productivity, plus lower sales volumes. Corporate and elimination costs were $11 million for the quarter and expect the full year to be between $40 million and $45 million. Now turning to the balance sheet. Cash for the quarter ended at $327 million with free cash flow of $75 million in the quarter. Receivables ended at just over $2 billion, with DSOs slightly higher at 58 days compared to 57 days in the prior year. Inventories for the quarter ended at $2.9 billion. That's a 31% increase versus prior year, but a 3% increase versus the second quarter. The year-over-year increase is primarily driven by inflation making up approximately 76% of the increase and versus prior quarter, inflation and acquisitions drive the increase. Q3 inventory days stand at 131 days. Property plant and equipment was just over $4.5 billion, with Q3 capital spending at $150 million and D&A at $153 million. To better align with the slowing demand, we have aggressively reduced our full-year capital plan by 20% to approximately $620 million with B&A projected at $559 million. And finally, our balance sheet is in a very strong position with liquidity exceeding $1.8 billion at the end of the quarter with the planned payout of our 2023 $600 million bond in November and net debt-to-EBITDA at 1.2 times, enabling us to manage through the current environment and optimize long-term results. And with that, I will turn it over to Chris.

Thank you, Jim. Our Global Ceramic segment delivered the strongest performance during the quarter even with substantial inflation headwinds in Europe. Sales in the new home construction channel were solid in most geographies and the commercial channel showed resilience with new construction and remodeling projects continuing. In most markets, residential remodeling has slowed due to tightening consumer discretionary spending and higher interest rates. We are managing through pricing and mix to reduce the impact of material and energy inflation on our cost. Natural gas prices remain a major headwind with volatile pricing in Europe significantly impacting our results. Recently, European spot gas prices have declined significantly as available storage nears capacity, though the future pricing for the winter has not followed the decline. Across the segment, we continue to reduce SG&A spending, operational costs, and capital projects to align with market conditions. Sales in our US ceramic business expanded during the quarter with the greatest growth in the commercial and new home construction sectors. Residential remodeling demand continued to lag in the retail channel and customers are reducing orders to better align their inventories. During the quarter, our margins were driven by our pricing actions and strong commercial sales improved our mix. We are gaining support with our new higher-margin introductions that are an alternative to European imports. To offset material inflation, we are identifying further process improvements, utilizing alternative materials, and reformulating glazes. To align with seasonal demand and manage our inventory, we are scaling back production in the fourth quarter and reducing sourced purchases. Our countertop sales grew during the quarter, led by our high-end quartz collections. Our quartz manufacturing plant is operating at full capacity, and we are sourcing products from around the world to satisfy demand. We expect that our new quartz production line will start up in early 2024 and will allow us to further expand our sales and improve our mix. Our European ceramic results in the quarter exceeded our expectations due to our sales and pricing actions, positive mix, and Italian energy subsidy. Subsidies are approved through November and may extend further. During the quarter, sales of our premium collections remained strong, while increased gas prices impacted our outdoor and lower-end products. European consumers are postponing residential flooring investments as high energy costs squeeze their budgets. Given lower spot gas prices and government subsidies, we are increasing production in the fourth quarter to raise inventory levels and improve service. In the first quarter, we anticipate lower production rates with winter energy prices expected to peak. Our operations teams are adjusting our production across our European plants to optimize mix, cost, and flexibility as demand evolves. We have addressed the shortage of Ukrainian clay by reengineering formulations with material from alternative sources. In our other markets, third quarter sales grew primarily through pricing, mix, and strengthening the commercial channel. Mexico's Central Bank has implemented additional interest rate increases, which is slowing the economy and ceramic sales. In Brazil, interest rates remain high and retail sales are slowing. We are increasing our activities in the A&D community and expanding our commercial product offering. Our pricing actions improved mix and productivity gains enhance results. All businesses are reducing production in the fourth quarter, which will increase our costs. Our team in Mexico has a detailed strategy to integrate our Vitromex acquisition to optimize short-term results. The combined organization will have a stronger product offering and a competitive position to address the $1.7 billion Mexican ceramic market. Government approval of the transaction may be finalized in the first quarter. For the quarter, Flooring Rest of the World sales rose year-over-year, primarily from price increases and growth in our panels, insulation, and Oceania businesses. The segment sales are mostly residential and were more impacted by constrained consumer spending. In Europe, inflation is reducing discretionary purchases, so we did not see the typical seasonal improvement after the summer holidays. The retail sector is reducing inventories and consumers are trading down in all categories. Our margins in the quarter were compressed by inflation, lower sales volume, and reduced production. The weakening markets are making additional price increases more difficult to implement. Natural gas prices in the period temporarily reached 12 times historical levels and governments are reviewing ways to assist industry and consumers with gas and electricity