莫霍克工業集團 (MHK) 2009 Q3 法說會逐字稿

Good morning. My name is Stephanie and I will be your conference operator today. At this time I would like to welcome everyone to the Mohawk Industries third quarter earnings conference call. All lines have been placed on mute to prevent background noise. After the speakers' remarks, there will be a question and answer session. (Operator Instructions) As a reminder, ladies and gentlemen, this conference is being recorded today, Friday, October 30th.

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

Thank you. Good morning, and thank you for joining our third quarter 2009 conference call. With me on the call is Frank Boykin, our CFO, who will review our Safe Harbor statement and later the financial results. Frank.

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 in our periodic filings with the Securities and Exchange Commission. This call may include discussion of non-GAAP numbers. You can refer to our press release at the Investor Information section of our website for a reconciliation of any non-GAAP to GAAP amounts. Jeff?

Thank you. Our third quarter earnings per share of $0.50 was slightly better than we anticipated. Earnings per share were $0.64 excluding restructuring charges relating to our distribution and manufacturing footprint. Our earnings were slightly better than our guidance, due to the changes we have made to manage through this difficult environment.

Our gross margin of 27% was an improvement of almost 200 basis point over last year. It benefited from lower raw material and freight costs, personnel reductions, cost containment measures, and plant consolidations. Third quarter sales were $1.4 billion, a 22% decrease from 2008, or 21% on a constant exchange rate. Our balance sheet is strong with over $300 million of cash, ample liquidity from our new $600 million bank facility, and free cash flow of over $340 million so far this year.

Though the third period remained weak, sales were only slightly off from the second quarter, which may be an indication that we're seeing a bottom. Both home sales and consumer confidence have improved since the beginning of the year, which historically has been followed by a higher investment and remodeling and flooring purchases.

The commercial category continues its decline with limited new projects and delayed remodeling, as corporations maintain tight controls on spending. We anticipate commercial continuing to decline this year and bottoming out in 2010.

Our European business, which is primarily residential, is being impacted by low consumer spending and compressed housing sales similar to the US, and appears to be stabilizing. The stronger Euro is making exports outside of Europe more difficult and negatively influencing pricing. Continued government stimulus and expected GDP growth should improve our residential business next year in the US and Europe, offset by a continuing decline in our commercial categories. Frank, do you want to give the financial report?

Thank you, Jeff. Good morning, everyone. If we start with the income statement, net sales were $1.383 billion, down 22% from last year or 21% on a constant exchange rate basis. All of our segments were down due to lower volume and some decline in price and mix, as the economic headwinds continued. Gross profit was $369 million or 27% of net sales compared to 25% last year.

Our favorable margin performance was driven by capacity rationalization, lower raw material costs and freight costs, and ongoing productivity and cost reduction actions, as our team continues to manage through this decline. SG&A was $301 million or 21.8% of sales, compared to 18.2% last year. If we exclude the $11 million of restructuring included in the $301 million, our SG&A was down $31 million or 9% from last year.

All of our businesses are continuing to reduce costs, but deleveraging is impacted by our declining sales. Operating income as reported was $68 million or 4.9% of sales. Operating income excluding charges was $84 million or 6.1% of sales. That compares to a comparable 7.5% of sales last year.

We had in the third quarter restructuring charges of $8 million included in the Mohawk segment, and then another $8 million included in the Dal-Tile segment. These were primarily driven by distribution consolidation and commercial carpet restructuring. In the fourth quarter we're estimating $25 million of restructuring costs of which $10 million would be included in cost of goods sold, and $5 million is estimated to be included in selling, general, and administrative costs.

Interest expense was $33 million. We're expecting it will be slightly higher in the fourth quarter. We completed our new ABL bank facility this quarter.

Our interest includes amortization of upfront costs, approximately a $1.5 million per quarter, and an increased rate on the bonds that we have from a recent downgrade from one of the rating agencies. Moody's just downgraded us to BA2 with a negative outlook; S&P currently has us at BB plus negative watch. Our interest rates are impacted by 25 basis points -- increased by 25 basis points on about a $1.4 billion of our debt, as required on any additional downgrades. We currently have a ceiling of 125 basis points on any future rate increases.

