Mohawk Industries, Inc. (MHK) Q1 2018 Earnings Report, Transcript and Summary

Good morning. My name is Erin and I will be your conference operator today. At this time, I would like to welcome everyone to the Mohawk Industries First Quarter 2018 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 27, 2018. Thank you. I would now like to introduce Frank Boykin. Mr. Boykin, you may begin your conference.

Thank you, Erin. Good morning, everyone, and welcome to Mohawk Industries' Quarterly Investors Conference Call. Today, we'll update you on the company's results for the first quarter of 2018 and provide guidance for the second quarter. I would 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. In the first quarter, we generated sales of $2.4 billion, up 9% over the prior year, with our businesses outside the U.S. growing faster and their stronger currencies benefiting translation. For the period, our adjusted operating income was $292 million or 12.1% of sales. Our adjusted EPS was $3.01, an increase of 11%. Mohawk is benefiting from its diverse geographic footprint and product portfolio. Our performance in the first quarter accentuated this strength, as we realized significant growth in LVT in our largest markets, and sales and profits grew strongly in our ceramic businesses outside the U.S. We are leveraging our global organization's strength to initiate manufacturing in new markets and extend our development of innovative products. Our global decentralized structure enables us to simultaneously manage numerous internal investments, while also executing new acquisitions. For the quarter, our operating income grew at a greater rate when adjusted for the loss of income from expired patents and higher start-up costs of new facilities and sales initiatives. In the first quarter, material and freight inflation increased more than we anticipated and impacted our costs. We are initiating selective pricing actions by product and region that, combined with improving mix and cost reductions, will offset expected inflation. Throughout the rest of the year, we anticipate higher growth rates in all segments, as we introduce new products, add capacity, implement price increases and complete acquisitions. Many of our operations are currently initiating new production, including Mexican, Italian and Russian ceramic, U.S. and European premium laminate, U.S. and European LVT, Italian porcelain slabs and European carpet tile. In addition, by the end of this year, we anticipate commencing production of quartz countertops in the U.S. and sheet vinyl in Russia, as well as expanding polyester carpet in the U.S.; ceramic in Poland; and laminate and ceramic wall tile in Russia. We anticipate finalizing the acquisition of Godfrey Hirst as early as the end of May, adding the largest flooring producer in Australia and New Zealand to our global portfolio. To prepare for the integration, we are assessing the sales, product and raw material strategies of Mohawk and Godfrey Hirst in the markets to optimize revenue and profits. Long term, our investments in new products and markets around the world will significantly enhance our profitability. Some of the projects will require significant onetime cost to start up the assets and build sales before higher utilization rates will deliver the margins and income we anticipate. This contrasts with acquisitions such as Godfrey Hirst, but we are investing about $450 million and we'll see an immediate increase in our annual EPS of $0.35 to $0.40 per share. In the U.S., strong job creation and continuing wage growth is supporting our ongoing economic expansion. A strong March retail report suggests that recent tax reductions are translating to increased consumer spending. The National Association of Home Builders reported that March housing starts rose 11% year-over-year. And the organization is predicting single family home growth escalating with higher construction. Harvard's Joint Center for Housing study predicts stronger remodeling gains spurred by increased home values, low rates for home improvement loans and high consumer confidence. The American Institute of Architects' index remains positive, projecting higher nonresidential spending as reduced corporate taxes encourage new construction and renovation projects. Outside the United States, continued economic growth is forecasted for the European Union as interest rates remain low. Business investment increases and employment improves. In Mexico, the economy was sluggish during the first quarter and is predicted to strengthen going forward. The Russian economy remains challenging amid political uncertainty. Now, Chris Wellborn, our Chief Operating Officer, will review our first quarter performance by segment. Chris?

