莫霍克工業集團 (MHK) 2017 Q1 法說會逐字稿

Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mohawk Industries First Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, ladies and gentlemen, this conference is being recorded today, Friday, April 28, 2017. Thank you.

I would now like to introduce Mr. Frank Boykin. Mr. Boykin, you may begin your conference.

Thank you, Rob. Good morning, everyone, and welcome to Mohawk Industries Quarterly Investor Conference Call. Today, we will update you on the company's results for the first quarter of 2017 and provide guidance for the second quarter.

I'd like to remind everyone that our press release and statements that we make during this call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which are subject to various 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, Mohawk sales rose approximately 4% on a constant days and local currency basis to a first quarter record of $2.2 billion, with Flooring North America and Rest of World outpacing Global Ceramic growth. Operating income grew 12% to about $275 million, and our operating margin increased to 12.4%, up 110 basis points over the prior year due to volume, mix and productivity, adding $60 million to operating income. Both our operating income and margin were first quarter records.

During the period, material costs increased across our portfolio, and we initiated price increases that should cover our material costs in the third quarter. This year, around the world, we plan to invest more than $750 million to expand our ceramic, carpet, laminate and LVT as well as our sheet vinyl and wood. To utilize this capacity, we will invest more in marketing and start-up costs this year, with the fourth quarter investment being the highest.

In addition, we are entering the European carpet tile and countertop markets as well as the Russian sheet vinyl business. In April, we completed the acquisition of 2 small ceramic manufacturers in Europe and a carpet nylon polymerization plant in the U.S. In May, we anticipate purchasing a mine for our U.S. ceramic operations. The price for these will be about $270 million, plus future investments to optimize them.

In the U.S., consumer confidence rose in March to the highest level since 2000, supported by job and wage growth. The National Association of Realtors reported March existing home sales improved to their highest level in more than 10 years. In March, new home starts increased 9%, and home prices continue to rise.

Harvard's LIRA index is forecasting home remodeling growth of 7% this year. In the first quarter, the AIA reported strong commercial inquiries, and the Architectural Index is projecting higher growth.

The European recovery is gaining traction, and the EU is forecasting expansion for all countries in 2017 and '18. In Russia, GDP is the fourth -- in the fourth quarter, increased for the first time in 2 years and could indicate a recovery.

With that, let's turn to our first quarter results by segment. During the quarter, our Global Ceramic segment increased 2% as reported and on a constant days and currency basis, with operating margins rising 15%, 190 basis point improvement. Growth slowed in the period due to customer inventory adjustments and postponed product transactions in North America, extreme weather in Russia and Eastern Europe and a weaker Mexican peso. Purchasing patterns have now returned to normal and our sales growth is increasing. To recover increasing costs, we announced a general price increase in North America, which should be implemented by the end of the second quarter.

Our recent investments in our North American ceramic business will propel our growth through the remainder of the year. In the U.S. this year, we are planning to open 18 to 20 new ceramic tile or stone centers to expand our distribution. Statements, our shop-within-a-shop concept, is being expanded among leading ceramic retailers. We have increased our regional and national homebuilder relationships by providing them with complete product offering that satisfies all of their needs. Our distributors are embracing our new product launches and replacing other imports with unique collections acquired directly from our Italian operations.

Our new Tennessee facility is operating at planned volume and quality levels, and we are using the plant's advanced technology to introduce premium products, such as sophisticated metallic and glazed color body collections. We are increasing our countertop sales as we open additional service centers and expand our product offering, including porcelain countertops from Italy. We are upgrading our floor and wall tile offering in the home center channels to address evolving consumer preferences.

Our ceramic sales in Mexico continue to outpace the growing market, but are limited by our current capacity. To utilize additional capacity coming from our Salamanca expansion later this year, we are developing new collections and distribution as well as adding South American customers to expand our geographic reach.

