Mohawk Industries Inc Q3 FY2023 Earnings Call

Good morning, everyone. My name is Jamie, and I will be your conference operator today. At this time, I would like to welcome everyone to Mohawk Industries Third Quarter 2023 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 27, 2023. Thank you. I would now like to introduce Mr. James Brunk. Mr. Brunk, you may begin your conference.

Thank you, Jamie. Good morning, everyone. Welcome to Mohawk Industries quarterly investor conference 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 will update you on the company’s third quarter performance and provide guidance for the fourth quarter of 2023. 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 will now turn the call over to Jeff for his opening remarks.

Thank you, Jim. In the third quarter, our net sales were $2.8 billion, down approximately 5.2% as reported or 8.1% on a constant and legacy basis, in line with our expectations as our industry faced continued pressures across all regions primarily due to constrained residential investments and tightening of consumer discretionary spending. Our adjusted EPS for the quarter was $2.72 with our margins across the business benefiting from cost reductions, productivity initiatives, and lower input costs. Our third quarter performance was seasonally impacted by vacations in Europe, which reduced our sales and earnings versus the prior quarter. Our lower material and energy costs offset the decline in both price and mix. We also faced FX headwinds of approximately $20 million on operating income, or $0.25 on EPS. We are managing our working capital and generated strong free cash flow of $385 million in the quarter and $660 million on a year-to-date basis. During the quarter, central banks around the world continued to raise interest rates to slow down their economies and reduce inflation. Their actions are affecting new construction and remodeling in both residential and commercial channels, postponing spending on new projects. In the U.S., mortgage rates have climbed to their highest level in more than two decades, which has suppressed the housing market and limited home renovation activity. In Europe, consumers are deferring large purchases such as flooring as a result of higher energy costs, inflation, and uncertainty due to the war in Ukraine. Our industry faces a greater impact from these pressures than other sectors, given that most flooring purchases are deferrable. With the high fixed costs required to produce flooring, competition increases as the industry slows, and participants attempt to increase their sales to maximize absorption. As a result, our average selling prices and mix have declined, with the impact partially offset by lower material and energy costs, restructuring benefits, and process improvements. Expected housing sector recovery continues to be postponed, and we are managing the business to optimize our results and cash flow until it occurs. We are taking actions to increase our volumes while managing margins and operating expenses. We have launched differentiated collections, selectively introduced promotions, and expanded our participation in the new construction channel. To further enhance our competitive position, we will shut down older ceramic production in Italy and we are converting U.S. rigid LVT production to a direct extrusion process. These restructuring initiatives will result in a non-recurring charge of approximately $55 million, of which $50 million is non-cash. When completed, these initiatives should improve our profitability by $30 million annually by enhancing our productivity, lowering our manufacturing costs, and optimizing our production flexibility. Our European expansions in insulation and porcelain slabs are currently in operation. Our U.S. premium laminate and LVT projects are continuing to start up. Expanded production in European laminate and U.S. quartz countertops should begin in the second half of 2024. As the integration of our acquisitions in Mexico and Brazil proceeds, we have consolidated the general management, sales, and administrative functions while enhancing the company’s product offering, operational efficiencies, and customer base. While the Mexican and Brazilian markets are experiencing reduced demand and margins, we anticipate gaining additional benefits from our acquisitions as these markets recover. In September, we released our 14th Annual Sustainability Report, and for the first time, we provided Scope 3 emissions. Institutional Shareholder Services rated Mohawk as one of the top companies for environmental quality in the durable goods and apparel category. We have significantly exceeded our 25 goals related to decarbonization, waste reduction, and water conservation. We are lowering our carbon footprint by using more recycled content, increasing our green energy production, and expanding our product circularity. We recently received the Susan G. Komen Promise Award for our two decades of partnership in the fight against breast cancer. We have also formalized a Board of Directors selection policy as part of our ongoing commitment to diversity. To learn more, you can read the report online at mohawksustainability.com. I will turn the call over to Jim for a review of our third quarter financial performance.

