Mohawk Industries, Inc.
Q2 2013 Earnings Call Transcript

Published: 2 Aug 2013

[Operator:]

Good morning. My name is Shelby, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Mohawk Industries' 2013 Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, August 2, 2013. Thank you. I would now like to introduce Mr. Frank Boykin, Chief Financial Officer. Mr. Boykin, you may begin your conference.

[Frank H. Boykin:]

Thank you, Shelby. Good morning, everyone, and welcome to the Mohawk Industries' quarterly investor call. We are pleased to be here today to provide an update on our progress during the second quarter of 2013 and guidance for the third quarter. I would like to remind everyone that our press release and statements we make on this call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which are subject to various 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 will now turn the call over to Jeff Lorberbaum, Mohawk's Chairman and Chief Executive Officer. Jeff?

[Jeffrey S. Lorberbaum:]

Thank you, Frank. And thanks to everyone for joining us. During today's call, I'll review our second quarter highlights, assess market conditions and later discuss our third quarter guidance. The U.S. flooring industry continues to improve with new residential construction up significant for the year, remodeling gaining strength and commercial construction continuing to grow. Mohawk is the world's largest flooring manufacturer and our second quarter was the most successful in our history. We had strong revenue and profit growth, as both our legacy business and recent acquisitions delivered strong performances that exceeded our expectations. Our earnings per share were $1.16 as reported or $1.84, excluding unusual charges, an increase of 61% over adjusted 2012, our best second quarter on record. For the quarter, our sales increased about 35% as reported or 34% on a constant exchange rate, supported by 6% growth in our legacy sales and the balance from our recent acquisitions. Our adjusted SG&A improved 110 basis points, as we continue to control our costs. Our adjusted operating income increased 9.8%, an improvement of 190 basis points. In the first half of the year, we invested approximately $1.85 billion in 3 acquisitions

[Frank H. Boykin:]