In Europe, our ceramic business increased our profitability as a result of improved product mix, productivity and equipment upgrades. Severe weather in Eastern Europe lowered our sales growth, which has now returned to normal. Our innovative new products are being well accepted by the market, enhancing our distribution and improving our average selling price. Our new product development and sales processes activated our spring collections earlier, and we train more retail salespeople to promote these new offerings.

Upgrades to our commercial technical plant are progressing as planned, with incremental production starting in May and continuing to expand through the end of July. We have successfully implemented our Italian information system in our Bulgarian business to improve our efficiency, controls and service. Additional enhancements will be executed over the next year. Multiple equipment upgrades are being installed in Italy and Bulgaria to enhance our product offering and reduce our costs further. We completed our previously announced ceramic acquisition in Italy and the purchase of a small Polish ceramic operation. We're initiating strategies to enhance product offerings, improve efficiencies and expand sales in both companies.

In the last quarter of 2016, the Russian economy realized its first GDP growth in 2 years, which could be an indication of a recovery. Since the downturn, the Russian ceramic market has declined almost 30%, while we have increased our market share and capacity. With the investments we have made, our domestic ceramic collections with award-winning designs and large sizes up to 10 feet long, are replacing premium imported products.

During the quarter, sales in our Flooring North America segment increased 4% as reported or over 5% on a constant days basis, with hard surface sales continuing to outpace our carpet category. The segment's operating margin increased to 10%, up 150 basis points over the prior year.

Our raw materials have risen and we are increasing prices as necessary. Our residential carpet sales performed well during the period, with ongoing strength from our proprietary SmartStrand franchise. During the quarter, we introduced SmartStrand Silk Reserve, the next generation of ultrasoft carpet. This is the third edition of our exclusive fiber system, which has extended our leadership in premium carpet. We are adding unique products and specialized sales personnel to expand our main street commercial and high-end care stand collections.

In the middle price points, sales of our Continuum polyester offerings are growing with their differentiated feel, performance and value. Our revolutionary new AirO product changes the way soft flooring is manufactured, installed and recycled. AirO's luxurious feel and unique construction has been well received as an innovative alternative to traditional soft flooring.

Our commercial carpet bookings improved during the period, though shipments were postponed due to timing. We are adding commercial sales personnel to target key regions and channels. We are growing our participation with both large U.S. and international accounts. We anticipate continued sales improvement from our new tufted, printed and woven technologies, and we are extending our design leadership in carpet tile. We are integrating our soft and hard surface offerings to provide architects and designers with more appealing combinations that satisfy their clients' needs.

Sales of our hard surface products continue to expand at a higher rate, with our LVT and premium laminate growing the fastest. With their superior design and performance, our flexible, rigid and commercial LVT collections are being well accepted across all channels. The continued improvement of our LVT manufacturing process is increasing our capacity and margins. Construction of our new LVT line will begin this quarter, and we anticipate startup in the fourth quarter. Our sheet vinyl sales strategy has improved our position with Mohawk retailers, independent distributors and home centers.

We've announced a price increase in sheet vinyl to cover increasing raw material costs. Sales of our laminate collections remain strong with our unique styling and performance features, and our new production line should be operational in the fourth quarter. We have upgraded our wood offering to meet growing demand for wider planks with rich textures and sophisticated colors.

During the second period, we acquired a nylon resin plant to extend our backward integration and improve our cost position. To improve service and efficiency, we closed the carpet dying operation, consolidated commercial carpet facilities and rationalized a wood plant while increasing our other engineered wood capacity. Across the segment, we have multiple new investments in various stages of implementation to introduce innovative products, add capacity and improve our profitability.

For the quarter, our Flooring Rest of the World segment sales were up about 3% on a local basis and constant days. The segment's operating margin was down versus the prior year due to higher material costs and currency changes. We are increasing prices across most product categories to offset higher material costs, which should cover the costs in the third quarter.

To utilize our upcoming LVT laminate sheet vinyl and carpet tile expansions, we're investing in more sales, marketing and product development during the year. All of our LVT brands grew significantly during the period as we increased our production and expanded our distribution and product offering. Our new LVT product introductions are being well received across all channels due to the unique design and performance attributes. We are reducing our costs as we improve our line speed, efficiencies and yields.

