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Executives

Frank H. Boykin - Chief Financial Officer and Vice President of Finance

Jeffrey S. Lorberbaum - Chairman and Chief Executive Officer

Analysts

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

Michael Dahl - Crédit Suisse AG, Research Division

Kathryn I. Thompson - Thompson Research Group, LLC

Stephen S. Kim - Barclays Capital, Research Division

Mike Wood - Macquarie Research

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Susan Maklari - UBS Investment Bank, Research Division

David S. MacGregor - Longbow Research LLC

Dennis McGill - Zelman & Associates, LLC

Eric Bosshard - Cleveland Research Company

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Dillard Watt - Stifel, Nicolaus & Co., Inc., Research Division

Mohawk Industries (MHK) Q3 2013 Earnings Call November 1, 2013 11:00 AM ET

Operator

Good morning, ladies and gentlemen. My name is Ryan, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mohawk Industries Third Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, Friday, November 1, 2013. Thank you. I would now like to introduce Chief Financial Officer, Frank Boykin. Mr. Boykin, you may begin.

Frank H. Boykin

Thank you. Good morning, and welcome to the Mohawk Industries' quarterly investor conference call. We will update you on the company's progress during the third quarter of 2013 and provide guidance for the fourth quarter.

I'd like to remind everyone that our press release and statements that 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 risk and uncertainties, including, but not limited to those set forth in our press release and our periodic filings with the Securities and Exchange Commission.

This call may include discussion of non-GAAP numbers. You can refer to our form 8-K and press release in the Investor Information section of our website for a reconciliation of any non-GAAP to GAAP amounts.

I'll now turn the call over to Jeff Lorberbaum, Mohawk's Chairman and Chief Executive Officer.

Jeffrey S. Lorberbaum

Thank you, Frank. Today, I'll review our third quarter performance, provide a general overview of market conditions and later, discuss our fourth quarter guidance.

As the U.S. housing industry recovers, the flooring industry results are improving, with ongoing growth in new residential construction and residential remodeling. Commercial construction and renovation continue to provide opportunities, particularly in hospitality. Mohawk's recent acquisitions have cemented our position as the world's largest flooring manufacturer, and this quarter, we reported the highest earnings per share -- adjusted earnings per share in our company's history.

During the period, higher U.S. volumes, efficiency improvements and the performance of our acquisitions have supported our strong growth. Our earnings per share were $1.63 as reported or $2.02 excluding unusual charges, an increase of 94% over adjusted third quarter 2012 results.

For the period, our sales increased about 33%. Our legacy businesses delivered solid sales growth, and our recent acquisitions contributed significantly to our increased revenues.

For the quarter, we controlled our overall SG&A and improved our adjusted SG&A in our legacy business, while continuing to invest in samples and merchandising to support our new product lines. Our adjusted operating income increased to 11%, improving 350 basis points over the prior year, with growth across all of our segments. To deliver higher operating income, we have enhanced our product mix through innovative collections, improved our manufacturing and distribution efficiencies with new systems and processes and lowered SG&A.

In our second quarter conference call, we discussed our ability to expand our markets and increase our profits through acquisitions. During today's call, we'll update you on the progress we've made integrating Pergo, Marazzi and Spano into our business through organizational restructuring, facility consolidation, cost reduction, relocation of production and assets, and new value-added product offerings. Additionally, shortly after launching our fourth annual sustainability report, a leading industry publication honored Mohawk with it's top sustainability award to recognize the exceptional success of the company's many green initiatives.

As more attention has been focused on the health care in the U.S., we're committed to having the safest and healthiest industrial workforce by investing in preventative care, chronic disease management and processes that save money through higher quality care, and empowering our people to make better individual choices through training and educational resources.

The recent U.S. government stalemate negatively impacted consumer confidence. Despite this, the fundamentals of the U.S. economy remain solid and we expect consumer confidence to get back on track after the recent agreements were reached by our government. Though rebounding, new housing construction has not yet risen to its historical average. The National Association of Home Builders projects a significant gain in new home starts next year, with volume rising 25% to 1,150,000 units.

During the next few years, we anticipate housing will grow faster than the overall economy as the market expands to satisfy pent-up demand from the recession. In August, home prices rose for the 18th consecutive month, which should positively impact remodeling and lead to improved industry product mix as homeowners select more premium flooring options. For some time, remodeling spending has lagged its historical average, but we're seeing signs of improvement in Harvard's LIRA index, which forecasts stronger residential remodeling for the remainder of this year and 2014. Leading construction management consultants project commercial construction will grow by 5% in 2014, with hospitality strong and retail trailing. In our other markets, Mexico's rapid growth has cooled, but should benefit next year from the proposed opening of Mexico's energy sector to foreign investment, government stimulus and construction required due to widespread tropical storm damage. Many believe Mexico is the emerging market with the greatest upside potential.

Russia's economy continues to experience headwinds and the government's taking steps to reignite economic growth through stimulus policies and lower interest rates. New residential and commercial construction remain strong, although remodeling has slowed in the overall Russian -- with the overall Russian economy.

While the European market remains at a cyclical bottom, many people are predicting improvement next year. Northern Europe is outperforming the southern part of the continent as government policies transition from a focus on austerity to an emphasis on growth and investment. The flooring industry in Europe has not yet seen a significant improvement, with both the residential and commercial markets remaining below historical averages.

