Mohawk Industries' (MHK) CEO Jeff Lorberbaum on Q2 2016 Results - Earnings Call Transcript

| About: Mohawk Industries (MHK)

Mohawk Industries, Inc. (NYSE:MHK)

Q2 2016 Earnings Conference Call

August 5, 2016 11:00 AM ET

Executives

Frank Boykin - Chief Financial Officer and Vice President Finance

Jeff Lorberbaum - Chairman and Chief Executive Officer

Analysts

Michael Dahl - Credit Suisse

Robert Wetenhall - RBC Capital Markets

Sam Eisner - Goldman Sachs

David MacGregor - Longbow Research

John Baugh - Stifel

Laura Champine - Roe Equity Research

Eric Bosshard - Cleveland Research

James Armstrong - Vertical Research

Sam Darkats - Raymond James

Scott Rednor - Zelman & Associates

Megan McGrath - MKM Partners

Susan Maklari - UBS

Operator

Good morning. My name is Julie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mohawk Industries Second Quarter 2016 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, August 5, 2016. Thank you.

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

Frank Boykin

Thank you, Julie. Good morning, everyone, and welcome to Mohawk Industries quarterly investor conference call. Today, we'll update you on the company's results for the second quarter of 2016 and provide guidance for the third quarter.

I'd like to remind everyone that our press release and statements that we make during this call may include forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, which are subject to various 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?

Jeff Lorberbaum

Thank you, Frank. Our second quarter earnings exceeded our expectations. Our earnings per share for the period were $3.42, an increase of 35% or $3.47, excluding unusual charges, an increase of 29% over last year and an all-time record for the company. This marks the ninth consecutive period that Mohawk has delivered record adjusted earnings per share. Our strategic business initiatives and our acquisitions all contributed to our rise in earnings.

For the quarter, our operating margin grew 270 basis points to a second-quarter record of 15.2%. As a result of productivity, sales volume, acquisitions and lower input costs offset partially by investments in SG&A and an unfavorable price mix. Our revenues for the second quarter were $2.3 billion, an increase of 13%, our highest quarterly revenues ever.

During the period, we generated free cash flow of more than $270 million. Our innovations in products and processes, investments in efficiencies and integration of our acquisitions enhanced our performance during the quarter and provide a foundation for long-term growth. Our recent acquisitions are progressing as we broaden their strategies, leverage their distribution and provide additional resources. Across the enterprise, we are investing in marketing to improve our product introductions and expand our distribution and sales. We anticipate SG&A is a percent of sales, will improve as we progress through this year.

To optimize our businesses, we have initiated many capital projects that will enhance our performance this year and beyond by expanding our capacity, product offering and efficiencies. We are in the final stages of the start-up of our new U.S. ceramic, LVT and outdoor rug operations as well as our European LVT plant. We have begun additional projects to support our growth, including LVT and laminate in the U.S. and Europe, ceramic in Mexico, Italy and Russia, continuum polyester carpet, engineered wood and utility mats in the US. This year, we anticipate our capital expenditures will exceed $600 million depending on the timing of payments.

Consumer spending at the end of the second quarter strengthened the U.S. economy. The most recent National Association of Builders report affirmed continuing recovery of the U.S. single-family home market. Continued job creation, new household formations and low mortgage rates should support housing growth throughout this year.

Harvard LIRA Index projects remodeling activity will approach as 2006 peak in the middle of next year. The latest architectural building index, which measures commercial design activity rose to the highest level at almost a year. In Mexico, low inflation has raised consumer confidence to its highest level in a year and the comments are predicting further GDP growth.

The European Central Bank continue to stimulate the economy through a quantitative easing and low interest rates. The Russian economy remains in a recession, though there are indications it may be nearing a bottom.

I'll now review our second quarter performance by segment. Our Global Ceramic sales rose 5% as reported with operating income for the segment growing 16% over last year to a margin of 17%. FX negatively impacted the translation of our sales for Mexico and Russia by $16 million.

Our North American ceramic business continue to grow and our margins benefited from higher volume productivity mix. The home construction channel outperformed the rest of the business and we're expanding our position with builders across the country. Our new product introductions are gaining momentum, imperatively impacting our margins. We increased sales personnel and distribution points to optimize our market position. The introduction of some new [indiscernible] programs were postponed by large customers in the period and are back on track. Sales of our countertops are increasing as we expand our distribution and product offering.

We continue to enhance the quality of our independent distributor network and have expanded American Olean and Marazzi service centers on the West Coast. Our new Tennessee ceramic plant is ahead of schedule with the final production line becoming operational in the third quarter.

We are manufacturing higher value products at this facility, including 48-inch wood planks and color body porcelain tiles. The plant in Western Mexico that we acquire last year is improving its performance with higher production levels and lower costs. We're focusing each of our North American plants on specific products to optimize our productivity and increase their efficiency and quality.

We are reengineering our product formulations and increasing the recycling of our ceramic wastes. Our ceramic operating margins in Mexico expanded as we've upgraded our mix and reduced our cost. All of our Mexican tile capacity is being utilized and we have begun the expansion of our Salamanca plant.

We will double its capacity by adding new lines that will be operational in the fall of next year. We continue to grow our retail sales as well as our participation in DIY and new construction channels in Mexico. Our European ceramic sales continue to improve with expanded margins of improved mix by upgrading our assets, enhancing our offering and improving our sales execution with increased revenue and profitability.