Construction has begun for a new LVT production line, which should start up in the fourth quarter, expanding our product offering in both flexible and rigid LVT.

Our sheet vinyl sales lagged compared to last year as low inventories from earlier plant disruptions limited our service. We anticipate normalized sheet vinyl sales in the second quarter. We have identified a location in Russia for our new sheet vinyl plant, which should be operational by early next year.

Our laminate production in Europe is running at capacity, and we're preparing the -- for the installation of new equipment that will give us additional capacities to extend our lead in the category. To meet growing demand, we're also expanding our Russian laminate operation, which is presently fully utilized. Our impressive collection has refined the premium laminate category with its unique water resistance and deeply textured surfaces and has now become our largest-selling product in the category. Our wood margins have increased as we enhanced the visuals of our wider planks and installed state-of-the-art equipment to improve our yields and efficiencies.

Our installation board sales continued to increase during the period. However, shortages in key materials are dramatically increasing our costs and impacting our production volume. We are aggressively raising prices to offset the costs we are incurring. Our wood panel sales are growing and our margins are expanding as we improve our mix, capacity and costs. We are preparing an existing site for our new Belgian carpet tile plant, which should be operational by the first of next year.

I'll now turn the call over to Frank to review our financial performance for the period.

Thank you, Jeff. Net sales for the quarter were $2,221,000,000, up 2% as reported or up 4% on a constant days and FX basis, with strongest growth in the Flooring North American segment. Our gross margin as reported was 30.6%. Excluding nonrecurring items, the margin was 30.8%, up 110 basis points. With the improvement from productivity of $36 million, volume of $14 million and price/mix of $10 million, offsetting input cost inflation of $22 million.

SG&A, as a percentage of net sales, was 18.3% as reported or 18.2% excluding charges. The percentage was flat to last year as we continue to invest into sales and marketing to grow our business. Unusual charges of $4 million were primarily related to plant consolidation in Flooring North America and continuing consolidation integration in Flooring Rest of World. Our operating margin, excluding charges, was 12.6%. This is 100 basis point improvement over last year. This includes productivity of $41 million; volume of $9 million; and price/mix of $9 million, all impacting our margin positively and offsetting input cost inflation of $22 million. Our interest expense was $8 million, a decrease from last year as we leveraged our lower-rate commercial paper program. We estimate total year interest expense of about $30 million, including our announced acquisitions. Other income loss was a loss of $2 million, with transactional FX impacting the results over last year. Our income tax rate for the quarter was 25.6%, and that compares to 25.4% last year. We expect the rate to be between 26% and 26.5% for the second quarter. Our earnings per share, excluding charges, was $2.72, an increase of 14% over last year.

Moving to the segments. In the Global Ceramic segment, sales were $785 million. That's up 2%, both as reported and on a constant basis as weather and customer product transitions impacted our results. Our operating income margin, excluding charges, was 14.8% or 180 basis points over last year. The primary factors for the increase were productivity of $19 million and positive price/mix of $5 million, offsetting input cost inflation of $9 million.

In the Flooring North American segment, sales as reported were $939 million, a 4% increase or 5% up using constant days. As Jeff mentioned, Flooring North America is implementing 2 carpet price increases to compensate for inflation.

LVT continues to be the highest-growth product category here. Our operating income margin, excluding charges, was 10.1%, up 140 basis points. The improvement was supported by productivity of $13 million and volume of $5 million.

In the Flooring Rest of World segment, sales as reported were $496 million, up 1% or up 3% using constant days and exchange rates. All product categories grew as LVT turned in another strong performance. Our operating income margin, excluding charges, was 15.7%. The margin was benefited by productivity of $10 million, offset by input cost inflation of $11 million and negative FX of $5 million. Price increases are being of implemented in most categories to offset the inflation.

I would like to remind everyone of our IP change this year that we described last quarter. We expect our total IP to be between $65 million and $70 million this year, with the annual run rate dropping to $35 million at the beginning of June.