Thank you, Jeff. Sales for the quarter were just under $2.8 billion. That’s a 5.2% decrease as reported and 8.1% on a constant legacy basis. Higher interest rates and continued inflation have weakened new housing and remodeling activity, negatively impacting our global business with lower volume and price and mix pressures. Gross margin for the quarter was 25% as reported, and excluding one-time items, was 26.6%, that’s up 100 basis points versus the prior year, with lower input and energy costs exceeding unfavorable price and mix in the quarter, along with stronger productivity, only partially offset by lower volume and unfavorable FX. The actual detailed amounts of these items will be included in the MD&A of our 10-Q, which we will file after the call. SG&A as a percentage of sales was 19.9% as reported. Excluding one-time items, it was 18.1%. The dollar increase was primarily attributable to the impact of acquired businesses, investments in new products, and marketing to drive increased future sales, unfavorable FX, and higher inflation. The operating margin as reported was negative 26.5%, and excluding charges, was 8.4%, 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 $876 million in the quarter. Total non-recurring charges were $967 million, primarily related to the impairment of goodwill and trade names, but in addition to further enhance our competitive position, we will shut down older ceramic production in Italy and convert our U.S. rigid LVT production to a direct extrusion process. These actions should improve our profitability by approximately $30 million annually. Adjusted operating income was 8.4% as I noted. The year-over-year decline was primarily driven by lower sales volume and unfavorable FX, partially offset by the reduction in input and energy costs exceeding the impact of negative price and mix and increased productivity gains, which were under pressure due to lower plant utilization. Interest expense for the quarter was $20 million. The year-over-year increase is due to a significant rise in global interest rates. Other income, other expense was income of $8 million. Non-GAAP tax rate was 20.8% in the current year versus 17.9% in the prior year. We expect Q4 2023 tax rate to be approximately 17.5% to 18.5%. That gives us an earnings per share on an adjusted basis of $2.72. Turning to the segments, in Global Ceramic, sales were just under $1.1 billion. That’s a 0.5% decrease as reported and 6% on a legacy and constant basis. The U.S. business volume outperformed, benefiting from our expanded positions in new construction and commercial channels in the quarter. Adjusted operating income was $88 million or 8% of sales, a decline versus prior year as the global slowdown in demand and pressure on price mix led to further temporary shutdowns, lower sales volume, in addition to the impact of unfavorable FX, partially offset by improving productivity gains and restructuring actions. In Flooring North America, our sales were just over $960 million. That’s a decrease of 11.7% as reported and 12.2% on a constant basis, as higher interest rates and inflation continued to pressure discretionary spending across all product channels. Adjusted operating income was $78 million or 8.1%. The operating margin was in line with the prior year as lower input and energy costs offset negative price mix, partially offset by weaker volume and lower productivity due to underutilization of our plant assets in the current demand environment. In Flooring Rest of the World, the sales were just over $710 million. That’s a 2.6% decrease as reported and 5% on a constant basis, as the business has been impacted by low consumer confidence, higher interest rates, inflation, and geopolitical events. The business in Australia and New Zealand and our resilient and insulation products held up the best in this environment. Adjusted operating income was $77 million or 10.9%. Our adjusted operating income margin expanded versus prior year as lower input and energy costs offset the weakening price mix, similar to Flooring North America, in addition to the benefits of green energy and fewer temporary plant shutdowns than the prior year, all partially offset by unfavorable FX. Corporate and eliminations were $10 million for the quarter in line with the prior year. Turning to the balance sheet, cash and cash equivalents were $518 million for the quarter, driven by strong management of working capital. Our free cash flow grew to $385 million in the third quarter and they are standing at $660 million on a year-to-date basis. Receivables were just over $1.9 billion with a DSO of 59 days, which was in line with the prior year. Inventories were just over $2.5 billion. The year-over-year Inventory decreased $380 million, and excluding the impact of acquisitions, the decrease was $438 million, primarily due to a focused reduction in units, supported by lower year-over-year costs. Inventory days also decreased to 125 days from 131 days in the prior year. Property, plant, and equipment was just shy of $4.8 billion with Q3 CapEx standing at $127 million with D&A of $150 million. Full year 2023 forecast includes CapEx of just over $620 million at this point. And finally, gross debt was $2.6 billion, with leverage at 1.5 times adjusted EBITDA. This positions the business to take full advantage of the rebound that historically follows a downturn like we are experiencing today. Now, with that, I will turn it over to Chris to review our Q3 operational performance.

