Mohawk Industries, Inc.
Q3 2017 Earnings Call Transcript

Published: 27 Oct 2017

[Operator:]

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. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. [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.

[Frank Boykin:]

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?

[Jeff Lorberbaum:]

Thank you, Frank. In the third quarter Mohawk delivered record earnings and EPS were 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 cost disruptions from hurricanes and reduced pattern revenues. Our price in mix continue to improve as we enhanced our product offering with unique designed and differentiated features. To recovery material inflation, we implemented enterprise-wide pricing actions this year. And with productivity and mix we cover a 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 cost 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 investment will satisfy increasing demand for our products as well as introduced 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 four acquisitions that 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 five years. In the United States job creation has been solid throughout the year and consumer sentiment remains positive. The U.S. economy and housing market continues to grow at a more measured pace even with the disruption of September's hurricane. Single family housing starts are growing a multi-family construction is contracting this year. The October National Homebuilders Association showed builder confidence rising to the highest levels since spring. Remodeling trends are projected remain strong in 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 this 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.

[Chris Wellborn:]

Thank you, Jeff. Our flooring rest of the world segment had an exceptional quarter with majority of our manufactured product sales and earnings growing dramatically. Our pattern revenue is running at a higher rate than we anticipated due to the broader use of our patterns and increase in worldwide sales of the LVT. During the period our price increases and mix improvement offset our inflation in currency changes. Third quarter results were also enhanced by a reduction in summer shutdowns allowing us to shift more and customers increased purchased prior to pricing actions in either of which will occur going forward. Our laminate innovation in proprietary structures and waterproof technologies is increasing the selection of our products by customers who would ordinarily purchase wood flooring. This combined with our broader ray 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 produced 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 gross 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 they are prepared for our new sheet vinyl plant which will be operational by the end of next year. We are also expanding the segments commercial sales force to increase the specification of sheet vinyl, LVT and our upcoming corporate tile collections. Our new commercial corporate 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 cost remain elevated it may encourage the substation alternative insulation products that could impact our sales of these products. Sales and margins in our wood panel category have increased as the market strengthens. In the quarter, our global ceramic segment sales increased 9% as reported and 7% on a constant days in currency basis with the strongest growth in Russia and Mexico as well as in our acquisitions in Italy and Poland which have 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 plan in Italy. These capacity increases will allow us to more aggressively expand our future sales. Our U.S. ceramic business was softer than we anticipated due to the impact of hurricanes in two of the country's largest ceramic markets. Though the recovery on 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 patterned its 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 just for 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 [indiscernible] 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 expanded 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 a pretty 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 ideal 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 level. 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 franchise 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 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 two years as the affected communities repair [indiscernible]. 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 affected end of this year to cover our increasing costs. With their superior softness and performance attributes, our smart strain collections continued to take market share, expanding our leadership in the premium market. Presently, our new smart strain self reserve and aero introductions are being installed in leading retail stores around the country. Each of these collections offers a unique differentiating proposition to the consumer. We are increasing the distribution of our luxury care stand brand which provides leading style and design in premium carpet. Our continuum polyester continues to expand its position as the medium to low-end price points and our soft collections made of recycle materials provided 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 and 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 sterilized options and increase our share. With new product collections and the expansion of our sales force, we are increasing the non-specified sales of our commercial collections 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 alliance complete, we will be the only U.S. manufacturer positioned as a competitive alternate to imports that can supply both high quality rigid and flexible LVT. We anticipate that the LVT market will continue to grow at high 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 a 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 will now turn over the call to Frank, who will review our financial performance for the period.

[Frank Boykin:]

Thank you, Chris. Net sales for the quarter were $2.449 billion 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 were 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 the 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 this $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 ends that we had as headwinds. 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] [ph] billion up 2% over last year. The storms in 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 elimination 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 and debt to quarter at $1.656 billion with days sales outstanding of 58 days. Our inventories ended the quarter to $1.911 million. 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 are 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 will now turn the call back over to Jeff.

