莫霍克工業集團 (MHK) 2006 Q3 法說會逐字稿

Good morning. My name is Angela. And I will be your conference operator today. At this time, I would like to welcome everyone to the Mohawk Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. [OPERATOR INSTRUCTIONS] Thank you. Now I'd like to turn the conference over to Mr. Jeff Lorberbaum, Chairman and Chief Executive Officer of Mohawk Industries. Please go ahead, sir.

Thank you. Welcome to the Mohawk Third Quarter Earnings Conference Call. With me, I have Frank Boykin our CFO. Would you please read the Safe Harbor statement?

I would like to remind everyone that our press release and statements we make on 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.

Thank you. Mohawk's third quarter GAAP net earnings and earnings per share were about $128 million and $1.88 per share, both about 10% improvement above last year. The adjusted net earnings excluding stock option charges and a custom refund were $124 million and about $1.82 per share. Net sales for the quarter were about $2 billion, an increase of 19% from 2005. The sales growth resulted from the Unilin acquisition, hard surface growth and price increases.

I'm pleased with our results for the quarter in light of the current business environment. The 19% sales growth, higher gross margins and a 10% improvement in earnings per share over last year, our third quarter was positive. The business is better balanced to minimize the impact of changing economic and industry cycles. The diversification of our product offering with a full line of soft and hard products, participation in all sales channels of residential and commercial and our broader geographic exposure in Europe improves our position.

The slowing U.S. economy is impacting our business. Consumers appeared to postpone the purchase of flooring as their discretionary purchasing power was squeezed. During the quarter, all areas of residential slowed. New construction fell more than anticipated and retail traffic showed a contraction of remodeling projects. The commercial sales continued to be positive. During the period, our raw material cost increased and they have remained high. The European economy was better than expected, positively benefiting our Unilin segment.

Frank, would you please give the financial report?

Sure. I'll be glad to. Net sales as Jeff just mentioned for the quarter came in at $2.24 billion compares to last year's nets sales of $1.698 billion representing a 19% increase. Without Unilin, our growth was 2% quarter over quarter. Gross profit was $569 million or 28.1% of net sales. That compares to last year's margin of 27.3% of sales. This year, the margin was benefited by a favorable mix improvement with the Unilin and Dal-Tile businesses growing faster and having higher margins.

SG&A came in at $346 million or 17.1% of net sales compared to 16.1% of net sales last year. SG&A was impacted this year by higher sampling cost, stock option accounting, which is new this year, and mix shifts with again, the Dal-Tile business, which has higher SG&A growing faster than the rest of the business.

Operating income was $223 million or 11% of net sales compared to last year's operating margin of 11.1%. Interest was $36 million compared to $10 million last year. Higher this year because of the higher debt related to the Unilin acquisition and slightly higher interest rates. In addition, we had $9 million included in other income, $9 million of U.S. customs refunds in the third quarter and $15 million year-to-date.

Income taxes were $59 million. This represents a 31.6% effective tax rate compared to last year's effective tax rate of 35.2. Prior to this quarter, our effective tax rate had been running between 33 to 33.5. It was impacted this quarter some one-time tax credits. We believe going forward that it would continue to run at 33 to 33.5, as it has in the first half of this year.

Our GAAP earnings per share came in at $1.88, 10% over last year's $1.71. Adjusted earnings per share were $1.82 or 6% over last year's $1.71. These adjusted EPS exclude the favorable impact of customs which is about $0.08 a share and the unfavorable impact of expensing stock options which is about $0.03 a share.

The Mohawk segment sales were $1.234 billion versus $1.248 last year down about 1% and related to softness in the residential carpet category. Operating income for the Mohawk segment was $111 million or 9% of net sales compared to 9.8% of net sales last year. The Dal-Tile segment sales were $501 million or 12% up over last year's 449. In operating income for Dal-Tile, $70 million or 13.9% of net sales versus 15.4% last year. The operating margin here being impacted by freight increases and then also by the start-up costs in our Oklahoma ceramic facility.

