Good morning. My name is Alan, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mohawk Industries 2nd Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press Star, then 1 on your telephone keypad. To withdraw your question, please, please press Star, then 2. Should anyone need assistance at any time during this conference, please press Star, then 0, and an operator will assist you. As a reminder, ladies and gentlemen, this conference is being recorded today, Friday, the 28th of July, 2023. I would like now to introduce Mr. James Brunk. Mr. Brunk, you may begin your conference.
Thank you, Alan. Good morning, everyone. Welcome to Mohawk Industries Quarterly Investor Conference Call. Joining me on today's call are Jeff Lorberbaum, Chairman and Chief Executive Officer, and Chris Wellborn, President and Chief Operating Officer. Today, we'll update you on the company's second quarter performance and provide guidance for third quarter of 2023. I'd like to remind everyone that our press release and statements that we make during this call may include forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995, which are subject to various risks and uncertainties, including, but not limited to, those set forth in our press release and our periodic filings with the Securities and Exchange Commission. This call may include discussion of non-GAAP numbers. For a reconciliation of any non-GAAP to GAAP amounts, please refer to our Form 8-K and press release in the Investors section of our website.
With that, I'll turn over the call to Jeff for his opening remarks.
Thanks, James. Mohawk's second quarter net sales were $2.95 billion, down approximately 6.4% as reported, or 9.6% on a constant and legacy basis, primarily due to continued pressure in residential remodeling across all of our regions. Our adjusted EPS was $2.76, as our margins across the enterprise expanded sequentially due to seasonal improvements, increased production, productivity initiatives, and lower input costs. We generated over $145 million of free cash flow during the quarter, further strengthening our financial position. Typical of housing recessions, higher interest rates and inflation are significantly impacting flooring sales around the world. To manage, we are selectively investing to increase sales and reducing expenses by enhancing productivity, consolidating distribution points, and improving administrative efficiencies.
In the quarter, we initiated restructuring and integration actions that will save $35 million annually at a cost of approximately $17 million. We anticipate approximately half of the estimated savings should be realized in the current year, partially offsetting the weak residential remodeling activity. In addition, we're limiting future capital investments to those delivering significant sales, margin and operational improvements. In all of our regions, we're taking actions to increase sales, including promotions, retailer incentives, and selective product launches. The integration of our recent acquisition is progressing as we combine strategies and enhance their manufacturing and product offering. While managing lower market demand, we're preparing for the rebound that historically follows cyclical declines in our industry. Our LVT, premium laminate, quartz countertop, porcelain slab, and insulation manufacturing expansion should deliver the greatest growth as the market recovers.
Across our regions, we continue to see stronger results in the commercial sector than in residential. Residential remodeling remains the industry's greatest headwind due to lower home sales and deferred improvement projects. We believe channel inventories have declined and could be at a bottom. Price competition is increasing, with declining industry volume, mix, and input costs. In the US, the housing markets remain under pressure due to limited supply, high interest rates, and continued inflation. Existing homeowners are not moving at historical levels to maintain their low mortgage rates. In Q2, new home starts increased to 1.45 million, showing the first quarterly increase since the beginning of last year. We believe the trend in housing starts will continue and will positively impact flooring shipments in the future. In our regions, home sales and remodeling are also declining due to inflation and interest rates.
In Europe, energy prices have continued to decline, though persistent inflation in other categories is limiting consumer remodeling. In the quarter, we benefited from lower energy prices that flowed through our PNL. Our investments in biomass, solar, and wind energy production reduce our operational expenses and carbon footprint, positively impacting our performance. During the second quarter, the Italian government provided energy subsidies at a reduced level, and the program will not be continued. In May, USA Today ranked Mohawk as one of America's businesses that made the greatest reductions in their global emissions over the past three years. Mohawk was the only flooring company recognized, reinforcing our position as a global leader in sustainability.
Earlier this month, we announced that Bernard Thiers will be stepping down as President of Flooring Rest of the World next year and will continue with the company in a senior advisory role to support a smooth transition. Bernard has made many important contributions to the success of the business since we acquired Unilin in 2005. He has led the Flooring Rest of the World segment for the past 14 years and delivered profitable growth by expanding our product offering, entering new geographies, and bringing new product innovation to the market. I'm proud of the exceptional team that Bernard has assembled across this segment. Wim Messiaen will be joining Mohawk in October after he completes his contractual notice period. He'll become President of Flooring Rest of the World on February 1st.
Wim has more than 30 years of leadership experience with multinational packaging, building products, and flooring manufacturers in Europe, Asia, and Australia. He has considerable experience driving both growth organically and through acquisitions. Wim will complement our strong leadership team with a passion for innovation, strong customer focus, and a commitment to sustainability. James will now cover our financial performance for the second quarter.
Thank you, Jeff. Sales exceeded $2.9 billion for the quarter. That's a 6.4% decrease as reported, and 9.6% on a legacy and constant basis, as global inflation and higher interest rates significantly impacted the flooring industry volumes, especially in residential remodeling channel. Our Global Ceramic business had the strongest year-over-year sales performance, in part due to a greater exposure to commercial and new home construction, which outperformed residential remodeling. Gross margin for the quarter was 24.8% as reported, and excluding one-time items, was 25.9% versus 27.7% in the prior year. The year-over-year decline is due to softening volume, temporary plant shutdowns, unfavorable price mix, higher inflation, and the net impact of FX, partially offset by productivity gains.
