莫霍克工業集團 (MHK) 2018 Q1 法說會逐字稿

Good morning. My name is Erin, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mohawk Industries First Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, ladies and gentlemen, this conference is being recorded today, Friday, April 27, 2018. Thank you. I would now like to introduce Frank Boykin. Mr. Boykin, you may begin your conference.

Thank you, Erin. Good morning, everyone, and welcome to Mohawk Industries' quarterly investor conference call. Today, we'll update you on the company's results for the first quarter of 2018 and provide guidance for the second quarter.

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

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

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

Thank you, Frank. In the first quarter, we generated sales of $2.4 billion, up 9% over the prior year, with our businesses outside the U.S. growing faster and their stronger currencies benefiting translation. For the period, our adjusted operating income was $292 million or 12.1% of sales. Our adjusted EPS was $3.01, an increase of 11%.

Mohawk is benefiting from its diverse geographic footprint and product portfolio. Our performance in the first quarter accentuated this strength as we realized significant growth in LVT in our largest markets, and sales and profits grew strongly in our ceramic businesses outside the U.S. We are averaging -- we are leveraging our global organization's strength to initiate manufacturing in new markets and extend our development of innovative new products.

Our global decentralized structure enables us to simultaneously manage numerous internal investments while also executing new acquisitions. For the quarter, our operating income grew at a greater rate when adjusted for the loss of income from expired patents and higher start-up costs of new facilities and sales initiatives.

In the first quarter, material and freight inflation increased more than we anticipated and it impacted our costs. We are initiating selective pricing actions by product and region that, combined with improving mix and cost reductions, will offset inflation.

Throughout the rest of the year, we anticipate higher growth rates in all segments as we introduce new products, add capacity, implement price increases and complete acquisitions. Many of our operations are currently initiating new production, including Mexican, Italian and Russian ceramic; U.S. and European premium laminate; U.S. and European LVT; Italian porcelain slabs; and European carpet tile.

In addition, by the end of this year, we anticipate commencing production of quartz countertops in the U.S. and sheet vinyl in Russia as well as expanding polyester carpet in the U.S., ceramic in Poland and laminate and ceramic wall tile in Russia.

We anticipate finalizing the acquisition of Godfrey Hirst as early as the end of May, adding the largest flooring producer in Australia and New Zealand to our global portfolio. To prepare for the integration, we're assessing sales, product and raw material strategies at Mohawk and Godfrey Hirst in the markets to optimize revenue and profits.

Long term, our investments in new products and markets around the world will significantly enhance our profitability. Some of the projects will require significant onetime cost to start up the assets and build sales before higher utilization rates will deliver the margins and income we anticipate. This contrasts with acquisitions such as Godfrey Hirst where we are investing about $450 million, and we'll see an immediate increase on our annual EPS of $0.35 to $0.40 per share.

In the U.S., strong job creation and continuing wage growth is supporting our ongoing economic expansion. A strong March retail report suggests that recent tax reductions are translating to increased consumer spending. The National Association of Home Builders reported that March housing starts rose 11% year-over-year, and the organization is predicting single-family home growth escalating with higher construction.

Harvard's Joint Center for Housing study predicts stronger remodeling gains spurred by increased home values, low rates for home improvement loans and high consumer confidence. The American Institute of Architects index remains positive, projecting higher nonresidential spending as reduced corporate taxes encourage new construction and renovation projects.

Outside the United States, continued economic growth is forecasted for the European Union as interest rates remain low, business investment increases and employment improves. In Mexico, the economy was sluggish during the first quarter and is predicted to strengthen going forward. The Russian economy remains challenging amid political uncertainty.

Now Chris Wellborn, our Chief Operating Officer, will review our first quarter performance by segment. Chris?

Thank you, Jeff. In the quarter, our Global Ceramic sales increased 12% as reported, with greater sales growth outside the U.S. First quarter sales sequentially improved, and we anticipate increased growth throughout the balance of the year, supported by greater capacity and new product introductions.

We are implementing sales actions to increase our customer base and market share in both the residential and commercial sectors. Our 2 acquisitions in Italy and Poland are progressing as planned as we integrate their operations and expand their product offering.

