莫霍克工業集團 (MHK) 2017 Q2 法說會逐字稿

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

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

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

I'd like to remind everyone that our press release and statements that we make during this call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which are subject to various risks and uncertainties, including, but not limited to, those set forth in our press release and our periodic filings with the Securities and Exchange Commission.

This call may include discussion of non-GAAP numbers. You can refer to our Form 8-K and press release in the Investor Information section of our website for a reconciliation of any non-GAAP to GAAP amounts.

I'll now turn the call over to Jeff Lorberbaum, Mohawk's Chairman and Chief Executive Officer. Jeff?

Thank you, Frank. Welcome to our conference call. Due to multiple requests to involve a broader part of our management team, Chris Wellborn will be joining us on today's call. Chris was appointed President of Dal-Tile when we acquired the ceramic business in 2002, and was promoted to President and Chief Operating Officer of Mohawk Industries in 2005. Chris has a deep knowledge and understanding of our entire business. And for the past 15 years, he's played a critical role in developing and executing our strategy across the entire organization. Today, I'll review Mohawk's overall results, and Chris will cover the operations of our 3 segments.

In the second quarter, Mohawk's performance continued at a record level, generating the highest sales, operating income and EPS in the company's history. Our businesses continued their exceptional execution, with sales growth of 6% as reported and 8% on a constant days and currency basis, including previously announced acquisitions. Adjusted operating income for the period increased to $381 million, up 7%, overcoming high material and start-up costs and reduction of IP.

Across the business, we're increasing prices to offset inflation, introducing innovative products and improving our productivity. We're fueling our growth around the globe with significant investments to extend our product portfolio and penetrate new markets. As detailed last year, we're expanding our sales capacity by approximately $1.4 billion. This production will come online over the next 12 months, and our start-up costs will be higher until we have optimized all of our new manufacturing operations later in 2018.

During the period, we completed the acquisitions of 2 small ceramic manufacturers to expand our European platform and 2 U.S. material manufacturing operations to enhance the vertical integration of our business. Our strong local management teams are identifying opportunities to differentiate our products and improve our productivity. This year, we're increasing our internal investments to over $850 million to capitalize on innovative new products, increase automation and greater efficiencies as well as to enhance the 4 acquisitions.

Between 2016 and '18, we have many projects being implemented. In the ceramic segment, we're expanding capacity in the United States, Mexico, Italy, Bulgaria, Poland and Russia and adding new porcelain countertop plant. In North America segment, we've been expanding the LVT, laminate, wood, polyester carpet, carpet pad and rugs. We're also upgrading our nylon resin plant. In the rest of the world segment, we're expanding our LVT, laminate in Europe and Russia and boards, also entering the carpet tile in Europe and sheet vinyl in Russia.

In every segment, we're investing in new product innovations, increasing productivity and expanding distribution. These initiatives will increase our sales and profitability, maximizing the long-term value of our business.

The U.S. economic outlook remains solid, with job and wage growth sustaining consumer confidence and supporting continued economic expansion. More first-time homebuyers are entering the market and housing starts are up, despite lot and labor shortages. Harvard's LIRA index is forecasting home remodeling growth above historic averages over the next 12 months. The Architectural Billings Index shows commercial and institutional building trends staying positive.

In Europe, the economic forecast is for sustained and steady growth across the entire region. The Russian economy expanded for the second consecutive quarter, reinforcing an optimistic outlook for the remainder of the year.

I'll now turn over the call to Chris for his review of the segments.

Thank you, Jeff. During the quarter, sales in our Global Ceramic segment increased 9% as reported and on a constant days and currency basis with adjusted operating income rising to $163 million, 16% increase. We completed 2 European ceramic acquisitions that increased our segment sales by 6% during the period. Our legacy business improved from the prior quarter, but was limited in North America by capacity constraints in red body ceramic, and in Europe, by the temporary plant shutdown to upgrade our technical lines. In Europe, half of our new technical equipment has begun production and is operating at expected levels, and we are importing products to satisfy U.S. demand until our Mexican expansion becomes operational later this year.

Our U.S. ceramic business improved during the quarter, even with capacity limitations in our lower-end products, which have now been resolved. New home construction continues to outperform the commercial and residential remodeling channels, and we made further inroads with regional and national builders because of our advantages in style, performance and service.

