莫霍克工業集團 (MHK) 2010 Q2 法說會逐字稿

Good morning. My name is Shawn and I will be your conference operator today. At this time I would like to welcome everyone to the Mohawk Industries second quarter earnings 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, Friday, August 6, 2010. Thank you.

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 second quarter 2010 conference call. With me I have Frank Boykin, our CFO, who will review our Safe Harbor Statement and the financial results.

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 those set forth in our press release and our periodic filings with the Securities and Exchange Commission. This call may include discussion of non-GAAP numbers. 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?

Thanks, Frank.

I'm saddened to announce that our Board member, Larry McCurdy, passed away Tuesday. Larry fought valiantly through his illness and his courage in the face of adversity reminded each of us of the true depth of his character. Larry served on Mohawk's Board since we went public, and he was a key contributor to our growth over the past two decades. He brought an intellect that was keen and helped us find to innovative solutions to the challenges we faced. Our thoughts are with his family, and we will miss his good counsel and friendship.

Our second quarter earnings per share of $0.99 were stronger than we had anticipated. Earnings per share were $0.77 excluding non-reoccurring tax benefits, redemption premiums on our bond, and restructuring activities. Our earnings were better due to higher sales in the Unilin, improving product mix in Mohawk, price increases and cost reduction programs. The second quarter sales were $1.4 billion, which were flat with 2009 net sales, or a 1% increase on a constant exchange rate. Our operating margin has improved to an adjusted 6.8%, which is the highest we've achieved in two years. We have a strong financial position with free cash flow of $111 million during the quarter, and cash of $343 million with an improving debt to EBITDA ratio of 2.1 times.

GDP in the US is expected to grow in the second half and private sector employment is increasing. At the end of the second quarter, consumer spending slowed across most categories, along with our business. In the second half of the year, residential remodeling markets should expand, driven by higher disposable income and low interest rates. New home construction remains low, but is higher than last year. The European economy is gaining momentum with positive industry reports, higher consumer confidence, and an improved banking outlook.

Our second quarter sales were flat compared to the prior year, as residential business improved. Our European business grew in most geographies and product categories with volumes increasing. Commercial markets are declining at a slower rate with expectations of a bottom this year. In July, we expanded our international presence with a minority investment of $80 million in Sanfi. In China, Sanfi is one of the top 10 ceramic tile manufactures and provides entry into our large and fast growing Asian market.

Together, Sanfi and Mohawk have extensive opportunities to increase market share in China by broadening our product offerings, providing leading style and innovation, improving efficiencies, marketing and distribution capabilities. Sanfi will also supply ceramic tile to Mohawk's North American flooring business. In 2010, Mohawk expects its investment to be slightly accretive excluding one-time accounting charges.

Frank, would you please give our financial report?

Certainly, Jeff.

As Jeff had mentioned, our sales of $1.4 billion were flat with last year, or on a constant exchange rate, up 1%. All of our segments improved from the first quarter in year-over-year comparisons. Unilin's performance was exceptionally strong and we benefited from carpet price increases. Both the Home Center channel and our Mexican business grew during the second quarter.

Our gross margin, at 26.8%, was up slightly from last year. However, when we exclude charges, gross margin was 27.1% compared to about 26.9%, so flat to last year. Margin was impacted by price increases, which partially offset raw material increases. Raw materials in the second quarter of last year, 2009, were at the trough and are much higher now. Restructuring activities that we've been putting in place have also benefited our results.

SG&A of $285 million was 20.4% of sales. We improved our SG&A, both in dollars and as a percentage of net sales. We are continuing to emphasize cost reduction across all of our segments. Restructuring charges for the quarter of $5 million included the closure of a small staple yarn plant, as well as some carryover from activities that we began in earlier quarters. All of these charges, the $5 million charges, were included in the Mohawk segment in cost of goods sold.

Interest expense included approximately $8 million of premium that we paid related to the purchase of $200 million of bonds earlier in the second quarter. This purchase of bonds will result in a net savings through the end of the year for us of $2 million. We also renegotiated our bank facility during the quarter, reducing the spread that we pay over LIBOR by 100 basis points, and reducing our unused fee by 35 basis points. This will result in annual savings of $3 million. In other expense, it was negatively impacted by foreign exchange compared to last year, primarily related to the Peso.

