Mohawk Industries, Inc. (MHK) Q1 2017 Earnings Report, Transcript and Summary

Good morning. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the Mohawk Industries’ First Quarter 2017 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, April 28, 2017. Thank you. I would now like to introduce Mr. Frank Boykin. Mr. Boykin, you may begin your conference.

Thank you, Rob. Good morning, everyone, and welcome to Mohawk Industries quarterly investor conference call. Today, we’ll update you on the Company’s results for the first quarter 2017 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 risk and uncertainties, including, but not limited to, those set forth in our press release and our periodic filings with the Securities and Exchange Commission. This call may include discussion of non-GAAP numbers. You can refer to our Form 8-K and press release in the Investor Information section of our website for a reconciliation of any non-GAAP to GAAP amounts. I’ll now turn the call over to Jeff Lorberbaum, Mohawk’s Chairman and Chief Executive Officer. Jeff?

Thank you, Frank. In the first quarter Mohawk sales rose approximately 4% on a constant days and local currency basis to a first quarter record of $2.2 billion was flooring North America and rest of world outpacing global ceramic growth. Operating income grew 12% to about $275 million and our operating margin 12.4%, up 110 basis points over the prior year due to volume mix and productivity, adding $60 million to operating income. Both our operating income and margin were first quarter records. During the period material costs increased across our portfolio and we initiated price increases that should cover our material costs in the third quarter. This year around the world we plan to invest more than $750 million to expand our ceramic, carpet, laminate and LVT as well as our sheet vinyl and wood. The utilize this capacity we will invest more in marketing and start-up cost this year with the fourth quarter investment being the highest. In addition, we are entering the European carpet tile and countertop market as well as the Russian sheet vinyl business. In April, we completed the acquisition of two small ceramic manufacturers in Europe and a carpet nylon polymerization plant in the U.S.; in May, we anticipate purchasing a mine for our U.S. ceramic operations. The price for these will be about $270 million plus future investments to optimize them. In the U.S. consumer confidence rose in March to the highest level since 2000 supported by job and wage growth. The National Association of Realtor reported March existing home sales improved to the highest level in more than 10 years. In March new home starts increased 9% and have home prices continue to rise. Harbors LIRA Index is forecasting home remodeling growth of 7% this year. In the first quarter the AIA reported strong commercial inquiries and architectural index is projecting higher growth. The European recovery is gaining traction in the EU is forecasting expansion for all countries in 2017 and 2018. In Russia, GDP in the fourth quarter increased for the first time in two years and could indicate a recovery. With that, let’s turn to our first quarter results by segment. During the quarter, our Global Ceramic segment increased 2% as reported and on a constant days and currency basis. With operating margins rising 15%, a 190 basis point improvement. Growth slowed in the period due to customer inventory adjustments and postpone product trends actions in North America, extreme weather in Russia and Eastern Europe and a weaker Mexican peso. Purchasing patterns have now returned to normal and our sales growth is increasing. To recover increasing cost, we announced the general price increase in North America, which should be implemented by the end of the second quarter. Our recent investments in our North American ceramic business will propel our growth through the remainder of the year. In the U.S. this year, we are planning to open 18 to 20 new ceramic tile or stone centers to expand our distribution. Statement, our shop within a shot concept is being expanded among leading ceramic retailers. We have increased our regional and national homebuilder relationships by providing them a complete product offering that satisfies all of their needs. Our distributors are embracing our new product launches and replacing other imports with unique collections acquired directly from our Italian operations. Our new Tennessee facility is operating at planned volume and quality levels, and we are using the plant's advanced technology to introduce premium products, such as sophisticated metallic and glazed color body collections. We are increasing our countertop sales, as we open additional service centers and expand our product offering including porcelain countertops from Italy. We are upgrading our floor and wall tile offering in the home center channels to address evolving consumer preferences. Our ceramic sales in Mexico continued to outpace the growing market, but are limited by our current capacity. To utilize additional capacity coming from our seller market expansion later this year, we are developing new collections in distribution as well as adding South American customers to expand our geographic reach. In Europe, our ceramic business increased our profitability as a result of improved product mix, productivity, and equipment upgrades. Severe weather in Eastern Europe lowered our sales growth, which is now returned to normal. Our innovative new products are being well accepted by the market, enhancing our distribution, and improving our average selling price. Our new product development and sales processes activated our spring collections earlier and we train more retail salespeople to promote these new offerings. Upgrades to our commercial technical plant are progressing as planned with incremental production starting in May and continuing to expand through the end of July. We have successfully implemented our Italian information system and our Bulgarian business to improve our efficiency, controls, and service. Additional enhancements will be executed over the next year. Multiple equipment upgrades are being installed in Italy and Bulgaria to enhance our product offering and reduce our cost further. We completed our previously announced ceramic acquisition in Italy and the purchase of a small Polish ceramic operation. We are initiating strategies to enhance product offerings, improve efficiencies, and expand sales in both companies. In the last quarter of 2016, the Russian economy realizes its first GDP growth in two years, which could be an indication of a recovery. Since the downturn, the Russian ceramic market has declined almost 30%, while we have increased our market share and capacity. With the investments we have made, our domestic ceramic collections with award winning designs and large sizes up to 10 feet long are replacing premium imported products. During the quarter, sales in our flooring North America segment increased 4% as reported, are over 5% on a constant basis with hard surface sales continuing to outpace our carpet category. The segment's operating margin increased to 10%, up 150 basis points over the prior year. Our raw materials have risen. And we are increasing prices as necessary. Our residential carpet sales performed well during the period, with ongoing strength from our proprietary SmartStrand franchise. During the quarter, we introduced SmartStrand Silk Reserve, the next generation of ultra-soft carpet. This is the third addition of our exclusive fiber system, which has extended our leadership in premium carpet. We are adding unique products and specialized sales personnel to expand our Main Street commercial and high-end Kyrgyzstan collections. In the middle price points, sales of our continuing polyester offerings are growing with their differentiated feel, performance and value. Our revolutionary new Aero product changes the way soft flooring is manufactured, installed, and recycled. Aero’s luxurious feel and unique construction is being well received as an innovative alternative to traditional soft flooring. Our commercial carpet bookings improved during the period. Those shipments were postponed due to the timing. We are adding commercial sales personnel to target key regions and channels. We are growing our participation with both large U.S. and international accounts. We anticipate continued