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Mohawk Industries [MHK] Conference call transcript for 2022 q3

2022-10-28 12:40:03

Fiscal: 2022 q3

Operator: 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.

James Brunk: 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?

Jeff Lorberbaum: 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 correspondently 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 consumer’s 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 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 & 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.

James Brunk: 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 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 year -- prior quarter, excuse me, 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.

Chris Wellborn: Thank you, Jim. Our Global Ceramic segment delivered the strongest performance during the quarter even with substantial inflation headwinds in Europe. Sales in 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 in a major headwind with volatile pricing in Europe significantly impacting our results. Recently, European spot gas prices have declined significantly as available storage near 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 or 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 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 Oceana 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 despite in 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 soften 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 on to 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 service 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. With that, I'll return the call to Jeff.

Jeff Lorberbaum: 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 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 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.

Operator: Ladies and gentlemen, at this time we’ll begin the question-and-answer session. Our first question today comes from Susan Maklari from Goldman Sachs. Please go ahead with your question.

Susan Maklari: Thank you and good morning, everyone.

Jeff Lorberbaum: Good morning.

Susan Maklari: 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 do move through a weaker global macro?

Jeff Lorberbaum: 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 impacted more than most. Interest rates and inflation are impacting the 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?

James Brunk: You covered it. Susan?

Susan Maklari: 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?

Jeff Lorberbaum: Listen, there's 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 major 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 is continuing to grow, laminate, which we have been able to take market share and expand the entire category. Quartz countertops is 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 are in good shape to have a dramatic impact on the business.

James Brunk: 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.

Susan Maklari: Okay. Thank you for the color and good luck.

Jeff Lorberbaum: Thank you. Operator: Our next question comes from John Lovallo from UBS. Please go ahead with your question.

John Lovallo: 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?

James Brunk: 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 anticipates production below sales in most areas and that unabsorbed overhead, I would expect to see that increase a little bit in the fourth quarter.

John Lovallo: 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?

James Brunk: 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.

John Lovallo: Great. Thank you, guys.

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

Michael Rehaut: Thanks. Good morning, everyone. Thanks for taking my question. First, I just wanted to circle back to some of the comments earlier around capacity additions for next year. How do you think about those in the face of the softer demand backdrop? And obviously, there's a big difference from perhaps what you did back in 2017, 2018, 2019. But can you just remind us with the -- on a rough basis, the capacity that's coming online next year from a revenue standpoint in terms of revenue capacity, what that might mean in terms of start-up cost. And you know, if there is any risk that you know, the P&L impact might be a little more negative if, you know, demand remains where it is today?

Jeff Lorberbaum: So let's go through all the different ones. Some of them aren't going to start up until 2024 to tell you the truth. So it depends on which one. Our laminate business is growing in the U.S. We have new capacities put on. We have full commitments for all of that we have and we have been unable to satisfy the demand. In laminate, it's taking -- it's really become an alternative as a waterproof option for every other product, including LVT in the marketplace. And it has some benefits it doesn't have. So it's growing, and we're continuing to invest in it. Quartz countertops, the business has been sold up. We're using imported products to support the business, and that should start up in 2024, enabling us to grow it. LVT is the expansion of the West Coast plant, which is probably about 30% done now. And the rest of it will come in over time. We have expanding commitments for it, and we're also importing products from around the world, which also offer opportunities to use it. We're investing in premium ceramic. The biggest piece is in slabs in Europe. It's also oversold, and we have been sourcing significant product from other people to support that business, as it grows. And then, we have the insulation business, which when we bought an acquisition, they were in the process of finishing the plant and starting up. And it has some regional advantages given where the locations of other ones are, and we think that we can -- we're expanding our customer base already and starting to fill it up. So those are the biggest ones.

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

Michael Rehaut: 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?

James Brunk: 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.

Jeff Lorberbaum: 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.

Michael Rehaut: Thank you.

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

Keith Hughes: 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?

James Brunk: 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.

Keith Hughes: 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?

Jeff Lorberbaum: In our -- the biggest part of it is in our ceramic business. And we have hedged some of it, but we're still on spot on a large part of it, too. And then they're basically short-term, trying to minimize the spikes in the periods, where we are.

Keith Hughes: Okay. Thank you.

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

Phil Ng: 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?