[Jeff Lorberbaum:]

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 release 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, our results as new operations come online. The destructions 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 first quarter is $3.25 to $3.34 excluding any one-time charges. We are 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 four acquisitions we have completed are enhancing our results and further our global strategy. Next year, start-up cost and marketing investments of 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 will now be glad to take your questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Bob Wetenhall from RBC Capital. Bob Wetenhall [Technical difficulty] Jeff Lorberbaum We are having a hard time hearing you. Bob Wetenhall Can you hear me okay? Jeff Lorberbaum Better. Frank Boykin That's better. Bob Wetenhall All right. Good. Nice Job in a tough quarter given the hurricane, Jeff, there is a lot of capital spending this year; it looks like it's gone even higher to $900 million. And I was hoping you could give us the view on the trajectory of sales gains you are going to experience from this. What's the sales impact in 2018, 2019, I'm not really talking about the quarter, I'm talking kind of big picture in the next two to three years. You got the $900 million this year, which is more than you spent last year. What's the sales benefit, what's the cadence look like? Jeff Lorberbaum 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. And ceramics were expanding in four countries and the U.S. were expanding laminate, wood, rugs and carpet were expanding laminate in Europe and Russia were entering new products and geographies across the world to give us new opportunities. In the U.S., we are going into rigid LVT in quartz countertops. In Europe, we are entering the rigid LVT carpet top and porcelain countertops and Russia we are going into sheet vinyl. All these investments should help us drive the growth depending upon which one they are if we are going into new categories and businesses the growth that fill up will take longer than the ones that were already in the market with existing infrastructure. Bob Wetenhall Jeff, that's helpful. Maybe you could talk to me a little bit about SG&A spending, it seems and correct me if I'm wrong, the dollar spend on CapEx is really to add capacity and to improve productivity. But, if it's going to be -- have more product coming to market, you are going to have to invest in marketing and distribution, how should we be thinking about SG&A, what you are doing on the distribution and marketing side to get the product to the consumer? Chris Wellborn We have 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 sales people in or putting more products in the marketplace, will 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 are going to have to invest in the sales people to sell the products in Russia and around the world. What happens is, the cost are front end loaded in front of the sales, 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. Frank Boykin The market we have invested through three quarters this year is about $20 million in SG&A for all these types of marketing sales investments that we are referring to. Bob Wetenhall Maybe you can give a sense, just think taking off what you said, is it fair to say Bill, there has been a bigger increase in CapEx to grow capacity, you will be increasing your investment in marketing and distribution next year on the distribution side and it's kind of good a mirror what's happened with CapEx? And any guess…. Frank Boykin It will go up. Now, some of it would be in the start-up costs that we break out for you because you have to put in all of the investment upfront and some of it we will give it you there as we did this year. Bob Wetenhall But, that's already starting to be a band, and that will continue a little bit into the first half of next year, correct? Frank Boykin It will continue all through next year as we are making a lot of investments, so that the business does well not just now but next year and the year after. Bob Wetenhall Got it. And so you are investing basically through the SG&A, so you get the distribution for the capacity you are adding and that's kind of going to help enable you to get to your top line target? Frank Boykin Once we get the business up where we expect and the SG&A as a percentage should start coming down. Bob Wetenhall Got it. So, was there something we could look at like an investment period that it peaks in the -- some point in the second half 2018 or 2019 and starts to decline on a relative basis, you get the leverage back? Frank Boykin Now, given all of the number of projects we have as I told you they are 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 pairing off as the next one picks up. Bob Wetenhall Got it. So, this is going to be a multiyear base project since you roll out. Helpful color. Thank you, gentlemen. Good luck. Jeff Lorberbaum Thank you.

