莫霍克工業集團 (MHK) 2007 Q4 法說會逐字稿

Good morning, my name is Heather, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Mohawk Industries Fourth Quarter and Year-End 2007 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.

(OPERATOR INSTRUCTIONS)

As a reminder, ladies and gentlemen, this conference is being recorded today, Thursday, February 14, 2008. Thank you.

I would now like to introduce Jeff Lorberbaum, Chairman and CEO of Mohawk Industries. Mr. Lorberbaum, you may begin your conference.

Welcome to the Mohawk Fourth Quarter and Year-End 2007 Conference Call. With me I have Frank Boykin, our CFO. Would you please read the Safe Harbor statement?

I'd be glad to. 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 Industries' fourth quarter earnings were $379 million, and earnings per share was $5.53, including a one-time tax benefit. Excluding the one-time tax benefit, net earnings were $108 million, and earnings per share was $1.57. Net sales for the quarter were $1.8 billion, a decrease of 5% from the prior year. The one-time tax benefit was required by US GAAP and a result of international restructuring, which will reduce our taxes long term. Frank will give more details in his review.

Sales were impacted favorably by the Columbia Wood Flooring acquisition, exchange rate gains, and growth in the Dal-Tile segment which partially offset other sales declines. Cash flow from operations continued strong at $273 million, and an additional $189 million of debt was paid down during the quarter.

During 2007, we endured a difficult US housing market and rising costs in the United States. For the year, our earnings were $707 million, and earnings per share was $10.32, including the one-time tax benefit of $272 million, a pre-tax benefit from a customs refund of $9 million, and a one-time pre-tax closing cost of $14 million. Net sales for the year were about $7.6 billion, a decrease of 4% from 2006. Sales were favorably impacted by the growth in the Unilin segment, exchange rate gains and the acquisition of Columbia Wood Flooring which partially offset other sales declines.

We closed several plants in all divisions to position us for the future. We implemented an international tax restructuring during the year which has reduced our tax rates on an annual basis from 32.6% in 2006 to 28% in 2007. Based on the international earnings, our tax rate should fall to about 26% in 2008. We are managing our working capital investment through this cycle and for the year had cash flow from operations of $875 million.

We also reduced our debt by $534 million. Our debt-to-capital ratio has continued to improve to 33%, providing us significant flexibility for future opportunities. Our management team handled in the US many challenges as the flooring market continued to decline. The industry softened with falling consumer confidence, employment deteriorating, credit availability tightening, and home sales declining.

The European economy was good but has begun to slow. Energy and raw materials have continued to increase and pricing actions have been executed across our businesses. We made adjustments in our business strategy during the year and continue to adapt to the changing environment. Frank, would you please give our financial report.

Yes.

Net sales for the quarter were $1.8 billion, down 5% from the prior year. Our commercial business and our European laminate businesses both grew while the US residential market impacted sales declining and then also our other boards and roofing business showed a decline in Europe. Gross profit for the quarter was down 190 basis points at 27.3%, impacted primarily by lower volume in residential products and higher costs across most of our businesses. SG&A came in at $309 million, or 17.4% of sales. SG&A dollars were actually down about $16 million from last year due to initiatives that we put in place and also impacted by lower marketing cost. Operating income of $181 million at 10% of net sales.

Interest expense and other expense came in at $36 million for the quarter. Our interest expense was down due to lower levels of debt during the quarter, and other expense was down during the quarter due to gains and foreign exchange in 2007. Our income taxes before the tax benefit were about $37 million. This represented a tax rate of about 25.5% compared to 31.5% last year, impacted by a lower tax rate due to the European tax planning structure that we put in place last quarter.

As Jeff had mentioned, we expect a 26% tax rate going forward. Our earnings per share before the tax benefit were $1.57, down 17% from last year. Our earnings per share after the tax benefit of $5.53 were benefited by the tax restructuring. That benefit was about $3.96 a share during the quarter.

During the fourth quarter, we implemented a change and restructured our organization in Unilin. Our tax records did not originally reflect the market value of our assets when we purchased Unilin. We made certain structural changes in the Unilin legal structure that allowed us to step up the tax basis of these assets and we'll benefit from that over the future.

If we look at the segments, the Mohawk segment sales at $968 million were down 13% due to a slower residential market. Operating income came in for the Mohawk segment at $70 million or 7.2% of sales, due to lower volumes and higher costs. The Dal-Tile sales were actually up 2% at $468 million, with their commercial and high-end residential businesses performing well. Operating income for Dal-Tile at $62 million represented about 13.2% of net sales.