The income tax rate was 6% as reported, due to geographical income mix. Our fourth quarter taxes should be a small expense for the fourth quarter. We expect our tax rate in future years to be in the low to mid-20% range. Our earnings per share as reported was $0.50, and our earnings per share excluding charges was $0.64.

If we turn to the segments, the Mohawk segment sales came in at $756 million, down 21% from last year, due to lower volumes and declining price and mix. Commercial was showing the most significant decline. Operating income, excluding charges of $8 million was $24 million or 3.2%, compared to 3.1% last year. Margin performance was driven by lower raw material costs and SG&A savings, offset by decreased volumes.

In the Dal-Tile segment sales were $362 million, down 23% from last year or 22% on a constant exchange rate basis. Commercial business decline impacted performance the most, with Mexico slightly ahead on a constant exchange rate basis. Operating income, excluding another $8 million in charges, was $29 million or 8.1% of sales, compared to 11% last year. We were positively impacted by improvements in manufacturing performance, which was offset by lower volumes and negative mix.

In the Unilin segment sales were $282 million or down 21% from last year, and that would be 18% on a constant exchange rate basis. We had lower volumes, as both the European and US businesses had similar pressures. Operating income was $35 million or 12.5% of sales, compared to 12.4% a year ago. We were favorably impacted by lower raw material costs and SG&A reductions, as well as good IP revenues. Foreign exchange negatively impacted our operating income by $2 million.

In the Corporate & Elimination segment, we had a loss of $4 million, and we anticipate a loss in the fourth quarter of anywhere from $5 million to $6 million.

Finally turning to the balance sheet, our cash ended up at $306 million, which includes about $266 million in cash and investments. Receivables at $832 million represented 50 days of sales outstanding which is up from last year, due to channel mix impacting this, but I will say that our aging is still in good shape. In addition, included in that number, we have an income tax receivable of $108 million, which we will receive in the fourth quarter -- a portion of it in the fourth quarter and the remainder in the first half of 2010.

Inventories were $940 million, representing turns of 3.8 times which is in line with last year, and the dollar is flat with the previous quarter. Fixed assets at $1.8 billion included capital expenditures this quarter of $19 million and depreciation and amortization of $76 million. We're estimating full year capital expenditures at $110 million, and full year depreciation and amortization of $300 million. Long term debt in total was a $1.855 billion at the end of the quarter.

We executed a new $600 million dollar four year bank facility during the quarter, with an interest rate that will be at LIBOR plus a range of 3.75% to 4.25%, and we incurred about $23 million of upfront costs, which will be amortized over four years. We currently have almost $500 million available under this facility after considering outstanding LCs. Jeff, I'll turn that back over to you.

Thank you. Our business remains under pressure in a difficult environment. All businesses continue their focus on aligning resources with the demand level by using improved sales and operations planning, reducing SG&A expenses, innovating new processes using lean techniques to cut costs, improving the use of working capital with enhanced systems, and reducing distribution infrastructure with more centralized inventory strategies. We have many initiatives to grow revenues with new products, customers, and channels. We continue the implementation of new information systems to enhance sales management, inventory controls, and our distribution infrastructure.

In the third quarter we reduced headcount by almost 850, and our total distribution footprint was reduced by about 700,000 square feet. Our capital investments have been curtailed to about $110 million this year and are focused on efficiency, new product innovation, productivity, quality, and high return projects.

Our Mohawk segment sales were down about 21% in line with the industry. We have made improvements in our controllable production costs and quality throughout our processes. Reductions in our SG&A continue to be made throughout the organization. Selling, distribution, and warehousing costs have been cut to reflect lower volume levels. Marketing and sampling costs have declined as the business level dropped.

We're focusing on improving customer service with the enhancement of our systems and processes, to provide greater information with more flexibility and speed. New product introductions are driving incremental sales with higher margins, while simplifying our manufacturing operations. Our proprietary SmartStrand residential collection continues to gain broader customer acceptance, and our service levels have improved with an increased supply of raw material.

The restructuring of our distribution model with the combining of our regional warehouses with the Dal-Tile segment will lower our infrastructure costs further. In the period, we lowered our headcount by 450 in the segment. We've announced a consolidation of our backing fabric production, which will lower our costs further and provide flexibility as required in the future. We're rationalizing some of our commercial production and improving productivity, as we adapt to the decreased demand.