[Operator:]

Our next question comes from Stephen Kim from Evercore ISI. Stephen Kim Thanks very much guys. Strong quarter. Good job. Interesting stuff, I wanted to -- I know you are doing a ton of different projects all around the world, then obviously, you touched on that in Bob's question in your opening remarks. But, one of the things that I thought might be helpful as we are just getting to the point where a lot of this capacity is starting to be turned on, and then, getting loaded, can you 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 that the longer term trajectory here, just I think the near term cadence might be helpful, if you give different color? Jeff Lorberbaum I think in Q3 what came online was a plant in Mexico that has started out then all three lines are running, so it's started coming up and then we finalized the replacement of equipment in Europe and our ceramic commercial plant so that capacity is up and running now. In the fourth quarter, if I can get all the timing right, the fourth quarter, the LVT plant in Europe is starting to come up, the laminate new capacity in the United States is coming up, I think the laminate capacity in Europe is coming up and let's say the carpet tower is coming up in the fourth quarter, they will just in limited ways. And then, I think maybe some capacity in Russia might be coming up and a [slam] [ph] line in Europe, I think might be coming up. This is just to name a few. Listen, I deserve an award just to be able to remember all of it. Stephen Kim I was going to say. It is remarkable the your 3Q rest of world was up and strong as it was when -- I heard you mention was an EU, European commercial plan, are you sure there wasn't any sort of additional capacity brought on in flooring rest of the world in 3Q versus 2Q? Jeff Lorberbaum That was an exceptional quarter for all our various manufacture products we are growing dramatically. We got the positive impact of price and mix offsetting currency and inflation. We got the patent for higher than we projected to the broader use of our technologies and increased sales of LVT. And then, the other thing that did help, we reduced the summer shut down, we actually staff different this year in order to allow us to run through some of the summer shut downs 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 happen and because of those, we don't anticipate the same level of improvement in the next quarter. Stephen Kim Got it. No, that's helpful. Understand. Great. And then, second question, just wanted to talk about ceramic, obviously some people are going to be zeroing on that, segment which had some challenges and you are not specifically quantifying hurricane and I understand that. When you rattle through or sort of went through the various things that we are driving the softness there, it sounded like most of those were things that will dissipate, possibly as quickly as in the fourth quarter. So, 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 be so much you're seeing so far in October, wouldn't we think that the dissipation, the source, transition and the large customers postponing and things in the hurricanes that were not, wouldn't that pretty much allow for an improvement in the ceramic even before the sales strategies? Jeff Lorberbaum Well you've asked a lot of question. Let me see; let's see if we can do the hurricane things first. The hurricane impacted us in larger markets; there is really a lot to tell what people would have ordered when they didn't order it. But we put together, I guess some of the things internally and I guess we'll give it. We believe the hurricanes impacted our U.S. businesses somewhere between 1.5% and 2% in sales. Stephen Kim Got it. Jeff Lorberbaum Now just one more to remind you, all the different products going in flooring is one of the last things that goes in after 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 do you want to give some overview on the ceramic growth. Chris Wellborn Yes, Steve. The way I would think about ceramic, first if you look outside the United States we're growing very rapidly, Mexico, Russia, new acquisitions and we're in the positives 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 strengthened next year. The second is we've got new business with large customers; we are 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. Stephen Kim Excellent. Thanks very much guys, great job. Chris Wellborn Okay. Thank you.

[Operator:]

Our next question comes from Mike Dahl of Barclays. Mike Dahl Hi. Thanks for taking my questions. I just wanted to follow-up on the last comment regarding the transition happening within the ceramic production. I think you've mentioned that it's taking longer than originally anticipated to go through this transition from sourced internal. Can you just give us a little more color on, what's drawing that out more than you anticipated? Chris Wellborn Well, what's happening and let's take the new technical capacity that we're adding to abuse commercial products. What you have to do is take those source 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. Mike Dahl Got it. And in terms, I guess there is nothing is it, I guess what am I getting at is, is it a market issue or internal production issue that's leading to that timeline to be different than what the original anticipation was? Jeff Lorberbaum Listen its certainly different in our original anticipation, what happens is, when you are sitting there with tight capacities you can't go out and aggressive sell things when you are putting a new capacity, 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 then they are just waiting for us to walk in and say here we are today after the equipment start to run it. I mean it's not turning the light switch on and off. Mike Dahl Okay, understood. And then regarding the expansion into countertops, I think you mentioned that you're reconfiguring at 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 in running, what the countertops? Chris Wellborn 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 markets is great opportunity for us its $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. Jeff Lorberbaum It's set up to except many new lines if we choose to do that. Mike Dahl Okay, great. Thank you.

