Mohawk Industries, Inc. (MHK) Q1 2015 Earnings Report, Transcript and Summary

Good morning. My name is Shannon, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mohawk Industries Second Quarter 2015 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer period. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, Friday, May 8, 2015. Thank you. I would now like to introduce Mr. Frank Boykin, Chief Financial Officer. Mr. Boykin, you may begin your conference.

Thank you, Shannon. Good morning, everyone. And welcome to the Mohawk Industries quarterly investor conference call. Today, we will update you on the company’s progress during the first quarter of 2015 and provide guidance for the second quarter. 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 in the Private Securities Litigation Reform Act of 1995, which are subject to various risks and uncertainties, including, but not limited to, those set forth in our press release and our periodic filings with the Securities and Exchange Commission. This call may include discussion of non-GAAP numbers. You can refer to our Form 8-K and press release in the Investor Information section of our website for a reconciliation of any non-GAAP to GAAP amounts. I’ll now turn the call over to Jeff Lorberbaum, Mohawk’s Chairman and Chief Executive Officer. Jeff?

Thank you, Frank. During the first quarter, Mohawk continued to deliver a strong performance. Our earnings per share were $1.70 excluding unusual charges, an increase of 38% on a constant exchange rate. The highest first quarter adjusted EPS in the company’s history. During the period, our adjusted operating margin was approximately 10%, an increase of 170 basis points compared to the prior year as a result of new products, higher volume and numerous productivity issues across the enterprise. Revenues grew across all segments with first quarter sales increasing approximately 6% at a constant exchange rate adjusted for additional days and disposable – disposed ceramic plant. Our results were even more outstanding when the impact of the strengthening dollar is excluded as EPS would have been approximately $1.90 per share. During the period, we improved SG&A as a percentage of sales by 90 basis points across the business, even as we expanded our sales organization, introduced leading product innovation and implemented merchandising systems that showcase our product value. We further enhanced productivity, efficiency and inventory management across the business to reduce our costs and improve our service levels. All of our segments introduced new products with unique features and benefits to differentiate our offerings and improve our mix. As the global economy improves we are well-positioned in each of our markets to expand our sales and margins with our leading brands, product offerings and expansive distribution. During the period the U.S. economy showed some improvement with housing sales and remodeling investments softer than predicted. Consumer confidence rebounded in March with the improved job market increasing personal income. In April, the National Association of Home Builders reported a rise in builder confidence and gains in new housing starts. In March, about one-third of new home purchases were made by first-time buyers, a stronger trend that could further improve housing growth during 2015. The National Association of Realtors reported that existing home sales in March rose to the highest rate in 18 months. And Harvard’s LIRA index is forecasting improvement in residential remodeling. The consensus among commercial construction forecasts is for continued growth in 2015. The Mexican ceramic industry continues to expand as government support of manufacturing and construction sectors has contributed significantly to the country’s GDP growth. Europe is showing signs of improvement as the Central Bank lowers interest rates and provides greater stimulus for the economy. The Russian economy continues to slow and the government is lowering interest rates and subsidizing home mortgages. Local manufacturers are benefiting from a significant decline in higher cost imports and consumers are using their savings to purchase products before inflation impacts. Turning to a review of our first quarter performance by segment, sales in our Carpet segment grew approximately 4% on a comparable daily basis. Our adjusted operating income increased 20% with a margin of 5.5%, up 40 basis points over the prior year. Our sales of commercial carpet, rugs and hard surface products increased more than our residential carpet sales which improved as we went through the quarter. We have completed our Continuum manufacturing expansion and are increasing sales in this faster growing polyester category. As consumer demand shifts to lower priced polyester products, it is de-mixing our residential selling prices. Sales of our Mohawk branded LVT, wood and ceramic products continue to grow in both residential and commercial sectors. The business continues to drive improvement through product innovation, while enhancing our productivity with process simplification, improved product management, leading-edge technologies and material optimization. SmartStrand Forever Clean, the next generation of our exclusive SmartStrand franchise, was launched in the first quarter and continues to gain momentum in the marketplace. During the period, flooring retailers voted Forever Clean as the best new carpet introduction and the most innovative flooring product in any category. Our new residential products have been well received with commitments for over 12,000 display systems, increasing sample investment in the period. Our expanded Karastan distribution and new product introductions have increased our sales in the luxury carpet category. The dealers across the industry also chose our new Karastan Studio display as the industry’s best merchandising system. Our participation in the builder multi-family channels increased as we expanded our relationships with leading accounts. In rugs, our sales mix improved in all product categories by leveraging our unique fiber technologies that differentiate our products in the marketplace. In commercial carpet, we continue to improve our sales and operating margin through innovative designs, process simplification and material optimization. To strengthen our presence in the growing educational sector we introduced the Get Smart collection which coordinates broad loom, carpet tile in squares and planks, as well as LVT to meet the needs of any institution. We are further enhancing our position in the fast-growing hospitality sector with expanded hard surface offerings, complementary carpet tile collections, and our new Definity technology as an alternative to traditional woven carpets. During the period, we reduced SG& A as a percent of sales by streamlining administrative and distribution functions while investing in additional salespeople and point-of-sale merchandising. We have completed our Continuum fiber expansion and aligned material flows to improve cost, service and inventory turns. Across this segment we delivered productivity improvements from enhanced processes, distribution