莫霍克工業集團 (MHK) 2005 Q1 法說會逐字稿

Good morning. My name is Michelle and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Mohawk Industries Q1, 2005 earnings conference call. [OPERATOR INSTRUCTIONS]

As a reminder, ladies and gentlemen, this conference is being recorded, today, Friday, April 22, 2005. I would now like to introduce Mr. Jeff Lorberbaum, Chairman and CEO of Mohawk Industries. Mr. Lorberbaum, you may now begin your conference.

Thank you. Welcome to the first quarter conference call of Mohawk Industries. With me I have Frank Boykin, our CFO. Frank, could you give the Safe Harbor Statement, please.

Sure, I will be glad to, Jeff. Certain of the statements made during this conference call, particularly those anticipating future performance, business prospects, earnings and expense estimates, operating strategies, acquisitions, new products, the impact of the military conflict, and similar matters constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended.

Estimates and forward-looking statements involve a number of risks and uncertainties. These, or other assumptions, could prove inaccurate and therefore there can be no assurance that the estimates or forward-looking statements will prove to be accurate. For those estimates and forward-looking statements, Mohawk claims the protection of the Safe Harbor and forward-looking statements, as contained in the Private Securities Litigation Reform Act of 1995. Back to you, Jeff.

Thank you.

Mohawk's first quarter net earnings were $70 million, 6% above last year, and the diluted earnings per share were $1.03, 5% above last year. Net sales for the quarter increased 7% to $1.5 billion. The growth rate results from increased selling prices, internal growth, lower SG&A expenses, and increased hard surface sales, offset by continuing raw materials and energy increases and a slight volume decline in soft surface.

The first quarter was impacted by the weather in some regions, and the timing of Easter holiday, which was in the first quarter this year versus the second quarter last year. I am pleased with our results, and the way we have managed the escalating costs. The timing of selling price and material cost increases, as well as weaker industry conditions, impacted our results.

The prior year comparisons were difficult, due to the cyclical rebound that occurred during the first quarter of '04, and is not repeating this year. We are implementing price increases in response to our rising costs. Future quarterly comparisons moderate throughout the year. And our customer expectations are for an improved selling environment, going forward. Frank, would you please give the financial report.

Yes. Thank you, Jeff. Net sales were up 7%. That's $1.493 billion in the first quarter of '05 compared to $1,390 billion in 2004.

This increase, as Jeff mentioned, was due to both price increases and some volume growth. The gross profit was $385 million, or 25.8% of net sales, compared to last year's number of 26.3%. The margins were negatively impacted this year by increasing raw material and energy costs, as well as a $5 million LIFO charge that occurred in the Mohawk segment. Selling, general and administrative expenses were $261 million, or 17.5% of net sales, which compares to 17.7% of net sales last year.

Operating income in this year was $124 million, or 8.3% of net sales, versus 8.6% of net sales last year. Interest and other expenses came in at $14 million this year versus $15 million last year. Our income tax expense was $40 million in 2005 and $37 million in 2004. The tax rate for both of the years was 36.2%.

Net earnings were $70 million this year for a 6% improvement over $66 million last year. Earnings per share were $1.03 per share, or a 5% improvement over the $0.98 per share in '04. The Mohawk segment sales were up 6%, to a $1.091 billion, compared to a $1.030 billion last year. Operating income for the Mohawk segment was $66 million, or 6% of net sales, versus 7% of net sales last year.

The Dal-Tile segment sales were up 12%, $402 million, versus $359 million last year. In the operating income for the Dal-Tile segment was $59 million or 14.5% of net sales, and last year it was 13.8%. On the balance sheet, receivables ended up at $740 million, and that compares to receivables a year ago, at the end of the first quarter, of $664 million.

The days outstanding in receivables at the end of first quarter of '05 were 45.1 days, and that compares to 45.7 days last year, first quarter. Inventories ended up $1.146 billion compared to $898 million. Turns were 3.8 times in 2005, compared to 4.3 times in 2004, due primarily to higher inventories of hard surfaces and higher raw material costs. Trade payables and accruals were $757 million at the end of the first quarter of '05, and were $713 million last year. This represents 63 days in 2005 and 65 days, in payables, in 2004.

Finally, our debt came in at $919 million, compared to $1 billion year, and our debt-to-cap ratio ended up at 25.1%. Jeff I'll turn it back to you.

Thank you. In the Mohawk segment, raw materials and energy continued rising following the oil and natural gas trends. We have announced two price increases to reflect these changes, but there is a lag that impacts on margins in the meantime.