In income taxes as reported, we had a benefit as we recorded non-cash benefits related to contingency settlements. Our second quarter tax rate, excluding one-time items was about 14%. We estimate the rate through the rest of the year, the second half of this year, to be in the high teens. Our earnings per share, excluding one-time items, were $0.77 for the quarter. If we move to the segments, in the Mohawk segment, sales were $748 million, down about 2.5% from last year. Price increases, new products and mix positively impacted our sales, but this was offset by lower volumes.

Operating income excluding charges was $31 million, or 4.2% of sales. This is a nice improvement over last year's 2.8%. Margins were favorably impacted from productivity, restructuring, and price increases and in addition to improving mix as raw material cost increased. In the Dal-Tile segment our sales were $364 million, down about 3% from last year. We sequentially improved from the first quarter and our Home Center and Mexican business grew over last year. Our operating income of $28 million was 7.7% of sales and was negatively impacted by increasing freight and declining mix. This was partially offset by a reduction in SG&A cost and improved productivity.

In the Unilin sales, we had a very good quarter with sales of $308 million, up 10% from last year, or on a constant exchange rate, up 16%. Almost all regions increased year-over-year. We had strong volume growth that benefited our results during the quarter. The operating income of $42 million was 13.5% of net sales, was impacted by a weaker Euro by $3 million, reducing operating earnings by $3 million. Raw material inflation was also a head wind to earnings during the quarter in the Unilin segment. Our corporate and eliminations segment reflected a loss of $7 million. We're estimating for the full year that we'll have a $20 million to $25 million loss in this corporate segment.

On the balance sheet, our cash position continues to be solid with $343 million in cash. Free cash flow of $111 million in the second quarter. We ended the quarter with about $160 million of cash in the US, and about $190 million of cash in Europe. Our receivables of $704 million improved in terms of our days sales outstanding to 46 days, compared to a year ago. Our inventories of $966 million also improved in terms of days outstanding, with 92 days outstanding compared to about 96 days a year ago. Included in inventories at the end of the second quarter, when we compared it to the end of the fourth quarter last year is about $30 million of raw material inflation. Overall, we've done a very good job of managing working capital with receivables days, inventories days, and payables days all improving compared to a year ago.

In our fixed assets we had Capital Expenditures during the second quarter of $24 million, and depreciation and amortization of $72 million. We continue to estimate our CapEx for the full year to be $180 million, and our depreciation and amortization to be $300 million. As I'd mentioned earlier, we repurchased $200 million of bonds during the quarter, leaving total debt of $1.7 billion, or net debt, net of cash, of $1.3 billion. The remaining $300 million of bonds that are due in January of 2011 we are expecting to use a combination of cash and the availability under our bank facility to pay those bonds. Our net debt to EBITDA ratio ended the quarter at 2.1 times.

Jeff, I'll turn it back over to you.

Thank you, Frank.

All of our business has improved from the first quarter. All segments have brought new products to the market with performance and design features such as GenuEdge technology in laminates, Reveal Imaging technology in ceramics and soft carpets of Triexta and polyester. We have expanded our international presence with our investment in China, and are committed to additional investments in Russian laminate and Mexican ceramic production.

We continue streamlining our organization by reducing both manufacturing and G & A costs. Both our ceramic an laminate businesses won top awards for service, quality and design in a national retail survey. Our sustainability efforts continued during the quarter. We further increased the recycled content used in our carpet, ceramic and laminate products. We received recognition for our Mohawk University course that teaches our retailers sustainability strategies that will enhance their businesses.

Our Mohawk segment net sales were down 3% and operating income was up $11 million before restructuring charges for the period. Profitability has improved as price increases, product mix, productivity improvements and cost reductions resulted in higher margins. We've initiated some specific promotions to respond to competitive market dynamics to improve sales. Our residential product introduction shipped earlier this year and should improve our volume in the second half. Our smart strength and soft fusion nylon and soft polyesters are growing with innovative products at different price points. We introduced our first smart strength commercial product, which provides high performance and luxurious feel with advantageous environmental properties for the commercial market.

