Mohawk Industries, Inc. (MHK) Q2 2017 Earnings Report, Transcript and Summary

Good morning. My name is Julian and I will be your conference operator today. At this time, I would like to welcome everyone to the Mohawk Industries’ Second 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 session. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, Friday, July 28, 2017. Thank you. I would now like to introduce Mr. Frank Boykin. Mr. Boykin, you may begin your conference.

Thank you, Julian. Good morning, everyone, and welcome to Mohawk Industries quarterly investor conference call. Today, we’ll update you on the Company’s results for the second quarter 2017 and provide guidance for the third 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. Welcome to our conference call, due to multiple request to involve a broader part of our management team Chris Wellborn will be joining us on today’s call. Chris was appointed President of Dal-Tile when we acquired the ceramic business in 2002 and was promoted to President and Chief Operating Officer for Mohawk Industries in 2005. Chris had a deep knowledge and understanding of our entire business and for the past 15 years he has played a critical role in developing and executing our strategy across the entire organization. Today I’ll review Mohawk’s overall result and Chris will cover the operations of our three segments. In the second quarter Mohawk performance continued at a record level generating the higher sales, operating income and EPS in the company’s history. Our businesses continue to exceptional execution of sales growth of 6% as reported and 8% on a constant days and currency basis including previously announced acquisitions. Adjusted operating income for the period increased $381 million up 7% overcoming high material and startup costs and reduction of IP. Across the business we’re increasing prices to offset inflation, introducing innovative products and improving our productivity. We’re viewing our growth around the globe with significant investments to extend our product portfolio and penetrate new markets. As detailed last year, we’re expanding our sales capacity by approximately 1.4 billion. This production will come online over the next 12 months and our startup costs will be higher until we’ve optimized all of our new manufacturing operations later in 2018. During the period we completed the acquisitions of two small ceramic manufactures to expand our European platform and two U.S. material manufacturing operations to enhance the vertical integration of our business. Our strong local management teams are identifying opportunities to differentiate our products and improve our productivity. This year we’re increasing our total investments to over $850 million to capitalize on innovative new products, increase automation and greater efficiencies as well as to enhance to the four acquisitions. Between 2016 and 2018 we’ve many projects being implemented. In the ceramic segment we’re expanding capacity in the United States, Mexico, Italy, Bulgaria, Poland and Russia in adding porcelain countertop plant. In North America segment we’ve been expanding the LVT, laminate, wood, polyester carpet pad and rugs. We’re also upgrading our nylon resin plant. In the rest of the world segment we’re expanding our LVT, laminate in Europe and Russia and boards, also in entering carpet tile in Europe and sheet vinyl in Russia. In every segment we’re investing in new product innovations, increasing productivity and expanding distribution. These initiatives will increase our sales and profitability maximizing a long term value of our business. The U.S. economic outlook remains solid with job and wage growth sustaining customer confidence and supporting continued economic expansion. More first time homebuyers are entering the market and housing starts are up despite lot and labor shortages. Harbors LIRA Index is forecasting home remodeling growth above historic averages over the next 12 months. The architectural billing index shows commercial and institutional trends staying positive. In Europe the economic forecast is sustained and study growth across the entire region. The Russian economy expanded for the second consecutive quarter reinforcing an optimistic outlook for the remainder of the year. I’ll now turn over the call to Chris, for his review of the segments.