In the Corporate and Eliminations segment, the operating loss was $9 million, and we expect the loss to be between $35 million and $40 million for the full year.

Turning to the balance sheet. We had receivables of $1,498,000,000, with DSOs up to 54.9 days compared to 52.3 days last year. This was primarily impacted by channel mix. Inventories were $1,741,000,000, with inventory days at 110 compared to 107 days last year, impacted by geographic expansion and product growth. Fixed assets were $3.5 billion and included first quarter capital expenditures of $201 million, with depreciation and amortization of $105 million. We're currently estimating full year CapEx of $750 million with D&A of almost $450 million. We do expect the CapEx spend to increase with acquisitions and additional projects, but we haven't finalized the number. Long-term debt was $2.6 billion and our leverage was at 1.4x debt-to-EBITDA.

With that, I'll turn it back over to Jeff.

Thank you, Frank. We remain optimistic about the economy, the flooring industry and Mohawk's potential. Our second quarter sales growth should accelerate sequentially on a local basis and our operating income should improve despite higher inflation, expiring patents and a weaker British pound. We are implementing product price increases across the enterprise due to escalating material costs. Our capital investments and process improvements will continue to yield higher productivity.

This quarter, we will finalize 4 acquisitions that will broaden our product offering, geographic penetration and competitive position. Taking all of this into account, our adjusted EPS for the second quarter is $3.53 to $3.62, including our acquisitions. In the third quarter, higher pricing and productivity as well as lower currency headwinds should improve our results. As we stated last quarter, this year's sales growth, prior to acquisitions, will be similar to last year's level and our adjusted operating margin will increase slightly. We are investing at record levels, absorbing start-up and marketing costs this year to enhance our long-term growth and make Mohawk a more profitable company.

We'll be now glad to take any questions.

(Operator Instructions) Your first question comes from the line of Bob Wetenhall from RBC Capital Markets.

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

Sure. I'd be glad to address that. Our business is improving significantly this year without start-up costs and IP. We have not changed our annual outlook. And with the 4 acquisitions, we'll add another $0.15 a share to EPS this year. We still maintain that our 2017 sales will increase 5.5% and operating margins will improve slightly, even with start-up cost, IP and some pretty high inflation.

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

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

Listen, there seems to be so much focus on the quarters. I just want to make sure that we're not missing how we are strengthening our business in total. We're going into new products and geographies. We're expanding our production across the world and we're doing all the right things to enhance the profitability. This is really the same strategy we've been using to compound our shareholder return by over 25% over the last 5 years. I mean, we're really doing the right things to make the business grow.

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

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

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

Yes, so I wanted to talk a little bit, if I could, about the productivity. You -- I don't think you mentioned in your release you did $140 million or better than $140 million productivity that you did last year. Wanted to make sure that, that was something that you still felt strongly about. And the $36 million of productivity you recorded, but I think it's actually $41 million, I think, you recorded in the first quarter. How should we think about that number going through the year? Will it be sharply weighted towards increasing in the back half of the year? Or is it going to take a step-down significantly in 2Q because of the factors we're talking about? Can you guys give us a sense for how that may flow year-over-year?

Yes. First, just to kind of level set it, we have hundreds of projects that are driving that productivity, both capital expenditures as well as process improvement. So a lot of moving parts and it's hard to say precisely how much productivity we're going to have in 1 quarter versus the other. But right now, as we look at the timing for those productivity improvements, as they roll out through the year, we would expect to see, as I mentioned before, higher productivity improvements in the third quarter compared to the other 3 quarters. And your point earlier, Steve, we -- the point we had made last time -- last quarter on the call, that productivity for the full year will be greater than the $140 million for last year. We still stand by that.

And don't forget, in the -- when I went to review it, all the different projects you heard coming up in the fourth quarter is going to have a higher percentage of the start-up costs in the fourth quarter than the prior quarters.