We are introducing higher-value products from our new Tennessee plant, including longer, more realistic wood visuals, surface, textures and registration with our designs and proprietary slip-resistant surfaces. We have added service centers and are growing our sales with unique merchandising and promotions to optimize each channel. We're adding sales personnel and distribution points to increase our countertop business and are introducing new porcelain slabs that we'll manufacture in Europe.

The market for countertops made of quartz is about $1.2 billion and growing more than 10% a year. To greater increase our participation in quartz countertops, we are constructing a new plant in Tennessee that will be operational by the end of 2018.

During the quarter, we completed the acquisition of a talc mine in Texas that will ensure our material supply and enhance our competitive position. Even with our capacity constraints, our sales in Mexico outpaced the strong local market. Our Salamanca expansion will start up later this year, relieving our capacity shortfall and allowing us to expand our distribution in the U.S., Mexico and South America.

Our European ceramic business grew substantially as a result of our new acquisitions and new products we've introduced. Presently, we are introducing creative new designs and finishes in our mid-price products and tailoring our collections to satisfy the taste of regional markets. We are expanding our focus on architects and designers to increase our participation in the commercial and new construction channels. We're finalizing the products for our new porcelain slab line, which manufactures countertops and wall tile.

The shutdown to upgrade our technical ceramic plant impacted our sales in the last period. However, our service will be fully remediated later this quarter. Our Eastern European business has rebounded from the severe winter, and we are introducing larger sizes and Italian design into that market. The integration of our Italian acquisition is progressing as planned, and we are improving their productivity and broadening their offering.

In Poland, we are enhancing the cost structure of our acquisition and restarting existing equipment. We are providing technical expertise to enhance their product offering and improve their efficiencies, and we'll be installing additional capacity next year. We believe there will be further opportunities to consolidate the European ceramic market and expand our market share.

Our Russian ceramic business is significantly outperforming the market, with sales and margins improving as a result of our unique design, strong brand and robust distribution. During the period, the ruble strengthened against the dollar, with the economy expanding the last 2 quarters. We are increasing our capacity in Russia to support future ceramic growth.

During the quarter, the Flooring North America segment's sales grew 6% as reported, with adjusted operating income rising to $140 million, an increase of 12%. For the period, our hard surface sales outpaced carpet, and residential sales were stronger than commercial. We have implemented price increases and improved our product mix, which, have -- together, have offset material and other inflation. We are executing productivity initiatives across our operations, resulting in improved efficiencies and yields.

Our premium residential carpet collections are growing faster than the market due to increasing consumer preference for the superior softness and performance of our exclusive SmartStrand franchise. We have begun shipping SmartStrand Silk Reserve, the fourth generation of our proprietary fiber, with an even greater level of softness. Retail commitments are increasing for our luxury Karastan brand as we enhance its style and design.

Sales of our Ultrasoft and standard Continuum polyester collections are growing across all price levels of the market, and we have expanded our Continuum capacity in the prior -- in the period to meet increased demand. For the quarter, our rug business improved on the strength of our sophisticated new heirloom collection and the success of our growing outdoor rug programs.

The expansion of our corporate cushion operations is running as planned and improving our sales and distribution. During the period, we completed the purchase of a nylon polymerization plant, which we are enhancing to improve our competitive position.

Our Mainstreet Commercial sales expanded faster than our specified channels, with carpet tile continuing to gain share. During the period, our sales in the hospitality, senior living and retail sectors surpassed the institutional and corporate categories. Our new broadloom and carpet tile introductions received awards from the architects and design community at 3 premier commercial expos.

Our LVT and laminate sales outpaced our other hard surfaces, with our distribution expanding as a result of our leading design and performance attributes. Our LVT operations are improving, and construction is progressing on our new rigid LVT line, which will start up by the end of this year.

Our SolidTech rigid LVT has quickly gained traction in the market, and we are expanding sales in the commercial and builder channels. In addition to carpet, our hard surface collections were honored by the design community at the leading commercial expos. Our proprietary water-resistant laminate with enhanced visuals is growing as an alternative to wood, and we are increasing our capacity later this year to support additional growth.