sales improvement from our new tufted, printed and woven technologies and we are extending our design leadership in carpet tile. We are integrating our soft and hard surface offerings to provide architects and designers with more appealing combinations that satisfied our client needs. Sales of our hard surface products continue to expand at a higher rate with our LVT and premium laminate growing the fastest. With their superior design performance, our flexible, rigid and commercial LVT collections are being well accepted across all channels. The continued improvement of our LVT manufacturing process is increasing our capacity and margins. Construction of our new LVT line will begin this quarter and we anticipate start up in the fourth quarter. Our sheet vinyl sales strategy has improved our position with Mohawk retailers, independent distributors and home centers. We’ve announced a price increase in sheet vinyl that cover increasing raw material costs. Sales of our laminate collections remained strong with our unique styling and performance features and our new production line should be operational in the fourth quarter. We have upgraded our wood offering to meet growing demand for wider planks with rich textures and sophisticated colors. During the second period, we acquired a nylon resin plant to extend our backward integration and improve our cost position. To improve service and efficiency, we closed the carpet dyeing operation, consolidated commercial carpet facilities and rationalized wood plan, while increasing our other engineered wood capacity. Across the segment, we have multiple new investments in various stages of implementation to introduce innovative products and capacity and improve our profitability. For the quarter, our Flooring Rest of the World segment sales were up about 3% on a local basis and constant days. The segment’s operating margin was down versus the prior year due to higher material costs and currency changes. We are increasing prices across most product categories to offset higher material costs, which should cover the costs in the third quarter. To utilize our upcoming LVT laminate sheets vinyl and carpet tile expansions. We're investing a more sales, marketing and product development during the year. All of our LVT brands grew significantly during the period as we increase our production and expanded our distribution and product offering. Our new LVT product introductions are being well received across all channels, due to the unique design and performance attributes. We are reducing our costs as we improve our line speeds efficiencies and yields. Construction has begun for a new LVT production line, which is start up in the fourth quarter, expanding our product offering in both flexible and rigid LVT. Our sheet vinyl sales lag compared to last year as low inventories from earlier plant disruptions limited our service. We anticipate normalized sheet vinyl sales in the second quarter. We have identified a location in Russia for our new sheet vinyl plant, which should be operational by early next year. Our laminate production in Europe is running at capacity and we're preparing for the installation of new equipment that will give us additional capacities to extend our lead in the category. To meet growing demand, we're also expanding our Russian laminate operation, which is presently fully utilized. Our impressive collection as refined the premium, laminate category with its unique water resistance and deeply textured services and has now become our largest selling product in the category. Our wood margins have increased as we enhance the visuals of our wider planks and install state-of-the-art equipment to improve our yields and efficiencies. Our insulation board sales continued to increase during the period. However, shortages in key materials are dramatically increasing our costs and impacting our production volume. We are aggressively raising prices to offset the costs we are incurring. Our wood panel sales are growing and our margins are expanding, as we improve our mix, capacity and costs. We are preparing an existing site for our new Belgium carpet tile plant, which should be operational by the first of next year. 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 $2.221 billion, up 2% as reported or up 4% on a constant days and FX basis with the strongest growth in the Flooring North American segment. Our gross margin as reported was 30.6%, excluding non-recurring items the margin was 30.8%, up 110 basis points. With the improvement from productivity of $36 million, volume of $14 million and price mix of $10 million, offsetting input cost inflation of $22 million. SG&A as a percentage of net sales was 18.3% as reported or 18.2% excluding charges. The percentage was flat to last year as we continue to invest in the sales and marketing to grow our business. And usual charges of $4 million were primarily related to the plant consolidation in the flooring North American and continuing consolidation integration and flooring rest of world. Operating margin, excluding charges was 12.6%. This is 100 basis point improvement over last year. This includes productivity of $41 million, volume of $9 million in price mix of $9 million. All impacting our margin positively and offsetting input cost inflation of $22 million. Our interest expense was $8 million a decrease from last year as we leveraged our lower rate commercial paper program. We estimate total year interest expense of about $30 million including our announced acquisitions. Other income loss was a loss of $2 million with transactional FX impact in the results over last year. Our income tax rate for the quarter was 25.6% and that compares to 25.4% last year. We expect the rate to be between 26% and 26.5% for the second quarter. Our earnings per share, excluding charges was $2.72 an increase of 14% over last year. Moving to the segments. In the Global Ceramic segment sales were $785 million that's up 2% both as reported and on a constant basis as weather and customer product transitions impacted our results. Our operating income margin excluding charges was 14.8% or 180 basis points over last year. The primary factors for the increase were productivity of $19 million and positive price mix of $5 million offsetting input cost inflation of $9 million. In the flooring North American segment sales as reported were $939 million, a 4% increase or 5% up using constant days. As Jeff mentioned flooring North America is implemented to carpet price increases to compensate for inflation. LVT continues to be the highest growth product category here. Our operating income margin excluding charges was 10.1%, up 140 basis points improvement was supported by productivity of $13 million and volume of $5 million. In the flooring rest of world segment, sales as reported were $496 million, up 1% or up 3% using constant days in exchange rates. All product categories grew as LVT turned in another strong performance. Our operating income margin excluding charges was 15.7%. The margin was benefited by productivity of $10 million offset by input cost inflation of $11 million in negative FX of $5 million. Price increases are being implemented in most categories to offset the inflation. I would like to remind everyone of our IP change this year that we described last quarter. We expect our total IP to be between $65 million and $70 million this year with the annual run rate dropping to $35 million at the beginning of June. In the corporate and elimination segment the operating loss was $9 million and we expect the loss to be between $35 million and $40 million for the full-year. Turning to the balance sheet. We had receivables of $1.498 billion with DSOs up to 54.9 days compared 52.3 days last year. This was primarily impacted by channel mix. Inventories were $1.741 billion with inventory days at 110 compared to 107 days last year impacted by geographic expansion and product growth. Fixed assets were $3.5 billion and included first quarter capital expenditures of $201 million with depreciation and amortization of $105 million. We're currently estimating full-year CapEx of $750 million with DNA of almost $450 million. We do expect the CapEx spend increase with acquisitions and additional projects, but we haven't finalized the number. Long-term debt was $2.6 billion and our leverage was at 1.4 times debt to EBITDA. With that, I will turn it back over to Jeff.