In our carpet segment, the third quarter operating margin was the strongest it's been in more than 6 years, and operating income rose 50% over the prior year as a result of product mix, productivity, cost controls and volume leverage. We've focused on the residential premium product category with differentiated supersoft carpets that have higher margins, and we're transitioning our commercial collections to premium fibers, which we manufacture and provide better value to our customers and higher returns to Mohawk. With this transition, our commercial volumes have been temporarily impacted, but will improve as new products gain traction in the market due to their more competitive positioning. We are substantially increasing polyester production capacity, allowing us to put -- and expand our participation in the value category of the builder, multifamily and retail channels. We're introducing about 40 new polyester residential products in the second half of this year to expand our sales in this faster-growing part of the market. We fully executed our carpet price increases in the period and our selling prices are now aligned with our costs.

Our adjusted SG&A continues to improve from cost reductions implemented during the year and are at their lowest absolute amounts since 2007. We have consolidated most of our carpet management team in Calhoun from multiple locations to enhance our collaboration efficiencies and speed of execution.

And residential product mix continues to improve as we expand our industry-leading position in soft carpet technology. We are broadening our selection of SmartStrand and Wear-Dated Embrace with more fashionable, higher-style product to maximize our share of the premium soft carpet category. We're introducing a new premium Soft Appeal collection of polyester, with luxurious softness and a leading environmental story, utilizing our Continuum technology with up to 100% recycled content. As we expand our polyester offering to satisfy all styles and price points, we expect additional growth in 2014. We have completed our product realignment in home centers and are seeing accelerated sales growth.

In commercial, our margins improved significantly with positive price and mix, while increasing the value proposition to our customers by utilizing premium fibers that we are manufacturing internally. Growth in hospitality continues to outpace other sectors by leveraging our specialized design capabilities, high-resolution print technology and collaborations with our ceramic business on large projects.

Productivity and efficiency gains are expanding our margins as we reduce our cost through improved manufacturing processes, higher material yields and efficiencies from realignment of our assets. Significant investments in fiber and yarn production and reengineered materials have improved our costs. Distribution costs have reduced with cuts in infrastructure, higher truck utilization and improved productivity from new processes and systems.

Our ceramic revenues were up 84% compared to the prior year through strong results in our legacy business and the Marazzi acquisition. During the period, operating margins grew 290 basis points to 12% as a result of higher volumes, efficiency gains and improved product mix. In the U.S., greater use of ceramic tile and new residential construction has driven sales growth higher than other flooring product categories. Our North American ceramic sales, which include Daltile, Marazzi and our Mexican operations, had a double-digit increase. We continue to optimize the value of our global ceramic assets by manufacturing products previously outsourced, moving production to the U.S. to improve lead times and margins, and utilizing our red body capacity from our new Mexican plant to meet demand in the United States. Additionally, we are launching, in our Daltile and American Olean brands, new products manufactured in Europe by Marazzi. A 2% to 4% price increase in the U.S. was implemented in August to offset higher energy transportation and other costs.

We continue to expand the Daltile brand position as the complete provider of all products in all price points, enhancing our position with national and regional builders, and retailers who focus on the tile category. We are executing the initial stages of our brand realignment with American Olean and Marazzi lines. The combined offerings will satisfy all residential floor and wall tile needs as well as a broad selection of commercial products. Marazzi products are positioned slightly above American Olean in the residential floor tile, and American Olean closes the gaps in Marazzi's wall tile and commercial selections. This combined offering has been implemented in the Las Vegas market and, over the next 6 months, we will be launching in additional markets on the West Coast. We will also be offering our American Olean and Marazzi distributors opportunities to enhance their market position, utilizing both brands where it's appropriate.

In commercial, we will begin offering higher-style tiles using Marazzi's Europe's unique technologies to enhance the design options for large commercial projects. We have realigned the U.S. Daltile and Marazzi ceramic operations with a unified management structure, including sales, marketing, manufacturing, product development and administration. During the first half of 2014, we will realign product manufacturing to improve asset utilization, customer service and distribution. The consolidated Daltile, American Olean and Marazzi business has strengthened our position in the U.S. ceramic market. Our home center and independent distributor market is now stronger and our product capability has improved. Efficiencies or gains through distribution and plant utilization in the U.S. are driving savings to enhance our margins.

In Mexico, our new plant in Salamanca continues to improve its productivity, quality and cost. To offset the slowing Mexican market, we've reduced SG&A and we will optimize capacity utilization by selling products into the U.S. builder market. Our Mexican margins and market share are improving by shifting Salamanca production to higher-value products from promotional goods during its startup.

In Russia, the ceramic market is softening with the general economy. We are improving our position and outpacing the market, though we have some pressures due to promotional activity by our competitors. Our extensive product offering and our strength in new construction in franchise retail channels have enhanced our market share during this time. This year's product introductions are performing well and are strengthening our differentiation as the style leader in the market. We are introducing channel-specific ceramic tile collections to increase our market opportunities, segmenting the commercial, new residential construction and home center channels.

We have expanded our advertising campaign to strengthen our consumer brand awareness and enhance market perception. With the strength of our brand, we're receiving greater interest from local ceramic retailers and opening new franchise stores that only offer our ceramic brand. Going forward, we're increasing participation in new residential and commercial construction centers -- sectors that are presently growing faster than the remodeling category. To support this, we're expanding our personnel to drive specifications, and introducing value-priced porcelain alternatives for large new construction projects. Best practices are being implemented to drive manufacturing efficiencies, enhance our logistics and marketing tactics, improve product life-cycle management and SKU management, as well as reduce the costs of our materials and operations. We continue to support future growth in Russia through investment in new products, increased marketing and the expansion of our sales organization and production capacity.