Thank you, Jeff. In the quarter, our Global Ceramic sales increased 12% as reported, with greater sales growth outside the U.S. First quarter sales sequentially improved and we anticipate increased growth throughout the balance of the year, supported by greater capacity and new product introductions. We are implementing sales actions to increase our customer base and market share in both the residential and commercial sectors. Our two acquisitions in Italy and Poland are progressing as planned as we integrate their operations and expand their product offering. Our North American ceramic business improved from the prior period as we introduced new products, increased promotional activities, and the home center channel improved. Our business is stronger in the Southern and Western U.S. for new home construction is expanding faster. Our home center customers are focusing more on ceramic and increasing product commitments to enhance their sales. Increased sales in the builder and home center channels are impacting our overall product mix. As our distributors consolidated operations, they have made inventory adjustments that have temporarily reduced our sales. We are aggressively pursuing new commercial projects with retail hospitality and healthcare sectors the strongest. In the U.S., LVT is being utilized more broadly and is impacting the industry growth rate of ceramic and other products. We are taking many actions to increase our ceramic share, including launching innovative slip resistant tile, introducing higher styled designs in all price points and marketing ceramic's durability and ease of care to consumers. During the second quarter, we are leveraging our recently implemented systems to cut our overhead costs by $5 million on an annual basis. Our new service center and countertop distribution are ramping up and will enhance our results as sales increase. Our countertop growth is increasing with quartz products taking share from natural stone. The building of our new quartz plant is nearing completion and equipment installation should begin this quarter. We are finalizing material formulations and designs to begin production at the end of this year. We're also introducing porcelain slabs made by our Italian operations for countertops as well as offering large sizes for flooring and walls. Specifications for these products are increasing as designers are inspired by the beauty of natural stone in large sizes with the value and easy care of porcelain. Our sales in Mexico grew during the period, significantly outpacing the ceramic market. The increased new capabilities of our Salamanca plant are allowing us to expand our customer base across Mexico and grow exports to Central and South America. We are introducing new higher-end collections on top of increasing our participation in medium and value-oriented price points. Over time, our product mix will improve and expand our margins in Mexico. The European ceramic business continues to integrate our recent acquisitions in Italy and Poland. Our product mix is improving as we capture a larger share of the premium market. And our new product launches will increase our average price. To grow our sales in the retail channel, we are adding about 100 Marazzi-branded shops within our leading customers this year. We're developing regional manufacturing strategies to optimize production, for transportation significantly impacts our costs. Since completing the upgrade of our color body porcelain - color body manufacturing, sales of our higher-end commercial products are increasing. And we are expanding our specified sales-force to increase our participation in the new construction channel. Our new porcelain slab production started in first quarter, providing industry leading visuals and performance features in sizes up to 5.5 by 11 feet. Building construction has commenced in Poland to install the production line that is being transferred from our Italian operations. It will be operational in the third quarter, so that we can expand our offering and better satisfy the Central European market. In Bulgaria, we have upgraded equipment to produce 48-inch tiles giving us a competitive advantage in the market. The productivity of our European ceramic operations is improving and we have dramatically enhanced the safety performance of our plants. We are upgrading our warehouse management and transportation system to increase our efficiencies and lower our costs. With the integration of our new businesses and consolidation of our systems, we reduce our overhead by $4 million by the end of the third quarter. We will complete the integration of all of our European ceramic systems by the end of 2019. In Russia, our investments in product, distribution and branded retail stores along with enhancements of our organization and systems have created a significant competitive advantage. We continue to grow our leading market position in a challenging economic environment. At the recent Russian national tradeshow, we further expanded our high styled offerings, reinforcing our position as the design leader with the broadest array of sophisticated collections. We're starting at new porcelain capacity this quarter, and by the end of the year we will convert part of our commodity flooring production to higher value wall tile to enhance our mix. In the first quarter, our Flooring North America sales were $950 million, increasing 1% with adjusted margin of 10%, including the startup for our new LVT line. During the period, we implemented the carpet price increase, we announced last year. In the first period, our raw materials and freight cost escalated more than we had anticipated. We announced another carpet price increase of 6% to 7% to cover inflation, along with the freight increase and the industry has supported it. Bitterly cold weather disrupted the energy supply to some of our plants resulting in lower output and higher cost. Our residential carpet sales increased during the quarter led by the retail replacement channel. Our SmartStrand Silk Reserve collection extends the success of the premium super soft carpet we pioneered, and our luxury Karastan line is accelerating from trendsetting designs and luxurious cashmere nylon introductions. We are gaining sales momentum with our proprietary Air.o unified soft flooring due to its luxurious feel, hypoallergenic properties and ease of installation. Our patented Continuum polyester carpets are growing as a value alternative, and we are expanding our capacity late this year to satisfy higher demand. In mainstream commercial we have introduced a new carpet tile technology called ECO-MATRIX [ph], which is more versatile for installation on a variety of subfloors. These nylon and polyester products are styled to coordinate with our LVT collections. Our commercial carpet sales during the period were impacted by the late construction dates and the substitution of LVT on projects. Projects bookings improved sequentially through the period and have continued to strengthen in April. We have realigned our commercial sales structure so that we can provide greater expertise with complete flooring solutions for each end use market. We are driving commercial design trends through complementary soft and hard surface collections that provide style and performance advantages. The hospitality sector was our strongest channel and our Divinity collections are growing as an alternative to premium woven wool products. LVT sales continue to expand in both residential and commercial, to support our increasing manufacturing capabilities, we are expanding our collections of both flexible and rigid LVT. We are upgrading our original LVT manufacturing line to increase its output and product features. The new rigid LVT production line, we'll be commissioning during the second quarter following the launch of identical line in Europe. We have begun training personnel, refining operational processes and developing new products for the market. Our new laminate production is working well and has unique capabilities to make products indistinguishable from natural wood with superior visuals and performance. Our revolutionary RevWood Plus, a new water-proof wood product, is rapidly gaining acceptance with longer planks and contemporary finishes. Our investments in new technologies and automation are enhancing our service levels and cost structures. By the end of the second quarter, we will cut administrative and indirect costs by a $20 million run rate. We continue to initiate hundreds of productivity projects to improve our efficiencies, quality and service due to limited common carrier capacity, we are purchasing additional trucks to expand our transportation fleet to provide higher levels of service. During this quarter, our Flooring Rest of World segment performed extremely well, with sales growing 18% and adjusting - adjusted operating income up 19%. The European market continues to do well, and the operating income of our ongoing business is up substantially on a local basis. LVT is the fastest growing product in the segment even though sales were constrained by our capacity during the period. We are starting new LVT and laminate production in Belgium, and we are launching new carpet tile and rigid LVT products. The price increases we implemented last fall are covering raw material increases from 2017, and we are selectively increasing prices to offset further inflation. Our mix, volume and pricing are increasing our margins in most categories. LVT in Europe is growing in acceptance, and we are the market leader. Our new production line is operating five days a week, as we refine our manufacturing processes. The line is presently producing existing products to satisfy growing demand. Through testing, we've validated the capability of our new technology to manufacture rigid LVT with enhanced performance and innovative features. We anticipate introducing new products during the second quarter and ramping up production just seven days a week by the end of the third quarter. All the equipment and process enhancements are being replicated in the U.S. to shorten the startup process. Our sheet vinyl assets in Europe are running at capacity, and we are seeing the Russian market to build demand for our new plant. The renovation of the building in Russia is progressing and equipment installation should be completed in the fourth quarter to initiate production. Our sales organization is collaborating with major Russian customers to develop new products and programs to utilize our new productions. At our new carpet tile facility, we are running trials to establish operating procedures and refined new products. We're in the process of assembling and experience commercial sales force to expand our sales of LVT, sheet vinyl and carpet tile across Europe. Our laminate business continues to perform well with our new product innovations improving our results. We lead the premium market in realistic design and water resistant products. Our new laminate press capacity is now operating, and we are introducing additional premium products to extend our market leadership. In our Russian laminate plant, we are installing a new line that will double our capacity in the third quarter. We are developing new sales and warehousing strategies in Russia to optimize the distribution of our laminate and sheet vinyl production across the country. Our wood panel sales are performing well as a result of investments that expanded capacity and improved our costs. Our insulation business is recovering as raw material supply increases and costs moderate. We anticipate insulation sales improving, as declining material cost allow us to be more competitive with other product alternatives as we progress through the year. The Godfrey Hirst acquisition is progressing as we expected along with our other smaller acquisitions in the segment. Plans are being executed to integrate and optimize the performance of all these acquisitions. I'll now turn the call over to Frank, who will cover our financial performance for the first quarter.