Thank you, Frank. We remain optimistic about the economy, the flooring industry, and Mohawk’s potential. Our second quarter sales growth should accelerate sequentially on a local basis and our operating income should improve despite higher inflation, expiring patents, and a weaker British pound. We are implementing product price increases across the enterprise due to escalating material costs. Our capital investments and process improvements will continue to yield higher productivity. This quarter we will finalize four acquisitions that will broaden our product offering, geographic penetration, and competitive position. Taking all this into account, our adjusted EPS for the second quarter is $3.53 to $3.62 including our acquisitions. In the third quarter, higher pricing and productivity as well as lower currency headwind should improve our results. As we stated last quarter, this year’s sales growth prior to acquisition will be similar to last year's level, and our adjusted operating margin will increase slightly. We are investing at record levels, absorbing startup and marketing cost this year to enhance our long-term growth and make Mohawk a more profitable Company. We will be now glad to take any questions.

[Operator Instructions] Your first question comes from the line of Bob Wetenhall from RBC Capital Markets. Your line is open.

Hey, good morning. Thanks for all the color and granularity. I guess this is more for Frank. I was hoping you could talk about core profitability and the reason I'm asking about it is you have a lot of moving pieces, you're calling out start-up costs related to plant openings, increased spend on marketing, you're losing IP operating income and there's also FX headwinds. So there are bunch of moving pieces, but if you look at the business and try to isolate price versus cost and all the productivity improvement, I'm just trying to understand directionally speaking which way operating margins go into each of the segments, once you take out some of the non-recurring items?

Sure, I'll be glad to address that. Our business is improving significantly this year without start-up cost in IP. We have not changed our annual outlook and with the four acquisitions, we'll add another $0.15 a share to EPS this year. We still maintained that our 2017 sales will increase 5.5% and operating margins will improve slightly even with start-up cost IP and some pretty high inflation.

With that being said, can you talk to me a little bit about the pace in cadence the profitability in 2Q and 3Q just because Jeff gave your updated outlook for second quarter EPS? Is there going to be – how do we think about profit margin moving in 2Q and 3Q, given what you're talking about price increases coming, loss of IP in rest of world, and then kind of maybe moderating FX headwinds in the third quarter. I'm just trying to put it together to get a more. It seems like there is a bunch of moving pieces, some are transitory. There is some movement in the P&L. I'm trying to understand how to think 2Q versus 3Q specifically. Thanks for the help.

Sure. Let me take a shy at it. So in the second quarter profitability is going to be negatively impacted by the British pound and inflation – with inflation across the business impacting us. Our third quarter operating income was going to increase sequentially over the second quarter and that's going to be driven by price increases and productivity with more of the productivity for the full-year impacting the third quarter. In the fourth quarter, we are going to incur higher start-up costs from investments.

Listen, it seems to be so much focus on the quarters. I just want to make sure that we're not missing how we are strengthening our business in total. We're going into new products and geographies. We're expanding our production across the world. We're doing all the right things to enhance the profitability. This is really the same strategy we've been using to compound our shareholder return by over 25% over the last five years. I mean we're really doing the right things to make that business grow.