efficiencies and reengineered material strategy. During the quarter, our raw material costs were higher than in the same period last year. We anticipate material costs improving in the second quarter partially offset by greater promotions, competition in commodity, and higher freight costs. All of these factors have been built into our future estimate. For the quarter, our Ceramic segment sales rose 9% with a constant exchange rate and comparable days excluding a disposed ceramic plant. For the period, our operating margins increased to approximately 12%, up 290 basis, as our product mix, manufacturing costs and SG&A improved. Our regional ceramic organizations are outperforming our competitors on a local basis as we leverage our product innovation, manufacturing expertise and distribution advantages. Our U.S. ceramic business continues to strengthen as we introduce unique products in all of our channels. In the period, new product introductions represented 25% of our total sales. We increased our average selling price in all product categories with enhanced visuals and larger formats across the range. We are supplementing our domestically produced collections with products manufactured across our global operations from Mexico, Italy and China. Our statement ceramic shop concept is improving our customer sales and margins. And we anticipate having 250 installed in the most successful ceramic retailers by year-end. As the commercial renovation market gains momentum, we are expanding the specifications of our products with major accounts across the country. Our new Tennessee ceramic manufacturing plant remains on schedule with the construction of the building now underway and staffing strategies being implemented. Across the business we delivered productivity gains to enhance material formulations, reduced labor costs and improved quality control. We have consolidated our distribution network and enhanced our logistic system to drive efficiencies and improve delivery times. For the 11th consecutive year, retailers voted one of our ceramic collections as the best in the industry, underscoring our leadership in design and technical innovation. The ceramic market in Mexico is expected to grow 7% to 10% this year and we are gaining significant share as a result of our styling and expanded distribution. Our margins are improving as we enhance our product mix and lower our costs. We’re expanding our customer base as well as our participation in commercial and new construction channels. Our European ceramic sales and margins were stronger than we anticipated with growth in all of our markets except France and greater improvement in our export markets. Our focus on bringing more differentiated products to market has expanded our distribution and improved our average selling price. We have completed the installation of about half of our production upgrades and anticipate the completion of our plan in the third period. We are benefiting from the realignment of our plants and gaining efficiencies from our investments in new manufacturing technologies. During the period, new introductions accounted for almost 40% of our sales in Europe as we eliminated older products to focus on our higher value collections. We anticipate continued margin improvement throughout 2015 as this year’s introductions gain traction and our cost position improves from productivity gains and material enhancements. Although the Russian ceramic industry and overall economy continues to decline, our ceramic sales on a local basis rose significantly as we gained market share from imports and increased participation in new construction and DIY channels. The strong performance of porcelain collections improved our mix and volume, yielding higher operating profits in rubles than last year in a difficult environment. We raised prices in the region 10% to offset the inflation of our costs. Almost half of our sales during the period were from collections introduced since 2013. Our new product introductions this year are being well received. We are opening new franchise stores and aggressively pursuing new construction projects to enhance our market share this year while continuing to improve productivity, logistics and material optimizations. Our performance in Laminate & Wood segment was better than anticipated during the quarter on a local basis. Net sales for Laminate & Wood segment increased approximately 5% at a constant exchange rate and days basis. The segment’s adjusted operating income was 14%, an increase of 280 basis points over last year. The segment’s improved results were driven by positive volume and mix, productivity improvement and successful product introductions, offset by the stronger dollar. On a local basis, our European laminate business showed improvement with strong growth in the UK, Australia and Russia partially offset by lower sales in France. Sales of our new Impressive laminate collection have grown rapidly during – due to the product’s richly detailed surface and exclusive water resistant technology. Greater initial sales than we anticipated constrained some early shipments. However, our production has been expanded to support the higher projected volume. Russian laminate sales increased significantly as consumers purchased locally produced goods rather than higher-priced imports. During the period, we implemented a 6% price increase in Russia in response to inflationary pressures. Our European LVT sales continue to expand as we increase our presence in this fast-growing category. We are aggressively marketing new LVT collections produced at our facility in Belgium to achieve our product expansion goal. We are leveraging our Pergo and Quick-Step brands to increase our Czech wood sales and improve our product mix. We have increased automation at our Malaysian wood facility which is reducing our costs. In the U.S. new laminate product launches featuring our most realistic visuals and textures drove sales across all channels with retailers selecting one of our new collections as the best new laminate product, the fifth consecutive year we’ve received this honor. Our Style My floor app was voted by retailers as the best consumer sales tool across all product categories. Sales of our engineered wood collections increased in both our retail in new construction channels and we announced a price increase for this category during the period. Across all our U.S. Laminate & Wood operations we offset higher costs by implementing new productivity initiatives while increasing investments in merchandising and sales personnel. We continued the integration of our Belgian board business with Spano with the closure of higher cost assets, equipment upgrades to improve productivity, increased use of recycled raw material. Margins have improved from our expanded product offering, reduced SG&A and increased volume. We are introducing new insulation products, which will expand the types of applications and price options. We are adding dedicated sales personnel to increase the distribution of our insulation products. I’ll now turn the call over to Frank to review our financial performance for the period.