Our focus continues on improving quality, product management, service and costs. Our product quality has consistently improved in both internal and external metrics. We're introducing additional soft residential fabrics, expanding our carpet/tile offerings, and rationalizing our lower volume and margin products. Service has improved as we reduced complexity and streamlined processes. Earlier restructuring efforts have been completed in our carpet and backing plants, improving our productivity. Material costs have been reduced by improving process controls, increasing yields, and using alternative options.

Our commercial team's selling efforts are still focused on government healthcare and education. Our commercial carpet tile continues strong growth, and we're broadening our offering at volume price points. We have a new commercial approach we call My Solutions, which is providing complete options for large projects, utilizing all the brands and services to satisfy every requirement for any project.

Our second price increase this year of 5% to 7% was announced in April and is being implemented to offset higher raw material costs. We have better management processes to control and believe margin improvement will result from these actions. The Dal-Tile sales were down 3% as a result of new residential construction, and commercial, still lagging the economy. We're improving manufacturing output, increasing productivity and lowering SG&A costs to expand margins. Additional large commercial accounts are specifying our products, which will benefit our ceramic sales as corporations increase investment. Our Home Center share continues to grow in all ceramic as well as stone slab products.

Our new patented easy install click technology for ceramic tile is now being tested in both Lowe's and Home Depot. We've become the largest distributor of stone slabs by providing excellent service throughout our distribution infrastructure. We're further leveraging our structure by offering engineered stone products for both interior and exterior uses.

The Mexican economy is expanding with GDP growth expected to be in excess of 4% this year. Home ownership in Mexico is increasing, and the ceramic industry could exceed peak shipments in 2011. We're strengthening our position in Mexico by broadening our product offerings and customer base in the retail, commercial and home center channels. We've approved an investment to add 90 million square feet of ceramic tile in Mexico, which will support both the local and US Markets. Plans are being completed, and we anticipate reaching full production during 2012.

In Monterey, Mexico, a flood caused by Hurricane Alex temporarily stopped all of our ceramic tile production in the beginning of July. Most of the equipment has been repaired, and most will be back at full capacity within a month. Shipping was not interrupted by the flood, since our finished inventories are stored at another site. We believe our aggressive actions will result in a minimal impact from the storm on our customers and performance due to actions taken to substitute products, move production, source products, and coverage from our insurance.

In manufacturing, we increased labor productivity and energy utilization with process innovation. Using our new reveal image technology, we've increased trim manufacturing, lowering our cost and inventory levels. Our distribution costs have declined as we've increased direct shipments, utilization rates and productivity. New systems have been implemented in our -- in over 200 service centers to improve efficiency, inventory turns and enhance customer service, along with new B to B processes.

Unilin sales increased about 10% as reported, or 16% in local currency. Our business improved in most European markets, Russia, and Asia, with nearly all product categories growing compared to last year. Our Quick Step laminate is positioned as the leading brand with innovative products and strong market presence. We began shipping a new product, called Colonial, which utilizes a new process technology creating cleaner, brighter, more realistic colors for exotic wood looks.

Production volume in our board products has also been strong, although raw material costs have escalated ahead of our pricing. Additional price increases are being implemented on our board products as we passed higher wood costs through to recover our margins. Production of new installation boards continues to ramp up and we are ahead of our sales plan. Entry into this new market takes more time due to product certification processes.

We completed the purchase of a building in Russia and anticipating local laminate production commencing in mid 2011. We're adding new customers and increasing sales in Russia to support this facility. New licensees have adopted our patented installation system, being utilized in laminate, wood and vinyl products. Both our US and European wood sales have grown, and the sales mix has improved. We have implemented multiple price increases in wood this year due to the inflation of our raw materials.

The US and European economies are expected to expand in the second half of this year. We believe product pricing will catch up with the inflation of our raw materials. Our new product introductions will benefit our sales, while cost reductions and price increases will improve our margins. We believe raw material prices have peaked in the second quarter and our results should benefit as we go through the year. In the Unilin segment, the third quarter is seasonally slower due to the European holiday. Our third quarter guidance for earnings is $0.70 to $0.79 per share, excluding restructuring charges, the timing of insurance reimbursements, and one-time acquisition adjustments.

In conclusion, global economic growth should benefit our business in the future as markets continue to recover. The execution of product introductions and cost initiatives will support expansion of our profits. Increased exposure to international markets will drive growth, and provide a better balance to our Company. Our cash flow remains strong and our balance sheet will support continued investment and new opportunities.