With that being said and that's what I was trying to get at essentially with what you're seeing year-to-date and your expectations based on what Frank outlined just now stepping through the next couple of quarters? Are you tracking today based on where you expect it to be at the start of the year or as what you're seeing in the marketplace across your different product categories consistent with your expectations and from an execution standpoint, are you delivering based on your plan ahead of it or behind it? Thanks and good luck.

As I really think we're doing better than the plant because we have all this inflation, we hadn't anticipated. There is significant pricing mix in the lag between the pricing and the costs we’re incurring. So we've overcome all those and we're still going to hit where we started the first of the year. I mean we're doing really well in our execution.

Your next question comes from the line of Stephen Kim from Evercore ISI. Your line is open.

Yes, thanks very much guys. Appreciate it. Yes, so I wanted to talk a little bit if I could about the productivity. I don't think you mentioned in your release, the $140 million or better than the $140 million productivity, which you did last year. Want to make sure that that was something that you still felt strongly about and the $36 million of productivity you recorded, I think actually $41 million, I think you recorded in the first quarter. How should we think about that number going through the year? Will it be sharply weighted towards increasing in the back half of the year or is going to take a step down significantly in Q2 because of the factors we’re talking about? Just give us a sense for how that may flow year-over-year?

Yes, first just a kind of level set it. We have hundreds of projects that are driving that productivity both capital expenditures as well as process improvement. So a lot of moving parts and it's hard to say precisely how much productivity we're going to add in one quarter versus the other. But right now as we look at the timing for those productivity improvements as they roll out through the year, we would expect to see, as I mentioned before, higher productivity improvements in the third quarter compared to the other three quarters. And your point earlier Steve, the point we had made last time, last quarter on the call that productivity for the full-year will be greater than the $140 million for last year, we still stand by that.

And don’t forget where they went to review it, all the different projects you heard coming up in the fourth quarter is going to have a higher percentage of the startup costs in the fourth quarter than the prior quarters.

Great, that’s really encouraging. I guess a lot of other things we could ask about. But let me ask about your net price input headwind. In the first quarter it looked like it was about $13 million, we know that you're going to recover that in the back half of the year, you’re very clear about that. I was curious about two things. One, in the second quarter, we know there’s going to be a little bit of a gap there. Could we see that net headwind of $13 million? I mean could be like meaningfully higher like maybe double, like $25 million, $30 million of a net headwind between price and input. And for the year, do you expect the back half to be able to recover some of the headwind that you have in the first half or is the back half just could be kind of a net neutral in the year will be negative by the amount of the first half is negative.

You exceeded your questions, with that one question. Let me take a shot and then Jeff will finish with that. It will – the raw material inflation will be more significant in the third and fourth – second, third and fourth quarters. We won’t cover it all with the second quarter, but we will cover it all with the third and the fourth quarters.

I forgot the rest of the question.

Basically what I was trying to figure out is, when we look at the whole year, will the recovery in the second half of the year also sort of help cover what you the negatives that you absorbed in the first half or is the back half just going to be kind of like breakeven in terms of price and input?

There is a lot of inflation going on of different types, labor, energy and the pieces and all flow-through. We think we had enough price to cover most of that. We always contribute some of the productivity and other things. We also contribute to offset some of it, it's not as black and white as you're asking the question.

Okay.

I mean I think the more important point is the comment that Jeff made before we started the questions is that we think even with all this inflation when we get to the end of the year, we're still going to be where we thought we’re going to be at the beginning of the year.

Right. Got that. Thanks guys.

Okay.

Your next question comes from the line of Stephen East from Wells Fargo. Your line is open.

Thank you and good morning, guys. Frank, maybe I'll ask you your core growth of 5%. Could you break that down for us as we go through the year between price mix and volume and maybe just give us a little indication of which segments sort of rank order your segment growth there?

That would be a lot of moving parts in the increased between now and the end of the year. And I would say that we're going to see volume growth, but we're also going to see some improvement in that topline with the price increases that we're putting in, but I don't have the data here in front I mean you give it to you that in that level of detail.

Okay. Is it fair to say, we think the volume would be the bigger driver that 5.5%?

Yes. And I think the other point to make on that. The cadence of that as you move through the year, as you saw in the first quarter the growth rate was lower and it should start to ratch it up in the second and then more so in the third and fourth quarters.

Sure. I got you. Okay, thanks. And second question, Jeff is sort of the bigger picture. I've never really seen company take the CapEx from the 2% to 7%, 8% for multiple years and truly drive the productivity like you guys haven't gotten the results that you guys have. So I wonder as you keep ongoing year-by-year. Could you talk a little bit about how you would view the risks, they're always risks of over investing getting diminishing returns. You haven’t really seen that yet. I guess I'm wondering how you think about that. What specifically to your business and then maybe give us some idea of how you are what tracking mechanisms you all used to make sure that doesn't creep into the CapEx spend?

The CapEx is made up of multiple things across the world we've discussed over multiple calls. Many of our production facilities are running at or near capacity and sell in order to keep the growth of the business, we have to invest in those things to keep expanding them. In addition, the capital investments to increase our product innovation, which allows us to make more differentiated products, which allows us to participate in higher margin premium categories. At the same time we've announced going into additional products and geographies we are not in like carpet tile we mentioned in Europe, sheet vinyl in and Russia and countertops in Italy and there's multiple of those and smaller ones we've been talk about we’re putting on in order to expand our base and improve our business. We are in a cyclical business, and it does change over time, we don't see anything occurring in the foreseeable future that would slow it down from where it is. We've been through multiple downturns, we understand how to handle and what to do with them and we'll do the same we've always done when they occur.