Our North American ceramic business improved from the prior period as we introduced new products to increase promotional activities and the homes in our channel improved. Our business is stronger in the Southern and Western U.S. where new home construction is expanding faster. Our home center customers are focusing more on ceramic and increasing product commitments to enhance their sales.

Increased sales in the builder and home center channels are impacting our overall product mix. As our distributors consolidate operations, they have made inventory adjustments that have temporarily reduced our sales. We are aggressively pursuing new commercial projects with retail, hospitality and health care sectors the strongest.

In the U.S., LVT is being utilized more broadly and is impacting the industry growth rate of ceramic and other products. We are taking many actions to increase our ceramic share, including launching innovative slip-resistant tile, introducing higher style designs in all price points and marketing ceramic's durability and ease of care to consumers.

During the second quarter, we are leveraging our recently implemented systems to cut our overhead costs by $5 million on an annual basis. Our new service center and countertop distribution are ramping up and will enhance our results as sales increase.

Our countertop growth is increasing with quartz products taking share from natural stone. The building of our new quartz plant is nearing completion and equipment installation should begin this quarter. We are finalizing material formulations and designs to begin production at the end of this year.

We're also introducing porcelain slabs made by our Italian operations for countertops as well as offering large sizes for flooring walls. Specification for these products are increasing as designers are inspired by the beauty of natural stone in large sizes with the value and easy care of porcelain.

Our sales in Mexico grew during the period, significantly outpacing the ceramic market. The increased new capabilities of our Salamanca plant are allowing us to expand our customer base across Mexico and grow exports to Central and South America. We're introducing new higher-end collections on top of increasing our participation in medium and value-oriented price points. Over time, our product mix will improve and expand our margins in Mexico.

The European ceramic business continues to integrate our recent acquisitions in Italy and Poland. Our product mix is improving as we capture a larger share of the premium market, and our new product launches will increase our average price. To grow our sales in the retail channel, we are adding about 100 Marazzi-branded shops within our leading customers this year.

We're developing regional manufacturing strategies to optimize production where transportation significantly impacts our costs. Since completing the upgrade of our color body porcelain -- color body manufacturing, sales of our higher-end commercial products are increasing, and we are expanding our specified sales force to increase our participation in the new construction channel. Our new porcelain slab production started in first quarter, providing industry-leading visuals and performance features in sizes up to 5.5 by 11 feet.

Building construction has commenced in Poland to install the production line that is being transferred from our Italian operations. It will be operational in the third quarter so that we can expand our offering and better satisfy the Central European market.

In Bulgaria, we have upgraded equipment to produce 48-inch tiles, giving us a competitive advantage in the market. The productivity of our European ceramic operations is improving, and we have dramatically enhanced the safety performance of our plants.

We are upgrading our warehouse management and transportation system to increase our efficiencies and lower our costs. With the integration of our new businesses and consolidation of our systems, we'll reduce our overhead by $4 million by the end of the third quarter. We will complete the integration of all of our European ceramic systems by the end of 2019.

In Russia, our investments in product, distribution and branded retail stores, along with enhancements of our organization and systems, have created a significant competitive advantage. We continue to grow our leading market position in a challenging economic environment.

At the recent Russian national trade show, we further expanded our high styled offerings, reinforcing our position as the design leader with the broadest array of sophisticated collections. We're starting up new porcelain capacity this quarter. And by the end of the year, we will convert part of our commodity flooring production to higher-value wall tile to enhance our mix.

In the first quarter, our Flooring North America sales were $950 million, increasing 1% with adjusted margin of 10%, including the start-up for our new LVT line. During the period, we implemented the carpet price increase we announced last year. In the first period, our raw materials and freight costs escalated more than we had anticipated. We announced another carpet price increase of 6% to 7% to cover inflation, along with the freight increase, and the industry has supported it. Bitterly cold weather disrupted the energy supply to some of our plants, resulting in lower output and higher cost.

Our residential carpet sales increased during the quarter, led by the retail replacement channel. Our SmartStrand Silk Reserve collection extends the success of the premium supersoft carpet we pioneered, and our luxury Karastan line is accelerating from trendsetting designs and luxurious cashmere nylon introductions. We are gaining sales momentum with our proprietary Air.o unified soft flooring due to its luxurious feel, hypoallergenic properties and ease of installation.