Thank you, Jeff. During the quarter sales in our global ceramic segment increased 9% as reported and on a constant days and currency basis with adjusted operating income rising to a $163 million, 16% increase. We completed two European ceramic acquisitions that increased our segment sales by 6% during the period. Our legacy business improved from the prior quarter but was limited in North America by capacity constraints in red body ceramic and in Europe by the temporary plant shutdown to upgrade our technical lines. In Europe, half of our new technical equipment has begun production and is operating at expected levels, and we are importing product to satisfy U.S. demand until our Mexican expansion becomes operational later this year. Our U.S. ceramic business improved during the quarter even with capacity limitations in our lower end products which have now been resolved. New home construction continues to outperform the commercial and residential remodeling channels and we made further inroads with regional, national builders because of our advantages and style, performance and service. We are introducing higher value products from our new Tennessee plant including longer, more realistic with visuals, surface texture and registration with our designs and proprietary slip resistance surfaces. We have added service centers and are growing our sales with unique merchandise in promotions to optimize each channel. We are adding sales personnel and distribution points to increase our countertop business and are introducing new porcelain slabs that we will manufacture in Europe. The market for countertops made of quartz is about 1.2 billion and growing more than 10% a year. To greater increase our participation in quartz countertops we are constructing a new plan in Tenseness that will be operational by the end of 2018. During the quarter, we completed the acquisition of a talc line in Texas that will ensure our material supply and enhance our competitive position. Even with our capacity constraints our sales in Mexico outpaced the strong local market. Our sell in market expansion will start up later this year where leaving our capacity shortfall and allowing us to expand our distribution in the U.S., Mexico and South America. Our European ceramic business grew substantially as a result of our new acquisitions and new products we have introduced. Presently, we are introducing creative new designs and finishes in our mid price products and tailoring our collections to satisfy the taste of regional markets. We are expanding our focus on architects and designers to increase our participation in the commercial and new constructions channels. We are finalizing new products for new porcelain slab lines with manufactures countertops and wall tiles. The shutdown to upgrade our technical ceramic plant impacted our sales in the last period however our service will be fully remediated later this quarter. Our Eastern European business has rebounded from the severe winter and we are introducing larger sizes and Italian design to that market. The integration of our Italian acquisition is progressing as planned and we are improving their predictability and broadening their offering. In Poland we are enhancing the cost structure of our acquisition and restarting existing equipment. We are providing technical expertise to enhance their product offering and improve their efficiencies and will be installing additional capacity next year. We believe there will be further opportunities to consolidate the European ceramic market and expand our market share. Our Russian ceramic business is significantly outperforming the market with sales and margins improving as a result of our unique design, strong brand and robust distribution. During the period the ruble strengthened against the dollar with the economy expanding the last two quarters. We are increasing our capacity in Russia to support future ceramic growth. During the quarter, the flooring North America segment sales grew 6% as reported with adjusted operating income raising to a 140 million an increase of 12%. For the period our hard surface sales outpaced carpet and residential sales were stronger than commercial. We have implemented price increases and improved our product mix which have together have offset material and other inflation. We are executing productivity initiatives across our operations resulting in improved efficiencies and yields. Our premium residential carpet collections are growing faster than the market due to increasing consumer preference for the superior softness and performance of our exclusive smart strain franchise. We have begun shipping smart strain self reserve, the fourth generation of our proprietary fiber with an even greater level of softness. Retail commitments are increasing for our luxury care stand brand as we enhance its style and design. Sales of our ultra-soft and standard continuum polyester collections are growing across all price levels of the market and we have expanded our continuum capacity in the prior, in the period to meet increased demand. For the quarter our rug business improved on the strength of our sophisticated new airline collection and the success of our growing outdoor rug programs. The expansion of our carpet cushion operations is running as planned and improving our sales and distribution. During the period we completed the purchase of nylon polymerization plant which we are enhancing to improve our competitive position. Our main street commercial sales expanded faster than our specified channels with carpet tile continuing to gain share. During the period our sales in the hospitality, senior living and retail sectors surpassed the institutional and corporate categories. Our new broadloom and carpet tile introductions received awards from the architects and design community at three premier commercial expos. Our LVT and laminate sales outpaced our other hard surfaces with our distribution expanding as a result of our leading design and performance attributes. Our LVT operations are improving and construction is progressing on our new rigid LVT line which will start up by the end of this year. Our solid tech rigid LVT has quickly gained traction in the market and we are expanding sales in the commercial and builder channels. In addition to carpet our hard surface collections were honored by the design community at the leading commercial expos. Our proprietary water resistant laminate with enhanced visuals is growing as an alternative to wood. And we are increasing our capacity later this year to support additional growth. For the quarter, sales in our flooring rest of world segment were up 2% as reported and 8.5% on a constant days in local basis. The segment was impacted by lower patent revenue and increasing material cost and currency changes which are recovering with price increases. We anticipate that the majority of the increases will be fully implemented by the fourth quarter allowing us to recover our higher cost. Our LVT sales are growing significantly, although we are reaching the limits of our present capacity. Our new LVT production line in Belgium will introduce both rigid and flexible products and should startup in the fourth quarter. Our sheet vinyl production has recovered and is now operating normally at full capacity. We are introducing new residential and commercial products to improve our mix and maximize their results. In Russia, we are finalizing a purchase of a building of ceramic facilities to house our new sheet vinyl manufacturing operation. In Europe, our premium laminate collections grew substantially and we have begun the installation of a new laminate press line to further expand our business and improve our product mix with value added introductions. Our Russian laminate sales are also constrained by our local manufacturing which we are expanding mid-2018 to increase sales in that market. We are raising laminate prices in most markets to cover higher raw material cost in currency changes. We are enhancing our wood business with higher value products and more efficient processes. Our installation business has been significantly impacted by raw material shortages which have reduced our sales and dramatically increased our cost. Raw material availability is presently improving and we are significantly increasing our installation prices to align with the inflation. Our roof panel sales have step changed as the improving European economy drives higher consumer confidence in a more robust housing market. Raw material increases have impacted our roof panel margins and we are implementing price increases to offset. We are seeing increased demand for our wood panels and we have changed our production schedules to minimize the shutdown days during the traditional summer holidays. We are raising wood panel prices to offset a higher cost and improving efficiencies with new investments and processes. Construction of our new carpet top plan is underway and we can limit it operations in the fourth quarter. We are recruiting experience sales and operations professionals to introduce our innovative carpet tile solutions featuring fashionable designs, easy installation and superior performance. I'll now turn over the call to Frank Boykin to review our financial performance for the period.