Unilin sales were $293 million with an operating margin of $50 million or 17% of net sales. This margin percent was higher than we had anticipated, and we would expect the fourth quarter to be in the 13% to 13.5% range.

Operating income for the corporate and the lamination segment was about $7 million versus $2 million last year, up this year due to stock option expensing and due to the Unilin acquisition. We would expect the annual run rate for this operating income to be around 32 to $34 million. On the balance sheet, receivables were $958 million representing about 43 days versus about the same 43 days last year. Inventories were a $1.275 billion representing turns of 4.6 times, an improvement over last year's turns of 4.4 times. Fixed assets of 1.9 billion, included capital expenditures through nine months of $124 million.

We're currently expecting our capital expenditures for this year to run between 220 to $230 million and then our depreciation and amortization for the full year to run about $280 million. And the long-term debt in total ended up with the third quarter at $2.947 billion which ended up with a debt to capitalization ratio of about 46%. We paid down around $168 million of debt excluding any foreign exchange impacts in the third quarter. And then to date since the third quarter and the Unilin acquisition, we paid down $593 million of debt.

Jeff, I'll turn it back to you.

Thank you. The slowing -- excuse me. The slowing new residential sales have fallen more than we had anticipated. We believe it's presently more severe due to the high number of cancellations which are being recorded and should moderate once these have flowed through. Retail redecorating declined in the quarter and has not shown any improvements from falling gasoline prices that other retail categories have experienced. We expect flooring sales improvement in the future with better consumer confidence, higher employment and favorable long-term interest rates. Presently, we're adjusting our production rates and reducing staffing and expenditures until the industry improves.

The Mohawk segment sales results were disappointing as industry sales slowed substantially. Sales declined 1% with margins impacted by higher costs and lower residential volume. Lower new home sales and a reduction in retail redecorating, reduced total carpet industry units by about 10% from the prior year. Commercial sales were positive and helped offset decreases in residential. As in other slowdowns, the industry at retail and manufacturing is trying to stimulate consumer purchases and we see increased promotional activity occurring. In our residential carpet, we've already reduced our manufacturing, sales, administrative and marketing costs. Lower manufacturing units during the period impacted our overhead absorption as we kept our inventories under control.

During the quarter, we announced a price increase to offset rising raw material costs which have remained at historically high levels. Decreases in oil prices have not yet translated to our purchases. We could see improvement in raw material prices if worldwide chemical demand doesn't impact prices and oil remains lower.

We continue to focus on lean manufacturing, improving efficiency, reducing waste and compacting the supply chain. During the third quarter, we've closed a carpet staple facility costing $500,000 and have reduced production shifts in our other facilities to match the demand level. In the Mohawk segment, we're separating the carpet and hard surface management teams to have greater focus on each product category. The product sales forces have been separated -- have been separate and will not be impacted by the change.

Our transition to Unilin produced laminate has completed the first phase, will complete our offering with additional introductions this fall and new innovative styles offered in our annual market.

The commercial business continues positive in the quarter. Our carpet tile products continue to grow rapidly and the increase strained some of our capacity levels. In the fourth quarter, we're starting up a new carpet tile production line with a non-PVC technology that will add new capacity, improve costs and be environmentally friendly. We'll continue to review the business and adjust to the changing environment.

The Dal-Tile segment sales continue to grow 11% during the quarter and are slowing with the industry. The commercial business continues strong and our breadth of product for this channel is a competitive advantage. Our past investments in product, sales and distribution should increase our share in a weakening market. Gross margins were impacted by higher energy, freight investments, freight, investments in distribution and the start-up of our Oklahoma expansion.

We also opened two new service centers in the third quarter and have more service centers and galleries under construction as we speak. We will reduce some wall tile production schedules in the fourth quarter as a result of the slowing demand.

Our Muskogee floor tile expansion is complete and we expect it to be operating near capacity by the end of the year. We are well positioned in all distribution channels to maintain our category leadership.