Thank you, Jeff. Net sales for the quarter were $1.881 billion, up 4% as reported, or 6% with constant exchange rate and days. As Jeff mentioned earlier, the first quarter this year had approximately four more days and the fourth quarter will have four fewer days than last year, which had about a 6% impact on sales. All segments grew in local currency with FX reducing sales approximately $137 million compared to last year. Our gross profit margin as reported was 27.2%. Excluding restructuring it was 27.7%, up 80 basis points from last year with increased volume and productivity driving improvement. Our SG&A was $468 million or 24.9% of sales. It was 18.1% of sales excluding restructuring which is a 90 basis point improvement even after investments we’ve made back into the business. Restructuring and unusual charges were $138 million for the quarter of which $10 million was in cost of goods sold and $128 million in SG&A with the majority related to a previously announced settlement of a lawsuit and the balance in the Laminate & Wood acquisition restructuring and carpet plant closures. We estimate $25 million to $30 million of additional restructuring in the last three quarters of this year. Our operating margin, excluding charges, was 9.6%, up 170 basis points with FX translation impacting results approximately $21 million compared to last year. Our interest expense came in at $16 million, that’s down $6 million primarily due to last year’s redemption of $254 million of the 2016 bonds and the implementation of our new commercial paper program. Also, we’ve improved our working capital management this year to drive lower interest expense. Other income was $1 million which increased $6 million – which improved $6 million, primarily due to foreign currency gains. The income tax rate was 25% for the quarter compared to 22% last year and was higher than expected this quarter due to the timing of certain deductions. We are still estimating a full-year rate of 21% to 22% in 2015. Our earnings per share excluding charges were $1.70 per share, which is up 38% from last year. If we jump to the segments, in the Carpet segment sales were $739 million, up 10% over last year, or 4% in constant days with volume increasing in rugs and hard surface products. Our operating income margin excluding charges was 5.5%, that’s up 40 basis points with productivity and volume supporting higher margins, partially offset by raw materials, lower mix and higher sample replacements. In 2014, the full-year margin was up 140 basis points from a year earlier, 2013. We expect the rate of improvement in 2015 to increase as we move through this year. In the Ceramic segment, sales were $720 million, up 4% over last year’s reported or 9% using constant FX and days on a pro forma basis. FX impacted sales approximately $67 million, compared to last year. Operating income margin excluding charges was 11.9%, that’s up 290 basis points from volume, productivity and improving price mix. FX impacted results in this segment approximately $10 million compared to last year. Our first quarter margin growth however is not sustainable, but margins will improve for the full year above last year’s margins. In our Laminate & Wood segment sales were $448 million, which is down 4% as reported. However, sales were up 5% on a constant FX and days basis. The declining euro reduced sales approximately $7 million versus last year. Our operating income margin excluding charges was $14.3%, that’s up 280 basis points due to higher volume and operations productivity with the weak euro negatively impacting results by approximately $11 million. The margin growth rate in the first quarter will not continue throughout this year, but we do expect full year margins will improve year-over-year. In our corporate and eliminations segment, our operating loss was $10 million in the quarter and we are expecting a $30 million to $35 million loss for the full year. If we move to the balance sheet, receivables ended up at $1.159 billion with DSOs at 54 days, slightly up from 53 days last year. Inventories ended at $1.506 billion with our days improving to 112 days compared to 115 days last year. Fixed assets were $2.619 billion, which includes CapEx of $106 million in the first quarter with depreciation and amortization of $86 million. We estimate the CapEx – we estimate CapEx of $450 million for the full year in 2015 and depreciation and amortization at $375 million, excluding acquisitions. Our total long-term debt was $2.4 billion with leverage at 1.9 times debt to EBITDA. Jeff, I’ll turn it back over to you at this point.