Jeff Lorberbaum: Listen, that answer might be above my pay grade. Seriously. There's really dramatic different scenarios that can play out next year. And so if you go through the two, we have an optimistic one, which starts out with the assumption that Europe has limited problems with gas as they go through the winter, and then they have adequate supplies going forward. In the US, the version would be, that the interest rates peak and they start declining, and we see a significant rebound in the second and third quarter as the economies start preparing themselves. The alternative on the other one, which we're also preparing for is that European struggles with energy throughout the entire year and that the US inflation remains high and escalated through 2023. In that scenario, you get industry volume remaining low throughout the year and being pressure -- we have been pressured by unabsorbed overhead in a more competitive environment. So given where we are, you can get two dramatically different conclusions to it. Keep in mind that either way, we always enter a growth cycle after the contraction, because of all the postponed sales in our category. Our top line expands. This time, we'll have initial opportunities from the product expansions that we're doing, as well as the acquisition investments.

Phil Ng: 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?

Chris Wellborn: Well, on the ceramic side, imported prices -- up until now, imported prices have increased. As we look forward, we could expect with a stronger dollar, they could decrease, but we're well positioned with our US manufacturing and sourcing capability to handle that.

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

Jeff Lorberbaum: 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.

James Brunk: 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.

Phil Ng: Okay. Thank you. Great color.

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

Adam Baumgarten: 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 maybe contributing?

Jeff Lorberbaum: The different channels in commercial?

Adam Baumgarten: Yes.

Jeff Lorberbaum: The question.

Adam Baumgarten: 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?

Jeff Lorberbaum: For the most part, there's still a lot of activity across the board with planned projects coming in. The projects that you get from the index, they still show that they're still running at a positive rate. You have the hospitality is doing better because the hospitality quit spending money during COVID, and there's a lot of projects that were postponed and you have to update those as they come through. The office you have, in some cases, more of them coming back to work and things are postponing. In some cases, people have to redo their offices for a different environment where they are going through -- the government projects are still coming through as they keep spending money. And then also in the healthcare piece, we're doing okay.

James Brunk: 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.

Adam Baumgarten: Got it. Thanks. And then just -- you called out the Italian energy subsidies that you received in the quarter, and that sounds like they're expected to continue at least partially through the fourth at this point. Can you maybe size the benefit there?

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

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

James Brunk: 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.

Adam Baumgarten: Great. Thanks.

Operator: Our next question comes from Mike Dahl from RBC Capital Markets. Please go ahead with your question.

Mike Dahl: 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.

Chris Wellborn: Well, the -- as you know, the costs are up dramatically year-over-year -- when you look just specifically at the fourth quarter, I think we're roughly about 60% hedged, now 60% to 70% hedged just for the fourth quarter.

James Brunk: 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.

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

Mike Dahl: Right. And just -- okay. So just as a quick clarification, when -- if it's kind of neutral at this point, is that inclusive of the subsidies. And my second question is there's some puts and takes around how you're managing production in European ceramic. You're ramping production into the fourth quarter to take advantage of the spot prices. Jeff, I think you said or maybe Chris said as you look to 1Q, that production will be gone.

Jeff Lorberbaum: 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.

Chris Wellborn: 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.

Mike Dahl: Okay. Thank you.

Jeff Lorberbaum: Just for the comment. The future prices in Europe are somewhere in the 130, 140 range last time I looked, that may be lower than it right now. I mean, they move around so much in any given week as you go through. And then the spot prices today are -- were under 40, is it? And so I mean, nobody knows where it's going to end up.

Mike Dahl: All right. Thank you. Appreciate that.

Operator: Our next question comes from Laura Champine from Loop Capital. Please go ahead with your question.

Laura Champine: 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?

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

Jeff Lorberbaum: 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.

James Brunk: And so what you also see, Laura, I think it's important to look at sequentially as well. And you see that quarter-over-quarter, we've definitely slowed the pace of that increase in really all the -- quarter-over-quarter increases, inflation and then the added acquisitions. So the plan is to continue to look at production levels in the fourth quarter in most of our areas to lower inventory as we end the year. Again, that's -- most of our areas with some exceptions we've already talked about.

Laura Champine: 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?

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

Laura Champine: Got it. Thank you.

Jeff Lorberbaum: Thank you Laura.

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

Stephen Kim: Thanks very much guys. Appreciate it. A Lot of interesting information you've given here. Just wanted to clarify a couple of things here. When you talk about your -- the destocking. You said it was hard to know how much destocking there is in channels, I guess, outside of the retail. I wanted to press on that a little bit, because I would think that particularly like in the North American new construction residential sector, there'll be certain SKUs that would be most susceptible. You do volume runs that would be most susceptible to destocking in the supply chain to volume builders. And so my question is, did you see that in the quarter? Are you assuming it worsens in your guide? And then also regarding the guide, when talk -- when you talk about price cost headwind for the whole company, do you anticipate that it will worsen in 4Q from whatever we see it as being in the third quarter?