Thank you, Chris. Net sales for the quarter were $2,412 million, growing 9% over last year, of which 4% was from currency and 2% from acquisitions. Our gross margin as reported 29.2% or 29.9% excluding charges with price, mix, productivity, currency and volume all offsetting inflation and lower IP. SG&A as reported was $436 million or 18.1% of sales, with 17.8% of sales excluding charges, which improved 40 basis points over last year. As we leverage our cost against higher sales and continued to control costs. Unusual charges for the quarter were $23 million, and primarily related to plant consolidation and integration of acquisitions across all three segments. Our operating income excluding charges was $292 million, up 5% over last year with a margin of 12.1%. Price mix of $38 million and productivity of $31 million offset inflation of $52 million. Our operating income was up significantly when adjusted for incremental startup cost of $9 million, patents that expired in 2017 and higher depreciation from our increased investments. The income tax rate improved to 20% from 25.6%, as the 2017 tax reform drove the overall rates down. We estimate our second quarter rate to be between 20% and 21%. Earnings per share excluding charges, was $3.01, an increase of 11% over last year. Turning to the segments. The Global Ceramic Segment had sales of $877 million growing 12%, of which 6% was from acquisitions and 4% from currency. Our operating income, excluding charges, at $117 million with margin of 13.3%. Productivity of $14 million and volume of $11 million, offset $13 million of inflation and $7 million of price mix decline. In the Flooring North American Segment, sales were $950 million compared to $939 million in 2017 with good growth in residential carpet and LVT. Our operating income excluding charges was $91 million compared to $94 million of operating income last year. Price mix of $14 million and productivity of $13 million, offset inflation of $25 million. In the Flooring Rest of World Segment, sales were $585 million with solid growth of 18% over last year, 14% of the growth was attributable to currency gains. We had strong growth that continued in LVT as our leadership position in that category advantages us over our competitors. Operating income excluding charges was $93 million and increased 19% over last year. Price mix of $31 million, currency of $6 million and productivity of $4 million, offset inflation of $14 million along with lower IP income. In the Corporate and Eliminations segment, the operating loss was $9 million, and we expect the segment loss to range between $35 million and $45 million for the full year. Jumping to the balance sheet. Receivables ended the quarter to $1,690 million with days sales outstanding of 56 days. Inventories were $2,045 million with inventory days at 116 days, which improved over the fourth quarter. Inventory turns continue to be impacted by increasing inflation and our backwards integration. Fixed assets ended quarter at $4,461 million. Our first quarter capital expenditures was $251 million with D&A of $123 million. We're estimating CapEx for 2018 of approximately $750 million with depreciation and amortization of about $525 million, which exceeds last year by $75 million. Long-term debt ended the quarter at $2.9 billion with leverage at 1.5 times debt-to-EBITDA. And with that, I'll turn the call back over to Jeff. Jeff?

Thank you, Frank. Around the globe, we are starting up a number of large investments that will significantly enhance our long-term results by expanding existing sales, adding product categories and entering new markets. As anticipated this year, we'll have non-reoccurring reduction and operating income of $70 million to $75 million, comprised of $30 million to $35 million from higher startup costs, $40 million from patented expired in 2017. In 2018, incremental depreciation of $75 million will curtail our operating margins until our sales reach a level to fully absorb these investments. Changes in the U.S. tax law will reduce our adjusted tax rate from 26% last year to an estimated 21% this year. Taking all of this into account our EPS guidance for the second quarter is $3.89 to $3.98, excluding any one-time charges. During the balance of 2018, our sales growth should improve as we increase the use of our new production, introduce additional products and complete the acquisition of Godfrey Hirst. We estimate that Godfrey Hirst acquisition will close by the end of May and will increase revenue by $180 million and EPS by $0.25 per share this year. In the third quarter, higher prices, mix and productivity should increase our adjusted operating income above last year, even with the lower margin. In the fourth quarter, our adjusted operating income and margin should exceed 2017, as the impact from startups and patent decline. We are confident that our new investments will create significant opportunities, with potential to have equal or greater profitability than our present businesses. We are adding $500 million of LVT with huge growth potential; $400 million of new product categories or geographies, including countertops, sheet vinyl and carpet tile; and $500 million of new capacity in constrained areas including ceramic outside the United States, laminate with new capabilities and polyester carpet. With the strength of our organization, we can execute additional acquisitions if appropriate risk and return can be achieved. The market is focused on the next two quarters, where we are absorbing material increases, startup and IT expiration. And overlooking the significant impact of our actions, we'll have on our sales and profitability in 2019 and beyond. Our management, cash generation and balance sheet will enable us to continue our aggressive growth strategies. We'll now be glad to take your questions.

[Operator Instructions] Your first question comes from the line of Michael Wood from Nomura Instinet.

Hi, good afternoon. Thanks for taking my question. First question on ceramics, the price mix decline that you called out, how much of that was from the distribution and retail mix shift? And can you just give us some color as to whether or not that's temporary or does it bleed over into second quarter and beyond?