Thanks, Jim. In Global Ceramic, our business outperformed due to our innovative product introductions and higher service levels. With this, we expanded our positions in the new home construction and commercial channels. Residential remodeling was slower due to lower home sales and postponed projects. Our investments in new decorating technology, polishing, and mosaics are providing domestic alternatives to premium imported ceramic. We are expanding our sales to regional builders, as well as kitchen and bath retailers with our coordinated tile and countertop collections. To further expand our quartz countertop sales, we are introducing more stylized collections, utilizing new technologies that provide greater value. We have lowered our distribution cost by shipping more product directly from our plants and bypassing our regional warehouses. In our European Ceramic business, retail traffic and new construction are being affected by economic uncertainty. In Southern Europe, where our business is concentrated, the economies are under greater pressure. Across all channels, low industry volume is creating more intense competition and we are responding with specific price promotions by geography and channel to gain additional sales. Natural gas prices have declined by 80% from their peak and we have reset our pricing to align with energy costs. While volumes have declined across most product types, sales of our premium porcelain slabs continue to grow and we are optimizing our recent capacity expansion. We continue to adjust inventory and production to align with changing market conditions. To contain cost, we have increased productivity, reduced overhead, and implemented alternative formulations. In Latin America, we have reduced our cost structures to adapt to slower more competitive markets with Mexico being less affected. Our margins are being impacted by lower industry pricing, partially offset by declining energy costs. Inflation in both Mexico and Brazil is receding and central banks are beginning to lower interest rates in response with further reductions expected this year. We are integrating our acquisitions in both countries and making significant progress in executing our sales, product, and manufacturing synergies. To increase our distribution, we are gaining customer commitments to expand sales across all channels and price points using the combined product portfolio. In each country, we are utilizing the assets of our legacy business and acquisitions to broaden our product offering. We have completed the information systems conversion in Mexico and the system consolidation in Brazil will be completed by the end of the year, enabling further operational improvements. In Flooring Rest of World, our margins benefited from declines in energy and raw material costs, partially offset by lower price and mix. Sheet vinyl continues to outperform other categories as it provides a lower-cost alternative and we have increased production to meet higher demand. With operational improvements underway, our Eastern European sheet vinyl acquisition is delivering higher style products and increased sales. Our laminate and LVT sales are under pressure in the softer market and we are introducing new products, merchandising, and select promotions to optimize volumes. We have executed the restructuring to support the conversion of our residential LVT offering from flexible to rigid cores, which is positively impacting our results. We are pursuing additional flooring sales, reducing costs, and aligning production with demand to manage the current conditions. Our panels business has slowed due to a decline in remodeling activity, construction projects, and industrial demand. Lower industry sales are affecting both our selling prices and volumes. Our material costs are declining and we are also benefiting from improved productivity and green energy production. Sales of our higher-margin HBO collections are growing as our customer base expands. Our sales and operational synergies are progressing in both our board and mezzanine acquisitions. Our insulation business position is positioned for longer-term growth as governments require greater energy conservation for new construction and remodeling. Insulation is less impacted than our other product categories as consumers and businesses invest to minimize their energy costs. Industry pricing has declined, along with input costs with regional variation caused by new plants coming online. In the third quarter, our volume improved and our margins were in line with the prior year. In Australia and New Zealand, the industry slowed during the quarter and our sales in both countries were down slightly. Our results were impacted by mix pressure in the residential channels as consumers sought lower-cost flooring options to maintain their project budgets. To increase sales and protect our margins, we are introducing enhanced collections across fiber categories, elevating the market of our high-end products and implementing targeted promotions to meet evolving demand. Commercial sales in New Zealand remain strong and our broad product offering is helping us secure larger specified projects. In our Flooring North America segment, pricing and mix were under additional pressure as competition increased across all product categories. The impact on our results was partially offset by lower input costs, restructuring, and productivity initiatives. To expand our retail presence in all flooring categories, we continue to invest in both products and merchandising systems. We are increasing our participation in the new home construction channel with regional and national builders. Across the segment, we are implementing many projects to reduce costs, improve efficiencies, and maximize material utilization. We are reengineering products with alternative materials and increasing recycled content. We have completed many of our restructuring initiatives to lower our cost and better align with current conditions. In residential carpet, to improve our mix, we are expanding our premium collections, which provide superior styling and features for the more discerning consumer. For the value-conscious homeowners, we are increasing our environmentally friendly recycled polyester offering. We have completed the integration of our non-woven flooring acquisition and are expanding their customer relationships. In resilient, our sheet vinyl collections continued to perform well as a preferred choice for budget-oriented consumers. As an alternative to PVC-based products, we introduced a new resilient polymer core that is more environmentally friendly and scratch resistant. In the third quarter, our imported LVT sales were disrupted by U.S. customs actions and to satisfy customer orders, we substituted higher-cost alternatives. We anticipate an increase in LVT inventories in the fourth quarter to improve service. We are continuing to ramp up our West Coast LVT production and the new extrusion process in Georgia. We anticipate both projects will be substantially operational in the first quarter. In addition, the proprietary technology we are implementing in these plants will enable us to introduce unique styling and features to the market. We are expanding our distribution of laminate in the retail and builder channels, our RevWood collections are being more widely accepted as a waterproof flooring alternative with superior visuals. Our new laminate product launches have been well received as consumers seek premium visuals at accessible price points. We are offering selective promotions to improve volumes in a soft market. Our trim and stair accessories business is growing as we broaden our range of re-patented products across all channels. Though U.S. commercial activity slowed in the quarter as financing became more difficult, our commercial performance is holding up better than residential, led by the hospitality sector. Our carbon-neutral product collections with industry-leading recycled content provide superior performance and design options to architects and designers. Our EcoFlex ONE carpet tile technology is gaining rapid adoption in the specifier community due to its acoustics, comfort, and ease of installation. We are expanding the sales and distribution of our recent flooring accessories acquisition through our existing commercial partners. Our business development group has leveraged our product and service advantages to cultivate new relationships with major retail, healthcare, senior living, and real estate development customers. I will return the call to Jeff for his closing remarks.