We have a limited forward view of our sales and our costs. Our suppliers continue to pass through their changes on a more frequent basis. Our corporate sales have been soft in the quarter, and we believe they are reflective of the industry, based on information from our customers. We continue to see a shift in our sales to less expensive products to offset some of the increased pricing. This does not necessarily mean a reduction in our selling margins.

Our carpet unit sales were slightly behind last year by 1 to 2%, which is about the same as the one day less in the period. Last year, in the quarter, the carpet industry was up about 9% in units, and this is making present sales comparisons more difficult. The commercial carpet products continue outperforming the residential products. Our carpet tile products are going faster than our broadland, which is reflective of the industry.

We believe that economic conditions, including corporate spending and vacancy rates, should be positive to a commercial category. The corporate, healthcare and hospitality areas should lead the other commercial channels. In the residential carpet products, the new construction business was stronger than the retail replacement. Housing is continuing at a solid level, while retail remodeling business has not shown the strength expected.

We believe that higher employment levels and continued investment in homes will improve the remodeling sales, as we move into the normal selling season. The sales of polyester carpet products is increasing. As nylon prices have escalated, polyester has become a better value. Mohawk manufactures polyester from bottles, and extrudes the majority of our staple and filament polyester requirements.

We are presently shipping our new SmartStrand products, made of DuPont Sorona, as we had planned. The timing is later than last year's introductions, and will benefit our second quarter sales. Mohawk home product sales were down, with some customers postponing introductions and inventory until the second quarter.

We have also dropped some imported products which did not meet our return expectations. Our surface products reflect a slower purchasing environment, as well. The sales trend of hard surface continue to outpace the carpet industry. The Dal-Tile segment continues with positive results, despite the slower environment and higher energy and transportation costs.

Our investments in higher end products and new production facilities are positively affecting our results. Our new-tile introductions resulted in an improved product mix, increasing our average selling price. We announced price increases in ceramic in the first quarter to cover rising costs. As in carpets, it will take a period of time to recognize these increases.

Our stone products continue to grow as we expand our offerings and extend our geographical reach. In the Dal-Tile segment, residential sales continue to outpace our commercial growth. We continue to invest in new products, displays and selection centers to improve our share.

We are in the process of expanding our plants in Muskogee and Mexico. When they are fully operational, the capacity will increase to about 20%. The Muskogee addition will add the ability to produce a higher value porcelain tile, with the color embedded in the body of the tile. We presently source this product type today.

Our inventories have grown over the prior year. About 50% is in hard surface to support new product introductions, long lead times necessary to procure, and the anticipation of an improved selling environment. About one third of the increase is due to raw material inflation, as costs continue to rise. The balance with the support backing production, stone distribution and lease carpet acquisitions, and a limited increase in the soft surface inventory.

We anticipate increasing our inventory turns to about four times as we move through the year. The growth and hard surface imports, or additional inflation, could impact these results. The backing operation we acquired in the first quarter is progressing as planned. We have implemented cost reductions, reduced product complexity, increased asset utilization, and are consuming the production internally. Our leverage, at 25% debt-to-cap, provides opportunity for continuing investments in our business as well as other opportunities.

We continue our approach to capital allocation, with capital expenditures being first priority, acquisitions second, and stock repurchases third. We are constantly monitoring the allocation of capital between these.

Finally, I'm proud to report that Dal-Tile has won the Dealers Choice Award, sponsored by The Floor Covering weekly magazine, for our newest Ceramic products from Muskogee. Our new SmartStrand carpet products won first place in the Floor Trends competition for residential carpet. Also, Mohawk placed number 340 on the Fortune 500 list, and number 959 on the Forbes 2,000 list. Most economists remain optimistic about future growth rates, with housing at a historical high, employment continuing to grow and corporate profits improving. However, recent economic data suggests the growth rate may be slowing. It is possible that oil and natural gas prices will negatively impact the economy and our industry.

Although there is some improvement in our business at the present time, the drivers that influence the industry's revenues and costs remain uncertain in the near term. After considering these factors, the second quarter earnings forecast is from $1.30 to $1.39 earnings per share. Our financial strength will allow us to manage the near-term circumstances. Our management has been tested over the past few years and is succeeding in adapting to the conditions.

We continue to be optimistic over the long term about the overall economy, our industry, and Mohawk's position within it. With that, we will be glad to take questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of John Baugh with Legg Mason.

Hi, John.

Good morning. Two questions. One on the inventory. You went through a bunch of things quickly and I got the 50% hard surface, one third inflation, and then you ticked off three or four other things. What what are those again?