Thank you, Chris. Our net sales of $2,453,000,000 were an all-time new record growing 6% as reported and 8% using constant days and foreign exchange. Our acquisitions added 2% to the sales growth rate for this quarter. Our gross margin as reported was 31.8% excluding charges the margin was 32.7%. Gross profit was $802 million dollars excluding charges and was favorably impacted by productivity of $38 million, price mix of $39 million and volume of $31 million offsetting $58 million of interest inflation. SG&A is reported was 17.3% of net sales or 17.1% excluding charges which improved 20 basis points over last year as we leverage higher sales and continued our focus on cost control. And usual charges were $25 million during the quarter and primarily related to plant consolidation in the Flooring North American segment and acquisition related charges in our Global Ceramic segment. Operating margin excluding charges was 15.5% and improved slightly over last year. Operating income excluding charges of $381 million was positively affected by $44 million of productivity, $38 million of price mix and $13 million of volume offsetting $58 million of input cost inflation. Other income loss was a lot of $4 million and primarily was due to unfavorable foreign exchange impacting our results. Our income tax rate for the quarter was 24.5% that compares to 26.3% last year. Our tax rate this quarter was favorably impacted by tax planning strategies related to our European ceramic acquisitions and partially offset by less favorable Italian statutory rates. We expect the rate to be 28% to 28.5% in the third quarter and then for the full year to be in the range of 26% to 27%. Our earnings per share excluding charges was $3.72 representing an increase of 7%. Moving to the segments. In the Global Ceramic segment, sales has reported were $903 million in increase of 9% or a 3% increase on a constant FX and days basis for the legacy business. We had growth in all regions with Russia turning into strongest performance for the quarter. Operating margin excluding charges was 18.1%, which is at a 110 basis points over last year. Primary factors for this increase were productivity of $19 million and volume of $14 million, with a $11 million of interest cost. Our Flooring North American segment has sales of a $1,040,000,000 and grew 6% both as reported and on a constant basis with a very strong growth in laminate and LVT. Operating margin excluding charges was 13.4% that was up 60 basis points over last year. The improvement was supported by $20 million of price mix and $12 million of productivity, partially offset by $22 million of inflation. In the Flooring rest of world segment, sales has reported were $510 million a 2% increase or 8.5% on a constant basis. Our LVT and laminate sales both had strong growth in the quarter. Operating margin excluding charges was 17.3% and was impacted by lower patent revenues. We had favorable price mix of $14 million plus $13 million of productivity offset by $23 million of input cost inflation. In the corporate and elimination segment, we had an operating loss of $10 million and we are expecting the operating loss to range between $35 million and $40 million for the full year. Jumping to the balance sheet. Our receivables were a $1,640,000,000 with day sales outstanding up to 55 days compared to 54 last year; this was due to changing mix in our customers in the quarter. Our inventories were a $1,866,000,000 with the inventory days at 109 days for the year. In increase from a 105 last year due to raw material inflation and more sourced product needed to support our LVT, ceramic, and countertop businesses. Our fixed assets for the quarter ended at $3,892,000,000 with capital expenditures in the quarter of $224 million in depreciation and amortization of a $110 million. We're currently estimating our full year CapEx to be in excess of $850 million with depreciation and amortization of almost $460 million. Our long term debt ended at $2.9 million with our leverage at 1.6 times debt to EBITDA. And with that, I will turn it back over to Jeff.

Thank you, Frank. Mohawk's operating performance in the third quarter should continue to significantly improve most sales and income strengthening further even with higher material inflation and changes in patterns. We're implementing price increases across most product categories and regions to cover material and currency changes in the third quarter. We will begin optimizing the acquisitions we completed in the second quarter by improving their strategies and enhancing their profitability. Taking all this into account, our adjusted EPS guidance for the third quarter is $3.70 to $3.79. To enhance our long term performance, we are investing a record level this year to expand our product offering and capacities, improve our efficiency and extend our geographical reach. In the fourth quarter, we will incur higher startup cost as our production expansions ramp up and we elevate our marketing activities to increase our sales. The expansion of our LVT, ceramic, laminate sheet vinyl and countertop capacity will increase our future growth in profitability, strengthening our position as the leader in flooring. We will now be glad to take your questions.

[Operator Instructions] Your first question comes from the line of David MacGregor from Longbow Research. Your line is open.

Yes, good court. Congratulations on all the progress. I guess, the whole notion of raw material inflation is something that's coming up a lot through the various earnings calls this quarter. You are clearly responding with the number of pricing initiatives. Is there any way you can talk about what percentage of your business, what percentage of your revenue streams would be subject to price increases?

We don’t really look at it on a global basis adding Mohawk together. So, I don’t have a real simple answer. Most of the product categories are being impacted by product, by raw material increases and most of them were pushing price increases through in United States as well as most of the rest of the world.

And is there one segment that would be more prevalent than the others in terms of the intensity of the pricing initiatives?

I'm not sure the -- anything that's got to do with oil based things, wood based things, the acid base things that go into vinyl, almost all the product categories are going up. That I mean, it's crossed every I will guess ceramic would have less pressure because it doesn't have those things in it.

Right, okay. And this is my --.

I would just add on the positive side that we're putting in price increases across the board in all of the segments to offset this inflation.