prices. Our wood supply and pricing is also being impacted as it is being consumed as an alternative source for both heat and electricity. As flooring sales softened, we increased promotional activity to encourage consumers to trade up. While our premium laminate and LVT face greater pressures, our more value-oriented sheet vinyl sales grew. In the quarter, we implemented price increases that partially offset rising material and energy costs. We anticipate sales volumes in the fourth quarter will remain weak and we are reducing production, substituting alternative materials, implementing process improvements, and postponing non-critical projects. We completed the acquisition of a small Polish sheet vinyl producer that will expand our business in Central and Eastern Europe. Our urethane insulation products provide the highest thermal resistance as consumers seek ways to reduce energy costs. New building projects in Western Europe are beginning to slow and we are enhancing our distribution by expanding our customer base and exports. Our selling prices were slightly behind inflation, and we are reviewing alternatives to optimize our costs. Our new insulation plant in the UK continues to ramp up as we increase our sales and distribution. Our panels results weakened as demand softened and competition intensified. Our margins declined due to the impact of lower sales and production volumes from the weakening market. The French panels plant we acquired last year is increasing sales and we have improved its productivity and operating expenses. We expanded the distribution of our higher-end decorative panels and acquired a small mezzanine flooring company that will bolt onto our existing business. In Oceania, our sales improved primarily from pricing and mix. The Australian market is improving as the country relaxes COVID restrictions, and New Zealand is more difficult with residential sales weakening. Our increased pricing is covering inflation and inventories increased as imported material arrived faster than expected. For the quarter, our Flooring North America segment sales increased primarily from pricing. The commercial sector was stronger than residential, with hospitality leading the other channels. Hard surface products outperformed, benefiting from technology and capital investments in premium laminate and LVT. The residential market softened as inflation impacted consumer discretionary spending and retailers reduced their inventories. Our pricing in the period offset material and energy inflation. The lower manufacturing volumes led to unfavorable absorption. We managed our sales, marketing and administration spending to align with volumes and offset inflation. We are implementing our restructuring plans to lower both our fixed and variable costs by shutting higher-cost assets, reducing staffing and aligning production with demand. We are executing many projects to improve productivity, reduce waste, reengineer products and lower energy costs. We are also deferring nonessential capital projects to align with the present environment. Our residential sales continued to improve, with our strongest performance in the new home construction, multifamily and commercial channels. We have introduced assortments tailored to regional preferences and optimized our portfolio to improve productivity and service. Our WetProtect and antimicrobial technologies are being well accepted as desirable features by consumers. Sheet vinyl sales strengthened, as inflation has increased in value-oriented flooring options. The first phase of our new West Coast LVT plant is operating at planned output levels. We are ramping up production and training the workforce for additional lines that will be installed throughout next year. Our East and West Coast operations will enhance service to our customers, lower our cost, and improve transportation efficiencies. Demand for our premium laminate continued to grow as high-performing value alternatives to other flooring. Sales of our waterproof collections and more realistic visuals are expanding in all channels. Inflation in other materials has reduced our margins, though we are beginning to see some cost decline. Our new manufacturing line is operating at our targeted levels to satisfy increasing demand. We have commitment to saturate our current capacity and have initiated further expansion investments. Market conditions for carpet softened in the third quarter, more than we had anticipated, and we reduced production, resulting in unabsorbed costs. In the second quarter, we announced price increases that were implemented in the third quarter, as inflation continued to rise. With demand softening, we were not able to increase prices further to recover the inflation after the announcement. We are seeing reductions in raw material costs that should align with our current pricing when our higher-cost inventory is depleted. To reduce our cost, we are eliminating less efficient capacity, streamlining operations, and lowering marketing and administration costs as well as reducing production to lower inventories. Our commercial business remains good and Architectural Billing Index reflects continued construction activity. The hospitality channel grew the strongest as postponed projects and renovation are increasing demand. Our margins remain strong as pricing and mix covered our inflation in the quarter. Our commercial hard surface sales growth is outpacing carpet, with flexible LVT being the preferred option. Our new, more sustainable carpet tile, EcoFlex ONE, is gaining acceptance with its low carbon footprint, recycled content, and acoustic advantages. To complement our flooring accessories business, we acquired a small rubber manufacturer that produces trim primarily used with commercial installations. The acquisition expands our current accessories business, which produces laminate, vinyl and wood trim. In the quarter, sales in our rug business were lower than last year as major national retailers continue to adjust inventories. We are taking restructuring actions to reduce our costs and lower our production with demand. In July, we completed the acquisition of a non-woven rug and carpet business, and the integration is delivering synergies.