Our European ceramic delivered a solid performance, with increased sales in Eastern Europe, Middle East and the Far East, offsetting softness in Western Europe. To drive significant sales and operational improvements in Europe, we're implementing our strategy of a single unified ceramic organization rather than a country-by-country structure that existed before we purchased Marazzi. Within regions, we've consolidated the sales force to remove duplication of efforts and offer a comprehensive selection of products. We're improving the planning and manufacturing processes to reduce run sizes and working capital as we improve our inventory turns, though, in the short term, it is negatively impacting our overhead absorption. To lower our cost position, we're eliminating underperforming SKUs and introducing more decorative and larger-sized ceramic tiles to improve our product mix. We're enhancing our merchandising to accentuate the value of our products and introducing CRM tools for better customer support and market knowledge.

To improve our styling and reduce costs, we've approved investments to upgrade our flooring production lines that will be installed next year. We are realizing synergies across our global ceramic business, and utilizing common vendors and sharing best practices across all manufacturing.

Sales in our laminate and wood segment rose 37% over the prior year, with most of that increase coming from North America and our acquisitions of Pergo and Spano. Operating margins, excluding unusual and onetime charges, were 13%, up 380 basis points over the prior year, with significant growth of North American sales offsetting slower European markets. Our legacy North American business improved in all product categories and customer channels, driven by residential new construction and remodeling. The U.S. management team is focused on improving productivity and efficiencies across the combined Unilin and Pergo organization, optimizing flexibility to be more responsive and adding new capacity to satisfy demand for single plank laminate products. The in-sourcing of raw materials, maintenance services and boards was executed during the period. We have integrated Pergo's freight and distribution with the Mohawk logistics system to deliver improved service and greater efficiencies.

Our Malaysian wood plant is running at full capacity, and efficiencies are improving with new automation to offset increased labor costs in the region.

In our Russian laminate plant, we are leveraging higher volumes and local materials to reduce costs.

In Ukraine, we've implemented our own distribution structure to maximize our sales as the country's economic recovery strengthens.

In Australia, we are increasing our distribution through multiple channels and broadening our product offering with the addition of carpet tile.

In both Russia and Australia, we have implemented price increases of 4% to 8% on laminate and wood to offset currency changes.

The Pergo manufacturing facility in Sweden has been closed, and we are now producing Pergo-branded laminate in our Belgian facility. New products to update the Pergo line are being refined and we anticipate introducing them in the first quarter of next year. We've approved the construction of a new luxury vinyl tile line in one of our Belgian facilities, and the line will be operational by 2014.

There are many similarities between LVT and laminate manufacturing, so we can leverage our technical design-and-click expertise to differentiate our products. Our European business continues to be soft. The most forward-looking indicators are predicting improvement in GDP, as a cyclical bottom appears to have been reached in the economy. To offset these conditions, we continue to control costs, introduce automation and deliver manufacturing efficiencies and material yields. Our new insulation board plant in France has begun production of our products. Our insulation board sales continue to grow significantly, and we're expanding our geographic reach with our new French facility. Roof panel sales continue to be hampered by lower home sales and new construction. We completed the consolidation of our Dutch roof panel plants to reduce costs. And we're enhancing our product mix with new panels that provide greater moisture and sound resistance, and are capable of spanning greater distances. Our board sales are under similar pressures from the European economy, and we are unifying our Unilin business and our Spano acquisition to reduce operating expenses and improve efficiencies.

To date, we have closed a high-cost production line, we've reduced conversion costs, improved material usage and implemented a 3% to 4% price increase to offset material inflation. We will close a manufacturing plant in the fourth quarter to further improve productivity. We have consolidated our sales organization so that customers now have a single point of contact, and are broadening our product offering utilizing the combined assets. We've identified many additional opportunities to enhance the costs and productivity of our plants, which will be implemented over time.

I'll now turn the call back over to Frank to review our financial performance for the period.

Frank H. Boykin

Thank you, Jeff. Net sales for the quarter were $1,962,000,000, up 33% from last year. The increase was driven primarily by acquisitions, which accounted for 28% of the growth, and our legacy business was up 5%. Our gross profit was $517 million for a margin of 26.4%. Excluding restructuring, the margin was 27.7%, 220-basis-point improvement compared to last year due to strong productivity, coupled with increased volume and favorable price and mix.

SG&A dollars were $341 million or 17.4% of sales. Excluding restructuring, SG&A was 16.9% of sales, 130-basis-point improvement compared to last year, due to a continued focus on managing costs and improved leverage on increased volume. Our restructuring charges were $37 million for the quarter, which included $14 million in noncash charges. In the fourth quarter, we estimate an additional $19 million of restructuring costs, all for our 3 acquisitions.

Operating income, excluding charges, was $213 million, with a margin of 10.8%. This is an improvement in our margin of 350 basis points, driven by a combination of the performance in both our legacy business and our acquisitions.

Our interest expense was $26 million, up from last year due to debt that we put on our balance sheet related to the acquisitions. Other expense at $3 million was up over last year and was impacted primarily by foreign exchange.

Our income tax rate was 21% for the quarter and that compares to a 20% rate last year. We're estimating the fourth quarter rate at 20%.

Earnings per share, excluding charges, was $2.02, up 94% over last year.

If we move to the segments, in the carpet segment, sales were $773 million, up 3% from last year, with carpet volume and positive mix driving higher sales. Operating income, excluding charges, was $70 million, with a margin of 9.1%. This is a 290-basis-point increase driven by improvements in price/mix, along with productivity. In our ceramic segment, sales were $767 million, up 84% over last year. Our legacy business was up 12%, with overall growth driven by acquisitions. We had improvements in both our U.S. residential and U.S. commercial businesses.