To continue these trends, we are introducing more differentiated products in the middle price points and investing in retail merchandizing, retail sales training, and consumer advertise. We have initiated the final phase of our Italian asset modernization, which we completed during the first half of next year. In addition, we've purchased a new manufacturing line to make even larger tiles to be used on floors, walls, and countertops. We're enhancing our position and product offering, improving efficiencies, and supplying product to our Western European and U.S. markets.

Despite the continued decline of the Russian economy in ceramic industry, our sales rose significantly on a local basis, with improvements in volume, price and mix. We're increasing our market share through industry-leading design and broader distribution. We've started up a new line to give us more porcelain production to satisfy our growing demand. We've enhanced the strength of our organization and broadened our sales and manufacturing capability. We are further expanding our capacity to prepare for a stronger Russian market in 2018.

For the second quarter, our Flooring North America segment sales were up 7%, with operating income for the segment increasing 25%, to a margin of 12% as reported. Operating income grew 16% over last year, to a margin of 13%, excluding unusual charges. The segment's profitability as we increased investments in sales personnel, retail merchandizing and samples. Like ceramic, some large customers postponed product launches and reduced inventory in the period, and we anticipate sales improvement in the third quarter.

Our residential carpet margins expanded as a result of our differentiated products, process innovation, and investments that lowered our cost structure. During the quarter, the industry's average selling price for residential carpet declined due to the shift of polyester and the lower cost of materials. Our mix was negatively impacted by the strength of the new home and multifamily channels, which utilize lower value products. To satisfy the changing corporate market, we're adding more continuum polyester production, which uses recycled materials to provide higher quality and value.

We widened the distribution of our SmartStrand carpet, Karastan broadloom and mainstream commercial collections, which outpaced our other residential sales. Our exclusive SmartStrand franchise is being benefited by our new Silk Naturals collection, which has the appearance of wool, but a softer, more luxurious and easier to maintain. We continue to strengthen our manufacturing performance with many process advances, higher yields, and material enhancements. Our commercial carpet sales increased as we strengthened our product offering and expanded our sales in all channels.

Our innovative commercial introductions received multiple awards at the recent show and gained interest from architects and designers who attended. We continue to simplify our manufacturing, consolidate plans, and improve our planning processes. We're enhancing the designing value we provide to our customers while increasing our margins at the same time. All of our commercial channels are showing improvement with hospitality and senior living, the strongest.

Our new innovations in laminate are differentiating our products and expanding our market share. We continue to deliver unique styling and performance features in our laminate collections. Our European operations are providing product to the U.S. until our new capacity as operational next year. Our engineered wood sales continue to grow and we have a price increase that will be implemented in the third quarter. By the end of this year, we will install more engineered wood production to satisfy greater demand and produce higher value products. There is pressure on the solid wood sales, as consumer preference shifts to engineer. In June, we had a disruption in our Virginia wood plant, which impacted sales by $2 million and we are now getting back to normal levels.

Our vinyl business continued to expand as we increase the product assortment and distribution of our LVT and sheet vinyl. Our growth in the LVT category has been constrained by our manufacturing capacity. We've recently made equipment modifications that will significantly raise our LVT production and reduce costs. We are preparing to introduce new designs and features to further grow our LVT sales in both residential and commercial. By the end of the year - by the end of next year, we will double our U.S. LVT capacity and enhance our capabilities in this fast growing category.

For the period, our Flooring Rest of the World segment sales were up 51%, with operating income rising 91% to a margin of 20% as reported. Operating income grew 67% to a margin of 21% on a local basis excluding charges. Our Flooring business improved significantly led by premium laminate and LVT. Our laminate mix benefited from our sales of our new collections featuring more realistic visuals and water resistance. We're adding laminate capacity in Europe to support the next generation of this unique technology. To offset currency fluctuations, we're announcing selective price increases. The system integration for Balterio Laminate, will be completed during the third quarter and allow us to realize additional synergies. In Russia, our laminate facility continues to be fully utilized and we're exploring options to add capacity. The mix of our wood business improved during the period, offset by negative currency. Higher sales of wider wood increased our material costs and we are raising prices to offset. We're reducing our wood SKUs and driving productivity and quality.

Our LVT sales and margins increased as our mix and efficiencies improved. To support our LVT growth, additional equipment is being installed there also to raise our capacity and we're sourcing products to supplement in the meantime. To satisfy future LVT growth, another production line should be operational by the end of the year.

Our sheet vinyl sales were negatively affected by a fire in our Belgium plant that we reviewed last quarter. The operations are presently running about 95% of our expected rate and full production will be achieved this period. The impact to the fire on second quarter sales and earnings was approximately €6.5 million and €2.5 million respectively. We anticipate recovery of about €2 million from insurance during this period. We are expanding commercial sheet vinyl sales and will improve - that will improve our mix.

During the period, our panel sales and margins expanded, as we implemented many actions to enhance our results. Our insulation volumes increased significantly, offset by currency changes and lower prices as material cost declined. The integration of Xtratherm and our legacy insulation business continues with sales, administration and systems being realigned to enhance our results.

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

Frank Boykin

Thank you, Jeff. Net sales as reported were $2.310 billion, up 13%. Our legacy business was up 3% on a constant days and exchange rate basis. We had one additional day in the second quarter and we will also have one additional day in the fourth quarter. In the third quarter, we'll have one last day compared to the last year.

Plant disruptions, temporarily pushed sales down by approximately $9 million in the quarter. We had a negative FX impact of $16 million with the decline in the ruble and the peso, offsetting the positive impact of the euro. All segments grew with the strongest performance in our Rest of World segment.