Our product mix declined in the U.S. due to higher sales in home centers and builders, as well as increasing promotions. We had incremental startup cost of $3 million from our new quartz plant. We're introducing higher styled products and reducing our annual fixed cost by $9 million. And sales and margins outside the U.S. are strong.

But, yeah, can you just elaborate on whether or not that negative mix shift that you called out, is that a one quarter temporary issue or does it continue?

It continues.

Okay, got it. At a high level, looking at your guidance for second quarter, the earnings growth is lower than what you actually achieved in first quarter. Now, I would have thought we would have seen some headwinds start to fade like the UNILIN patent, startup cost. And you would have time for price recovery. So could you just give some color in terms of what's offsetting some of those headwinds that may be starting to fade in 2Q that's limiting that earnings growth?

Your assumptions that they are fading are wrong. The IP continues as a big decline. The startup costs grow in the second quarter. And what else - and the material inflation is getting impacted. And we've hardly - and we haven't got any price increase at all. And we won't start getting price increase till the end of the second quarter and then into the third quarter.

Okay, that's very helpful color. Thank you.

The other thing I would point out to there, remember we got incremental depreciation of $75 million this year spread across all four quarters.

Our second question comes from the line of Michael Rehaut from JP Morgan.

Hello.

You may go ahead with your question.

Maybe we should go to the…

Got to the next one.

Let's go to the next one.

Our next question comes from the line of Matthew Bouley from Barclays.

Hi. Thank you for taking my questions. I wanted to follow up on Jeff, what you kind of quantified at the end of your prepared remarks. You've separated out some of the capacity that's currently initiating production and ramping, and then the several areas that are set to commence. And it sounded like you quantified $1.3 billion across some of the new capacity. So are you able to just kind of separate out, where you are on the utilization of the plants you have that are currently ramping, as well as the outlook for the timing of that new capacity that you've mentioned will be opening during this year? Thank you.

The problem is there are about 20 different activities going on. The activities range from starting up new plants that was never operated before and have no sales which will take long periods of time to get them ramped up. It could be sheet vinyl in Russia or carpet tile in Europe. And those are startup projects from ground up, with no sales and marketing to begin with. And then we have other projects that we have significant sales already that will be added to, those will come up different. And then you have no new plants such as quartz countertops. We haven't manufactured before, but we've assembled experts from around the world. We have LVT product lines that haven't been run before, they're starting up. So I mean trying to get down to a month by month and quarter by quarter doesn't really make any sense.

Understood, that's helpful. So, I guess, on the new LVT line specifically and, obviously, you've highlighted that LVT is taking share across categories here including ceramic in the U.S. Are you able to kind of outline how your margin profile differs between the U.S. ceramic business and the U.S. or the new lines on the U.S. LVT business? Just trying to think about how that margin profile will shift as you do ramp on these new facilities here. Thank you.

In the remarks, we were trying to say that our expectations for the total of all these should be equal or greater than our business average in the margins and profitability. And they're going to be different from one to the other, as well as what part - where they are within the startup strategy over time.

Understood. Thank you very much.

Our next question comes from the line of Susan Maklari from Credit Suisse.

Thank you. Good morning.

Good morning.

The first question is around, you made a comment in your opening remarks on some efforts to increase your customer base in Global Ceramic. Can you just give us a little bit more color there on what you're doing in any specific geographies within that?

Well, we're doing things in all geographies. We're introducing new slip-resistant tiles and large sized commercial projects. We're expanding our builder and commercial distribution. We're increasing our sales in home centers in Mexico and South America. We're ramping up new tile and stone centers. And we will soon begin manufacturing quartz countertops with the opportunity to become a leader in the category.

Okay. Thank you. And then second question is just on the productivity. It sounds like you're off to a pretty decent start there. Any updates on that as we're now past the first quarter how we should be thinking about it for the year?

I think we said the last time that the productivity would approximate 140 and with some of the niche - the new initiatives, we're thinking it's going to be a little higher, but some of the benefits that you don't all get in this year.

Okay. So still around 140 for this year, but potentially higher as we exit the year. Is that how we should think about it?

I think it will be for the full year a little bit higher than the 140, and then we'll have some projects like Jeff was saying that start this year. And then you get part of the benefit this year and part of the benefit next year.

All right, all right. Thank you.

Our next question comes from the line of Keith Hughes from SunTrust.

Thank you. The $52 million you gave on inflation impact for the quarter. I just want to confirm that includes transportation costs. And do you expect a similar number for the next quarter or two, based on where…

The inflation does include transportation. And inflation is a moving target and it's hard to say what the number is going to be as we look down the road. And it's…

Okay. And…

Any kind of estimate we got is - any kind of guess we got that is built into our estimates right now.

Okay. And on the negative price mix and ceramic that you listed out, can you break down how much of that was price, how much of that was mix? Hello.

No.

Hello.

We don't have that, because the introductions of our different products in different categories, it's difficult to separate it into specific things and the estimates become so large it doesn't make sense to try to separate it.

Okay. Is that something that - I know you talked pretty possibly in the release about the new introductions that are going to be coming in, the new capacity coming in. That seems like that's something that would turn around given the history of ceramics. Is that your view for the year?

Yeah, what we have is LVT is impacting our business in North America. And we also had the higher freight and startup costs. Our ceramic business grew in all regions. And in North America, we increased our share in that new home construction and home centers. We're launching new products and reducing our costs, which will improve our margins going forward.

We were trying to get across in the statements that when we put out introductions, we know the margins of those relative to our average. So our - the average into - the introductions are at higher points, which we assume as we push those in the marketplace will help offset part of it.

Okay. Great. Thank you.

Our next question comes from the line of Stephen East from Wells Fargo.