The Unilin segment results were strong for the third quarter with good sales growth in the European laminate business. The third quarter margins were higher due to better laminate product mix, improvement in U.S. distribution business, improved raw material pass through of pricing and productivity of the plants, and control of discretionary spending. Unilin sales increased about 4% on a constant exchange rate without nonrecurring items. In the U.S., we continued to work on opportunities to expand the Quick-Step and Mohawk laminate brands in the specialty store channel and improving our position in the other channel.

In Europe, laminate growth was better in most countries and we have opportunities to expand in the mid price points. Roofing and other board sales improved and we continued to pass through higher energy and raw materials in many channels.

Our ongoing IP revenue continues to increase. We anticipate margins in the range of 13 to 13.5% in the fourth quarter. We're pleased with the Unilin's performance since the acquisition was completed last year. We're managing our balance sheet with the debt to capitalization ratio improving to 46% after paying down $168 million of debt in the third quarter.

The organization has many initiatives focused on increasing efficiencies, inventory, turns and working capital management. During the quarter, we maintained our improved inventory turns compared to last year despite the lower sales levels we were experiencing. The lawsuit filed against us in 2004 alleges that Mohawk hired undocumented workers to suppress wages and was reviewed by 11th Circuit Court during the quarter. After reconsidering the case, the court refused to dismiss the RICO claims against Mohawk. Mohawk will continue to appeal the decision and believe the allegations are unfounded.

We're anticipating continued slow sales in the fourth quarter that will create unabsorbed overhead costs and impact on margins. We're reducing our manufacturing, administrative and marketing expenses. Our carpet margins will also be affected by the lag between costs and selling price changes. Unilin results will decrease to a more sustainable rate. Based on these factors, our earnings guidance for the fourth quarter of 2006 is from $1.51 to $1.60. This guidance does not include the closing of higher cost ceramic production at a cost of $6 million in the period or additional refunds which are expected from U.S. customs. With that, I'll be glad to take questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Michael Rehaut of JPMorgan.

Hi, guys this is actually [Ray Huang] for Mike.

Good morning.

Good morning. Just had a couple of questions. I was wondering on the commercial side if you guys have seen any signs of that side of the business slowing into October or maybe towards the end of the third quarter?

The commercial business continues at good rates. We see the backlogs are reasonable. We are anticipating it to continuing at good levels. We don't have any indications of a substantial slowdown.

Okay. And what percentage of your business is commercial?

If you look over the entire business, it's around 25%.

Is that of revenues or operating profits?

Revenues.

Okay. And what's the typical lag time between commercial construction and like when you guys step in there with the carpet? Like if that starts to slow?

From a new construction project that just started? I don't know what point to start. Now these things sometimes take years. They just start with the designing of the building. By the time they get the building designed and executed, could be years, on that extent.

Okay. And also another question. I was wondering if you could provide some comments on what you're seeing in the M&A pipeline. And at what point or how far along would the Unilin integration have to be for you to start pursuing other larger opportunities?

The Unilin business, I mean, we've progressed significantly over the last year. We're happy with the progress we've made of both the internal structures of separating the U.S. business from the European business from a management perspective to focus on each and maximize each. We think we have a good infrastructure under the business that's continuing to improve. On acquisitions, we would consider acquisitions that were of a reasonable size presently if we felt they were positive to our business.

Okay, great. Thanks.

Your next question comes from David MacGregor of Longbow Research.

Hi, Jeff. Hi, Frank.

Hey, David, how are you?

Good, thanks. I wonder first of all on Unilin, you indicated that the margins will decrease to a more sustainable rate. Then in your prepared remarks, Jeff you indicated 13, 13.5%. I'm wondering if you can just sort of help us understand from this point forward what's behind that adjustment in margins and also are we at a point now where you can start to give us a little more visibility into the European business and the makeup of that business, so we can just maybe better forecast going forward? Thanks.

The Unilin margins in the fourth quarter are affected by normal seasonality that we have within the business. There were some marketing expenses that we had expected them to fall in the third quarter and just because of timing they're going to fall in the fourth quarter. At this point, we see a high probability of increasing raw materials from the fourth quarter, higher than the prior quarter.