Our gross margin as reported was 32.7% or 32.8% excluding charges, up a 180 basis points over last year. Volume and productivity were the biggest drivers for our improvement. SG&A as reported was $405 million or 17.5% of sales. It was $402 million excluding charges or 17.4% of sales, which was 20 basis points higher than the last year.

Marketing investments primarily in the ceramic and flooring North American segments continued during the quarter. We expect the SG&A percent to net sales to decline in the second half as spending slows and we leverage our cost better with the higher sales. Operating income as reported was $351 million with the margin of 15.2%. We had restructuring charges of $6 million related primarily to the woven carpet consolidation in our North American segment. We estimate another $20 million to $25 million of charges in the second half of this year.

Our operating margin excluding charges was 15.4%, which is at a 160 basis points, even with a $4 million foreign exchange headwind. The operating increase over last year was impacted primarily by a positive volume at $46 million, and productivity at $41 million, offsetting SG&A investments of $18 million.

Interest expense for the quarter was $10 million, which improved $7 million as higher rate bonds were refinanced last year under - this year under CP program. Other income was $5 million, and includes favorable FX. Our income tax rate was 26% this year, compared to 24% last year. And we are estimating our full year rate at 25%. Earnings per share as reported were $3.42. Earnings per share excluding charges, was $3.47 up 29% over last year.

Moving to the segments. In our Global Ceramic segment sales as reported were $830 million, which is a 5% increase over last year. Our legacy business is up 4%, on a constant days and FX basis. We had very strong local currency growth in Russia, with both North America and Europe also growing. FX was a $16 million headwind in this segment. In Europe, our premium products experienced the strongest growth. Operating income as reported was a $141 million, or a margin of 16.9%. The operating margin excluding charges was 17%, an increase of a 140 basis points. Operating income growth was driven by positive volume of $12 million and productivity of $14 million, offsetting $6 million of SG&A investments.

In the Flooring North American segment, sales as reported were $981 million, an increase of 7%. The legacy business using constant days was up slightly with a 1% increase. Hard surfaces and LVT sales growth was the strongest. Operating income as reported was $119 million with a margin of 12.1%. The operating margin excluding charges was 12.8%, up 110 basis points.

The operating income increased primarily from productivity of $22 million, an input cost deflation of $9 million offsetting negative price mix of $9 million and another $9 million from SG&A investments.

And then finally, in our Flooring Rest of World segment, sales as reported were $500 million, up 51%, with the legacy business on a constant days and FX basis, up 5%.

Both, LVT and laminate had good growth in the quarter. The operating income as reported was $101 million with a margin of 20.2%. Our operating margin excluding charges was 20.1% and was an increase of 160 basis points. Operating income was positively impacted by volume of $28 million with lower input cost of $8 million and productivity of $6 million. If you look at the corporate elimination segment, we had an operating loss of $10 million and we expect a full-year loss of about $35 million.

Turning to the balance sheet, receivables ended at $1.4 billion with our days' sales outstanding up to 54 days from 52 days last year. This was primarily due to channel mix.

Inventories at the end of the quarter were a $1.7 billion. Inventory days continue to show good improvement with the 105 days this year compared to a 106 days last year. Fixed assets were $3.2 billion at the end of the quarter. We add capital expenditures in the second quarter of a $136 million and depreciation and amortization of a $101 million.

CapEx for the fiscal year is estimated to be between $600 million and $650 million for the quarter - for the year and depreciation and amortization of $410 million. Long-term debt ended up at $3 billion with our leverage at 1.8 times debt to pro forma EBITDA.

Jeff, I'll turn it back over to you.

Jeff Lorberbaum

Thank you, Frank. We are optimistic about our future performance as a result of our ongoing investments and people products and assets. Our current booking trends have improved and we anticipate third quarter sales growth will be higher on a local basis. We expect continued margin expansion in all of our segments due to processed improvement, operational innovations and greater efficiencies.

Across the business, we are introducing differentiated products and leveraging customer relationships to increase our market position. We are making significant investments to expand our capacity and grow sales in all of our products and geographies. Our LVT sales growth is accelerating and our new plants are making gains in capacity productivity and efficiency.

Taking these factors into account, our EPS guidance for the third quarter is $3.40 to $3.49. This represents a 14% to 17% increase over a third quarter of 2015 EPS, excluding any restructuring charges from 2013 through 2016. We have invested over $2 billion in new assets to drive Mohawk's profitability. We have substantially integrated our recent acquisitions and with our strong organization and balance sheet, we can exploit additional opportunity. In every region, our differentiated product collections, operational excellence and extensive customer relationships give us advantages, so we can deliver stronger results. We'll now be glad to take any questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Mike Dahl from Credit Suisse. Mike, your line is now open.

Michael Dahl

Hi. Thanks for taking my questions. I think you mentioned some of the modifications to the current LVT capacity. And, I'm just curious, is that's helping your productivity out of these plans. Could you give us a little more color around that and also maybe an update on just in light of that and some of the other investments you're making, where you stand from an LVT capacity on a revenue basis? And when you talk about doubling over the next year or so just forward, does that put you as far as how many dollars of revenues you will be able to produce? Thanks.

Jeff Lorberbaum

We presently have three plants, two in Europe and one in the United States. The plant in Europe was started before we purchased IVC and it's been a ramping up, we've just made - when we put the plant in, we didn't put in all the things that took to optimize the capacity, because we weren't sure what we didn't know. We've recently added more capacity to feed it, which is going to up the production levels as we speak in Europe. In the U.S. plant, with a totally different technologies than the other two, which ran about 50%, 60% faster over there. It's also in its final stages of startup. We've been making modifications to it, and over the July 4, we made additional changes to it, to try to get it to what we believe to be is optimum capacity later in the fall of this year.