[Operator:]

Our next question comes from Susan Maklari from Credit Suisse. Susan Maklari Good morning. Frank Boykin Good morning, Susan. Susan Maklari My first question is around the Chinese government recently put a permit in place limiting the ways that they are taking some of the imports that they are taking from the U.S. and that seems to be impacting, some of the bottle recycling prices that are out there. Given your backward integration and incorporate 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 that business? Chris Wellborn The bottle market is unusual market you go though at times of the year people drink a lot of them other times they don't at different points in time that exports will be really high and really low. And it, goes all over it's a fluid marketplace, its supplying demand that goes up and down as the bottles get more and less in supply. And, what we do is look over the price over the entire year and try to average amount for the whole year. And I think that, it's a moment where the Chinese taking less it should help us in the piece, but on the other hand as more people are using it. Susan Maklari Okay. So you haven't seen any net benefit to-date yet from that bottle? Chris Wellborn Listen there is fluctuations everyday and daily we fight 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 is 100s of people doing them at different markets, there is different freight to get from different places. It's not homogeneous like you think. Susan Maklari Right. Okay. That's helpful. And then you know you mentioned that you've been seeing a bit better trends in the pattern revenues 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? Chris Wellborn So originally, we said it was $35 million, we said last call that we thought it was coming in higher than it was, but we found is the other patterns which, we have a broad use of them in designs in both designs, features and benefits that different people use around the world and 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 as helping it. We decided not to be specific about the IT going forward, because it really impacts our execution as we go through with the as we try to maximize it and we're just kind of treat it like other products. Susan Maklari Okay. Thank you.

[Operator:]

Our next question comes from John Baugh from Stifel. John Baugh Okay for the good intro. Good morning gentlemen. Let's see, I had a kind of a question on LVT and its growing rapidly here, I presume its growing internationally as well. And I'm just wondering Jeff as you look at that, how that affects Mohawk obviously, you are one of the largest, but not the largest producers of LVT in the world, I presume you are still there outside to some degree and you are adding capacity, but also disrupt some of the other categories of flooring and I'm just wondering from your perspective, is there a mix favorable on margin from this, does it offset though by some things that maybe you don't, won't be able to produce as much of in fixed plan. And any thoughts there? Jeff Lorberbaum Its first the U.S. is a head of the rest of the world in the use of the LVT. And there is more at more use of it in different commercial and residential uses as well at different price points and its evolving. What happens 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 what we had because, we haven't started bringing the differentiations and features and benefits as much just trying to get the start up as we have now ready to move forward 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 is really no good method of getting the information how much is being sold, is 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 long 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 well here it's been going on for a while. So, we think we'll be at the forefront of it too as it, but it will impact the there is only something, the floors haven't changed because we're putting new products in. John Baugh Correct. And it is my follow-up, I was wondering on the carpet side, where we are fairly significant cost spikes in PET and of course you primarily utilizing bottles, it sounds like there has been a price increased 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/ Jeff Lorberbaum The carpet side, the labor and materials have increased commodity chemicals are rising. We announced a 5% increase at the end of this year. Our other manufacturers you noted actually announced the price increases before we did. John Baugh Great, thank you, good luck.