Right, it's good to see. As my follow-up question, I guess you talked about adding $1.4 billion of sales capacity, what percentage of that $1.4 billion of capacity comes on in the second half of '17?

I don’t have that in front of me. There are a lot of pieces that are coming online at different points in time. There is different parts that have already been implemented. There is some that are just finishing. There are parts that will come on in the fourth quarter, more of them and several of them will come on till further into 2018.

Right. Is there historically a typical relationship between startup cost and percentage of revenue capacity?

No. Each one, different. It depends on if you're putting it in the existing plan if you're starting a new plant somewhere else, if you're going into new product category, a new geography and you have to build up the sales and marketing to pieces. So, the pay up on where it is some start up row that quickly and have the sales to support. And others, they are newer technologies that take, it could take a year more to get optimized. And the same thing with the sale. You go into new geographies, the customers are waiting there for you to fill it up on day one.

Got it. Thanks, very much.

You're welcome.

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

Yes. Good morning, everyone. To just on organic growth, there does seem to be an inaudible step up in the pace for organic growth over the last four quarters your last 12 months. So, curious if you can talk a bit about your expectations for organic growth going forward. I think you guys have commented in the first quarter that you expect 5.5% for this year. But do you think that we've reached a kind of inflection point in the pace organic growth for the organization and then also if you can talk about the 0.70 number.

We're optimistic about our business this year and we still expect the historical sales growth at 5.5%, historical business is to grow about 5.5% this year. Without acquisitions, which means the full period will be stronger. We think the results in the second half will be greater even absorbing the higher startup cost, the inflation, as well as the reduced IP. And again, we're investing a record levels to drive these and a large part of the benefits and all these things won't show up until '18 and these and beyond because the capacities coming on, the cost will be at the front end and you'll get the benefits in the end of '18 and in future years, a lot of it.

That's helpful. And then talking about productivity, I think to the first half of the year, you guys are around $80 million, $85 million run rate on that, which's certainly be higher than the 140 that you guys did last year. And then I also think on the first quarter, Frank you commented the third quarter would be higher than in the first quarter as well. So, just curious how we should think about the progression of productivity and is it a very strong asset for you guys?

Yes, Sam. The productivity, we continue to believe that that will be higher this year than it was last year. I would say it's a little bit hard to judge exactly which quarter it is because we've got so many projects that are going on. Some are good, some in that better than we thought, some in that worse we thought, so it's going to be hard to say if third quarter or fourth quarter are going to be higher. But I would say we are still looking at a higher number for productivity this year.

Got it and maybe just lastly going back to the questions from the prior person just in terms of price cost on the quarterly basis or annual basis do you think that you will be price cost positive in the back half of the year given the price increases that you put out across the globe?

I think it will be the fourth quarter before we get most of them implemented so there should be implemented now and should be coming on this quarter most of them will be placed by the fourth quarter.

Got it and appreciate that. I will hop back in queue. Thanks.

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

Hi, good morning and another fantastic quarter and encouraging outlook. I was hoping that Chris is here and he is a Dal-Tale maybe he could give us download where you are in terms of adding capacity on the ceramic side it seems like you are importing product from Europe to satisfy U.S. demand, Tenseness is online and it has something going on in Mexico. Where are we in terms of meeting your needs?

Yes so, we are adding capacity in all of our segments. We are adding in North America, we are adding in Mexico we are adding capacity in Italy. We are adding capacity in Russia. And in North America as well and most of that capacity is going to come on towards the back end of this year and throughout next year.

Got it. And maybe Jeff you could talk about LVT plant openings both in Europe and North America and while we have Frank maybe you can just touch on your expectations for maybe some of the plants start-up cost both on the LVT and ceramic side when that's going to start to show in the P&L and if that flows into 18? Thanks and good luck.

Thank you. LVT continues to grow significantly. Our estimate is that LVT in the United States is little about 20% this year with that we have our plant we put up is still improving its productivity and increasing its production capacity. In the United States the plant will come up the end of the year at the end of the fourth quarter and start producing for next year and Europe all our lines are running at capacity we are doing things to increase those. The plant in Europe will actually start up probably a month or two earlier than the one in the U.S. they both have capabilities to make all the products flexible and rigid in the marketplace and combine across the world we will have over a billion dollar worth of LVT capacity when it's through.

And I will just address the start-up question Bob. The fourth quarter of this year as well as future quarters into next year will have higher startup cost and what we have seen in the preceding couple of quarters. We are increasing capacity as Jeff has mentioned earlier by $1.4 billion and we are expecting about $45 million of start-up this year and then again as I mentioned we will see LVT start-up as we move into next year we are expanding almost all categories with our largest investments in ceramic and LVT to increase growth and profitability.

Frank, just to be a little tactical on this given the timing of some of the openings that Jeff and Chris were talking about would you say that $45 million of start-up cost is back in _ in 4Q?

Yes I am saying most of the start-up are much of the startup cost is just going to be in the fourth quarter.

And will we see some in the first half of the 18 as well?

Absolutely, you see an elevated start-up cost number as we move into next year for the first half at least for the first half.