Thank you, Frank. We were pleased with our progress during the first quarter and anticipate improving U.S. economy and a stronger flooring market will benefit our business for the remainder of the year. The U.S. continued economic and income growth, low gasoline prices and interest rates, and increased home values should drive our business throughout 2015. In Europe, we are seeing improvement in some areas as the market slowly recovers from a prolonged downturn. We expect our European sales in local currency to improve slightly with new product introductions enhancing our mix along with manufacturing and productivity initiatives improving margins. In Russia, our leading brand and product positions combined with efficient manufacturing will improve our market share in a challenging economy, while increased inflation and competition will impact our margins. Throughout the business we are introducing innovative new products across all categories that are being well received in their markets generating higher growth in margins. Foreign currency will continue to negatively impact our results during the second quarter with the euro approximately 20 weaker and the ruble approximately 30% lower than last year. This will partially be mitigated by our sales and productivity initiatives, SG&A reductions, and cost improvement projects. Taking all these factors into account, our guidance for the second quarter earnings is $2.51 to $2.60 per share excluding any earnings from acquisitions or restructuring charges. Our second quarter earnings guidance would have been approximately $0.25 per share higher on a constant exchange rate relative to last year. After the close of the transactions in the second quarter, we estimate the IVC and Kai acquisitions will add $0.06 to $0.08 per share earnings in the second period. We anticipate significant opportunities in our IVC acquisition, which will expand our participation in LVT and fiberglass sheet vinyl categories in the U.S. and Europe, and our Kai acquisition, which will increase our ceramic participation in Eastern Europe. These acquisitions will improve our future growth, broaden our geographic coverage, and solidify our position as the world’s largest flooring manufacturer. We’ll now be glad to take questions.

[Operator Instructions] Your first question comes from the line of David MacGregor of Longbow Research. Please go ahead.

Hi, guys. This is actually Andrew Brown on the line for David. We were wondering if you could just elaborate a little bit on your comments on the increased participation in the builder and multi-family channel. Specifically is that just the result of more feet on the street, new product introductions or something else, and whether the strength has been specific to any region or more of a national trend?

It’s just a national strategy to make sure that we participate fully in the channel. It’s been doing better during the period, so we’re putting more effort into it across the different divisions.

Okay. So no regions have been particularly strong?

I don’t understand the question.

I was just saying no regions within the country have been stronger on a relative basis than another?

I don’t have it by region here, but there is more hard surface being sold into it. We’re participating more with it and making sure that we’re focused on the growing accounts across the country.

Okay, great. And then on the commercial carpet side, just wondering if you could talk a little bit about the growth you are saying there. Which verticals have shown relative strength or weakness?

The commercial business during the first quarter outperformed the residential business. What we see is that our margins have improved from our offering that we’ve created, our productivity that we are doing on new fiber innovation. Tile is growing faster than the broadloom business and the corporate category is growing faster than the others. And then we are continuing to expand our participation in the LVT business in the U.S.

Okay. Thanks.

Your next question comes from the line of Mike Dahl from Credit Suisse. Your line is open. Please go ahead.

Hi, thanks for taking my questions. I wanted to start out with a question on the carpet margins. I think you mentioned that the mixed polyester, it’s negatively impacting selling prices. Wondering if you can comment on just what the margin impact has been there? And then also kind of what the impact from raw materials was in the first quarter and how should we think about that going forward?

In the first quarter, our income was up 20%. The biggest parts of it were from volume and productivity partially offset by raw material costs compared to last year, a lower mix and then higher sample placements within it. The polyester products sell at anywhere from 5% to 15% cheaper than an equivalent of nylon. So as the market moves, our selling price moves down along with the industries. Just to remind you that our 2014 margins were up 140 basis points from 2013 and we expect continued improvement as we move through the year in the segment.

And Mike, I would just add, you’ll see in our 10-Q which will come out in a little bit, in the bridge that we do by each of the divisions that input cost inflation, which includes raw materials, was about $# million for the quarter.

Got it, okay. And then, Frank, my second question, you highlighted just the amount of improvement you’ve seen in SG&A, which is really – it’s pretty impressive when you consider absolute SG&A dollars have still been falling year-over-year despite rising sales. So just wondering your thoughts on how sustainable that is from here, especially as we start to layer on some of these acquisitions?

Well, so first off I would say our SG&A as a percent to net sales will continue to improve as we compare year-over-year as we move through the year. The other thing you have to take into consideration is if you look at SG&A on a constant exchange rate basis the value would actually be up a little bit year-over-year. So we will continue to reinvest back into the business to grow the top line, but we will be able to leverage that top line growth with a lower percent to sales.

Okay. Thank you.

Your next question comes from the line of Kathryn Thompson from Thompson Research. Your line is open. Please go ahead.

Hi, thanks for taking my question today. Just tagging onto your commentary on the Carpet segment and the input cost headwind in the quarter, conversely when you look at your guidance on a go-forward basis for Q2, how much of raw material is benefiting that segment?

We are not giving out a specific amount for the raw materials. Oil, which everyone is focused on is a component of the raw materials we use that make up the chemicals and resins that we use for us. Now in addition we have others like natural gas, corn, soda bottles and other raw materials we use, so it’s one of a myriad of components. The oil prices have started to rise somewhat and we are seeing some changes in our raw materials. Our raw materials are basically purchased on a market basis or on a cost plus basis, so they change continuously. But we expect benefit in the second quarter and beyond, but we haven’t identified a specific amount.

Okay, great. Thank you. And then on the IVC acquisition, is there any risk to that not closing in Q2? I know it’s very difficult to quantify that, but to what you can comment, what risk would there be to not closing the quarter?