Thank you, Jeff. Net sales for the quarter were $1,976,000,000, up approximately 35% as reported, or 34% on a constant exchange rate basis, and include an incremental $416 million from our acquisitions. Legacy sales for the quarter were up 6% compared to last year. In the U.S., new residential, residential remodel and commercial all grew while Europe remained slow. The performance of our acquisitions exceeded our expectations in the quarter. Our gross margin as reported was 26%. However, excluding charges, the margin was 27.7%, up 80 basis points due to higher volumes, better mix, cost initiatives and our acquisitions. Our SG&A for the quarter was $381 million or 19.3% of sales. Excluding charges, it was 17.9% of sales and improved 110 basis points from cost reductions, better leverage and lower Unilin amortization of $10 million. Our restructuring charges for the quarter were $60 million. Total restructuring and acquisition costs are estimated to be $120 million for the full year, of which $45 million to $65 million is expected to be recovered from future real estate sales over time. In the second quarter, the $60 million of restructuring and acquisition costs that were incurred include $42 million for Marazzi, $15 million for Pergo and $2 million for Spano, with $1 million in other categories. The $60 million was comprised of $14 million for legal, accounting and banking fees, a noncash $19 million charge for the inventory step-up and $27 million for restructuring, primarily related to the Marazzi reduction in force and the Pergo plant closures and related relocation. In the second half of 2013, we estimate the $50 million balance of restructuring charges will include an additional $14 million for a noncash inventory step-up and the rest will be for plant and infrastructure consolidation, product changes and system conversions, which are being finalized. Operating income, excluding charges, was $193 million, with a margin of 9.8%. Operating income dollars are up 66% from last year, with our margin improving 190 basis points. EBITDA, excluding charges for the quarter, was $275 million, with a margin of 13.9% or a 120 basis point improvement. Interest expense grew to $25 million with our increase in debt from the acquisitions. Our income tax rate was 21% compared to 18% last year. And for the full year, we expect a rate of 20%. We had a loss from discontinued operations, which was $1.4 million for the quarter or $0.02 per share. This includes a loss from the operations of a noncore Marazzi sanitary ware business held-for-sale. Our earnings per share, excluding charges, was $1.84 and is up 61% over last year. If we move to the segments. In the carpet segment, our sales were $771 million, an increase of 5% over last year. We had volume increases in all of our end markets, with improvement also driven by price increases and mix. Our operating income in the segment was $55 million or 7.1% of sales. This is an increase of 100 basis points and related to volume increases and mix improvement. In the ceramic segment, sales were $760 million. This was an 88% increase over last year. The increase was driven by the Marazzi acquisition and volume increases in our legacy business. Marazzi contributed $310 million to sales in the quarter. New residential, remodel and commercial all grew over last year. Operating income, excluding charges, was $88 million or a margin of 11.6%. Operating income dollars were up 144% over last year. Our margin improved 260 basis points. The Marazzi acquisition, volume improvement and cost savings all contributed to the margin growth. The Marazzi results will be included in Mohawk for only 9 months in 2013. Their full year sales last year were $1,160,000,000, and we expect a 4% to 5% growth rate in 2013, with a margin of 10% to 11%. In the laminate segment, sales were $471 million, or a 33% improvement over last year. Acquisitions and North American growth offset a slower European business. Acquisitions in the quarter contributed $105 million to our sales. Operating income, excluding charges, was $59 million with a margin of 12.6%. The operating income dollars were up 44% with lower volumes and mix improvement in Europe, offset by higher volumes in North America, as well as earnings from our acquisitions. Pergo and Spano sales were $500 million combined last year, after excluding discontinued raw material sales and products previously dropped. Both are expected to be down in 2013 due to a slower European economy. Pergo will be owned for the full year and Spano for 8 months, with combined margins estimated at 7% to 8% this year. In the corporate and eliminations segment, we had an operating loss of $9 million. We're expecting the full year loss to be in the range of $25 million to $30 million this year, with the intercompany profit eliminations impacting us more as we grow our top line. On the balance sheet, receivables ended the quarter at $1,146,000,000. This includes $300 million of an increase from acquisitions. Our days sales outstanding were flat to last year at 47 days. Inventories at the end of the quarter were $1,592,000,000. $410 million of the increase in inventories came from acquisitions. Our days inventory outstanding were flat to last year at 106 days. Fixed assets at the end of the quarter were $2,594,000,000 and included capital expenditures of $83 million during the quarter, with depreciation and amortization of $81 million. We continue to anticipate full year capital expenditures of $380 million and depreciation and amortization of $315 million. Total long-term debt was $2.5 billion. Total net debt at the end of the quarter was $2.4 billion. And that compares to net debt on a pro forma basis at the end of the first quarter of $2.5 billion. Our net debt-to-EBITDA improved to 2.6x compared to 2.8x at the end of the first quarter on a pro forma basis. Cash flow from operations in the quarter was $153 million, with free cash flow of $70 million in the period. I'll turn the call back over to Jeff.

[Jeffrey S. Lorberbaum:]

Thank you, Frank. Our performance during the second quarter underscored the value of our recent acquisitions and our ability to integrate them into our business. Our talented management team is focused on driving our historical businesses while optimizing our new acquisitions. We've quickly identified and executed many significant changes during -- including new organizational structures, cost improvement, asset consolidations, realignment of marketing strategies and the enhancement of our product offering. We continue to make the necessary strategy changes and investments to improve our profitability. We're committed to bringing innovation to the marketplace in all our products. And our new acquisitions have enhanced our ability to realize this. We anticipate improving each of our product categories with our strong brands, efficient manufacturing, innovative products and broad distribution. We are increasingly confident in the continued strengthening of the U.S. market. And we believe that continued job growth, expanded new home construction and greater remodeling investments, along with our new acquisitions, will improve our future results. With these factors, our guidance for the third quarter is $1.81 to $1.91 per share, excluding any restructuring or acquisition costs. With business improvement and acquisitions in 2013, we anticipate the fourth quarter seasonal decline to be slightly more than in 2010 and '11. Our second quarter result demonstrate our ability to grow our legacy businesses while delivering positive results through acquisitions. Mohawk is a global business with the knowledge and expertise to effectively compete in local markets while satisfying regional trends. While Mohawk's product and geographic presence have dramatically broadened over the years, the constant that remains is our commitment to operational excellence, continuous innovation and the satisfaction of our customers. We'll now be glad to take questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of John Baugh.