Thanks, Chris. In the present industry downturn, we are managing the controllable aspects of our business while adjusting to regional market conditions. In all of our geographies, elevated interest rates and persistent inflation are restricting consumer discretionary spending, resulting in postponed remodeling projects and new home purchases. Similar pressures are beginning to reduce commercial investments as business sentiment declines. Competition for sales to utilize plant capacity is increasing in all of our markets and lower input costs should offset the impact. With enhanced products and merchandising, selective promotions, and expanded participation in the best performing sales channels, we are maximizing our volumes while managing our margins and operating expenses. Across the enterprise, we are implementing productivity cost reductions and restructuring initiatives to lower our expenses and improve our results. We continue to manage our working capital to optimize our cash flow. We expect foreign exchange rates to continue to be an earnings headwind. Given these factors, we anticipate our fourth quarter adjusted EPS to be between $1.80 and $1.90, excluding any non-recurring charges. With this, our full year 2023 adjusted EPS should exceed $9. Historically, the flooring industry undergoes greater cyclical peaks and troughs than other building products due to its postponable nature. Our business fundamentals remain strong and we will benefit from significant pent-up demand when the industry rebounds. Given the aging U.S. housing stock, more than 80% of homeowners who responded to recent surveys indicated they are planning renovation projects in the near-term. In addition, after years of construction trailing demand, substantial new homebuilding will be required for many years to come. Commercial activity will expand as the economic outlook improves. As the world’s largest flooring provider, Mohawk is well positioned to capitalize on these opportunities. We will now be glad to answer your questions.