The Unilin sales came in at $394 million, up about 21% over last year. If we exclude the Columbia acquisition, sales were up 7%, with FX, foreign exchange impacting us favorably by about 10%. On a constant exchange rate basis, sales actually declined about 3%. Operating income for the Unilin segment came in at $59 million or 15% of net sales. If we exclude the Unilin operations which unfavorably impact or the Columbia operations which unfavorably impacted Unilin, the operating margin came in at about 18.3%. Within the corporate and elimination segment, our operating loss was about $10 million. And the difference between this year and last year was primarily timing, with the year-to-date amount of about $35, being in line with the prior year.

If we look at the balance sheet receivables of $821 million, our day sales outstanding of about 43 days, slightly up from last year. The days are up because of the Columbia acquisition and also because of the change in our business mix with a higher mix towards Unilin that has higher days.

In addition, our inventory days were at about 90 days compared to 88 days last year. And if we look at inventories without Columbia, they would have been down about $61 million from the stated amount. Fixed assets were about $1.9 billion.

Capital expenditures for the quarter were about $65 million, with depreciation and amortization coming in at $82 million for the quarter. We are estimating that capital expenditures for next year or for 2008 will come in at about $300 million. That's our original budget.

However, with the current environment we're expecting it could be less than that. Our depreciation and amortization for the year, for 2008, is estimated to be $300 million. Our debt-to-capitalization was improved at 33% over last year, and then if we look at our debt reduction, it was down $190 million for the quarter.

Going into 2008, I'd like to point out several things that will favorably impact us during the year. As we've talked about in the past, our tax rate will be improved at 26% compared to a 28% rate in 2007. We're also expecting a favorable foreign exchange impact.

Last year, the average exchange rate was about $1.38. And we expect interest to be lower as we continue to pay down debt and then our intellectual property amortization should also be lower by about $20 million during the year.

Thank you, Frank. The US economy is slowing with the housing and flooring industries being among those most affected. Credit markets, lending standards, and declining housing prices have all contributed to the present cyclical downturn in the flooring industry. The concern about the overall economy caused the Federal Reserve to cut rates significantly and increase liquidity which has reduced mortgage rates. Congress has a stimulus package which should increased consumer and business spending and can help the housing market in the future. We can not predict the cycle bottom but pent-up demand from consumers postponing purchases will cause a rebound in the residential remodeling market when the economy improves.

The European economy has been running at above average growth rates. Currently, Europe is being impacted by tightening credit, a stronger Euro, and higher energy which is causing the construction and remodeling industries to slow. Eastern European and Russian economies are expected to grow at above average rates this year.

Our three segments are managing this environment with many initiatives for reducing costs and improving revenues and margins. The Mohawk segment has been impacted the greatest than the other segments with sales down 13% and operating margins of 7.2%. Sales declined as industry conditions have weakened. The commercial channel outperformed the residential channel and the trend is expected to continue for the foreseeable future. We aggressively dropped more products than normal last year as industry volume fell.

In commercial, we have a higher share of broadloom carpet which is being impacted by the growth in carpet tile. To improve our sales, we introduced more high-volume products in the fourth quarter and are delivering our 2008 introductions earlier than normal. We've introduced the new wonder weave collection which has been accepted and will improve our high-end carpet sales. We put more emphasis on the multifamily channel with specialists across the country, and are introducing more carpet towel products in our commercial brands. Increased sales focus is being put on the commercial multifamily and high-end residential channels which are expected to perform better in the current environment.

We are right sizing the business in all areas. There are many initiatives to improve productivity, yields, and working capital. We are in the process of adding extrusion capacity to replace higher costs to assets and give us additional flexibility. Raw materials have escalated and we announced a carpet price increase in December and have made further adjustments to it in January based on a changing environment. We announced an increase of 6% to 8% in carpet which will take four to six months to implement. We have discontinued production in our flat woven plants as well as the yarn plant. The exit of the woven business will reduce sales by about $40 million this year.

In the Mohawk segment, the hard surface products had greater penetration in the new housing channel and have been more affected than our other hard-soft surface products. In addition, some of our ceramic sales have been transferred to our Dal-Tile division to give our customers broader choices and improve our inventory turns. We've also announced increases on many of our hard surface offerings to cover the rising costs of the products and logistics.

Our 2008 Mohawk regional product shows have been well attended. Our customers who inventory products are being more conservative in their purchases this year. Even under the current environment, our accounts receivable quality remains good with our exposure spread over thousands of accounts.