The acquisitions that we made over the last period of time increased the inventory, and there was the backing plant we just purchased, stone acquisitions that we had made, and the [Lees], which was a little earlier, but we had increased inventories for it.

Okay. And you said there was a limited increase in area rug and --

And the carpet business.

And carpet. Okay. And then I wanted to ask you -- with Armstrong failing once again to come out, -- that process looks like it will drag on for a much longer period, still, and there is is a lot of pressure on the wood manufacturers domestically right now. Does this change your thinking at all about the timing and / or likelihood of going after that, if it ever became available? And, in the context of that question, [inaudible] increase the likelihood of share repurchase, assuming there aren't other major acquisitions looming?

The -- you're accurate in the Armstrong piece, that it does look like it is further out. The pressure -- there is additional pressure in the wood industry on pricing, due to imports and other things. That is not new news to us, but it has been going on -- and -- as the trends have been moving that direction for a period of years now. [Inaudible] we continually to monitor the different pieces of how to use it and, based on the changing data, we continue to change how we operate.

Did you answer my question?

I can't -- if you would like, I can't give you a specific answer, if I'm going to buy stock tomorrow , if that is the question.

Would it be fair to say that the likelihood of a stock repurchase has gone up in the last quarter, versus down?

We constantly evaluate it and we consider it. We have an open-to-buy, I think about 4 million shares, which is a few hundred million dollars and we will consider it if we think it makes sense.

Great. Thanks. I'll defer to others.

Your next question comes from the line of Laura Champine with Morgan Keegan.

Good morning, Jeff. I just wondered if we could get some clarity on the imported product that you discontinued in the quarter. What product category was that in, and why do you think it didn't meet your return expectations?

That specific one was in the home products. The home products sales were down, and that was one of reasons. And, what we did with those imported products -- we found that certain customers we were selling, expected us to have immediate availability forever and that they had wanted -- they had the desire to stop purchasing it at any moment in time.

And I had a long pipeline of product coming over that I had to discontinue at significant discount, so it didn't make economic sense to continue doing business under those conditions.

In home products, are we talking about window treatments or cheetah bath mats, or what exactly is that?

Mostly rugs and a few textiles.

Great, thank you.

The next question comes from the line of Karl Reinhardt with Wachovia Securities.

Good morning,Jeff and Frank, how are you?

Good, Karl.

I'm curious about margin differential between commercial and residential in both Mohawk segment and Dal-Tile. Can you gave some clarity on whether or not that has changed at all over the course of last quarter as the mix has shifted a little? I'm just trying to figure out if the mix shifts, one way or the other, in either business -- if that has significant impact on margin?

The margin impact in, most cases, is related to the commoditization of the particular products within a category. And the more commodity they are, the lower margin we work on, and the more differentiated they are, the higher margins we tend to work on. And, we -- I don't see a shift due to anything other than those things in the change.

Okay.

In our residential products, I think on extremes, our builder products which tend to be low end, have been doing better and some of the higher end tend to be better, and there is probably more pressure on the consumer in the middle.

Just as a follow-up, you mentioned that 9% unit comp in Q1, on the soft side. What is that unit comp in Q2?

It was about 5% and then 5% and about flat in the fourth last year.

Great, thanks so much. I appreciate it.

You're welcome.

Your next question comes from the line of David Macgregor with Longbow research.

Good morning.

Good morning, David.

I was also, I guess, interested in some thoughts related to Armstrong, and I guess I'm just wondering what this means now for your acquisition plan. Is there a need to do a large transaction at this point in order to deliver the growth to support the share evaluation. And also, maybe, if you could talk about whether, within hard surface categories other than ceramic, are any of these other categories more likely now based on what you are seeing evolve in those markets?

If you look at the industry, the projection for the flooring industry -- we historically have expected about a -- on a normalized basis about a 5% growth rate in the industry, assuming limited inflation. As a business we are assuming our goal is to participate in the industry growth, plus capture some more market share as we go forward. In order to go faster than that we have to do acquisitions.

We have started a few years ago in building a sourced hard surface business, and we continue to increase it. Long-term, we would expect in those businesses to end up similar to the Dal-Tile business where we have -- the Dal-Tile business -- we have about 60 to 70% of it manufactured, and about 30 to 35% sourced.

And so, we would expect on an ongoing basis to end up in some similar pieces with those. Which means that we would be looking for acquisitions in the various categories, but continue to support sourcing where it makes sense. What else?

The Armstrong piece is just one of the options in the marketplace. We have never given the intent that we would absolutely buy it. All we said is that we would consider purchasing it if it came available, and it would be one of candidates that we would look at. And it would have to be at the proper valuation in order to do that.