[John A. Baugh:]

I wanted to inquire on the acquisitions, where you think you are in terms of timing of executing the full realization of synergies and if you could do that by the 3 acquisitions. And then whether or not any of the 3 opportunities on the synergy front are perhaps greater than when you first acquired or analyzed the business.

[Jeffrey S. Lorberbaum:]

With the new acquisitions, we expect over the next few years to be able to improve the operating margins by about 2% to 4%. In addition, we believe there'll be revenue growth, which should continue. We've made significant progress in the integration. Some of the pieces are in our control and some aren't. Some of the things that we intend to do include putting new assets in. That could take 2 years to get them in before we realize all those. So the actions that we're doing include realigning the organizations, which we've done; consolidating plants, which is an ongoing process; reducing costs in all parts of the business; relocating production between the plants to optimize the plants that produce it; as well as enhancing the product lines to do that.

[John A. Baugh:]

So Jeff, where do you -- first inning, third inning, fifth inning?

[Jeffrey S. Lorberbaum:]

Listen, some of the businesses was only owned for about 30, 45 days. You could say we're further along on Pergo, but we're not as far along on Spano.

[Operator:]

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

[Kenneth R. Zener:]

Looking at tile in Mexico, where you've been, obviously, expanding your capacity as you bring in new product. Could you discuss the growth you kind of had in that market, and how much was share gains and organic? And you talked about Russia as well, in terms of a bit more promotional activity. I know that's, obviously -- I believe that was about 1/4 of Marazzi, if you could go into that as well?

[Jeffrey S. Lorberbaum:]

We'll try to give you some feel for it, but we don't break out specific products and sales in each of the parts or the margins of each.

[Kenneth R. Zener:]

Okay. I guess, if you were just taking share in Mexico, if that was half the growth -- and then if in Russia, what's happening there -- and -- because it's a hard market to understand, I think, from our perspective.

[Jeffrey S. Lorberbaum:]

Well, in Mexico, we put in capacity of -- new capacity of, I think, just under $100 million about a year ago, little less than a year ago. During the year, we have gotten [indiscernible] because it takes over a year to get it up to the efficiencies. We're getting close to where we'd like it to be. By the end of the year, the cost in the new plant should be pretty close to the same as every other facility that we have. At the same time, we started promoting product to use the new capacity, using lower-value products as we're training the people and the production is running through the plant. And what we're doing now is moving it to higher-value products in the marketplace. We still have a limited share of the Mexican marketplace, and a large amount of room to grow. We believe in the marketplace that our customers are looking for alternatives to purchase product from. So we believe we're a good alternative with a product offering from the top all the way to the bottom. In Russia, the market is very fractured market. We believe we're the largest participant in it. Nobody in the market has more than mid-teen market shares approximately. So there's a lot of opportunities to grow in Russia. We have a management group that's been there for a very long time building the business from a very small business to where it is today. We have the integrated structure there, where we manufacture the product. We have distribution across the country, all the way up to retail and franchise stores to move the product to market. In this period we just finished, we've started doing more advertising in the major retail markets in order to enhance the value of our brand and become more aware of our products in the marketplace, which is helping us overcome the slower growth in the economy. What else? To offset sales, the softness in the marketplace, we're also increasing our sales into the new construction part of the market, which still did not have the decline or softness that we saw in the replacement marketplace. In addition, I guess, in Russia, we've come out with a brand-new product line in the first of the year, and it's being accepted better than we had anticipated. So we think we're doing well, given the structure. We believe we have a long-term opportunity to grow in the categories we are as well as expand into other markets.

[Operator:]

And your next question comes from the line of Dennis McGill with Zelman & Associates.

[Dennis McGill:]

The first question, Frank, you mentioned that the acquisitions were coming in ahead of expectations thus far. Can you just talk a little bit about where that is? Is that top line or cost and maybe even by geography?

[Frank H. Boykin:]

We're not prepared to talk about them individually. But we have, I would say from a margin and bottom line standpoint, probably better performance than what we had anticipated.

[Dennis McGill:]

Okay. And then on the nonresidential side, I think you've talked consistently that, that's been a growing market for you. Could you maybe break that down between ceramic tile, carpet tile and then broadloom carpet just to kind of understand the puts and takes within that?