Listen, I can’t guarantee what the government does. We think there is a very low risk that it doesn’t go through, all the antitrust filings except the EU have been approved and we anticipate the EU approval sometime in June.

Great. Thank you very much.

Your next question comes from the line of Keith Hughes of SunTrust. Your line is now open. Please go ahead.

Thank you. A question on LVT, are you starting to see any price moves particularly in the deflation and pricing at LVT given the capacity that’s starting to come online either in the U.S. or in Europe?

First I have to start that the LVT market is really growing rapidly and we are expecting it to be up somewhere 15% across the world in the different markets we are in, so it is absorbing it. The LVT prices was primarily driven by the Chinese across the world markets as different ones, and we don’t see significant changes in the pricing of those at this point. There is more capacity coming into the marketplaces. We expect the markets to evolve. There is going to be more innovation and styling of performance in the category. We believe there are going to be different features and benefits added by the new participants, us included. There will be more differentiated products and those will have higher margins than other ones. We anticipate that our plant and others will improve manufacturing efficiencies costs over time and all this will be reflected in the market.

Okay. Switching it to carpet, you called out the mix in polyester, this has been going on for a long time. Is there anything new that’s come about, or is this just a continual gradual mix shift down?

It’s the same thing that’s been going on for some period.

There’s no news step down or anything like that?

It’s just that it keeps increasing in its proportion of the total, so it makes up a bigger part of it.

Okay. Thank you.

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

Thank you for taking my questions, and good morning, congratulations. Carpet segment, there’s so many pieces that aren’t carpet. It sounds like residential units were down, I don’t know, were commercial units down also? Then you mentioned you were trending up in the quarter residentially sort of what would be your volume pure carpet, excluding rugs, for the rest of the year, Jeff?

We did not say what you said. We said that our surface products in rugs were up more. We don’t give out specific pieces about each. The industry volume in carpet showed up, I think, about 3.5% in total, but the industry numbers we believe – not we believe, the industry numbers don’t take into consideration changes in calendars. And we know that our calendar as well as others change, so we think that the number is a little higher than the actual pieces on comparable days that will offset itself going into the – it will take through the year to get it back in line because of the calendar changes.

Okay. And then my follow-up to that, but I had a question on the timing of the acquisitions as well. The follow-up to that would be any thoughts about how volumes in carpet go through the year? And then, Frank, on the two acquisitions assuming they close, any thoughts about earnings impact to the back half of the year? Thank you.

I think that the carpet unit volumes will be up a limited 1%, 2% maybe; it would be more or less as we go through.

And, John, on the two acquisitions, we said 6% to 8% accretion assuming, we’re assuming that the Kai acquisition closes in May and the IVC acquisition closes in June, so $0.06 to $0.08 accretion.

Yes, I know. Any thoughts on the back half?

Oh, sorry. We haven’t really quantified that, Jeff.

Okay. Thank you.

In our carpet business, we believe we are going to improve our mix by increasing our SmartStrand sales with our new introductions and differentiation with SmartStrand Forever Clean.

Great. Good luck. Thank you.

Your next question comes from the line of Stephen East from Evercore. Your line is open. Please go ahead.

Okay, yes, thanks. Good morning, guys. Jeff, just sort of to follow on a little bit, you gave some fairly good detail about what you all are expecting in Europe. As you look at the U.S. with your guidance, it sounds like just sort of a general market improvement that you’re counting on, or is there some more that’s going on specifically in the US related to your business that you think will drive your business a bit faster than maybe the industry?

We are optimistic about the industry in total and where it’s going and what’s going on in the different markets. And in our business we have a lot of initiatives including – we mentioned that the new introductions in carpet. We have commitments for over 12,000 new display systems which will improve our retail business, which is the part that has better margins because it’s higher quality products. We are expanding our ceramic business and our other categories and all the businesses are doing the right things to improve more than the industry in general.

Okay, thanks. And then if you looked at the ceramic op margin, you talked about, okay, don’t expect a similar type improvement as you go through the year. But can you talk a little bit about how much the U.S. was driving your op margin in ceramic versus Europe? And then you’ve talked a lot about the commercial side of the business for carpet, but can you talk a little bit about what’s going on with the – on the ceramic side of commercial?

I will address the margin question and then let Jeff address the other part of the question. So in all four of our regions, Mexico, U.S., Russia, and Europe, the margin percentages improved year-over-year. Now the translation of the rubles and the euros had a negative impact obviously on Russia and Europe coming back in dollars, but the margin percentages improved in all of them. They were all – strong performance in all four.

Okay.

I forgot the other part of your question?

The other part, just what’s going on with ceramic on the commercial side? You talked about carpet, but an update there. Is that driving that business?

I think the ceramic business, the ceramic commercial business we have more difficulty in actually breaking it out, because a lot of the products go both ways and you can’t see them. Our general belief is that the commercial business with us is growing slightly less than the other – than the residential business because so much of it’s going into new construction and you get higher growth rates in the new – it’s a much bigger part of the total category.