The commercial team is focused on government, healthcare, and education markets, which will be stronger than the other channels. Our rug division's also introducing lower priced products, as customer purchase more value oriented items. Much of our efforts to reduce costs and improve processes have been offset by low industry volumes and unabsorbed overhead. Customers are purchasing more value oriented products, and selling prices on commoditized products have compressed.

In our carpet materials most of the chemical costs utilized have risen substantially, as chemical production has been reduced. This has raised our raw material costs more than we anticipated at the beginning of the third quarter and will increase our manufacturing costs in the fourth quarter and beyond. We plan to recover raw material increases from the market as soon as possible.

The Dal-Tile sales were down 23%, or 22% with a constant exchange rate. The decline in new housing sales and commercial construction is significantly affecting the ceramic industry. Dal-Tile is taking share from imports, which make up about half of the industry volume, with our broad product line and strong distribution. In addition, we have replaced significant amounts of product we have previously outsourced with our own manufactured tile.

Our new introductions of engineered stone and terrazzo tile are growing in the market. We continue to increase product placement in home centers and specifications with large commercial customers. We reduced our Dal-Tile SG&A further in the third quarter by merging seven service centers, consolidating regional warehouses, and reducing our leased warehousing space. Manufacturing costs continue to improve, with increased productivity, lower waste levels, and higher quality.

We've upgraded our production processes by improving our efficiencies and reducing costs. Inventory turns are being maintained through improvement in changeover times, smaller run sizes, and a more consolidated inventory strategy. Long term, these changes will reduce the working capital requirement to support our business growth.

Our Mexican business grew on a local basis as our distribution expanded. In the Mexican market, we're broadening our product line to offer a comprehensive selection, increasing our specification of commercial products and expanding our customer base. During the third quarter a 2% price increase has been implemented in Mexico.

Unilin sales declined 21% as reported, or 18% on a constant exchange rate. Our operating margins for the quarter were 12% and EBITDA margin was 26%. Demand in both our US and European markets remain challenging in the period. We were favorably impacted by raw material costs, postponed expenses, royalty income, and better than anticipated sales volume.

Our laminate business has been influenced by customers trading down to lower alternatives and pressure on our exports from Europe, as the Euro has strengthened. To improve our sales we're increasing participation in the DIY channels, growing sales of our new introductions, adding new product features, and investing in new product innovation.

We continue to review options to expand our presence in Russia, and have acquired a small UK distributor to support the market. We've broadened our wood distribution in both the US and Europe under multiple brands to reach all markets. Changes in our wood product line have been completed, upgrading our product offering and providing a comprehensive selection with improved costs.

We're utilizing a new click system that makes our wood easier to install. We're investing in research and development to provide innovative products and equipment to lower our wood production costs. And the board products remain under significant pricing pressure, due to excess capacity in the markets and high [sys] operating costs. We've raised prices in some products and markets during the period and are broadening our customer base with specialized products and new channels. Some board plant closures have been announced in Europe and others may occur in the future.

Unilin has implemented many cost reductions to lower SG&A, reduce manufacturing costs, and manage inventory levels. Marketing, organizational, and personal changes have been made to lower costs. New lower priced products have been introduced to provide more alternative for the price conscious consumer.

All of our segments have reduced infrastructure to adapt to lower volume levels. Organizational changes have been made to reduce management levels and combine functions. We're leveraging our resources to improve R&D, planning, product management, and other processes. Innovation in processes have enabled us to control costs and reduce direct labor. SG&A has been cut, and working capital is being intensely managed.

Our strategy continues to be adjusted as the economic environment requires. Business conditions remain weak as we move into seasonally slower quarters. The residential business appears to have stabilized, and the commercial business we believe will continue to be difficult next year.

Substantially lower plant utilization rates in the fourth quarter will result in higher unabsorbed overhead. Carpet material costs will reduce margins until we pass them through with higher prices. Interest costs will be higher, due to the new short term credit facility and a step up of our bond rates.

Our fourth quarter guidance for earnings is $0.28 to $0.38 per share. Excluded from the guidance is an estimated restructuring charge of $25 million, primarily non-cash reductions of our manufacturing distribution infrastructure further. Our cash position remains strong with free cash flow exceeding 2008 by almost 55%; a strong balance sheet and ample liquidity.