In addition to those, we are in the process - or have ordered pieces of equipment that open the next generation of the United States plan that will run even better and have more capabilities, and we're going to put another line in the United States and into Europe, both of which should be running by the end of next year, will enable us to grow the business. The combination of all those together, will give us capacity exceeding a $1 billion between the two. We will have slightly more capacity in Europe, than we will have in the U.S. when we get through.

Michael Dahl

That's great. Thanks. And as my follow-up, I guess once you're fully ramped, and online with the three plants, could you give us sense for just differential in cost between fully producing domestically versus your current sourcing model?

Jeff Lorberbaum

I'm not sure, I'm prepared to break that out for you.

Michael Dahl

Okay. Thank you.

Operator

Our next question comes from the line of Robert Wetenhall from RBC Capital Markets. Robert, your line is now open.

Jeff Lorberbaum

Bob, are you there? Maybe, we should go to the next one.

Robert Wetenhall

Hello.

Jeff Lorberbaum

Hey.

Robert Wetenhall

Can you hear me?

Jeff Lorberbaum

Yeah, we can hear you now.

Robert Wetenhall

Sorry about that. Fantastic results I think, these speaks for themselves. Instead of going in because there is a lot of detail that both of you provided. I was hoping to kind of go big picture today and talk about the $600 million of capital spending through this year. If you could walk us through the kind of paybacks that you are getting on the dollar spend, and why it is that heavy investments that you've been making both in SG&A and capital spending to $2 billion between 2013 and 2016? Why does that make more sense for Mohawk, given your track record, your successful track record of acquisitions? Why is that preferable to share buybacks in returning capital to shareholders?

Frank Boykin

If I can get all those out, if I forget, you remind me. Our strategy is and has been to aggressively drive our business growth and profits through our profit allocations. And okay, where the truth I'm really not sure that our ability to do that's been fully recognized by the entire market. Prior to 2016, we invested about $5 billion into the business which is why we've been doing so well and expect to continue doing well.

Of that, about a $1.5 billion was into our existing assets and about $3.5 billion was into nine other acquisitions. With those things, the paybacks range from the short-end of two years for some of the capital to the long-end of about five years with most things and the difference in doing some of the internal pieces is, when you go into big projects, they can take year to year-and-a-half to get it going another year to bring it up to level. So, you don't get as much return in the first year too, but over the IRR over the five-year period and 10-year period is usually much greater, is it along with lower risks.

At the same time, during those things, we have invested, investing as the business get stronger, we started investing more in SG&A and most of the business is to drive it, and with the investments we're putting in, they get about $1.2 billion to $1.4 billion as what we said of additional sales. We have to be bringing up the SG&A in order to support those things and it goes in before you actually get the sales results, when you get through.

From there going forward, in 2016, we've announced, we're going to invest over $600 million, [indiscernible] in the same things of new products, increasing efficiencies, and giving us more capacity in all of our different businesses. Again, these investments are the ones that give us the highest return at what we believe to be the lowest risk of our various opportunities as they're.

Today, the fastest growing part of flooring industry is LVT as we just went through before, we'll have over $1 billion of capacity to support this in the U.S. and Europe, so we think we're well positioned. Our plants are more automated than others that are in the more integrated forward and backwards in order to make it at lower costs and give us high flexibility to make wherever the customer wants. With this, we continue to look at acquisition opportunities around the world. We remain disciplined in our approach to get good returns on those, and organization's ability to identify and execute these opportunities is really what sets us apart.

Robert Wetenhall

I agree. And that's a very helpful articulation of the strategy, and I also agree with your comment that I don't think this is being fully recognized by the investor base. Could you talk to us about the $600 million is a lot more than you normally spend, and we're thinking about only the next two years to three years. What's the trajectory of SG&A spending on a dollar basis. Frank mentioned you're going to get leverage. And although, it's a little early, how should we'll be thinking conceptually about CapEx in 2017 and 2018? Thanks. And good luck, nice quarter.

Jeff Lorberbaum

Thank you very much. On the SG&A, we started raising it last fall, getting ready for all of these investments in order to have the sales stride, pushing through the growth to support all of these different pieces we're in. We've been doing it across the company in the various regions, which is why we are doing as well as we are. In the second quarter, even with those investments, the SG&A as a percent of sales, I think was only slightly above last year...

Frank Boykin

About 20 basis points.

Jeff Lorberbaum

So, it was slightly ahead of last year. And as we go through the fall, we think we're going to get leverage and expect percent of sales decline above the prior year as the sales get more in line with it. On a going forward basis, we'll have to keep investing, but we hope to keep the percent where it is or going down. For a given moment, it might get ahead or behind it as you try to align it with the new capacities we have coming in. did I get all the questions?

Robert Wetenhall

I was - that was great and just the other part of that and then I'll hand it over. What about capital spending in 2017 and 2018? Should we expect the elevated level of $600 million or do you see capital spending because you made a lot of investments in the last three years to your credit, should we think that will taper off?

Jeff Lorberbaum

We haven't finalized next year and beyond, a lot of the investment we're making this year there'll be parts of the carry over in next year. I would guess, it's going to be elevated, but we - next year, but we really haven't put it together yet. Just one last comment, the best thing I can do for the shareholders and the company is continue to find internal investments that have good paybacks. And I mean, if I could find twice as many I would do it, assuming that the risk and rewards are right which is what we're paid to do.

