Mohawk Industries, Inc.

My name is Natalia and I will be your conference operator today. At this time, I would like to welcome everyone to the Mohawk Industries first quarter 2021 conference calls. All lines have been placed on mute to prevent any background noise. After these speakers' remarks, there will be a question and answer period. If you would like to ask a question during that time, simply press star, then the number one on your telephone keypad. To withdraw your question, press the pound key. Should anyone need assistance at any time during this conference, please press star zero and an operator will assist you. As a reminder, ladies and gentlemen, this conference is being recorded today, Friday, April 30th, 2021. Thank you. I would now like to introduce your speaker, Mr. James Brock. Mr. Brock, you may begin your conference.

Thank you, Natalia. Good morning, everyone, and welcome to Mohawk Industries' quarterly investor conference call. Joining me on today's call are Jeff Lauerbaum, Chairman and Chief Executive Officer, and Chris Wellborn, President and Chief Operating Officer. Today we'll update you on the company's first quarter results. 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 step forth in our press release and our periodic filings with the Securities and Exchange Commission. This call may include discussion of non-GAAP numbers. For reconciliation of any non-GAAP to GAAP amounts, please refer to our form 8K and press release in the investor section of our website. Now I will turn the call over to Jeff for his opening remarks. Jeff? Thank you, Jim.

In the first quarter, we had all-time record sales of almost $2.7 billion. an increase of 17% as reported or 9% on a constant basis with adjusted operating income of $329 million, our highest ever first quarter EPS of $3.49. Our business continued to strengthen in the first quarter and did not reflect the industry's normal seasonality. Around the world, consumers are continuing to invest in their homes and new flooring plays a major role in most remodeling projects. We're also starting to see Moderate improvement in commercial demand as global economies expand and businesses begin to invest in an anticipation of a return to normal. In most countries, construction is considered an essential business, so our sales have been less impacted by government restrictions. Those specific regions have interrupted our customers' businesses. Our flooring rest of the world segment continues to outperform with strong residential sales of our flooring, improved mix from our premium products, and less exposure to commercial channels. The segment benefited from lower marketing expenses, product mix, and increased days, which resulted in a greater margin in the first quarter. Other segments also performed well with strong growth in residential products and expanding operating margins, while their results were impacted by low commercial sales and severe storms in the United States. Market demand strengthened as the period progressed, and our order backlog remains robust going into the second quarter. Most of our businesses are running at high production rates, though inventories remain lower than we would like. Our production and operating costs were impacted in the period by supply limitations in many of our markets, as well as absenteeism, new employee training, and severe winter weather in the United States. Our margins have benefited from stronger consumer demand, our restructuring and productivity actions, and leverage on SG&A costs. We've increased prices in most product categories and geographies, reflecting inflation in raw materials, labor, energy, and transportation. Global transportation capacity has been limited, increasing our costs and delaying receipt of our imported products. We've seen similar constraints on local shipments and are increasing our freight rates to respond. The investments we made in our U.S. trucking fleet and local delivery systems have enabled us to provide our customers with more consistent service while improving our efficiencies. Even with COVID surges in some markets, we anticipate continued strengthening of economies around the world. Government actions and monetary policies are stimulating higher economic growth rates and stronger housing markets, and vaccination programs should reduce the risk of COVID-related disruptions. Recent U.S. stimulus actions as well as proposed infrastructure spending should further expand economic growth and employment levels. Though government investments are lower than in the U.S., other countries are beginning to see their economies expand, which should support ongoing demand in our product categories. We continue to implement our restructuring plans, which have achieved $75 million of our anticipated $100 to $110 million in savings. The balance of the savings will be spread over the next three quarters as specific projects are completed. In the first quarter, we purchased 123 million of our stock at an average price of $179 for a total of $686 million since we initiated our purchasing program. Our balance sheet remains strong with net debt less short-term investments of $1.3 billion. Our leverage is now below one-time adjusted EBITDA. Given our higher sales and operating levels, we are reviewing additional investment opportunities to expand our business and capacity.