So, as you look at the other hard service categories where you are outsourcing , and you'd look to recreate that Dal-Tile, I mean hardwood laminates resilience -- is there a priority there, is there one that stands out as a potentially better value, right now, better industry fundamentals -- more attractive?

As you look over the various flooring pieces, the least attractive would be the vinyl business, because it is basically a flatter, declining business. And so that would tend to be on the lower end. The wood business has been growing significantly, and we think it will continue. There are pressures from imports and we are positioning ourselves as an importer of products today. So, we think that we are well positioned. We think, with that we need some manufacturing capacity of our own, so we would look for some of that.

Besides that, in each of the categories. if you can buy market share and make sense and get the returns that we expect, that becomes part of the evaluation of what we do. The laminate business is a growing business that has tended to be, most of it, imported today, So, we are importing hours and so that continues to be a viable growth business.

That is largely the commodity business, too, isn't it?

As in all businesses, there are commodities and others within it. The laminate business has been declining as a -- in a price points -- over the years, moving down in price, which is not atypical of young businesses, as it becomes more commoditized.

Just a last question, as far as acquisition roadmap for Dal-Tile, what can you offer us there in the way of insight, maybe by geography or by price point or by product, to help us understand where the acquisition growth at Dal-Tile takes you next?

There are limited production facilities in the U.S. in ceramics, which I assume you are aware. We would have interest in any of those if they came available. There are a few large ceramic players in the Mexican market which -- we have limited share in the Mexican market, because we have been shipping the majority of our production from there up into the U.S. marketplace.

Right.

And, from there, it would be looking at producers in other parts of the world, and it would be a two-fold strategy. One would be, are those areas low cost producers where we are importing things, and they could provide additional benefits as a source to the U.S. market. And it could be we are already utilizing them today. And, does it offer an entry into those local geographic markets, and how do we participate and enhance the business under those circumstances.

When looking at those types of businesses, a major part of our thought process is the management and structure that is there to help us operate the business on a going-forward basis.

That makes sense. Just to recall , there has been a fairly large commitment to a North American business model, but it sounds now as though you are prepared to explore growth outside the North American market?

We have always said that our first priority is the North American market, because we can leverage all the assets -- relationships and assets -- that we have. Second to that, at some point we would have to consider either geographically expanding, or expanding product categories at some point.

Right. Good. Thank you very much.

You're welcome.

You're welcome.

Your next question from the line of Michael Rehaut with JP Morgan.

Good morning.

Good morning,

First, I was wondering if you could discuss the price increases that you've put through over the last few months and, in particular, the level of success that you feel you have had with them compared to -- let's say -- looking back over the last couple of years. Do you find that your ability to pass through has stayed the same, gotten worse, gotten better? And then, I have a follow-up.

Okay. It is hard to talk about all as a single entity. We have price increases in the first quarter. We have announced two price increases in carpet. We have announced price increases in Dal-Tile. And we have announced Mohawk hard surface because we [inaudible] are in different product categories, and they don't all come out at the same time, so they are all various levels.

Most of all of the increases have been in the ranges of 3 to 8%. And, as we do those, and you have multiple increases, it is not always the one that goes the low amount may be the high amount next time, or vice versa, because they are made out of different products and categories, so you can't take them all and add them up together. From an implementation standpoint -- from a customer's view, they have had it.

In order for them to make all the changes in their stores, and they are getting price changes on the various products from various suppliers -- it just makes their business very difficult to operate, and they would like other circumstances, as would we. Throughout most of the time, most -- throughout the increases -- the industries in each of the categories are tending to move in similar step, because they have the similar pressures with it, as you go through and so typically most of them are in line.

There is timing between some of the different competitors in the marketplace, where some tend to be a little sooner or later. I guess, at this point, anything that is making it more difficult today, in the first quarter of every year we tend to promote more because it is a slower selling season, and the industry tends to promote, and try to get people to purchase more inventory in the slower parts of the season. And that tends to confuse businesses, and those promotions are ongoing.

There may be -- there are more now than there were in the last couple of quarters, but there are always more now compared to the last year -- but there might be a little more due to the little slower environment that we are in.

And, as far as being able to get a sort of proportion of the price increases that you have set out to achieve, would you say that, again, this year versus prior years is it -- give the rapidity of the price increases that you have had to do, I mean, is it -- is it at all impeding your ability to continue to pass through going forward?

First, is the recent increases take a significant time to get through the marketplace and understand how they finally arrive. So, I'm not sure that I have a -- until it is over with, and you passed through about 3 to4 months, you don't know the total impact of what you have already done. It is a moving target.