As we look forward to the first quarter, we anticipate continued seasonal headwinds that will improve as we go through the year. Indicators such as housing and consumer confidence are pointing toward an improvement in residential flooring expenditures. This has been the longest and most severe downturn we've had to manage.

We continue to make the necessary structural changes to strengthen our long term business. Each segment is executing innovative ways to positively position us in all product categories. All our efforts to strengthen the business during this downturn will significantly benefit us in the future as the industry recovers. With that, we'll be glad to take questions.

(Operator Instructions). Your first question comes from line of Sam Darkatsh with Raymond James.

Good morning, Jeff and Frank. How are you?

Excellent.

A couple quick questions. It looks like you're going to have about $57 million of restructuring costs this year. Some of that capacity takeout some of that asset write-down and it's happening throughout the course of the year. If you could give us a sense, Frank, as to what the incremental savings might look like in 2010 versus 2009, so we could get a sense of what's to come?

We should see a payback on that over the course of about anywhere from a year to a year and a half payback, Sam, starting in 2010.

But you would have already picked up some of the savings in 2009. Is that correct?

Correct, correct. More towards the back end obviously than the front end, but just answering your question in terms of payback for next year and how to look at it.

And would the payback be similar on the Q4 restructuring, because it seems to be more asset write-down than capacity takeout?

Yes, and we talk about payback, I'm talking about earnings.

Okay. Second question, this is housekeeping, can you help quantify the timing issue with some of the Unilin expenses that were pushed out? Could you help quantify that a little bit?

Let's see. Well, we've not broken it down separately, Sam. What we were trying to do when we described the third quarter and then the fourth quarter, was just to go through some of the issues that impacted the third quarter favorably and how they might impact the fourth quarter. So we're not prepared to break that out separately.

And then as we go into the fourth quarter, we're expecting Unilin margins to be lower based on the impact of low volume and the price in mix changes. We have higher raw materials we're anticipating as well as energy costs, as we went from the third quarter into the fourth quarter. We're expecting to spend more money in our marketing with our new product introductions, as well as investments in our brands, and some of the maintenance costs, we keep trying to postpone them as long as possible. So with some of the maintenance costs will be higher in the fourth quarter than they will through the rest of the year as we invest in the maintenance pieces. And then finally the exchange rates are having an impact on both the pricing and the volume as we ship stuff outside the European marketplace, and those things combined are going to lower the margins.

Your next question comes from the line of Megan McGrath with Barclays Capital.

Hi, good morning. It's actually Matt Landon on for Megan. I was hoping we could talk a little bit about the commercial market. Is there any way you could quantify how much weakness impacted this quarter, and how do you go about forming your expectations for 2010?

Based on all the information we gathered through our sales in the marketplace, most people have the market in commercial declining about 20% to 25% in 2009, and then there's another 10% to 15% decline in 2010, seemed to be like the best overall estimates that we're getting in. We would assume those are somewhere in the ballpark.

Would you say that those expectations are different from where your expectations were a year ago for the commercial market?

I mean as we've gone through the year, as the financing has become more difficult, there are very few projects being started as you go through, so the new construction has continued to decline. On the other hand, as businesses get under pressure, they start postponing remodeling and different pieces of it. So I mean I guess our perception is it's declining more so than we would have guessed a year ago.

Okay. And then finally, you mentioned that your commercial team is focused on government, healthcare, and education. I was wondering if you could quantify what percentage of your commercial business is aimed at those subsectors and how quickly you think you could shift focus at the subsector level?

I don't have the percentage between them. In many case it's a guess as we don't see it all as it goes through the channels, but what's happening is when we're out in the marketplace specifying the price, we have changed the direction and amount of time people are spending in each of the channels because we know that the government supported pieces and healthcare will stay up better than the other categories.

Your next question comes from the line of Dan Oppenheim with Credit Suisse.

Thanks very much. Was wondering if you could talk a little bit more about the challenges in terms of what you're seeing in terms of the pressures from raw materials here and pricing. As you see that going up into the negative margin impact, is there much more that you can do in terms of taking out costs overall? Is there more plant consolidation? How is it you're looking at that thinking forward to 2010?

I mean in the quarter we're in, we're going to have another $25 million worth of consolidations in various parts of both the ceramic business, the carpet business, as well as the distribution structures. So as the business contracts, we're making arrangements to lower our structures with it.