In the Dal-Tile segment, our sales in the fourth quarter were up 2% over the prior year, substantially exceeding the industry's performance. Dal-Tile is focusing on the commercial and higher end residential, which should do better in this cycle. We have implemented a price increase to pass through energy logistics and other costs. Earlier investments in SG&A are enabling us to outperform the market, but they are impacting our margins.

In 2007, we opened six new service centers and galleries. The Mexican market continues to expand, and Dal-Tile is growing by focusing on the premium ceramic categories. We've closed a high cost ceramic facility in the US in the quarter and reduced outside purchase of ceramic, resulting in better utilization of our plants and control of our inventory levels. New systems have been purchased to improve the operations of our local service centers and the inventory management. Many initiatives are being implemented to reduce costs, improve productivity, and manage SG&A expenses.

Last year, we received a custom refund of $9 million in the first quarter, and we don't anticipate the same occurring this year. We've completed the introduction of a new exterior collection of porcelain and stone tiles. These extend the interior living areas to the outdoors, and we believe it will offer a nice, new niche.

Unilin has had excellent results for the full year, with operating earnings increasing by 27% over last year. Excluding Columbia, the sales were up 15% or 7% with a constant exchange rate, and had operating margins of 19.7%, 240 basis points above last year. Unilin sales in the quarter were 20% above the prior year with an operating margin of 15%. Without Columbia, Unilin sales growth was 7%, and operating margin was 18.3%. In local currency, Unilin had a sales decline of 3% excluding Columbia sales. This comparison is extremely difficult due to the 34% sales gain in the prior 2006 period.

Our European laminate business grew with US laminate and other European board businesses declining based on the local currency. We're being impacted by the contracting US residential industry, along with the slowing European building and remodeling sector. Volume and margins have weakened in some of our European roofing and other board channels. Lower laminate industry volumes are also reducing patent revenues. We're adding infrastructure to expand our penetration into Eastern Europe and Russian markets which are growing faster. We've completed the transition from the outside laminate suppliers to Unilin-manufactured products for the Mohawk brand.

Unilin is also experiencing raw material increases and has implemented price increases in many product categories. We continue our innovation with a new laminate in Europe that's water resistant, and another which is easier to install with random links and improved sound absorption. The new US laminate flooring capacity should start production late in the second quarter. The equipment will produce higher value products in the US which will improve our production costs and enhance our service and inventory levels. The Columbia integration is progressing but anticipated volumes are being impacted by the slowing industry.

The wood plants are improving productivity, quality, and cost. New processes and equipment changes continue to be implemented in the facilities. New products are being introduced to replace outside purchase product, to fill in product voids, and to offer higher style options. The Unilin systems will be implemented in the wood business in the first half of the year to give us greater control and flexibility. Our US wood management team is in place to execute our strategies, and we're finalizing our European wood team to drive our Malasian sales. The Malaysian plant manufactures long strip engineered wood which is popular in Europe where a significant portion of the sales occur.

Under our Mohawk green works umbrella, we continue to enhance our sustainability efforts in all divisions. Green works entails such wide-ranging initiatives as reclamation of post consumer carpet, the development of recycled material into our flooring products, programs to lower greenhouse gas emissions, as well as reductions in energy and water usage, and designing products that can be reused for another life.

In the first quarter, the company is expecting the US flooring industry to continue its decline and the European building and remodeling sector to soften. Material costs are rising, even though the industry volumes are falling. We have reduced production in the plants in the first quarter due to lower customer demand and both our customers and Mohawk are not building inventory as we have in prior years. With the current conditions, we're reducing our infrastructure cross further and increasing prices which will lag the rising costs. Based on these factors, earnings guidance for the first quarter of 2008 is from $0.81 to $0.90 earnings per share.

The second quarter earnings are expected to improve and be more in line with last year's. We anticipate sales and earnings will benefit from higher seasonal sales rates, increases in selling prices, reduced infrastructure costs, and favorable foreign exchange. Postponed flooring purchases by our customers during the past cycles have resulted in an industry rebound when the economy improves. 2008 will also benefit from lower intangible asset amortization, lower interest expense, and lower tax rates. We continue to focus on managing our business through this cycle. With that, we'll be glad to take questions.

(OPERATOR INSTRUCTIONS) Management requests that you limit your questions to one primary and one follow-up. (OPERATOR INSTRUCTIONS)

Your first question comes from the line of Dan Oppenheim with Banc of America Securities.