Thanks, Chris. It's challenging to predict either the duration of the current economic conditions or the impact on our industry, as central banks around the world continue to raise interest rates and inflation reduces the discretionary expenditures. We expect our business to remain under pressure. Residential remodeling drives the majority of our sales and customers are deferring purchases and trading down. In Europe, gas and electricity prices are reducing demand and increasing our manufacturing and material costs. We anticipate that governments in Europe will take action to lower the impact on the economy, businesses and consumers. We're focused on managing through the current environment while investing to maximize our long-term profitability. We anticipate demand will slow further in the fourth quarter, and we will reduce production resulting in greater unabsorbed overhead. To enhance sales, we're increasing promotional activity, introducing differentiated collections and reacting to competitive actions. We are executing restructuring actions, lowering administrative and manufacturing costs and reducing investment in marketing. Material prices spiked in the period and have begun softening in many categories. In Europe, flooring projects are being deferred, compressing industry volumes, and we are raising inventories of specific products ahead of higher energy costs this winter. After our second quarter U.S. pricing announcement, we incurred peak carpet material costs that will compress our margins until they flow through our inventory. We are postponing capital projects that do not impact our long-term strategies while completing those that are critical to the near-term performance of the business. Finally, we expect the strengthening U.S. dollar will continue to reduce our translated results. Given these factors, we anticipate our fourth quarter adjusted EPS to be $1.40 to $1.50, excluding any restructuring charges. During the past decades, Mark has successfully managed through many challenging periods and industry recessions. The fundamentals of our business remain strong, and floor remains an essential component of all new construction and remodeling. Mark has built leading positions in key markets around the globe with well-known brands and an extensive product offering. During this period, we're investing for the market rebound that always occurs after our industry contracts. We're expanding our higher growth categories of LVT, laminate, quartz countertops, premium ceramic and insulation, which will increase our revenue and profitability with the next growth cycle. We've also made strategic bolt-on acquisitions for our business that creates significant synergies that will enhance the combined results. Mohawk has a strong balance sheet with low net debt of 1.2 times EBITDA and available liquidity exceeding $1.8 billion to manage through the current environment and optimize our long-term results. We'll now be glad to take your questions.

Ladies and gentlemen, we will now start the question-and-answer session. Our first question today comes from Susan Maklari from Goldman Sachs. Please go ahead with your question.

Thank you and good morning, everyone.

Good morning.

My first question, Jeff, is just thinking about demand at a high level. Can you talk about how things slowed during the quarter? And then how do you think about the consumers' elasticity in flooring? What is their willingness to reenter the market? And how are you thinking about demand as we move through a weaker global macro?

Our sales in the period increased with pricing and mix as strength in the commercial sector. The sales were weaker in the residential channel softened across all regions and product categories, and it got weaker as we went through the period. The income was lower with the reduced sales and production levels and higher absorbed inflation we had in the period. And our global organization responded by changing our production, managing inventories, finding more productivity, and optimizing our costs. Residential remodeling does drive the majority of our sales. And as you know, the residential remodeling, unlike other product categories, customers can defer them almost indefinitely. So when you have slowdowns, our categories are impacted more than most. Interest rates and inflation are impacting spending both in the US as well as Europe. Europe is in a crisis, and people are just pulling back from spending and they're going to have to get through it. And there's all kinds of discussions going on how to help both the consumers as well as businesses. And we believe that something will come out of it. Some countries have already done things like Italy has already started helping with the gas costs. Let's see. What else have I missed?

You covered it. Susan?

Okay. And then you mentioned, obviously, the balance sheet, the liquidity that you are generating, you've got a better balance sheet going into this downturn than you probably just about have ever had in a downturn. Can you talk about what that will mean in terms of thinking about investing in the business in the long run? And where Mohawk will be as we eventually come through this and what the profile of the business could look like?