Okay. All right, thanks. And one last question, any markets giving true pricing power other than Russia with the inflation?

The pricing is really driven by mix and products, so in Europe we are increasing our pricing, but we keep talking about the product introductions. In our categories we try to differentiate the products so more of it’s coming from product innovation than it is coming from raising the pieces above inflationary pieces and/or reducing our cost through productivity improvements.

Okay. So the raw material pressures that you felt really aren’t – you don’t truly pass them through, but only with a different product if you will?

No, I didn’t say that. We try to pass through the raw material changes. What I thought you are asking me is – was I raising prices unrelated to raw materials.

I was, but then I assume that you weren’t really changing pricing just due to raw materials, though.

So we raise prices as the raw materials change in all the marketplaces, because raw materials make up such a large part of all our categories.

Okay. Thank you.

Your next question comes from the line of Bob Wetenhall from RBC Capital Markets. Your line is now open. Please go ahead.

Good morning and congrats on a very nice quarter, very strong on a like-for-like basis. Hey, I just wanted to get your thinking right now on IVC and Kai acquisition in terms of how significant is this and how should we be thinking about synergies as you close on these acquisitions in May and June and any other kind of update around these transactions.

Well, let’s start with IVC. IVC, the first to repeat what it is, they are the leading manufacturer of ceramic in the Bulgarian and Romanian marketplace and they have the low-cost positions in the marketplace. With the Kai business we are going to focus on improving their product offering in the marketplace, implementing best practices from product design to manufacturing costs et cetera and then exporting products to Western Europe to supplement our business, as well as helping them expand within the categories and regions they are in. On IVC, the main categories are leveraging the Mohawk relationships, brands and design both in the U.S. and the European markets. In the U.S. market we can help drive their products through the commercial market. There are best practices we can learn from both and then just leveraging the strong management and efficient manufacturing they have to improve those across everything and best practices in everything.

And Bob, I would just add with regards to how big or how significant they are, we had guided the EPS accretion in the first 12 months because we never know exactly when they are going to close – for the first 12 months of $0.25 to $0.45 for IVC and $0.10 to $0.15 for Kai. And we obviously always try to do better than that and improve, but that’s what we are guiding right now.

That’s really helpful. And I think, Jeff, you had said that LVT as a product category is growing 15%, which is a pretty rapid clip. And it sounds like there’s a lot more domestic production and now with IVC you’re going to have greater capability in Europe as well, I guess two plants under Mohawk. And I just wanted to ask, is LVT from your perspective a game changer in flooring? And is it going to be the fastest-growing product category? And do you see this taking share from competing products? And how does that kind of unfold in the next 12 to 24 months? Thanks very much and good luck.

LVT is a product that brings certain values to certain uses, which is what’s driving it. We believe it’s going to continue to expand in its style and design as well as performance features and other things. All those things are helping it grow. It’s starting from a relatively low base. We think it will continue to grow and take market share and it’s going to take market share from all of the different categories because the flooring market is not increasing because you have a new product category coming into it.

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

Hi, thank you guys for taking the question. Frank, just to push you a little bit more on the carpet margins to make sure we understand the moving pieces here. When you look at the last few years, the margin expansion call it somewhere in that 130, 150 basis points has been without the same type of raw material headwind that you’d expect this year. And volume seems to be accelerating, demand seems to be accelerating as well. So, is there any reason you couldn’t see the same type of lift on an annual basis that you saw in the prior year’s? Or is there something on the efficiency or caustic outside that would be different?

Yes. I mean, I think we will continue to see good improvement year-over-year and full-year margins on the carpet side.

I know you don’t want to give guidance, which I’m not really asking for. But on the fixed cost side is there anything that would be different about how that would play out this year versus the last couple years?

Well, as Jeff has said earlier, we have seen some improvement that we think is going to impact our P&L in the latter part of the year on raw materials. We are continuing to put in place productivity improvements that will benefit us, taking out both fixed and variable cost and so margins should improve.

And mix should continue to improve as we go through the year if we don’t get any surprises. At the same time the raw materials are volatile we don’t know where they are, so we’ll have to see where they end up.

And we don’t know what competition is going to do with regards to processing either.

I guess that’s why I was kind of asking more so on the productivity side, as far as what you are budgeting this year. Is that somewhat consistent with what you’ve been able to generate the last couple years?

We will continue to generate good productivity.

Okay. Thank you, guys.

Your next question comes from the line of Susan Maklari from UBS. You line is open. Please go ahead.

Good morning.

Good morning.

I wanted to know, in the carpet side, it sounds like the residential consumer business has definitely slowed and you’re doing some more promotions there. Can you give us a sense of maybe what would drive some more improvements in that or what the trends are?