With that, we'll be glad to take questions.

(Operator Instructions). Your first went comes from the line of David MacGregor from Longbow Research. Your line is open.

Good morning everyone.

Good morning.

Good morning David.

Can you just talk about your guidance for the third quarter and revenue growth, within that $0.70 to $0.79 guidance, can you just talk maybe about each of the three individual segments what kind of revenue growth you're anticipating versus cost reductions to get you to those numbers?

David, we don't usually give guidance by segment or by revenue growth, so we're just going to have to pass on that one.

Yes, I guess I realize that. I was hoping for something a little more qualitative. I'm trying to differentiate from getting to these numbers with cost reductions which you continue to do such a great job with, but we were flat year-over-year on the second quarter and I'm trying to get a sense of what you were expecting for the second half.

I guess we're in the same condition as everybody else which, is the sales levels are very volatile, and very difficult to predict. We believe that if you compare to last year, last year was so bad and everything, we had declining employment, we had decline in profits by businesses, we had lower income by individuals, we had housing almost come to a stop so we look at this year, we think it has to get better, not because it's so much better, but because it was so bad last year, but the question really becomes when.

The things we look at we'll say employment is going up, profits are going up for businesses, there are more houses being built which when they started even though it's lower, more than it was and we believe there should be pent-up demand, and given these things we just assume that it should be somewhat better, as we've always said we have very limited forward views because our customers don't place orders out, but very limited places but we think we'll be able to manage the profitability with the volume we expect and the changes we've done in the business.

Thanks for the color. I appreciate that. You mentioned as well in passing that you were rationalizing lower margin products and what percentage of your revenues are now associated with products or lines that losing money or that you think are potential candidates for rationalization?

I think the point we're trying to make is that in the carpet segment, there has been a major change as the value of different raw materials increase, and what you've seen is a move away from staple products to filament products, as a major move and we had a significant portion of the staple business in both nylon and polyester, and at the same time you've seen the value of polyester go up, so there's been a move to higher value products within the lines.

In addition, we have a unique position with the first new fiber in the industry in 50 years called Triexta, and so there's a major change going on with the products as well as the consumers are moving faster towards soft products, the industry continues to make the products softer, and so what we're trying to say is that in the first half we have made a lot of these moves, we spent the money to make them, we pushed out some of the other products that are in declining modes and we think we are positioned well going forward.

Great. Thanks.

Your next question comes from the line of Dan Oppenheim, Credit Suisse, your line is now open.

Hi, it's actually Mike Dahl on for Dan. I just wanted to follow-up on David's first question there. Just specifically, what we've seen over the past several months is a 32% decline in pending home sales, and 20% decline in starts, both of which would actually suggest at current levels we're going to be running well into the double digit year-over-year declines in Q3. Can you just help us think about how you're looking the improvement you expect in sales against that back drop here?

I'm missing, what's you're starting point you're comparing to so I get on the same page as you?

Just if we look at the June pending sales numbers are basically what translates into existing home sales this Summer.

Comparing to last year is our basis as we start with last your saying as bad as it was that the things that have happened in the first half and the trends that there are so many existing home sales that have been changed in the past few years that the remodeling pieces haven't been there, that and the remodeling was so bad last year that our assumption is that with income improving by consumers, that the pent-up demand is there, that we're assuming that it will hang in and be reasonable. Now you can reach other conclusions. That's our basis is that we're having a temporary lull and that it's going to improve because the incomes are up and people have done so little in the past few years that with any positive we should see at least some reasonable basis from where we've been.

And in our European business, Mike, our European business continues to improve along with that economy over there.

The European business has been dramatically different. The consumers don't use as much debt as we do here and so even though the banking system we've all been talking about the consumers haven't been as impacted like they are here.

Okay, appreciate the color. My follow-up would be just on the price increases you talked about on the carpet side and then also on the wood side. Could you quantify maybe what type of pricing is needed to cover the raw material inflation that you're anticipating to come through in the second half and how your conversations have been going with customers as you implement these increases?