For the quarter, sales in our Flooring Rest of World segment were up 2% as reported and 8.5% on a constant days and local basis. The segment was impacted by lower patent revenue and increasing material cost and currency changes, which are recovering with price increases. We anticipate that the majority of the increases will be fully implemented by the fourth quarter, allowing us to recover our higher cost.

Our LVT sales are growing significantly, although we are reaching the limits of our present capacity. Our new LVT production line in Belgium will introduce both rigid and flexible products and should start up in the fourth quarter. Our sheet vinyl production has recovered and is now operating normally at full capacity. We are introducing new residential and commercial products to improve our mix and maximize our results.

In Russia, we are finalizing the purchase of a building near our ceramic facilities to house our new sheet vinyl manufacturing operation. In Europe, our premium laminate collections grew substantially, and we've begun the installation of a new laminate press line to further expand our business and improve our product mix with value-added introductions.

Our Russian laminate sales are also constrained by our local manufacturing, which we are expanding mid-2018 to increase sales in that market. We are raising laminate prices in most markets to cover higher raw material costs and currency changes. We are enhancing our wood business with higher-value products and more efficient processes.

Our insulation business has been significantly impacted by raw material shortages, which have reduced our sales and dramatically increased our cost. Raw material availability is presently improving, and we are significantly increasing our insulation prices to align with the inflation.

Our roof panel sales have step changed, as the improving European economy drives higher consumer confidence and a more robust housing market. Raw material increases have impacted our roof panel margins, and we are implementing price increases to offset. We are seeing increased demand for our wood panels, and we have changed our production schedules to minimize the shutdown days during the traditional summer holidays. We are raising wood panel prices to offset higher cost and improving efficiencies with new investments and processes.

Construction of our new carpet tile plant is underway, and we will begin limited operations in the fourth quarter. We are recruiting experienced sales and operations professionals to introduce our innovative carpet tile solutions, featuring fashionable designs, easy installation and superior performance.

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

Thank you, Chris. Our net sales of $2,453,000,000 were an all-time new record, growing 6% as reported and 8% using constant days and foreign exchange. Our acquisitions added 2% to the sales growth rate for this quarter. Our gross margin as reported was 31.8%. Excluding charges, the margin was 32.7%. Gross profit was $802 million, excluding charges, and was favorably impacted by productivity of $38 million, price/mix of $39 million, and volume of $31 million, offsetting $58 million of input inflation. SG&A as reported was 17.3% of net sales or 17.1%, excluding charges, which improved 20 basis points over last year as we leveraged higher sales and continued our focus on cost control. Unusual charges were $25 million during the quarter and primarily related to plant consolidation in the Flooring North American segment and acquisition-related charges in our Global Ceramic segment.

Our operating margin, excluding charges, was 15.5% and improved slightly over the last year. Operating income, excluding charges of $381 million, was positively affected by $44 million of productivity, $38 million of price/mix, and $13 million of volume, offsetting $58 million of input cost inflation.

Our other income loss was a loss of $4 million and primarily was due to unfavorable foreign exchange impacting our results. Our income tax rate for the quarter was 24.5%. That compares to 26.3% last year. Our tax rate this quarter was favorably impacted by tax planning strategies related to our European ceramic acquisitions and partially offset by less favorable Italian statutory rates. We expect the rate to be 28% to 28.5% in the third quarter and then for the full year to be in the range of 26% to 27%. Our earnings per share, excluding charges, was $3.72, representing an increase of 7%.

Moving to the segments. In the Global Ceramic segment, sales as reported were $903 million, an increase of 9% or a 3% increase on a constant FX and days basis for the legacy business. We had growth in all regions, with Russia turning in the strongest performance for the quarter. Our operating margin, excluding charges, was 18.1%, which is up 110 basis points over last year. Primary factors for this increase were productivity of $19 million and volume of $14 million, with $11 million of input cost.

Our Flooring North American segment had sales of $1,040,000,000 and grew 6%, both as reported and on a constant basis, with very strong growth in laminate and LVT. Operating margin, excluding charges, was 13.4%. That was up 60 basis points over last year. The improvement was supported by $20 million of price/mix and $12 million of productivity, partially offset by $22 million of inflation.