The price -- the raw material costs are related to the chemical costs that support our raw materials in our carpet division. Almost all the chemical costs have gone up. The chemical costs have risen out of proportion with oil prices as the production levels have gone down by the supply base, and the industry needs to pass them through.

Got it. And in terms of the -- you're talking about stabilization in residential, what is it that you're seeing in terms of the end markets there? And how do you look at the -- as consumers are more price sensitive, how do you look at the margins you can achieve on the more commoditized product versus the more branded?

You go through the different parts of it, you have the new construction business, it's hard to get less than it's at or we'd just close up the whole industry. So I mean we're assuming that it's going to improve and from a very low base, but not be significant, because we're not expecting a quick rebound. You have existing home sales that impact the remodeling part of the business, and we're expecting those to remain at reasonably healthy levels and have a positive impact, and then as you look at consumer confidence, we know consumer confidence isn't where we'd like it to be but it's dramatically better than it has been. So given these things, we're hoping that we've seen the bottom, and that next year will show improvement.

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

Yes, hi, thanks. Good morning. First question, I was wondering if, following up on the raw materials for 4Q in the carpet segment in particular, what type of a dollar impact we're talking about there?

The most likely range of increases, that was -- we announced the industry talked about and we announced increases [in the earlier point] that we postponed executing were in the 5% to 7% range. So I assume that as we go forward, we'll see an increase somewhere in that range to the carpet industry in our pricing.

What would that translate back into the actual raw material hit that you're expecting to absorb in the quarter itself?

The expectation is that when we put our price increase in is that we try to cover the raw material cost increase. One thing to remember, too, is that you never get everything you ask for.

Your next question comes from the line of David Goldberg with UBS.

Good morning. It's actually Susan for David. Wondering if you could talk a little bit about expanding the laminate business into the DIY channel. Give us some details around that, and discuss the overall sort of impacts to your pricing power and profitability.

Historically, most of our sales been through the specialty trade, and again, we have focused on the [mid to] high end of the marketplace with limited in the commodity ends. As we've gone through this recession in both Europe and here, what's happened is the DIY channel appears to be doing better than the overall marketplace, and so we've started going after and have had some opportunities with various DIY companies in both the US and Europe, and we are continuing to go down that path. We think that we bring to the marketplace sophisticated style and design that differentiates us from the market, and we think that we can participate in all of them successfully.

So are you seeing any significant trade down? Are your customers moving from your higher price down to your lower, and how do you think that, in the long term as things normalize and come back, that will play into the ultimate profitability of that segment?

In every product category that our business and most that I'm aware of in the world, in the country, the customers are going to lower cost options and trading down to cheaper products, and in most cases lower margin products. How this changes over time is anybody's guess. We believe as we come out of the recession, that people will desire to have better quality products and it will come out of the compression it's in today.

Okay. So no change in terms of your longer term thoughts on the overall profitability there?

Of Unilin?

Yes.

I think as we increase our participation in the DIY, that they tend to buy lower quality products, and so it will have some impact if that becomes a larger portion of the business.

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

Good morning, everyone. Just a couple questions just to build on the last caller's question, you talk about taking your style and your design down market. Are you a little concerned about compromising your brands in the recovery phase of the cycle?

You have to be very delicate about how you do it and where you go. We have different brands to go into different marketplaces. So we have strategies of how to use those and to keep them differentiated in the marketplace, not to destroy one market when you create another. And it's through both product design, it's through brands using different brands which we have a lot of brands we can use. It's between segmenting the marketplaces, both geographically, as well as channels within it, and also using different products from channel to channel.

Okay. Thanks. Second question was just, historically fourth quarter has been one of your better quarters. I'm just wondering if we should infer from your guidance that most of the low hanging fruit's been picked on the cost cutting opportunity, and while you still have some consolidation, distribution, some other things that you're talking about, that the cost cutting opportunity has kind of decelerated from here, and what you really need is just a volume recovery before you can get any material improvement in your earnings power?

We're still cutting costs. In the third quarter we said we'd reduce [by] 850 people in the total organization. We have $25 million of costs we're going take right off, we're going to take in the fourth quarter. We're continuing to reevaluate all the pieces on an ongoing basis. So we're trying to manage through it as best we can.

I'd say in the third -- in the fourth quarter, we discussed before that Unilin is going to have some higher costs both in marketing and new products, as well as maintenance that don't continue at the same levels, but they'll happen in the fourth quarter. And then we have the raw material increases that we're having to absorb in the carpet category until we can pass them through.