The actual detailed amounts of these items will be included in the MD&A of our 10-Q, which will be filed after this call. SG&A expense as a percentage of sales was 19.6% as reported, and excluding one-time items, was 17.6% versus 16% in the prior year. The increase in SG&A expense is primarily attributable to higher inflation, the net impact of acquisitions, partially offset by productivity gains. Operating income, as reported, was 5.2%. Restructuring, integration, and other items were $91 million for the quarter, comprised of legal settlements and reserves, as disclosed in our quarterly filing, costs associated with restructuring actions announced in 2022, and acquisition and integration costs, primarily for our ceramic acquisitions in Mexico and Brazil. In the quarter, we have taken additional actions across the enterprise to lower our costs and strengthen our results.
The total cost of these actions is $17 million, for an annual savings of approximately $35 million once completed. Operating margin, excluding charges, was 8.3% for the quarter. The decline year-over-year was primarily driven by the lower sales volume and higher inflation, along with temporary plant shutdowns, negative price mix, and the unfavorable net impact of FX, partially offset by productivity gains. Sequentially, though, we saw significant margin expansion as seasonal volume helped strengthen our quarterly sales and reduce our manufacturing shutdowns. Lower costs, especially in raw material and energy, combined with increased productivity, offset weakening price and mix. Interest expense for the quarter was $23 million, increasing from the prior year, mainly due to the higher interest rates. Non-GAAP tax rate was 19.5% versus 22% in the prior year.
Our forecasted Q3 tax rate is between 18%-19%, and the full-year rate is forecasted to be 19%-20%. Earnings per share, as reported, were $1.58, and excluding charges, were $2.76. Turning to the segments. Global Ceramic segment had sales just shy of $1.2 billion. That was basically flat as reported, and a decrease of 6.7% on a legacy and constant basis. Weaker volume and unfavorable FX were only partially offset by positive price and mix. Compared to the prior year, our business in the U.S. held up the strongest in the quarter, led by its performance in commercial and new construction.
Operating margin, excluding charges, was 8.6%, as higher interest rates and inflation are impacting the flooring industry across our regions to varying degrees, leading to lower volumes and increased plant shutdowns, partially offset by productivity gains, positive price mix, and the favorable impact of FX. Turning to Flooring North America. Sales just exceeded $1 billion. That was an 8.9% decrease as reported, and 12% on a legacy basis, especially in the residential remodeling channel and negative impact of price mix, along with the lower volume. In the quarter, the year-over-year weakening conditions were felt the most in our residential soft surface businesses. Operating margin, excluding charges, was 6%, as current economic conditions with reduced inventory volumes and increased competition is driving negative price mix, lowering sales volume, and creating more temporary plant shutdowns, partially offset by decreasing input costs.
It should be noted that sequentially, we saw strong margin expansion in both Global Ceramic and the Flooring North America segments. Flooring Rest of the World, its sales is just over $790 million. That's an 11.4% decrease as reported and 10.2% on a legacy and constant base basis. The decrease was primarily attributable to lower volume, negative price mix, and unfavorable FX. The weakness in residential remodeling was felt the most in our laminate and wood businesses. Our insulation and panels business was negatively impacted by the deferral of new projects. Operating margin, excluding charges, was 12.1%. As consumer spending in our category has not improved at this point and market competition increases, we are negatively impacted by the lower volume, temporary plant shutdowns, and unfavorable net impact of FX, partially offset by productivity gains.
Corporate and eliminations was $12 million for the quarter. On a full year basis, corporate expenses should be approximately $45 million. Turning to the balance sheet. Cash and cash equivalents were $571 million for the quarter, with free cash flow of $147 million in Q2 versus a use in the prior year. Free cash flow year to date is over $275 million. Receivables were just shy of $2.1 billion, with a DSO of 58 days versus 56 in the prior year and prior quarter. Inventories for the quarter finished at just over $2.6 billion. Excluding the impact of acquisitions, inventories decreased $277 million versus Q2 of 2022.
Inventory days are at 120 days versus 116 in the prior year, but have decreased from the 128 days in the prior quarter. Property and plant and equipment is just shy of $5 billion. Q2 CapEx was $117 million, with D&A of $157 million. For the full year, our forecast includes CapEx of approximately $600 million, with D&A of $595 million. Finally, gross debt finished just shy of $3.1 billion, with leverage at 1.8x adjusted EBITDA. This provides us the flexibility and strength as we look forward to the rebound in our industry. Now, Chris will review our Q2 operational performance.
Thank you, James. Our Global Ceramic segments result improved from the first quarter, with increased sales, higher production, and lower energy costs. Around the globe, high interest rates and inflation are reducing housing sales and remodeling investments to varying degrees based on local conditions. We believe that most of our customers have now aligned their inventory levels with market conditions. Our asset utilization remained low with compressed demand, and we further reduced our inventory and working capital. Our PNL benefited from lower materials and energy flowing through the inventory. This reduction was partially offset by greater market competition and lower mix, which impacted our selling prices. While energy costs around the world have substantially decreased, they continue to be highly volatile. In our acquisitions in Brazil and Mexico, we are realigning the organizations, defining new sales and product strategies, and executing cost reductions.
Our US ceramic business benefited from a greater participation in the commercial and new construction channels, enhanced styling, and more consistent service. As energy and freight costs decline and industry volumes weaken, the market is becoming more competitive. We are introducing higher style products to improve our mix and are focusing on stronger sales channels. We've expanded our customer base, which is helping to offset the weakness in residential remodeling. In the quarter, we further reduced our inventory while maintaining high service levels. The decline in energy prices will improve our cost as it flows through our inventory. We have taken cost reduction actions in response to increased competition and other inflation. As we prepare for the start of the additional countertop capacity, we are enhancing our product portfolio and expanding our kitchen and bath channel with complementary tile and countertop selections.