I guess what I'm asking is -- what you have done so far consistent with the results that you have been able to get over the past couple of years. What I'm getting at is, if I look at your company versus some others in the building product space, I would say that Mohawk has been among the more successful in its ability to pass through, and I am just wondering so far with what you have done, particularly in the last 3 to 6 months, have those actions been any more or, I guess more accurately, less successful given that you have had to do so many?

I think that I don't see a significant deterioration in the process. As in all increases, what happens is -- we announce increases, our competitors announce increases, and there is a period of time where the market is meeting equilibrium so that everybody is on some competitive reasonable state. And as you go through them, that is part of the process, and that is not unreasonable and looks like that we are passing them through similarly. The thing clouding it a little is the promotions going on in the first quarter and we are not -- we haven't been able to determine exactly where they are going to end up at this minute because it is a continuing process. I don't see any dramatic changes from historical that the point.

Thanks, Jeff. And just one second question, I guess. If you would just kind of review you said this at the beginning of the call but perhaps with a little more numbers, if possible, on the Mohawk side of the business you said units were down 1 or 2% largely because of one less selling day. Is that correct?

I said the units were down 1 to 2%, and we had -- in the prior quarterly meeting, we discussed how we arrived at last year's change in the amount of days in the first and fourth quarter. And what happens is that every year one day moves from the first quarter to the fourth quarter every year until they build up to a certain number and then we have to move them all back which we did last year. And so, what happened is the one day is about the same as the amount the units were off.

Right. And if you could just give us an idea. You said new construction did better than remodeling. Would you say that -- give us an idea in terms of revenue growth for new construction and remodeling and also what the impact of the home products sales decline, how that -- what the overall impact that had on the Mohawk segment?

Can you answer that one?

The -- which was the first part of your question?

New construction revenue growth versus remodeling revenue growth.

Okay. We don't have exact numbers. What we do is we -- we have certain accounts that do primary one or the other and we have a lot of accounts that do both. So that we tend to look over the account structures and see how a few accounts are doing versus the other. And we tend to look at it, there are certain products that sell much more within one segment than the other so we don't have an exact number.

What we see is if those categories proportionately have done better than the others. When we look at -- when we talk to our retail customers, they tend to be having a more -- a less selling seasons, or they are struggling more.

There is part as the new construction business moves to larger home builders there is also a portion of the business that is moving from retail to contractors which is affecting my customers' mix a little bit but not as much mine, as it changes how it gets to the marketplace.

The home products piece, the commercial side of the business, it was better than the other by several percentage points over the other.. We said that the certain categories in it, which were the corporate -- the corporate piece. The hospitality piece. What other. What was is it? Are doing slightly better. We expect those to continue doing better.

The indications are, as we look through the first quarter, what has happened is that the sales have -- the rate of sales change has declined through the first quarter. But it is difficult to take that and make a conclusion because we are running more our new product introductions the way we are doing it with our markets. We had more of those and they were more successful in the first part of the year. We had, as you move through it, price increases which changes the point in time that people make certain orders, so that moves the sales level.

And then Easter, moving out, made the more difficult comparisons as we look at it this minute, we see an improvement in all of the categories. But you still have the effects of Easter which is -- wasn't in the last few weeks, so that is helping the last few weeks. And you still have some purchasing patterns due to pricing.

So we are having a difficult time making a concrete statement about the rate of business in the future, at the moment. We believe it is going to be better. But we don't have a lot of concrete evidence and the timing hasn't been enough to make a significant conclusion of that.

Okay. And, just, last question on this, you know, sales -- sales breakdown. Can you just give us an idea in your Mohawk segment, roughly, you know, percent from -- of sales from commercial versus residential versus home products? And again, you know, give us an idea, was the home products revenue down,, you know, 5%, 10%, what type of magnitude?

Answer that one?

We generally haven't disclosed that information, Michael, for competitive reasons. We are the only one with public information out there. The competitors in the marketplace, so we have been very careful about disclosing that level of information.

What we are attempting to do is to make sure that, you know, with the carpet business, to make sure that you understood that the -- where the business level was. We historically haven't gone with giving you units.

We have given you the units this time in order to make sure that you are aware of those things and this some of the differential between the dollar sales and the unit sales is due to a decline in the -- in the home business of which there is two parts that are one, due to our customers we have a couple of large customers that actually -- usually did all their introductions in the first quarter and pushed them to the second quarter and we are not sure what effect that is going to have on them.

One is because the seasonality that people purchase, that they usually run white sales and they didn't run sales like they did this year. So we are not sure how that is going to impact the business in the second quarter.