Operating income, excluding charges, was $91 million, with a margin of 11.9%, again, an improvement of 290 basis points driven by a combination of volume, acquisition performance, continuing productivity and leveraging of our SG&A.

In the laminate and wood segment, sales were $451 million, a 37% improvement over last year. On a constant exchange rate basis, our legacy business was flat, as weakness in Europe was offset by stronger North American business. Operating income, excluding charges, was $58 million, with a margin of 12.9%. The improvement was from acquisition synergies as well as productivity.

In the corporate and eliminations segment, we had a loss of $7 million and expect the full year to be about a $30 million loss.

On the balance sheet, our receivables ended at $1,154,000,000 and include $328 million from the acquisitions. Our DSOs for the quarter were 48.2 days, flat with last year. Inventories on the balance sheet were $1.6 billion and include $387 million from acquisition. Inventory days ended the quarter at 108.5 days, up primarily due to the acquisitions. We've improved both our acquisition and our legacy business DIOs, but still have some work to do. Fixed assets ended the quarter at $2,684,000,000. Total capital expenditures for the quarter were $109 million, with depreciation and amortization of $82 million. We anticipate $410 million of capital expenditures and $315 million of depreciation and amortization for the full year.

Finally, free cash flow was $104 million for the quarter, resulting in total debt of $2.3 billion. Our leverage improved to 2.3x debt-to-EBITDA, as we generated good cash flow in the quarter.

With that, I'll turn it back over to Jeff.

Jeffrey S. Lorberbaum

Thank you, Frank. Mohawk today is in the strongest position in our company's history. We have substantially grown our profits and expect continued improvement next year. We have the most effective management team ever, and each of our segments has a well-defined long-term strategy to improve our business. With our Pergo, Marazzi and Spano acquisitions, we are quickly moving to drive synergies, lower costs and increase topline growth. We have already executed many initiatives to improve the performance of these acquisitions, including implementing new strategies and organizational structures, upgrading marketing tactics and product lines, and reducing costs through best practices and closing high cost assets.

In our legacy businesses, each segment has defined significant opportunities to deliver improved results as the U.S. business strengthens and we strategically invest in our products, capacities and organization.

With these factors, our guidance for the fourth quarter earnings is $1.66 to $1.75 per share, excluding restructuring or acquisition costs. We have an aggressive improvement plan for 2014 and beyond. Over the next few years, we intend to expand faster than the economy as our category rebounds in the U.S. and abroad, improve our costs and efficiencies across our new and old businesses, and expand into new product categories and markets. We have the management strength, the balance sheet and the vision to maximize returns to our shareholders.

We'll now be glad to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Sam Darkatsh from Raymond James.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

A couple of quick questions, and I'll defer to others. First off, the carpet margins, trying to get a sense -- they were terrific. How sustainable would they be? I understand that you have some more capacity coming online, you've got a new polyester mix that may degrade the overall margins a little bit, you've got the new fiber after the transition for the commercial business that may impact mix and margin. How should we look, Frank, at the carpet margins over the next couple of quarters or so?

Frank H. Boykin

We'll tag team on that, Jeff and I. I would say that the margins in the carpet segment over the next several quarters will continue to improve as we compare them on a year-over-year basis. Remember, we'll have seasonal impacts in both our sales and our margins, depending on what quarter we're in.

Jeffrey S. Lorberbaum

The margins improved from product mix, productivity and cost savings, which should continue. We're really focused on the SG&A costs as a percent of sales and we continue to improve our cost controls, as well as we've made recent reductions this year. We expect higher sales from expanding the polyester that you mentioned, which should help the topline, and then the commercial expectations are that we'll have higher growth and improved margins in it also.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

And then the final question would be, I understand in October, the industry has been much improved. Do you expect that to potentially continue into November, December? What do the year-ago comparisons look like in November and December versus that of October?

Jeffrey S. Lorberbaum

Typically, October and November in normal years will be similar as you go through, then it falls off as you hit the end of the year. It's anybody's guess, but we think we're going to continue at the rates we're at.

Operator

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

Michael Dahl - Crédit Suisse AG, Research Division

It's actually Mike Dahl on for Dan. I was hoping to follow on, on the margin angle. I guess, you guys have certainly maintained an intense focus on productivity and bringing down costs. And I think we're all hoping for the type of improvement in demand that some of those forecasts called for that you noted. But could you characterize what maybe -- what inning you think you are in as far as progress on margins, absent any meaningful rebound in demand? How much juice is really left there?

Jeffrey S. Lorberbaum

In all our businesses, we believe that we can keep improving the margins through all the actions that we've been taking over the past few years. We made substantial investments in our capital this year. We're going to make more next year than we made this year. We believe -- at the longer-term outlook, we really believe that sales rates will improve next year in the U.S., that assumes the government doesn't stop it. We've had really strong growth in the ceramic piece and -- though we're expecting that to slow somewhat. In Europe, we believe that there'll be a slight increase in the sales, but it has some risk over there. We've seen in Russia, as we talked about, the economy slowing, so we assume that growth will slow a little bit -- will slow there, but we expect to outpace the economy there. Given all those things, we still see the acquisition synergies are on track, but it's going to take full execution. That'll go beyond 2014, but there'll be many things implemented during the year. So we see the margins continuing to expand as we go forward.

Michael Dahl - Crédit Suisse AG, Research Division

Okay. And then moving on, the vinyl tile line, when you say up by 2014, should we assume -- is that a 1Q? And how should we think about the amount of capacity that represents and what it can do for sales here?