In the Flooring Rest of World segment, sales as reported were $510 million, a 2% increase or 8.5% on a constant basis. Our LVT and laminate sales both had strong growth in the quarter. Operating margin, excluding charges, was 17.3% and was impacted by lower patent revenues. We had favorable price/mix of $14 million plus $13 million of productivity, offset by $23 million of input cost inflation.

In the Corporate and Eliminations segment, we had an operating loss of $10 million, and we're expecting the operating loss to range between $35 million and $40 million for the full year.

Jumping to the balance sheet. Our receivables were $1,640,000,000, with days sales outstanding up to 55 days compared to 54 last year. This was due to the changing mix in our customers in the quarter. Our inventories were $1,866,000,000, with the inventory days at 109 days for the year. It increased from 105 last year due to raw material inflation and more sourced product needed to support our LVT, ceramic and countertop businesses.

Our fixed assets for the quarter ended at $3,892,000,000, with capital expenditures in the quarter of $224 million and depreciation and amortization of $110 million. We're currently estimating our full year CapEx to be in excess of $850 million, with depreciation and amortization of almost $460 million. Our long-term debt ended at $2.9 billion, with our leverage at 1.6x debt-to-EBITDA.

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

Thank you, Frank. Mohawk's operating performance in the third quarter should continue to significantly improve, with sales and income strengthening further, even with higher material inflation and changes in patents. We're implementing price increases across most product categories and regions to cover material and currency changes in the third quarter. We will begin optimizing the acquisitions we completed in the second quarter by improving their strategies and enhancing their profitability.

Taking all this into account, our adjusted EPS guidance for the third quarter is $3.70 to $3.79. To enhance our long-term performance, we're investing at record levels this year to expand our product offering and capacity, improve our efficiencies and extend our geographical reach.

In the fourth quarter, we will incur higher start-up costs, as our production expansions ramp up, and we elevate our marketing activities to increase our sales. The expansion of our LVT, ceramic, laminate, sheet vinyl and carpet tile capacity will increase our future growth and profitability, strengthening our position as the leader in flooring. We will now be glad to take your questions.

(Operator Instructions) Your first question comes from the line of David MacGregor from Longbow Research.

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

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

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

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

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

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

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

Right. Is there historically a typical relationship between start-up costs and percentage of revenue capacity?

No, each one's different. It depends on if you're putting it in an existing plant, if you're starting a new plant somewhere else, if you're going into new product category in a new geography and you have to build up the sales and marketing to pieces. So depending upon where it is, some start up relatively quickly and have the sales to support. And others, there are newer technologies that take -- it could take a year or more to get optimized. And the same thing with the sales, you go into new geographies, the customers aren't waiting there for you to fill it up on day 1.

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

So just on organic growth. There does seem to be a notable step-up in the pace of organic growth over the last 4 quarters or last 12 months. So curious if you can talk a bit about your expectations for organic growth going forward. I think you guys have commented in the first quarter that you expect 5.5% for this year. But do you think that we've reached a, kind of, inflection point in the pace of organic growth of the organization? And then also, if you can talk about that 2017 number.

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

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

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

Got it. And maybe just lastly, going back to the questions from the prior person. Just in terms of price/cost, on either a quarterly basis or an annual basis, do you think that you'll be price/cost-positive in the back half of the year, given the pricing increases that you put out across the globe?

I think it'll be the fourth quarter before we get most of them implemented, so they're still being implemented now and they'll still be coming on in this quarter. Most of them will be in place by the fourth quarter.

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

Another fantastic quarter and an encouraging outlook. I was hoping that Chris is here and he's the Dal-Tile guy. Maybe you could give us a download where you're at in terms of adding capacity on the ceramic side. It seems like you're importing product from Europe to satisfy U.S. demand. Tennessee is online, and you have some things going on in Mexico. Where are we in terms of meeting your needs?

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

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

Thank you. LVT continues to grow significantly. Our estimate is that LVT in the United States will grow about 20% this year. With that, we have our -- the plant we put up is still improving its productivity and increasing its production capacity. In the United States, the plant will come up the end of the year at the end of the fourth quarter and start producing for next year. In Europe, all our lines are running at capacity. We're doing things to increase those. The plant in Europe will actually start up probably a month or 2 earlier than the one in the U.S. They both have capabilities to make all the products flexible and rigid in the marketplace. And combined across the world, we'll have over $1 billion worth of LVT capacity when it's through.