This is Mike Vaughn for Dan. I was wondering, could you provide a little more color on the order trends you've seen since you announced the price increases, just given, last summer we saw a pull forward and demand pulled forward only to see it drop off afterwards?

I think we're projecting the industry to -- we're still anticipating the industry to decline. We're in a moment in time where it's very difficult to read the order entry rates because January sales levels are always off significantly, and with markets and timing of markets as well as the price increase, it's difficult to interpret those today. I mean, we don't have a clear indication that they're --

And I guess it seems that the comment about fully implemented in four to six months, that seems a little more drawn out than we've seen previously. Is that an attempt to kind of just ease into the price increases and minimize that effect?

No. It's the same thing we've been saying since I've been here is this. So it's typical of what we've always said.

Okay. Great. And one quick follow-up. Could you quantify, you know, the reductions in SG&A that you're targeting there, and what we could expect for modeling purposes?

We're still in the process of putting together all of those right now. And we don't really have a good number that we can show you at this point or talk to you about at this point. It's an ongoing process.

Okay. Great. Thanks.

Your next question comes from the line of Keith Hughes with SunTrust, Robinson, Humphrey.

Hello?

Mr. Hughes, your line is open.

He must have changed his mind.

Your next question comes from the line of David MacGregor with Longbow Research.

Hello, there is actually Shawn Ross in for David MacGregor. How are you guys doing?

Excellent.

Good morning.

Good morning. I had a quick question. Could you walk us through on your assumptions for the second quarter on how you plan to get back to -- in line with 2Q '07? You're going from first quarter guidance of $0.81 to $0.90 cents and going back up to $1.60 to $1.70.

I mean, to start out with, our assumptions are that the industry is still declining. That we had lower production rates in the first quarter as both Mohawk and the consumers are being more conservative than they are. There's the lag in the pricing of our products which the costs are being affected much more in the first quarter, but the pricing's not.

As we look for the rest of the year, we see that Unilin's improvement is not going to be quite as much as historical, but we think -- so it won't help us quite as much as in prior years. The actions that we're taking are we're cutting the infrastructure costs, we're improving productivity. The price increases as we've already mentioned, the accelerated product introduction. And then the normal thing to happen is we have a higher seasonal sales as we move through the year.

Now, what we said was that we expect the second quarter to improve from the first quarter, but we still expect it to be below last year. We said we expect it to be more in line. We didn't say we expected it to be the same.

Okay. And can you give any more insight into that number by business segment unit? Can you break it down Unilin vs. Mohawk vs. Dal-Tile?

I don't think I'm prepared to do that at this point. We just give one quarter worth of direction. And we just give the operating margin for the business, the earnings per share.

Okay. Okay. Then final quick question is can you talk about the revenues, profitabilities of products that you manufacture versus products that you're just distributing?

I'm hesitating because I mean we have a lot of different products and categories, and they're all different from each other. I don't really know how to answer the question. I mean, we have a lot of products in each of the divisions that we purchased and that we sell. And they're all over the place.

Okay. How about as consolidated, is it trending up or down in percentages of distribution in the past quarters?

We don't have that information in front of us.

Okay. All right. Thank you very much.

Your next question comes from the line of Sam Darkatsh with Raymond James.

Yes, this is Jeffrey calling in for Sam. Good morning, guys.

Could you speak a little louder, please?

Is this better, Frank?

Yes.

Okay. My first question relates to collect ability and if you've seen any change there versus what you were describing in Q3 and Q4. You know, both from the builder channel and then from some of the smaller, independent retailers and stores and that kind of thing.

We've not seen any change in terms of the quality of our receivables. As Jeff had mentioned, remember, we've got thousands of customers and there's no one customer that comprises more than 5% of our sales. And we don't actually sell directly to the builders. We sell to contractors and dealers that sell to and install to the builders. So, I think overall, our accounts receivable agent is still in pretty good shape right now.

Okay. Next question, you mentioned that you expect favorable foreign exchange in Q2. What did you mean by that?

Well, if you look at the exchange rate now, I mean, it's moving around. But it's 146, 147 today. Between the Euro and the dollar. A year ago, which is what we would be comparing to in Q2, it was in the mid-130's. And so when we take our European operations and we translate those into dollars, year-over-year, we should have a benefit.

But on a year-over-year basis, you should have been benefiting for the last --

Exactly. We expect to continue to have a benefit into the second quarter as we had in the past.

Okay. Understood. My final question relates back to the tax benefit. Can you help me understand what you're talking about there? It sounds like you're basically just taking your cost basis up on some of the Unilin assets. So if you -- is it if you decided to sell those assets, you would pay lower taxes on them? Is that what you're saying?