Our patented Continuum polyester carpets are growing as a value alternative, and we are expanding our capacity late this year to satisfy higher demand. In mainstream commercial, we have introduced a new carpet tile technology called Eco-Matrix (sic - EcoFlex Matrix), which is more versatile for installation on a variety of subfloors. These nylon and polyester products are styled to coordinate with our LVT collections.

Our commercial carpet sales during the period were impacted by delayed construction dates and the substitution of LVT on projects. Projects bookings improved sequentially through the period and have continued to strengthen in April. We have realigned our commercial sales structure so that we can provide greater expertise with complete flooring solutions for each end use market.

We are driving commercial design trends through complementary soft and hard surface collections that provide style and performance advantages. The hospitality sector was our strongest channel, and our Definity collections are growing as an alternative to premium woven wool products.

LVT sales continue to expand in both residential and commercial. To support our increasing manufacturing capabilities, we are expanding our collections of both flexible and rigid LVT. We are upgrading our original LVT manufacturing line to increase its output and product features. The new rigid LVT production line we'll be commissioning during the second quarter following the launch of an identical line in Europe. We have begun training personnel, refining operational processes and developing new products for the market.

Our new laminate production is working well and has unique capabilities to make products indistinguishable from natural wood with superior visuals and performance. Our revolutionary RevWood Plus, a new waterproof wood product, is rapidly gaining acceptance with longer planks and contemporary finishes.

Our investments in new technologies and automation are enhancing our service levels and cost structures. By the end of the second quarter, we will cut administrative and indirect costs by a $20 million run rate. We continue to initiate hundreds of productivity projects to improve our efficiencies, quality and service. Due to limited common carrier capacity, we are purchasing additional trucks to expand our transportation fleet to provide higher levels of service.

During the quarter, our Flooring Rest of World segment performed extremely well, with sales growing 18% and adjusting -- adjusted operating income up 19%. The European market continues to do well, and the operating income of our ongoing business is up substantially on a local basis.

LVT is the fastest-growing product in the segment, even though sales were constrained by our capacity during the period. We are starting new LVT and laminate production in Belgium, and we are launching new carpet tile and rigid LVT products. The price increases we implemented last fall are covering raw material increases from 2017, and we are selectively increasing prices to offset further inflation. Our mix, volume and pricing are increasing our margins in most categories.

LVT in Europe is growing in acceptance, and we are the market leader. Our new production line is operating 5 days a week as we refine our manufacturing processes. The line is presently producing existing products to satisfy growing demand.

Through testing, we have validated the capability of our new technology to manufacture rigid LVT with enhanced performance and innovative features. We anticipate introducing new products during the second quarter and ramping up production to 7 days a week by the end of the third quarter. All the equipment and process enhancements are being replicated in the U.S. to shorten the start-up process.

Our sheet vinyl assets in Europe are running at capacity, and we are seeding the Russian market to build demand for our new plant. The renovation of the building in Russia is progressing, and equipment installation should be completed in the fourth quarter to initiate production. Our sales organization is collaborating with major Russian customers to develop new products and programs to utilize our new productions.

At our new carpet tile facility, we are running trials to establish operating procedures and refine new products. We're in the process of assembling an experienced commercial sales force to expand our sales of LVT, sheet vinyl and carpet tile across Europe.

Our laminate business continues to perform well with our new product innovations improving our results. We lead the premium market in realistic design and water-resistant products. Our new laminate press capacity is now operating, and we are introducing additional premium products to extend our market leadership.

In our Russian laminate plant, we are installing a new line that will double our capacity in the third quarter. We're developing new sales and warehousing strategies in Russia to optimize the distribution of our laminate and sheet vinyl production across the country.

Our wood panel sales are performing well as a result of investments that expanded capacity and improved our costs. Our insulation business is recovering as raw material supply increases and costs moderate. We anticipate insulation sales improving as declining material costs allow us to be more competitive with other product alternatives as we progress through the year.

The Godfrey Hirst acquisition is progressing as we expected, along with our other smaller acquisitions in the segment. Plans are being executed to integrate and optimize the performance of all these acquisitions.

I'll now turn the call over to Frank who will cover our financial performance for the first quarter.