We also have some energy hedges that are expiring that were favorable to us in prior quarters which is how we get to the lower margin. If you look at it on a longer term basis and average out the margin for this year, we should come out in the mid 15. But we expect for next year over the entire year the margin to be slightly lower because of the investments we're going to make in broadening the channels where we expect to have some more margins in different channels as we add to the business as we go forward. Did I answer all the questions?

Well, I mean, when you talked about on a more sustainable rate, is 13, 13.5% kind of what we should start thinking about as a normalized margin for this business going forward or --?

It should be -- that's the seasonal dip, first quarter. So what happens is, if you look over the whole year using that, you'll end up with somewhere around the mid 15s for this year. And what you should use for the next year is something slightly lower than that.

Slightly lower than that. And is there any -- ?

About the low seasonal point.

Okay. And I would -- I realize there's a limited amount of forward visibility in this business but do you foresee at this point, based on the overall economics of this business us getting back into sort of high teens margins on a sustainable basis, in this business in the next two to three years?

No. What we said was we expect to grow the business, and with the growth to improve the operating profit dollars.

Right.

We've never said that we expect to grow the gross margin percent dramatically.

Okay, Final question. Just on Dal-Tile. Can you possibly give us some breakout on pricing versus volume?

On which business?

On the Dal-Tile business.

I don't have that at my fingertips this minute.

I think most of the increase I believe was volume, David, but I'll get back with you on that.

We'll be glad to get it for you.

Okay. Thanks very much, guys.

Your next question comes from Laura Champine of Morgan Keegan.

Good morning.

Good morning. I have a follow on question to Dave on the seasonality of the Unilin business. I had thought that last quarter we talked about Q3 being the weakest quarter, and now are you saying it's actually Q4 that is the weakest quarter for Unilin in terms of margin as we model?

The third quarter was better than we had anticipated. There were some different pieces going on. The European laminate business was stronger than we expected along with the entire economy that, with that we had higher production levels and better absorption within it.

The product mix was a little improved over what we had anticipated. We were able to pass through some of the raw material increases faster than we had anticipated. And going through some of the shutdowns we normally have costs that we do, maintenance that we do, we were able to have lower costs going through that. And then in addition, some of the, which I think we said before, some of the marketing expenses that we had anticipated falling in the third quarter just due to timing's going to fall in the fourth quarter. So the combination of those things did it.

Now again, I'm going to represent the business -- the Unilin business historically has not made forward projections which we've said multiple times. We are getting better and better processes in place to give forward projections but we're still not where we want to be and we really have to get a better infrastructure under where we can give you much more precise future estimates than we have. Historically as a private business, they didn't even make them.

Got it. And then you mentioned, Jeff, that units in carpet in Q3 for the industry were down 10%. Can you comment on Mohawk's unit trends and, I mean that would imply that you had maybe double digit positive price mix realization. Is that accurate?

We have to break down the different pieces of the business you have. First is the residential piece was down more, and just guessing at it, because it's not there. We're guessing the residential piece could be down three to four, 3 to 5% more than the average because the commercial is doing better. And then Mohawk would follow along with the piece and there was also a price increase. And we also have some business that's outside the carpet business in the segment.

So is it possible to just -- to break down just Mohawk's carpet units and tell me how many yards you made versus the year ago period?

That would be similar to the industry.

Got it. Thank you.

Your next question comes from Margaret Whelan of UBS.

It's actually Susan for Margaret.

Hi, Susan.

You mentioned a lot of the cost cutting that you already started to do. When do you expect a lot of that to be completed and we'll start to get the benefits of that?

A lot of it's been -- the third quarter, it started deteriorating in the third quarter. We started making plans of changing the pieces after we felt that it was more than a momentary blip.

We have reduced a lot of staffing in the plants. We have cut out shifts in the plants. We've reduced administrative people. We've reduced some sales people where we felt that they weren't achieving what we wanted to already. So, many of these things were already in place and operating. We have a stack of projects on the table. There's probably about 15 pages long of various things we're continuing to do as we go through. We are reducing some of the new -- the amount of new introductions we've done historically to a lower number given the environment we're in.