Our ceramic business in Europe remains under pressure as residential remodeling remains slow. Our volumes in the quarter improved sequentially, and our results benefited from sales of premium residential collections, commercial products, and exports. Competition is becoming more intense in all channels due to low industry volume and declining energy costs. We are adjusting to the changing environment and using promotional activities to deliver additional volume. To utilize our new porcelain slab capacity, we are broadening our portfolio with innovative visuals and will manufacture products we have been outsourcing. We continue to focus on cost containment, including overhead reductions, productivity projects, and alternative formulations. As with our other regions, our Latin American ceramic businesses are also being pressured by higher interest rates, which have compressed residential remodeling.
We are making progress integrating our existing businesses and new acquisitions, and we have begun to leverage sales of our total product portfolio to expand our distribution. The combined synergies we are realizing are partially offsetting the weakening market conditions. By the end of the year, we should complete the migration of our acquisitions onto our existing information systems, which will facilitate further sales and cost opportunities. Of the two regions, Mexico is performing better due to the economy and lower interest rates, while Brazilian ceramic industry is now being more impacted by economic conditions after holding up longer. We are taking additional sales and operational actions to manage the softening environment. The Brazilian government has recently announced that it will subsidize low interest rate mortgages to support new home construction and help the economy. Our Flooring Rest of World segment continues to successfully manage a difficult environment.
Consumer spending has not improved as we expected, confidence remaining low given inflation, higher interest rates, and the war in Ukraine. Sequentially, our sales volume and production rates improved from the first period. With low manufacturing utilization and declining input costs, industry pricing and mix continues under pressure. During the quarter, energy and raw material costs declined, partially offsetting weakening conditions. To manage lower volumes, we're pursuing additional sales, reducing costs, and aligning production with demand. The segment's third quarter is seasonally impacted by extended vacations, which will reduce our sales and earnings in the period. Though our flooring sales are under pressure, our sheet vinyl collections are outperforming as consumers trade down to lower price alternatives to minimize project costs. To meet rising demand across our regions, we are increasing our sheet vinyl production. The integration of our Eastern European sheet vinyl acquisition has significantly progressed.
We have enhanced its offering with higher performance products, sped up its operations, and added another manufacturing shift to support growing volume. We are managing production of laminate and LVT to align with present demand and are introducing new products, merchandising, and specific promotions to expand sales volumes. We have begun to transition our residential LVT offering from flexible to rigid cores and are executing the previously announced restructuring to support this conversion. In our panels business, fewer projects are being initiated, and industrial use has decreased due to slower market conditions. We are increasing sales of our higher-margin decorative HPL products as we expand our customer base. Our plant utilization remains low, and our selling prices are declining, partially offset by lower material costs, improved productivity, and our green energy production.
We have made considerable progress integrating our small board and mezzanine acquisitions, including enhancing their operations, aligning sales strategies, and combining administrative functions. Long-term prospects for our insulation business remain strong, supported by increasing energy conservation and government regulations. Presently, demand is declining as residential and commercial investments are being deferred and new industry capacity is increasing competition in some of our markets. Industry pricing is declining as input costs fall, and we are reducing expenses to adjust market conditions. Similar to our other regions, the Australia and New Zealand housing markets have softened due to inflation and higher interest rates. Our results for the quarter were impacted by lower volumes and mix in our residential channels, and we are introducing new products and selective promotions to increase sales volume. Our commercial sales in New Zealand were stronger, and we are leveraging our innovative collections to capture larger projects.
Our Flooring North America segment has faced the same challenging conditions as inflation, high interest rates, and more conservative lending practices have impacted the US housing market and our industry. As we anticipated, the segment's margin sequentially expanded in the quarter due to seasonality and lower costs flowing through the inventory. To control costs, we have enhanced productivity, streamlined administrative functions, and initiated restructuring actions. With weak residential remodeling and softer mix, retailers continued to tightly manage their inventory levels, further impacting demand in the quarter. With energy and raw material costs declining, market competition is increasing. New single-family home starts have begun to increase, with some builders subsidizing interest rates to attract buyers. In retail, we are providing new product options to trade-up consumers and value alternatives for those with budget constraints. To increase sales, we're initiating selective promotional activity, enhancing our product offering, and introducing more consumer-friendly displays.
The U.S. commercial sector has proven more resilient as businesses continue to invest in new construction and remodeling projects. The July Architecture Billings Index reflected a stable environment for new projects. We are experiencing some mixed pressure in commercial as customers seek to maintain budgets. The hospitality and Main Street channels performed best in the quarter, and we are expecting our participation in the healthcare channels. Our unique products, which are certified carbon neutral, are growing as they deliver superior performance with a negative carbon footprint. Our commercial accessories acquisition is performing well as we leverage our relationships to enhance its product sales. Mohawk is the leading producer of premium laminate due to our more realistic visuals and waterproof performance. We continue to see a broader adoption of our RevWood products in both retail and builder channels.
We have increased our offering of our revolutionary Signature Technology, which enhances the richness of our Pergo and Karastan collections. We are aligning production with current conditions, implementing cost reductions, and managing pricing and mix to optimize our results. In residential carpet, we've seen a sequential improvement in sales and production, along with a decline in input costs, which improved our margins from the first quarter. We have enhanced our luxury Karastan and Godfrey Hirst collections and are providing retailer incentives to grow volumes. Our expanded solution-dyed polyester carpet portfolio is increasing our position with multifamily developers and single-home builders, negatively impacting our product mix. We have integrated our recent nonwoven acquisition and are improving its sales and operations. With the decline in ocean freight costs, market pressures for LVT are increasing, and the U.S. Forced Labor Protection Act is impacting some shipments.