[Jeffrey S. Lorberbaum:]

So we're not prepared again to give you specific numbers. We could tell you that the commercial market is still growing for us in each of our segments. It's growing on all the pieces. The ceramic segment has a larger portion of commercial than does the carpet segment. I think we've given before that it's about 40% of our business in that segment. And in the carpet segment, we're seeing a change in it as the commercial tiles continue to grow. So we're having very high growth rates in our commercial tile, taking share from our broadloom business. We see going into the fall a continuation of what we've been seeing.

[Dennis McGill:]

But broadloom is growing still?

[Jeffrey S. Lorberbaum:]

Yes.

[Operator:]

And your next question comes from the line of Mike Wood with Macquarie.

[Mike Wood:]

Can you give a bit more color in terms of the positive mix shift in carpet? So that's mainly coming from area rugs or new product introductions? And essentially, how sustainable is this? Is this a one-time snapback or a cyclical shift or just a continued product evolution?

[Jeffrey S. Lorberbaum:]

We've been working for the last 4 or 5 years, our strategy is to improve our business, improve everything within it. And they're starting to pay benefits that we have. We're seeing better mix from higher-value products, and we've been talking about leading the soft category with -- we have 3 different pieces within it driving it. We have better volume going on in our carpet business, which is helping our cost. We continue to improve our manufacturing costs, and we continue to control our SG&A costs, all of which are benefiting the margins.

[Mike Wood:]

Okay, got it. And also in the Belgian -- the melamine business with Spano acquisition, I believe you said in the past that there was some tougher price discipline in that market. Since the acquisition, have you attempted any price increases or had any success there?

[Jeffrey S. Lorberbaum:]

We have not done anything. What we've done so far is we've restructured the management and sales organizations to put them together. We are getting the products, so each one had some slightly different product. So by putting the sales groups together, we could offer the product offering to a broader customer base. We're optimized -- we have the potential to optimize the manufacturing assets. We believe that reductions in infrastructure, we can do to improve it. We're just in the initial stages of developing how we're going to get there.

[Operator:]

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

[Michael Dahl:]

This is actually Mike Dahl on for Dan. Appreciate all the color on the various initiatives across the business. I was curious about on the ceramic side, you mentioned you're testing this distribution strategy, the single center distribution in Vegas. How should we think about the margin opportunity from that? And is this a sign that if this were to go well, you'd explore broadening that out to other markets as well?

[Jeffrey S. Lorberbaum:]

You have to go back to what the strengths and weaknesses were of each of the brands prior. The Marazzi brand basically focused on medium- to higher-end residential floor tile. And they were trying to drive their business through that. In our business under American Olean, we have a commercial product line, which they don't offer. We have wall tile they don't offer. We have a broader pricing spectrum of products we cover. And then we also offer assorted things in installation and other packages to give a full package to the customer. What we're doing is offering to both our distribution customers as well as where we have weak distribution, the combination of offering both brands to our customer base together. And that will allow us to have a complete line, competitive with our complete Dal-Tile line. And we believe that doing so, we'll be able to attract more customers and increase both the brands' penetration in the marketplace.

[Michael Dahl:]

Okay. And then also on ceramics, could you quantify what percentage of SKUs were impacted by the product review? And also talk to the margin differential between some of the larger decorative tiles and some of the weaker SKUs that you're discontinuing.

[Jeffrey S. Lorberbaum:]

I don't have the detail of the SKUs. There's a significant number of low-productive SKUs in the Marazzi Europe line that we're going to remove from the line. At the same time, due to limited capabilities and equipment, they were limited in how much of certain higher-value products they could make. We've agreed to increase the capacity, make changes in it to improve the amount of the higher-value products we can do and restructuring the manufacturing. They ran the business. They had plants in different countries in Europe and they ran them each fairly independently. What we're doing is running them more holistically. And so by moving products around, we have capability short-term of producing a different mix of products. We think it's the right thing to do and we'll continue down that path.

[Michael Dahl:]

And any quantification on just what you can do on a margin basis from those higher-value products?

[Jeffrey S. Lorberbaum:]

A minute ago, we gave a view that said that over time, we expect that the margins of all the acquisitions collectively over the next few years, we'll be able to move it up 2% to 4%. This is about as close as we're going get you.