And second, that we have moved out of this imported products and home, that we didn't generate the profitability required to support it and we dropped it. and I guess it was probably on an annual basis, I don't know, 15 million plus or minus, just that piece.

Great. Thank you.

Your next question comes from the line of Keith Heath with Suntrust Robinson Humphrey.

Thank you. You had mentioned earlier some positive comments to your commercial business. If we broke out the commercial business, would Lees be seeing the best growth right now? Is that the leader?

Break the business down to so many pieces, I don't remember every piece. The three -- the commercial business is all growing. Lees' business is growing. The tile business is growing more than the balance and the Lees business is growing slightly more than the other business.

That that answers it. And it -- is tile a large percentage of Lees overall business?

I think it was about a third of it.

A third. Okay. Thank you.

Your next question comes from the line of Arnold Brief with Goldsmith and Harris.

There is some conjecture that the raw material price increases are only partially related to what is going on in oil. And more related to supply and demand and the ability of the fiber manufacturers just to increase prices after long periods of not being able to increase prices.

Would you discuss that and how you see that proceeding over the next 12-18 months? Do you think they are going to continue to try to get price increases? And the second part of that question, the carpet industry has consolidated quite a bit and has proven its ability to raise prices during this difficult period.

What do you think is going happen some where out there, be it 16 months or 18 months, raw material prices start to go down which they must do at some point. Do you think the industry is going to be able to hold carpet prices when raw materials start to decline?

The first is that there is a stream of processes to get it from the oil wells to us and so, first you have a -- the oil price itself has gone up. Which is an increase in the price. The second is that the conversion of chemicals between that and the process to make our raw materials has gotten tighter and there is supply and demand within each of those pieces. Prior to getting it to our industry's needs.

Then, within our industry, the industry has consolidated down in suppliers and those suppliers are -- have increased their margins over the past year as they had gotten squeezed during the cyclical downturn.

They are expanding those, trying to get their returns up to where they think they need. And, that is an ongoing process, and there are different supply and demand pieces based on, depending upon whether you talk about nylon, polyester or polypropylene. The circumstances that are going on are similar, but the results aren't the same in all place. Is that close to what you like in that area?

Do you see the supply and demand situation, the fiber manufacturers, continuing to be able to sustain price increases over a longer term period? Are you bracing yourself for further price increases through '06?

From a supply and demand part, what it appears is, because our fiber suppliers have not made the returns, there are not many investments going in to extrusion of our raw materials. So, that extrusion that is going to be required, there is a large part of it that is going to have to be put in by the manufacturers within it.

We have announced that we are adding capacity as we speak, and we are adding about 10% to our capacity, which will come up towards the end of the year, this year, to help relieve some of that pressure. The ongoing pricing strategies of those of our fiber suppliers, I'm sure, is to maximize their margins to meet their requirements. And so it is going depend on the cost of the materials coming in.

I don't know if oil is going to be $80 or $40 as we go through the year, so that is going to be a large determinant. And then there are specific chemical shortages within the industry that are going on. How those play out, either through degradation of demand in different product that created imbalance or new capacity coming on are going to all influence those things. I have given up projecting.

The second part of the question, at some point, without projecting, at some point let's assume that fiber prices decline somewhat. Would you think the ability of the industry given this consolidation to sustain carpet prices during a period of declining raw material prices?

If you look historically, the industry has increased profitability in a declining circumstance and decreased profitability in a rising one. Now, the question is, as they decline, will we hold on to some of it and have the margins more than they were in the historical references and that really comes down to a question of how the individual manufacturers react in the marketplace.

I believe that the large manufacturers in our industry are not prepared to give up market share. So what happens, is depending upon how individually we react, will we give it all back or not. Historically, for the most part, as it has declined, we have given it back slowly, and ended up with similar margins over the past. If you look over a ten year period, our margins have continued to increase, and some of that is in keeping the margin there, and some of it in reducing the costs, and some of it just through the change in the whole industry structure. So, there is potential for it to gain more than a historical average but we have to see how the different participants act. We are not going to lose share, due to price.

Okay. Could you just give us capital expenditures and depreciation for the year [inaudible].

The depreciation is about $125 million. The capital expenditures will be about $250 million. The difference between our historical and this year is basically going into three large pieces. The three pieces are -- the extrusion and yarn processing we just talked about and expansion of it.

Expansion of our ceramic business, which will add about 20% to the capacity, and then we are building warehousing to replace leased warehousing that we have. Those are the unusual, large pieces.

So you expect it to drop more to 125, 150 next year?

Yes.

I'm not sure exactly that low next year. There is timing issues.