Robert Wetenhall

Sounds good to me. Good luck. Thanks very much.

Operator

Your next question comes from the line of Sam Eisner from Goldman Sachs. Sam, your line is now open.

Sam Eisner

Yeah. Thanks and good morning, everyone.

Jeff Lorberbaum

Good morning.

Sam Eisner

So going back to the productivity numbers Frank, if I heard you correctly I think you said about $41 million of productivity savings and I think that compares to $29 million in the first quarter or so. You're running at close to $70 million if I annualize that's about a $140 million. And so I'm curious the sustainability on the productivity savings. I understand that you're spending $600 million this year. But perhaps you can give us more of a medium-term commentary on how you think about productivity savings that's been steadily marching higher from about a $100 million in 2014 going to about $130 million in 2015 and now it seems to be, again run rate about $140 million for 2016. So, curious how you think about the medium-term productivity savings for the company.

Jeff Lorberbaum

This is Jeff to start. All these capital investments that we're putting in, a significant portion of them is also going towards improving the cost structures. As they come up, we have lower cost as well as higher revenues in pieces. So, some of it - some of the investments are going there. Every part of the business starts out the year with an internal productivity goal. It's made up of two parts. One is capital investments and the other is process changes. And we have very disciplined procedures of coming up with innovative ideas and then ensuring that they get driven through the business and execute it.

And the ideas, we start at with, I think, we probably get about 60 - I mean, some of it, we don't know how to do, we just put them down, so we need to do something, but probably get about 65% of get executed. At the same time, we come up with more of them every year and I am really putting a good process to drive it.

Frank Boykin

And besides that, Sam. I would not say that we're prepared to give a number or guidance, but like Jeff said, we are driving the business, everybody has goals in terms of productivity improvement, whether they're in manufacturing distribution or administrative roles, and it's a deeply embedded part of our culture here to continually improve the business.

Jeff Lorberbaum

Yes. I just want to make sure you understand, we're not out of ideas as the - and that's the reason we keep raising the profits and the margins.

Sam Eisner

Got it. So in your terms, we're halfway there on the productivity improvements?

Jeff Lorberbaum

Yes. I'm looking at a signing my office, it is halfway there, no matter where we are - we are always have quite.

Sam Eisner

Sounds good. And then maybe secondary, a little bit more of a macro question here. We've heard a couple of comments from other participants within the kind of broader building product sector this quarter talk about credit. And ultimately consumers beginning to use some credit, whether it HELOCs, whether it's home equity loans or even cash out refinancing. Curious what you're seeing on the ground level from some of the customers or at least commentary from some of your retailers, about how customer are ultimately using financing, if they're using it, in particular in North America? Thanks.

Jeff Lorberbaum

Hey, it's true, and that's close enough to actually give you a specifics of it. We think that the credit lines are getting better with people as their incomes go up. We think that the banks are getting a little easy in giving some credit. At the same time, as the incomes increase, and gasoline prices come down, we think all of the things are in place for us to do well over the near-term.

Sam Eisner

Appreciate that. Thanks.

Operator

Our next question comes from David MacGregor from Longbow Research. David, you line is now open.

David MacGregor

Hey, good morning, everyone. Great quarter, Jeff. With all of the things you've got going on right now, and where you started off, so can you just talk about the impact of startup costs on your 2Q margins, and how that might have compared with first quarter and year ago?

Jeff Lorberbaum

Yeah. Startup cost in the second quarter were about $4 million. I don't know what year ago numbers were off the top of my head. We're estimating about another $3 million to $5 million in startup through the second half of the year though.

Frank Boykin

That's the amount of increase over last year.

Jeff Lorberbaum

That's total startup. Total startup.

David MacGregor

Yeah. Sound a little light to me. Congratulations on that. And then secondly, just if you could talk a little about China. And I know you've had investments there, you haven't really talk much about that lately, could you just update us on the scope of your presence there, are you profitable, what level of growth you're achieving, just any general elaboration would be helpful? Thanks.

Jeff Lorberbaum

Somewhere in the recent past, we changed the ownership position that we have in the China joint venture from an equity position to a debt position with agreements on a buy and sell arrangements between us and we changed the strategy because what we needed to do to operate in that environment, with us as an equity partner has limited their ability to participate on an equal basis in the marketplace. So, we still have a relationship with them, we are still purchasing product with them, but that's the relationship at this point.

David MacGregor

Great. Thanks very much.

Operator

Your next question comes from the line of John Baugh from Stifel. John, your line is now open.

John Baugh

Thank you. Good morning and congratulations on another terrific quarter.

Jeff Lorberbaum

Thank you.

John Baugh

Could you tell us - you made this comment about orders improving. I am just curious is that a - an inventory pipeline time to refill comment or are you seeing end market demand actually improving and if you could maybe, discuss Jeff, regionally where you are seeing it as well as product wise where you see them? Thank you.

Jeff Lorberbaum

Normally, we don't discuss the order side in the piece. We did it this time because the growth rate was a little lower, than we had wanted it to be and we wanted to make sure to understand that going into the next quarter, we are actually seeing the bookings from our customers increasing and going up. We believe that the growth rate is going to strengthen our growth rate, I can't speak for both, our growth rate is going to strengthen in the third period, and the first month that we've been seeing, we're seeing those things, and we think we're confident that it's going to occur going forward. At the same time, last time, we also had this $25 million of sales that were reduced between a combination of plant disruptions and negative FX, which decreased the - a little bit as we go through.