Thank you, and good morning, guys. Just to follow up on the raw materials. Frank, could you maybe rank order which raw materials where you're seeing the biggest impact including transportation if that's a big one? And then, as you look at - are you seeing some ongoing escalation of any of those or do you think the pricing that you're putting through now is going to cover what you see as you move through the year?

Let's see if I can sort of get you directionally. The chemical costs are the biggest parts in the materials and the ones that use chemicals to go into them would have the highest one, which are carpet and vinyl. Now, it doesn't mean that the other ones aren't there. But those have much higher percentages of chemicals then, let's say laminate, which just the top is affected. And in the freight rates, the United States - it's the freight rates in the United States, there are all kinds of things going on with the transportation, because capacity was tight to begin with. The regulations that they put through reduce the capacity even further, with the regulatory changes. And with that we're also investing more in our own trucking fleet to take a higher percentage of it with all those going on.

Okay. All right, that's helpful to me. And then, if you look at your ceramic in North America, you gave a lot of examples of what was driving your business. Your core sales were up 2% and 1%. Where are you seeing the offsets in your business that you probably need to redouble your efforts on those two categories?

Well, again, LVT is taking a portion of the market. And what we've done is increased our share of the new home construction and home center business. The biggest impact right now is in the re-modeling business in the retail stores, but it's growing - I don't know - it's growing in all the parts. The good news is that we have huge capacities coming on. We're introducing new products to participate in the LVT. And we'll maintain or grow our shares in the other categories.

Okay. So retail is where you think you're seeing the biggest. I wouldn't call it disruption, but…

I don't want to - it also goes into all kinds of commercial installations. I mean. LVT in the United States is not like any other part of the world. It's probably approaching almost 15% of the industry. And we haven't seen anything do this since carpet in the 60s.

Okay, all right. Thank you. I appreciate it.

Our next question comes from the line of John Baugh from Stifel.

Thank you. Good morning. I wondered about the comment that ceramic improved in the first quarter sequentially. Was that a March quarter to December quarter comment or was that January through March as well?

The comment was from fourth quarter last year compared to first quarter, the rate of growth improved.

Okay. And then - and this is a question that maybe is U.S. focused, and not just ceramic, but overall. We heard about a tough start to the year in January and February. But we've heard that business in general has picked up in March and April in the U.S. again. Have you seen that yourselves, any color there and Chris you walk through a whole bunch of things, you're doing in ceramic domestically, and of course, there was some noise last year with the home centers. I'm just curious, if you can give any color, I don't know, on the progression you see in U.S. ceramic sales as we go through 2018 and/or into 2019? Thank you.

I would say also that the first part of the year, when it started, it started off a little slower than we had expected. But we're presently still with the same estimate of 3% to 4% growth for the industry for this year is our best estimate at this time.

Yeah, I'd also add besides just the impact from LVT that we're doing a lot of new things in the U.S. with this slip resistant products, with the quartz coming on, so we have a lot of areas where we can grow our business.

Great. Thank you and good luck.

Our next question comes from the line of Phil Ng from Jefferies.

Hey, guys. As we look at 2019, appreciating that your IP earnings and the headwind from the startup costs should start reversing. Can you talk about how you're positioned on a productivity standpoint? And you get back each on track to delivering the type of operating leverage we've seen in your business in the past?

What you should see is, as you said, the IP changes should be behind us. The startup costs, we haven't put a plan together for next year, so I can't tell you what it's going to be. But the startup costs should be down with $35 million more this year than we were last year, and last year was probably the highest on record. So we would expect it to come down assuming we don't come up with more new projects, but I don't know that yet. The same time this year not in the startup costs, is that once the plant gets turned on and turned over to the operational group. You get 100% of the depreciation even though you're running at limited amount. So as that ramps up, the cost will fall and allow us to expand the margins going forward, and all of those things will start happening next year and we should get a significant jump in all the pieces.

Okay. That's helpful. And then Jeff, I think last call you mentioned, you're seeing good operating and deploy your capital internally and M&A. But given the big pullback in your stock here, can give us a sense how you're thinking about that? And we would certainly agree with the market being a little more too focused about some of the near-term headwinds you're seeing? Thanks.

We believe that our business isn't doing really well. We are - our cash flow is significant, and we believe that - you can see this year, we've announced acquisitions, we've announced significant spending on capital. And by the time, we get to the end of the year we hope to find more new projects for the future. There's always companies who want to sell. The question is not if there's companies wanting to sell. The question is can we find the right valuations, and we have the right things, we can do to help it. So we get the returns on it. As we go forward, we still have the capability of our management to execute multiple acquisitions at the same time, and we're always looking. And we don't see any limitations in our ability to continue growing our business and all the categories. And at the same time, you see as this year we're doing more Greenfield operations, and I would consider more of them in the future in addition, if all of things come together and we can find the right investments. At some point, we would be quite comfortable buying our own stock back.

Okay. Thank you.

Our next question comes from the line of Scott Rednor from Zelman Associates.

Hi, good morning. Jeff, in the Rest of the World business it's very hard for us to see kind of what the underlying growth rates are just given the patent headwind and various other things. It sounds like in Europe, the LVT markets growing double digits. Do you guys think, you're getting your fair share of that in the international scheme?

LVT is really primarily a U.S. business, and it's starting - in Europe, it's probably three, four years behind could be more. Out of that, we have the largest participation in it and we intend to grow the most in it, we believe that our strategy unlike others, of having low-cost, high-volume capacity gives us competitive advantages in both marketplaces and with best position in Europe than anybody.

So I guess more broadly recognizing that you went through the shift from soft surface to hard surface prior to last housing cycle and margins today are significantly higher. I think you alluded to this as the largest shift from - towards LVT from other products. How do you leave investors confident that you can leverage your current assets to continue to drive margins higher over the next three to five years?