Jeffrey S. Lorberbaum

The plant is being put up in Europe. What I said was it will take most of the year to get the plant up and operating, so the impact will be more in the 2015. However, we are selling LVT that we're importing from around the world into the European market as well as the U.S. market as we prepare for that.

Michael Dahl - Crédit Suisse AG, Research Division

Okay. And any sense of -- just the amount of capacity that you're bringing on?

Jeffrey S. Lorberbaum

The capacity will probably be about $100 million worth.

Operator

Your next question comes from the line of Kathryn Thompson from Thompson Research.

Kathryn I. Thompson - Thompson Research Group, LLC

We had started to see some improving residential repair and remodel trends, really, late spring, early summer. Could you talk a little -- discuss a little bit more what you're seeing in the market now and, based on your past, what you would project forward for the residential repair and remodel trends? In particular, are you seeing particular types or price points doing better now, that, say, you weren't seeing 6 months ago?

Jeffrey S. Lorberbaum

As you look at the different pieces, our remodeling business in the carpet was doing better because of the aggressiveness we're taking in the high-end part of the marketplace. We're tending to see some improvements overall, though it got a little softer lately. We think that as the home prices go up, people will become more and more comfortable spending money on their existing houses as we go through. So I mean, we're still optimistic about the remodeling business improvement.

Kathryn I. Thompson - Thompson Research Group, LLC

We're also hearing the market that there's just been a little bit more of a focus with you in particular, and I would say taking market share, but you've spent a lot of time, understandably, integrating several major acquisitions and are taking some specific efforts to further enhance your U.S. carpet sales. Could you discuss some of these programs and maybe talk about -- and I know you brought in a higher-end product this year, but what you're doing as you plan for the next 18 to 24 months in terms of product and sales programs?

Jeffrey S. Lorberbaum

We've continued to upgrade and drive the product categories. In the residential carpet, we're continuing to support the higher-end products, but we're presently in the process of introducing about 40 new products in the polyester category with new technology we call Continuum. The Continuum technology is really differentiated, where we can produce products with up to 100% recycled raw materials, as well as they have better attributes. Our commercial business, we've been transitioning our premium products to fibers we produce, and this provides a better value to the customer as well as higher margins. Though in the short term, it's impacted the top line a little bit, but we believe it's going to significantly enhance our position. We think we're well positioned for the market as it changes. We've done a lot of things to enhance our sales execution in the marketplace, use better information tools to drive change through our organization and be able to communicate to our customers better. So we believe we're well positioned as the market improves.

Operator

Your next question comes from the line of Stephen Kim from Barclays.

Stephen S. Kim - Barclays Capital, Research Division

It's Steve Kim from Barclays. Two questions related to topline, if I could. First in ceramic, I was intrigued by 2 things you said. One, you said that you expected to expand your integration, which you -- a process, which you've started in Las Vegas, over the next 6 months in West Coast. Just want to make sure that -- that seems to suggest that you've had some success, initial success in Las Vegas, I just wanted to confirm that. And then also, if you could talk about -- in North America, you said that you thought that your sales were up double-digits, but should slow somewhat in '14. I thought that was surprising because what we just talked about, this integration going well in Las Vegas. And then also commercial really hasn't rebounded quite as strongly as we think it can, and neither with remodeling. And so I was just curious if you could put a little more color around that expectation for '14 in light of what we just talked about.

Jeffrey S. Lorberbaum

What happened is neither the American Olean nor the Marazzi line were complete lines by themselves. And so by owning the 2 together, we're starting to merchandise them as a comprehensive offering to the customers. The first initial attempt at it was in the Las Vegas market. In addition, we had some service centers around the country that Marazzi had. They had a limited number that only sold their products. We had some in our side of the business that only sold American Olean. So the first thing is to convert those all to complete lines, so we can attract all customers in the marketplace and broaden the offering to both. In both companies, we have -- opportunities on the West Coast seem to be the greatest ones to begin with, to pull those together. And at the same time, both of those brands we sell through a distribution where its strong. So in markets where we're using third-party distribution, we're going to offer those customers the opportunity to have a stronger product line also. Depending upon the success we have at it and what happens in the marketplace, we'll determine how fast we roll it out over the next few years. The other question, I guess, is when we look over the marketplace, our growth in ceramic this year has been really high. And what happened is we've been able to grow it through new product introductions. There's new -- we're leading the market in wood looks out of ceramic, which are growing rapidly because they don't have all the problems of real wood, but you can't scratch them. So we've really captured a large part of that business. We believe they're all growing. We just think it's going to be hard to have that happen again next year.

Stephen S. Kim - Barclays Capital, Research Division

Well, that's fine. It always makes sense to be conservative, so I appreciate that color. My next question relates to laminate. You had talked about the fact that in laminate, sales overall, legacy were flat, European down, North America up. My understanding is that North America represents a minority share of the sales in that category. And so my expectation was that North America was up pretty well. I just wanted to understand, is there anything out there that you have had -- been benefiting from, like a sell-in to a major -- from a major product line win or anything like that, which we have to think about as we model -- anniversarying something as we model out to 2014?

Jeffrey S. Lorberbaum

Remember, with the purchase of Pergo, Pergo was the major supplier to the high-end laminate through the home centers. So together, we now have the dominant share of the laminate business that's manufactured in the -- or sold in the U.S. as it -- so we have a much bigger position. So that business, we've been able to improve as we go forward. In Europe, the market is still tough. People are spending less. I think it's probably a lot like the U.S. market, where the home side of it is getting hurt more than the general economy. When people cut back, they cut back there. So we'll probably lag a little bit in Europe and improvement of it as the European economy gets better. I forgot what part I didn't answer of your question.