We have more focus on the discretionary expenditures and we're continuing to watch expenses. Now, you have to balance all of the cutting that we think that the industry will pick back up and so we don't want to cut out infrastructure that we can't put back in place rather rapidly with limited costs. So there's a balance between those two things on an ongoing basis.

Okay. And then on the carpet side, you talked about seeing some increased promotional activity. How do you balance that against the price increases that you've been putting in place? How does that play out?

What the industry attempts to do is to isolate specific products in specific channels and have promotions to say this is what we -- we want to try to help you as retailers and we want to help move certain assets and each of the different manufacturers attempts to try to focus promotional activity on a very limited part of the business. And you attempt to do that, and separate that activity from the ongoing broad-based piece where you have tremendous investments to pull the stuff through. And it's a balance. And we attempt to minimize the impact of one on the other.

Okay, thank you.

Your next question comes from [Steven East of SIG].

Good morning, guys.

Good morning.

Good morning.

If we're looking at the Mohawk segment of your business, third quarter revenues were less than second quarter but you were able to pick up your operating margin. I assume that's really the price cost dynamic that you've got going on.

That was prior increases plus we have a lot of activities managing our business.

Okay. All right. So it's not just the incrementing pricing you're getting as costs are falling then?

No it was actually the pricing -- remember we have price increases in the spring due to the higher prices. So those are flowing through covering the costs. And, what -- just managing the business.

Okay. Is it fair to say, Jeff, that you think that you can continue to improve that marginally in the face of a declining volume number?

It's going to be did to continue improving it. I mean, you've heard all the things we've done in the quarter. We're doing a lot more. And again, we're not sure if we -- we may be at the trough of the volume. We're not sure. It depends what happens to the industry volume and pieces. And as you can tell, anything that's discretionary spending, I mean, we're going after it with a vengeance.

Okay. All right. On Dal-Tile, do you have the same type of pricing power that you do on the Mohawk carpet side of the business?

You have a lot more people participating in the production of tile when you look at the whole world marketplace. And so there's tile coming in from around the entire world. But then it ends up being sold, for the most part, through most distributors and redistributed to the customers. So, there's a lot more diversity of product and pieces coming in.

With that, all of the participants have the same problems we do, which is the biggest thing that we have impacting the business is the distribution and trucking costs moving this stuff around. And it doesn't matter where you ship it from, you have those, isn't it? So for the most part, our competitors are trying to raise the prices to recover those same pieces we are.

Okay. And then, one last question. Frank, could you help me out a little bit on the options expense just -- I assumed it was not included but then during your prepared remarks, you made a comment about SG&A 17.1% versus 16.1 last year. And you mentioned stock options as one of the issues, but it looked like on your release, you had actually excluded that from your calculations.

Well, yes. It was excluded out of the adjusted earnings number, but included in the SG&A that you see, 17.1% is about $3 million of stock option expense this year, that we didn't have last year.

Okay. And then looking forward in 4Q and for '07, do you have any estimate for us there?

It will be in that same range.

Okay. Thanks a lot, guys.

[OPERATOR INSTRUCTIONS] Your next question comes from John Baugh of Stifel Nicolaus.

Good morning, John.

Good morning. Dal-Tile question. The closure of a facility. I assumed in a downturn, you would obviously try to reduce your sourcing. But that may not be the only thing you cut off. It looks like you're going to have to close production, too. Can you comment, if it continues to weaken at Dal-Tile, are we looking at more plant closures or can we just cut off sourcing?

Yes to both. We have certain categories that we have that we manufacture a 100% of and we have other categories that we manufacturer, you know, 60 to 70% of. So depending upon which category, they're each separate. The plant that we closed down was -- made a unique type of tile, that was a high-cost plant. We have over time come up with other ways of getting it more cost effectively and so we're shutting down. If we went through it, we also noticed that our new flooring plant in Muskogee we said is going to be running near capacity at the end of the year. It makes basically 100% floor tile.

What will happen is we will reduce the amount of sourced material and continue running it. It could possibly, due to the timing of the sourced stuff and moving it in and out together, the inventories may even go up a little bit in this segment during the quarter. But it's because we're still sourcing so much amount and the more we make the less we're going to source in the next six months.

