莫霍克工業集團 (MHK) 2017 Q3 法說會逐字稿

Good morning. My name is Craig, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mohawk Industries Third Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, ladies and gentlemen, this conference is being recorded today, Friday, October 27, 2017. Thank you.

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

Thank you, Craig. Good morning, everyone, and welcome to Mohawk Industries Quarterly Investor Conference Call. Today, we'll update you on the company's results for the third quarter of 2017 and provide guidance for the fourth 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 third quarter, Mohawk delivered record earnings and EPS with sales growing approximately 7%. Our business outside the United States experienced the strongest revenue growth as economies of those countries expanded. In the period, we overcame rising material costs, disruptions from hurricanes and reduced patent revenue. Our price and mix continue to improve as we enhanced our product offering with unique designs and differentiated features. To recover material inflation, we implemented enterprise-wide pricing actions this year. And with productivity and mix, we covered our higher cost earlier than we expected this quarter. Our many operational initiatives and process improvements resulted in significant productivity gains of approximately $49 million, and we incurred $8 million of start-up costs in our results.

For the full year, we are investing $900 million to optimize long-term results by entering new product categories, extending our reach into new geographies and facilitating growth in our existing businesses. These projects include ceramic expansions in Mexico, Russia, Italy and Poland; additional premium laminate, engineered wood, rug and polyester carpet capacity in the United States; and increased premium laminate capacity in Europe and Russia. Our investments will satisfy increasing demand for our products as well as introduce state-of-the-art manufacturing technology to further our position as the industry's innovation leader. During 2018, in the United States, we will launch production of rigid LVT as well as quartz countertops. In Europe, we will enter the rigid LVT, carpet tile and porcelain countertop business. And in Russia, we will open a manufacturing plant to participate in the large sheet vinyl market.

Our strong financial position allows us to aggressively grow through both internal investments and acquisitions. This year, we've completed 4 acquisitions that have broadened our product offering and enhanced our manufacturing advantages. Combined, all of these initiatives will allow us to drive our long-term profitability and outperform the market. With our strong management team and balance sheet, we are well positioned to continue our extraordinary performance of the last 5 years.

In the United States, job creation has been solid throughout the year, and consumer sentiment remains positive. The U.S. economy and the housing market continues to grow at a more measured pace even with the disruption of September's hurricanes. Single-family housing starts are growing, and multifamily construction is contracting this year. The October National Homebuilders Association showed builder confidence rising to the highest level since spring. Remodeling trends are projected to remain strong, and recovery in Florida and Texas regions will fuel substantial renovation and rebuilding. The October Architectural Building Index shows positive commercial and institutional building trends in most of the country, with a slight softening in the West. Outside the United States, the International Monetary Fund has increased its forecast for economic growth in Europe and in Russia through 2018.

Now Chris Wellborn, our President and Chief Operating Officer, will provide you an overview of our segments' performance during the third quarter.

Thank you, Jeff. Our Flooring Rest of World segment had an exceptional quarter, with majority of our manufactured product sales and earnings growing dramatically. Our patent revenue is running at a higher rate than we anticipated due to the broader use of our patents and increase in worldwide sales of LVT. During the period, our price increases and mix improvement offset our inflation and currency changes.

Third quarter results were also enhanced by a reduction in summer shutdowns, allowing us to ship more and customers increased purchases prior to pricing actions, neither of which will occur going forward. Our laminate innovation and proprietary structures and waterproof technologies is increasing the selection of our products by customers who would ordinarily purchase wood flooring. This, combined with our broad array of sophisticated designs, is expanding our lead in the premium laminate category. In this quarter, the start-up of our state-of-the-art laminate equipment will enable us to expand this growing category and broaden our distribution.

The utilization of LVT is continuing its rapid acceptance in the marketplace. We are using the value of our well-known brands to segregate different channels and price points to address all components of the LVT market. Our present European LVT manufacturing is running at capacity, and our new plant will begin operating by the end of the year. The new plant will expand our capacity of flexible LVT as well as produce rigid LVT. As always, we will bring new innovations to LVT to differentiate our value proposition in the marketplace. Our process improvements and investments in leading technology continue to reduce our cost, enhancing our position as the LVT market grows and becomes more competitive.

We improved the visuals in the sheet vinyl to offer a value alternative for LVT, and we are increasing our participation in the commercial sheet vinyl sector. We are exporting products to Russia to prepare for a new sheet vinyl plant, which will be operational by the end of next year. We are also expanding the segment's commercial sales force to increase the specification of sheet vinyl, LVT and our upcoming carpet tile collections. Our new commercial carpet tile plant should initiate limited production in the fourth quarter.

Our insulation business has improved as we have aligned our pricing with the dramatic inflation of raw materials. Our production is still being limited by material shortages, which we anticipate will be resolved early next year. If our raw material costs remain elevated, it may encourage the substitution of alternative insulation products that could impact our sales of these products. Sales and margins in our wood panel category have increased as the market strengthened.

In the quarter, our Global Ceramic segment sales increased 9% as reported and 7% on a constant-days and currency basis with the strongest growth in Russia and Mexico as well as in our acquisitions in Italy and Poland, which had been integrated with our existing European ceramic business. The segment's operating income rose 5% as reported and 10% on an adjusted basis, driven by improved productivity and volume. New capacity came online during the period with new production in Mexico and our modernized commercial tile plant in Italy. These capacity increases will allow us to more aggressively expand our future sale.

Our U.S. ceramic business was softer than we anticipated due to the impact of hurricanes in 2 of the country's largest ceramic markets. Though the recovery in these regions has begun, we are projecting lower volumes through the end of the year. As our new ceramic capacity comes up, transitioning sales from outsourced products to manufactured products is taking longer than we anticipated. Additionally, the timing of product changes for some of our large customers was delayed. We anticipate our fourth quarter ceramic sales will improve as we execute more aggressive sales strategies. We have introduced new porcelain collections with greater durability and patented slip resistance, highlighting the easy maintenance, safety and health benefits of our products.