So - at the moment, it's a U.S. question, because you don't have the same growth in LVT. But to start with, we have over $ 1 billion, we'll get through not long of LVT capacity. And as the market will absorb it, we'll keep growing the capacity further. So we're well positioned and where it's going. In the existing assets and businesses, I think that we have the premium positions in the categories. We have low cost market, but production assets. And whatever the competition is going to be, we're going to get our fair share or more.

Okay. Our next question comes from the line of Laura Champine from Loop Capital Markets.

Good morning. So you mentioned that LVT is growing very rapidly to 15% of the industry. And my question is, whether or not you see that once your capacity is fully ramped out, what you've got planned anyway. Do you think that your Flooring North America Segment will also be 50% or more devoted to LVT? Or will you still under index here?

Listen, I'd like to have more, is it. There is no constraints on our ability to expand capacity. So it takes - now with where we are, probably it takes a little over a year to execute it. So we'll go for four, five months, and see what happens. And if we see we're going to be able to grow up further, there's nothing that's stopping us from keep going on capacity in the United States.

But more directly, Jeff, once you're fully ramped on all the LVT capacity, you've got planned approximately what percent of your total North American Flooring capacity will that represent?

I don't know that off the top of my head. I don't even know my present North American capacity is off the top of my head with all these businesses. It will be - I would guess it's still going to be less than our market share of everything else of the average. We have much higher market shares in the other pieces, is it. Now, what's happened is we made a conscious decision to hold up going after the marketplace as aggressively. Our sourcing some, but almost everybody else is sourcing almost everything they're buying from China. So we made a decision to put in capacity and we didn't want to spend all the marketing cost and then throw it out six, nine months later. So it's held us up a little bit from being as far along as we would like. But I believe that we're going to be the best position in the marketplace, when we get through, and we'll keep growing it as the market will accept it.

Understood. Thank you.

Our next question comes from the line of John Lovallo from Bank of America.

Hey, guys, thank you for taking my questions. The first one is, you mentioned that most of the - or a lot of the raw material inflation is in carpet and vinyl. Just curious, are there opportunities in your recycling business to step up that to be a bigger positive impact.

We're running all of our recycling pieces that capacity, so it's hard to push much more through it. We have announced to put an investment in this year that will be running the end of the year to increase our recycling and extrusion capacity relative to that, we'll be running in, and I don't know if it's the third or fourth quarter, is it. So we're expanding it, but we're utilizing all that we have presented.

Okay. That's helpful. And then, I guess the follow up would be can you just remind us what freight is as a percentage of your COGS in North America?

Anybody know the answer?

Low to mid-single digits as a percent.

The problem is, it's really different based on product and pieces you go through, so I don't really know what the number is off the top of my head.

And I think that percentages is not a cost of goods, but of sales I just gave you there.

Low-single-digit?

Yeah. Low to mid.

Low to mid. Okay. Thanks, guys.

But it's different by products ceramics higher than others. Carpet is - you go into different distribution channels, they pick it up and we don't have anything to do with it. So everyone is different.

Got it. Thank you.

Our next question comes from the line of Tim Wojs from Baird.

Hey, guys, good morning. Maybe just a following up on that last question. Frank, I guess, specifically in ceramic, when you think about freight. Is there an ability to put through any sort of freight surcharges? Or have you done that? I'm curious just how you can maybe offset some of that inflation on the freight side?

We already do that. We have surcharges on it that we move up and down with the freight costs trying to recover it, as we go through. But it depends on the market conditions and where you are. Sometimes, we recover all, and sometimes, we recover less.

Do you feel like you're recovering more of it today?

It depends by product category and region. I have to give you different answers. It depends on the competitive situation in each product, in each market of where it's going. But we try to recover all of it back. In some cases, we can get more and in some cases we get less, and we hope it all works out.

Okay. Fair enough. And then just maybe in carpet, have you guys seen any changing competitive dynamics at all just within the carpet business. I know, you guys have put through a fair amount of pricing offset raw materials. So just any sort of resistance from customers or anything like that, any color there would be helpful.

I haven't met a customer yet that likes to pay more for anything. What happened to it all, but we're trying to align the raw materials with our cost better and the increases. So we started in the fourth quarter, we saw it coming. But we underestimated dramatically what was going to happen. We announced an increase, the rest of the industry followed. We got into the first quarter and we saw getting worse. We announced another increase, the industry followed. So we're all acting rationally.

Our next question comes from the line of the David MacGregor from Longbow Research.

Yes, good morning, everyone. Just to pick-up on the discussion on LVT. I guess, as you ramp the LVT plants, how much more profitable is the manufactured product versus the sourced product?

We aren't really looking at - we weren't able to compete with sourced products. And - we're using sourced to either give us products that are slightly different from where we are once we get it up or to act as buffers as the business changes, and we need more capacity as we go through. We made a conscious choice, as I said before, we're lagging the industry a little bit, we started from a low base. And we're lagging, because we postponed the aggressive introductions. But starting about last - the end of last year, we're moving into every market and every product category as fast as we can go to use up all this capacity that we're putting in.

Right. But as you bring up that manufacturing capacity, you substitute that out for the sourced product, the unit margin should be up. Shouldn't it? Is that 20%, 30% lift? I'm just trying to get a sense of what that might be?

I don't know. We're not going to get that granular detail I can just tell you that we can be competitive with whatever we need to be.

Okay. Is that - the second line, it becomes more fully ramped, how will you mix between residential and commercial?