As I said earlier, the U.S. market and the economy wasn’t as strong as anybody thought it was going to be in the first quarter. And we are assuming, like everyone else with the economy, that it’s going to improve in the first quarter. We are assuming that the housing part will do better, we’re assuming remodeling will improve. So we are looking forward to the category improving as we go through. We think that with our new product introductions and our new commitments for sampling we’re going to improve our business within it and we think we are well-positioned for the rest of the year.

Okay. And then in terms of the new product, can you give us any sense of how we can think about the pricing or maybe the profitability on those relative to some of your legacy products?

It is really more related to price points. The higher priced items have more differentiation and you get more margin off those because of the differentiation. And the lower more commoditized products tend to be more price conscious and we have lower margins on them. So the displayed items tend to be mid- to high-end for the most part. So the new introduction we’ve been talking about tend to create a higher mix for the products. On the other hand, we want to fully participate in the home marketplace including in the commodity products.

Okay, thank you.

Your next question comes from the line of Mike Wood from Macquarie Group. Your line is now open. Please go ahead.

Hi, this is actually Ryan Hunter filling in for Mike. First question on CapEx, your CapEx has been running at around $500 million, $600 million for previous years and you guided to $450 million for this year. Is this the start of a shift back towards the $300 million level of CapEx over the next several years? And can you give us your take on the pipeline and pay-off opportunities still see?

The part of the CapEx in the past is dependent on a few things. One is it was higher as the carpet industry shifted to polyester. We have been putting more money in all our businesses with the acquisitions and putting those together. So this year the CapEx is now around $450 million. We haven’t put the plan together for next year. There will be some additional CapEx with the new acquisitions that are required for them and managing those. We’ve been more aggressive with interest rates being low. We are putting more new capital in the businesses. We are also investing in other areas such as we are putting up a new ceramic plant in Tennessee as we speak. We have a lot of major things going in this year. I can’t tell you what it’s going to be next year until we get further in the year and start focusing on it.

The only thing I would add to that would be that the $300 million number you quoted was back before we had the Marazzi and Pergo and Spano acquisitions, and the size of the company was much smaller. Our G&A now is running $375 million, could go up to $400 million next year. So it’s hard to imagine that we’d hit a run rate of $300 million CapEx over a long period of time. But we can – if the economy changes, if situation circumstances change, we can make adjustments pretty quickly as we showed over the last few years.

We are going to continue investing. I mean, we believe the economy is going to be relatively good for a while. We continue investing to take advantage of it and position the company to improve its margins. The margins keep going up not because we just show up every day.

Yes, awesome. And you guys have had some positive commentary in the U.S. flooring industry growth, which has lagged other building product categories over the last several years. What are you guys seeing that tells you that we’ll see North American growth accelerate? And do you envision a period of cyclical catch up that you talked about previously?

What we said was we thought it would be better than last year. Whether it’s equal or better than the other things, I don’t really have an opinion on. I think it’s has lagged. Part of it has been that we’ve said is that people that own existing homes haven’t been investing in them as they had in prior times. We are hoping as the housing prices go up people get more comfortable about putting more money in their homes as their incomes go up that they put money in them. And we don’t see any reason why that won’t occur over time.

Thank you.

Your next question will come from the line of Steven Kim from Barclays. Your line is now open. Please go ahead.

Thanks very much. I wanted to ask another question on margins, but wanted to particularly talk about it from the perspective of productivity. Our sense is that much of the margin improvement and the improvement in productivity has been related to investments that you have been making as opposed to things that you might categorize as cost-cutting. I was wondering, obviously within the cost cutting there were some related to the acquisitions, Pergo for example and Spano I assume, and you also closed the ceramic facility. But I guess is there a way you could help us think through how much of the margin improvement we’ve seen and maybe how much of the groundwork set for future growth has been achieved in your view through investments as opposed to cutting?

We have the information I don’t have in front of me. We gave – it is significant of both and it’s more than just cutting and investment. So you have one part that’s coming from new equipment that’s allowing us to do things. Another is consolidating the existing facilities to make them more efficient. Another is strategies in our raw materials and processes to make them more efficient. Another is reengineering our raw material strategies to lower our costs. We have done things to improve productivity with systems. We have reduced our cost of distribution by improving the processes, the fill rates of the trucks and different things. So it’s all parts of the business. When we go into every year, every one of the business functions has a cost savings plan and efficiency and productivity issues that start from the bottom-up and top-down and they are set up with hundreds of actions to be taken during the year and implemented in a very disciplined manner. Typically out of the list we probably achieve about 75% of what’s on the list as well as add more things to it. It’s very disciplined how we drive change through the organization.

That’s great, that certainly seems to be coming through here in the results. I wanted to ask – my second question I wanted to ask regarding products and the differentiation there. I think on the call you mentioned in ceramic that the U.S. was seeing 25% of its sales from new products, Europe 40%, Russia 50% that kind of thing. I wanted to see if you could give us some comparison to what you think is standard in the industry. Is that just sort of par for the course in the industry? I assume not. And also maybe some historical perspective. Is this an accelerated rate of sort of new product contribution versus what we’ve seen in the past? And then a quick follow-on. Is it true that roughly half or even more of your carpet sales are – really don’t have direct competition?