Higher cost inventory reduced our margins as we adapted to the changing market. Our new rigid LVT introductions with updated visuals, WetProtect, and antimicrobial technologies differentiate us in the market, and our sheet vinyl sales rose as consumers selected more affordable options. Our West Coast LVT plant will continue to ramp up throughout the rest of the year. With that, I'll return the call to Jeff.
Thanks, Chris. Mohawk's second quarter performance reflected the positive impact of the many initiatives we're executing across our business. We're managing the current market conditions while preparing for the rebound in demand that follows cyclical downturns. Central banks have raised interest rates to reduce inflation and are signaling additional rate hikes are possible. In the U.S., we've seen a rise in builder confidence, and housing starts will increase our residential new construction business. We expect the commercial sector to outperform the residential category through this year, even with continued weakness in the office category. Though employment remains strong, remodeling and existing home sales are being delayed due to limited housing availability, higher interest rates, and inflation. Historically, when the economy recovers, these postponed remodeling projects fuel greater industry growth.
Our new restructuring initiatives could save $35 million per year, and our recent acquisitions will add greater benefit to our results as we optimize their performance. In this competitive market, we expect continued pressure on pricing and mix, partially offset by the flow-through of lower material and energy costs. Our third quarter seasonally weakened due to summer holidays, lower consumer spending, and lower production in Europe. Given these factors, we anticipate our third quarter adjusted EPS to be between $2.62 and $2.72, excluding any restructuring, acquisition, and other charges. At Mohawk, we're taking the necessary steps to manage today's challenges while preparing for tomorrow's opportunity. When central banks shift their focus to a more balanced approach, our business will accelerate as the industry recovers.
In all of our regions, housing is in short supply, aging homes are in need of remodeling, and businesses will invest to grow in more favorable conditions. These factors will create higher growth for flooring, and our investments in capacity expansion and our recent acquisitions will further enhance our results. We'll now be glad to take your questions.
Ladies and gentlemen, at this time, if you would like to ask a question, please press star, then the number 1 on your telephone keypad. Management requests that you limit your questions to 1 primary and 1 follow-up. Your first question comes from Phil Ng of Jefferies. Go ahead.
Hey, guys. Jeff, you've been in the business for some time now. You've talked about potentially the R&R cycle turning. Any color on the bidding activity you've seen through the last few months? Then when you looked at past cycles, what are some of the things that you're looking to kinda inform your view that it's inflecting? Is that existing homes turning, rates coming down? Any color on that front would be really helpful.
As you look at the cycles, what happens is, as we go through these downturns, all the activity is postponed. Our product category of flooring, nothing has to be replaced, as it, from either breaking or anything else. When people get uncomfortable, it gets postponed. This cycle, though, is not really typical of the other ones as you go through. What we believe is that when central banks change to a more balanced approach, you know, you'll see a, all the pent-up demand from these postponed purchases coming through. That'll expand the volume. At the same time, the mix improves. As retail increases, the retail channel tends to have higher margins because customers pick higher-value products. It's most effective now.
As that turns, you get an increase in it, and then the use of the asset goes up and reduces the cost per unit, and the margins expand at the same time. This time, we think also that our new investments in expansion will allow us to increase the categories of the business that are growing the most, and we should see acquisitions help us position us as we come out of this, because we should have them integrated about the time that things starts coming together. We're optimistic about the long term.
Gotcha. Have you seen the order activity for the R&R side of things at least flatten out here, or it's still TBD free?
We're hoping it's at a bottom.
Got it.
Consumers, when they have inflation, and they start managing their budgets, again, our category is more postponable than most. We're hoping it's gonna get better, but I can't say that we've seen it yet.
If you look at also the, Phil, the inventories in the channel, you know, across our region, customers did reduce inventory and did become, more conservative. We believe most channels have largely aligned with the, the current conditions.
Okay. That's that's a perfect segaue, James, to my next question. It sounds like inventory is flushed out to the channel. What about your inventory? Is your inventory at a good spot? The reason why I ask is because you started curtailing production pretty heavily last year, and you're starting to lap that. It was a pretty negative headwind. Does that flip positive? Are you at a pretty good spot? Any color there would be really helpful.
From a year-over-year perspective, you heard that, you know, certainly inventory is down for the quarter. What is key to us is sequentially, from Q1 to Q2, the inventory decreased about $110 million. About 60% of that was volume and 40% was the lower cost. We do anticipate further inventory decreases this year, you know, certainly depending on demand and inflation. What we're doing is we're keeping the inventory low. You get better churn in the plant operations, which helps with that unabsorbed overhead.
Okay, but you're still curtailing production in the back half. Is that what you're saying, James, on a year-over-year basis?
Yes. You know, if you look at, you have to consider the seasonality as well. You have certain shutdowns in the third quarter, mostly associated with Europe and, and the shutdowns. Obviously, in the fourth quarter, you will also have shutdowns associated with holidays. In the fourth quarter, though, we would expect that the shutdowns would be less than in the prior year.
Okay. Thank you. Appreciate the call, guys.
Our next question comes from Keith Hughes of Truist. Go ahead.
Thank you. You've made some comments on Europe on pacing and demand. I, I, I might be confusing the geographies. If you could just go back over where you think, particularly European consumer demand is trending, you know, during the quarter and in here, and here in July.
We had expected when we came out of the first quarter, that the decline in energy prices, which was a huge burden on the consumer, that we had expected it to come down and that the consumer would be positively impacted. At this point, we haven't seen the demand in flooring reflect that. Like, here, there are more vacations being taken and other things, experiences they're doing, but in our category, we haven't seen an improvement yet.
Okay. You talked about lower input costs, lower energy costs. Are you seeing any more sequential declines as we head into the second half of the year on those costs?