In the third and fourth quarters of this year, we are opening about 15 tile and stone centers in the U.S. at key U.S. markets. In the period, our manufacturing plants were operating at record levels for volume, quality and cost. We continue to expand our countertop sales and distribution, significantly increasing our participation in the quartz category to support our upcoming production. We are reconfiguring a site in Tennessee to install new quartz manufacturing equipment, which should begin operations by the end of next year.

Our sales and margins in Mexico increased as we broadened our product offering and enlarged our customer base. We have completed the expansion at our Salamanca plant, and all the new production lines are presently operating. This additional capacity with capabilities to make larger, higher value sizes in ceramic will allow us to expand our sales in the U.S., Mexico and South America.

During the period, our European ceramic business increased dramatically with growth in our local markets and the addition of our Italian and Polish acquisitions. We are implementing many investments across the region to improve our productivity and introduce new product innovation. The final upgrades at our Italian commercial porcelain plant have been completed, and we are expanding our offering to utilize our new operations. We have just completed our major European ceramic trade show where we introduced new collections differentiating each of our brands. Our new ceramic slab manufacturing is progressing as planned, and we are finalizing our large countertop and wall panel collections to enter this new category.

We are improving our product offering in the Bulgarian market as we invest to create larger sizes and improve our efficiencies. We have implemented our Italian information system in Bulgaria, and we are preparing to deploy the system next year in our recent acquisitions. We have started up the idle assets at our Polish plant, and we are installing additional equipment to broaden our position in the Northern and Central European markets.

The Russian economy has bottomed out, and the country's GDP has started to grow. The Russian ceramic industry's volume and margins are presently at a cyclical low. Our ceramic business is meaningfully outperforming the industry, and we are adding capacity to increase our share as the market expands. With our premium designs, distribution and network of owned and franchised shops, we are well positioned as the market leader.

For the quarter, our Flooring North America segment's profitability decreased as reported but increased 11% on an adjusted basis with adjusted margins growing 140 basis points as sales rose 2%. Our price, mix and productivity improved during the period, covering increases in material and other inflation. By improving the efficiency of our administrative operations, we lowered SG&A as a percentage of sales even as we expanded our sales organization to foster greater engagement with our customers. Our new product introductions improved our average selling prices and margins, and our process innovations and investments in manufacturing technology improved our cost. Capacity limitations in laminate, LVT and some residential carpet categories constrained our sales during the period and will be addressed in the fourth quarter. Additionally, the hurricanes in Texas and Florida interrupted normal purchasing patterns and impacted our sales during the period. After a short-term decline, we anticipate increased sales in these regions over the next 2 years as the affected communities repair and rebuild.

During the period, our soft surface sales growth exceeded hard surfaces, which were constrained by production limitations. Growth in our residential carpet outpaced our commercial sales. In carpet, we announced a 5% to 6% price increase on our products effective end of this year to cover our increasing cost. With their superior softness and performance attributes, our SmartStrand collections continue to take market share, expanding our leadership in the premium market. Presently, our new SmartStrand Silk Reserve and AirO introductions are being installed in leading retail stores around the country. Each of these collections offers a unique differentiated proposition to the consumer. We are increasing the distribution of our luxury Karastan brand, which provides leading style and design in premium carpet. Our Continuum polyester continues to expand its position at the medium- to low-end price points, and our soft collections made of recycled materials provide a superior alternative in the category.

In commercial, the specialization of our sales force by end market has increased the specification of our products. Our award-winning carpet tile collections in squares, rectangles and planks work together to provide designers with unsurpassed options to create unique designs in every commercial space. We are broadening our offering at mid-price points to provide more stylized options and increase our share. With new product collections and the expansion on our sales force, we are increasing the non-specified sales of our commercial collection in the retail channel.

We have enhanced the productivity of our U.S. LVT operations, and we are expanding our product offering in both residential and commercial categories. We introduced a proprietary rigid LVT collection designed for exceptional stability and durability as we prepare for new U.S. LVT production in the second quarter next year. When the line is complete, we will be the only U.S. manufacturer positioned as a competitive alternative to imports that can supply both high-quality rigid and flexible LVT. We anticipate that the LVT market will continue to grow at higher rates for the foreseeable future, and next year's capacity expansion will extend our position as the largest domestic manufacturer in the category.

Our new laminate production will be operational this quarter and will allow us to expand our successful waterproof laminate that improves on Mother Nature in both performance and visuals. The increased capacity will allow us to extend the distribution of our new collections and enhance our premium position in the marketplace.

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

Thank you, Chris. Net sales for the quarter were $2,449,000,000, up 7% over last year, with the legacy business growing 3% on a constant exchange rate basis. We had our strongest growth in the Rest of World segment for the quarter. Our gross margin as reported was 32%. Excluding charges, the margin was 32.5% and was favorably influenced by $63 million of price/mix and $40 million of productivity. These were partially offset by $61 million of input cost inflation as well as lower IP.

SG&A as reported was 16.5% of net sales or 16.3%, excluding charges, which was slightly better than last year. Productivity of $9 million offset investments back into SG&A of $6 million. We had unusual charges in the quarter of $17 million, which were primarily related to plant consolidation in the Flooring North American segment and acquisitions related to charges in Global Ceramic.

Last year, we had a net benefit of $12 million related to a legal settlement. Our operating margin, excluding charges, was 16.2%, up slightly over last year. The results were positively impacted by $62 million of price/mix and $49 million of productivity, offsetting the $61 million of input cost in IP.

If we look at income tax, the rate for the quarter was 27.6%. That compares to 26.4% last year. We expect the rate to be 27% to 27.5% in the fourth quarter. In 2018, we expect the full year rate to range between 28.5% and 29.5% as the geographic mix of our earnings shifts to higher tax jurisdictions. Earnings per share, excluding charges, was $3.75 and increased 7% over last year.