Some of it may spill over?

May be a little bit higher.

For the two years together $400 million?

We haven't. We haven't made the plans for next year. Depends what happens with the economy, the industry and various pieces. Historically, we have run about our depreciation level.

Okay. Thank you.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of Sam Darkatsh with Raymond James.

Good morning. I have but one question.

Hello, Sam.

In three parts. I'm kidding. You had, all things considered, a pretty nice leverage in Dal-Tile. And talk -- it would appear that, given the inventory build in hard surface, given the fact that you are going to be adding capacity there, given the fact that there may be some timing differences and price realization, that that leverage will be much more modest over the next few quarters or so. Could you help us understand that dynamic?

Yes. The -- we are reaping the benefits of what we have been doing the last couple of years which is, we have spent money on capital expenditures in order to manufacture more of our products and higher value products.

We have then done things to market those, so that we have improved the mix of the quality that we are selling, which is helping our margins within it. Going forward, the capacity takes a minimum of 12 months, and as much as two years, to get the capacity in, and operating at, maximum capacity levels.

The industry has grown about 8% in units as an industry over the past years. So if you look out and say this thing is going to take a year to two years out, and the industry is going to grow 8% we're going to need 16% more just to match the industry, over time, so and then we are importing product to take it. We believe that the infrastructure that we built in the industry in Dal-Tile is helping us increase our share. We believe that the improved margins that we are having are not momentary, but the result of all of the various pieces that we put together.

The other thing to keep in mind, too, Sam, is, you know, 35% or so of the sales that Dal-Tile ceramic is making right now is imported so -- that balance of leverage there.

So, if I were to paraphrase, provided that the growth rates are maintained at generally current levels, there shouldn't be much of a negative impact on leverage going forward, despite the apparent headwinds?

Unless the whole market falls apart.

Right. Okay.

Now, there will be as we put in the plant -- as there was with the other plant -- there will be startup costs that come in to play as we go along in the -- as we get further along in the business. And probably be in the end of this year, first half of next year.

The next question comes from the line of Alex Mitchell with Focus Asset Management.

Hi, this is Bob Goldberg. I'm sitting in for Alex. Just wanted to follow up on the carpet market. Were you surprised by -- it seems like there was some prebuying in the first quarter. I know you put through a number of price increases. Had you seen similar impacts from prebuying from prior increases or was it a little bit different this time, in the first quarter, and just a follow-up after you answer that.

One, is you have to recognize that when we go through from sometime in December through March, there is a normal cyclical dip. It is also the same time we carry on our various markets and the industry has historically done things to promote buying of product during the slow period and those markets. So that is not an unusual occurrence.

It is a normal occurrence that we go through. Do I see any more prebuying than normal? I am not sure -- I do see abnormal prebuying versus normal in the pricing -- due to pricing.

Okay. Just a follow-up. Inventories. You mentioned you had a little bit of excess inventory on the soft side of the business. Is that something that is impacting pricing. Do you see that -- is there some industry inventory out there at the moment, or is it just a function of the demand environment?

I think that the slower environment -- typically in our business, as business gets slow, we don't just go out and lower all the prices. What happens is, we do more promotions. And there are a little more promoting going on to encourage people to buy more which is typical of how the industry operates.

Your next question comes from the line of [Edmond Griffin] with BlackRock.

Morning. A quick question. Just sort of a follow-up question on the previous question asked. But looking at the residential and commercial mix, can you just give us rough ranges of your mix and then also, on margins, sort of the difference between the two? I mean not -- not absolutely numbers but just rough ranges to get an idea?

Residential and commercial?

Yes.

The margins are not that dissimilar from each other. As you get within each category, there are commodity products and less commodity -- and more differentiated ones, and where you see a big difference is between those extremes. In both categories, as you move into the commercial business there tends to be more differentiation. As you have more differentiation, those tend to give more margin than the pieces. But they are similar. They are not , like, dramatically different, the results.

Okay and you are saying on the commercial side of things, that there is actually more differentiation versus residential?

Correct.

Okay.

Because there is more pattern-specific things. There is more unique durability things that are important. You have a more educated customer as you move up the stream in the commercial business.

Your next question comes from the line of Scott Scher with Clovis Capital.

I think you answered the question, but I just want to make sure that I understood correctly. You don't think there has been much prebuying that has gone on over the last couple of months, with prices going up as fast as it has, and you said you were comfortable with inventory at the store level. I think that was the question before. Is that exactly what you said?

First, is what I said was, that the purchasing of inventory is always higher in the first quarter, due to how the business runs. And so that is not abnormal but there is more being purchased at the first period than normal. And the second was that, relative to the price increase and specific purchases due to the price increase, I don't have specific evidence that that is dramatically different than the prior increases.