Yeah. In essence that's what we're saying, we increased the tax basis of our assets. And that increased basis is going to allow us to take a larger for tax purposes amortization deduction.

But it will affect it on an ongoing basis, not if we sell it.

Understand it. Relates to the amortization. Thank you.

Your next question comes from the line of Laura Champine with Morgan Keegan.

Hi, guys. This is actually John calling in for Laura. Can you hear me?

We can.

Okay. Can you comment on your inventory build in Q4 that came on as sales decline. And then maybe comment about some of the progress we see with inventory in Q1, given that you're probably looking at some year-over-year sales declines also in that quarter.

Let me address the first part of the question. And then maybe Jeff will address the second part. On the first part, if you look at inventories at the end of Q4, and as I mentioned, it's about $60 million of [inaudible] for Columbia.

Columbia, okay.

You kind of back that out. When you do that, our terms, are pretty much flat year-over-year.

So we don't -- if you extract the wood business, the inventory didn't increase.

Okay. And you expect -- what's your outlook for Q1 would be --

We're trying to not let them increase as much as they have in the past.

Okay.

We're trying to maintain control of the inventories.

Can you also comment on the commercial side? I mean, we get monthly data on the residential housing market. But do you see any weakness in commercial construction markets because it seems like recently there's been some concern over that market?

The commercial market appeared to still be doing reasonably well. They tend to track differently because the large projects are done way in advance. Once you start them they continue through completion. And so if you look in cycles, the commercial business when the economy goes down, it won't trail off for at least six to nine months, and sometimes longer after it. So at this point, it's continuing reasonable, and most people believe it will do okay this year but will tend to soften as we move through the year.

Okay. Thanks, guys.

You're welcome.

Your next question comes from the line of Ivy Zelman with Zelman & Associates.

(inaudible) of 2Q and think about the expectations you're forecasting for new residential, do you see sequential improvement and kind of quantify what your expectations are for repair and remodel for the industry that assuming we could get a better framework, if you're looking for things to get better. Or are you thinking that housing activity is still going to be down year-over-year 20% as most are expecting for housing starts kind of quantify some of the expectations in the end markets?

Let me just make sure we're starting from the same point. We don't expect the business to be much better. What we said was we expected the seasonality which normally occurs from first quarter to second quarter to still occur. So the improvement we referred to is not in the industry versus the historical. It's improvement in sequential that first quarter's always low. And second quarter's always better. So are we starting --

Okay, so your year-over-year, you're still assuming new construction will be down and I guess quantity -- can you quantify that, what you think it would be and what repair and remodel might be for year-over-year declines?

We don't have any better information than the marketplace does. The marketplace is assuming that new houses will be down to 900 to a billion units. And we don't have any other reference points than you have in the general market. We're using the same one.

Okay. Second question relates to CapEx. Did we hear you say that you spent $160 in '07 and you think you'll spend $300 in '08? If so, can you give us an explanation of what the increase would come from? Is it the new plant for wood products in the US?

We start out every year with a plan that we've put in the budget. And the budget anticipates what's going to happen on a certain set of circumstances. As we go through the year, we keep adapting it as it changes. And our plans is -- when we make the plan at this point, it takes a long period of time to put in new capacity in many of our pieces. And in the plan was investments in new capacities in ceramic as well as new capacities in laminate. Replacing higher cost extrusion capacities and investing in other cost improvements within the business.

Now because of the length of time it takes to put these in, which in many cases is two years or greater, you have to anticipate what's going on. So in the plan are those investments. We haven't turned any of the large ones through, which is the same thing that happened this year.

This year we started out with about a $300 million plan, and what we did is we didn't turn loose these large, new plants for future because we read the economy and said that we thought it would be longer before we would need them. So we're starting the year with the same expectation, but we're not going to turn those new capital investments loose if we don't see us needing them. But you have to put them in place before you need them.

Your next question comes from the line of Michael Rehaut with JP Morgan.

Hi, guys. This is actually [Ray] calling in for Mike. Good morning. Want to talk about your uses of cash. Looks like you guys have pretty good flexibility right now. Looks like historically when your net debt to cap got down to about 25%, you did the Dal-Tile and Unilin acquisitions. You're at 32% right now. What kind of opportunities are you seeing in the marketplace now, and when do you think it would make more sense to just repurchase your own shares since your EBITDA is only seven times now versus eight times historically?