Moving to the segments. In the Flooring Rest of World segment, sales, as reported, were $523 million or up 13%. This was an 8% increase on a constant exchange rate basis. We had an extremely strong growth in most products with volume adding $8 million, along with accelerated implementations of price increases as the price/mix contributed $29 million to the quarter. In our operating income margin, excluding charges, it came in at 16.2% with price/mix of $28 million and productivity of $8 million, which helped to mitigate $22 million of input cost inflation as well as IP loss.

In the Global Ceramic segment, sales as reported were $893 million or an increase of 9%. FX and acquisitions added approximately 8% to growth even with storms, product transitions and delayed load-ins that we had as headwinds. Our operating income margin, excluding charges, was 16.8% with productivity of $16 million and volume of $8 million covering input cost increases of $10 million.

In the Flooring North American segment, sales, as reported, were $1,032,000,000, up 2% over last year. The storms and capacity limitations were headwinds, but price/mix of $41 million drove higher sales performance. Operating income margin, excluding charges, was 16.7%. That was up 140 basis points, with $32 million of price/mix and $25 million of productivity offsetting $29 million of input cost increases.

In the Corporate and Eliminations segment, we had an operating loss of $10 million. We expect $35 million to $40 million of loss for the full year.

We jump to the balance sheet. Receivables ended up the quarter at $1,656,000,000, with days sales outstanding of 58 days. Our inventories ended the quarter at $1,911,000,000. We had 112 days of inventory on hand, with raw material inflation and source product growth impacting the days. Fixed assets were $4.1 billion with third quarter capital expenditures of $229 million and depreciation and amortization of $114 million. Currently, we're estimating full year CapEx of almost $900 million with an estimated depreciation and amortization of approximately $450 million. Our total long-term debt was $2.7 billion with leverage at 1.5x debt-to-EBITDA.

I'll now turn the call back over to Jeff.

Thank you, Frank. In the fourth quarter, we anticipate that the business will improve as we benefit from innovative new products, increased volume and the performance of our recent acquisitions. We expect higher sales with the relief of some of our capacity constraints, enabling us to expand our market position. During the period, we will absorb higher start-up cost estimated at $15 million in our results as new operations come online. The disruptions caused by the hurricanes in the U.S. should diminish as those markets begin their recovery. Greater productivity, better product mix and price changes should improve our fourth quarter results, overcoming the reductions from our expired patents.

Taking all this into account, our EPS guidance for the fourth quarter is $3.25 to $3.34, excluding any onetime charges. We're leveraging our strong financial position to invest in the business at record levels, expanding our capacity in most categories, broadening our product portfolios and entering new markets. The 4 acquisitions we have completed are enhancing our results and furthering our global strategy. Next year, start-up costs and marketing investments for our new operations will vary quarter-to-quarter as we expand our business into new products and geographies, with many of the benefits in future years as our utilization increases. Our organization's ability to maximize internal investments and execute acquisitions around the world will deliver greater long-term growth and profitability.

We'll now be glad to take your questions.

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

Nice job at a tough quarter given the hurricanes. Jeff, there's a lot of capital spending this year. It looks like it's gone even higher than $900 million, and I was hoping you could give us a view on the trajectory of sales gains you're going to experience from this. What's the sales impact in 2018, '19? Not really talking about the quarter, I'm talking kind of big picture into the next 2 to 3 years. You've got the $900 million this year, which is more than you spent last year. What's the sales benefit and what's the cadence look like?

Well, listen, our internal investments provide the highest returns of anything we can do. We said before that the capital expenditures of last year and this year would add about $1.4 billion of new capacity to our existing businesses. In ceramic, we're expanding in 4 countries. In the U.S., we're expanding laminate, wood, rugs and carpet. We're expanding laminate in Europe and Russia. We're entering new products and geographies across the world to give us new opportunities. In the U.S., we're going into rigid LVT and quartz countertops. In Europe, we're entering the rigid LVT, carpet tile and porcelain countertops. In Russia, we're going into sheet vinyl. All these investments should help us drive the growth. Now depending upon which ones they are, if we're going into new categories of businesses, the growth to fill up will take longer than it was that we're already in the market with existing infrastructure.

That's helpful. And maybe you could talk to me a little bit about SG&A spending. It seems, and correct me if I'm wrong, the dollars spent on CapEx is really to add capacity and to improve productivity. But if you're going to be -- have more product coming to market, you're going to have to invest in marketing and distribution. How should we be thinking about SG&A? What are you doing on the distribution and marketing side to get the product to the consumer?

We've already started investing in different SG&A even as the business -- so we gave up some of the leverage we could have had this year by putting more salespeople in. We're putting more products in the marketplace. We'll have additional costs as we drive it further in each one. We talked about putting -- expanding our commercial sales force in Europe to sell the different products. We're going to have to invest in new salespeople to sell the products in Russia and around the world. What happens is the costs are front-end loaded in front of the sale because you have to put the investments in before, so it will have an impact on using some of the leverage we would have had.

And the amount that we've invested through 3 quarters this year is about $20 million in SG&A for all of these types of marketing and sales investments that we're referring to.

Maybe you could give a sense, just saying -- taking off what you said, is it fair to say there's been a bigger increase in CapEx to grow capacity and you'll be increasing your investment in marketing and distribution next year on the distribution side and kind of going to mirror what's happened with CapEx? Any guess or...

It will go up. Now some of it will be in the start-up cost that we break out for you because you have to put in all the investment upfront and some of it, we'll give it to you later as we did this year.

But that's already starting to be spent and that will continue a little bit into the first half of next year, correct?

It will continue all through next year as we're making a lot of investments so that the business does well not just now but next year and the year after.