Stephen S. Kim - Barclays Capital, Research Division

Well, I was asking about was there a sell-in, because you -- I was referring to the legacy business, not so much Pergo. Was there some sort of a -- something that would cause a difficult comparison on the legacy side, the Quick-Step side in North America?

Jeffrey S. Lorberbaum

I don't think so. I think I'm missing something in answering the question. We also have a wood business in our piece. The wood business is increasing sales, too, in the U.S., so that's helping the U.S. side.

Stephen S. Kim - Barclays Capital, Research Division

Yes, maybe that's it.

Jeffrey S. Lorberbaum

It may be the wood piece.

Operator

Your next question comes from the line of Mike Wood from Macquarie.

Mike Wood - Macquarie Research

Can you give us some color in terms of the higher growth that you're seeing in the polyester side of carpet? Is that cyclical because of the low price point at this point in the cycle, or is it more permanent because of new product development and the relatively lower price points of that category forward? Say, can you just give color on that and sort of how you're positioned from a mix of polyester versus nylon?

Jeffrey S. Lorberbaum

The answer to all your questions is yes. Polyester has become a more value proposition than the other pieces in the market, which is causing it to grow. It is participating across the spectrum. We are leading it in the higher-end part with soft ones. We have not participated fully in the more value categories, and we are taking actions to fully participate in that going forward.

Mike Wood - Macquarie Research

Great. And also, I believe you had previously commented that, for the carpet segment, high single-digit operating margins, maybe more mid-cycle. And you hit 9% in this quarter. Last time you did that was 2006, and your sales are 37% lower. Given the updates in terms of -- should we still be thinking about high-single-digit operating margins as normal in carpet or have you changed that?

Frank H. Boykin

Michael, we were -- what we've been talking about is kind of an annual margin number. So you're looking at the third quarter there, which is one of our strongest quarters in terms of topline and margin, so I would say the answer is no. We're still saying kind of the normal run rate, and normalized environment is going to be 9%, 10% range.

Jeffrey S. Lorberbaum

Listen, I have a saying we use around here, "You're halfway there." So wherever we get, we're expecting to go higher.

Operator

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

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

My first question has to go back to, I think, the biggest area of positive surprise for you guys, on the carpet margins. And if you look at 3Q versus 2Q, you essentially did the same amount of sales, but you did another 200 basis points of margin. A real strong sequential improvement. And so, just trying to understand, number one, what are the biggest drivers to that? I mean, you've mentioned a bunch of them in terms of mix and productivity, et cetera, some positive price as well. But I was hoping if you can break down the drivers of that. And then looking forward, it does appear that in 4Q, you are looking, at least on a consolidated basis, for margins to slow sequentially or to soften sequentially. And so, just trying get a sense of, again, number one, particularly in carpet, the drivers of the sequential improvement, the degree of magnitude there. And number two, why would the margin soften sequentially on ostensibly a similar number of sales?

Jeffrey S. Lorberbaum

Sequentially meaning next quarter or sequentially meaning next year?

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

I'm really just talking about 2Q '13 to 3Q '13 in the first part of the question, and then 3Q '13 to 4Q '13 in the second part of the question.

Jeffrey S. Lorberbaum

All right. First is -- I'm not sure I got it exactly right. I think that the SG&A from second to third dropped about 1%. And the 1%, as a percentage, was driven by a lot of actions we took to reduce the different costs, and we keep working on it. And I don't -- when I say reduce it, I don't want you to think we're cutting back on the things that impact the future business. We're investing in new products, we're investing in marketing, we're investing in sales groups in order to do it. But we are cutting out the things that don't give us the returns that we want. On the other side, with the manufacturing piece, we do have the improving mix. That continues as we keep selling a higher amount of higher-value products and it growing, which is one of the reasons that the sales weren't quite as high. We were so focused on driving the high end, the high end didn't grow as fast as the lower end process, which we're in the process of fixing. In the improvements, besides mix, we continue to cut cost everywhere. We continue to realign the plants. We continue to upgrade the products with the manufacturing assets, with the investments we're making. The team is really working on maximizing all the pieces. And the things we've put in place over the last 4 or 5 years are paying off.

Frank H. Boykin

And Mike, on your other question regarding the sequential change in margins from Q3 to Q4, if we have that right, that question. Normally, again, it's a seasonal issue, where sales are down and margins are generally down when you compare to the preceding 2 quarters.

Jeffrey S. Lorberbaum

I mean, the last part of December, there are very few people who buy carpet at the end of December. So I mean, we have very little sales once you get past the first week.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Okay. No, I appreciate that. And I guess, just looking forward into 2014, when you talk about the successful focus on mix this year that's occurred as you've focused more on the higher end in carpet. At the same time, you've spent a lot of time talking about polyester and a lot of new products there to address more the commodity side, I believe -- or not the commodity, but more the value side, which does have a little bit of a lower margin. So just trying to get a sense, for next year, everything else equal, if you're just thinking about mix, would that have a positive or negative impact on margins in '14, given that you're still probably going to see some positive follow-through from the higher end?

Jeffrey S. Lorberbaum

Is that a carpet question or a total product question?

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Just carpet.

Jeffrey S. Lorberbaum

The carpet, we expect the high end to keep selling more. You're correct that we're going to sell more of the mid to low price that are going to have not quite as much margin. At the same time, we're expecting an increase in the volume, which is going to give us absorption, the positive pieces there, and we're going to continue managing all the costs that we've been. So I mean, were expecting an increase in margins.