Got it. Good luck with the growth gentlemen. Great quarter.

You next question comes from the line of Keith Hughes from SunTrust Robinson Humphrey Capital Markets. Your line is open.

Thank you. You had talked about the loss of the patent revenue starting during the second quarter can you give us any kind of idea what that was like in the quarter and is there been any change in your view what patent revenue is going to look like over the next 18 months or so?

Yes. The pattern revenue, the operating income coming from it actually dropped about $11 million in the second quarter. And going forward we expect the IP could be a little higher than the $35 million operating income that we gave you before as the FX has improved a little bit we think there is some potential for life and this is on an ongoing basis.

So the $35 million was the run rate once the IP falls off on a yearly basis you are saying that could be higher. Is that am I understanding that right?

That was the prior number that we have given everyone and we think there is some opportunities to improve it.

Okay. Second question you had in the ceramic decision you had two acquisitions I believe one was in Poland. Where was the other one?

Within Italy. Italy and then we bought a small mine in the United States.

Okay. And the one in Italy can you give us any kind of indication what it specializes in and the reason for the purchase?

Sure. The one in Italy is right across from our existing [indiscernible] business which gives us a good opportunity for synergies. They tend to be in the mid to higher end price category I think it will be excellent acquisition for us.

Thank you.

Your next question comes from the line of Susan Maklari from Credit Suisse, your line is open.

Thank you. Good morning. Your foreign North America margins have really improved nicely as we have moved through this year as we think about the back half and maybe some of these price increases continuing to come through can you give us some sense of how you are thinking about the progression there over the next few quarters and then maybe looking into 2018?

So, the first we have is the whole raw material cost increases that are flowing through. They won't be fully covered till sometime in the third quarter and the second quarter we cover some of those for the mix improving as we go through. I think that we think what happen to similar improvement over the year in the business in the margins as we go through as we have been having in order to hit the increased margins and sales that we are having everything has to improve to offset the IP the declining and have the increases we are in and if you guys look at the total and take the IP out the basic businesses are increasing much more.

Okay. Thank you. And then just following up you have mentioned sort of your portion to the countertop market you mentioned the construction of new course plant in Tennessee that's going to come up next year. It's certainly in area that's growing a lot but it has also seen a lot of competition coming in can you talk to generally how you think about positioning yourself in that market and maybe sort of where you want to play in terms of price points or product offerings within that?

It’s different to some of the others we have been building a countertop business for ten years and we have been putting in warehouses and distribution points selling all different types in United States and we continue to expand those businesses. The total countertop business we believe around the $5 billion industry in United States and the quartz part of it makes up about 25% of the business and there we are going to move into both manufacturing quartz and manufacturing porcelain countertops which are small part of the United States business today. Italy is about 5 years ahead and starting to grow there and so we are going to put a plant in Europe to start manufacturing those and bring those in. now we think it offers another opportunities to grow our business with the products that we have knowledge with.

Okay. Thank you.

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

Thank you. Good morning and congrats again. My questions are little bit different but I am wondering if you could somehow quantify what you think all of your revenues that are not flooring i.e., countertops, walls, roofing installation and what the growth rate of that business is relative to your flooring business?

It’s still relatively small to the total. There is spread in all the different divisions or different pieces and normally we don't look at them that way so I don't have an easy way to pull them together for you.

Any sense if they are growing too fast or slow than flooring overall Jeff?

Yes, some more some less. As you would expect. There are all in different parts of the pieces like the roofing business is growing faster now but it's been depressed to prior three or four years so we are getting back some of the pieces in Europe. The European academy is better so the board business over there has improved lately and we have invested things to consolidate difference. Remember about a year or two ago we bought an acquisition over there we put them together close plants so those are improving. So the European academy all the pieces are suffering for a while. They are all bouncing back a little bit now which is a good thing. So I am still relatively small part of the total.

And any color on what you have got traction over the padding carpet the product you introduced earlier this year?

The carpet pad we have I think about five or six plants in the United States. We built a new plant and to satisfy the needs in the Southwestern part of the country. The plant is up and running well at this point. And we are increasing our revenues.

I was asking about I think you call the Aero or the combo product where you already have the packing installed to the carpet.

Got you. That's a really brand new product. And we have just installed equipment and make it on our large basis the products are just hitting the marketplace but we are going slow, we are not mass pushing it out at this point. We are putting it in a limited group of customers so find out how to train them and teach them, how to sell it and make sure that we are ready to expand it much more dramatically so it's a really unique product and you have to start building it overtime.

Thank you. Good luck.

Your next question comes from the line of Michael Rehaut from JP Morgan, your line is open.