We think we're in an excellent place given the environment. We think that having cash available is the right thing to be at today. And it gives us a lot of flexibility. You know, we just got through with the capital expenditures. It gives us the availability to invest heavily in capital expenditures and futures if we determine it's the right time. And you're right, the two big pieces are with the capital either to look at acquisitions or to buy back stock. And we like having the flexibility that whichever one of them appears to have the most value to the business we have the cash that enables us to do that. We don't have a specific acquisition or a specific price point that we will invest in. We take the opportunities as they arise, and all of the basic information we have at that point and determine which one makes the most sense. And it's a continuing changing analysis.

The acquisitions, I think, some of the multiples we perceive are coming down as the cost of high-risk debt has gone up. Some of the valuations are coming down. So we believe there will be or could be some opportunities over the near term that we might want to take advantage of. So we're leaving -- so we believe we're in an excellent position to go whichever route makes the most sense.

Okay. Are there any opportunities in eastern Europe or Russia you're seeing now, or would that kind of be organically groomed for you guys?

We have looked at some. If you get in those marketplaces, the businesses that are there are smaller so they're not going to be large ones. And in some of the cases, there's other risks associated with them. So if we do anything in those markets, it will be more limited. And not have a dramatic effect impact on our business.

Your next question comes from the line of Eric Bosshard with Cleveland research.

Good morning, this is Mark stepping in for Eric. First question, can you guys give a little bit more color on your organic growth within Unilin in the US and Europe. You mentioned Europe grew and the US contracted. Can you kind of compare the numbers this quarter to what we saw in previous quarters.

I'm not prepared to break down product by product for you in the markets. You have to understand first, again, that the year-ago fourth quarter we had a 34% gain in the quarter, which is highly unusual and unsustainable. So when you compare the fourth quarter this year to that, I think we had a good quarter, but that last year's was so off the charts and unusual that our results were good for where we are.

On a local basis, we said that we had a decline of the volume after you take out everything with it of about 3%. Then within that one, you have the piece that grew with the European laminate business. And we said that the other businesses which is the US laminate business and the other European roofing and board businesses declined slightly versus the comparison in the prior year.

In terms of Europe, though, the laminate business in Europe, can you talk about the slowing sequentially from 3Q to 4Q, give us a sense of the magnitude.

I mean, I guess a few percent.

Thank you. And then secondly, have you seen anything different, talk about price increases across the business. Have you seen anything different from your peers which suggests you -- maybe your ability to realize price is less with volumes continuing to contract more than expected?

I think that we are attempting to put pricing increases through in all product categories and all marketplaces, and every one of them has its unique set of circumstances. There are different competitors in the various product categories. There's different circumstances by geographic region. We believe that all of the industry is under great pressure to put through price increases in most categories. As you would suspect, the more commoditized an individual product is, the more pressure on it. And the less commoditized the less pressure it is.

The customers don't like it in any market, in any place. It's difficult to push them through. I think we have the highest cost rises in the carpet side. The carpet side of the business has all its raw materials are oil based. We use a lot of energy to process it. You have distribution costs to do it. And the carpet industry over the last three or four years has continued to push through prices in a declining marketplace. This year there was a 6% to 8% increase announced in the carpet industry, which was led by my competitor in December. The industry has all followed with increases. And we're trying to execute those as we speak.

Your next question comes from the line of John Baugh with Stifel Nicolaus and Company.

Yes. This is Joe Herrick with Gutamer Research. You talked a lot about production being down, less demand, inventory build-up. Obviously this year is going to be very challenging with coming along of others in this economy. What are you guys doing in terms of operational improving initiatives to revolving around Lean and Six Sigma to improve throughput throughout your plant and what benefits do you expect to see?

We have a tremendous amount of effort in every facility, in every business around improving productivity. Those productivities, Lean is a concept of how to get the total business from the floor up through the management all on looking at the total processes and making them more efficient. We have changes in the processes. We have changes in the information that's flowing through them. We have moved equipment between facilities in order to make the costs less. We have taken out and are using the highest cost equipment the least and have mothballed it. We are reducing shifts. We've shut down plants.

We have gone back on -- and looked at the infrastructure costs we have in both all the SG&A prices and continued SG&A costs and tried to reduce those as we go through. We also have high material usage. So you look at the material usage and try to improve the material yields. You try to find alternative products and substitute lower cost products to improve your cost structures. All the way down to things such as energy usage, water usage, as well. So there are innumerable projects going on under those umbrellas and every one of the businesses that we have.