[Operator:]

Our next question comes from Mike Wood from Nomura Instinet. Mike Wood Hi thanks for taking my question. 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 ceramic specifically in third quarter. But also there has been a lot of shatter 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? Jeff Lorberbaum The price, really want much price and a little bit of mix on the ceramic side. And then we had inflation, but inflation was not raw materials inflation was in energy and in labor. Chris Wellborn Yes. We haven't had much inflation or much pricing in ceramic. Frank Boykin 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, we had capacity constraints, I guess we're little less aggressive, its little hard to sell stuff you don't have and we're expecting next year to improve the sales and keep growing our business. Mike Wood Great. And the incremental CapEx the 900 versus I think 850 last quarter, curious what the reason and really for that increase, and if there was tax reform past where you can fully depreciate equipment purchases, what sort of trends that we would expect next year from CapEx? Frank Boykin 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 return do we have and usually there are 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 and helps our innovation and product mix. And we're going to keep investing as long as we can find good projects to invest in. Mike Wood Great. Thank you.

[Operator:]

Our next question comes from John Lovallo of Bank of America. John Lovallo Hey, guys. Thanks for taking my call. 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 go from the hurricanes and if so, is that, some of that starting to come back on line at this point? Jeff Lorberbaum Yes. There were some disruptions, yes there was increase pricing as the capacities were limited. There is some of it coming back on stream; we'll have to see how it evolves over time, its little early to tell. John Lovallo Okay. And then as a follow-up, there is more and more to talk about NAFTA the renegotiations in the news given your exposure to Mexico, how you guys thinking about potential contingency plans if NAFTA where to fall apart? Chris Wellborn We have capacity in Mexico, we have a growing business in Mexico, we are increasing our capacity to support. We have been just recently started to moving and using the craft 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 product out of Mexico versus the rest of the world which is another as I said before 50% of its coming from somewhere and we'll have to see how well it works out. We have the largest capacity in the United States and if we need to change strategies we'll turn left. John Lovallo Okay. Thanks guys.

[Operator:]

Our next question comes from Sam Eisner of Goldman Sachs. Sam Eisner Yes. Good morning guys. Chris Wellborn Good morning. Jeff Lorberbaum Good morning. Sam Eisner So on the rest of world segment, obviously I know you're not breaking out the pattern 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 of margin business with the headwinds and now it seems like you're doing much better than that. So, curious if rebasing to higher profitability level within the rest of world segment given your new patterned revenue streams as well as better performance? Jeff Lorberbaum I don't know where you were, is that's I don't know how to help you. But, the pattern revenue is a higher margin percent so it goes lower, it will impact it also the patterns 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 in Europe starting to improve and Russia is starting to improve, Mexico has been doing well. So, our business is outside the United States, you know we're anticipating will keep improving. Sam Eisner Got it. And then maybe transitioning over to North America, you know you commented that soft services is growing faster than hard services, if the expectation that mix, substantially improves into 2018 which also becomes a margin driver? Chris Wellborn 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 had something try to drive our margins and mix up as we through, we think it will improve what the, as the rigid comes on, rigid is a higher price product. So, it will participate more in it will average it up, on the other side there is going to be more pressure in LVT. But we think we'll have the right cost position to compete. Sam Eisner Got it, if I can maybe just sneak one more in the start-up cost for this year are $45 million have you given Frank if you've given a [indiscernible] how you guys are thinking about that in 2018? Frank Boykin We have just said that, we're going to continue to see elevated start-up cost probably a little bit higher as we move into next, we'll - 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 the way towards the first half. But, stay tuned we'll have to focus numbers together when we get our budget together for next year. Sam Eisner Got it. Thanks so much guys.

[Operator:]

Our next question comes from Laura Champine from Roe Equity Research. Laura Champine Good morning. 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, there are new projects or the current projects just costing more than you had thought three months ago? Frank Boykin I think the only incremental increase in the old projects would be some of the new ideas we spent money on in our two LVT plants as part of some of that, the rest of it is just new projects and new opportunities. Laura Champine Got it, and referenced in the press release… Frank Boykin One more piece, just as you put these new things in the timing, when you get to the piece the timing of when the equipment comes in and the timing of when the bills are paid, I mean it's by throwing darts at the wall. So, I mean they could come in December, they can come in January and changes years, but it didn't change anything for us. Laura Champine Understood, and you did reference and comments this morning that in the North American hard surface business there were some production limitations, what does that mean? Frank Boykin It means that we have sold all of the laminate that we could make without putting in new capacity which is just getting started out, the men 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. What LVT we increased the capacity of our LVT through productivity initiatives we were selling all of that we could have. So, as those things reverse, we can now be more aggressive in our marketing and selling. Laura Champine Got it. Thank you.