Got it. And so you're investing basically the SG&A so you get the distribution for the capacity you're adding and that's kind of going to help enable you to get your top line targets.

Now once we get the business up where we expect, then the SG&A as a percentage should start coming down.

Got it. So is there something we can look at like an investment period that it peaks and then at some point in the second half of '18 or '19, it starts to decline on a relative basis and get the leverage back?

Now given all the number of projects we have, as we've told you, they're coming in at different points in time. So each one of them will have those investments at the front end of each one and then they could be paring off as the next one picks up.

Got it. So this is going to be a multiyear phased project that you roll out. Helpful color.

Our next question comes from Stephen Kim from Evercore ISI.

I wanted to -- I know you're doing a ton of different projects all around the world and obviously, you touched on that in Bob's question and your opening remarks. But one of the things that I thought might be helpful, as we're just getting to the point where a lot of this capacity is starting to be turned on and then getting loaded, is maybe help us understand, in 3Q, what capacity was open in 3Q and actually shipping in 3Q that was not in 2Q. And in 4Q, what's going to be opening up or what will be shipping that was not in 3Q? Understanding there's a longer-term trajectory here, I think the near-term cadence might be helpful if you could give us some color.

I think, let's see, in Q3, what came online was a plant in Mexico that has started up and all 3 lines are running, so it started coming up. And then we finalized the replacement of equipment in Europe in our ceramic commercial plant, and so that capacity is up and running now. In the fourth quarter, let's see if I can get (inaudible) right, the fourth quarter, the LVT plant in Europe is starting to come up. Is it? The laminate new capacity in the United States is coming up. I think the laminate capacity in Europe is coming up. And let's see, the carpet tile is coming up in the fourth quarter. It'll just start in limited ways. And then I think maybe some capacity in Russia might be coming up. And the slab line in Europe, I think, may be coming up. This is just to name a few. Listen, I deserve an award just to be able to remember all of it.

I was going to say, it is remarkable but your 3Q Rest of World was up as strong as it was when I heard you mentioned was an EU, European commercial plant. Are you sure there wasn't any sort of additional capacity brought on in Flooring Rest of World in 3Q versus 2Q?

No, it was an exceptional quarter for all our various manufactured products were growing dramatically. We got the positive impact of price and mix offsetting currency and inflation. We got the patent, we're higher than we projected to the broader use our technologies and increased sales of LVT. And then the other thing that did help it, we reduced the summer shutdowns. We actually staffed different this year in order to allow us to run through some of the summer shutdowns differently in Europe, so that gave us more to sell. And then one more, some of the customers increased purchases ahead of price increases as we go through. So all those things happened. Now because of those, we don't anticipate the same level of improvement in the next quarter.

Got it. Yes, that's helpful to understand. Great. And then second question, just wanted to talk about ceramic. Obviously, some people are going to be zeroing in on that segment, which had some challenges, and you're not specifically quantifying hurricane and I understand that. When you rattled through or sort of went through the various things that were driving the softness there, it sounded like most of those were things that will dissipate possibly as quickly as in the fourth quarter. But then in your opening remarks, Chris mentioned something about new sales strategies making you feel that the business will improve in 4Q. And so I just wanted to understand even if you didn't have these new sales strategies, which I assume will be successful, wouldn't -- based on what you're seeing so far in October, wouldn't we think that the dissipation of the source transition and the large customers postponing and things and the hurricanes and whatnot, wouldn't that pretty much allow for an improvement in the ceramic even before the sales strategies?

Let's see. Well, you asked a lot of questions. Let's me see. Let's see if we can do the hurricane piece first. The hurricane impacted us in 2 large markets. It's really hard to tell what people would have ordered when they didn't order it, is it? But we've put together a guess on the thing internally and I guess we'll give it to you, we believe the hurricanes impacted our U.S. businesses somewhere between 1.5% and 2% in the sales. Now just one more to remind you, all the different products going in, flooring is one of the last thing that goes in. They have to replace the roofs, the windows, get the water out of the walls. So whatever happens, we're trailing a little bit for most of the other product categories as we go through, and we anticipate less impact in the fourth quarter from the hurricanes. And over the next -- over the long term, we're expecting it to help our business. Chris, you want to give him some overview on the ceramic growth?

Yes. Steve, the way I would think about ceramic, first, if you look outside the United States, we're growing very rapidly, Mexico, Russia, the new acquisitions, and we're in the process of adding capacity to make that even grow better. We've got a couple of transitions in the United States as we're bringing up our new capacity. We are transitioning product that we were sourcing before. We'll now make it, but what has to happen is you have to move out the old product and let the new go in, which is happening right now. That will continue going into the fourth quarter and strengthen next year. The second is we've got new business with large customers. We're taking out the old product and waiting for them to take the new product. Again, that transition will help us a little bit in the fourth quarter but mainly next year.

Our next question comes from Mike Dahl of Barclays.

I just wanted to follow up on that last comment regarding the transition happening within the ceramic production. I think you have mentioned that it's taking longer than originally anticipated to go through this transition from sourced to internal. Can you just give us a little more color on what's drawing that out more than you anticipated?

Well, what's happening -- and let's take the new technical capacity that we're adding to these commercial products. What you have to do is take those sourced products that have been specified, reduce those and then go get new specifications for your new products, which will be at a higher profit and help us going forward, but it takes a while to go through that transition.

Got it. And in terms of, I guess, there's nothing -- is it a -- I guess what I'm getting at is, is it a market issue or an internal production issue that's leading to that time line to be different than what the original anticipation was?

Listen, it's not any different than our original anticipation, is it? What happens is when you're sitting there with tight capacities, you can't go out and aggressively sell things. When you're putting in new capacity, you don't know exactly when the date is going to start up and where it is, so you can't start selling it. Then some of the customers make other arrangements, and they're not just waiting for us to walk in and say here we are the day after the equipment starts running. I mean, it's not turning the light switch on and off.