Thanks. Good morning everyone. And Chris it's good to hear your voice. First question you mentioned of the quartz plant that you’re bringing up I guess from what I understand be ready for production in the back half of 18. I just wanted to your thoughts around the entry into this kind of emerging market. Obviously you already do lot of porcelain and other I guess primarily the porcelain that you are already doing, countertops with but what are your plans for this market and what type of capacity will the plant ultimately give you let’s say in 19?\

So the quartz industry and has been growing significantly we think it's going to continue growing. It's about 25% of the U.S. marketplace we are selling products already in it and we are growing our sales in it today. We think it offers an opportunity, we think it's going to keep growing. There are multiple people in it and doing different pieces but we think that we can bring with the distribution we already have and with our knowledge of product and design we think it will bring some new things to the marketplace and be prepared to compete against anybody. The new plant will have a capacity of approximately a 100-125 million with the first line that's going in it and we can expand it as needed going forward.

Yes I will just echo what Jeff said in terms of distribution we have been in this category a long time with stone, quartz that we got a good foundation to start with.

Okay. That's helpful. And I guess just on secondly on LVT the 20% growth that you mentioned for 2017 I assume it’s in the U.S. is that for Mohawk company specific or the industry and if it's the industry it kind of sounds like a little bit of an acceleration but in either case I was kind of curious where that – what materials primarily it's cannibalizing from I assume from different parts of the laminate term, but where is the give on that or the cannibalization occurring?

The number we gave you is our guess what the LVT business is growing in the United States as an industry. There are different pieces of it growing at different rates and I forgot the last part of your question.

Just canalization Jeff, I assume it's primarily laminate but are there other product line let's say that your – to the extent that laminate is giving the share up how is that affecting your own laminate business in the U.S. as well?

It's growing so rapidly and so much it's affecting every other product categories. So if the growth rate of the industry is I’ll make my guess, 3.5% to 4% it's taking a large portion of the 3.5% to 4% and slowing down almost everything else somewhat.

And does that impact your decision making around maybe even shutting down some of the capacity and some of the other products areas?

No. the other one are still growing they are just growing slower by maybe 1% to 2%.

Okay. Thank you.

Your next question comes from the line of Timothy Wojs from Baird, your line is open.

Hey guys. Good morning. I guess just maybe back on the countertops piece is how do you guys think about the Greenfield opportunities within countertops versus maybe something on the M&A side and then maybe more broadly how do you feel about the pipeline within the M&A more broadly?

So on the Greenfield we were putting up a plant in U.S. for quartz and a plant in Europe for porcelain so we think that's an opportunity. On the other side we are always open to acquisitions and if the right opportunity came about we would be interested and looking at different pieces. On the overall acquisition piece we continue to look at acquisition, there is opportunities out there but as always we are selective to make sure that we are going to optimize our long term returns for shareholders and do what we want to do.

Okay and then Frank on the production capacity that was taken off line in Europe for the production upgrades. Is there – can you give us a sense of what that might have kicked in out of the quarter and kind of what the expectation for that to come back online in the second half would be?

It just slowed down we built the inventories up to try to offset it back in the fall of last year we made the best guesses we could as you would suspect you aren’t perfect so it limited some of our sales there. The plant has we actually shut down the entire plant to replace all of the equipment in it. We have half the plant is running today another 25% coming up as we speak and the rest of it will be operating by the sometime this quarter. So I mean all things are going forward it just shut it down temporarily.

Okay, great. Good luck on the second half.

Thank you.

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

Good morning. Just on that topic on the U.S. in the ceramic piece can you just explain what exactly slowed the growth this quarter and recognizing there is some puts and takes in the capacity side are you guys turning away customers or is it something that's you guys can correct in the next quarter or so?

In the U.S. we were constrained by capacity and some of the categories we have begun importing product temporarily which is here now and we are building a plant in we are doubling the size of our plant in Mexico which will come up in this fall to take care of our capacity constraints. On the other hand the ceramic industry we believe is growing slightly slower rate than it did last year because of LVT taking part of it which is well positioned in as well as the economic growth of the country isn't as high as we all had hoped it would be.

Okay. Jeff is there any issue that you are losing some sales there that you can correct or do you think the import model is picking all that up?

I think that the ceramic business in general is growing at a slower rate and we compete against imports all the time. The imports make up probably almost 40% of the total industry in the United States which we are part of because we import our stuff from Mexico is considered import also as that so we participate in it. We are well positioned.

And then just interested in rest of the world I mean the high single-digit organic growth there. Can you maybe just elaborate a little bit more clearly LVT is helping you there but from outside perspective in that's a much longer growth rate than we see now that business in some time. So I just wanted to get some more color from you Jeff beyond LVT and is there anything there that's not sustainable or is there certain pieces of that business that have now turned the corner if you will?

We have seen a setup in the European market and everything. It's improving. Our sales are 8% on a constant basis and these are local basis there. We are investing in everything over there to expand our LVT business, our laminate business. We are introducing carpet tile. We are going into Russia with new capacity and laminate. We are expanding our – we are going in the sheet line of business over there. We are expanding our ceramic business in Russia. Our European businesses have more capacity in the ceramic and the southern end of the piece. Just feels better and we are going to keep this right up that's a different question.

Fair enough. Thanks for your time.

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

Hi this is Mason on for Mike. So your main three segments is growing faster in the specified market and carpet tile. How much of your carpet tile business is mainstream specified and why noticeable difference between two?