Okay. As you look at your productivity side of your spend is there, can you give us maybe a peak under the covers about where it may start to show up per store what you all would be looking for from that perspective.

We’ve given you a high level view that said it’s going to be more than next year. We try to give you a direction over what the operating profit will be for the year and I mean it all adds up to those numbers and direction that we've given you as we go through. The productivity pieces or a combination of just innovative ideas how to do things different a one side and on the other side, it's a result of many of these acquisitions that either increase our productivity as we go through. And then at the same time following another category you have as we introduce new products that have more differentiation and actually increase the margins of the products, which flows into the price mix category and it's a combination of managing all those things all these investments and how we're doing and the innovation that we're driving through the company is really what's enabling us to perform at levels that I don't think anybody's ever been that in our industry.

I would definitely agree with that last statement. So thanks a lot. I appreciate it.

Your next question comes from the line of Mike Dahl from Barclays. Your line is open.

Hi. Thanks for taking my questions. Jeff, just a follow-up on that last comment of yours it truly is differentiated performance compared to how I think any of us have thought about the industry in the past. And if I look at your guidance for this year and what it implies for the back half of the year as far as growth ramping up. You've clearly laid out all of the capacity initiatives, the pricing initiatives, is this a period where we could be entering kind of a sustained period of high single-digit type of growth for your business from a topline standpoint compared to what historically, it was more like a low to maybe mid single-digit?

Listen that would be a favorable conclusion. I'm not sure that I have been embedded in mine that way. The business is huge at this point. It takes a lot of capital to keep growing at the rates we're in and we really look at it as a two-pronged piece. One is increasing the sales of our present businesses, improving the mix of the business, reducing the cost structures through investments and innovation at the same time continuing to find additional acquisitions that we can help and fit our strategy, and the combination of the two, we believe will allow us to continue growing at a rate much faster than the market.

Okay, thanks. As a follow-up on the acquisitions, I think you mentioned $270 million total investment plus some future spend to optimize the manufacturing. Can you help us understand from a – how these businesses are going on from. How much it has the sales and presumably since there is some investment needed to optimize they may currently be running at below company line margins, but just a little detail on the margin profile and how long it will take you to get them back up to company average?

First thing, we gave you an indication that said for the balance of the year, we expect them to add about $0.15 to earnings to give you a view of the present piece. Each one of them is different, and the biggest one is in Italy and the one in Italy is almost across the street from our present business and so combining those is basically a bolt-on business to combine the two together to enhance – to reduce the – improve the productivity and efficiencies of both businesses, putting together to broaden the distribution of the products. We have a much broader product offering and we can use our assets to give them a broader offering to their customer base. The Polish business is really a very small plant that is really a foundation to grow a new business. The business itself is relatively small. We're going to increase the capacity of the plant. It's in a low cost labor area. It has raw materials that are almost next door to it, so you have low cost manufacturing base. We can provide it through more investments. The ability to make much higher stuff and better products, the vicinity where it's located gives you low transportation cost to get to Northern Europe and the places around and compete in a lower price points than the focus of our Southern European business today. The other pieces are just what the other things we're buying the mine in the nylon plant are just ways of securing our raw materials at better prices and more control, and all the businesses will require investments to drive them over time. And I think we have a long history of buying businesses and improving them and it's just doing the same thing over again.

And just to remind everyone last quarter, I think we have said that the Italian ceramic business itself we’re about €160 million.

Okay, great. Thank you.

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

Thank you and good morning. I wanted to touch on carpet I guess and you have pretty good expansion in the margin in that segment. Just curious, I’m not sure you are not going to give me a number, but what overall carpet played in the margin in the quarter. The carpet is a large piece of the business. We've been investing heavily in it as we go through, you heard we have closed plants, consolidated plants, put more investments in backward integration. We're driving the productivity of the business up. We're using our product innovation to improve the mix and quality of it. I mean it's a good part of our business and we think we can keep it operating well and improvement.

So I presume given its way – it had a fairly nice margin performance year-over-year in Q1, despite implanting [indiscernible] conclusion?

It would be hard to drive the margins up dramatically without – and leads out such a large part of our business.

Got it, and then on the acquisition front, Jeff, what if anything are you seeing I guess as you get longer into a cycle, people tend to certainly get higher expectations. You've done some small things here, but I'm just curious what the acquisition pipeline looks like? What you're seeing from potential sellers are you just so focused on all your CapEx expansion really, really not focused there?

We continually talk to acquisition candidates. Given that our management is capable of buying things around the world. There’s always people looking to do differently with the businesses. We continuously talk to ones all the time. The question really becomes the perception of value and how to get both sides together to make it work out. And sometimes that work out easily and sometimes a take a long time.

WE believe we've got both the balance sheet and the management strength to do both capital projects, as well as more acquisitions.

Noted, eye on that. Thanks and good luck.

Your next question comes from the line of Mike Wood from Nomura. Your line is open.

Hi, this is Mason on for Mike. What is the early read on sales in Adult Novelty plant and where is that plant stand with production efficiencies?