Okay, understood. And then regarding the expansion into countertops, I think you mentioned that you're reconfiguring a Tennessee facility. Which facility was that? And how should we think about kind of the size and number of lines that is planned once you get that up and running with the countertops?

Well, it's not a site that we had. It's a site that we bought that was used for something else, and we're putting in our quartz production capability into that site. We think the countertop market is a great opportunity for us. It's $5 billion with quartz estimated at $1.2 billion and growing more than 10%. We're already expanding the sales of quartz through our stone centers. This new plant will be operational at the end of 2018.

And it's set up to accept many new lines if we choose to do that.

Our next question comes from Susan Maklari from Credit Suisse.

My first question is around the Chinese government recently put a permit in place limiting the ways that they're taking some of the imports that they're taking from the U.S., and it seems to be impacting some of the bottle recycling prices that are out there. Given your backward integration in carpet, specifically, do you see any of that coming through? And how should we think about that relative to maybe some of the inflation that you've been seeing in that business?

The bottle market is an unusual market. You go through the times of the year. People drink a lot of them. Other times, they don't. At different points in time, the exports will be really high and really low, and it goes all over. It's a good marketplace with supply and demand that goes up and down as the bottles get more and less than supply. What we do is look over the price over the entire year and try to average them out for the whole year. And I think that at the moment, with the Chinese taking less, it should help us in the piece. But on the other hand, there's more people using them.

Okay. So you haven't seen any net benefit to date yet from that though?

Listen, There's fluctuations every damn day we buy these things. It's an open market. You bid on them as they go, and you get what you get at different prices. It's not a -- there's hundreds of people doing them. There are different markets of them. There's different freights to get from different places. It's not homogeneous like you think.

Right. Okay, that's helpful. And then you mentioned that you've been seeing a bit better trends in the patent revenue than what you had been initially sort of forecasting or expecting. Can you give us a little bit more color there? How sustainable is that? And how should we think about that relative to the $35 million run rate?

So originally, we said it was $35 million. We said last call that we thought it was coming in higher than it was. What we found is the other patents which -- we have a broad use of them in designs in both designs, features and benefits that different people use around the world in laminate as well as into LVT. So the broader use of it is going on. The increase in LVT sales is just happening around the world as we go through is helping it. We've decided not to be specific about the IP going forward because it really impacts our execution as we go through with the -- as we try to maximize it, and we're just going to try to treat it like other products.

Our next question comes from John Baugh from Stifel.

Let's see, I had a kind of high-level question on LVT, and it's growing rapidly here. I presume it's growing internationally as well. And I'm just wondering, Jeff, as you look at that, how that affects Mohawk. Obviously, you're one of the largest, if not the largest, producers of LVT in the world. I presume you're still though outside to some degree and you're adding capacity, but also this robs from the other categories of flooring. And I'm just wondering from your perspective, is there a mix favorable on margin from this? Is it offset though by some things that maybe you don't -- won't be able to produce as much of in fixed plant? Any thoughts there?

Let's see. First, the U.S. is ahead of the rest of the world in the use of LVT and there's more -- at more use of it in different commercial and residential uses as well as different price points, and it's evolving. So what's happening is we think we're putting ourselves in the best position by having the lowest cost and largest capacity in the U.S. to support it, and we really haven't really started pushing the extremes of what we have because we haven't started bringing the differentiations and features and benefits as much, just trying to get the stuff up as we have. Now we're ready to move forward with that, and the new plant will put us in the faster-growing rigid place in the U.S. It will impact the growth rate of the other products if it keeps up at this rate. We think it grew more than 20%. There's really no good method of getting the information how much is being sold. There's all kinds of estimates all over. I don't know how good they are as they go through. Also in the U.S., the distributors are selling a lot of it, importing it from somewhere else, and we think that we can take some share from the Chinese over there. In Europe, it's not quite in the same spot. It's not as far along as it is, and we have more capacity over there, and we have a bigger share of what's going on over there. And the rigid piece is just starting, where here it's been going on for a while. So we think we'll be at the forefront of it too, is it? But it will impact the -- there's only -- somewhat the floors haven't changed because we're putting new products in.

Correct. As my follow-up, I was wondering on the carpet side, we're aware of fairly significant cost spikes in PET. And of course, you're primarily utilizing bottles. It sounds like there's been a price increase announced by your competitors, and I presume you'll go along. But I'm wondering how that's going to play out. It sounds like a favorable development for the carpet side of your business.

The carpet side, the labor and materials have increased. Commodity, chemicals are rising. We announced a 5% increase the end of this year. Our other -- the other manufacturers you noted actually announced the price increases before we did.

Our next question comes from Mike Wood of Nomura, Instinet.

Just wanted to follow up on the ceramic segment. You gave a lot of numbers. I'm not sure if you had given price/cost impact in ceramics, specifically in third quarter. But also, there's been a lot of chatter in the investor community about ceramic price declines because of new capacity additions and losing share to LVT. So I was hoping you can address that concern.

The price -- there really wasn't much price and a little bit of mix on the ceramic side. And then we had inflation, but deflation was not raw materials, inflation was in energy and in labor.

Yes, we haven't had much inflation or much pricing in ceramic.

And then just another comment, over 50% of the ceramic that's used in this country is imported, and it's been that way forever. I mean, we always compete against the imports where they are. When we had capacity constraints, I guess, we were a little less aggressive. It's a little hard to sell stuff you don't have, and we're expecting next year to improve the sales and keep growing our business.

Great. And the incremental CapEx, the $900 million versus, I think, $850 million last quarter, curious what the reasoning really for that increase. And if there was there tax reform passed, where you could fully depreciate equipment purchases, what would sort of trends would we expect next your from CapEx?