Our first question today comes from Matthew Bouley from Barclays. Please go ahead with your question.

Hey. Good morning, everyone. Thanks for taking the question. Did I hear you correctly that the reduction in input costs actually exceeded the decline in price mix during the quarter? I guess, correct me if I misheard that. But how do you anticipate price mix versus cost to play out into Q4 and perhaps any early thoughts on 2024 there? Thank you.

Thank you, Matt. Yeah. Let me frame that. So the cost started gradually falling in late 2022 and it takes usually three months to six months to flow through our P&L. In Q3, and I will provide some numbers here that will also be in our 10-Q, lower costs led by material and energy totaled $112 million, offsetting the weaker price mix of $106 million. Now sequentially, cost declined $65 million, exceeding the lower price mix of $29 million. In the fourth quarter, we would anticipate lower costs should continue to flow through the P&L.

Got it. Okay. That’s super helpful. Thank you for that, Jim. Then, secondly, you mentioned, maybe zooming into Europe and natural gas and ceramic there specifically, I know you mentioned certainly the costs have come down quite a bit from the extreme levels last year, but now European natural gas seems like it’s creeping higher again clearly in a market that seems like it’s a little more competitive. So, how do you anticipate specifically cost and price playing out in that market, European ceramic? Thank you.

You are right that the cost of gas has decreased significantly, but in Europe, our business is still under pressure due to falling retail traffic and new construction. We are addressing these challenges through promotions, and our premium slabs continue to grow while we optimize our new slab line. Additionally, we are starting restructuring efforts to phase out older assets and enhance our cost efficiency and utilization. We will need to wait and see how gas prices stabilize, as they are definitely much lower than last year.

All right. Thanks, guys. Good luck.

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

Good morning, guys. Thank you for taking my questions. Maybe just following up on Matt there, did the lower material and input costs offset the declines in price mix across segments in the quarter? I am more curious, I guess, about Global Ceramic there specifically. And then as we move into the fourth quarter, how should we think about margins by segment, is there anything outside of normal seasonality that we should consider there?

Well, in the quarter, the lower material and energy offset price mix in Flooring North America and Flooring Rest of the World. As Global Ceramics still has some higher cost material that is flowing through, it should kind of complete hitting the P&L in the third quarter.

Got it. And then any factors we should consider on margin in the fourth quarter outside of sort of normal seasonality?

No. If you look at the fourth quarter, we still have elevated interest rates and inflation, we anticipate constrained discretionary spending with postponed remodeling and home purchases. Remember, obviously, it’s seasonally slow due to the holidays. Margins are expected to be higher than last year with greater pricing pressure and increased shutdowns. We do anticipate lower input costs, as I noted, and we should be continuing to implement productivity and cost reductions, and don’t forget, foreign exchange, we anticipate will continue to be a headwind in the quarter.

The higher volumes in the quarter deleverage the margins as we pick up later, sorry, that’s not this quarter. In the quarter, you have got it right, I am sorry.

Okay. Thank you. And then as a follow-up, the $620 million in full year CapEx implies a pretty good step-up I think around $250 million in the fourth quarter. Is that just timing or is there anything going on there in particular that we should consider?

It’s really timing. As we end the quarter, between 2023 and 2024, our focus continues to be investing and optimizing the future of the business with the growth investments that we have talked about really making up $200 million to $250 million. Of that, maintenance CapEx would be another $250 million and then the balance of that budget for the year are on cost reductions, product innovation, and acquisitions.

Our next question comes from Joe Ahlersmeyer from Deutsche Bank. Please go ahead with your question.

Hey. Good morning, everybody. Thanks for taking the questions.