I'm not sure, we're starting out with a preconceived idea. The - typically, commercial is lower run sizes and lower units. But higher margins in the residential is higher volume at lower margins. And then you have with the product category, rigid LVT, which is what the new plan is going to do, is growing at the top end, and it's a limited portion of the commercial business. So we'll just have to manage the assets to whatever the customers want. Our new facilities will make any other product types that customers desire, and we'll just balance it between them as they go forward and we'll optimize - once we– if we ever get - if we get to a point where we're constrained. We hope to either put more in, or we'll manage the mix based on what makes the most sense for our business and operations.

Okay. Thanks very much.

And our next question comes from the line of Eric Bosshard from Cleveland Research.

Hi. Two questions for you. First of all on the U.S. ceramic business, last quarter you talked about, I think, North America was down but improved through the quarter. Could you just give us perspective on the U.S. ceramic growth rate in the quarter, and how it performed in the quarter?

Well, we improved our growth rate in the quarter as we took more business in new home construction and home centers.

So it improved as we went through the quarter.

Is it still down? Or is the business now growing in total here on a year-over-year basis?

The business is up. It's not up as much as I'd like it to be, though.

Okay.

Our ceramic business grew in all regions.

Okay, great. Thank you, Chris. The - secondly on - Jeff in terms of the LVT business, I'm curious your thoughts on how the category is evolving in two areas: one in terms of the changing designs of the product; and then secondly the import capacity that's been added. I'm curious how you view those two dynamics influencing the LVT effort of yours in the U.S.?

You have to start from that up to now, the category is growing so rapidly, I mean, it's absorbing anything and everything, is it. There's more capacity coming on in China to support it, which is where most of its coming. As you'd expect, as things mature, the prices are getting a little lower in some cases depending upon the product category. And the designing, everybody keeps coming up with different designs to do differently. And in anything that's in this stage you have a lot of innovation going on both in materials, product types, designing across the board, and it's all part of the maturing process. The question is, how big - as the base gets bigger, what rates are going to grow and when is it going to peak out, and I have no idea.

Related to that, as you think about your opportunity the capacity you're adding, will there be a third and a fourth U.S. facility, and when would that happen? How do you think about, I know you commented on this earlier, but how do you think about the timing and opportunity in regards to that?

Depending upon what we see over the next three to six months, we could make a decision to put more in.

Okay, great. Thank you.

Our next question comes from the line of the Alvaro Lacayo from Gabelli.

Good morning. I just have a question regarding the pricing actions that have already been taken. If you could maybe comment on just price realization and has it met expectations? And maybe if you could provide some conjecture in terms of product categories, where you're seeing better realization than others? And then on the comment regarding industry rationalization everybody increasing price would that include product that's being imported and how does that impact your ability to realize price going forward?

So the major part of the price increases, we've been talking about is around carpet, which has had the biggest impact. And the carpet price increases, we've announced the increase and they're going up. We hope to have most of them in place in the third quarter to help offsetting - offset it. The price increases in vinyl with the increase in the LVT that's going on and the capacities that are coming in, there's a reduction in price rather than increase going on in pricing in it.

Thank you. And then with regards just to the capacity that's coming online this year, I mean, over the last year that $1.4 billion has been the number that you guys have talked about, and it seems like most of that capacity will be coming online at some point during this year. It also seems like you're interested in continuing high levels of capital expenditures. But I'm just wondering with all this capacity that's coming online now, what are the CapEx plans beyond 2018, considering that at this point you're probably have some time to go before you could absorb demand with all the new capacity that's coming online.

If I had to give you my best guess now, which is it has no value, is that I would assume that the capital expenditures would decline next year, because we won't need all this new capacity, unless we can come up with new projects, new greenfield things. And at the same time, when we do acquisitions, when we buy the business, typically we try to figure out ways to make them better than they were before we got them. And it's not unusual to significantly invest in either upgrading the assets or putting them into new product innovations or pieces, so it's not unusual that we buy something. We'll put $50 million in it without even thinking to help it get to the next start. So it all depends on all those things as we go through it.

Okay. Thank you very much.

Our next question comes from the line of Michael Rehaut from JP Morgan.

Thanks. Good afternoon now. Thanks for taking my question, and sorry about the earlier phone issues. I wanted to circle back and maybe ask the CapEx question from a different perspective. If you look back at the last cycle, your Cap Ex as a percent of sales was pretty consistent around a 2% to 3% of sales type of average. And obviously, in the last five years it's been more in the high single digits as a percentage of sales. So kind of asked a different way and understand that, obviously, there's a lot of capacity expansion investment in the acquisitions and so forth. But from an industry structure standpoint, I was just curious if there's anything that's kind of changed in the industry or the way that you have to be competitive within the industry that requires a higher level of capital investment. Jeff, you just said that you would expect Cap Ex to maybe decline next year. But would it still be in something of a mid-single-digit percent of sales range, because it certainly appears very different than the last cycle in terms of the level of required investment.

Let's see the best way to try to answer it. Our assets are among the best in the industry in every category. We have low cost high efficient assets. And we're constantly looking to improve them from there to stay at the leading front business. Anything that we can do that makes economic sense, which gives us returns and paybacks, that meet our expectations, we will put on and continue doing, because we have the capital to do it. And it will enhance our performance both short-term and long-term. At the same time, we have a huge organization that can take on a lot of things. And if we can find new products such as quartz countertops in United States, such as sheet vinyl in Russia, such as carpet tile in Europe, I mean we're building new businesses from scratch as you go through. And I know sometimes from the outside it's a little uncomfortable, because you guys would like it predictable by quarter. These things that have our startups, you find things that happen good and bad. And you can't exactly get them. The customers aren't sitting there, waiting on you to show up. And you have to give them reasons and build relationships to do it. Now, in the long-term these things over five years will be much higher returns than anything I can do other than my internal investments that I turn on and start up almost immediately. So to answer the question is we have a huge cash flow that's growing. We have an organization that's creative and executes well. And if we can continue doing these things, these are what is going to allow us to grow our earnings and our share value higher than the market over time. And they all come back to return on investment and risk. And I don't know how to give you specifics. And the answer is, if we can find those opportunities and it makes sense and they have reasonable risks, we're going to use our capital to do them. And they will give you higher returns to me giving the money back to you.