Thank you, Chris. Net sales for the quarter were $2,412,000,000, growing 9% over last year, of which 4% was from currency and 2% from acquisitions. Our gross margin as reported was 29.2% or 29.9%, excluding charges with price, mix, productivity, currency and volume all offsetting inflation and lower IP.

SG&A as reported was $436 million or 18.1% of sales. It was 17.8% of sales excluding charges, which improved 40 basis points over last year as we leveraged our cost against higher sales and continued to control costs. Unusual charges for the quarter were $23 million and primarily related to plant consolidation and integration of acquisitions across all 3 segments.

Our operating income, excluding charges, was $292 million, up 5% over last year with a margin of 12.1%. Price/mix of $38 million and productivity of $31 million offset inflation of $52 million. Our operating income was up significantly when adjusted for incremental start-up costs of $9 million, patents that expired in 2017 and higher depreciation from our increased investments.

The income tax rate improved to 20% from 25.6% as the 2017 tax reform drove the overall rates down. We estimate our second quarter rate to be between 20% and 21%. Earnings per share, excluding charges, was $3.01, an increase of 11% over last year.

Turning to the segments. The Global Ceramic segment had sales of $877 million, growing 12%, of which 6% was from acquisitions and 4% from currency. Our operating income, excluding charges, at $117 million with a margin of 13.3%. Productivity of $14 million and volume of $11 million offset $13 million of inflation and $7 million of price/mix decline.

In the Flooring North America segment, sales were $950 million compared to $939 million in 2017 with good growth in residential carpet and LVT. Our operating income, excluding charges, was $91 million compared to $94 million of operating income last year. Price/mix of $14 million and productivity of $13 million offset inflation of $25 million.

In the Flooring Rest of World segment, sales were $585 million with solid growth of 18% over last year. 14% of the growth was attributable to currency gains. We had strong growth that continued in LVT as our leadership position in that category advantages us over our competitors.

Operating income, excluding charges, was $93 million and increased 19% over last year. Price/mix of $31 million, currency of $6 million and productivity of $4 million offset inflation of $14 million, along with lower IP income. In the corporate and eliminations segment, the operating loss was $9 million, and we expect the segment loss to range between $35 million and $45 million for the full year.

Jumping to the balance sheet. Receivables ended the quarter at $1,690,000,000 with days sale outstanding of 56 days. Inventories were $2,045,000,000 with inventory days at 116 days, which improved over the fourth quarter. Inventory turns continue to be impacted by increasing inflation and our backwards integration.

Fixed assets ended the quarter at $4,461,000,000. Our first quarter capital expenditures was $251 million with D&A of $123 million. We're estimating CapEx for 2018 of approximately $750 million with depreciation and amortization of about $525 million, which exceeds last year by $75 million. Long-term debt ended the quarter at $2.9 billion with leverage at 1.5x debt-to-EBITDA.

And with that, I'll turn the call back over to Jeff. Jeff?

Thank you, Frank. Around the globe, we are starting up a number of large investments that will significantly enhance our long-term results by expanding existing sales, adding product categories and entering new markets.

As anticipated this year, we will have nonreoccurring reduction in operating income of $70 million to $75 million, comprised of $30 million to $35 million from higher start-up costs, $40 million from patents that expired in 2017. In 2018, incremental depreciation of $75 million will curtail our operating margins until our sales reach a level to fully absorb these investments. Changes in the U.S. tax law will reduce our adjusted tax rate from 26% last year to an estimated 21% this year. Taking all of this into account, our EPS guidance for the second quarter is $3.89 to $3.98, excluding any onetime charges.

During the balance of 2018, our sales growth should improve as we increase the use of our new production, introduce additional products and complete the acquisition of Godfrey Hirst. We estimate the Godfrey Hirst acquisition will close by the end of May and will increase revenue by $180 million and EPS by $0.25 per share this year.

In the third quarter, higher prices, mix and productivity should increase our adjusted operating income above last year even with a lower margin. In the fourth quarter, our adjusted operating income and margin should exceed 2017 as the impact from start-ups and patent decline.