What metrics are you using in your manufacturing process to measure your success? Obviously right now it's going to be very challenging. How are you going to measure success for 2008, and regarding your plants, which -- in what parts of the world do you have more concern with throughput than others? Or is it overall throughout all the business as a whole?

As the results show, we have a greater decline in our Mohawk segment. So the Mohawk segment is having to adapt to them more aggressively than the others. So within it, it has many more pieces to adjust to not only increasing productivity but then adapting to the lower volumes that we have. But we have the same thing in the Dal-Tile business in the fourth quarter.

We closed a ceramic plant. We closed a yarn plant in the Mohawk division. We closed some assets in our European division. And those were closures, then underneath that as smaller pieces, we are taking out the highest cost equipment to do those. So -- and there's hundreds of these things.

Your next question comes from the line of Carl Reichardt with Wachovia Securities. Mr. Reichardt, your line is open. Your next question comes from the line of [Daniel Donato] with [inaudible] Global.

How's it going?

Good.

Question, this regards the Unilin intellectual property income. I mean, I've heard figures all over the place, some of which are pretty significant. I was hoping you could tell us what percentage of Unilin's operating income is due to IP royalties.

Again, we don't break out individual product categories or pieces of any of the pieces. The only data we've ever given out is when we purchased the company, that those incomes were about 5% of the -- not the incomes, the revenues made up about 5% of the total at that point. So we haven't broken them out. The thing that we tried to get through is that the revenue stream is based on the industry's volume, and as the industry volumes come under pressure, it's also affected the revenues and the IP.

Right. But what's important is the margin, right, because assuming that it is like a royalty stream, it's pretty much just money in the bank.

They were not exactly. People don't pay you IP income because you just show up. We have a high overhead structure in enforcing and legal fees. It's not unusual to spend $5 million to $10 million on a single case for IP's invested and we have them all over the world.

Yes. Back when you first acquired it, did you disclose what the actual operating income attributable to the royalties were or just the revenue?

It was just the revenue at that point.

Just the revenue.

Your next question comes from the line of Steven East with Pali Capital.

Good morning, guys.

Hi, how are you?

Good. Couple questions on your assumptions. Your guidance for first quarter. I realize you don't give specific detail about how you get to it, but can you talk a little about the moving pieces between sort of revenue assumptions versus raw material costs being escalated year-over-year versus I guess the lack of overhead absorption by slowing down your facilities et cetera to control your inventories.

I'm trying to figure out how to answer it given we have multiple segments, multiple products and multiple pieces. I mean, there's -- it's a very complex business today. The assumptions I guess start with a high level are that the US economy is continuing in a difficult environment. That the difficult environment is going to continue. That the US business is -- the flooring industry is in a cyclical recession and will continue. That the European business is starting to slow and that we think that the laminate business, in Europe, will continue to grow but at a slower rate. That the other businesses in Europe will decline at this point.

The ceramic business in the US is affected by the same pieces. I'm very happy that we were able to grow the revenues 2% in the fourth quarter. It's going to continue to be difficult to have positive results in the US. Given the environment we're in, the ceramic business. A lot of the ceramic business goes into the new construction business. And we've been able to grow the other categories to offset it. The carpet business is affected by the same recessionary environment. And, we're assuming that it's going to be in a decline, in a continued decline over prior-year results.

We are finding that the customers that use, in the first quarter, the industry has typically does promotions, and we're finding that our customers are not being as aggressive in their purchasing of product because they're also concerned about the future, so with that, there are lower order rates in the first quarter. What else can I tell you from there? The raw material costs in all the businesses are going up. We are raising, the raw materials are going up before we execute the prices in the marketplace so there's a lag between the time we receive them and all the businesses, every one of the businesses is trying to raise prices in its various categories and different amounts depending upon where they are. There are also distribution costs that we're trying to pass through in each of the businesses. We do not know if the raw material costs are going to go up more or down more at this point. What else?

The overhead absorptions, I guess go back to the running of the plants. I think that the business has done well in controlling the inventories and holding the terms about the same as where they've been given the environment we've been in in order to hold the inventory terms the same over time, that means you have to produce less than the incoming order rate because you have to not only produce the -- you have to reduce the inventory with that, and that impacts the overhead absorption. So we have the pressure of both on it as you try to maintain those inventories. And we've assumed that we're going to continue trying to manage the business as we've had the last 12 months. In a very difficult environment.

Your next question comes from the line of Alex Mitchell with Scopus Asset Management.

Good morning, guys.

Good morning.