Good morning.

A couple of peers of yours have offered some early assumptions on residential U.S. end-markets into next year, might call it a flattish outlook on balance. And for simplicity, let’s just maybe take the international markets aside for a second and the commercial as well and just talk about North America residential across your segments. Question is, I guess, do you agree with that assessment that the market could be relatively flat next year within that and what the sources of upside and downside to that might be?

We look forward at it or the flooring industry has actually been in a downturn since mid-2022. We believe that we are going to see an improvement in the middle of the year as inflation moderates and financing improves. When these occur, we think consumer confidence will improve and the industry has started to get better. So we see the first half basically as a continuation of where we are with improvement as we go through the year and then depending upon how strong when it occurs, we will determine what the volume is versus this year.

That's very helpful, Jeff, I appreciate that. So maybe a follow-up here. From late 2020 to early 2022, you bought back $1.4 billion of your stock, around $170 a share, even going up to $200 at some points. You stopped buying it back last March, and I know cash flow softened, you were investing in CapEx, and there were some maturities. But in several calls now, especially this one, you've mentioned the health of the category and that your competitive position hasn't changed much. So how might an investor who is looking to buy your stock today reconcile that sentiment with the apparent hesitancy around buying back your stock right now?

At the moment, there’s still a lot of economic uncertainty in the world. The financing conditions are still difficult, there are regional conflicts that can affect everything. So we believe that at the moment, having excess capacity is preferred. But we are continuing to review it and would consider buying stock as our visibility improves from where it is today.

Our next question comes from Susan Maklari from Goldman Sachs. Please go ahead with your question.

Thank you. Good morning, everyone.

Good morning.

Jeff, maybe just building off of Joe’s question, as you think about 2024, you are going to go into the year with some excess capacity. I know you mentioned that you think the market can improve in the middle of the year. But how do you think about the company’s specific efforts that you detailed in your remarks around cost cutting in new products and how those will be layered in over the course of 2024 and what they could mean for Mohawk?

As we review the situation, we anticipate that increased volumes will enhance our business, allowing us to better utilize SG&A overhead and boost productivity. We foresee improvements in average selling prices as margins grow. Customers are likely to opt for higher-quality products, which will benefit from the upcoming restructuring and adjustments. Additionally, our recent acquisitions will contribute to this growth, as we expect volumes to increase significantly and positively impact our performance. Finally, our investments in growth areas will enhance our sales capabilities as we move forward. Overall, we expect our margins to expand considerably as the business evolves.

Okay. That’s helpful color. And then, as part of that, you have mentioned the macro in some of these markets, especially some of your newer markets is hopefully maybe taking a bit of a turn for the better next year. As you think about the opportunities in some of those areas and those categories, anything that is interesting to you that we should be thinking about over the next year and a half or so?

In Latin America, they have raised interest rates more aggressively than the rest of the world. We are beginning to see them lower rates, and we anticipate significant reductions in Mexico and Brazil even this year. These countries may recover from the current economic challenges sooner than others. Business conditions in Australia remain favorable for us, as there is less competition in the market, allowing us to maintain our margins better. However, Europe presents uncertainties, with low consumer confidence that needs to improve. Unlike the United States and Europe, the average worker in Europe has received higher wage increases that outpace inflation. Therefore, the main issue in Europe is one of confidence.

Okay. Thank you for the color and good luck with everything.

Thank you, Susan.

Our next question comes from Stephen Kim from Evercore. Please go ahead with your question.

Yeah. Thanks very much, guys. I appreciate all the color you have given so far. Jeff, you have laid out pretty clearly in both your press release and what you have said today. The factors that drive your business to be rather cyclical. Right now you have got a lot of challenges that are coming from all quarters, with competitors trying to leverage their fixed costs in a tough market and drive pricing and all that. And then also on the way up everything gets better. I think you just were talking about with Susan. More broadly, my question is, how important is it to you to drive changes in your business that may deliberately reduce this embedded cyclicality in your business over the longer haul?