We've implemented price increases at almost every product across the entire spectrum. The wood raw materials have gone up significantly impacting our wood costs. The chemical costs have gone up significantly and we've put through price increases in the neighborhood of 5% to 7% across most of the different product categories. At the same time you have a declining mix that's going on as people try to tradeoff to find higher value products for the customers. As we talked a minute ago about the change to polyester in the carpet business, the reason it's driving it is that polyester is a lower cost raw material and so the retailers trying to meet lower investments by consumers are pushing people to polyester which is causing it to grow faster, at the expense of higher nylon prices for instance. If you look at the mixes when we put through price increases, there's a mix decline so you lose part of that, and then as you do the piece, you don't get 100% of what you start for, so I don't know if you start with 5% to 7% if we would end up with 3% to 4% would probably be a number.

Okay, great. Thanks.

Your next question comes from the line of Eric Bosshard, Cleveland Research. Your line is open.

Can you talk about the market share performance in the second quarter in carpet, I was a little bit surprised to see the revenues down and it felt like a quarter where perhaps there would be revenue growth in carpet. Can you just talk a little bit about what's going on you believe with the market in the second quarter and your market share in the second quarter?

Let's back up a little bit further. In the prior quarters our carpet business we gained share relative to shows same numbers. At the same time we improved both our mix and our margin, and the mix improvement and average selling price kept improving in the second quarter for us. The industry at the same time had declining mix as well as declining unit prices in there. We talked about, we more aggress every trend our product line as we made changes to move from the new products selling more in the marketplace we more aggressively drop products in the pieces and we think we're prepared there. We raised prices in the second quarter and we were much more disciplined in how we raised prices in the marketplace. With that, I think that we've made changes to respond with specific promotions and some pricing actions to address some of the commodity volumes which I think we lost a little bit in.

How does that play out then as we move into the back half of the year? In other words the posture you took in the second quarter, do you maintain that posture or do you expect to be a little bit more aggressive in some of the lower end that you walked away from or lost share in the second quarter?

I think some of it, I mean there were a lot of things going on and once you go through these things you have to interpret market conditions and I think that we were trying to show more discipline and trying to verify things before they happen. I think we just probably took a little longer to react than I would like to but we're doing what we need to do.

So does that, to finish the question does that mean in the second half, can you maintain the margin progress and can you have it all, can you maintain the margin progress and do a little bit better in terms of the volumes or do you have to sacrifice one to get the other? How do you manage that balance?

It's a balance we're going to try to maintain and we looked into the estimate we have we think we can hit the numbers we said given what we know today and we think we can balance them.

Okay, second question in terms of the momentum of the residential replacement business, is there anything noteworthy that you've noticed in the last 90 days in that business?

I think that we and everyone else that we felt as we went into the second quarter, the first part of the second quarter was momentum building and then like everybody else at every other industry, we got to June, I don't know what happened but the consumers changed. I think it's been confirmed almost everything I read. But it feels like we stabilized in July so we'll see.

Okay, thank you.

Your next question comes from David Goldberg, UBS. Your line is now open.

Good morning. It's actually Susan in for David.

Welcome.

Can you talk a little bit about you decided to do a JV in China which is a little bit of a different approach for you guys historically. Is that something that we should expect to see more of as you enter some new markets and how do you think ability the tradeoff between doing a JV versus going in more directly?

I think you have to look at every market and what it is and the Chinese market we felt that having a partner who understood the business was a good thing. As we go into different markets, you can either acquire the entire Company, you can acquire most of it or you can start with a JV. We felt that in China there was so much to be understood in the marketplace that having a strong partner that has a good growth strategy that has a good business strategy, was a good place to go into the Chinese market. We felt that we could add a lot of value to their product line, their marketing and add some value to how they operate the business. At the same time we think that would give us some value to use over here too.

All companies have innovations so we think we'll learn from them, so I don't think we have a set plan, each thing is different. We have a joint venture in Italy that we've had as we went into porcelain tile where they have a small portion of our factory here, its worked out for us. I think under the right conditions they work well and under bad ones they're horrible.

Okay, and then you also discuss the fact that you're adding some capacity to your Mexican facility. Will the Chinese facility then mainly serve that market? Is there any thoughts maybe you could start importing from there as well? How do you think about that?