We are confident that our new investments will create significant opportunities with potential to have equal or greater profitability than our present businesses. We are adding $500 million of LVT with huge growth potential; $400 million of new product categories or geographies, including countertops, sheet vinyl and carpet tile; and $500 million of new capacity in constrained areas, including ceramic outside the United States, laminate with new capabilities and polyester carpet.

With the strength of our organization, we can execute additional acquisitions if appropriate risk and return can be achieved. The market is focused on the next 2 quarters where we are absorbing material increases, start-up and IP expiration. And overlooking the significant impact of our actions will have on our sales and profitability in 2019 and beyond, our management, cash generation and balance sheet will enable us to continue our aggressive growth strategies.

We'll now be glad to take your questions.

(Operator Instructions) Your first question comes from the line of Michael Wood from Nomura Instinet.

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

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

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

It continues.

Okay, got it. And at a high level, looking at your guidance for second quarter, the earnings growth is lower than what you actually achieved in first quarter. And I would have thought we would have seen some headwinds start to fade like the Unilin patent start-up cost and you would have time for price recovery.

So could you just give some color in terms of what's offsetting some of those headwinds that may be starting to fade in 2Q that's limiting that earnings growth?

Your assumptions that they're fading are wrong. The IP continues as a big decline. The start-up costs grow in the second quarter and what else?

Price/mix.

And material inflation which it will -- getting impacted. And we've hardly -- we haven't got any price increase at all. And we won't get -- start getting price increase until the end of the second quarter and then into the third quarter.

The other thing I would point out too there, remember, we've got incremental depreciation of $75 million this year spread across all 4 quarters.

Our second question comes from the line of Michael Rehaut from JPMorgan.

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

I wanted to follow up on Jeff, what you kind of quantified at the end of your prepared remarks. You've separated out some of the capacity that's currently initiating production and ramping and then the several areas that are set to commence. And it sounded like you quantified $1.3 billion across some of the new capacity.

So are you able to just kind of separate out where you are on the utilization of the plants you have that are currently ramping as well as the outlook for the timing of that new capacity that you've mentioned will be opening during this year?

The problem is there's about 20 different activities going on. The activities range from starting up new plants that we've never operated before and have no sales, which will take long periods of time to get them ramped up, could be sheet vinyl in Russia or carpet tile in Europe. And those are start-up projects from ground up with no sales and marketing to begin with.

Then we have other projects that we have significant sales already that will be added too, those will come up different. And then you have new plants such as quartz countertops we haven't manufactured before, but we've assembled experts from around the world.

We have LVT product lines that haven't been run before. They're starting up. So I mean, trying to get down to a month by month and quarter by quarter doesn't really make any sense.

Understood. That's helpful. So I guess, on that, the new LVT line specifically and obviously, you've highlighted that LVT is taking share across categories here, including ceramic in the U.S.

Are you able to kind of outline how your margin profile differs between the U.S. ceramic business and the U.S. -- or the new lines on the U.S. LVT business? Just trying to think about how that margin profile will shift as you do ramp on these new facilities here.

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

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

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

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

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

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

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

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

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

The $52 million you gave on inflation impact to the quarter, I just want to confirm, that includes transportation cost. And do you expect a similar number for the next quarter or 2 based on where raw materials are going?

The inflation does include transportation, and inflation's a moving target. And it's hard to say what the number is going to be as we look down the road. And any kind of estimate we've got is -- any kind of guess we've got at that is built into our estimates right now.

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

No. We don't have it because the introductions of our different products and different categories, it's difficult to separate it into specific things. And the estimates become so large, it doesn't make sense to try to separate it.

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

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

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

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

Just to follow up on the raw materials. Frank, could you maybe rank order which raw materials where you're seeing the biggest impact, including transportation, if that's a big one?

And then as you look at -- are you seeing some ongoing escalation of any of those? Or do you think the pricing that you're putting through now is going to cover what you see as you move through the year?

Let's see if I can sort of get you directionally. The chemical costs are the biggest parts in the materials and the ones that use chemicals to go into them would have the highest one, which are carpet and vinyl. Now it doesn't mean that the other ones aren't there, but those have much higher percentages of chemicals than, let's say, laminate, which just the top is affected.

And then the freight rates, the United States -- as the freight rates in the United States -- there are all kinds of things going on with the transportation because capacity was tight to begin with. The regulations that they put through reduced the capacity even further with the regulatory changes. And with that, we're also investing more on our own trucking fleet to take a higher percentage of it with all this going on.