The cyclicality is influenced by two main factors: our sensitivity to interest rates and the high capital fixed costs that affect both our company and our competitors. We constantly work to minimize these costs, which is part of staying in the industry. We are also exploring other areas, such as the insulation business in Europe, which has lower fixed costs and better margins. Therefore, we are involved in different markets that respond in various ways.

And remember, as these are not purchases that are canceled. These are deferred. So, if you see a pent-up demand and with the aging stock of housing, and as Jeff said in prepared remarks, the building just being behind, the need for housing, we feel like we are in a great position over that mid to longer term.

For the first couple of years following this situation, the demand for homes, as well as for improvements and remodeling that have been put off, will not disappear; it will simply return later.

I agree that there is likely a longer-term rebound ahead. Regarding the timing of this rebound, you mentioned the U.S. market. It seems you are anticipating a challenging first half of next year, but you expect things to improve by midyear. If that turns out to be the case, how are you planning to manage your inventory levels? Higher inventory levels can support strong service levels as demand picks up, so I'm curious if you plan to increase your inventory in the U.S. to ensure strong service levels, especially at the start of the third quarter. Additionally, can you share your perspective on Europe and Latin America? Do you also believe that midyear next year is when we might see a turnaround in those regions?

Let’s start with the first part. The inventory levels are based on two things, one is what the market is and other is in our ability to respond. Given the low volume rates we are at presently, we have a significant upside in capacity to react to it and so we probably won’t build much inventory until we see it coming and then we think we have the ability to utilize the capacity that we already have to satisfy it as it goes up. On the other side, the different regions. I think that is possible, Latin-America will come out of this first and then Europe is a little hard to know. I would guess Europe may trail, the U.S. If I had to pick Latin-America may come out of it earlier, U.S. in the middle and maybe Europe a little later, would be my present guess, but we will have to see how it evolves.

One aspect of your regional question is that the restructuring actions we are implementing aim to permanently reduce our cost structure, which will benefit us during both strong and challenging times.

Okay.

Thank you. Can you discuss the changes made to your LVT product from rigid to direct expansion regarding direct extrusion? Specifically, what are the potential cost savings, and what is the timeline for this conversion?

Yeah. Keith, our Georgia rigid production is presently being converted to direct extrusion to lower our costs. We are also installing new technology in both plants that will provide unique styling and features and these changes will give us more flexibility to ship the products from both the east and west plants, and we will have savings of more than $20 million annually when it’s executed.

Will this change all of your rigid LVT production to this method instead of the partial conversion?

No. It will all be changed to this.

Okay. Does this lead to more efficient machine time or how do you achieve the savings from it?

Well, we are changing from a heated press technology to an extrusion process and this allows for a lower-cost formulation and it’s just currently in the startup phase. We should be substantially operational in Q1.

Q1. Okay. All right. Thank you very much.

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

Hey, guys. Energy prices have kind of bounced off the bottom. Are you starting to see any upward pressure on your input costs more broadly? I know it’s somewhat tied to oil, presumably there’s a lag. And have you started seeing your price mix in your different respective business stabilize here or there is still some pressure as we kind of look forward?

Let’s explore this from a few angles. We believe that material costs have likely reached their lowest point, and there is a possibility that pricing has also stabilized, but we will need to monitor the situation. As oil and energy prices rise, it affects the basic cost as well as supply and demand dynamics. Given the current low demand in the industry and among categories utilizing various chemicals, it may take longer than usual for these changes to take effect. Typically, as we emerge from a recession, demand increases, leading to a recovery in chemical margins. When this occurs, we must pass on the increased costs as they materialize.

Okay. That’s helpful. And then a few more questions on LVT. With the investment you are making in the extruding side and with Mexicali coming online early next year, how does your product stack up from a cost and quality standpoint versus imports coming out of Asia? And does your LVT manufacturing business now at this point, early next year stack up from a margin standpoint versus North American Flooring, is it accretive, neutral, still a headwind? How should we think about all those things?