Great. No, that's really encouraging. I guess, a lot of other things we could ask about. But let me ask about your net price input headwind. In the first quarter, it looked like it was about $13 million. We know that you're going to recover that in the back half of the year. You were very clear about that. Was curious about 2 things. One, in the second quarter, because we know there's going to be a little bit of a gap there, could we see that net headwind of $13 million? I mean, could it be like meaningfully higher, like maybe double, like $25 million, $30 million of a net headwind between price and input? And for the year, do you expect the back half to be able to recover some of the headwind that you have in the first half? Or is the back half just going to be kind of a net neutral and the year will be negative by the amount of the first half is negative?

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

I forgot the rest of the question.

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

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

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

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

Frank, maybe I'll ask you. Your core growth of 5.5%, could you break that down for us as we go through the year between price/mix and volume? And maybe just give us a little indication of which segments -- sort of rank order your segment growth there.

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

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

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

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

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

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

Productivity pieces.

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

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

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

Listen, that would be a favorable conclusion. I'm not sure that I have it embedded in mind that way. The business is huge at this point. It takes a lot of capital to keep growing at the rates we're in. And we really look at it as a two-pronged piece. One is increasing the sales of our present businesses, improving the mix of the business, reducing the cost structures through investments in innovation, at the same time, continuing to find additional acquisitions that we can help and fit our strategy. And the combination of the 2, we believe, will allow us to continue growing at a rate much faster than the market.

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

The first thing, we gave you an indication that said for the balance of the year, we expect them to add about $0.15 to earnings to give you a view of the present piece. Each one of them is different. The biggest one is in Italy, and the one in Italy is almost across the street from our present business. And so combining those is basically a bolt-on business to combine the 2 together to enhance -- to reduce the -- improve the productivity and efficiencies of both businesses put in together, to broaden the distribution of the products and to -- we have a much broader product offering and we can use our assets to give them a broader offering to their customer base. The Polish business is really a very small plant that is really a foundation to grow a new business. The business itself is relatively small. We're going to increase the capacity of the plant. It's in a low-cost labor area. It has raw materials that are almost store next to it, so you have low-cost manufacturing base. We can provide it through more investments, the ability to make much higher style and better products. The vicinity where it's located gives you low transportation cost to get to Northern Europe and the places around and compete in lower price points than the focus of our Southern European business today is at. The other pieces are just what -- the other things we're buying the mine and the nylon plant are just ways of securing our raw materials at better prices and more control, and all the businesses will require investments to drive them over time. And I think we have a long history of buying businesses and improving them, and it's just doing the same thing over again.

And just to remind everyone, last quarter, I think we had said that the Italian ceramic business had sales of about EUR 160 million when we bought it.

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

I wanted to touch on carpet, I guess. And you had pretty good expansion in the margin in that segment. And just curious, I'm sure you're not going to give me a number, but what role carpet played in the margin in the quarter?

The carpet is a large piece of the business. We've been investing heavily in it as we go through. You heard that we have closed plants, consolidated plants, put more investments in backward integration. We're driving the productivity of the business up. We're using our product innovations to improve the mix and quality of it. I mean, it's a good part of our business and we think we can keep it operating well and improve it.

So I presume, given its weighting, it had a fairly nice margin performance year-over-year in Q1 despite the inflating raws or is that a wrong conclusion?

Listen, it would be hard to drive the margins up dramatically without -- and leave out such a large part of our business.

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

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

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

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

This is Mason on for Mike. What is the early read on sales in the Dalton LVT plant? And where does that plant stand with production efficiency?

The existing plant continues to improve. The line speeds continue to go up. The yields continue to improve. We're focused on 2 things, which is driving them up even further and then putting more complexity in the plant to get more higher-value products. We're working through both of those as we speak. We have broken ground to expand the buildings to put in a new line, which should be installed and starting operation by the end of the year. We think it's a good category and we intend to be a leader in it.

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

Not sure we understand that question. One more time?

How much of Unilin bleeds into your 2Q guidance for June?

You mean the IP?

Yes, yes.

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

You have 7 months at 35 and the difference in the 2 gives you the first part.