Yeah, Keith, if you kind of step back, sequentially, if you look Q1 to Q2, inflation, or deflation, you know, was about $55 million from Q1 to Q2, which offset the reductions in price and mix of about $36 million, which helped us expand the margins as the cost declined. Now, I would expect to see, as we go through, the second quarter to the third quarter, also, that same phenomena of lower input costs, lower inflation, helping offset the price mix, again, from a sequential standpoint.
Okay. Thank you.
Our next question comes from Eric Bosshard of Cleveland Research. Go ahead.
Thank you. If, first of all, if we could just circle back on that comment, the path forward on costs getting better and price getting worse. Did I interpret what you just said to say that the savings and inputs more than paid for the impact or pressure from price mix? Am I saying that right?
Yes. Sequentially is what I was focused on, is from Q1 to Q2, you saw that from Q2 to Q3, we, we expect the same to occur. Again, that's sequentially. It's very... You know, it's an interesting year where looking at sequential changes are actually more important. You can see the flow-through quicker of the lower cost, material, and energy, offsetting the pressure on price mix.
Then secondly, I guess, related to that, and somewhat answered within that statement, the, Jeff, you talked a good bit, kind of globally, about price mix pressure, either related to demand or influenced by what's going on with inputs. In terms of what you're seeing from consumers or your customers, is that path, a steady one, per the comment that was just made? Is it increasing? Is it stabilizing? Just trying to figure out what the slope of that curve looks like.
I mean, it's being caused by the low utilization rates, depending on geography and product category. To remind you, the industry, all the different pieces are, tend to be highly capital intense with high fixed costs, so the participants tend to try to maximize volume to cover the overhead. The energy and material are, are declining, and we're tending to pass through the majority of that to the customers. At the same time, you have a mix change that's going on with it. As we said before, the retail has higher margins, and as the retail is declining more, it's impacting the, the margins and average prices as well.
Okay, then, then last, Jeff, you, you spoke to it today and, and, and was in the release about signs of a bottom and, and hoping for a bottom as well. I, I guess I look at the channel, the retailers, taking inventory out, would suggest their position more conservative. In normal cycles, you know, I, I guess historically, we, we would look to see that inventories would increase and mix would get better, and that would be a sign of a more bullish consumer. What should we be watching for if it's not inventories and price mix to suggest more bullishness from either your customers or the end consumers about better demand?
I guess to begin with, we're, we're, we're hoping that the demand is maybe at a bottom for the cycle. As you said, the cycle is not exactly typical of prior ones. Unusual to have the employment remaining strong and our category be so pressured, which it is this time. The whole housing market is totally different than prior ones. You see right now, the housing is starting to, the new starts are going up. It's gonna take 4-9 months for us to see that, depending upon which house and how long it flows through before we see that.
On the longer-term side, when people's confidence historically, the consumer confidence is also a good indicator of when they start spending more money, because as that goes up, they'll start taking these postponed projects that they have and, and doing them. So far, the commercial is still holding up. We're assuming it's gonna weaken as we go through the fall, we'll have to see how it goes. So far, the, the index, or the billing index for the architects doesn't show it declining yet, but we're anticipating it's gonna get weaker.
Thank you.
Our next question comes from Susan Maklari from Goldman Sachs. Go ahead.
Thank you. Good morning, everyone.
Good morning, Susan.
Maybe to start with, when we think about your third quarter guide, can you help us walk through each of the segments and how we should be thinking about the sequential changes coming through from a seasonality perspective in terms of the top lines as well as the margins?
Yeah, I think James and I, I think both of us to do that one for you. In the third quarter, everybody didn't look like they built in the European decline that we always have. Given the vacations they take, our volumes over there dropped, and our margins dropped as well. We expect lower industry volumes will continue pressuring pricing and mix across the whole industry. At this time, we're not building in any catalyst for remodeling to improve. At some point, it will, but we don't, we don't have it in any of our expectations at this point. The period will continue to benefit from lower material and energy costs, as well as our restructuring actions. We're gonna keep controlling the inventory relative to the demand. We've talked a few times about, you know, the retail margins impacting our mix.
We also think that the currency changes have been going on, it could have an impact of another $5 million-$15 million, just in the currency changes. James, you want to sort of give her between the different segments?
Flooring Rest of the World, obviously, is most exposed to the European holidays. From, again, sequentially from Q2 to Q3, you would expect to see a, a margin decline in their business. Global Ceramic has some exposure to Europe, but the largest component and piece of that segment is the US. Margins from Q2 to Q3 could be, you know, flat to slightly down. Then in Flooring North America, usually Q3 is 1 of their strongest quarters, so we expect to, to see margin expansion from Q2 to Q3.
Okay, that, that's very helpful color. Then, you know, perhaps as we think about 2024, as, as that approaches, you know, understanding that it's hard to understand where the global macros will go and, and some of these demand factors. When you think about all the cost actions that you have taken across the business in the last, call it, 3 or 4 years, you think about some of the capacity changes that you've made in there as well. Any thoughts, Jeff, on how the business can perform across the different end markets and segments that you have at some sort of a level?
First, I don't think I'm capable of calling the turn. I don't know when it's gonna happen. It will happen. It usually follows the interest rates peaking and then starting to fall. I don't know if that's gonna happen the end of this year or sometime the end of next year, or anywhere in between. With that, the next year, all of the things you mentioned is right. We should have, as we talked about before, the volume should, should jump significantly. Usually, you have a significant increase in the industry volume, making up for the decreases that we've had as you come out. We think the margins will expand in all the businesses. Typically, the sales also go up further because our suppliers start raising our costs, and we pass those through, so those help the top line further.