[Operator:]

And your next question comes from the line of Eric Bosshard with the Cleveland Research Company.

[Eric Bosshard:]

Two questions for you. First of all, Europe, can you clarify what you're seeing and expecting in Europe? I know you talked about Pergo and Spano being down this year and Marazzi being up, but I know there's different pieces there. Could you just cut through and talk about what you're seeing in terms of demand in the Europe market in the first half and expectations for the second half?

[Jeffrey S. Lorberbaum:]

The Southern part of Europe continues to be weak. We're seeing declines. The Northern part tends to be better but also declines. We have different product categories that are more related to new construction versus remodeling, and you're seeing differences there. Country-by-country, there are significant differences. Going forward, our hope is to have limited downside and possibly be at a bottom. We don't know.

[Frank H. Boykin:]

The other thing, Eric, I would point out is that if you look at our 2 businesses over there, Unilin, Unilin is primarily in middle and Northern Europe, which countries are performing better, as you know, than Southern Europe. Marazzi does have a presence in Southern Europe. But as we've talked about, they've been able to offset a lot of that. Their businesses in Europe have been able to offset all of that. A lot of that with exports into other areas around the world.

[Eric Bosshard:]

And then secondly, the management changes that you've made as you consolidated the new businesses within tile and laminate, could you just speak a little bit of what their marching orders are? I know you've spoken of the focus on improving profitability. But interested in how that is balanced relative to accelerating sales growth and market share.

[Jeffrey S. Lorberbaum:]

I'll try to repeat some of the things that we talked about. In the U.S., we're operating both together as a single entity, that we are looking at combining the 2 brands here, which we think we can increase penetration both through distribution as well as the areas where we don't go through distribution. We believe that the combination of those will allow us to increase the penetration of those. We believe that the equipment can be optimized by taking the products that fit which plant best across the entire enterprise and increase the productivity and cost structure of those. In the European business in ceramic, I mean, we're changing the business philosophies dramatically. They used to run the business as a country-by-country basis, almost as independent businesses. We are -- we have put a single management structure over the top, where all the manufacturing is reporting to one gentleman. All the sales are reporting to another. That we are taking the product lines, which they used to go to market separately, and we're going to put them through all of the -- a unified sales force to drive those. We are focused on increasing our business in areas in Northern Europe. We're focused on increasing our business in Northern Africa and other countries around. We are increasing the amount of premium products through short-term changes, as well as new investments to allow those to occur, which will take some time to maximize. What else can I tell you?

[Operator:]

And your next question comes from the line of Susan Maklari with UBS.

[Susan Maklari:]

You mentioned that you're seeing a definite improvement in the repair or remodel side of demand in several of the segments. And it seems like this is the first quarter that we've heard about that in quite some time. Can you give us some more details around exactly what you're seeing there? Is it increased sales? Is it people moving to a higher price point in terms of product mix? Just some sort of sense of what's going on there.

[Jeffrey S. Lorberbaum:]

In all of the different channels in both the businesses, we're seeing growth through the specialty store channel. We're seeing growth in the home center channel in both cases, as well as the other parts and pieces of them. We believe that it's being driven by several things

[Frank H. Boykin:]

I'll add on the mix side though, Susan, it is still early, a little difficult in the cycle, a little difficult to evaluate mix. With price increases that we've had in new products and prebuying that's going on, it's a little difficult to evaluate what's going on with mix.

[Susan Maklari:]

Okay. And then have you guys seen or heard sort of anecdotally that there's been any changes in demand? Are consumers having any reaction to the fact that rates have moved at all? Is that impacting their ability to maybe finance projects or the way that they think about taking these things on?

[Jeffrey S. Lorberbaum:]

We're not getting any input in either direction on that.

[Operator:]

And your next question comes from the line of Bob Wetenhall with RBC Capital Markets.

[Robert C. Wetenhall:]

Wanted to ask you guys, what are you seeing in terms of raw material costs and pricing initiatives to offset it? It sounds like it's kind of at loggerheads right now. Any color would be terrific.