The existing plant continues to improve, the line speeds continue to go up. The yields continue to improve. We're focused on two things, which is driving them up even further and then putting more complexity in the plant to get more – higher value products. We're working through both of those as we speak. We have broken ground to expand the buildings to put in new line, which should be installed and starting operation by the end of the year. We think it's a good category and we intend to be a leader in it.

All right, and the second question, how much of – bleeds into your 2Q guidance for June. And are there any potential SG&A offsets from the royalty loss?

Not sure we understand the question, one more time.

How much of [indiscernible] in your Q2 guidance for June?

I mean the IP?

Yes.

Well, again what we said was if you do the math, the full-year will be between $65 million and $70 million. But in that run rate is going to drop to an annual run rate of $35 million starting in June 1.

We had seven months at $35 million, the difference in the two gives you the first part.

Yes.

Okay, great. Thank you.

Your next question comes from line of Megan McGrath from MKM Partners. Your line is open.

Good morning. Just wanted to get some more detail if I could on the input cost inflation, you mentioned a couple of items, but it also sounded like you might have seen an unexpected inter quarter spike and I lose one input cost. So could you give us a little bit more detail on what you're seeing and the biggest pressure and where you've seen them kind of trend throughout the quarter if there is any sort of relief on the horizon?

I’m not sure I can get the granular on every product category has inflation and more than we anticipated. The chemical-based materials are going to everything has increased the prices in everything from glue to fiber types to anything this got chemicals and it's going up. The wood prices have moved up in Europe, there is labor and energy increases across everything. And then you have currency changes that have impacted as we shift between currencies that we have to overcome. There is in polyurethane there is actually a shortage in urethane chemicals going into it. The shortages severe the prices are going up dramatically and to the point where we actually won't be able to manufacture as much as we want. So it's across the anything and everything and everyone of the businesses is repricing the products, both on a local basis and we ship across currencies they're making adjustments for the currencies, as we go through and we believe that we'll be covering those costs in the third quarter.

Great. Thank you. Any potential impact from the proposed Canadiantariff?

Listen, if you can tell me what the proposals will look like how decide what it is. The tariffs up there are on softwood and we use hardwood. And then the woods we use typically we buy in local areas because the freight so much. So that particular tariff won't impacted is it.

Great. Thanks very much.

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

Hi, thanks. Good morning, Mike Rehaut. Question around price points during the quarter, I was hoping you could speak to the relative strength as you saw in North America in terms of - I'm thinking here particularly in terms of just residential carpet and ceramic. If you could kind of talk to the relative strength of kind of the lower-end value commodity type product versus more the typical mid-price point and as well as anything on the higher end. How those different price points are trending both in carpet in ceramic?

The price points are in carpet are really hard to read when you start putting out price increases, what’s you get is the high volume, more commodity products they start pre-buying and front of it and then you have to guess, how much is pre-buying how is it going to flow through. So it's hard to see I think in general the business was probably a little softer than we had hoped that we just saw the GDP numbers come out, they were lower than we thought it would be. The remodeling business, the stronger it gets it trades at a higher price points. And then at the lower price points, you have typically the new construction of apartment businesses. So it depends on a little bit on how each of the categories are running relative to each other, is probably the biggest impact as we see. And we also mentioned in our ceramic business, we had some unusual things with large customers postponing introductions, which impacted the piece and then we have inventory reductions going on. So there's a lot of moving parts I can't tell you that I seeing anything that dramatically change the historical trends.

Okay. That's helpful, Jeff. And I guess secondly just looking at the three different businesses in terms of profitability. You talked obviously a lot about in the back half of the year, being able to recover the higher raw materials. How would you consider this year a bigger picture - do you feel like the raw material pressures are a little higher than normal or then in 2016 and as you go later into the cycle would you still expect to be able to more or less recover inflation through price and obviously just kind of more of a timing issue in the second quarter?

So last year you had the oil prices hit a bottom and then I came back up. So you had the prices going down and back up, is that happened. As we came to the end of the year those things were flowing through and we're guessing how those we're going to apply to the year. So it looks like – my guess is oil looks like it's going to stay relatively in the range of that for a while you've then have the chemical companies in between that are trying to improve their margins as they go through, and I don't know enough about it to know how they're going to react in the supply and demand of those things to projected forward any better than you do. So there is a chance that we've seen the majority of the inflation. We're going to get for a while or we could be surprised. Only thing I can tell you is just like you saw us to react now, we will react to push them through to the marketplace.

Great, thanks guys.

Welcome.

Your next question comes from the line of Sam Eisner from Goldman Sachs. Your line is open.

Good morning, guys. Just on the – you cited I think across all segments there was some kind of revenue that was missed in the quarter either regards to customer inventory dynamic, the product transitions. So is there a way to put a point estimate on how much that was a drag in terms of organic growth in the quarter, dollar basis or even percentage basis. And then perhaps maybe just give a little bit more color on kind of where those customer kind of squeeze points are today?

I can't tell you what something would have been if something else didn’t happen. I'm not that smart. What we said is that even though the growth rate in the first quarter was lower than our annual estimate that we think we're going to hit the annual estimate as close to of around 5.5%, which means the future quarters have to strengthen and we've said that we anticipated strengthening further as we go through the year. We have said that some of our product categories have been limited by capacity and some of those things will change over time as they go through. I think that’s the best we can do for you.