You have an expansion of the volume, an expansion of selling prices, then you have the margins expanding as the leverage in the businesses go. This time, we also have more capacity in what we think are going to be the high-growth areas for our business. Then again, we should have. There's going to be very limited accretion in the acquisitions until the business turns. When it turns, we should have the costs take out, we should have restructured the product portfolios, and those should be ready to expand. We're expecting a significant improvement as we come out of this.
Okay. Thank you for the color, Jeff, and good luck with everything.
Thank you, Susan.
Our next question comes from Laura Champine from Loop Capital. Go ahead.
Thanks for taking my question. First, on the ceramic business, your press release calls out inflation. I'm assuming that's year on year. Is that just flowing through the higher cost inventories? Are you still seeing product cost inflation for that segment?
No, energy and- energy has started to come down. What you're seeing in the third quarter is the flow-through or the higher cost inventory that we had.
Is this the last quarter to where you would expect to see that impact?
I think most of it will be finished through this, after the third quarter.
After the third quarter. Got it. Then on CapEx, there's, there's language in the press release about sort of being careful on projects and needing a, a, a serious return. However, the budget doesn't seem to have shifted. Maybe what did change, if anything, this quarter versus last on your, your CapEx plans?
Well, you know, we're very focused on investing to optimize the, the future of the business. You know, the growth investments that we talked about, they make up about almost about $250 million of the 2023 budget, depending on timing. Maintenance CapEx for the business is roughly, you know, $200-$250 million as well. We're also focused, the balance really is on the quick kind of return projects on cost reductions or focus on product innovation, and then also some projects on acquisitions. What we were speaking about is now looking forward into next year, about being very, you know, very, I guess, diligent at looking at the CapEx budget for next year.
Got it. And is it too early to give us kind of a first look on the direction there?
Yeah, it's a little bit early, but we're working with all the teams as we speak.
Understood. Thank you.
Our next question comes from Truman Patterson with Wolfe Research. Go ahead.
Hey, good morning, everyone. Thanks for taking my questions. You know, clearly, you all have been pretty open about, you know, increased pricing competition globally. Do you think you could discuss just some of the big buckets, you know, where you're seeing this occur, either product category or, or region, as well as perhaps how this has evolved versus, you know, your expectations through the year?
Sure. In the US, you have, which, the declining import prices, which affect both LVT and ceramic. Those are moving down, and we're adjusting as we have to, to do those. Some of that is impacting our margins as we have higher cost inventory. In our European business, our ceramic businesses, they've been at very low levels, so the marketplace is getting very aggressive trying to run the assets that are there. The market pricing there is under pressure. In our flooring business in Europe, it's more of a mix problem than a pricing problem. On the other hand, you have growth in the lower-cost product categories, so we're bringing people down rather than lowering prices.
Then our panels and insulation businesses tend to go up and down with the material and energy prices, and those are being passed through as they occur.
Okay, perfectly. In North America, with oil coming down, quite a bit, understood, if I look at your margins kind of sequentially, it seems like that raw material deflation, versus pricing benefit probably occurred in North America a little bit more than some of the other regions. Could you help us think through what's built into your third quarter guide regarding raws in the North American segment, specifically?
Well, in Flooring North America, similar to the other segments, you know, from Q1 to Q2, you're absolutely right. We started to see, sequentially, the benefit of the lower costs coming through, not only in raw materials, but in energy as well. In our view of Q2 to Q3, we still see some of that, maybe a slower pace sequentially, but you still get a benefit of the lower cost in raw material, energy, and also freight, as you look in the US as well. Those are the assumptions around Flooring North America.
All right. Thanks for taking my questions.
The next question comes from John Lovallo of UBS. Please go ahead.
Hey, guys. Thank you for, for taking my questions. Just wanna make sure I have the, the cadence right here on, of the input cost inflation and on price mix. In terms of the input cost inflation, it looks like sequentially, we'll see improvement in the third quarter. Should we expect sort of a leveling off as we move into the fourth quarter? You know, should the third quarter and fourth quarter, on a year-over-year basis, be improved? Then in terms of price mix, are we still expecting sequential deterioration as we move through the third quarter and the fourth quarter?
Yeah. John, you kind of asked two different time periods there. Let me tackle sequentially first. Again, sequentially, you know, from Q1 to Q2, we benefited where you had lower costs versus the impact of lowering price and mix. I would expect a similar occurrence, albeit maybe less impact, but a similar occurrence in Q2 to Q3, and also in Q3 to Q4. Again, that's sequentially. Year-over-year, you're absolutely right. What we've said is that we have a tailwind in the back half of the year, again, year-over-year, from lower materials and lower energy. Price mix and the pressure on both will continue in the third and fourth quarter.
The gap from a year-over-year perspective will close, by the end of the year, but it will still exist, from a little bit.
Okay. That, that's helpful. You know, on the $17 million in restructuring charges that will generate the $35 million in annual savings, are those related to headcount? I'm just curious how you know, there it sounds like the savings are gonna come through pretty quickly here. If that is the case, I mean, are, are you at all concerned that it could negatively impact your ability to react if activity does pick up a little faster than anticipated?
No, these, these actions are really focused around, you know, headcount reductions, as you said, in both administrative and manufacturing functions, along with some consolidation of distribution points. Most of that, that cash is, will, you know, will occur in the third, fourth quarter of this year.
Gotcha. Thank you.
Our next question comes from Michael Rehaut of J.P. Morgan. Go ahead.