[Jeffrey S. Lorberbaum:]

Each one of the businesses have different things driving it. So the carpet business, we're in the middle of implementing a 4% to 6% price increase that we announced some time ago. We talked about the lag and recovering it and that we anticipate to cover it now. At the moment, we haven't seen significant changes in it. We continue to watch it as we go through. In that area, some of the chemical prices are under pressure. However, there's some increases in the oil prices. So we're just watching it and we'll have to react to it. In the ceramic segment, we have the natural gas prices have gone up and the gasoline prices on the trucks, and in that business, we sell a lot of it delivered. So we've announced a price increase in the third quarter to try to recover those changes and some others with it. In the wood business, the lumber prices on the solid woods and the engineered woods are going up. We've announced 3 or 4 price increases this year. We're still implementing those. Hopefully, we're reaching a peak.

[Robert C. Wetenhall:]

That's very helpful. So your carpet sales were up 5%. This is the best growth rate since the fourth quarter of 2011. So that's obviously an exciting development. Is this mid-single-digit growth rate, in your opinion, based on what you know now, likely sustainable during the back half of the year?

[Jeffrey S. Lorberbaum:]

We're hoping that the present trends will continue.

[Operator:]

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

[Jason Aaron Marcus:]

This is actually Jason Marcus in for Mike. The first question is going back to the ceramic segment for a minute. So you saw a really impressive improvement of about 260 basis points in the quarter. I was wondering if you could let us know, kind of in order of magnitude, how much of an impact the higher volumes had relative to Marazzi and the sales mix? And then in terms of the year-over-year progression in margins for the next 2 quarters, do you think you'd be able to maintain the same type of improvement you saw in the second quarter? Or do you think you will maybe even be able to improve that even more in the back half?

[Jeffrey S. Lorberbaum:]

Jason, it's all built into the estimates we gave you. We gave you an estimates for this quarter. We tried to give you some view of the seasonality of the businesses in reference to history. And you should be able to get pretty close.

[Jason Aaron Marcus:]

Okay. And then in terms of the different industries that you sell to on the commercial side, like education, office, health care and government, I'm just wondering if you could quickly run through the trends that you're seeing in each of those.

[Jeffrey S. Lorberbaum:]

I guess, just high level, the corporate, hospitality and health care are the strongest markets that we're seeing in the different pieces. We see that they'll continue like they're going at this moment.

[Operator:]

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

[Sam Darkatsh:]

At the risk of being overly simplistic -- and I do respect the fact that you don't give a whole lot of details around your guidance, but I'm looking at the third quarter guidance that, frankly, shares -- results pretty similar from an EPS standpoint in Q2, yet you've got a lot of things that are sequentially better in Q3 as you suggested. You've got the fair carpet pricing in Q3. You've got no FIFO impacts like you had in Q2. You've got higher prices in ceramic and wood and the volume has also accelerated through the quarter. So I'm just confused as to what the offsets there exist between Q2 and Q3 on the negative side that would cause you only to be hitting in the same general area as you did in Q2.

[Jeffrey S. Lorberbaum:]

If we could get the Europeans to quit going on vacation for a month or so in the third quarter, you wouldn't have the same result. So it's all got to do with what happens in Europe, the majority of it is what's happening in Europe and around that they all take off, which is -- it always happens every year.

[Sam Darkatsh:]

I would think though that the overall volumes there will not be all that dissimilar Q2 to Q3. So is that the area of conservatism that you see that you're baking in there, is you're not sure where European margins shake out?

[Jeffrey S. Lorberbaum:]

No, the European sales are less.

[Sam Darkatsh:]

Okay. And the last question I would have, Frank -- and if you mentioned this on the call, I apologize. Available liquidity as it stands and where would you feel comfortable where that liquidity needs to be for you to make a fairly substantial acquisition going forward?

[Frank H. Boykin:]

We're at $300 million right now available on our revolver. And with regards to acquisitions, we continue to look at anything anybody brings us. But we're focused right now primarily on integrating those acquisitions, and we'll continue to pay down debt. And the other thing to point out that has happened favorably is our debt-to-EBITDA ratio has continued to improve. Just from the first quarter to the second quarter, it's improved significantly, so we'll continue to drop that.