[Operator:]

Our next question comes from Kathryn Thompson of Thompson Research Group. Kathryn Thompson Hi thank you for taking my questions today. Before acquisitions completed in 2017, could you quantify the forward 12 to 18 month revenue contribution from each and also help sort of little bit more around with potential revenue synergies of these acquisitions? Thank you. Chris Wellborn We could give out any kind of sales numbers. We don't give out the detail of that level of those things and as small as they are. It just gets incorporated into the total business; there is synergies between the businesses. So, in Europe the two biggest ones are ceramic businesses which is one of the largest, it's in, it's almost across the street from our existing businesses, to show you how fast we move 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 the each one. We're putting, we're selling products, 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 it. Jeff Lorberbaum And I would just remind you is that, we may have given the one of the ceramic, the largest ceramic acquisition and the number was about €150 million to €160 million of revenues annually in euros and two of the acquisitions were actually raw material backwards integration that clearly on adding revenue. So four acquisitions two were manufacturing that are adding revenue and two were backwards integration of raw materials. Kathryn Thompson Understood, thank you. And I know there has been a better focus throughout our earning seasons with rising raw materials would you've been effectively managing this year. But when do you look poor beyond just what's over your nose in Q4 and as you look more structurally into 2018 and beyond. What categories do you structural see, more persistent pressures and what are your thoughts about how you manage around those? And if could just, if we know that inflation is a reality and to the current market, but there are certain categories that have structurally more challenging, just helping us to frame how you think about managing that would be helpful? Thank you. Jeff Lorberbaum 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, the thing driving the increase in our corporate prices that we spoke about. The other category I guess it has a lot of 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 incur and at the moment we think we've done the things we needed to do this year and whatever happens next year we'll react to. Kathryn Thompson Currency is harder to manage, the other two you can at least count where it's particularly around, so point taken. Thank you very much.

[Operator:]

Our next question comes from Keith Hughes from SunTrust. Keith Hughes Thank you, another question I had on, you spoken about hard service run slower than soft service in the United States. And I guess we have laminate capacity coming on the floor, are you full on capacity in the United States in flexible LVT? Chris Wellborn We were but what happened is, we got -- we made changes in the manufacturing and increased the capacity of LVT -- of our LVT plant there and then we have the new one coming up which should be running end of the first quarter, early second quarter. Keith Hughes Not the segments are solid plant, correct? Chris Wellborn It's a rigid plant but I have to tell you, we could make either or on it we need to. Keith Hughes Okay. And the changes you made to the existing capacity that help to just plug the market here in the fourth quarter? Chris Wellborn Yes. They will also give us, enable us to bring out some new products, we are 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 will see in this quarter maybe the end was start putting out more products in both the commercial and residential. But, you won't see the impact up until next years. Keith Hughes Okay. Thank you. Chris Wellborn Thank you.

[Operator:]