Let's see. So you sometimes have broken out just how much you would have to recapture to get even on costs in the Mohawk segment. Are you able to do that?

I'm not exactly sure what you're asking.

I don't remember doing that --

I don't remember what it is, but I'm not sure what you want.

On the cost push in Mohawk, how much would you -- how much would price have to go up to recoup that?

That is not a number we've talked about in the past.

The industry --

Rough percentage terms, please.

You have two parts. One's the material cost, and one's all the overhead pieces. The price increases we typically try to get the raw material cost in this environment. If you can get slightly more than the raw material costs, you've done an excellent job. And that's what we're attempting to do and we'll know when it's over.

We've put out price increases. The marketplace adapts to them, you have to stay competitive with the changes. It depends on the actions of our competitors in the marketplace. We hope they act in a rational manner, and push through the material costs. But we have to stay competitive for the environment and we're attempting to do so.

Okay. And can you talk about some of the -- you spoke about seasonally the business should be up first quarter, second quarter. Does that also apply in Europe with Unilin, and did some of the weakness that you've seen affect that at all to date? The weakness you've seen to date?

It's typically second quarter is always better than the first quarter. So we would assume the same thing over there.

I think one of the things impacting the second quarter over there favorably is they're trying to gear up before the holiday season there. So they're shipping out and making more in the second quarter than what you would normally expect.

Your next question comes from the line of Ben Joseph with Rice Voelker.

Hi, guys. Just back on the seasonality, you mentioned you expect 2Q to increase sequentially from 1Q '08, just wondering what kind of magnitude we're looking at. I mean, 2Q '07 we saw roughly 30% sequential increase relative to 1Q. I'm wondering if we can expect similar types, or if 10% to 15% is more reasonable. I mean, what's the expectation?

I think if you go back and look historically, our expectation is that possibly the second quarter will improve slightly more. And our expectation is that the first quarter will be worse because of the lack of inventory investments by the customers and same thing, our own volume. I think so we're expecting it to have a slightly higher differential than the historical reference for those reasons.

Okay. All right. That's it. Thank you, guys.

Your next question is a follow-up from the line of Michael Rehaut with JP Morgan.

Hi, a quick follow-up on the 1Q guidance. Looks like you're getting a benefit from the lower tax rate, lower interest expense and lower Unilin amortization. I am just trying to reconcile the $0.81 to $0.90. I'm having a pretty hard time actually getting that number unless I'm having sales and margins fall off a cliff here. I'm wondering if you could like maybe split out, I mean, is the deterioration coming mostly from sales or is it from the margin side?

The sales and volume we are expecting to be lower, we're expecting lower throughputs in the plant so there's higher unabsorbed overhead in the plants. There is a significant reduction due to the price lag and the pricing within it. Well, historically -- the last couple of years, we're not anticipating the Unilin results improving like they have which offset some of those things in some prior years.

Right. You're also getting the foreign exchange benefit, though, out of Unilin still in the first quarter?

Correct.

Correct.

Okay. Thanks.

Your next question is also a follow-up question from the line of Steven East with Pali Capital.

Just one question on the raw material costs. Frank, if you look at raw material costs year-over-year, about how much are they up and probably how much of you already been able to offset in ignoring the 4% to 6% price hike that you've got coming down the road?

I don't think we have those numbers in front of us. The one we're talking about now is the increase that we've received, take it from December through now.

Right.

The pricing -- the compression is based on that piece. And we didn't bring the numbers from the prior year for the divisions.

Really what we try to do with our price increases is offset the cost increases. And if you go back over time and look at price increases in the industry which we tracked, that's been a, assuming that, accurately assume that that's what the cost increases have been.

We never give the announced amount; as we all know, you start out with an announced amount, and it gets compressed somewhat as you do it. And you are expecting to get something in excess if the cost increases.

We have reached the end of allotted time for questions for today. Mr. Lorberbaum, are there any closing remarks?

I think that we had an excellent 2007 given the environment that we're in. I think that our managers handled the various problems that we had. We're looking forward to 2008 remaining difficult at this point. We think that we are doing the right things and controlling costs and still investing in our business. We believe we're well positioned with our liquidity to take advantage of any opportunities that we have. We believe that the industry will improve at some point. When it does, the residential remodeling business and replacement businesses are the first ones to come out of it. And they typically jump significantly when it happens.

We're working our way through the short term. We're still positive about the industry and our position in it over the long term. We appreciate you joining us and have a nice day.

Thank you for your participation in today's Mohawk Industries fourth quarter and year end 2007 conference call. You may now disconnect.