We already import products from around the world from different pieces. We think that we can use some of the capacity there to import and support our business here and we intend to do so. The Chinese business, the majority of the sales in excess of 80 something percent are going to the local marketplace. They go to market and they tend to have the majority of their customers have exclusive arrangements with them with distribution and they use the words differently than we do, the market channel, so it's basically a Chinese business, we're focused on growing the share in China.

Just to give you some little color, the Chinese ceramic business is a greater proportion of it than the carpet business and the total in the US business. Over 70% of the Chinese market is ceramic and the numbers in China are hard to get to. We estimate it as 50 billion to 60 billion square feet of tile is sold in China which relate to somewhere around $25 billion to $30 billion in dollars. With that the Chinese market, the Chinese structure is supposed to grow, the whole economy should grow 8% to 10% by most estimates. In that, the square feet per person is estimated to be growing almost 50% over the next 10 years. The square footage is going to grow tremendously. Ceramic is in the center of it. The top 10 manufacturers have less than 10% of the total piece, so there is a huge opportunity to grow and we think we're in the right spot at the right time.

Your next question comes from the line of Michael Rehaut from JPMorgan. Your line is now open.

Thanks, good morning everyone.

Good morning.

First question, I was hoping you could maybe provide a little bit more color on the different end markets of the Mohawk segment in the second quarter and how it plays into your outlook for growth in R&R in the latter part of the year. Is it possible just to give us a view of how new residential repair and remodel and the commercial segments, end market segments did in the quarter year-over-year?

I think we're typical of the flooring industry. The residential business was better than the rest for the parts and the commercial business as a percent slowed, the decline slowed within it. We see home center channels still gaining share in the marketplace as we go through and it's typical across the businesses, we seem to find a bottom in most places. You start talking about markets. The Texas markets seems to be doing a little better. You still have the markets of Arizona and California and Florida and they did bottom. We haven't seen any tremendous change in them as we go through.

We think commercial is going to continue. The commercial construction has very long lead times so as the financing came through, there's very little being built so it's going to take a while for it to come up. We believe it got cutoff about two years ago, so most of that has flown through, we're hoping we'll see a bottom in the commercial business this year and hopefully we'll see some improvement next year as businesses get more confident in what they're doing and start spending more money on remodeling but there will be a lag in the new construction side of it. Does that help you?

To an extent I guess. Also, price increases that you had implemented during the second quarter, is there any further carry through effect in terms of a incremental positive impact that you're expecting to see in the third quarter or is the profitability that you showed in Q2 kind of the full impact of those increases?

The increases are still being implemented through the various product categories and customers. It wasn't fully implemented in the second quarter. At the same time, some of our raw material cost that we think peaked in the second quarter, those costs, some of them don't flow through until the third quarter so those peak costs will flow through in the third quarter and you have the fourth quarter of things go as they look, there may be opportunities in the raw material costs as they flow through towards the end of the year.

And lastly if I could, the China venture, you'd also mentioned that they provide some tile to your North American operations. I wanted to know if there was any cost savings that might be achieved through the investment or the partnership or if that's more part of the view that 2010 should just be slightly accretive.

Well, in the Chinese business, they have, let me back up a second. They are in the midst and they completed a huge increase in capacity. They had a single plant in the south of it and several thousand miles north at the complete other end of the country are the other side of the country in Inner Mongolia, they completed another plant. That plant is coming up and it's been absorbing the cost of the start up of that plant in the north and in support of that we said in the first six months which you can see from that they are having 50% growth in the top line as this comes up and going forward so we see it as a big opportunity over there. I'm not sure I answered your question. Ask me what I missed.

You have a question from the line of Joshua Pollard, Goldman Sachs. Your line is open.

Hello?

Joshua Pollard, Goldman Sachs, your line is open.

I think we should move to the next question, Shawn.

Your next question comes from the line of Sam Darkatsh, Raymond James. Your line is open.

Good morning, Jeff, Frank.

Good morning.

Wanted to ask about Unilin if I could. Up 16% in local currency, I think you were up 2% in the first quarter and fairly similar year on year comparison so very good accelerating growth there. You'd mentioned the Colonial line. You mentioned new licensees. How much of that sequential acceleration was due to those items and/or perhaps some lumpiness of royalty payments as opposed to the base business or the core European theatre?