[Jeffrey S. Lorberbaum:]

We're expecting the ratio to continue improving significantly. So it's not a matter of being able to get the money, it's a matter of being able to have the management to tackle how many things at the same time. And we think we have the capability to buy other ones, it'll be greater over time. And if we find the right ones, we'll take actions.

[Operator:]

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

[Kathryn I. Thompson:]

Wanted to pull the string a little bit more on ceramic margins, both in the quarter and looking forward, not only just for the back half, but over the next 2 to 3 years. First, for the quarter, how much of the over 260 basis points year-over-year improvement was to the core business versus acquired -- just relatively higher acquired margins? And as we look into the back half of the year, how should we think about Marazzi? Then finally, you originally had targeted a 13% to 15% type margin over the next several years. Do you think that there could be upside to that target?

[Frank H. Boykin:]

So look, a couple of questions in there. I'll see if I can hit them all. The first thing I want to point out is with these acquisitions. As I talked about last quarter, as we get further and further along in the integration, it's very difficult to pull them apart and say x amount of the margin improvement came from the acquisitions and the other amount came from other things that we're doing. So we really can't address that. With regards to the future, looking out over the next couple of years, we are expecting our ceramic margins to get back up to the kind of 13%, 14% range that they've run historically.

[Jeffrey S. Lorberbaum:]

It would also help to have Europe improve a little bit, has a lot of upsides.

[Kathryn I. Thompson:]

Do you think that there's possibility for upside beyond that 13% to 14%?

[Jeffrey S. Lorberbaum:]

One step at a time.

[Kathryn I. Thompson:]

Okay, great. And if I could sneak one last in, how much of America's low-teens growth in ceramic was Mexico versus the core U.S. business?

[Jeffrey S. Lorberbaum:]

The core business is so much larger than the other. It's basically setting the pace. The other one is a small part of the total.

[Operator:]

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

[David S. MacGregor:]

I guess, for starters, Frank, in the past, you've given some guidance on contribution margins of ceramic, carpet and wood. And I'm just wondering how the acquisitions changed those numbers you gave us in the past?

[Frank H. Boykin:]

I think we're still in the same vicinity as what we've given you in the past, about a 20% contribution margin in carpet and mid-20s for ceramic and upper 20s to 30% range for laminate.

[David S. MacGregor:]

Okay. And then the 2% to 4% margin improvement on the consolidated numbers you discussed earlier, I just wanted to clarify, how much of that was restructuring and how much of it, if any, is just the operating leverage off the top line growth?

[Jeffrey S. Lorberbaum:]

It's all of the above.

[David S. MacGregor:]

So that's everything, all-in, you expect at margin improvement?

[Jeffrey S. Lorberbaum:]

Yes.

[David S. MacGregor:]

And then finally, just because Sam brought up the M&A question, if I could tag on there. Most of the category growth, at least in North America, has been in hardwood and LVT. And these are both categories where you've got a fairly limited presence or you're sourcing products. So I realized you've got your hands full right now. You're integrating, you plan to pay down debt. But can you just talk about where, within your M&A priorities going forward, these 2 categories may stand?

[Jeffrey S. Lorberbaum:]

We have a significant wood business. We have a limited LVT business that we're importing products into U.S. and Europe. We're in the process of building an LVT plant in Europe. It should be up and running sometime next year. As that one proves itself out, we would be prepared to expand into those categories in other geographic markets.

[Operator:]

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

[Keith B. Hughes:]

First question, within Pergo, the plant closures in Sweden you'd referred to, when would those be completed? And when will all the costs have been incurred on that process?

[Jeffrey S. Lorberbaum:]

The completion will be by the end of this quarter. The operations will be moved to our Belgian plant and be supplied out of our Belgian plant. And the cost, I guess...

[Frank H. Boykin:]

Most of the cost will have been done by the end of the third quarter.

[Jeffrey S. Lorberbaum:]

There's some in the fourth -- there's some later because there's product transitions and other things and updating the product line in Europe. So some is -- Frank gave you some numbers earlier about the rest of second half.

[Keith B. Hughes:]

Okay. And I don't know if you mentioned this in the prepared segments, but on Spano, I know there's going to be some manufacturing rationalization there. What kind of timeframe are you looking at on Spano?