We haven't finished the capital plan this year. We haven't put it in front of the board yet. I can tell you that the capital investments we make are the highest returns we have. And usually, they're lower risk than buying other things. We have a strong organization that finds new ways to do it. It's what helps our productivity go up. It helps our innovation and product mix, and we're going to keep investing as long as we can find good projects to invest in.

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

I guess the first question, just going back to raw materials for a second, did you guys see any -- was there any disruption in the Gulf from the hurricanes? And if so, is some of that stuff starting to come back online at this point?

Yes, there was some disruption. Yes, there was some increased pricing as the capacities were limited. There is some of it coming back on stream. We have to see how it evolves over time. It's a little early to tell.

Okay. And then as a follow-up, there's more and more talk about NAFTA renegotiations in the news. Given your exposure to Mexico, how are you guys thinking about potential contingency plans if NAFTA were to fall apart?

We have capacity in Mexico. We have a growing business in Mexico. We're increasing our capacity to support. We have been just recently started to moving and using the capacity in Mexico to sell into the South American marketplace. We've been constrained in Mexico by our ability to support the business. We're putting new capacity in now. If the NAFTA changes, we'll have to see how it affects the cost of products out of Mexico versus the rest of the world. There's another -- as I said before, 50% of it is coming from somewhere, and we'll have to see how that works out. We have the largest capacity in the United States. And if we need to change strategies, we'll turn left.

Our next question comes from Sam Eisner of Goldman Sachs.

So on the Rest of World segment, obviously, I know you're not breaking out the patent income there but I'm curious how to think about medium term. I recognize you don't give kind of margin targets, but I think we were all kind of thinking that this was kind of a low teens, maybe low double-digits type margin business with the headwinds and now it seems like you're doing much better than that. So curious if -- are we rebasing to a higher profitability level within the Rest of World segment given your new patent revenue streams as well as better performance.

I don't know where you were, is it? So I don't know how to help you, is it? But the patent revenue is a higher margin percent so it goes lower. It will impact it. Also, the patents tend to pay lower tax rates so it also impacts the tax rates, which are affected. But we're aggressively trying to grow all the other products. And Europe is starting to improve and Russia is starting to improve, and Mexico has been doing well. So our businesses outside the United States, we're anticipating it will keep improving.

Got it, and then maybe transitioning over to North America. You commented that soft surfaces is growing faster than hard surfaces. Is the expectation that mix substantially improves into 2018, which also becomes a margin driver?

As you said, we had constraints in laminate, LVT and some of our residential carpet. We're expecting this quarter to get out of the limitations of those products with all the investments and stuff coming through. As our laminate production is in premium laminate LVT, we're going to bring new things to the marketplace. We constantly try to drive our margins and mix up as we go through. We think it'll improve as the rigid comes on. Rigid is a higher-priced product, so we'll participate more in it. It will average it up. On the other side, there's going to be more pressure in LVT, but we think we have the right cost position to compete.

Got it. If I can maybe just sneak one more in, the start-up cost for this year $45 million, have you given -- Frank, have you given any bogey on how you guys are thinking about that into 2018?

We have just said that we're going to continue to see elevated start-up costs probably a little bit higher. As we move into next year, it will be hard to say exactly how much is going to hit which quarter because those numbers move around. But you should see probably more of it weighted towards the first half. But stay tuned. We'll have to pull those numbers together when we get our budget together for next year.

Our next question comes from Laura Champine from Roe Equity Research.

One more question on the CapEx spend. I think that the announcement today included about $50 million in incremental CapEx versus last quarter's. What's incremental in there? Are there new projects? Or are the current projects just costing more than you had thought 3 months ago?

I think the only incremental increase in the old projects would be some of the new ideas we spent money on and our 2 LVT plants is part some of that. The rest of it is just new projects and new opportunities.

Got it. And referenced in the press release...

And one more piece, just as you put these new things in, the timing -- when you get to the piece, the timing of when equipment comes in and the timing of when the bills are paid, I mean, it's like throwing darts at the wall. So I mean, it could come into December or it could come in January and it changes years, but it didn't change anything for us.

Understood. And you did reference in comments this morning that in the North American hard surface business, there were some production limitations. What does that mean?

It means that we have sold all of the laminate that we could make without putting in new capacity, which is just getting started up. Then in ceramic, that prior to the third quarter, we were limited in what we could make and we couldn't turn it on and off as fast as we meant. With LVT, we increased the capacity of our LVT through productivity initiatives, so we were selling all of it we could have. So as those things reverse, we can now be more aggressive in our marketing and selling.

Our next question comes from Kathryn Thompson of Thompson Research Group.

Of the 4 acquisitions completed in 2017, could you quantify the forward 12- to 18-month revenue contribution from each and also help put a little bit more color around with potential revenue synergies of these acquisitions?

Did we give that out any kind of sales numbers?

Yes.

We don't give out the detail at that level of those things as small as they are. It just gets incorporated into the total business. There's synergies between the businesses. So in Europe, the 2 biggest ones are ceramic businesses, which one of them is the largest. It's almost across the street from our existing businesses. To show you how fast we moved, the slab plant that we were putting it in our plant, we actually installed it in the new acquisition business. We have integrated the administrative and marketing strategies of each one. We're putting -- we're selling products from -- made in different plants through the pieces. We're coordinating the sales efforts between the pieces. So I mean, as you would do with any acquisitions, we're doing the right things to optimize the businesses as we go forward, and we're expanding the capacities in them, is it?

I've just been reminded that we may have given the -- of one of the ceramic, the larger ceramic acquisition, the number is about EUR 150 million to EUR 160 million of revenues annually in euros. And 2 of the acquisitions were actually raw material backwards integration that really aren't adding revenue. So we had 4 acquisitions, 2 were manufacturing that are adding revenue, then 2 were backwards integration of raw materials.