I think the point was not just carpet tile, at least in this quarter business changes from quarter. In this quarter our mainstream business grew faster than our commercial business overall and then our carpet tile business is also growing faster than our total commercial carpet which includes Broadalbin carpet. I am not sure if that was the answer to the question or not there.

No. it's helpful. Thank you. And then the new carpet tile plant in Europe that will start in 4Q, what countries are reserved and is this your first carpet tile exposure to give up?

It's our first carpet business outside the United States is that the gentleman who runs our final business in Europe also came out of Balata and he ran a carpet business in Europe and has good knowledge about it which is why we decided to go into Europe because of the talent he brings to it as well as we understand how to make it so we are building a sales forces as we speak to start selling it or not sell that but also sell our final products, our laminate products, our other products that we are making to build a commercial business which is a fairly small part of our total business in Europe.

Okay, great, thank you.

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

Good morning. Your inventory growth in the quarter was pretty significant. Is that just chasing demand or what is or is it the difference in raw materials cost or what's driving that?

It's really made up of few pieces. First is right as the material cost go up all of that flows into the inventory immediately as the prices go up. The second is that we are building our businesses in different places. We are importing products for LVT, ceramic and countertops so those inventories are going up. And then finally, the Europe economy was not quite as robust as we were expecting.

Got it. And then, on the increase in the CapEx budget for this year. Is there any way to put that in buckets whether its buyer specific plan investment or maintenance versus new capacity versus productivity and so forth?

I think it's sort of a luck, its big categories. One is the acquisition we bought we put in money into expand or improve those to get the profits up for one or the sales up. We pull some of the these projects that we are talking about I mean these are all huge investment in different pieces and we pull some of those back into earlier so some of the expenses will come into 18, 17 some of the expenses will come in here and a lot of this too there is a good chance at the end of the year some of the payments could come up month earlier or a month later in fall in one year or the other. Some of it's going into additional ideas about more product innovation which will put in new capital and to make those and then the quartz plant will pull some of the expenses in the year you may have seen something about it a plant or property we bought in Tennessee that payment was for the building that we are going to put the quartz plant in.

And Laura I will just address your question about maintenance and productivity etc. I would just say that there is – the additional amount that we are putting in doesn't include any maintenance if that was part of your question. The maintenance we are working to drive it down and it could be $100 million or more as we go forward and then in the balance it's going to be split probably more of it will go into capacity maybe two thirds of it go into capacity and about one third of the balance go into productivity in round numbers.

Got it. Thank you.

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

Thanks guys. First question I guess Frank just kind of housekeeping on the tax rate the 28 to 285 in the third quarter is that a reasonable kind of rate going into 2018?

I don't think we are in a good position right now to talk about the 2018 rate. There is some movement going on around in some of the countries that we are in right now talking about reducing stress to our rates. We are going to need little bit of time to understand that and how it impacts us. So I need to wait and see how that all works out before I address next year's rate.

Okay and then I guess moving on in our travels we have seen that your LVT product is being offered standard feature at least in one of the home builders entry level products. I am just curious is this kind of relationships if you have that would be several home builders and do you see that as kind of a driver of your growth?

The home building piece is one of the faster, is the fastest growing part of the U.S. business that's growing probably 8%-9% estimate you want to use it's a large part of our business. We sell all kinds of products through the channel to those home builders. We have relationships with the national home builders as well as the original home builders to specify our products into the marketplace that use wood, that use carpet, that use laminate, they use countertops. All the different categories that we make are sold to the channel and we get there through a lot of different ways.

Okay. Thanks guys.

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

Thank you and good morning guys. Jeff premium carpet so your soak reserve etc. growing faster than the industry. I guess we really heard that for quite some time so I am wondering is that how much would you attribute to that being a great product in pulling demand versus is the consumer finally are we done with this missed shift down and the consumer starting to move up in mix?

I think that let me try to answer it two different ways. One is that softness is becoming more and more important part in premium carpet. The carpet that we make are softer than anybody else in the marketplace and then Louis think we are coming out or even softer than those were. Now while that's going on you still have polyester carpet growing in the marketplace and the polyester carpet is at lower price points and it tends to pull that on the average mix. So you have both things happening at the same time. And I think that we are doing better in the higher end of the market in general.

Perfect. All right. And then on the M&A, you did a couple of acquisitions that are vertical. Is that by happen stance that they both occurred or you are putting more focus on going vertical and if you are what type of – how has that helped your margin if you will?

We really haven't changed the strategy. We are quite comfortable back at integrating businesses and then improving our cost positions and it's really depended upon what comes available some of it we do green field and some of it we buy so it's not a change in strategy.

Okay I got you. And one last quick one. Just your raw material trends are they backing off or you still seeing inflating?

It seems like they have plateau but you never know. Most of our raw materials we buy on at market and they fluctuate up and down month to month and just as a comment a lot of the raw materials supply didn't put much investment in -- as the economy was down either the high cost stuff was taken out or no capacity was putting in so if you look at the supply chain of this whole thing there is a lot of pressure to increase it and as those capacities get tight our suppliers are trying to increase margins really unrelated to their cost structures which is atypical at this time of the cycle.