David, just to add on that, you're right. I mean the easier restructuring items have been done, and what we're doing now are the more difficult and complex, and obviously volume is going to help a lot once we get that back. The fourth quarter and the first quarter seasonally are always the slowest, so that's impacting our margins.

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

Good morning. This is Mark stepping in for Eric.

Hi, Mark.

In terms of your ability to get through a price increase, do you have any sense of the timing on the carpet side, and then how quickly do you typically recover the cost pressure when you do put through a price increase? What's kind of the timeline of that?

The timing is going to be as soon as we think we can execute it, push it through the marketplace. So sooner is better. What was the second part of the question?

How long does it take to implement?

It takes more than a quarter; the different channels that have different time requirements [and basis] with it, so somewhere between four, five, six months, depends on which channel and where it is.

Okay. Secondly in terms of inventory, continue to slow production and bring inventory levels down, are you seeing from your customers in the non-made-to-order businesses, are they showing any willingness to carry a little bit more inventory, and how are you thinking about inventory levels if demand were to show some sort of an uptick in the coming quarters? Do you expect any sort of restocking at that time?

I believe inventory levels are low through most of the channels. Most people have cash flow opportunities of their own, and so most of them are being very cautious about the inventory levels. So that's a good thing.

When business picks up, the question is how fast will they put inventory in the channel or keep it. I think that we have enough capacity availability to move up with it. As far as we can see in our own estimates of how it might rise up over the next few years.

Thank you.

Your next question comes from the line of Denis McGill with Zelman and Associates.

Hello, guys. Thanks for taking my question.

Good morning.

Good morning. The one thing I was hoping maybe you could elaborate on a little bit is on the pricing that you guys attempted to push through but delayed for the time being, can you maybe just go through, from a customer standpoint, what was different this time versus in prior attempts to raise pricing? I know the industry's had a lot of success in the past, and with residential stabilizing, I would think that you'd have similar success now. So what's the pushback to the price increase that caused you to delay it?

The price increase was announced by my competitor, and the industry followed with announcements of it. Before we could put out our specific product and price increases, my competitor postponed the increase. (inaudible) We assumed the reasons are because they felt it would disrupt the selling season and the environment it was in.

So just the weaker demand environment today than maybe fourth quarter of last year?

You'll have to ask the competition why they did what they did.

Okay. Fair enough. And then on the raw materials side, can you maybe go into some of the specific areas where you're seeing a pressure and maybe just give us an order of magnitude of how much they're up from, say, second quarter, and then also detail any type of raw material that maybe you're feeling pressure on in the Dal-Tile and Unilin segment?

The carpet side, the nylon, polypropylene, the backing, the latexes, all the things that have various chemicals in them, those chemicals have risen significantly and are being -- impacting the costs of our raw materials that we utilize in almost all of the various product categories we have. On the Unilin side, the oil-based chemicals, and then some of the wood prices, are anticipated to be going up this quarter from where they were impacting those costs.

Dal-Tile doesn't really have any impact.

Dal-Tile is not really having the impact of the raw materials. Most of theirs are dirt and glass.

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

Frank, this is just housekeeping, but the $5 million to $6 million you said we should expect in Q4 on the corporate line. I'm assuming that's operating income, and then that caught my eye because I think that is usually a down line sequentially. So I'm wondering if you've got some restructuring going on at corporate that's inflating that line or what's in there?

Well, it's about in line. It was about $4 million this quarter loss and we're expecting a $5 million to $6 million next quarter. So it's kind of in line with, and a lot of that's just due to timing when you make certain payments.

Okay. Thank you.

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

Good morning, guys, just sort of staying on the raw material bend because it seems like the topic of the day. Frank, if you look at third quarter versus second quarter, could you put some impact on your gross margins? What it hit you by, and given that you're trying to put through a five to seven for the fourth quarter, but that obviously takes time, what you all think that similar impact between third and fourth quarter will be?

I think the way we've been talking about it, Stephen, is sequentially in the third quarter, we saw an increase and then another increase in the fourth quarter, and that's where, when we tried to put in that 5% to 8% price increase, the intention was to cover the cost increase that we had in the fourth quarter.