Yes, yes.

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

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

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

Great. Any potential impact from the proposed Canadian tariff?

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

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

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

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

Okay. That's helpful, Jeff. I guess, secondly, just looking at the 3 different businesses in terms of profitability, you talked, obviously, a lot about in the back half of the year being able to recover the higher raw materials. How would you consider this year bigger picture? Do you feel like the raw material pressures are a little higher than normal or than 2016? And as you go later into the cycle, would you still expect to be able to, more or less, recover inflation through price? And obviously, this kind of have more of a timing issue in the second quarter.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Okay. And then, Frank, just I guess one housekeeping item here. The -- a number of your competitors have adjusted for excess tax benefit from the exercise of stock options from running that through the tax line. Is that scheme that's in your guidance now? Or how should we think about that?

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

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

You had announced 20 new Dal-Tile service centers. So 2 questions on that. First, how many does that bring you to in total in the U.S. right now? And is there any look on those to present those more of a retail format, where you can actually do transactions in the store or different -- or anything along those lines?

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

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

The -- just one question for me. Lots of different capacity add projects that you highlighted, Jeff. I think the only one, at least by my notes, that you actually mentioned was on time and on plan was the Tennessee ceramic facility. Are we on plan and on time with all the other ones? Are there any delays or cost overruns? How are we doing with mileposts as the year progresses?

It wasn't that it was on time and the others weren't. That one actually came up out of the ground and went through start-up in the fall of last year. So it went through start-up. So what we were saying is, not only had it started up, it's now operating at peak performance that we expected it to get to. The other ones are all moving as we expect. But I mean, these things there are 1 million variables in them, from getting the permits, to government approvals, to suppliers putting stuff in, to all kinds of things. And we try to give you directionally that we thought they would -- when they would come up and be operating. And most of the big ones are running from the fourth -- some of them. The big ones will be in the fourth quarter, some in the first quarter of next year as we go through. But we have all kinds of things. We have a carpet cushion plant that we put up in -- to satisfy the market in the Western United States. It's up and running well. We have a new engineered wood plant that's in -- came up and it's running well. I mean, there's multiple of projects that are coming up or not. We tended to focus on the big, new capacity increases, which are being spent this year, is it? But there's all kinds of projects that came through last year that are in various stages of optimizing.

What I'm getting at is as you look at all the different projects, were there any material call-outs that a project or 2 has been delayed enough where it may cause some risk to sales route expectations over the next few quarters?

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

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

Just quickly, Frank, the 5.5% sales growth for the year, that excludes currency, it excludes the acquisitions? Does it include or exclude the patent revenue that's rolling off?

It includes the patent revenue.

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

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

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

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

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

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

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

Sure. First, you have to start out that we run our business in a decentralized manner, that we run different products and different geographies under local managers. And we do that on purpose in order to allow them to adjust to local circumstances and needs. With that, it enables us to give different projects to different groups and handle a multitude of things at the same time, where each group is only handling 1 or 2. So that collectively, we can handle a lot of projects at a time. At the same time, we do have interaction between them to help them with technology, knowledge, design, style, engineering capabilities that we share across as needed. And each of the managers knows that their goal is to optimize their piece, but they better do the right thing for the whole, is it? And they get a lot of positive things out of doing -- helping each other, is it? It's good for them and it's good for the whole group as you go through. So I mean, we're really in a unique position. And then connected to that, our strength of our balance sheet and the cost of our debt is extremely low as we go through, and it's all because of the strength of the entire company. And then we have, as we've grown different than most companies. When we go through acquisitions, we buy the management as much as we buy the assets. And I don't know many companies that have been able to maintain the managements from these acquisitions like we have. And it takes a unique method of driving it in order to make sure that they feel that they're part of the business and can help. And when we buy good acquisitions, we feed them capital and ideas. But I mean, they're still driving the business as we go through, which is why you can go back to the first big one, which was Dal-Tile, the same management is here driving it today that was driving it 15 years ago. And we have the same thing through a large number of all the acquisitions.

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

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

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