I think you have to first start in the comparison so first of last year that as the economy went south you had a big inventory adjustment with some of the marketplaces so first is you had offsetting it you got rid of the inventory adjustments which is a positive. The second is that the consumers are spending more money and it's not isolated to one country or one place and so we're seeing those things occur. In some of our other board businesses last year the volumes were down as well as the pricing so we're seeing you have pricing increases that are going through as the raw material prices escalate and as we try to recover some of the margins we lost in the downturn are helping, the Russian market is improving, the Asian market that we're shipping into is improving, Western Europe is improving with it so it's not one thing. We're just seeing an improvement in the structure throughout the whole thing.

The comparison get a little bit more difficult in the second half. You would anticipate the acceleration you're seeing is going to more than offset that and you'll see for pretty healthy growth in the second half on a local currency basis?

It will be hard to replicate that growth in the second half I think, Sam.

We expect to see growth but I don't think we can keep that growth up.

Okay.

And one more point, just remember that the third quarter in Europe, they take holidays so historically, it's seasonally lower than the second and fourth quarter.

I understand. I'm not looking on a year on year basis though where you'd take that into effect but your point is well taken. The other question also with Unilin. Frank, help me with the accounting treatment of the recognition of the licensing and royalty payments. Do you recognize those on a periodic or as incurred basis or an accrued basis? How should we look at the lumpiness of those particular items?

They are accrued as earned but the lumpiness would come about depending upon when we get new ones or if we have some that we think go back and they come back and they start paying again, that's how I would describe or the source of the lumpiness.

Or the industry going to hell, but it pays less.

And the industry go the up or down the royalties go up or down, right?

Your next question comes from the line of Dennis McGill, Zelman & Associates. Your line is now open.

Hello and thank you. First question just has to do with on the international side, can you maybe talk relative to the strength in this quarter and also your expectations in the second half of the year if you had to split that between the actual economies improving versus action that you guys are taking, market share improvements do you have a sense of how that would split out roughly?

What happened is we don't have in all cases we don't have good data yet for industry what happened with an industry to match them up. You have individual countries and have different things going on so I'm not sure we have a reference point to tell you how we are versus other industry metrics.

And the other thing too, Dennis is I think Jeff mentioned earlier over there, we had some restocking in the channel that impacted us in the quarter favorably.

Do you have any sense if one was more important than the other even if you can't put a percentage on it would you say that the market share is driving it or the markets are driving it?

I think the markets are improving and I think we're gaining share. I think both are happening.

Your next question comes from the line of Laura Champine, Cowen & Co. Your line is now open.

Hi guys. Jeff, I think you gave a lot of detail on what you're doing to reduce manufacturing costs which is very helpful but we've been at least equally impressed by I think this is your fourth year in a row of driving SG&A expense down on an absolute basis. What is left that's coming out of there?

It's all based on making painful decisions over a period, it's not happening in a day, it's what we continue to do to streamline the business and as the Company gets bigger, you put in more segmentation of all of the different processes and pieces and as it gets smaller you have to pull them back together. At the same time you have to build better controls in it, better systems. We have continued to spend money we mentioned the Dal-Tile store systems, we've we placed the tile service center systems. This year we've replaced warehousing systems. We've replaced trucking systems. We keep spending money to take out and make things more efficient across the business and there's no easy answer to it. I mean you got a question I think that we are, we made tough decisions over the last year or two and we continue to look forward to try to make the business as efficient as possible.

Does that mean there are headcount reductions that are significant in your salesforce? I'm just looking for some specifics that would be continuing to take those numbers down.

I don't know how to answer the time frame. Over long times we've reduced every part of the business and every piece.

You could just go down the list in SG&A and everything has been streamlined and layers have been eliminated and we've built in efficiencies that we didn't previously have and we've reduced heads across the whole process, as well as improved processes.

Your next question comes from the line of John Baugh, Stifel Nicolaus. Your line is now open.

Good morning. I'm glad you're not in charge of my bonus, Jeff. A lot of questions have been asked already but on Dal-Tile, those numbers on the revenue line really impressed me in terms of only being down 3%. You mentioned Mexico. I think you mentioned home center channel gains. I'm just curious there because the commercial construction piece as I recall at least domestically was in the meaningful part of that business and that has to be down sharply, so just a little more color around Dal-Tile, thank you.