Our next question comes from David MacGregor of Longbow Research. David MacGregor Yes. Good morning, everyone. Jeff, in responding to an earlier question, you made the observation that about 50% of ceramic is imported into the United States and then import supplied market for years. My understanding was -- it was always kind of bifurcated as a general observation between 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, it is import product, I guess on the assumption I think you made the same forever, things are going to be some kind of change in presence, are they winning share or are they losing share and if you could maybe detail that a little bit, that would be helpful. Jeff Lorberbaum The first is, the market there -- we call it ceramic and porcelain. So, what's happening is, the porcelain product had been growing over the last five years as the start of design and differentiation. The ceramic products which are read by the products, tend to be the end and as consumer want to pay more. They want 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 importance stuff, the bottom end is just the lowest price stuff. We sell as much as we want to win and but our goal isn't to be the largest commodity producer that has no value add, no marketplace as if. David MacGregor I guess, I'm just wondering if you are seeing improving product quality coming out of some of those foreign mills that is allowing them to creep from what may have been 20%, 25%, up to maybe 30%, 35% of the low end of the market, or just overlap with that portion. Chris Wellborn I don't think, we have seen much change and from 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 was we receding that market for a new expansion, so we probably had less read by ourselves during that period of time. Jeff Lorberbaum We don't really see a much difference in the competition as it is. The other thing just to keep in mind, when the market crash back in the downturn. I mean, we kept running our capacity through it and all the thing came out. So, what's happening is, that it comes back, it's coming -- the low end stuff, there is more of it coming in and most of it's supplied producers that don't know what to do with it rather than sell it at zero 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 are talking Florida or maybe part to California. It's not so easy to bring in a lot of blow in product. David MacGregor Yes. That makes a lot of sense. This is my follow-up, quick question on LVT, what percentage of your mix now is commercial versus residential. And then, could you talk about profitability of North American LVT versus profitability of European markets and realize that your -- this scale differences between those few markets, which is in terms of what the market is competitively allowing. Jeff Lorberbaum Just to add an answer to 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 got to do with the products and what we have been focusing or not, when we through we are trying to expand our commercial business we go through. And we lagged a little bit in the rigid because we were waiting on our plant, we have been importing some now. So, it's going to get bigger for us. Europe is a different market completely. We tend to focus more on the residential pieces historically because our strength in the distribution in residential as we build up our sales force over there to go in a more commercial, it should grow more as we see. David MacGregor And where the profitability of the two? Jeff Lorberbaum Commercial historically in most things is more profitable because there is more differentiation in it, they like design and sound different in it, they pay for performance features, so, typically it's a higher margin, its lower volume. David MacGregor Got it. Thanks and Congratulations on all the progress. Jeff Lorberbaum Thank you.

[Operator:]

Our next question comes from Stephen East of Wells Fargo. Stephen East Good morning guys. If you look at -- wanting to bridge a little but quarter to quarter, if you look at your third quarter EPS, you are up about 7% year-over-year and your guidance for fourth quarters, sort of flattish if you will. I know you got a couple of incremental points headwind from higher start-up. But, what else would be driving the slower growth at least on an EPS basis quarter-over-quarter. Jeff Lorberbaum You have the -- IP is declining from where it was, the start-up cost are higher, yes, that would be the big ones. Frank Boykin Are you comparing pervious Q4 or Q4 this year to Q4 of last year? Stephen East I'm looking at Q3, your EPS is up about 7% year-over-year. And then, if you look at your 4Q guidance, it's basically flat, up a couple of percent on the 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 startup cost is going to take a couple of points away, but I was wondering what those other four or five point where that's coming from. Frank Boykin I mean that's primary, I mean start-up cost also includes to go to market SG&A investments that we are making as well that's probably more heavily weighted in the fourth quarter. Stephen East Okay. All right. I got you. And would the price raw material issue be meaningfully different quarter-over-quarter? Frank Boykin No. We think that we cover -- it's hard to tell, we're having a difficult time telling price and mix apart in it. So, we sort of have to look at them but the other in the price mix offset the most of the inflation this quarter. So, it will be about the same the next quarter. Stephen East Okay. Frank Boykin 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 into the fourth, so that was one impact. We also had buy-in for price increases. Stephen East Okay. All right. And that's one of the things I was going to ask, so okay, that helps. Jeff, you talked about, the best in highest use of your cash is reinvestment versus acquisition and I appreciate where you are 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 to understand how much more attractive reinvesting with the -- versus a typical acquisition? Jeff Lorberbaum You have to start to do there is a timing difference. So, they got to help you. There is a whole different types of pieces to the acquisitions, you have to pay for the cash flow, the existing businesses and typically you could end up with return on capital and mid-6% to 8% range when you start and then over time you have to take all the pieces you have to do, and bring it up above your cost of capital, could you pay not for the equipment, you pay for all the pieces they have done. On the other ones, we don't pay for the cost of capital is that but depending on which one they are sometimes you have a year to investment getting the marketing setup, the broadening of the pieces. And then, when you go into the incremental investments those you already have the distribution piece, you fill them up much quicker, and so they ride. And in the end, I would -- the goal is to get the acquisition above the cost of capital, it usually takes three to five years to drive it up because the premium he paid for all acquisitions. And the other ones it depends on whether they are short or long and then you usually have a higher return in the other one when you get through and it happens earlier. Stephen East 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 covered for now. I guess as you look at, do you think you are seeing any type of deceleration in the raw material inflation path that they are taking? Jeff Lorberbaum We don't believe that we are going to see a deflation. We think we are going to see an increase. Stephen East Yes. I just didn't know if they were moderating, I'm sorry, if you were -- if the inflation rates were moderating, the further away we get from these hurricanes et cetera? Jeff Lorberbaum We have a spike in some of those, but then you have the ongoing changes that you always see. The hurricanes spike, we should see moderation in it, but they were expecting increasing raw materials, this is a normal course of event. Chris Wellborn And Stephen, I don't know, if you are referring just to the U.S. or worldwide, but over in rest of global where we had a lot of inflationary earlier in the year that seems to have subsided inflation. Stephen East Okay. All right. Thanks a lot.