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

Jeff Lorberbaum: 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.

James Brunk: 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.

Stephen Kim: 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?

Chris Wellborn: 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.

James Brunk: 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 cost. 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.

Jeff Lorberbaum: Just as a comment and the incremental, it's much easier to hold your costs as the volume rises than it is to decrease the fixed cost or even the variable cost as the thing goes down and then longer term, we have to make -- in the short term, we have to make decisions, how long is it going to last and where it is and how much you want to maintain even though the volume decreases.

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

Stephen Kim: Sure. Okay. Thanks, guys.

Operator: Our next question comes from Truman Patterson from Wolfe Research. Please go ahead with your question.

Truman Patterson: 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.

Chris Wellborn: 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.

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

Chris Wellborn: 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.

Truman Patterson: All right. Thanks, guys.

Chris Wellborn: Thank you, Truman.

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

Kathryn Thompson: Hi. Thank you for taking my questions today. Granted, understandably a lot of focus on reductions in production and along that line, but often it's in these times of economic stress that M&A opportunities arise. In light of the -- two-part question. In light of a changing world set up with deglobalization and also changing consumer preferences post-COVID, how are you thinking about growth opportunities from an M&A standpoint, both from a geographic and a product standpoint? Thank you.

Jeff Lorberbaum: In past downturns, the compression of the earnings and the compression of the multiples, most companies don't try to sell unless they have to in this environment. And -- so usually, most of the transactions are done on the other side of as you're coming out and the margins are expanding. I would expect that's where the opportunities are going to come this time also.

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

Jeff Lorberbaum: I can say that we've made a specific decision. We have to take each geography and each opportunity that comes and we evaluate it given how we perceive the future. At this point, I mean, Europe -- as you can tell, we don't have a view for the next three, four months, you alone the next year. So in Europe, under this circumstance, we have to have much more something that got us to do something immediately. As I would assume the rest of the world is in the same place we are. At this point, we're really trying to get ready for a slowdown and try to minimize things. But with the capital structure we have, if the right opportunity arises, we would take it.

Kathryn Thompson: Okay. Great. Thanks very much.

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

Matt Bouley: 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.

James Brunk: Well, look, in the short-term, just looking at the fourth quarter and what we included in our guidance, again, we expect the softening volume to continue and the shutdown -- the related shutdowns also to occur. So you'll have a very similar pattern to what you saw in Q3. And then I'll let Jeff answer on the longer term, but looking into 2023, as Jeff said, it really comes down to the two scenarios, and we want to be well positioned for wind as pent-up demand comes back to us.

Jeff Lorberbaum: A big part of it is we think we're going to produce less than we're selling in most marketplace 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.

Matt Bouley: Got it. Thanks.

James Brunk: 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 is 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.

Matt Bouley: Understood. That's helpful color, guys. And then just 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.

Jeff Lorberbaum: 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.

Matt Bouley: Got it. Well, thanks Jeff. Thanks everybody.

Jeff Lorberbaum: Thank you.

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

David MacGregor: Yes, good morning or good afternoon as the case maybe. 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?

Jeff Lorberbaum: 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.

David MacGregor: 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?

Jeff Lorberbaum: Well, the first part is -- the new capital investments, most of them take anywhere from a minimum of a year to as much as two years to implement. So the projects that are coming through now were agreed to the end of a year ago, is it. And once you start them, the ability to stop from is almost none, is it -- you have to write off all the investment that's already there. So those are in place and moving forward. Some of those will -- some of the costs of those will flow in the next year. And they're all in growth categories that we're going to need. We may not need as much of it in the short term as we thought, but we'll need it as soon as the business turns around in all of them as we go through. So, beyond those, we're cutting back on anything that doesn't impact the short-term business and managing through as we see the business today.

James Brunk: Yes, the key -- and I think you hit that word. We have to stay very disciplined as we look into 2023 and go through our budgeting process. As Jeff said, we've initiated a number of projects to have the carryover effect into 2023. But beyond that, we will certainly scrutinize based on the demand levels.

Jeff Lorberbaum: 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.

James Brunk: 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.

David MacGregor: Good. Thanks very much gentlemen. Good luck.

Jeff Lorberbaum: Thank you.

James Brunk: Thank you.

Operator: And ladies and gentlemen, we've reached the end of the allotted time for today's question-and-answer session. I'd like to turn the conference call back over to Mr. Lorberbaum for closing remarks.

Jeff Lorberbaum: We're taking the right steps to manage the existing conditions, and we're adjusting as a 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.

Operator: Ladies and gentlemen, that concludes today's conference call. We do thank you for attending today's presentation. You may now disconnect your lines.