Listen, there are a lot of differences in this time versus other ones. In other cycles, employment wasn't strong like it is now. We have wages increasing. We have housing remaining strong. We have aging homes that will help. So this whole cycle is really different than the last couple we've been through where warehousing was majorly overbuilt and had to adjust. We have strong positions in all of our markets, and we're continuing to invest in each of the different categories. As I said before, the major growth categories of the business are in LVT, which is the industry continues to grow, laminate, which we have been able to take market share and expand the entire category. Quartz countertops are taking share from all the other alternatives, which includes stone and laminate countertops, so it's in a growth mode. Premium laminate continues to grow. And our installation business in Europe is in a good position, as people invest more to reduce their energy. So we're in really good shape for those. We've also made strategic acquisitions, all of which bolt on to the business and every single one of them has dramatic synergies with our present business, enhancing both the existing businesses in it. So with all this, we think we're taking the right actions in the short term, and we think we're well positioned to grow. And as always, we would expect the volume to increase our margins to expand, and we think we're in good shape to have a dramatic impact on the business.

And as Jeff noted, this is not being driven by really the housing market as we're underbuilt still in the US especially and have aging homes. So that should mean that you have a rebound with strong pent-up demand, as that's released, you'll get a higher EBITDA for the company and multiple expansion.

Okay. Thank you for the color and good luck.

Thank you.

Our next question comes from John Lovallo from UBS. Please go ahead with your question.

Great. Thanks for taking my questions, guys. The first one is, how should we think about decremental margins here as we move through the quarter and maybe into 2023, just given the volume declines, production cuts, continued investment?

With the volume of declining in most businesses, you're going to see also pricing increasing due to inflation. In the period, as I kind of pointed during my prepared remarks, we had a negative impact from volumes of about $45 million and on unabsorbed overhead about $55 million. We would expect the volumes to be lower and continuing into the fourth quarter and anticipate production below sales in most areas and that unabsorbed overhead, I would expect to see that increase a little bit in the fourth quarter.

Great. That's helpful. And then, can you just maybe expand a little bit on some of these restructuring initiatives that you're initiating and what the cash cost will be?

So as we announced earlier in the year, we're implementing restructuring plans. We talked about $90 million to $95 million of cost, cash being about $15 million to $20 million, the largest really in Flooring North America, where we're taking out high-cost assets and reducing rug manufacturing. In Europe, we're also reducing costs in overhead accordingly. It should generate savings somewhere between $35 million and $40 million annually starting with next year.

Great. Thank you, guys.

And our next question comes from Michael Rehaut from JPMorgan. Please go ahead with your question.

Thanks, good morning, everyone. I appreciate you taking my question. I wanted to follow up on the earlier comments about capacity additions for next year. How do you view those in light of the weaker demand environment? There's a significant difference from what occurred in 2017, 2018, and 2019. Can you give us an overview of the capacity expected to come online next year in terms of potential revenue and the associated start-up costs? Additionally, is there any risk that the impact on the profit and loss statement could be more negative if demand stays at current levels?

Let's discuss all the various aspects. Some will not launch until 2024, to be honest. It varies depending on the specific area. Our laminate business is experiencing growth in the U.S. We have added new capacities and are fully committed to meeting demand, but we've struggled to satisfy it. Laminate has become a viable waterproof alternative to other products, including LVT in the market, and it offers distinct advantages. Therefore, we are continually investing in it. The quartz countertops business has been integrated, and we are sourcing imported products to support it, setting the stage for growth in 2024. The LVT expansion at the West Coast plant is currently about 30% complete, with more to follow over time. Our commitments to this area are growing, and we are also bringing in products globally, creating further opportunities. We are investing in premium ceramics, particularly in slabs in Europe, where demand exceeds supply. We have been sourcing considerable amounts from other suppliers to support its growth. Additionally, our insulation business has been bolstered by an acquisition, and while the plant was still being completed, it offers regional advantages compared to others, allowing us to expand our customer base. Those are the primary focuses.

And really, Mike, when you take the combination of all those activities, it should lead us to sales opportunities of about $800 million.

Great. That's helpful. I guess just my follow-up, maybe just switching back to near-term sales and the outlook for the fourth quarter. Just want to be clear. On a revenue basis, obviously, volume plus price, and obviously, price continues to be a big driver of results here. But on a consolidated revenue basis, are you expecting sales to be down year-over-year in the fourth quarter? And if so, how much of that impact do you estimate is from continued channel inventory reduction? And if you could just remind us again, I'm sorry if I missed it, what that impact was on a net basis to 3Q sales?