I think that you have the Markets right. We have about 40% of the markets in commercial and I hesitate to 40 because as residential goes up and down as they change so there's a large part in the commercial business. A large part in new construction in both residential and pieces. Over the last couple of years, I think that we have gained share from a large part of the business that's been import products from around the world the industry so I think we've taken share consistently the last few years from imports. We did a lot of things to get there. We've put a lot of time into changing our manufacturing processes for cost. We have been innovative in the products that we're putting out to the marketplace.

We have in this time, we have some of it that comes up in the contraction of the margins, we're participating more and more value pieces historically as we went down the value scale, the imports participated at extremes of the bottom and the top. We've moved into both directions. We've moved into the top participating more in the higher value product that used to be made in Italy and we participated in lower value product, which is also affected some of the margin loss in it. All those actions together have helped our market share.

And Jeff, you mentioned stone somewhere in there in your comments. What is stone as a percentage of business if you or if you don't want to give a number just some relative guidance, and how much are you doing in kitchen countertops or other sort of non-flooring? I know you've got the ceramic wall tile as well as floor but I'm just curious what stone's impact is.

I don't have those numbers with me. The stone business is basically a distribution business. Historically, it's been run mostly by small regional players. We went into it saying we could leverage our distribution structure and our customers. I think today we could have 20% of the market, maybe 15% to 20% from zero not too long ago. We also mentioned because of this experience in that business we're now starting to sell what's called engineered stone and engineered stone is basically taking the dust that's left over from various things and putting resins and pulling back together and coloring it and so we think we have an opportunity to act as a distribution arm in stone and there may be a bigger opportunity in that business longer term. Over time, we could consider manufacturing different types of countertops as well as different types of engineered stone, as if our opportunities to grow the business in new categories.

Your next question comes from the line of Stephen East, Ticonderoga Securities.

Thank you, good morning guys. First question is on the Mexico flood. How much did that impact the op margin at Dal-Tile?

In the quarter remember the storm was like I don't remember the exact date, it was like almost the last day or two of the quarter so the only impact I guess is we expect the insurance deductible, the day it happened is it, but it's really mostly impact is going to be in the third quarter.

Okay, and you won't get your insurance proceeds in the third quarter will you?

We're hoping to. We've been meeting with the insurance company. We've been managing our way through it. If everything goes right, we think there's a high probability. We won't know until we get there.

But the point to be made though, Stephen, is that we think that the impact from the storm is going to be minimal, immaterial to financials and the only issue is going to be whether we get the payment in the fourth quarter versus the third quarter. The full final six months will be fine.

I got you and then Jeff, if you look at the Mohawk soft flooring division, pretty much throughout the entire decade even during the better times, the Op margin trended down even as late as 2005 or 2006 though you're running at eight or 9%. Do you think, what do you think as you look forward is the true structural operating margin potential of this industry? Or of your business?

What's happened in the time which is two things which have impacted, one is that oil prices which are oil and chemical prices have become much more volatile and the industry is the industry. Mohawk is trying to figure out how to operate within those pieces and I think we're getting better at it. At the same time we had such a downturn in volume, those have impacted it. If you look over the long term, 8% to 10% margins seemed like they were most of the time, at the better end we got 10% to 11% so I think there's reason to believe we can get back on the 8% to 10% range in the not too distant future.

Your final question comes from the line of Keith Hughes, SunTrust. Your line is now open.

Most of my questions have been asked but you'd talked earlier about board prices or board input prices moving up and your price increases in response. Are you referring to both hardwood as well as laminate in both US as well as Europe?

Yes. As the industry started picking up, the wood prices have gone up and affected both marketplaces. I can't say they are exactly the same in Europe. They have a tremendous amount of things going on for environmental and burning wood so now you have wood being burned is competing with wood making boards out of it, so the combination of all of those things are increasing the raw materials going up and we're trying to pass those through as quickly as we can.

All right, thank you.

There are no further questions. I'd turn the call back to you, Mr. Lorberbaum.

We appreciate everyone joining us for the call. We're diligently working to keep managing the business in the environment we're in, and we'll continue taking the actions to get the business where we want it to be for growth and profitability. Have a good day.

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