Jim, will you review the first quarter financials? Thank you, Jeff. Sales in Q1 2021 were $2,669,000,000. That's a 17% increase as reported and 9% on constant basis. All segments showed positive volume growth, with flooring rest of the world being the strongest. As a reminder, Q1 had three additional shipping days and Q4 will have four fewer days. Gross margin was 29.7% as reported, or 30.1% excluding charges, increasing from 27.5% in the prior year. The year-over-year increase was driven primarily by higher volume and productivity, greater manufacturing uptime, improved price mix, and favorable FX, partially offset by increased inflation. The actual detailed amounts of these items will be included in the MD&A section of our 10-Q, which will be filed later today. SG&A is reported with 17.8% or 17.7% versus 20.3% in the prior year, both excluding charges, as we saw a strong leverage on the increased volume and productivity actions, partially offset by inflation and FX. Gives us an operating income, as reported, of 11.9% of sales. Restructuring charges for the quarter were $11 million. And our savings, as Jeff said, are on track as we have recorded approximately $75 million of the plan. Operating margin swing charges at 12.3%, improving from 7.2% in the prior year, or 510 basis points. Similar to gross margin, the increase was driven by stronger volume, productivity actions, improved price mix and FX, greater manufacturing uptime, partially offset by the increased inflation. Interest expense of $15 million includes the full impact of the 2020 bond offerings. Other income of $2 million, mainly the result of favorable transactional FX. Our non-GAAP tax rate was 22% versus 20% in the prior year, and we expect the full year to be 21.5% to 22.5%. It's giving us an earnings per share, as reported, of $3.36. or excluding charges $3.49, which is 110% improvement versus prior year. Now, turning to the segments, global ceramic had sales of $930 million, a 10% increase as reported, or approximately 5% on a constant basis, with strong geographic growth, especially in Brazil, Mexico, and Russia, while the U.S. was unfavorably impacted by the February ice storms. Operating income excluding charges of 9.6% at the 400 basis points versus prior year. And this improvement was from strengthening volume and price mix, increased manufacturing uptime and productivity, partially offset by unfavorable inflation. In Florida and North America, sales of $969 million, or a 14% increase as reported, or 9% on a constant basis, driven by a strong residential demand, with commercial beginning to recover from its trough. Operating income exceeding charges of 9.3%. That's an increase of 410 basis points versus prior year. The improvement, similar to global ceramic, was driven by increased volume and productivity, left temporary shutdowns partially offset by higher inflation. And finally, flooring rest of the world with sales 770 million. That's an increase of 31% as reported or 15% on a constant basis as our focus on the residential channel drove improvement across all our product groups led by laminate, LVT, and soft surface business in Australia and New Zealand. The operating margin including charges of 20.9%, an increase of 740 basis points versus prior year, driven by the higher volume, favorable impact of price mix, and productivity, partially offset by the increase in inflation. Corporate in eliminations came in at $11 million, and I expect for the full year 2021 to be approximately $40 to $45 million. Turning to the balance sheet, cash and short-term investments are approximately $1.3 billion, with pre-cash flow in the quarter of $145 million. Receivables at just over $1.8 billion, giving us a DSO improvement to 54.4 days versus 57 days in the prior year. Inventories were just shy of $2 billion. That's a decrease of approximately $200 million, or 9% from the prior year, with a marginal sequential increase of 4% from Q4, or approximately $80 million. Inventory days remain historically low at 105.5 days versus almost 130 in the prior year. Property plant equipment just over $4.4 billion with capex for the quarter of $115 million versus DNA of 151 million. Full year capex is currently estimated 620 million with us re-evaluating our plan and we will most likely see an increase from that level. Full-year DNA is projected to be $583 million. And lastly, the overall balance sheet and cash flow remain very strong, with gross debt of $2.7 billion. As I said, total cash and short-term investments of over $1.3 billion, giving us a leverage of 0.9 times adjusted EBITDA. And with that, I'll turn it over to Chris for an operational overview of our first quarter.