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

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

Yes, I would say most of the start-up -- or much of the start-up cost is going to be in the fourth quarter.

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

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

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

You had talked about the loss of patent revenue. I know, that kind of started here in the second quarter. Can you give us any kind of idea what that was like in the quarter? And has there been any change in your view of what patent revenue is going to look like over the next 18 months or so?

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

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

That was the prior number that we've given everyone, and we think there's some opportunities to improve it.

Okay. Second question you had in the ceramic division, you had 2 acquisitions. I believe, one was in Poland. Where was the other one?

It was in Italy. In Italy, and then we bought a small talc mine in the United States.

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

Sure. The one in Italy is right across from our existing Marazzi business, which gives us a good opportunity for synergies. They tend to be in the mid- to higher-end price category. I think it'll be an excellent acquisition for us.

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

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

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

Okay. And then just following up, you've mentioned sort of your approach into the countertop market. You mentioned the construction of a new quartz plant in Tennessee that's going to come up next year. It's certainly an area that's growing a lot, but it's also seen a lot of competition coming in. Can you talk to, generally, how you think about positioning yourselves in that market? And maybe sort of where you want to play in terms of price points or product offerings within that?

Different than some of the others. We've been building a countertop business for 10 years, and we have been putting in warehouses and distribution points, selling all different types in the United States, and we continue to expand those businesses. The total countertop business, we believe, is around a $5 billion industry in the United States. And the quartz part of it makes up about 25% of the business. And then we're going to move into both manufacturing quartz and manufacturing porcelain countertops, which are a small part of the United States business today. Italy is about 5 years ahead and is starting to grow there, so we're going to put a plant in Europe to start manufacturing those and bring those in. And we think it offers us another opportunity to grow our business with products that we have knowledge with.

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

Congrats, again. My question, a little different, but I'm wondering if you could somehow quantify what you think all of your revenues that are not flooring, i.e., countertops, walls, roofing, insulation are in? And what the growth rate of that business is relative to your flooring business?

It's still relatively small to the total. They're spread in all the different divisions or different pieces. And normally, we don't look at them that way. So I don't have an easy way to pull them together for you.

Any sense if they're growing faster, slower than flooring overall, Jeff?

Listen, yes. Some more, some less, as you would expect. They're all in different parts of the pieces, like the roofing business is growing faster now, but it's been depressed the prior 3 or 4 years. So we're getting back some of the pieces in Europe. The European economy is better, so the board business over there has improved lately. And we've invested things to consolidate difference. If you remember, about a year or 2 ago, we bought an acquisition over there. We've put them together, closed plants, so those are improving. So the European economy, all the pieces were suffering for a while. They're all bouncing back a little bit now, which is a good thing. So I -- but it's still a relatively small part of the total.

And any color on whether you got traction with the padding carpet product you introduced earlier this year?

The carpet pad, we have, I think, about 5 or 6 plants in the United States. We've built a new plant in -- to satisfy the needs in the southwestern part of the country. The plant's up and running well at this point, and we're increasing our revenues.

No, I was asking about -- I think you call it Airo, the combo product, where you already have the backing installed to the carpet.

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

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

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

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

And I'll just echo what Jeff said. In terms of distribution, we've been in this category a long time with stone, quartz, so we've got a good foundation to start with.

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

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

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

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

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

The other ones are still growing. They're just growing slower by maybe 1% to 2%.

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

I guess, just maybe back on the countertop piece. Is -- how do you guys think about the greenfield opportunities within countertops versus maybe something on the M&A side? And then maybe more broadly, how do you feel about the pipeline within the M&A more broadly?

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

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

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

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

Just on that topic on the U.S. and the ceramic piece. Can you just explain what exactly slowed the growth this quarter? And recognizing there is puts and takes on the capacity side, are you guys turning away customers? Or is this something that you guys could correct in the next quarter or so?

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

Okay. And Jeff, is there any issue that you're losing some sales there that you can't correct? Or do you think the import model is picking all that up?