Quantitatively I guess if I had to look at the third quarter, what would be like the basis point impact you think you had versus second quarter and maybe what you think for the fourth quarter?

I don't think we're prepared to get that information out.

Okay. And then if you look at Unilin, even though you had pretty much similar volumes in third quarter versus second quarter, the margin was down nearly 300 bips. I know a lot of that had to be due to shutdown. But what else was being -- were the primary drivers, was this just the board situation?

We had said in the second quarter, we were guiding for the third quarter that we expected the Unilin margins to go down. They just didn't go down quite as much as we thought, but they did have pressures in pricing and pressures in raw materials, but not as much as we're expecting in the next quarter.

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

Thank you. On the raw materials is both your residential carpet as well as your commercial carpet being affected by this?

It's going to be all the products. All the raw materials are going to be affected.

Okay. So even the commercial nylons are going up?

Yes.

Okay. Second question, within Unilin, the pricing impact from currency moving, does that impact specific countries more than others, or is it pretty much continent-wide?

I mean it would be like Eastern Europe, Russia, and the UK, as we export products to those marketplaces, that in some cases we've had to absorb part of the difference in order to do that. As well as in the various marketplaces, there's their own competitive pressures from the poor market -- poor conditions. So those things are impacting the margins that we sell into those markets at.

Your next question comes from the line of [Garland Buchanan] with Babson Capital.

Thank you. I was wondering if you could give any color around the geographic performance for residential carpet. Did you see it particularly worse in any area, or was there any area that might have surprised you in outperformance?

To tell you the truth, I don't have that detail of that level here. If you'd like to call Frank afterwards, we'll be glad to get it for you.

Okay. And just generally speaking, what were your capacity utilization rates?

The capacity utilization rates are all over. We have multiple steps in the businesses. I would guess in the low end they're probably in the 65%, 70% range, and in the high end they're probably in the 85% range, depending upon different parts of the business.

In the third quarter.

In the third quarter.

Your next question comes from the line of Carl Reichardt with Wells Fargo Securities.

Morning, guys.

Hey, Carl.

I was curious about the local retail customers. I think I've asked this question before. Are you seeing much change in the number of them, any consolidation fallout or brand switch occurring any more than you've seen in past cycles?

In past cycles, as a matter of fact, every past cycle I've ever been in, we've predicted that the independent retailer was almost disappeared. I mean that's an extreme, but the independent retailer would fall out and not come back, and what historically has happened is that due to the limited amount of capital, the number of retailer shrinks because you don't need as many outlets to get the product to marketplace, and then at least up to now, we start creating new outlets as we come out of this because of the low capital required. If this one's going to be the same, we'll have to see again. (inaudible) but I'm not about to predict that it's going to change dramatically, given my last four years.

Okay, thanks. And then on the bigger picture question outside the cycle, I'm curious about your capital management strategy once you come out of the downturn once the industry does. Are you expecting that you'd continue to try to - - you've got a broad product line now. Would you look to try to add additional product line to additional geographies? Or could we expect more of the cash you're generating to go to reduced leverage, perhaps pay a dividend, perhaps increase share repurchases, or what could we think about capital management once we come out of this, Jeff?

Our primary objective is to find ways to grow the top line and enhance the shareholders' value. If we don't find the right acquisitions or risk levels that we think will do that, then we'll move on to reducing debt and trying to drive cash through the business and give it back to the shareholders. So it really depends on the opportunities that are available when that occurs.

And our focus will be primarily in products that we're already in, floor covering products.

Your next question is a follow-up from Sam Darkatsh with Raymond James.

Hey, Jeff, this is an impossible question to answer, but I just want to throw it out there anyway.

Maybe you can answer it when you ask it.

You have a crystal ball that I'm just curious as to what it's telling you. Same thinking at least that the commercial is down next year and your builder business, at least the industry builder business, is probably going to be flat to down, also, given the delay and when you ship versus the start. I'm guessing maybe half your business is going to be pressured next year. Do you see signs in what you're looking at in the retail business that would give indication that the other half of your business would be up more so than that, where your sales might be up on a year on year basis next year?

You're right. We don't have any indicators different than the world has. Our assumption is that the marketplace is at a bottom and the replacement side of it, that consumer confidence is improving somewhat. That the government pushing monies through the structure is going to have an impact, and that people's confidence will improve, and that we have still a lot of existing homes that have been sold that have not been remodeled like we would have expected in normal times.