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

Well, again, LVT is taking a portion of the market. And what we've done is increased our share of the new home construction and home center business.

The biggest impact right now is in the remodeling business in the retail stores, but it's growing -- I don't know -- it's growing in all the parts. The good news is that we have huge capacities coming on. We're introducing new products to participate in the LVT, and we'll maintain or grow our shares in the other categories.

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

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

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

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

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

Okay. And then this is a question that maybe is U.S. focused in not just ceramic, but overall. We heard about a tough start to the year in January and February. But we've heard that this, in general, has picked up in March and April in the U.S. again. Have you seen that yourselves? Any color there?

And Chris, you walked through a whole bunch of things you're doing in ceramic domestically and of course, there was some noise last year with the home centers. I'm just curious if you can give any color, I don't know, on the progression you see in U.S. ceramic sales as we go through '18 and/or into '19.

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

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

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

As we look out to 2019, appreciating that your IP earnings and the headwind from start-up costs should start reversing, can you talk about how you're positioned on a productivity standpoint? And do you get back on track to delivering the type of operating leverage we've seen in your business in the past?

What you should see is, as you said, the IP changes should be behind us. The start-up costs, we haven't put a plan together for next year, so I can't tell you what it's going to be. But the start-up costs should be down.

We're at $35 million more this year than we were last year, and last year was probably the highest on record. So we would expect it to come down, assuming we don't come up with more new projects, but I don't know that yet.

At the same time, this year, not in the start-up costs, is that once the plant gets turned on and turned over to the operational group, you get 100% of the depreciation even though you're running at limited amounts. So as that ramps up, the cost will fall and allow us to expand the margins going forward. And all of those things will start happening next year, and we'll get -- we should get a significant jump in all the pieces.

Okay, that's helpful. And then, Jeff, I think last call, you mentioned you're seeing good opportunities to redeploy your capital internally in M&A.

Just -- but given this big pullback in your stock here, can give us a sense how you're thinking about that? And we would certainly agree with the market being a little more too focused of the -- about some of the near-term headwinds you're seeing.

We believe that our business is doing really well. We are -- our cash flow is significant, and we believe that -- you can see this year, we have announced acquisitions. We have announced significant spending on capital. And by the time we get to the end of the year, we hope to find more new projects for the future.

There's always companies who want to sell. The question is not if there's companies wanting to sell. The question is, can we find the right valuations and do we have the right things we can do to help it so we get the returns on it.

As we go forward, we still have a capability of our management to execute multiple acquisitions at the same time and we're always looking. And we don't see any limitations in our ability to continue growing our business in all the categories.

And at the same time, you see us this year, we're doing more greenfield operations. And I would consider more of them in the future in addition. If all those things come together and we can't find the right investments, at some point, we would be quite comfortable buying our own stock back.

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

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

LVT is really primarily a U.S. business, and it's starting -- in Europe, it's probably 3, 4 years behind, could be more. Out of that, we have the largest participation in it, and we intend to grow the most in it. We believe that our strategy, unlike others, of having low-cost, high-volume capacity gives us competitive advantages in both marketplaces and we're the best positioned in Europe of anybody.

So I guess, more broadly, recognizing that you went through this shift from soft surface to hard surface prior to the last housing cycle and margins today are significantly higher. I think you alluded to this as the largest shift from -- towards LVT from other products. How do you leave investors confident that you can leverage your current assets to continue to drive margins higher over the next 3 to 5 years?

So I think at the moment, it's a U.S. question because you don't have the same growth in LVT. But to start with, we have over $1 billion would get through and not long of LVT capacity. And if the market will absorb it, we'll keep growing the capacity further. So we're well positioned on where it's going.

In the existing assets and business, I think that we have the premium positions in the categories. We have low-cost market production assets. And wherever the competition is going to be, we're going to get our fair share or more.

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

So you mentioned that LVT is growing very rapidly to 15% of the industry. My question is whether or not you see that once your capacity is fully ramped out, what you've got planned anyway, do you think that your Flooring North America segment will also be 15% or more devoted to LVT? Or will you still under-index there?