And so, we're seeing - so, we believe the businesses will be better. However, the European businesses were actually stronger in the second quarter, and we think those could moderate a little, because it was so strong in the second quarter. I want to remind everybody that our friends in Europe, in August - take August off, so it's always at a lower level and the margins drop - and the sales drop as things go in Europe. We keep trying to get them to work out through August, we're not working - we can't get them to do that. Yes.

John Baugh

If anybody can do it as you can, so just follow on up that, is there - you're saying then the - what you can see is better or but you're sure is that necessarily means, the end markets are better or [indiscernible] Thank you.

Jeff Lorberbaum

I can just say that our business is increasing. We also - we believe that we've taken actions that our business should be better than others. I'm not sure, how the home market is going to be versus where we are.

John Baugh

I appreciate that. Good luck.

Operator

Our next question comes from the line of Mike Wood from Macquarie Capital. Mike, your line is now open.

Unidentified Analyst

Hi, guys. This is Drew on for Mike. Thanks for taking my questions. So, on LVT, there's no secret, that there's a lot of capacity coming on in the U.S and Mohawk alone is doubling capacity by the end of the year. So, I just wanted to ask what products do you think that the new LVT capacity is going to cannibalize and what products from Mohawk are most at risk?

Frank Boykin

So, the cannibalization within the marketplace. First is, there is a huge amount - I mean, almost all of the LVT is coming in from China as is. So, first is there is going to be a switch between the America sold from China and amount that's made here. The industry today here depending upon whose estimate years is somewhere around $1 billion, $3 billion, $4 billion, it's expected to grow maybe 15%, but it's going to grow $200 million over the next 12 months, so that's occurring, separate from that. So, one is there is the change from where it supplied from on a separate basis, it's taking a little bit from everything, it's coming out of almost every product category where it is. If you say, it's going to grow unlike up something, and you say, it's going to grow $200 million over the next 12 months, that's approximately 1% of the industry.

And if you do that the - if the whole industry grows maybe $3 million to $4 million, it's taken about one-third to 25% to 30% of all the growth is what's happening and it's coming from all over. We hope - we think we are going to be the best position in the marketplace with the lowest cost access and ability to deliver the best style and features in the marketplace, we know, we are ahead of everybody else.

Unidentified Analyst

Great. Thanks. And then, just on the margins for LVT in the U.S. Is that expanding across all price points or are there major differences between the high-end and the low-end?

Frank Boykin

There are different - and it's more segmented than that. The differences between residential and commercial, this differences between low, medium and high and a different products and different features require to optimize each. They are installed different, as at the low-end you know it could be glued in or laid in, the high-end could be clicked. And the performance features are different, depending upon residential and commercial.

Unidentified Analyst

Great. Thanks guys. Nice quarter.

Frank Boykin

Thank you.

Operator

Our next question comes from the line of Laura Champine from Roe Equity Research. Laura your line is now open.

Laura Champine

Thanks. Jeff, the question is about the assets that you're adding in Russia. You said they were to meet demand in 2018. Is that demand that you expect just through your own market share gains or are you actually making a call on a recovery of the end market there?

Jeff Lorberbaum

The first is, our present capacities, we're about three years into what I believe into the market decline. The ceramic industry in Russia, my estimate is, it's off about 35% from the peak, so the first thing that happened was the imports coming into Russia declined first. And they headed close to zero if they are not already. In that environment, the imports for supplying, the mid-to-high end part the marketplace. We were positioned in the mid-to-high end part of the marketplace and so we became the best option to replace it. Our business in connection with the rest of our businesses, we can make any product in Russia, you can get for anywhere.

So over that time what's happened is, our business has been expanding in the midst of a year to recession that's going on over there. We've also been expanding the - so have expanded the product offering with more style and design at different price points, and we've also been expanding our distribution points. But I don't know if you remember we also have over 300 either owned or franchised retail stores that we put through there as well as our own total national distribution system over there. In addition, because of these things, we're the only company over there that has a consumer brand.

So, with all this, we've been running our assets wide open at the moment. This year, we've actually increased the capacity. It's coming on in the fall of this year because we've run out our personal capacity as we speak today and that's coming in over the next, this period we're in right now. And then, the market is really close to looking like it's bottoming soon, so it takes us about almost a year and a half to two years to get new capacity in. So, we've ordered right now in order to be able to sustain the growth after 2017. We have to have some more capacity, so that's what we're ordered and it's coming in.

If the market picks up, we know the market is going to pick up somewhere, it's really low from where it is. It's got to pick up. Our distribution has been broadened, so we're really ready for it. And there is a chance we could be a little early or we could do a little late, but I mean we're in a right position. And I think we can push it through the marketplace no matter what.

Laura Champine

Great. Thank you.

Operator

Our next question comes from the line of Eric Bosshard from Cleveland Research. Eric, your line is now open.

Eric Bosshard

Thanks. I'm curious for what you see going on in terms of your market share progress as you're adding capacity and adding new product and new designs of interested, but understand a little more about how that's connecting and what's happening with that, with your partners and your retail customers?

Jeff Lorberbaum

I think that we're doing a little better than the overall market. The target go through, because each of the market is different. Carpet is about the industry this year is about flat in units; however, the dollars are down because of the change to polyester, which is the lower priced product and then the pass-through of the pricing, so the dollars are down even though the units were about flat. In the last quarter, I think we've done a little better than the industry.