So in terms of the year-over-year sales, as we've talked about, we are highly exposed to residential remodeling. I would anticipate on a year-over-year basis, sales to be flat to down given the decline, especially in Europe, but across the business as well, we'll reduce production, which is resulting in the unabsorbed overhead, it's going to impact margins as well. I just want to make sure we pointed out; we talked about the peak carpet material costs flowing through in the quarter, that should impact the Florida, North American segment somewhere in the $30 million to $35 million range. So most of that will come out in Q4 with a much smaller piece in Q1.

The destocking, we get feedback from customers, they're all more pessimistic about the future. With the feedback's telling us that they're reducing inventories, but we really don't have a good way to quantify it. We're hoping that the bottom is in the near term, and it will improve the future once it bottoms out, but we don't have good information to give you.

Thank you.

And our next question comes from Keith Hughes from Truist. Please go ahead with your question.

Thank you. Questions on the carpet business, you refer in the release and the initial statement about some raw material inflation that was not covered given some of the weak volume given how much input costs are that, I know that could be a big number. Can you give us any feel for what impact that had in the third or the fourth quarter?

Yeah. So I would just Keith and Mike, is that in the fourth quarter, that should impact us included in our guidance is about $30 million to $35 million, and then you have a much smaller piece carrying over to Q1.

Okay. And you had talked earlier about producing more in Europe right now, given response energy and costs are. Are you still on your energy in Europe, or are you still running basically spot, or are there some hedges in place?

The largest component is within our ceramic business. We have hedged some of it, but a significant portion remains on a spot basis as well. We are essentially focused on the short term to mitigate the price spikes during certain periods.

Okay. Thank you.

And our next question comes from Phil Ng from Jefferies. Please go ahead with your question.

Hi guys. Jeff, you've highlighted you've seen a few cycles. So curious, once you work through the destock, how are you thinking about volumes going out to 2023, or maybe just the end markets and thoughts in geographic exposure, whether it's Europe, North America, LATAM, some of your indirect peers have called out mid-single-digit declines in R&R, maybe down 10% in single-family. Just help us unpack how you're thinking about 2023 once you work through some of the inventory in the channel?

That answer might be beyond my expertise. There are truly significant different scenarios that could unfold next year. On one hand, we have an optimistic outlook, which assumes that Europe experiences minimal issues with gas during the winter and has sufficient supplies moving forward. In the US, this scenario would mean that interest rates peak and then decline, leading to a notable rebound in the second and third quarters as economies start to recover. On the other hand, we are also preparing for a scenario where Europe faces ongoing energy challenges throughout the year and inflation in the US remains high and escalates through 2023. In this situation, we could see low industry volume persisting all year under pressure from unabsorbed overhead in a more competitive environment. Thus, we could reach two vastly different conclusions. It's important to note that regardless, we typically enter a growth cycle after a contraction due to postponed sales in our category. Our revenue will grow, and this time we’ll benefit from the initial opportunities from our product expansions and acquisition investments.

Okay. That's helpful perspective. In your press release and prepared remarks, I think you alluded to some competitive activity, given the weaker demand backdrop. Is that more on the price mix side of things, more mix? Any slippage on like-for-like pricing? And then, your ceramics business has held up really well, just from a profitability standpoint. Just given where imports have historically benefited from stronger dollar ocean freight containers with some of those changes, how do you think about pricing and competitive activity, particularly in the ceramic side?

On the ceramic side, imported prices have been increasing up until now. Looking ahead, with a stronger dollar, we might see a decrease in those prices, but we are well positioned with our US manufacturing and sourcing capabilities to manage that.

Okay. Any like-for-like slippage in some of the categories that you're seeing outside of ceramics?

Listen, all the categories have had problems recovering the last increment of pricing, because as the markets soften and then, at the same time, you have material prices peaking. So all the businesses are under pressure with the last incremental pricing. What else? At the same time, we started more promotional activities, where it makes sense, to try to improve volume. In some cases, we try to get people to trade up more in the business. As the costs flow through, it should improve our margins.

That's the key is, the good news is that we're seeing a reduction of the raw material costs, and therefore, it's better aligned with our pricing. And as you know, that will improve the margins as it turns through the inventory.

Okay. Thank you. Great color.

Our next question comes from Adam Baumgarten from Zelman & Associates. Please go ahead with your question.

Hey. Good morning, everyone. Maybe just on commercial, that stood out as a bright spot. I think you mentioned hospitality being one of the areas that was strong. Could you maybe walk through some of the other verticals, maybe like office that are also contributing?

The different channels in commercial? The question.