Great. Thank you very much.

Your next question comes from the line of Bruce Wilcox with Cumberland Associates.

Hi, guys. I wanted to ask a little bit more general question on terms of, as you think about the three uses of cash flow, which are paying down debt, reinvest in the business or buying stock. What sort of standards are you thinking about now, for internal rates of return on acquisition?

Our long-term goal is to meet our cost of capital, over time, which is around 11%. Typically, when we do acquisitions we start out less than that and builds up to that, over time, as you improve the business -- invest more in it.

The pricing in the marketplace for acquisitions appears to have increased over time as there is -- there are more players in the marketplace looking to buy businesses. There's created more liquidity in the marketplace and so with the equity players in the market or venture capital groups there is more money looking for a home, and that is impacting some of the historical rates.

We have bought businesses that were poor, for less than the asset value. And we have bought businesses that were high growth for as much as nine times cash flow, and everywhere in between.

Right. Well, so, I guess your historic pretax return on invested capital has been in the 20s, so the sum of all those things has been pretty successful. A quick related question, Jeff, and then I will get out of the way. You made a comment which I only caught of piece of, with regards to your expansion in fiber. And I'm wondering whether, you know, that might be an area, like for instance, the nylon fiber business [dissolution] once they get out of bankruptcy, is that the kind of thing that might be interesting for you, acquisition wise?

The industry has consolidated because those players in the marketplace haven't had the returns that they expect. As that evolves, depending upon what is available and not, we will have to determine what proportion of our supply we want to own versus we want to purchase.

Those suppliers, unless they get to a certain return, won't exist and someone else will own them either players like ourselves or other players. In either case, they are going to have to get to a return that makes sense. There is a process going on now where the industry is moving from raw material types.

Historically, if you go, way back the majority of the industry was done on staple. Today, filament, which is a different type of fiber, has been growing and has exceeded it. It looks like the staple part will continue to decline, and even with limited industry growth, the industry is going to have to invest in more filament production.

We're investing in it. Some of our competitors are investing in it. The question is, what happens to those present assets and the answer, I guess, we are giving you is that, under the right set of circumstances, we would consider those as part of our portfolio.

Okay. Thanks very much, Jeff.

Your next question comes from the line of Joe [Varry] with Hunter Global.

I apologize if I misheard you. Was anything mentioned on the LIFO charge at all?

The LIFO charge for the Mohawk segment was $5 million.

Okay. Could you also talk a little bit about, growth in the hard surfaces side, on the Mohawk side of the business, and perhaps give us, even if it's a rough idea, what that business is growing at?

The Mohawk side of the business we are involved in the wood business, the laminate business and the vinyl business make up the majority of it and the ceramic businesses, they are all different pieces of it, that we sell under the Mohawk label.

We source almost all of it from somewhere else. The sourcing of it has, in most cases long lead times and limited flexibility, so we have to bring in products prior to the needs and build up the inventories and make sure that we have a constant source of supply to our customers, because we are not sure at all points how fast it ramps up. We have to manage that and that's created part of the inventory growth that we have here.

It would be about 10% of our whole business, plus or minus, as a category. In the business.

And the growth rate approximately?

Growth rate would be in double digit.

Okay. Just one other question. I mean, do you have a targeted return on invested capital? You said your cost of capital is about 11% percent so it has to be higher than that, you know, and where do you see, you know, that return on invested capital over this year and maybe the next two or three years going?

We are trying to exceed on an ongoing basis, the cost of capital. The -- we use a different goal based on what the risk level is of each of the different investments we make. If it is the lowest risk level, we would consider doing internal expenditures, that we have a high degree of expectation of what is going to happen, such as the Dal-Tile ceramic growth, and so that would be the lowest. And then depending upon what the specific piece was, we would have higher and higher expectations of return.

Now, we know that whatever we do, some of them are going to work out better and some worse, so we have to start out with a higher expectation than our 11% and with at least a goal, and we hope that we could be as low as 15% or something on some, and we could be as my as 30% on others and anywhere in between.

When we do acquisitions, we look at it over a longer term piece of where it is today and where will it be over the next five years and if you want to have the prices the acquisitions are trading for in the marketplace most of them that are any good you cannot get the return on capital they want.

At this time there are no further questions. Mr. Lorberbaum, do you have any closing remarks?

Thank you very much. Have a nice day.

Thank you, ladies and gentlemen, this concludes today's Mohawk Industries first quarter 2005 earnings conference call. You may now disconnect.