We believe the new high-end products we are launching in the LVT category will be very competitive with imports.

The pricing has declined substantially to import prices with both lower freight, as well as lower material costs. Our U.S. manufacturing costs are also coming down with it. We still have other things going on like service disruptions from China, given the U.S. in different pieces and so next year our margins should expand and we expect the profitability of the business to improve.

And we also introduced a new resilient polymer core that’s environmentally-friendly with superior scratch resistance, that’s doing really well.

Okay. And some of the friction, you mentioned in terms of imports coming in from Asia, how does that position Mohawk, especially as you ramp up some of those domestic capacity. Is it a good guy or just broadly your cost goes up, because at the end of the day, you are still importing from Asia, maybe not directly from China.

The combination of both, as you would suspect, the lower cost we are getting through with the imports that we do. We are also getting lower costs here as the material costs fall, energy prices here fall also. On the other hand, competition has increased with the lower volumes and pricing has come down.

Okay. I appreciate all the great color. Thank you.

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

Hi, guys. This is Andrew Harvey on for Mike. Thanks for taking my question. I appreciate you guys show yourself in your press release. I just wanted to ask maybe from a pricing standpoint, any markets in particular that you have concerns for that prices will fall more significantly or maybe even vice-versa.

Most of the markets, as a matter of fact, all the markets we are in, the pricing has declined. You have a combination of the cost of the material is coming down, the energy price is coming down and there is unabsorbed overhead that we have talked about. So the pricing has come down. The question is, is it at the bottom today and/or will it go down or not. We think it may be at the bottom as we speak, and as things improve going forward, we think that there will be pressure must-see once the industry improves to increase the material prices from our supply base and we will react to that when it occurs, but that’s usually after the industry does. At the same time, you have the world events with oil and gas and how that affects everything, that one is anybody’s guess, we just have to react to it.

Well, again, from a total material and energy costs, in the fourth quarter versus the prior year, we should continue to see the positive impact of the flow through to the P&L offsetting the lower price mix. That’s from a year-over-year perspective.

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

Hey, guys. Just one from me. Good morning. Just wondering if the recent changes in carpet payment terms and the removal of some of the discounts you guys have historically had as an industry will have a positive impact on the Flooring North American segment going forward?

The industry has modified some of its terms. Depending on the location, this has slightly improved margins. We are maintaining alignment with our customers and, unlike some competitors, we have not attempted to implement a price increase. Instead, we are focusing on strengthening our position with our customers.

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

Hi. Thank you for taking my question today. Just focusing on the commercial end-markets, we looked at some resi focused stocks traded better on less bad news this year, early this year and then you have passed for this week you had more commercial focused sewing manufacturer also trade up on less bad news in the commercial space, relatively less bad news. What are you seeing in terms of your pipeline of your business in North America with commercial end-market and what have you done to shift your business and focus towards certain end-markets that are performing relatively better than the traditional office and retail? Thank you.

Commercial business is holding up better than the residential business. We are seeing softening in the marketplace in different categories. The ABI Index which predicts the new parts coming online is showing declines. So as in other recessions, typically a year to year-and-a-half later, the commercial start softening as the commercial projects finish up. So we are starting to see that. On the other hand, in commercial, you have a much more differentiated product offering. So the pricing is more resilient than it is in the residential business and different categories, government, senior care, hospitality, and restaurants are all doing better and we are emphasizing our participation in those.

Okay. Ladies and gentlemen, at this time we will be concluding today’s question-and-answer session. I’d like to turn the floor back over to Mr. Lorberbaum for closing remarks.

Yeah. We are managing the controllable costs that we have been discussing, we continue to react to changing market conditions which are volatile, we see significant upside when the market returns and we think we are well positioning ourselves for that to occur. We appreciate you joining us. Have a great day.

And ladies and gentlemen, with that we will conclude today’s conference call. We thank you for attending today’s presentation. You may now disconnect your lines.