Yes, just maybe some color. You called out hospitality, but are there any other areas within the broader commercial market that you're seeing strength?

There is still a significant amount of activity overall with planned projects underway. The projects indicated by the index are continuing to progress positively. Hospitality is improving as spending decreased during COVID, leading to many postponed projects that need updates as they move forward. In the office sector, some employees are returning to work, while others are delaying plans, and some offices require renovations to adapt to the new environment. Government projects continue to be funded, and we are managing well in the healthcare sector.

Yes. Really, if you think about what commercial was led by in the beginning was really government and healthcare with hospitality lagging. As Jeff pointed out, now hospitality and that includes hotels, casinos, airports, anything along the route of travel as consumers have moved their spending from kind of the day-to-day and now more into the travel and entertainment area, hospitality is having to catch up because of those low investments over the last couple of years.

Got it. Thanks. You mentioned the Italian energy subsidies received in the quarter, and it seems they are expected to continue, at least partially, through the fourth quarter. Can you provide an estimate of the benefit from that?

It's about $15 million a quarter so far. And, I think, they've been approved through November.

Just as a comment, the government in Italy is turning over, so they keep approving these things almost month by month.

Yes. So you'll see a benefit of that in Q3 and Q4 and a little bit will carry over into Q1 as it turns through the inventory.

Great. Thanks.

And our next question comes from Mike Dahl from RBC Capital Markets. Please go ahead with your question.

Hi. Thanks for taking my question. Just as a follow-up, can you quantify what the year-on-year headwind was for European nat gas in 3Q? And what's that expectation for 4Q? And if current spot prices hold, how much would that change as you look out over the next couple of quarters?

Well, as you know, the costs have increased significantly year-over-year. Specifically for the fourth quarter, I believe we are approximately 60% to 70% hedged.

Yes. In terms of the headwind, they've done a very good job of pushing price, running the premium end of our products. So there's really not a significant difference between price mix and energy at this point in ceramic Europe.

We don't have the energy. Just the energy costs in front of us at this point.

Just to clarify, when you mention it's neutral at this point, does that include the subsidies? Additionally, regarding the management of production in European ceramics, you're increasing production for the fourth quarter to capitalize on spot prices. Jeff, you mentioned or maybe Chris did, that by the first quarter, that production will not be available.

It gives you the impression, it's a neutral impact. It's not. We're raising the prices almost weekly, monthly over there. We have surcharges we're changing. We're walking away from product categories that the economics don't make any sense. We're moving products between different reasons based on the cost of it. We're starting and stopping the plants, I mean week-to-week based on what the energy costs are in different countries and regions. So I mean, it's a full effort to manage through changing environments.

Yeah. And the comment about producing, what we're deciding to do is produce more in the fourth quarter where we anticipate having lower energy prices, and then reducing it in the first quarter when we expect the prices to be significant.

Okay. Thank you.

And our next question comes from Laura Champine from Loop Capital. Please go ahead with your question.

Thanks for taking my question. If I look at the inventory balance at the end of the quarter, up 31% year-on-year, how much of that is the cost inflation versus how much are units up in that inventory number?

So the costs make up about the 75%, 76%, so in terms of the inflation. So it's by far the largest piece.

And remember, when we came out of last year, the inventories were low in most of the businesses and the service was poor in most.

It's also important to analyze the sequential data, Laura. Quarter-over-quarter, we have definitely reduced the pace of our increases across the board, including inflation and our recent acquisitions. Our plan is to monitor production levels in the fourth quarter across most areas to decrease inventory by the year's end, with some exceptions that we've already discussed.

Okay. So where you are taking promotion is not the clear excess for the most part, it's because you're trying to drive sales into a better mix of goods?

And we're trying to utilize the capacities of the equipment.

And our next question comes from Stephen Kim from Evercore ISI. Please go ahead with your question.

Thank you very much, everyone. I appreciate the interesting information shared here. I wanted to clarify a few points. When you mention destocking, you indicated it’s difficult to determine the extent of it in channels outside of retail. I’d like to delve deeper into that, particularly concerning the North American new construction residential sector, where certain SKUs may be more prone to being affected. Are you noticing this impact in the quarter? Are you forecasting that it could worsen in your guidance? Additionally, when you discuss the price cost headwind for the entire company in your guidance, do you expect it to become more challenging in the fourth quarter compared to what we observe in the third quarter?

I'll let Jeff start with the demand question and then I'll address your price cost.