Great. Thanks very much. Just wanted to make sure I understood right in terms of your, your prior comments. If you kind of think about, you know, price mix versus cost, I just wanna make sure I'm understanding that it sounds like you're saying, will be negative, in the next 2 quarters, but perhaps that negative gap moderating or, or lessening as you get to the fourth quarter versus the third. Is that the right way to think about it?
If you're speaking about it from a year-over-year perspective, that, that is, that is a correct statement, that the benefit in, in the lower cost, compared to the pressure on price and mix, that differential will lessen, we anticipate, as we move through the balance of the year. That's why, Mike, I think sequentially is so important to look at because you see more in real time, the benefit of the lower cost offsetting, the impact of price mix.
Right. Then, but, you know, at the same time, it sounds like, you know, at least for the third quarter, you've pointed to that historical seasonality kicking in, where on a, you know, broad basis, inclusive of even, you know, price cost, but on a broad basis, you're looking for margins to decline on a consolidated basis in three Q versus two Q. It would sound that even if the price cost gap is narrowing in four Q on a year-over-year, I would assume you're still expecting, again, consistent with the typical seasonality, you're, you're expecting in a three Q, a further sequential margin contraction in, in four Q. Is that, is that fair to say?
Well, Mike, it really, first of all, depends on that demand cycle. What we talked about in, you know, from a fourth quarter perspective, you know, yes, you'll have seasonally lower production with, you know, Christmas vacations. You know, the industry volume, though, may be at a bottom, so pricing pressure could continue. Higher cost inventory by then should relatively be consumed, as Chris indicated earlier. We do have a bump, as you well heard and seen, on new home construction, which could help us increase flooring sales. We have the restart-restructuring that's gonna benefit our cost structures. Last year, as I noted earlier, we included, you know, much more shutdowns than normal, so that should help us in the fourth quarter as well.
We're also, as we've said before, anticipating commercial to weaken somewhat as we go through the year. That we'll have to see. Hopefully, we're wrong.
Right. Maybe just one last quick one: The Italian subsidies, does that end right on June at the end of 2Q?
If you could just quantify what that meant on a quarterly basis?
Yeah, as we said before, it's about $15 million-$20 million per quarter. The government did stop it at the end of the second quarter. It will flow through my inventory into my P&L. I'll get some benefit at a lower level in Q3, and then by Q4, it's basically gone.
The energy prices have continued to drop without those. They were making up for high energy costs, so the energy costs have dropped substantially. The difference will not be dramatic.
Yeah, with that lower cost, we are expecting to, you know, be aligned with the, the competition, as well.
Okay, great. Appreciate it. Thank you.
The next question comes from Mike Dahl of the Royal Bank of Canada. Go ahead.
Hi, thanks for taking my questions. Sorry to, sorry to beat the horse a little bit on the pricing comments. You know, it seems like the, the, you know, the sequential versus year-on-year is, is obviously a bit weird, just given the magnitude of all the changes. But it would seem like on a year-on-year basis, your cost tailwind should step up significantly in 4Q versus 3Q, again, on a year-on-year basis. I just wanna make sure I heard correctly that even in 4Q, you're still assuming that the price cost is slightly negative. And then, I guess, how do we think about that kind of an exit rate? Do you think you'll get back to, to neutral by, by year-end, as you, as you think about kind of 2024 planning?
Or, 'cause it seems to imply still some sequential price decline through the year, or accelerating declines through the year, I should say.
Let me kick that off, Mike. You're absolutely right. The benefit from a year-over-year perspective should, should peak, in terms of this year, should peak in the fourth quarter. That's why I said the gap will close significantly between the inflation and price mix. You know, it's, it's very difficult at this point to say it's gonna be, it's gonna be flat, slightly negative. You know, we'll have to see as, as the pricing evolves and the mix over the balance of the year. Certainly, the inflation gets or the lower costs flowing through the PNL gets much more substantial in the fourth quarter.
Got it. Okay. My second question, just related to kind of the LVT import dynamics and, and some of the puts and takes around the Forced Labor Act. Can you just-- you mentioned it in the opening comments, but just elaborate a little bit more on kind of how you've seen that evolve and, you know, whether supply chains have shifted enough and you've gotten product on port, or competition has gotten product into ports. Just what's, what's the update on that?
Yeah, we're seeing market pressures increasing with lower volumes and declining freight, higher cost inventories, reducing our margin as it flows through. We, we also have our West Coast operations will be in startup phase at the end of the year, but that Forced Labor Act is still impacting some of the sales and timing of our new introductions.
It is stopping product from coming in. They seem to be doing it on a individual business, supplier base. They keep adding to it over time. It has stopped shipments from coming in. It, we in particular, it stopped ours. It's impacted our service level on existing, existing sales, and it's also impacted our new product introductions, which got stopped. It, it's difficult to tell how it's gonna evolve.
Got it. Got it. Okay. Thanks, sir.
Our next question comes from Stephen Kim of Evercore. Please go ahead.
Yeah, thanks a lot, guys. Appreciate the color. My line cut out a couple of times, so apologies if this was asked. I don't think it was. I wanted to ask you about the impact or the benefit we can anticipate when volume ultimately returns. I know you're not giving a specific timeframe for when that will be, but when it does occur, inevitably, I'm curious about what we might see from productivity and temp shutdowns, in particular. Regarding productivity, we've usually seen a positive boost to your EBIT from productivity when volume's rising. You know, recently, you've actually generated positive productivity when volume was going down. I'm curious, when volume ultimately inflects up, is it reasonable to think that we could still get, you know, positive productivity year-on-year?
Similarly, with temp shutdowns, you mentioned, I think that in fourth Q, shutdowns, you will have shutdowns, but they'll be less than the prior year. What I'm interpreting that to be is that you're gonna get an EBIT benefit year-on-year from the reduced shutdowns. When you move forward and volume picks up, I assume you won't have any shutdowns, and so that should also be a benefit in, on top of whatever volume benefit you would get. I just want to make sure that both of those are true.