Listen, I'd like to have more. Is it -- there's no constraints on our ability to expand capacity. So it takes -- now with where we are, it probably takes a little over a year to execute it. So we'll go for 4, 5 months and see what happens. And if we see we're going to be able to grow it further, there's nothing that's stopping us from keep going on capacity in the United States.

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

I don't know that off the top of my head. I don't even know what my present North American capacity is off the top of my head with all these businesses.

It will be -- I would guess it's still going to be less than our market share of everything else of the average. We have much higher market shares in the other pieces, is it?

Now what's happened is we made a conscious decision to hold up going after the marketplace as aggressively. We are sourcing some, but almost everybody else is sourcing almost everything they're buying from China. So we made a decision to put in capacity, and we didn't want to spend all the marketing costs and then throw it out 6, 9 months later.

So it's held us up a little bit from being as far along as we would like. But I believe that we're going to be the best positioned in the marketplace when we get through, and we'll keep growing it as the market will accept it.

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

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

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

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

Anybody know the answer?

Low to mid-single digits as a percent.

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

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

Low single digits?

Yes. Low to mid. Yes. Low to mid.

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

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

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

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

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

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

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

I haven't met a customer yet that likes to pay more for anything. What happened to us all was we're trying to align the raw materials with our cost better in the increases.

So we started -- in the fourth quarter, we saw it coming, but we underestimated dramatically what was going to happen. We announced an increase. The rest of the industry followed. We got into the first quarter, and we saw it getting worse. We announced another increase. The industry followed. So we're all acting rationally.

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

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

We aren't really looking at -- we were able to compete with sourced products. And we're using sourced to either give us products that are slightly different from where we are once we get it up or to act as buffers as the business changes and we need more capacity as we go through.

We made a conscious choice, as I said before. We're lagging the industry a little bit, we started from a low base, and we're lagging because we postponed the aggressive introductions. But starting about last -- the end of last year, we're moving into every market and every product category as fast as we can go to use up all this capacity that we're putting in.

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

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

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

I'm not sure we're starting out with a preconceived idea. The -- typically, commercial has lower run sizes and lower units, but higher margins and the residential is higher volume at lower margins.

And then you have the product categories. Rigid LVT, which is what the new plant is going to do, is growing at the top end, and it's a limited portion of the commercial business. So we'll just have to manage the assets to whatever the customers want.

Our new facilities will make any of the product types the customers desire, and we'll just balance it between them as they go forward. And we'll optimize once we -- if we ever get -- if we get the -- if we get to a point where we're constrained, we hope to either put more in or we'll manage the mix based on what makes the most sense for our business and operations.

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

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

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

So it improved as we went through the quarter.

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

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

Our ceramic business grew in all regions.

Okay, great. The -- secondly, on -- Jeff, in terms of the LVT business, I'm curious your thoughts on how the category is evolving in 2 areas, one in terms of the changing designs of the product; and then secondly, the import capacity that's been added. I'm curious how you view those 2 dynamics influencing the LVT effort of yours in the U.S.

You have to start from up to now. The category is growing so rapidly. I mean, it's absorbing anything and everything, is it? There's more capacity coming on in China to support it, which is where most of it is coming.

As you would expect, as things mature, the prices are getting a little lower in some cases, depending upon the product category. And the designing, everybody keeps coming up with different designs to do differently.

And in anything that's in this stage, you have a lot of innovation going on, both in materials, product types, designing across the board. And it's all part of a maturing process. The question is how big -- as the base gets bigger, what rate it's going to grow and when is it going peak out, and I have no idea.

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

Depending upon what we see over the next 3 to 6 months, we could make a decision to put more in.

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

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

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

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

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

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

I wanted to circle back and maybe ask the CapEx question from a different perspective. If you look back at the last cycle, your CapEx as a percent of sales was pretty consistent around a 2% to 3% of sales type of average. And obviously, in the last 5 years, it's been more in the high single digits as a percentage of sales. So kind of asked a different way and understand that obviously, there's a lot of capacity expansion, investment in the acquisition and so forth. But from an industry structure standpoint, I was just curious if there's anything that's kind of changed in the industry or the way that you have to be competitive within the industry that requires a higher level of capital investment. Jeff, you just said that you would expect CapEx to maybe decline next year. But would it still be in something of a mid-single-digit percent of sales range? Because it certainly appears very different than the last cycle in terms of the level of required investment.