We know what the buying is, what we don't know is what our customers' inventories are. So we have indications that they're reducing their inventories. But I don't know if they're at the bottom or there's somewhere between, are they going to change them further. So we don't know that. All we know is the business, and we can't tell the difference between our shipments to them and their shipments to their customers.

And then, on the price mix cost equation in the fourth quarter. Yes, especially because what we've called out, the impact in Flooring North America, I expect the gap to widen in the fourth quarter as compared to the third quarter.

Yes. That makes sense. And in terms of the decremental margins, I just want to clarify a couple of things. You talked about the Italian energy benefit. I'm curious, do you think that you can maintain decremental margins in line with your historical incremental margin range, even taking out that Italian energy benefit? And then regarding that Italian energy benefit, it sounds like in the ceramic business that's causing you to sort of shift your production into the fourth quarter. But you also said that you might see those subsidies get extended beyond November. If that happens, would you likely diminish your 4Q production, or would you merely keep your production higher for longer into 1Q?

Well, I think the way to think about that is, even if you're getting subsidies, the cost of gas should be much lower in the fourth quarter than it will be in the first quarter. So that's why we're doing more production in the fourth versus the first.

And in terms of the decremental margins, Stephen, you have to really watch. They're going to vary by each one of our business lines depending on exactly how much production that we take out, which is going to equate to your uncovered overhead costs. So it really varies across each of the businesses within the segments. So I'm not sure if you can kind of just go on historical one, percentages at that point.

It's easier to manage costs as production increases than it is to reduce fixed or variable costs when production decreases. In the short term, we need to make decisions about how long this situation will last and how much we want to maintain despite a drop in volume.

Yes. So the length of the shutdown periods will definitely impact what that percentage is.

Hey, good morning guys. Thanks for taking my questions. First, Jeff, you mentioned that the European consumers in a bit of a crisis, which, I guess, I'll extend to Russia as well. But in the Rest of World segment, I'm trying to understand how much volumes might have declined in the third quarter. And since we're a month into 4Q, looking to understand how that's trending in the fourth quarter? I'm really just trying to understand how much that consumer is pulling back.

Well, if you look at Flooring Rest of World, sales were up 9% on a local basis, which was driven mainly by price increases in panels and insulation. The segment sales are primarily residential and overall inflation is reducing retail purchases. When we came back from the holidays, we didn't see the normal increase in demand that we normally get. Our customers are reducing inventories and consumers are trading down in that market.

Okay, okay. Got you. And you all mentioned some temporary manufacturing shutdowns in Rest of World. I know you've previously mentioned some plant rationalization and cost initiatives. Just any incremental initiatives to right-size this business?

Well, just talking about what happened in margins. Our margins were compressed by inflation, lower sales and reduced production. There's weakening markets are making our prices difficult to implement. We're assessing alternative sources to lower our material cost. And in the market, similar to Italy, governments are reviewing ways to assist the industry and consumers with gas and electricity prices.

All right. Thanks, guys.

And our next question comes from Kathryn Thompson from Thompson Research Group. Please go ahead with your question.

Hi. Thank you for taking my questions today. I understand there's a lot of focus on production reductions, but economic stress often brings M&A opportunities. With the changing global landscape due to deglobalization and shifting consumer preferences after COVID, how do you view growth opportunities from an M&A perspective, both geographically and in terms of products? Thank you.

In previous downturns, companies typically refrain from selling unless absolutely necessary due to the compression of earnings and multiples. Most transactions tend to take place as the economy improves and margins increase. I anticipate that the same will hold true for this current situation as well.

And following the part of the question, have you changed thinking from a geographic standpoint where you think about growth from an M&A standpoint? So in other words, less focus on Europe, greater focus on North America, et cetera.

I can say that we've made a specific decision. We need to evaluate each geography and opportunity based on our outlook for the future. Currently, we do not have a clear perspective on Europe for the next three to four months, let alone the next year. Given this situation in Europe, we need to find reasons to act immediately. I would assume the rest of the world is facing similar challenges. At this moment, we are preparing for a slowdown and trying to minimize activities. However, with our current capital structure, we would seize the right opportunity if it arises.

Okay. Great. Thanks very much.

And our next question comes from Matt Bouley from Barclays. Please go ahead with your question.