Operator

Your next question comes from the line of Susan Maklari from UBS.

Susan Maklari - UBS Investment Bank, Research Division

A question for you regarding the pricing increases that you've been putting through. As things have gotten better, are you noticing that your pricing power's improving any, so that maybe you're able to get not just the offsets to the input costs that you're -- the higher input costs that you're seeing, but potentially just getting any true pricing that's coming through in there?

Jeffrey S. Lorberbaum

I mean, we always attempt to. We have to react to the market and we have to sell at competitive market prices. I'm not sure whether it's a lot of extra price going in to -- other than all the actions we're taking to improve our mix as well as reduce our costs across -- in general. At the same time, we have to keep absorbing all the cost increases of labor and insurance and everything else that goes on. We have to offset. Not so easy.

Susan Maklari - UBS Investment Bank, Research Division

Right, right. Okay. And then in terms of -- are you seeing people moving up in terms of the kind of products that they're choosing? Is there a less sort of a move down and maybe that trend is slowly reversing itself, and you're getting people that are instead choosing to move up to a better product now?

Jeffrey S. Lorberbaum

I think it's bifurcated. The people with money are trading up and buying better, but there's a whole lot of people in the mid to end that have limited discretionary income. And I'm not sure there's a lot there being moved up. It would also help if our government would help maintain our confidence in what's going on.

Operator

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

David S. MacGregor - Longbow Research LLC

At the risk of beating this carpet margin issue to death, I wonder if I can just go back and kind of pick up on Mike's question, and he asked if you could explore the individual buckets. And I guess I'm going to ask you if you -- if there's any way you could help us by kind of weighting the individual buckets in terms of the influence of that 290-basis-point margin lift?

Jeffrey S. Lorberbaum

I don't have the details of that to break it down further, other than to give you the pieces that caused it.

David S. MacGregor - Longbow Research LLC

Would it be -- with the 3 -- you talked about mix and operating and leveraging cost reductions. Would they be relatively equal in terms of their impact on that 290 basis points or was mix, by far, the biggest element?

Frank H. Boykin

I would say that productivity is actually the largest component of the improvement, but mix would be right up there with that.

David S. MacGregor - Longbow Research LLC

Okay, that's helpful. What are you modeling for revenue growth in carpet for the fourth quarter?

Jeffrey S. Lorberbaum

We typically don't give very specific pieces. We give you the total that we expect it to be, and you can see the trends that we're at.

Frank H. Boykin

We'd expect it to go up.

Operator

Your next question comes from the line of Dennis McGill from Zelman & Associates.

Dennis McGill - Zelman & Associates, LLC

Frank, I guess I'll just ask the same question backwards. In the third quarter, where was the upside relative to your initial guidance?

Frank H. Boykin

Relative to our initial guidance?

Dennis McGill - Zelman & Associates, LLC

Yes, for the third quarter earnings. In other words, you were performing probably about 10% better that what you guided us to. I'm just curious where the upside came from.

Frank H. Boykin

Are you just in the carpet segment?

Dennis McGill - Zelman & Associates, LLC

No, no, no. It's the whole business.

Frank H. Boykin

Well, I think...

Dennis McGill - Zelman & Associates, LLC

Relative to the EPS guidance that you put out there last quarter.

Frank H. Boykin

Yes. So I would say we probably got a little more productivity across all the businesses than maybe what we were originally estimating, and the mix was a little bit better.

Jeffrey S. Lorberbaum

Also, we -- the new acquisitions, it takes a while to make sure that our financial reporting and estimating in the future -- we keep improving it. So we think we've gotten much better from where we were 6 months ago. And every quarter, we keep enhancing our confidence in the future numbers.

Dennis McGill - Zelman & Associates, LLC

And by that, Jeff, do you mean the benefit of the acquisitions was better than you thought 6 months ago?

Frank H. Boykin

Well, you're generally -- to Jeff's point, you're generally a little more conservative, probably, when you're looking at outlook numbers, forecast numbers, until you become a little more comfortable with the business that you just bought.

Dennis McGill - Zelman & Associates, LLC

Okay. And then I think -- could you get a little bit more specific on what you're seeing in Europe? I think the phrase of yours was that it was soft. But are the rates of either decline or modest growth changing at all relative to what you saw over the last few quarters?

Jeffrey S. Lorberbaum

I'm not sure. The overall business in Europe of our legacy businesses was probably down about 4% overall. We have some categories, like insulation, growing. We've got other categories off more. So they are all over, depending upon what it is.

Operator

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

Eric Bosshard - Cleveland Research Company

Two questions. First of all, you mentioned a strong October earlier. I'm just wondering if you can talk a little bit about the pace of business through the quarter and if 4Q is expected to then be materially different than 3Q. The second question relates to the acquisitions. And I'm curious how you would characterize where you are in the cycle of integrating these businesses in terms of the effort, and also what the payback curve should look like and where that should terminate.

Jeffrey S. Lorberbaum

Okay. I think that what we're trying to get across with the sales was that as we went through the third quarter, we saw some softening as we went through. And we think that in the October, it looks like it's going back to more normalized levels that we had anticipated. And what was the second question?

Frank H. Boykin

Well, on the acquisition synergies, in each of those 3 companies' acquisitions, I would say they are pretty much on track with where our initial plans were. Obviously, the Pergo acquisition would be further along than the other 2 because we closed on it earlier. But -- and we'll see improvements. We're seeing some this year. We'll see more next year. But it's going to carry on into -- beyond 2014 before we complete the execution of all that.