[Operator:]

Our next question comes from Tim Wojs from Baird. Tim Wojs Good morning. Just a couple of modeling questions from me. I guess, first, of the $1.4 billion for that you've talked about in the capacity adds. Could you maybe breakout what might be existing versus completely new markets for you just maybe ballparks figures. And then, second, on productivity, I think year-to-date you are almost even with what productivity was in 2016, so just anything that kind of mind around productivity if we go into 2018? Jeff Lorberbaum I don't in my head have a breakdown between new and existing pieces that you go through within each one. I will have to give you that one. We don’t normally think of it like that. So, I mean, if that what I have off the top-off my head, the big things are -- the new products and geographies are going into rigid LVT, which we just recently started selling some in the last 6 months, importing it from China, so that's got a new business for. We have the countertop business, which is countertops in the U.S., we are in the countertop business, selling it, but this will be first manufacturing of quartz countertops. Porcelain and countertops is a new business for us in Europe, we are going to shift some to the U.S. and start seeding the market here and potentially open another line here to support, when the market is ready for it. We have the carpet top business which -- the plan will be up and running limited this fourth quarter and more next year, so that's an entirely new market for us. And then in the sheet vinyl business -- the business we bought, they greenfielded a sheet vinyl plant in the United States and it's brought up doing well and the groups can do this same thing in Russia. And Russia is a big market for us. We think there is an opportunity for us. Those are the pieces, I don't have the numbers by each of them is separating. Tim Wojs And then, anything just kind of think about productivity in 18? Jeff Lorberbaum Yes, never rough. Frank Boykin Every year everybody signs up for new productivity projects and initiatives and we will have a large number of projects next year just like we had this year. Tim Wojs Okay, great. Good work on the rest of the year. Thanks. Jeff Lorberbaum Thank you.

[Operator:]

Our next question comes from Eric Bosshard from Cleveland Research. Eric Bosshard One question on the tile business, the U.S. tile, I think it's growing kind of low single digits 2% or 3% for three quarters now. Curious how we should be thinking about the growth rate of that piece of business moving forward? Jeff Lorberbaum It's going to increase. I mean, that's why we keep telling you that the first six, seven months, we didn't have anything more to sell. It's hard to grow a whole lot doing that. It's hard to be an 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 elevate something of these things and we expect the business to grow more than it had. Now at the same time, every business we have is going to get impacted by LVT. There are some of these 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. Eric Bosshard Great. Thank you.

[Operator:]

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

[Jeff Lorberbaum:]

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 is going to be more variation quarter-to-quarter with the all the aggressive actions we're taking. Thank you for joining us.

[Operator:]

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