The only other point I would make on the ceramic side of the businesses is the first quarter of 2016. That growth was unusually high. So we had a difficult comp going into the first quarter with ceramic.

That’s helpful. And then with regards to the acquisitions and the new product offerings that you guys are doing, you commented that fourth quarter should have some elevated sales and marketing expense. Is it just a way to think about for the full-year how much higher sales and marketing expense should be? You obviously have given some guidance around productivity initiatives and things of that nature, just curious where that particular line item, any kind of thoughts around it? Thanks.

We've given guidance that the combination of start-up costs and marketing additional is going to be around $45 million for the year and it doesn't come through level, but the biggest piece would hit in the fourth quarter, but it’s going all the way through, as we start adding salespeople marketing as we go through and different projects come up with different times.

Very helpful. And maybe if I can just sneak one more in here. Your growth or your kind of further expansion into the countertop market, any kind of sense of how much traction you're seeing there anyway to kind of think about the medium term kind of opportunity for you guys? Thanks so much.

It's made up of a couple of different pieces. One is we have a significant stone and slab distribution in the United States. We said we're increasing the number of those in the United States to improve our distribution and increase the sales of the products. Those products we presently buy from around the world to support that business. In Europe, we are building a plant specifically to make countertops out of ceramic, which is a business that's been in Europe for several years. It's being more and more accepted there. So we're going to enter there. We are going to use the same equipment to ship those products into the United States to sell-through our present distribution. And then presently, we're actually importing similar products to build the market for it. It typically takes a while to build it and we would assume that once we establish and get it running, we will build another plant like the one we've built in Europe here to support it. So we see the ceramic and the countertop businesses as another leg to grow with.

Your next question comes from the line of Laura Champine from Roe Equity Research. Your line is open.

Good morning. Could you talk a little about the backward integration you're doing in terms if you can generalize about how much that can add to margins and how much more you have to do along those lines in your different segments?

Those pieces are so small relative to our total business. It’s not going to change the margins of the business. What we do on each one, as we look at it on a return basis on each investment, and we expect to get a return on investment over time, they tend to be low risk because we use most if not all of the capacities. We know what's going to happen, and we know that we're going to need it over 20 years. So those are just normal pieces. We own mines around the country around the world to support some of our ceramic in some cases it makes sense to own them and other cases it doesn't and when things become available. We consider them. We also look to start our own mine to different places we've done. The raw materials supply the ceramic piece and ceramic just the mine piece usually the transportation for the mine to the plant has more than the materials. So the location of those things is really important as we go through and we mentioned that do thing in Poland, it sitting on top of mind closed by, which gives it an economic advantages manufacturing point. The same thing with the backward integration on the carpet side, it's just one of many that we have and it just fills another gap that we had. Nylon makes up somewhere around 35% of the industry. And so it gives us a stronger position than we’ve had.

Got it. Thank you.

Your next question comes from the line of John Lovallo from Bank of America. Your line is open.

Hey guys, thanks for fitting me in here. First question, I guess you've done a nice job of pushing price through to offset some of the raw material inflation here, but I guess I'm curious how do your contracts work if I'm thinking of specialty stores with contractors and home center et cetera. I mean, are you able to go back to them and push price even further than it is now if materials continue to rise?

The majority of our sales are done at market. So they are fluid and changeable and depending upon which market and what type of account, there are some different lead times on different things, but for the most part they change relatively limited period of time. On the other side with most of our suppliers, they’re either at market or cost plus some basis and they’re different all over the place.

Okay. And then Frank, could you just, I guess one housekeeping item here. A number of your competitors, who have adjusted for excess tax benefits from the exercise of stock options, running that through the tax line, is that that's in your guidance now or how should we think about that?

You're talking about a new share-based payment accounting rule that came out and only impact us was in the first quarter with new material impact in our first quarter tax rate. And that was all included in our guidance we gave guidance for the first quarter.

Okay, thanks guys.

Your next question comes from the line of Keith Hughes with SunTrust. Your line is open.

Thank you. You announced 20 new Daltile centers, so two question on that. First, how many does that bring to in a total right now? And is there any work on those two presenters more of a retail format. We can actually transactions in the store or different anything along those lines?

What we said was there 20 either Daltile surface centers or Daltile slab centers. So they’re not all exactly the same. What each of those do, it is distribution operation for a local market in order to supply it, and then within those pieces there also selection centers, so that our customers can bring their customers and help them pick out and make choices of the products as we go through. We have areas that we think we can improve our business and get more market share out of it and we do it that way. In addition, we also add more salespeople, which we talk about in order to get to more customers and it could be builders, it could be commercial jobs they operate out of those local market, local places in order to optimize our position in the marketplace.

Okay. Thank you.

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

Jeff, Frank. How are you? Just one question for me a lots of different capacity at projects that you highlighted Jeff, I think the only one by my notes that you actually mentioned was on time and on plan was the other Tennessee ceramic facility? Are we on plan and one-time with all the other ones, are there any delays or cost overruns how we doing with milepost says the year progresses?