Jeffrey S. Lorberbaum

With the acquisitions, I mean we closed up multiple plants already. We have integrated the organizations. I mean, we have some things that we're looking to make some large investments to throw out old assets. Those things take a while to do. We're watching and trying to learn about the businesses. I mean, they'll continue through '14 and '15.

Operator

Your next question comes from Keith Hughes from SunTrust.

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Just going back to the carpet question again, with the refocus on polyester. As you go into the market, other than price, what would be the drivers to take some share back in that market?

Jeffrey S. Lorberbaum

Well, we have a huge customer base that typically likes us. We have a very broad offering. We're going to expand and have differentiated products. We're the only company that can offer recycled products. I mean, in the high end, we're going to be offering 100% recycled products which the consumer likes. We think we just can execute well in the marketplace, and then we expect to be competitive.

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Second question, on ceramic tile. As you put these 3 businesses together, American Olean, Daltile and Marazzi, the concept of doing retail ceramic tile, like you're doing in Russia, in the U.S., is that something that could be on the radar screen?

Jeffrey S. Lorberbaum

We don't see any way that it's appropriate for the U.S. marketplace. In Russia, what happened was there really was a lack of distribution and retailers and methods to go to marketplace. They -- at points and places there, they sell stuff out of the back of trucks in fields. So it's just an immature market that allowed us to be in that position at this point. The U.S. is very mature, and it wouldn't make any sense.

Operator

Your next question comes from the line of Ken Zener from KeyBanc.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Gentlemen, with the success in the Marazzi acquisition in the U.S., I wonder if you could -- you talked about a 2% to 4% price increase to cover costs, can you describe how the competitive landscape is changing, given your size and your distribution, and how your competitors -- fragmented competitors, largely, I guess, imports, have been responding to date?

Jeffrey S. Lorberbaum

I think it's a little early to either know or answer the question. Most of the things we've been doing are on the backside of the business about how we operate it to get in place. We're looking to utilize best practices across the business. We're looking to improve the design of the products. We now have a broader offering of the products. And then, you're right, we're going to go to market in a stronger position. The competitive position is that a larger and larger amount of the U.S. needs are being manufactured in the U.S. There's companies in Europe that have opened or are opening manufacturing in the U.S. to try to participate in it. And so in most of the markets, the majority of it comes out of the local manufacturing. So we see that as a positive and we're well positioned for it. On the other hand, we also have -- where most of it's coming in from is either China or Mexico, are the 2 biggest pieces, and we have positions in both markets so we can support those. So we think we're well positioned. What everybody else is going to do, they'll have to develop their own strategies.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Understood. And could you -- since you mentioned China, it hasn't been, obviously, something you've been talking about in terms of the JV. Any comments there would be appreciated.

Jeffrey S. Lorberbaum

The Chinese market, there is dramatic overcapacity in the marketplace that's going on. We have reduced our costs in the marketplace to improve our manufacturing within it. We're upgrading our product line within it to improve the margins. We're getting benefits out of exporting products that make sense to bring to the U.S. and Mexican marketplaces. We're manufacturing specific products in our plants just for those marketplaces. With our sales in Marazzi, we have sales forces around the world that we think we can utilize those capacities to ship more around the world, and we have opportunities to achieve it. We're not achieving the profitability that we would like over there.

Operator

And your next question comes from the line of Dillard Watt from Stifel, Nicolaus.

Dillard Watt - Stifel, Nicolaus & Co., Inc., Research Division

Going back a little bit on the -- your comment about perhaps being a little more -- or a little less conservative on forecasting acquisitions. Wondering if you maybe could give us an update in terms of have you changed what you think your synergies can be in the various acquisitions or are we still maybe at the same level? Just if you could kind of walk us through the 3 acquisitions, let us know if there has been any changes to the synergy estimates.

Jeffrey S. Lorberbaum

We had a fairly good estimate of what we were going to do with each of the acquisitions. We had a long list of opportunities with each one that we're in the process of executing as quickly as possible. We're moving down those things. If I had to give you any surprises about the acquisitions, the positive ones would be the U.S. market is doing better than we had expected with Marazzi. The European market, we had really anticipated dropping more in sales. We're surprised positively by shipping stuff to other marketplaces to keep the sales up. The Russian business, the surprise there is the economy was growing probably 4% to 6% higher a year ago, and we anticipated the Russian marketplace staying better, so it's declined a little more than we had expected. The transition with Pergo is going as expected. We hope to come out with new product lines to really enhance the position of Pergo in Europe, because their assets were really outdated, and we can significantly improved the value and styling and design that we bring to marketplace and that should be executed in the first quarter. The Spano business, we're going through -- it's going to take longer because there's more changes in realigning the assets of Spano, because the 2 companies are basically in the same marketplaces and so there's a lot of opportunities to realign the manufacturing assets. We said we've shut down one line and we've announced the closing of another. There are other opportunities to take advantage of them. And the businesses, in some cases, there are some major capital investments that can be done in some to throw out even older, poorer assets than we're doing. And some of those will take more than a year or more from the time we order them to get them and implement them. So I think we're going right along where we had expected, and no big surprises.

Operator

There are no further questions at this time. I'd turn the call back over to the presenters.

Jeffrey S. Lorberbaum

We believe we're well positioned in the marketplace. We believe the U.S. marketplace is going to keep improving. There's a good chance that Europe has hit bottom and will improve. We're executing well, and I'm really proud of our management and how well they are implementing all the changes and adapting to the marketplaces. We appreciate your support. Thank you very much.

Operator

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

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