On the other side of the thing you have products are growing much faster, so laminate is growing faster. I would guess, we're probably growing a little less than the industry in LVP, but I'm not sure, because we've held it up to - we don't want - we've held it up a little bit waiting for our capacity to support it, but it's going to start getting more as we go through. They have ceramic, it's growing relatively well and we're fully participating in it, would grow and we're putting in a new wood plant to folks participate more in it. Our plants have been running full. We've increased the capacity of it coming into this year. So, I think, we're doing well. I think we'll grow more than the marketplace.

Eric Bosshard

Okay. That's helpful. Secondly in terms of you're pretty specific on SG&A, the curious and how we should be thinking about gross margin you had now four quarters of benefit from I think lower input costs, we saw this quarter, I think a little bit less benefit and a little bit less give back on price? But any guidance you could give us and how we should think about the gross margin and/or the price cost environment that we should look forward to?

Jeff Lorberbaum

The margins we're expecting to have higher margins this year over last year in the fall going forward, has built into the estimate that we've given you in the earnings per share. All these investments and things we're doing, are trying to drive the two pieces, which is the top line up and the cost down. And then you hear us, managing the SG&A piece on purpose, we raised the SG&A last fall, and we're going to have to keep tweaking it based on what the market is and what's happening in order to balance our sales with our production expectations. And hopefully, we'll be able to drive that without going - without raising the percentage and driving it down, but we'll have to see how it goes.

Eric Bosshard

Okay. That's helpful. Thank you.

Operator

Our next question comes from the line of Michael Rehaut from JPMorgan. Michael, your line is now open.

Unidentified Analyst

Good morning, this is Jason in for Mike. My question is on the organic growth trends in Flooring North America. I know, obviously the growth on an organic basis went to about 1% from 4% last quarter, and I think you highlighted that there was some large customers that postponed product launches, is one of the drivers there. Just wanted to see if that was really the biggest driver of the slow growth or is there anything else to call out?

Jeff Lorberbaum

And then, I know I think you talked about having more of an indication of solid orders in terms of 3Q, just wanted to see what July trends look like in Flooring North America and a better organic growth rate return to the kind of 3% to 4% number you saw over the last few quarters?

I think first our belief is that the GDP growth slowed, it was - didn't increase as we had anticipated and the market growth was a little slower. Second is that you have to realize that residential carpet is a huge part of our total business and the average selling prices are negative, and that for all the reasons we've already discussed. We did have large customers in multiple categories push product launches out, but they're still going in. We had some customers actually lowering inventory in the period. And given all those things what we said is that we expect the higher growth in the third quarter and the bookings that are in hand that we've been receiving through July, support that expectation.

Unidentified Analyst

Okay. Great. And then just a question on what you're seeing in terms of hardwood volumes in North America, and where do you stand right now from a price cost standpoint relative to [indiscernible]?

Jeff Lorberbaum

We announced a price increase sometime prior to now, with those increases are being implemented as we speak. And there will be put through the marketplace. We have seen from that as the categories, they have to look at it from an engineered wood product and a solid wood product. The solid wood product is under pressure because as the prices has gone up on the solid wood, the engineered price has gotten less and so the engineered capacity is going to continue growing at the expenses of the solid wood is that, I'm guessing that the wood - the total wood volume, if you look at the year we're guessing somewhere in the 3% to 4% range for the industry. And overall for the whole industry and it could be 3% or more, we think the wood piece will be growing at a faster rate in that, maybe 5% to 6%, but then the start - all the growth is going to be in the engineered piece and the solid could be flat or down.

Unidentified Analyst

Okay. Great. Thanks.

Operator

Our next question comes from the line of James Armstrong from Vertical Research. James, your line is now open.

James Armstrong

Congrats on a good quarter. First question is, have you seen any impact of Brexit on either your business or the M&A potential, and the European market cap?

Jeff Lorberbaum

I have to understand that the - our business in those areas only make up about 1% of our income. So, relative to our whole business, I mean, it's really a small part of it. Part of that, we support what we have here in two ways. One we have local manufacturing and the local manufacturing is in products that don't easily ship and have high freight costs. So, those businesses haven't seen a significant change in anything at this point.

The other part we ship from Western Europe into there, we have been - we're in the process of adjusting prices relatively where the pounds have been to get them leveled out. And it's a little early to tell exactly how this whole things going to move forward, but our total business is going to have a significant impact in one way or another?

James Armstrong

Okay. That helps. And switching gears, you talked about the mix shift in carpet in the North American business. Do you think that mix shift will continue into the back half of your or should it rebound more towards the consumer higher margin business.

Jeff Lorberbaum

I'm not sure the mix shift you're talking about.

James Armstrong

You talked about more shift to the home - to the new construction market.

Jeff Lorberbaum

Yes. What I said was that there are channels that are doing better. And so as a general piece, new housing is growing much faster than the general market. The - some of that - a lot that new housing is at lower quality level, and at the same time you've seen the multifamily business grow. On average those channels use lower quality product, and when the consumer comes in and purchases it as a remodel piece.

So, as those pictures - I don't see those changing in the near term. I'm hoping that the remodel piece will improve as yet it more, but we'll have to see how it goes. On the other side, the other thing that's happening is the builder multi-family channels have moved faster to polyester. So, the different in moving from, when I used to buy nylon the polyester is also impacting the average price in those even more so than the other one.

James Armstrong

Okay. That helps. Thank you very much.

Operator

Our next question comes from the line of Sam Darkats from Raymond James. Sam your line is now open.

Sam Darkats

Good morning, Jeff and Frank. How are you?

Jeff Lorberbaum

Great.

Frank Boykin

Good morning, Sam.