Let's see the best way to try to answer it. Our assets are among the best in the industry in every category. We have low-cost, high-efficient assets, and we're constantly looking to improve them from there to stay at the leading front of the business. Anything that we can do that makes economic sense, which gives us returns and paybacks that meet our expectations, we will put on and continue doing because we have the capital to do it and it will enhance our performance, both short term and long term. At the same time, we have a huge organization that can take on a lot of things. And if we can find new products such as quartz countertops in the United States, such as sheet vinyl in Russia, such as carpet tile in Europe, I mean, we're building new businesses from scratch as you go through. And I know sometimes, from the outside, it's a little uncomfortable because you guys would like it predictable by quarter. These things have -- are start-ups. You find things that happen good and bad, and you can't exactly get them -- the customers aren't sitting there waiting on you to show up, and you have to give them reasons and build relationships to do it. Now in the long term, these things, over 5 years, will be much higher returns than anything I can do other than my internal investments that I turn on and start up almost immediately. So to answer the question is we have a huge cash flow that's growing. We have an organization that's creative and executes well. And if we can continue doing these things, these are what is going to allow us to grow our earnings and our share value higher than the market over time. And they all come back to return on investment and risk. And I don't know how to give you specifics. And the answer is if we can find those opportunities and it makes sense and they have reasonable risks, we're going to use our capital to do them, and they will give you higher returns and be giving the money back to you.

Understood. And again, just coming -- understand all the rationale behind the investment. But I was just curious from, I guess, from another angle, from a structure angle, but I appreciate that, Jeff. That's helpful. I guess, secondly, just drilling down a little bit on the Global Ceramic segment. You highlighted that some of the year-over-year margin decline driven by mix -- increased mix towards home centers and builders, but just to focus on the home centers or kind of a 2-part. Number one, if you could give us a sense of how much mix accounted for the 150 bp year-over-year drop in margins. And in terms of the home centers -- higher sales through the home centers for the ceramic business, if that's something that we should expect to continue over the next 1 to 2 years. I think for a long time, you've talked about, if I recall correctly, being a little under-indexed to that distribution channel. Just any thoughts around that.

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

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

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

Yes. I think I mentioned that earlier. It's about $7 million.

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

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

Let's see. I'm not sure. I think what you're asking is -- there's 2 parts. One is that the reason it's hard to talk about capacity is it's a moving target. So if you go back a year ago, I was putting in -- a year ago, we were ramping up a ceramic plant in the United States. That was in the number a year ago. And now this year, that's off the list. The plant's running pretty good. And now it's dropped off and something new has come on. So that number happens to be the same as a random event, is it, if I can tell you. Second from that is in the growth of the business, all of this -- as you were right, all of this is going to incremental. At all points in time, we have businesses increasing sales businesses, decreasing sales and you have profits going up and down. So 100% of this isn't going to fall to the bottom line, but major parts of it are, is it? I mean, if you take the thing and just take our average EBITDA, 20% times 1.5, you got $300 million of EBITDA, if it all fell to the bottom. I'm not telling you going it's all going to fall to the bottom, but the numbers are so big. I mean, I don't think the group's focusing on the opportunities that we're investing in. And if you look at it, the $1.4 billion, don't hold me to this, I think it might put us -- just the incremental capacity we're adding might be equal with the top 5 or 6 flooring producers in the world.

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

No, I can answer that. So our ongoing business had good growth with LVT with wood -- and wood panels performing the best. Our LVT was constrained in the period, and the new production will increase sales and add new products. Our investments in the laminate, carpet tile, sheet vinyl will further enhance the business. So we have a lot of things that's going to improve going forward.

And the Godfrey Hirst acquisition is going to go under there also.

Sure, yes. I was talking about volume excluding Godfrey Hirst. So Chris, it would be your expectation that some of the things you just mentioned should elevate 2Q volumes?

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

Listen, we don't think as narrowly as you guys by month, is it? These things, you start setting them up and putting them in. I mean, it might be 2 or 3 months longer or maybe 2 or 3 months shorter than our plan. That's just part of the deal.

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

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

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