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

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

We've seen a step-up in the European market, and everything is improving. Our sales, as you said, are up 8% on a constant basis and days on a local basis there. We're investing in everything over there to expand our LVT business, our laminate business. We're introducing carpet tile. We're going into Russia with new capacity in laminate. We're expanding our -- we're going into the sheet vinyl business over there. We're expanding our ceramic business in Russia. Our European businesses have more capacity in the ceramic in the southern end of the piece. It just feels better. And whether we keep this rate up, that's a different question.

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

This is Mason on for Mike. So your Main Street segment is growing faster than the specified market in carpet tile. How much of your carpet tile business is Main Street versus specified? And why the noticeable difference between the 2?

I think the point was not just carpet tile, at least, in this quarter. Business changes from quarter-to-quarter. In this quarter, our Main Street business grew faster than our commercial business overall. And then our carpet tile business is also growing faster than our total commercial carpet, which includes broadloom carpet. I'm not sure if that was the answer to the question or not though.

No, that's helpful. And then the new carpet tile plant in Europe that will start in 4Q. What countries will this serve? And is this your first carpet tile exposure to Europe?

It's the first carpet tile -- it's our first carpet business outside the United States. The gentleman who runs our vinyl business in Europe also came out of Balta, and he ran a carpet business in Europe and has good knowledge about it, which is why we decided to go into Europe because of the talent he brings to it as well as we understand how to make it. So we're building a sales force as we speak to start selling it. It will not only to sell that, it'll also sell our vinyl products, our laminate products and our other products that we're making to build a commercial business, which is a fairly small part of our total business in Europe.

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

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

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

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

I think there's a sort of lumpiness to big -- a couple of categories. One is the acquisitions we bought, we're putting money into expand or improve those to get the profits up where we want or the sales up. We pulled some of the -- these projects that we're talking about. I mean, these are all huge investments in different pieces, and we pulled some of those back into earlier. So some of the expenses will come into '18 -- '17, where are we, '17. Some of the expenses will come in here.

And a lot of this too -- there's a good chance at the end of year, some of the payments could come a month earlier or a month later and fall in one year or the other. Some of it's going into additional ideas about more product innovation, which we're putting new capital in to make those. And then the quartz plant, we pulled some of the expenses in there. You may have seen something about a plant or property we bought in Tennessee. That payment was for the building that we're going to put the quartz plant in.

And Laura, I would just -- to address your question about maintenance and productivity, et cetera, I would just say that there is -- the additional amount that we're putting in doesn't include any maintenance, if that was part of your question. And you know the maintenance, we're working to drive it down. It could be $100 million or more as we go forward. And then the balance is going to be split, probably more of it going to capacity, maybe 2/3 of it going to capacity, and about 1/3 of the balance going to productivity in round numbers.

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

First question, I guess, Frank, just kind of housekeeping on the tax rate, the 28% to 28.5% in the third quarter. Is that a reasonable kind of rate going into 2018?

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

Okay. And then, I guess, moving on in our travels, we've seen that your LVT product is being offered as a standard feature, at least, in one of the homebuilders' entry-level products. I was just curious if this kind of relationship, if you have that with several homebuilders, and do you see that as kind of a driver of your growth?

The homebuilding piece is one of the faster -- is the fastest-growing part of the U.S. business. It's growing probably 8%, 9%, depending on whose estimate you want to use. It's a large part of our business. We sell all kinds of products through the channel to those homebuilders. We have relationships with the national homebuilders as well as the regional homebuilders to specify our products into the marketplace. They use wood. They use carpet. They use laminate. They're using vinyl. They use countertops. All the different categories that we make are sold to the channel, and we get there through a lot of different ways.

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

Jeff, premium carpet, so your Silk Reserve, et cetera, is growing faster than the industry. I guess, we haven't really heard that for quite some time. So I'm wondering, is that -- how much would you attribute to that being a great product and pulling demand versus is the consumer finally -- are we done with this mix shift down and the consumer is starting to move up in mix?

I think there -- let me try to answer it 2 different ways. One is that softness is becoming a more and more important part in premium carpet. The carpets that we make are softer than anybody else's in the marketplace, and the newest things [we're] coming out are even softer than those were. Now while that's going on, you still have polyester carpet growing in the marketplace, and the polyester carpet is at lower price points, and it tends to pull down the average mix. So you have both things happening at the same time, and I think that we're doing better in the higher end of the market than the market in general.