[Jeffrey S. Lorberbaum:]

We're still evaluating the opportunities. There are a number of plants close to each other. And the opportunities are, can we move the -- use the best assets and the place? Should we put more investments in? We haven't concluded yet.

[Frank H. Boykin:]

Nothing's been announced.

[Keith B. Hughes:]

Okay. And then finally, you had some positive comments on the press release on rugs. I know that's been a problem for some time. Do you think rugs year-over-year will be a growth category for you in the third quarter?

[Jeffrey S. Lorberbaum:]

The sales have improved. What's happening in the rug business is that as the retailers perceive the cuts -- we tend to sell a large portion of it to discounters, mass merchants. And over the last year or so, they've been compressing the price points, trying to make them more available for people with incomes that are getting squeezed. So we're having a significant problem into average value as they compress it. We're spending a huge amount of effort trying to bring them higher-value products that they can sell at higher price points. So it's a compression of the prices that's our biggest problem.

[Keith B. Hughes:]

So not really units, compression of prices?

[Jeffrey S. Lorberbaum:]

Yes, the retail price points.

[Keith B. Hughes:]

Retail price, okay. Is that -- you think it's going to turn positive? Or we've still got some work to do with them?

[Jeffrey S. Lorberbaum:]

It's better than it was, but we're still working on it.

[Operator:]

And your last question comes from the line of Stephen Kim with Barclays.

[Stephen S. Kim:]

Jeff, this is probably a question for you. I was curious if you could give -- talk a little bit about the evolution of your management style. And in particular, I'm curious as to whether you can give us some sense for how you -- what current bottlenecks you see in your current -- the way you currently have your management structured, how you have -- how you monitor what's going on in the field and how you allow the operation to make decisions, as well as you have. If there's any bottlenecks that we should be -- or that you're primarily thinking about, which you might need to address as you contemplate becoming an even bigger and more global organization?

[Jeffrey S. Lorberbaum:]

I think that what was just taken on in the last 6 months is a huge piece of acquiring as many businesses and as many continents and as many different product categories that we have all at the same time. The reason we're able to handle it is because of the management structure. Within the management structure, I have a Chief Operating Officer, who's over the business and helps me execute these strategies across the business. Under each of those, we have 3 segments

[Stephen S. Kim:]

Well, certainly so far, it's been working great. So I appreciate that color. I guess, my next question relates to Marazzi and the Pergo acquisitions, both of which you're doing integration work and seeing opportunities for expansion both domestically and overseas. I was curious if you could share with us kind of a generalization as to whether you feel that -- where you feel for Marazzi and Pergo more of the opportunity or low-hanging fruit exists, whether it be domestically or overseas for Marazzi and also then for Pergo?

[Jeffrey S. Lorberbaum:]

Each of the businesses have unique opportunities. We talked through a lot of them in the last hour. The U.S. business, the operations side of the Pergo business, there's ways of improving it. They were starved for cash and putting them together, utilizing the best assets across it, internalizing things, like board production both in Europe and there. They had simple things like they were outsourcing maintenance. I mean, it's all being in-sourced as we speak. There were things like the raw material supplied in different pieces, we're internalizing those. In Europe, the Pergo assets were put in -- most of them were 20 years old and outdated. The reason we're closing the plants up, it costs more to fix them than they're worth. We can leverage the assets where we are by closing the assets there and moving them to our other plants. They go from having the worst assets in the industry to having the best assets in the industry. On the Marazzi side, the business in the U.S., I mean, it was running really well when we got it. We're looking for synergies across the pieces, in marketing, branding and product. Increasing distribution, we think a big opportunities. Europe, the European ceramic industry from peak to bottom is off like 50%. So they had already done many changes to do it. The big opportunity in Europe is to reduce the infrastructure costs, which we -- we have many things going on to improve the asset quality and to broaden the product mix. And boy, if we ever get any help in the marketplace, I mean, we have big upsides in it. The Europe -- the Russian business, I mean, is running well. We just have to keep feeding it capital and keep looking how to grow it in other areas that they're not in over time. All have good opportunities. We've got them all lined up and we're going after them all.

[Operator:]

And there are no further audio questions.

[Jeffrey S. Lorberbaum:]

Thank you for joining us for our second quarter. Have a nice day.

[Operator:]

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