So we should expect possibly another plant closing or two?

No. We have no more plant closing. We tried to open up the thing and tell you what we see for the next quarter. We don't see any more closings or we would have announced them.

Okay. Good. And then on the raw material questions, I thought I heard you say that even into this quarter raw materials have moved up from the third quarter. Did I hear you right and what materials are moving up? And then I haven't heard anything on nylon, but what do you see possibly moving down or are you seeing move down currently?

The statement was that the third quarter raw material prices are significantly higher than the second quarter. So they've come up. So far we haven't said anything about going forward. What we said about on a forward basis is that the oil prices have come down and it takes a while for it to pass through.

The second part of the question is that if there is a worldwide limitation on certain chemicals and those worldwide demands could create higher prices for here as they ship it through, it could impact the decline that you would normally expect. And we don't have enough information to know what's going to happen. We believe that there is potential for the prices to decline as long as they're not stuffed up with very high demand from somewhere else. And we'll have to see what happens.

Okay. So your raw materials have not moved up from the third quarter into the fourth quarter? They're relatively flat and you're waiting to see if they'll come down, is that correct?

They're only a couple of weeks into this, so --

Yes, great. Okay, thank you.

Thank you.

Your next question comes from [Sam Darkatsh] of Raymond James.

Good morning, Jeff. Good morning, Frank.

Good morning, Sam.

A couple questions. I guess these would be more theoretical than actual grinding down into the numbers. But I wanted to talk about the industry promotional activities that you are seeing, Jeff. I guess theoretically speaking between you and your largest competitor, your listings at the retailers are fairly static and you have a consolidated industry where it's essentially a duopoly. In this type of environment, why would you think that the promotional activity would occur to the degree it did instead of perhaps being a little bit more closer to the vest or I don't want to say rational, but a little bit more maintaining existing pricing levels?

Well, let's start out with the big picture. The big picture is that our retail customers are trying to increase the customer flow into their stores. They're trying to do something. They are looking for ways to stimulate their own businesses, and with that, it creates an expectation that we, as their suppliers will try to help them. And that's normal in these conditions.

The second is, as you have large decreases in your own volume, you try to say how can we stimulate the consumer and you end up promoting more. And it's happened every time I've been in the industry. I've seen it and it happens now. And the question is, you have to continue to try to do that without destroying the infrastructure of the whole business. And it's a difficult line to walk but I mean we walk it all the time.

Got you. Second question would be, in your guidance and in your thinking going forward, are you assuming that demand continues to deteriorate at a faster clip than what you're seeing in the third quarter or are you assuming that the demand would be at similar drop-offs to what you saw in the third quarter? Help us understand what your thinking is in terms of the ramp in demand.

As a piece, the third quarter continued to get worse as we went through it. So if you look at the average, the average is above where the actual activity level was at the end. So we started instead that the activity at the end of the quarter is going to continue. And I don't remember we said it was going to hit a little bit softer than that right here. We might have anticipated going down a little bit more than that but the average is lower than the third quarter.

Okay. And the final question --?

One more piece. We don't have any information to tell us where it's going to be.

Correct. I was just trying to figure out in terms of the inputs into your assumptions how severe a slope are you assuming for fourth quarter demand as to what you saw in the third quarter, that's all.

We're hoping that we're near the bottom of the cyclical piece but we don't know.

Got you. Last question. I guess this would be for Frank. Have you yet seen a deterioration in credit quality from some of the smaller, perhaps less solvent builder customers of yours and adjusted your allowance for bad debts accordingly as of yet or you haven't seen that development?

Nothing as of yet, Sam.

Nothing as of yet. Okay. Thank you, thank you, folks.

Your next question comes from [Eric Bosshard of Cleveland Research].

Good morning.

Good morning, Eric.

Two questions for you. First of all, can you give us any sense with the capacity you've added into tile what you're producing in house now versus what you are sourcing externally?