Yes. All right. Thank you.

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

Yes. Thanks very much. Strong quarter guys. I am Stephen Kim from Evercore if you are confused. I wanted to ask you about the startup cost. I know that you have talked a bit about it already but what's the start-up cost in 2Q and in the first part of this year and I am trying to understand whether or not the numbers that you gave or the 45 million for the year which was unchanged is that netted out of the productivity numbers, productivity numbers you are giving or is it a separate offset?

So first on your later part of the question start-up costs are not included in productivity there. And then if you look at how much we have incurred in the second quarter we have incurred about 6 million start-up cost and in the first quarter we incurred about $11 million start-up cost. And what was said at the total should be around 45 with more in the fourth quarter than in the third quarter.

Perfect. Yes that's very helpful and then Frank when you were going through all the puts and takes on the operating income did I hear you say the volume benefit for ceramic was 14 million and the total company was 13 million or did I hear that wrong?

Volume was 13 for the total company and yes ceramic was 14 correct.

So the difference there in – suggest there was no volume benefit in the other two categories or the other two segments just wondering if you could flash that out for us a little bit I mean with that because you had maybe some dysfunctionality somewhere can you just sort of talk a little bit about that?

I think what is causing to look strange like that Steve is the high fee that we lost with the higher margin.

Yes I know that would definitely do it and just one last thing in your prepared remarks I think you said that sales should strengthen in 3Q just wanted to make sure that we are on the same page on what that comment was referring to I assume that you meant that your growth rate which was about 5.6% on an organic basis would be higher in the back half of the year. Is that what you meant or did you mean something else?

What we meant was that we gave earlier direction we thought that the legacy business will grow 5.5% and in the first half they grow less than that and then in the second half we expect to make up the difference in the pieces plus the addition of the acquisition we made.

Okay. Got it. That's helpful. Appreciate it. Thanks very much guys.

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

Sure. On the target for legacy revenue growth Jeff that you just talked about why does the back half grow faster than the front half. What visibility do you have there in regards to either market trends or your market share?

Some of the new capacities businesses and products for moving in and we expect to get some advantages from those as we go through. And we expect to improve some of our businesses all different.

From an underlying demand standpoint what you observe in second quarter what are you observing with your customers, is that notably different in the second half across the business at any point?

I am not sure the general but the general business is better across the pieces we have new product launches and we are going into new product categories and we are doing things to expand our business in different places.

And then lastly in terms of pricing in the carpet business you picking some steps of how has that gone and a little bit more clarity on the flow through of that relative to catching up to the input cost or digging you out of the input cost hold that you had been in and what does that look like?

We have implemented two price increases the first was implemented. The second one is going in. some of it will be coming into the third quarter as we speak and the second quarter we offset all the cost increases but it was using some of the mix improvement that we’ve done to get it and so the industry is pushing through the price increases we need to cover the cost.

Okay. That's helpful. Thank you.

Your last question comes from the line of Michael Dahl from Barclays Capital. Your line is open.

Thanks for fitting me in. couple of follow-ups here. A lot of comments or questions around the startup cost and some of the productivity I guess just thinking about heading into next year Frank you have noted that start-up cost are going to remain elevated but if I think about the productivity side and how it should be tied to basically your CapEx budget for that given the higher CapEx budget are we directionally is it fair to assume that productivity improvement should accelerate next year as well?

We have not put together all the budgets for next year and the pieces so I can't give you a rational answer on the question we are still focused on this year which roll in that half way through. All of the businesses are coming up with new ideas to increase the productivity and to bring new products to market and then we are trying to release any constrains on a business to all the assets. And we think those things are going to have long term positive profitability in our sales growth with all those things when you put it all this new equipment you have the lag time to optimizing the sales and optimizing this equipment so that's going to all be happening over the next 12 months as we try to bring all these things up and therefore from quarter to quarter I can't give you an exact piece but I can tell you a year from now will be much better shape.

Got it. And then going back to the some of the vertical integration, I appreciate that's always been a part of your business. Maybe if you could help us help refresh where are some areas if there are any large areas outstanding that you are not currently backwards integrated that if the right opportunity arises you would be interested in going that direction.

I think the biggest opportunities would be in our ceramic business and owning mines to support the raw materials in some places we have them and other places we don't and some cases that make sense and other doesn't. I guess most of the other businesses the board businesses which support laminate we buy raw materials from them when Europe was buying a lot more waste products to put in we are looking for ways of utilizing waste product surround like we do and polyester bonds in different places. So we are fairly well integrated but there is some places where we have old, and as they become available we might make changes like we did in the carpet business with nylon as it we were doing just final without it but there was an opportunity and we took advantage of.

Okay. Great. Thank you.

There are no further questions at this time. I will turn the call over to Mr. Lorberbaum.

Thank you for joining us. The company is in a very strong position and the organization is generating a lot of ideas to grow both internally and externally, introduce the products and expand in our geographies. We think all of these things will help our business long term and we are putting in place to optimize the return to our shareholders. Thank you very much for joining our second quarter call.

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