Perfect. All right. And then on the M&A, you did a couple of acquisitions that are vertical. Is that -- was that just by happenstance that they both occurred? Or are you putting more focus on going vertical? And if you are, what -- how does that help your op margin, if you will?

We really haven't changed the strategy. We're quite comfortable backward-integrating into businesses and improving our cost position. And it's really dependent upon what becomes available. Some of it we do through greenfield and some we buy. So it's not a change in strategy.

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

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

Your next question comes from the line of Stephen King (sic) [Kim] from Evercore ISI.

Strong quarter, guys. It's Steve Kim, by the way, from Evercore, in case you were confused. I wanted to ask you about the start-up costs. I know that you've talked a bit about it already, but what was the start-up cost in 2Q and in the first part of this year? And I'm trying to understand whether or not the numbers that you gave -- or the $45 million for the year, which was unchanged, is that netted out of the productivity number you're giving or is it a separate offset?

So first, on your latter part of the question, start-up costs are not included in productivity there. And then if you look at how much we've incurred in the second quarter, we incurred about $6 million start-up costs, and in the first quarter, we incurred about $11 million of start-up costs.

And what was said is that the total should be around $45 million, with more in the fourth quarter than the third quarter.

Perfect. Yes, that's very helpful. And then Frank, when you were going through all the puts and takes on the operating income, did I hear you say that volume benefit for ceramic was $14 million, $1-4 million and the total company was $13 million, 1-3 million? Or did I hear that wrong?

Volume was $13 million for the total company. And yes, ceramic was $14 million, correct.

So the difference there and that would seem to suggest there was no volume benefit in the other 2 categories or the other 2 segments. Just wondering if you could flesh that out for us a little bit. I mean, was that because you had, maybe, some dysfunctionality somewhere? Can you just sort of talk a little bit about that?

I think what is causing it to look strange like that, Steve, is the IP that we lost, the higher margin we sourced it to.

Got it. No, that would definitely do it. And just one last thing. In your prepared remarks, I think, you said that sales should strengthen in 3Q. Just wanted to make sure that we are all on the same page on what that comment was referring to? I assume that you meant that your growth rate, which was about 5.6% on an organic basis, would be higher in the back half of the year. Is that what you meant? Or did you mean something else?

What we meant was that we gave earlier direction that we thought that the legacy businesses would grow 5.5%. And in the first half, they grew less than that and in the second half, we expect to make up the difference in the pieces, plus the addition of the acquisitions we make.

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

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

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

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

I'm not sure the general business is better across the pieces. We have new product launches, and we're going into new product categories, and we're doing things to expand our business in different places.

And then lastly, in terms of pricing in the carpet business, you've taken some steps. How has that gone? And a little bit more clarity on the flow through of that relative to catching up to the input costs or digging you out of the input cost hole that you have been in? What does that look like?

We've implemented 2 price increases. The first one is implemented, the second one is going in. Some of it will be coming in, in the third quarter as we speak. In the second quarter, we offset all the cost increases, but it was using some of the mix improvement that we've done to get it. And so the industry is pushing through the price increases. We need to cover the cost.

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

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

We haven't put together all the budgets for next year and the pieces, so I can't give you a rational answer on the question. We're still focused on this year, which we're only about halfway through. All of the businesses are coming up with new ideas to increase the productivity and to bring new products to market, and then we're trying to relieve any constraints on the business through all the assets. And we think those things are going to have long-term positives for our profitability and our sales growth. With all those things, when you put out all this new equipment, you have the lag time between optimizing the sales and optimizing the equipment, so that's going to all be happening over the next 12 months as we try to bring all these things up. And from quarter-to-quarter, I can't give you an exact piece. But I can tell you, a year from now, we'll be in much better shape.

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

I think the biggest opportunities would be in our ceramic business and owning mines to support the raw materials. In some places, we have them. In other places, we don't. In some cases, it makes sense and doesn't. I guess, most of the other business, the board businesses, which would support our laminate, we buy raw materials from them. In Europe, we're buying a lot more waste products to put in, and we're looking for ways of utilizing waste products around like we do in polyester bottles in different places. So we're fairly well integrated, but there's some places where we have holes. And if it comes available, we might make changes, like we did in the carpet business with the nylon as -- we were doing just fine without it, but there was an opportunity and we took advantage of it.

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

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

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