I can't give you an exact number but I would guess we're probably sourcing about 30%. Could be more or less. I can get you exact number. What happens is the capacity doesn't all come on at one minute and then our sales have been going up. So we've been supplying those. And we have the ability to run all the assets and flooring that we have. We have some specific specialty pieces that we will have some excess in during the period but for the most part, all of the flooring, which is a flooring tile which makes up most of it, we are expecting to continue to run straight through.

Related to that the margins in tile since 2002 have been in excess meaningfully of what you've earned in the Mohawk segment. And now that you've seen softer volumes, and you haven't really defined it, but can you talk about your ability to sustain the mid teens kind of operating margin in an environment where you've closed some capacity and industry volumes seem like they're softer?

If you look through this year, the things that impacted it were higher freight costs and getting those passed through, investments in -- the reason the business is doing as well as it is, each year we invest in sales people, products, merchandising, marketing substantially more so that it impacts the business in the future and so we continue investing in those. And that had some impact in it. This year, when you look over the whole year, you'll have the $6 million shutdown.

You'll have the investments we've made with starting up the other plants. And if you take those out, I think this year, the margins for Dal-Tile will be in the low 14% range. Once you add back the close down on average for the year. And what we hope for next year, is that we'll be able to improve that slightly. And the reason it's slightly is because all this will have the flow through of the things we've done this year, but we have no intention of slowing down. We're continuing to invest in the business for the long-term future and continuing to try to gain more share in the marketplace.

I guess the question is you think that or you believe based on your position in tile that that business is going to always earn a meaningful premium in terms of the operating margin relative to the carpet business?

Yes.

That's just the nature of the business?

They're different business models.

Okay. Okay. Very good. That was my question. Thank you.

Your next question comes from Keith Hughes of Robinson Humphrey.

Thank you. Just a follow-up on the promotional activity, kind of when you look within the flooring retail stores, your residential replacement business, is this kind of situation where to your earlier point you're discounting on certain skews, certain price points as opposed to across the board cuts on price, is that correct?

That is correct. And I would--and in many cases, it's actually products that are different than the one you inventory, also. In addition to isolating it.

To what you said earlier, every time you go down to the slowdowns in the carpet business for probably a long time you usually see this type of activity. Is that fair to say?

It is. In addition, which I've said historically, there's always this type of activity going on even in the good times. And what happens is, historically in the good times we use it to balance our assets with the sales level, with the customer sales and try to move them to balance our assets with the sales level. As this slows down, you continue doing that and you try to go ahead and create additional consumer demands.

Yes. And I guess finally, are you seeing more pressure on the builder side of your business right now?

We're seeing -- with the --

On pricing, on pricing.

On pricing? I mean, the builders, their business has slowed down. They're trying to get participation by anybody they can get participation from to help subsidize themselves, and that's the way business works.

All right. Thanks, Jeff.

Your next question is from [Steven Fockens] of Lehman Brothers.

Good morning.

Good morning, guys. Just two quick questions. First on Unilin, did I hear you right that same-store volume growth year-over-year was 4%?

Correct.

And what's the split there -- ?

That was on a constant exchange rate in taking out non-recurring things in the third quarter.

Okay. Thanks. What was the -- if you were to look at U.S. versus Europe, how would that break down?

The U.S. business grew faster than the European business.

Was U.S. double digits?

No.

Okay. And then secondly in terms of the distribution opportunities for laminate here in the U.S., is that at this point more on the big box side or more through the independent channel?

Yes.

Or both?

What happened is we are -- we're putting a new brand into the marketplace on the independent channel, which is the Mohawk branded pieces. It's going to take us about a year or more from the time we bought them to redevelop new products, to implement them through manufacturing, to put the displays out in the field and get the customers to start using them and we just got through the first phase. We'll have the second phase through by the end of the year in the stores and it will be back on track with normal introductions at markets that we normally expect. So that's growing.

We have continuation of the Quick-Step brand through the independent specialty store distribution. And then we have different projects going into the other distribution channels including home centers and others through increased share in those channels which we had minimal participation in as Unilin.

Great. Thanks very much.

Your next question comes from [Arnold Brief of Goldsmith and Harris].