It was on time and other one that went actually came up out of the ground and went to start up in the fall of last year. So I went through startup. So what we're saying is not only of the start-up is now operating at peak performance that we expected it to get to the other ones are all moving as we expect. But I mean these things there are million variables and from getting the permits to government approvals to suppliers putting stuff and to all kinds of things and we tried to give you directionally that we thought they would - when I would come up in the operating and most of the big ones are running from the fourth quarter - some of the big ones to be in the fourth quarter. Some in the first quarter of next year as we go through, but I mean we have all kinds of things. We have a carpet cushion plant that we put up in to satisfy the market in the Western United States, it's up and running well. We have a new engineered wood plan that's in came up that it's running well. I mean there is multiple of projects that are coming up or not we tended to focus on the big new capacity increases, which are being spent this year. But there is all kinds of projects that came through last year that are in various stages of optimizing.

What I'm getting - just as you look at all the different projects are there any material call-outs that that project or two has been delayed enough where it may cause some risk to the sales growth expectations over the next few quarters?

There's nothing at this point that we would say is dramatically ahead or behind where we thought it would.

Thank you very much.

Thank you.

Thank you. Your next question comes from the line of Scott Rednor from Zelman & Associates. Your line is open.

Hey, good afternoon at this point. Just quickly, Frank the 5.5 sales growth for the year, that excludes currency, it excludes the acquisition? Does it include or exclude the patent revenue that's rolling off?

It includes the patent revenue.

Okay. Great thank you for clarifying. And then just quickly, can you guys frame how much of for North America is soft surface right now carpet rugs just broadly and Jeff, if you had to guess what you think the share of that business is going over the next couple years.

But we don't break out the details of the different product categories across it. Carpeting as loss share relative to the total growth. In the U.S. we would guess flooring over time will grow about 3% to 4% and I would guess carpet could be flat to up a level plus or minus, who knows exactly as it relative to it and then same embedded in the same thing, you have LVT that’s going rapidly as a percent, so it's growing much higher. You have ceramic that’s growing at a faster rate in the industry as general from industry trends. And then you have the other ones that are growing tend to be at the 3% to 4% or less. We participate in all of them.

Thank you.

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

Thank you. Jeff, you had commented a bit on the market earlier and I just wanted to hear you expand on that, understand how GDP growth behave, but in terms of your markets the demand in 1Q and the visibility you have on order books as we go into 2Q and through the year, how is that behaving relative to what you expected coming into the year?

I mean going back, what I just said was our view is that the flooring industrial growth rate of 4% this year. I don't think anything's is changed it for whatever reasons, first quarter GDP and first quarter growth for the industry historically has been a little slower than the average. So we don't see it changing anything. When you look at the big parts, the new housing construction seems like it's going to grow somewhere around 10% based on most people's estimate is in line with what the expectations are to reach that. The commercial business should be growing about industry growth rate plus or minus a little bit overall. And then the big upside question is how does remodeling take off or not and it's been running slightly less than those, is it going to pick up and do better or not as housing prices go up, as interest rates go up. People may start staying at – see that they're not going to move and may start investing more in it. And we could have more upside if that occurs. But we're still sitting with an industry growth of 3% to 4%.

Okay, thank you.

Your final question comes from the line of David MacGregor from Longbow Research. Your line is open.

Hi. This is Robert Aurand on for David. I guess just going back to the capacity additions, Mohawk has always been the company recognized with a strong management bench, but just given the magnitude of the growth you're undertaking into your manufacturing capacity within a relatively short period of time. Can you talk about how you're developing the management capability to step in and run all those capacity efficiently?

Sure. First, you have to start out that we run our business in a decentralized manner that we've run different products and different geographies under local managers and we do that on purpose in order to allow them to adjust to local circumstances and needs. With that it enables us to give different projects to different groups and handle a multitude of things at the same time, where each only handling one or two, so that collectively we can handle a lot of projects at the time. At the same time we do have interaction between them to help them with technology knowledge, design, style, engineering capabilities that we share across as needed and each of the managers know that their goal is to optimize their piece, but they better do the right thing for the whole as yet. And I get a lot of positive things out of doing – helping each other. It's good for them and it's good for the whole group as you go through. So I mean we're really in a unique position and then connected to that our strength of our balance sheet and the cost of our debt is extremely low as we go through and it's all because of the strength of the entire company. And then we have, as we've grown different than most companies when we go through acquisitions, we buy the management as much as we buy the assets. And I don't know many companies that have been able to maintain the management from these acquisitions like we have, and it takes a unique method of driving it in order to make sure that they feel that they're part of the business and can help and when buy good acquisitions we feed them capital and ideas, but I mean they're still driving the business as we go through, which is why go back to the first segment, which was Daltile, the same management as you're driving at today that was driving it 15 years ago and we have the same thing through a large number of all the acquisitions.

Thank you. I appreciate the color.

There are no other questions at this time. I will turn the call back to Mr. Lorberbaum for closing comments.

We appreciate everyone joining us. We want to keep focusing on that we're investing at record levels. And we're looking at acquisitions and we’re improving our business and the goal is to keep and maintain Mohawk as a high growth Company and make it more profitable in the future than it is today. We're doing the right things and I know it's uncomfortable that the variation between quarters goes up and more as we do these things, but I mean the long-term conclusion is we're going to have a much stronger and more profitable business. We appreciate your support and thank you for joining us.

Ladies and gentlemen, thank you for your participation, this concludes today's conference call . You may now disconnect.