Understood. And I know there's been a bit of a focus throughout earnings season with rising raw materials, but you've been effectively managing this year. But when you look more beyond just what's over your nose in Q4 and as you look more structurally into 2018 and beyond, what categories do you structurally see more persistent pressures? And what are your thoughts about how you manage around those? If you could just -- we know that inflation is a reality into the current market, but there are certain categories that are structurally more challenging. Just helping us to frame how you think about managing, that would be helpful.

I guess, the biggest ones you get in this part of the cycle, the chemical manufacturer start getting tight and typically, the chemical prices start going up irrelevant of the raw material inputs as they expand their margins. So it wouldn't surprise me to keep having those things, part of that's the thing driving the increase in our carpet prices that we spoke about. The other category, I guess, that has a lot fluctuation would be wood prices both in the U.S. and Europe. They fluctuate up and down. And then the other thing you didn't really ask about was the currency changes. So we have to take all those things as they happen and try to pass them through as they occur. And at the moment, I think we've done the things we needed to do this year. And whatever happens next year, we'll react to.

Yes. Currency is harder to manage. The other two, you can at least kind of work strategically around, so point taken.

Our next question comes from Keith Hughes from SunTrust.

The only question I had on that you had spoken about hard surface is growing slower than soft surface in the United States. And I guess, we had laminate capacity coming on the fourth. Are you full on capacity in the United States and flexible LVT?

We were but what happened is we got -- we've made changes in the manufacturing and increased the capacity of LVT -- of our LVT plant there. And then we have a new one coming up, which should be running end of the first quarter or early second quarter.

And that second one is a solid plant, correct?

It's a rigid plant. But I have to tell you, we can make either/or on it if we need to.

Okay. And the changes you made to the existing capacity, will that help just drive the market here in the fourth quarter?

Yes, the loss will give us -- enable us to bring out some new products. We're putting new products. So what happened is until we got the capacity to step up, we couldn't put more products in the marketplace. So what you'll see in this quarter, maybe the end, we'll start putting out more products in both the commercial and residential. But you won't see the impact of them until next year.

Our next question comes from David MacGregor of Longbow Research.

Jeff, in responding to an earlier question, you made the observation that about 50% of ceramic is imported into the United States and then it has been an import supplied market for years. My understanding was it was always kind of bifurcated as a general observation between the presence of imports at the high end of the market and presence of imports at the low end of the market. So just to focus on that low end for a minute. What are you seeing in terms of change there? Is import products -- I guess on the assumption nothing remains the same forever, there's got to be some kind of a change in presence, are they winning share? Are they losing share? And if you can maybe detail out that a little bit, that would be helpful.

First is that the market, there's -- we call it ceramic and porcelain. So what's happening is the porcelain products have been growing over the last 5 years as the style, design and differentiation. The ceramic products, which are red body products, tend to be the end. And as consumers want to pay more, they want the porcelain with it, so ceramic has gotten pushed into a smaller category as you go through. On the competition piece, it moves around the world depending upon exchange rates, capacities, excess capacities. And it moves around the world, the commodity piece of it. And if you want to sell, a lot of the imported stuff at the bottom end is just the lowest price stuff. We sell as much as you want to in it. But our goal isn't to be the largest commodity producer that has no value-add at the marketplace, is it?

I guess I'm just wondering if you're seeing improving product quality coming out of some of those foreign mills that is in line with the creep from what may have been 20%, 25% up to maybe 30%, 35% at the low end of the market now at least overlapped with that portion?

I don't think we've seen much change in where it's coming from. Like Jeff said, when the currencies around the world, depending on how they change, it could fluctuate. We -- at the first part of this year, we kept more of our red body capacity in Mexico as we were seeding that market for new expansion. So we probably had less red body ourselves during that period of time.

We don't really see that much difference in the competition as it is. The other thing just to keep in mind, when the market crashed back in the downturn, I mean, we kept running our capacity through it, and all the thing came out. So what's happening is as it comes back, it's coming. The low-end stuff, there's more of it coming in, and most of it is supplied by producers that don't know what to do with it other than sell it at 0 margin.

Right. It's also a lot of times limited to the coast. Because when you have a low-end product, the freight becomes a very important part. So unless you're talking Florida or maybe parts of California, it's not so easy to bring in a lot of low-end product.

Yes, that makes a lot of sense. Just as my follow-up, a quick question on LVT. What percentage of your mix now is commercial versus residential? And then could you talk about profitability North American LVT versus profitability of European markets? And I realize that there's scale differences between those 2 markets, but just in terms of what the market is competitively allowing.

Let's see how to answer that one. I think in the United States, the residential is probably twice as big but not exactly as you go through. Some of it has got to do with the products. And what we've been focusing or not as we go through, we're trying to expand our commercial business as we go through. And we lagged a little bit in the rigid because we were waiting on our plant. We've been importing some now, so it's going to get bigger for us. Europe's a different market completely. We tend to focus more on the residential pieces historically because our strength is in the distribution in residential. As we build up our sales force over there to go into more commercial, it should grow more as we see.

Okay. And the relative profitability of the 2?

Commercial, historically, in most things is more profitable because there's more differentiation in it. They like design and style different in it. They pay for performance features. So typically, it's a higher margin but it's lower volume.

Our next question comes from Stephen East of Wells Fargo.

If you look at -- I'm wanting to bridge a little bit quarter-to-quarter. If you look at your third quarter EPS, you're up about 7% year-over-year, and your guidance for fourth quarter's sort of flattish, if you will. I know you got a couple of incremental points headwind from higher start-up cost, but what else would be driving the slower growth at least on an EPS basis, quarter-over-quarter?

We have the -- IP is declining from where it was. The start-up costs are higher, is it, would be the big ones.

Are you comparing Q3 to Q4 or Q4 this year to Q4 last year?

I'm looking at Q3, your EPS is up about 7% or year-over-year. And then if you look at your 4Q guidance, it's basically flat to up a couple percent on a year-over-year basis. So what I'm trying to understand is there anything that occurred last year or that's in there this year? I know your start-up cost is going to take a couple of points away. But I was wondering what those other 4 or 5 points, where that's coming from.