Yes, they are all true. As the utilization of the factories goes up, that will reduce the fixed overhead costs. Usually, the productivity of the plants also increases as well. We usually get leverage in the sales, sales cost as well, as it all turns. Somewhere along the line, as it goes in, we'll start raising prices as our suppliers start trying to expand their margins as we go forward. All those things occur.
Yeah. Great. That's, yeah, we look forward to that day. All right. Second question for me is, in ceramic, we've seen, you know, over the years or so, we've seen a pretty big rise in ceramic imports from India. You all have, you know, obviously moved, stepped into LatAm pretty significantly, Brazil, Mexico, et cetera. And I'm curious if you could help us understand, are there any salient differences, either in product quality or other costs of doing business, that favor Latin America for, as a place to import for you, or ship product to the U.S. from, versus other parts of Asia?
Just as a comment before he answers that one, our investments in Latin America are primarily for the Latin American markets, is it. We do ship some into the United States, but the majority of it is for the local markets. Chris, you wanna answer for the rest?
The other thing I would say, Stephen, is that the from India right now, the freight rates are really low, which we don't think are sustainable. In the US, we've done a lot of work on our mid and premium product to reduce the impact of the changes in that imported product.
Right, right now, India does have an advantage with freight.
Yeah.
Gotcha. Okay, great. Thanks very much, guys.
Our next question comes from Matthew Bouley of Barclays. Go ahead.
Good afternoon. Thank you for taking the questions. I, I think you mentioned a few times that commercial has been outperforming, but that you expected commercial to, to weaken later this year. I guess, how is that dynamic evolving for you specifically? You're actually starting to see signs of, I don't know, weakening orders, in the commercial end market, and, and just how, how might you expect that to play out from a volume and price perspective?
Well, first, you have to go back to other cycles. I've never seen a cycle where the commercial business didn't fall off, and it usually falls off about a year after the other one. It's possible you get through this without it, but hard to believe. There is some indications of some weakening new projects being started, and new orders, so we're gonna have to see how it, how it evolves. There's a chance it could keep going through it, but at least in our, our expectations, we're assuming there's gonna be some weakening show up.
Got it. Okay, that's helpful. Secondly, on the $35 million of savings actions, you know, I think you said half would be realized this year. I, I mean, should we assume that, you know, you're, you're kind of reaching the run rate really in Q4, or are you already starting to realize a lot of that in Q3? How, how does that kind of phase between the next two quarters? Thank you.
It's, it's fairly split between Q3 and Q4. I would say by the, you know, the run rate, you're correct, is, is you'll see it, as we get through Q4.
All right. Thanks, guys. Good luck.
The next question comes from Adam Baumgarten from Zelman. Go ahead.
Hey, good afternoon, everyone. Just curious if you could walk through where you're seeing the biggest negative mix impacts across the various products and geographies.
Right now, in the second quarter, you know, the price mix was unfavorable from a year-over-year perspective, and the largest part in, in the second quarter was in Flooring North America and LVT, with the pricing declines, driven by imports.
Okay, got it. Then just as, as we think about the restructuring actions, maybe how to think about that across the various segments as you spread it across the different businesses?
If you, if you back up a little bit. We announced in 2022, in Q2 and Q4, restructuring actions that, that should save as we go through this year and the next, about $60 million. That was mainly split between Flooring North America and Flooring Rest of the World, as they took out higher-cost assets, around reducing rug production, phasing out the residential flexible LVT in Europe, as, as well as some other initiatives. This current action that we just announced is, is fairly spread between Flooring North America and Global Ceramic.
Okay, great. Thanks. Thanks a lot.
The next question comes from Rafe Jadrosich of Bank of America. Please go ahead.
Hi, good afternoon. Thanks for taking my question. When you look at the dealers that you sell through in the US, sort of the smaller independent ones, just can you talk about the health of that sort of network? Obviously, like the industry sales have been under pressure, and I'm sure they're sitting on some, or they were sitting on some high-cost inventory and prices have come down. How is like the health of that retail channel for you? Are you seeing any consolidation there?
Most of the retailers have been able to, you, you go through the last year, they were able to pass through the costs. They were able to pass through the higher labor installation rates, and in some cases, many of them, their margins expanded. For the most part, most of them are in fairly good shape at this point.
Okay, that's good. It's good to hear. The second question was just on as pricing comes down with the lower input costs, like you're talking about in the second half here, what have you historically seen in terms of volumes with lower pricing? Like, what is the demand elasticity to price? Do you ever get an uptick in volumes because the pricing is lower?
Usually, in these environments, we're lowering prices in reaction to the marketplace and to. People start taking, trying to take isolated pieces and increasing their share, then, as you would suspect, the other participants are trying to hold their share. Typically, as prices decline, we pass through much of the, much of the lower cost to our customers as we're all trying to run assets.
Is this pricing competitive environment different than other doubts? Like, is it the kind of a similar level that you would have anticipated? Like, more competitive, less competitive than what you've seen historically?
I think it's probably typical. The difference will be in Europe. You know, you have a much lower environment. I think in Europe it might be more aggressive than historical. Also, the costs were up higher, much higher in Europe, too. You have both dynamics.
That makes sense. It's very helpful. Thank you.
This concludes our question and answer session. I would like to turn the conference back over to Mr. Jeff Lorberbaum for any closing remarks.
We'd like to thank everyone for joining us. We are focused on managing the short term, and we think we're well-positioning the business to maximize the long-term growth and earnings. Thank you again.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.