So we believe there's a postponed purchases of both homes you're living in, as well as people that have purchased homes in the last couple of years that haven't been remodeled. Those things tend to portray an upside in there, and we're hoping to see that.

Okay. Thank you.

Your next question is a follow-up from Michael Rehaut with JPMorgan.

Thanks. Two quick questions here. First on the cost cutting actions and, Frank, you had mentioned the payback of one to one and a half years. Just to make sure I'm thinking about it in terms of dollar terms in the right ballpark, you know, given what you've taken and what you expect to take in 4Q is a $30 million, $35 million incremental of benefits in 2010 in the ballpark?

Yes, that's in the ballpark, Mike.

Okay. Second question, you know, a comment earlier on the laminates business for Unilin in the US talking about shifting towards even more value-type products away from laminates. Given that laminate is typically thought of as a value alternative to wood or even in some cases ceramic, where are the customers going away from laminates? Are they going to vinyl, or just some other wood substitutes, or maybe you can give some color there?

I'm not sure laminate is any different than all the categories. In all the categories the customers are shifting down to lower priced products and all the shift isn't away from categories. It's to lower cost options within the category.

On the other side, if you look at the last 12 months, you've seen as an industry amount, carpet and vinyl have done better in a share portion versus the other categories. Now the problem is it's a little misleading, because if you look at the hard surface categories, they tend to have a higher percentage in new construction. So as you look at it, the newer construction being off is impacting those even more. So I mean, I don't see a significant shift different than the other categories.

Your next question comes from line of Arnold Brief with Goldsmith & Harris.

Based on your presentation today, I'm sort of concluding that your volume is off in line with the industry, and I would think that given the severity and the duration of the decline, that a Company of your financial strength at this point should be increasing market share. Could you discuss those market share trends and give me some perspective on what the smaller competition is doing? Are they folding up, are they going out of business? What's going on in the industry?

You crossed a lot of pieces. I think that if I had to give you a high level view, I think in my carpet business that we're holding our share. I think in the ceramic business, we're gaining share, and I think in the laminate business we're gaining share, but the category in laminate we're in is not growing as much as the DIY portion or the lower end part of it. So that's where we are at the moment.

Do you see smaller competitors going out of business at all?

There are some. When you go through these things, the competition doesn't die rapidly, and banks tend to try to keep people going until they can find another alternative versus losing their investments in them. So it's a long, drawn out process for people to fall out of the industry. There have been smaller ones, but they don't amount to a lot to change significantly the landscape.

Your next question is a follow-up from Stephen East.

If we looked at the demand, just two questions on that, if we looked at first, what you saw in the progression of demand as you went through the quarter, and then if we look at commercial on your subsegments, you talked about overall down about 25%, how much worse was office, and how much better were some of the target areas you're going after, government, healthcare, education?

To tell you the truth, I don't have the data in front of me, but if you'd like we'll get it for you, and call Frank and he'll give you some view of it.

Anecdotally just I mean, are those three significantly outperforming, do you think, the industry averages overall on commercial?

I mean take an extreme, like the hotel category we look at. I mean nobody is building a new hotel. Nobody has got any excess money. They're not going to remodel it much. So they've contracted all their expenditures significantly. The same thing on the corporate side you see is that businesses under stress try to minimize their expenditures in areas that they don't think will impact them significantly, and remodeling becomes one of the first things you throw out the window.

And then if you looked at your demand trends -- ?

The good news is, though, the remodeling that gets thrown out is still required, and when on the other side people's confidence improves, they're ready and needed, and at that point the rooms or areas look so bad they have to do it.

I'm with you there. Okay. And then the trend of the demand?

Our belief is that the demand is going to continue to be under pressure, that you have the new construction that takes multiple years to flow through. It continues to tail out with less and less to be finished. Our products tend to go into the tail end of them, so the new construction piece, and there's very little being financed. So that's going to create this void in the process, and it's going have to be taken so the commercial thing lag coming in and it's going to lag coming out, as it always does.

Okay, thanks.

At this time there are no further questions. I would now like to turn the conference back over to Jeff Lorberbaum.

We thank you for your interest in Mohawk and appreciate your time. Have a good day.

Thank you. This concludes today's conference call. You may now disconnect.