I mean, that's primarily -- I mean, start-up costs also includes the go-to-market SG&A investments that we're making as well. That's probably more heavily weighted in the fourth quarter.

Okay. All right, I got you. And would the price raw material issue be meaningfully different quarter-over-quarter?

No, we think that we covered -- it's hard -- we have a difficult time telling price and mix apart in it, so we sort of have to look at them together. And the price/mix offset most of the inflation this quarter, so it will be about the same next quarter.

We did have in Europe when we ran in the -- longer in the third quarter this year, it brought some sales into the third quarter you would normally get in the fourth. So that was one impact. We also had buy-in for price increases in the third quarter.

Okay. All right, and that's one of the things I was going to ask. So okay, that helps. And then Jeff, you've talked about the best and highest use of your cash is reinvestment versus acquisition, and I appreciate where you're coming from on that. Could you talk a little bit -- could you give us sort of some magnitudes of example? I don't know what primary metric you look at to evaluate an acquisition versus a reinvestment. But can you help us out understand how much more attractive reinvesting would be versus a typical acquisition?

You have to start to there's a timing difference, is it? So boy, I mean, let's see how to help you. There's all different types of pieces. So the acquisitions, you have to pay for the cash flow, the existing businesses. And typically, you could end up with return on capital in the mid to, I don't know, 6% to 8% range when you start. And then over time, you have to take all these pieces you have to do to bring it up above your cost of capital because you paid not for the equipment, you paid for all the pieces that they've done. On the other ones, we don't pay for the cost of capital, is it. But depending on which ones they are, sometimes you have a year to invest in getting the marketing set up, the broadening of the pieces. And then when you go on to the incremental investments, those you already have the distribution piece, you fill them up much quicker. And so they rise. In the end, I would -- the goal is to get the acquisition above the cost of capital. It usually takes 3 to 5 years to drive it up because of the premium you paid for all acquisitions. And the other ones, it depends on whether they're short or long, and then you usually have a higher return than the other ones when you get through and it happens earlier.

Okay. All right, I appreciate that. That helps me a lot there. And then you made a comment, I think, on Kathryn's question, about the raw materials you've covered for now. I guess as you look out, do you think you're seeing any type of deceleration in the raw material inflation path that they're taking?

We don't believe we're going to see a deflation. We think we're going to see an increase.

Yes, I just didn't know if they were moderating. I'm sorry, yes, if the inflation rates were moderating the further away we get from these hurricanes, et cetera.

So you had a spike in some of those but then you have the ongoing changes that you always see, is it? So the hurricane spike, we shift in moderation in it but then we're expecting increase in raw materials just as a normal course of events.

And Stephen, I don't know if you were referring just to the U.S. or worldwide, but over in Rest of World, where we have a lot of inflation earlier in the year, that seems to have subsided, the inflation.

Our next question comes from Tim Wojs from Baird.

Just a couple of modeling questions for me. I guess, first, of the $1.4 billion that you've talked about in capacity adds, could you maybe break out what might be existing versus completely new markets for you, just maybe ballpark figures? And then second, on productivity, I think year-to-date, you're almost even with what productivity was in 2016. So just anything to kind of keep in mind around productivity as we go into '18.

Let's see. I don't know in my head if I have a breakdown between new and existing pieces as you go through within each one. So I don't know how to give you that one. Do you have any ideas? We don't normally think of it like that so, I mean, it's not what I have off the top of my head. The big things are the new products and geographies are going into rigid LVT, which we've just recently started selling some in the last 6 months, importing it from China. So that's a new business for us. We have the countertop business, which is countertops in the U.S. We're in the countertop business selling it, but this will be the first manufacturing of quartz countertops. Porcelain countertops is a new business for us in Europe. We're going to ship some to the U.S. and start seeding the market here and potentially open another line here to support it when the market's ready for it. We have the carpet tile business, which the plant will be up and running limited this fourth quarter and more next year, so that's an entirely new market for us. And in the sheet vinyl business, the business we bought, that greenfield of the sheet vinyl plant in the United States has brought up and doing well and the same group is going to do the same thing in Russia, is it? And Russia is a big market for it, and we think there's an opportunity for us. So those are the pieces. I don't have the numbers by each one to separate them.

And then anything to just kind of think about productivity in '18?

Yes, it's never enough.

We do that every year. Everybody signs up for a new productivity projects and initiatives, and we'll have a large number of projects next year just like we had this year.

Our next question comes from Eric Bosshard with Cleveland Research.

One question on the tile business. The U.S. tile, I think, has grown kind of low single digits 2% or 3% for 3 quarters now. Curious how we should be thinking about the growth rate of that piece of business moving forward.

It's going to increase. I mean, listen, we keep telling you that the first 6, 7 months, we didn't have anything more to sell, is it? It's hard to grow a whole lot doing that. It's harder to be in aggressive posture in order to get new accounts and push business. And so what's going to happen is next year, we're going to alleviate some of these things, and we expect the business to grow more than it has. Now at the same time, every business we have is going to get impacted by LVT. There are so many square feet of floors on the floor. And as LVT grows at a rapid rate, it's going to impact the growth rates of everything else, is it? We think we're well positioned to compete in everything, and we're doing things to improve our productivity and costs. We're bringing new products to market and everything so, I mean, we're well positioned to satisfy the consumers whatever they want to buy.

I'm showing no further questions at this time. I would like to turn the call back over to Mr. Lorberbaum for closing comments.

Thank you very much for joining us. We think we're well positioned for next year and beyond. We're putting investments in to drive the business and profitability long term, and we're really interested in the long-term growth. And there's going to be more variation quarter-to-quarter with all the aggressive actions we're taking. Thank you for joining us.

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