It’s not easy to give you a flat answer. What happens is in the product life cycles we have commodity products that can last six, seven, eight years. We have very high fashion things that three years could be in some of them and the average depends on the product mix and pieces and comparing one business to another depends on your participation in the different markets and ages. I think what we were trying to do – so if you took the 25%, that would mean that we turn the whole thing over in four years with the lowest number we gave you and 50% means that over a two- or three-year period you’ve changed it so it shows how much growth the new introductions are causing and changing in the marketplace. We’re also using those, as we said, to drive simplicity in the operations as well as trying to differentiate performance features and value add to the customers. So again, like our capital expenditures, we have very disciplined processes within each business to say what are we going to do different to bring value to the marketplace which includes, A, differentiation, on the other side is cost-cutting which we hope the customers don’t see it as we go through and improve value. I forgot the last part of your question.

Maybe if you could clarify that second question for us. I’m not quite sure what you are asking, half of our carpet products don’t have direct competition. Maybe give us a little more color on what you’re trying to?

Yes, sure. So we know that with the Continuum innovation, for example, that’s something that is a differentiated product fundamentally. We know that with the SmartStrand and the ever clean now, we know that’s obviously something which you can’t just get from somebody else. And their Karastan brand similarly had got a unique niche in the marketplace and things like that. That kind of thing is what I was addressing. These kinds of sort of – I would say sort of step function changes are materially different type of products within the carpet segment. Would it be fair to say that that represents the majority of your sales in that segment?

It’s a large part, but – so Continuum is our way of participating in the polyester category and adding something other than my price is different than someone else’s. So it’s an entire strategy around how can I add value to the customer? How can I have a differentiated selling story so when they make choices they prefer ours? Now to say that there’s no alternative polyester products that can be used for the same customer is incorrect. So there are incremental differences of how you differentiate things in a common marketplace and we spend a lot of time doing that and those things help our customers give reasons to their customers why they should buy it and help their margins and help them say you should buy from me, which is why it has value.

Okay. I didn’t hear a number there, but that’s fine. Appreciate the help and good luck.

Thank you.

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

Two questions for you. First of all, Frank, you commented that the margin progress in laminate and tile in the first quarter wasn’t sustainable through the balance of the year. Can you give us a little bit of color what may have incrementally benefited 1Q that doesn’t recur through the balance of the year? Just a little color behind that statement would be helpful.

I think the best way to answer it is our business doesn’t move in a straight line. We’ve got puts and takes in all of our businesses every quarter. And we try to look at it on a full-year basis and, like I’ve said, I think all of our – we believe all of our segments are going to improve margins year-over-year. Those two segments just performed much better with all things clicking – all eight cylinders clicking this quarter.

Secondly, in terms of tile sourcing, it sounded like you commented that there were some Europe tile export opportunities. Could you just expand a little bit on if there are opportunities to benefit from a lower euro in terms of your tile manufacturing assets?

We commented in two different areas. In the U.S. market, we bring product into the U.S. market from Mexico, China and Europe and we bring different products in based on the economics of what they are and/or differences in the equipment or pieces as well as supplementing our other things. For the most part the European imports tend to be very high end differentiated products. They tend to go into the commercial business and in some differentiated residential products, such as in Europe we are making ceramic wood looks 6 feet long. The market here is limited so making them there and bringing them in is a good idea. Mexico we have low cost manufacturing and we tend to bring in certain products there, but as we have bought Marazzi and putting in a new plant we are using more of that to satisfy the local market, but we’re bringing them in. China has very specific products that they make low-cost because of what – they sell a huge amount of them and they are set up to make them differently. So we are bringing in specific products for different reasons. The other thing we mentioned was with the new acquisition of Kai, our business in Europe in ceramic we’re focused on the mid- to high-end. Kai is a low-cost producer in a low-cost area where we have access to the water to move it relatively cheaply. And we believe that we can use those assets to participate more in the lower part of the marketplace which tends to come from Turkey and Poland in Europe now. So it using our worldwide assets to maximize what they’re good for and then as the markets change we’ll change and move around.

Great. And then my second question, in terms of the carpet investment in samples, Frank, that sounded like third in line as you explain the carpet margin performance in the quarter. Any way to frame the magnitude of that or if that is sustained through the year or more focused on 1Q?

It will be higher for the year because we are investing more in it. However, what we have done is cut other overhead costs. We’re making other arrangements to cut costs in our carpet business on things on the backside and invest more into new samples, new products and more sales personnel which should help us drive the top line.

Great. Thank you.

There are no questions on the phone lines. So I’ll now turn the call back over to Mr. Lorberbaum for closing comments.

We had a very good quarter in the first quarter. We are anticipating the year continuing to get better. And we are enthusiastic about our position and the marketplaces. We appreciate you joining us. Thank you very much.

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