Afternoon, everyone. Thanks for taking the questions. Just back on the topic of decrementals. I know, Jim, you mentioned volumes were a $45 million headwind and the unabsorbed overhead was a $55 million impact. And not to oversimplify, but if we think of those two together as a volume-based decremental as we model, should we assume that, that even or close to even split between the two is how it will continue to look going forward as we model out the impact from volumes, or at what point will you be able to rightsize some of the fixed costs and maybe that split won't look the same. How should we think about that combination of the two? Thanks.

In the short-term, when we look at the fourth quarter and what we forecasted, we anticipate that the softening volume will persist along with the related shutdowns. Therefore, you can expect a pattern similar to what we experienced in Q3. As for the longer term, it really comes down to two scenarios, and we want to be well prepared for when pent-up demand returns.

A big part of it is we think we're going to produce less than we're selling in most marketplaces and reduce the inventories. And as we go into next year, it's going to be really based on the demand. Usually, in the fourth quarter and first quarter, historically, it'd be coming out of a high season in the piece, and we'd actually be building inventories for next year. This year, we're going to not do that because we don't expect the demand to require it. So that's another pressure on just the short-term.

But remember, the key point is how different the situation is and the fact that we're not overbuilt on housing and you have an aging inventory as well. So both remodeling and new housing are still poised to have a strong rebound in the future. And we certainly do not want to get caught without the ability to produce the required products.

Understood. That's helpful color, guys. And then just the second one on the US end markets. You're saying remodeling has weakened. But it sounded like you still had strong performance on the new construction channel in the US. Given the slowdown that's going on there on the front end, is that slowdown in new construction incorporated in your fourth quarter guidance, or are you still benefiting from the prior backlog of construction there on the new construction side? Thanks.

The answer is yes, meaning that it is built in that may or may not know that the flooring typically is at the end of the construction. So ours holds up a little bit longer than some of the ones that are at the front end. So right before they completed, they used the flooring, but the number of housing is being started is going to impact our business until it turns around in the future.

Got it. Well, thanks Jeff. Thanks everybody.

Thank you.

And our next question comes from David MacGregor from Longbow Research. Please go ahead with your question.

Yes, good morning or good afternoon as the case may be. Thanks for taking the questions. I guess, first of all, just a mix question. Just thinking across your various lines in various regional markets globally, what percentage of your offering would you characterize as premium collections within their respective categories versus more value-positioned products?

I'm not sure we've ever added up like that across all the categories. We have some of the businesses only participate in the premium and some participate from bottom to top, and it's different by product category and by region. I believe that we would have a much larger position in the medium to high, but I don't have a number to give you as yet across most of the businesses.

Okay. All right, thanks. And as a follow-up, I guess, there's been a few questions here about investing for the long run. And I’m just thinking back to Jim's comments at the beginning of the call about taking the CapEx guide down by 20%. I guess, the question is around kind of investment discipline at this point. And if you think beyond maintenance CapEx and just focus on kind of the growth CapEx and acquisitions. How do you think about the limits on what you're prepared to spend until you see convincing evidence of the pending recovery?

Well, the first part is that new capital investments typically take a minimum of one to two years to implement. The projects currently underway were approved about a year ago. Once you commence these projects, there is little ability to halt them, as you would need to write off all the investments made thus far. These projects are progressing, and some costs will carry over into next year. They are all within growth categories that will be essential for us. While we may not require as much in the short term as initially anticipated, we will need it as soon as the business starts to recover. Additionally, we are reducing spending on anything that does not affect the short-term business while managing according to our current business situation.

Yes, the key is that we must remain very disciplined as we look into 2023 and go through our budgeting process. As Jeff mentioned, we've started several projects that will have a carryover effect into 2023. However, we will definitely evaluate based on the demand levels.

Just another comment about the acquisitions. All the things that we've done recently, all have huge synergies between the new business and in the old business that connecting the two together, not only improves the margins of the acquired business but also the existing business. Is it. So that should help us as we get those together and get all the cost synergies out of them. And there's also product and sales synergies.

Really, when you think about this collection of acquisitions, though being small, if you add Vitromex in, which hopefully will close in the first quarter, accumulation of additional sales that those are generating about $375 million on an annual basis. So as you look at those bolt-on ones, they are important to the ongoing business as well.

Good. Thanks very much gentlemen. Good luck.

Thank you.

We're taking the right steps to manage the existing conditions, and we're adjusting as they change over time, and it's a volatile environment. We're putting ourselves in the company in a really good position, but when the economy improves and comes out, we appreciate all of you joining us. Thank you very much. Ladies and gentlemen, that concludes today's conference call. We do thank you for attending today's presentation. You may now disconnect your lines.