Understood. And, again, we're just coming - I understand all the rationale behind the investment. But I was just curious from a - I guess from another angle, from a structural angle so. But I appreciate that, Jeff. That's helpful. I guess, secondly, just drilling down a little bit on the Global Ceramics segment, you highlighted that some of the year-over-year margin decline driven by a mix - increased mix towards home centers and builders. But just to focus on the home centers or kind of a two part. Number one, if you can give us a sense of how much mix accounted for the 150 bps year-over-year drop in margins. And in terms of the home centers, higher sales for the home centers for the ceramic business, if that's something that we should expect to continue over the next one to two years, I think for a long time you've talked about, if I recall correctly, being a little under indexed to that distribution channel, just any thoughts around that.

Let's see if I can get close to you. If the industry growth slows down, we have to go take share in the pieces that are growing the most. The builder channel has the most growth in it. And then, we're going to be more aggressive in all the pieces. Now, in - in the typically the specialty channel uses higher value stuff that's more differentiated, that's prettier than the other channels. So if we're selling more into the other channels it affects our product mix as we go through, as if. We manage the business based on utilizing the assets. And at the same time, we have to balance it with our margins, as if. I don't know if you know. When we go into recessions we change strategies and we start selling much lower value products. We go in and start taking in ceramic. I don't know if you know, about 50% or more of the industry is imported. So when things slow down, we go after the things where they make a home in it. And that's just to use the capacity and as we come out, we change the mix again. So we're just in this part where we anticipate it and growing more the whole industry, that LVT is taking it. And we're now readjusting our strategies to get more of what's left.

The other thing, Michael, I would add is that while LVT is impacting it in the U.S., when you get to markets like Mexico, where we're growing fast, Russia where we're growing fast, and even in Europe we've been able to improve our product mix, so the ceramic sector is a global business with a lot of levers.

And the impact on the mix, on the margin for the quarter?

Yeah, I think I had mentioned it earlier. It's about $7 million.

Right, so that's true. Thanks. Sorry about that. Great, thank you.

Our final question comes from the line of Stephen Kim from Evercore ISI.

Yeah, thanks very much, guys. I appreciate it. I just wanted to revisit the $1.4 billion number, Jeff, that you talked about. I mean, a year ago you were talking about a sales opportunity at $1.4 billion from planned capacity additions. At that point, it was off of the base of 2016 rev. Now, even though you're a bigger company than you were - have more sales than you had then, it sounds like you're still looking for another $1.4 billion in potential sales. Just want to confirm that this $1.4 billion is growth over what your annualized run rate of sales is right now. And also, if you didn't have all these capacity additions planned, do you still think you'd be able to grow sales 1% or 2% per year anyway even without those expansions?

I think what you're asking is, there's two parts. One is that the reason it is hard to talk about capacity is it's a moving target. So if you go back a year ago, I was putting in - a year ago we were ramping up a ceramic plant in the United States. That was in the number a year ago. And now this year that's off the list. The plant is running pretty good and that one has dropped off and something new has come on. So that number happens to be the same as a random event, as if.

Yeah.

If I can tell you. Second from that is, in the growth of the business all of this is - as you were right, all of this isn't going to be incremental. And at all points in time we have businesses increasing sales, business decreasing sales. And you have profits going up and down. So it's - 100% of this isn't going to fall to the bottom line but major parts of it are, as if. I mean, if you take the thing and just take our average EBITDA 20% times 1.5, you got $300 million of EBITDA if it all fell to the bottom. I'm not telling you it's all going to fall to the bottom. But the numbers are so big. I mean, I don't think the group is focusing on the opportunities that we're investing in. And if you look at it, the $1.4 billion - don't hold me to this. I think it might put it, just the incremental in capacity we're adding might be equal to with the top five or six flooring producers in the world.

Yeah. All right, I appreciate that. The second question I had related to the rest of world business, we saw kind of a noticeable slowdown in volume growth in 1Q. You had made some comments about laminate capacity sort of running full out. I was curious whether or not there was a particular thing you could highlight as to maybe why the volume growth was little slower this quarter. And in particular, it looks like if it was sort of a - if this run rate kind of thing continues, it looks like we might expect over tougher comps, maybe a negative volume number in rest of world volume. I just want to make sure that we understand that properly.

I can answer that. So our ongoing business had good growth with LVT and wood panels performing the best. Our LVT was constrained in the period and the new production will increase sales and add new products. Our investments in laminate, carpet tile, sheet vinyl will further enhance the business. So we have a lot of things that's going to improve it going forward.

And then the Godfrey Hirst acquisition is going to go under there also, as if.

Sure, sure. Yeah, I will talk about volume executing Godfrey Hirst. So, Chris, it would be your expectation that some of the things you just mentioned should elevate 2Q volumes.

Well, I don't know exactly by quarter. But I can tell you that the capacity we're adding in LVT is coming up, plus later on in the year we'll have these investments in laminate, carpet tile, sheet vinyl, all things that should increase the sales of the business over time.

And so, we don't think as narrow as you guys by month, as if. These things, you start setting them up and putting them in. I mean, it may be two or three months longer or it might be two or three months shorter than our plans. That's just part of the deal.

Yeah. All right, I appreciate that, guys. Thanks very much.

Thank you.

Thank you.

There are no further questions in queue. I will now turn the call back over to Frank Boykin.

Listen, we appreciate you guys joining us. We are excited about our opportunities. We believe we're doing the right thing for the long term of the business as well as the short term. And we think in long term, we're going to have a much stronger business. Have a good day.