Sam Darkats

Couple of questions, first of there is a piggyback on one of the earlier questioners. I know you mentioned the delays in - in some corporate shipments due to customers reducing inventory. I think you also sided in ceramic tile, there were some delays in the second quarter getting push to the third quarter. Can you estimate what the sales impact of that - I know, you have estimated the plant disruptions, but could you estimate what the shipping delays were because of customer timing?

Jeff Lorberbaum

No. I don't have those to give you in front of me.

Sam Darkats

Was it material?

Jeff Lorberbaum

I would have mentioned if - it didn't impact it.

Sam Darkats

Perfect. Okay. My last question, it's been maybe 12 months or so outside of Xtratherm, that you've made a deal, an acquisition of some significance, trying to get a sense of why that is based on the fact that that you've indicated as a real fertile hunting ground for deals, I'm wondering, if is it a lack of selling interest, is it the fits that you're looking at may not be that great or is it valuation being too high, what's been impediment or the constraint on making deals?

Jeff Lorberbaum

We continue to talk to people and look at various opportunities. We remain disclaimed in our approach with the risk and values. So we apply different risk levels to different businesses depending upon where they're located and what they are and we haven't been able to come to a common agreement with anybody in the last six months, but it doesn't mean, we're not trying.

Frank Boykin

Sam, I would also remind you that many of our acquisitions that we've done over the years have been discussions and negotiations that have gone on for years. Dal-Tile is a good example, IBC is a good example, is a good example, those each were at least two years or three years of ongoing discussions.

Sam Darkats

Helpful. Thank you much. Have a great weekend.

Frank Boykin

Thank you.

Operator

Your next question comes from the line of Scott Rednor from Zelman & Associates. Scott your line is now open.

Scott Rednor

Good afternoon. Frank real quick question for you, cash flow from operation year-to-date has essentially doubled from the last year. Just curios if you could talk about the cash conversion in the back of the half of the year, anything unusual on those numbers that we see?

Frank Boykin

No I expect - Scott I expect the cash flow this year to be - continue to be strong as we move into the second half of the year there, we're going continue to see good strong earnings and manage operating - our working capital even with the elevated CapEx. The CapEx, it will be more in the second half and it was in the first half as we go through, but so should the earnings. And then I don't know about acquisitions, whatever shows up.

Scott Rednor

Okay. Thank you.

Operator

Your next question comes from the line of Megan McGrath from MKM Partners. Megan, your line is now open.

Megan McGrath

Thanks, good afternoon. Most of the my questions have been answered. I didn't want to ask you know you go through a lot of the capital projects each quarter, are there any of that - I know it's involved in increasing capacity. I could guess LVT, but I'd love to hear your answer. Where do you think the most acute need is to increase capacity and have you either accelerated plans or reprioritized any in the last couple of months?

Jeff Lorberbaum

Yeah I think LVT is the most important one because of the changing marketplace and the opportunity would make it that at the high one. The question about changing plans or not, given our capital structure, which I've spoken about few times up to now, we will have a huge amount of capital available to us. So, if it's a good idea, we're going to support it today as we go through. We have other things that, if you look at the different businesses, my laminate in the United States is running full out, we're importing products from other places, my ceramic, I'm actually importing product from our manufacturing in Italy, Russia and Bulgaria into my ceramic business, as you go through.

We mentioned, that my Mexico business, I was selling everything that we were making at this point. My wood business in the United States, as I said, I was building a new plant, because I'm sold up there. I mean, I can go through one of the timely deal, but I mean, the business is running really well and we are adding capacities to support our growth.

Megan McGrath

Thanks. That's helpful. That's all I have.

Jeff Lorberbaum

Thank you.

Operator

And our final question comes from the line of Susan Maklari from UBS. Susan, your line is now open.

Susan Maklari

Thank you. Good morning. Quickly, I'm just wondering, in your comments, you mentioned that your countertop sales are increasing and it sounds like as if perhaps you are gaining some share there, can you just talk about, who you think you are taking that from and maybe what the trends have been there?

Jeff Lorberbaum

I forgot how many years ago, we decided the goal into the countertop business. We saw it as an adjunct to our ceramic business, and we've become the largest distributor of countertops in the country. It's a very fractured business as a distribution business with a lot of small people in regional places and because we cover most of the United States, but not all of it, with it, so it's an opportunity to grow our business as a broad distribution company. We've been able to leverage our relationships with ceramic and stone flooring to build a nice business that we have and we see opportunities to expand the position into more distribution and look at the other opportunities within it. There are - for instance, in Europe, there is a porcelain countertop being made similar to ceramic tile, and we're actually putting in capacity, I mentioned earlier, to actually make it in Europe. So once we put that in, which should be sometime next year, we'll start importing it and selling it through our own distribution as it for instance.

Susan Maklari

Okay. Thank you. And then more broadly and you touched a little bit on this in some of your other comments. But can you talk about what you're seeing on the remodel side in general? Has that accelerated at all, and are you seeing any shift in people perhaps taking or choosing some higher margin kind of choices within that?

Jeff Lorberbaum

I think my best answer is more of the same is that it's okay, but you would normally think it should be really much stronger, given where we are in the cycle and what's going on, but it is what it is.

Susan Maklari

Okay. Thank you.

Operator

There are no further questions. I would like to turn the call back over to Mr. Lorberbaum for closing comments.

Jeff Lorberbaum

Thank you for joining us. We're optimistic about our position in the marketplace. We believe the market is going to continue doing well, and we think we're well positioned. Have a great day.

Operator

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

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