Two questions. One, recognizing that the business is dominated by cut orders, but could you have any feel to what extent the decline in manufacturing and overhead absorption is relating to inventory adjustments, both at retail and manufacturing? And the second question is, is there any ability to quantify the degree of cost cutting?

We believe that the customers are being more conservative about the part of the business they're inventorying. If you get into the large big box retailers, I think across all channels, they're doing things to postpone new introductions and reduce inventories, which is impacting us as well as everyone else in the industry. I don't have any empirical data, but I would presume the same thing's happening with the large contractors' inventory product as well as other retailers that they're being more conservative in their inventory levels. So that's there. I forgot the rest of the question.

I guess what I'm trying to get at is, in terms of manufacturing, how much is inventory reductions versus actual slowness of consumer demand?

Well, I mean, what you see is that our inventory turns from the second quarter to the third quarter, we've been able to maintain them. So we have kept the inventories in line with the present volumes, which is difficult, which means we're running the plants to make that occur and it's creating down time in the facilities. But we don't see any reason to leave them high or to run them up higher and have to take it out later.

So if demand picks up in the fourth quarter a little bit, the -- your inventories are really running for a lower level of sales? Manufacturing may have to pick up fairly quickly in these --

Manufacturing would have to raise to support those levels.

Okay. And the cost cutting, can you quantify it at all? Give us in the ballpark.

I mean, that's a lot of it is that is -- goes up and down with the production as we reduce shifts and people and the production facilities. We're doing those things to keep the costs in line with the historical costs per unit as best we can. We are -- I can't give you any costs in each department. We have cut people in every department. We have looked through the sales forces and said how much -- which guys are not paying their weight in the pieces or not. And we've taken out the poorest performers at the bottom of it. We have reduced the number of new products we're introducing. We're putting in -- this year we had higher sample costs as you can tell in our SG&A because last year there was a major change in the raw materials supplies, so we reacted by having to put in new products and restructuring the product line.

So that created higher sample costs. And we probably got more aggressive than we needed to be. We have the introduction, the Unilin laminate which means we had to throw out all of the laminate in the Mohawk system and put in more. And all of those things created a higher SG&A cost. And we're taking each piece of it and trying to put it in place. But the reverse side is, if business picks up in the next 30 days or next six months, we can't destroy the infrastructure to support the business. And I can't give you exact numbers on each piece. But we've given you the earnings per share expectation, which is the result of all those changes.

Thank you.

Your next question comes from [Bob Thompson of Advantis Capital].

Hi, guys. Most of my questions were answered. But I wanted to clarify the CapEx budget for fourth quarter and if you have any early estimates on '07? And then also, just your bonds coming due in '07, $300 million due in April. Any plans to refinance those?

I think we said the CapEx for the year is going to be between 220 and 230. Nine months we've been 124. You can do the math on that.

Okay.

And then the bonds, at this point, we really -- haven't really considered anything other than just rolling them into our revolver.

Okay. Any early estimates on '07 for CapEx?

No. We're still working through that right now.

Okay. Thank you very much.

Again, ladies and gentlemen, to ask a question, please press “*1” on your telephone key pad. Your next question comes from Frank Dunau of Adage Capital.

Yes, just a quick question. I think at some point in the call you said Unilin's costs are going to rise third quarter to fourth quarter, material costs. I'm trying to figure what raw materials are rising?

We have our wood prices in Europe are rising. Our melamine are rising. Our energy and electronic costs are all rising.

And just on Unilin, what's the rough breakdown now about U.S. versus Europe in terms of sales?

One-third/two-thirds.

Thanks.

There are no further questions. Mr. Lorberbaum, do you have any closing remarks?

We're in a cyclical downturn. We are taking the necessary steps to minimize the impact without destroying the long-term capabilities of our business. We think we're acting very rationally. And we believe we'll get through this. And we believe that we are set up in order to have a very strong long-term that is more diversified than it has been in the past. And we think that it will enable us to maximize our returns to our shareholders. We appreciate everyone joining us, and have a nice day. Ladies and gentlemen, this concludes today's conference call. You may now disconnect.