Chris? Thank you, James. First quarter sales of our flooring rest of world segment increased 31% as reported, or 15% on a constant basis, exceeding our expectations. Sales across all our product categories and geographies were strong as housing and residential renovation continued at a brisk pace. Margins expanded over last year to approximately 21% due to higher volume, favorable price and mix, and positive leverage on SG&A, partially offset by inflation. During the period, most of our facilities ran at high levels, though some supply constraints limited our utilization. At this point, we anticipate some material shortages continuing into the second quarter. Our backlog has increased as customer inventories remain low. We have raised prices across all product categories and have announced additional increases where material inflation has continued to expand. Our laminate business, the segment's largest product category, continues to record significant growth as consumers embrace our more realistic visuals and superior performance. Our leadership in premium laminate products and our higher volumes drove improved margins during the period. Our unique manufacturing methods create proprietary products that cannot be duplicated. Our next generation laminate technology provides premium wood consumers with features that exceed traditional wood in beauty and durability. In the second quarter, we are installing additional manufacturing assets to support future growth. During the period, our LVT sales rose substantially, with significant growth in rigid LVT. Our margins expanded from enhanced formulations and operational improvements that increased our production speeds. In the period, our sales were restricted by material supply disruptions that caused unscheduled shutdowns. We anticipate continued improvement in our operations as the material supply normalizes and production increases to expand our new rigid LVT collections. Our sheet vinyl sales were limited in the period by COVID lockdowns of our retailers in Europe. We anticipate sheet vinyl sales improving as government restrictions are lifted and our customers reopen their shops. Our Russian sheet vinyl business continues to expand rapidly as we broaden our customer base and product offering. We have initiated a third shift at the plant to support higher sales volumes. Our insulation business continues to grow as our panels provide the best option for energy conservation. Sales growth was robust in most of our geographies, though COVID restrictions in Ireland impacted our plant operations and results. Chemical supply problems have limited our production and dramatically increased our costs. We have announced our third price increase to offset the continued inflation and chemical shortages are expected to last through the second quarter. Our wood panels business delivered improved performance with our plant running full and operating margins expanding. As market demand for panels grows, we are allocating our production. We improved our mix during the period with increased sales of our higher value decorative products and mezzanine floors. We're installing a new melamine press to expand production of our higher value products and increase efficiencies. Our new plant that uses waste to create energy for the facilities is operating well and benefiting our results. Sales in both Australia and New Zealand increased significantly. and margins expanded due to higher volume, improved productivity, and favorable price mix, partially offset by inflation. Sales grew in soft and hard surfaces with a strong residential performance driven by high levels of remodeling and a solid housing market. Our updated carpet collections and smart strand and wool have enhanced our sales and mix. We increased our sales by leveraging our comprehensive soft and hard surface collections, strong sales organization, and industry-leading service. The commercial performance was stronger, primarily driven by projects that were postponed. For the period, our Flooring North America sales increased 14% as reported, or 9% on a constant basis. Adjusted margins expanded to 9% due to higher volume, productivity gains, and mix improvements, partially offset by inflation. Our performance was seasonally stronger than historical first quarters with consumers increasing investments in residential remodeling and new construction. Our commercial business continued to improve sequentially from its trough with growing investments in new projects. Our order rates remain strong and our backlog is higher than normal. We have increased prices as the material and transportation costs have escalated and will adjust further as required. All of our operations are maximizing their output to support higher sales and improve our service. In the period, we managed through interference from labor shortages and supply constraints, which impacted our production levels. Our inventories and service levels have also been impacted by delayed shipment of our imported products due to bottlenecks in ocean freight. We are continuing to execute our restructuring initiatives which will provide ongoing benefit to our results as they are completed this year. Our residential carpet sales improved as consumers desire more comfortable, quieter spaces in their homes. Retail remodeling was our strongest channel, improving our mix through increased sales of our premium products. We are expanding our proprietary SmartStrand franchise with new collections that offer superior design and performance. We have significantly reduced operational complexity by simplifying our yarn and product strategies and reducing low-volume SKUs. To grow our workforce to meet higher market demand, we have implemented extensive training processes and are relocating assets to increase production where necessary. Our commercial sales are recovering as business remodeling increases along with the economic improvement. We are also seeing increasing volume of higher value products as larger specified projects are commencing. The April architectural billing index reflects the highest level of project inquiries since 2019. We have increased carpet tile production in anticipation of the commercial markets improving. In our commercial LBT business, we are managing supply limitations and import delays. Our laminate sales are setting records as the appeal of our realistic visuals and waterproof performance expands across all channels. Through numerous process improvements, we have significantly increased our domestic production and are supplementing it with imports from our global operations. We are installing additional production at the end of this year to further expand our sales. Our new line will also produce the next generation of Revwood, which is already being well accepted by European consumers. We have completed upgrades and streamlined our MDF board facility to enhance our volume and cost. We are ramping up production of our premium Ultrawood, the first waterproof natural wood flooring that also features industry-leading scratch, dent, and fade resistance. Ultrawood is being well-received as a superior alternative to traditional engineered wood flooring. Our LVT and sheet vinyl sales continue to increase in the new construction and residential retail channels. We are upgrading our LVT offering with enhanced visuals, unique watertight joints, and improved stain and scratch resistance. Our local manufacturing has continued its improvement and production output increased as we implemented processes similar to those proven to work in our European operations. Our service has been impacted by material supply disruptions in the U.S. and delays in shipments of sourced products. We anticipate our supply will increase and we will see further improvements in our domestic offering and production output. In the quarter, our global ceramic sales rose 10% as reported and 5% on a constant basis. with sales increases in each of our markets driven by growth in residential remodeling and new construction. The segment's adjusted margin expanded to approximately 10% due to volume, price, mix, and productivity gains partially offset by inflation. Our Russian, Brazilian, and Mexican ceramic businesses delivered strong results, though they were limited by their capacities and are allocating production as necessary. All of our businesses are facing rising material, energy, and transportation costs, and we have taken pricing actions to offset. Our U.S. ceramic residential sales grew from remodeling and new construction, and commercial sales are improving from their low levels. Our strongest growth was in new residential construction, and we are seeing activities strengthen with contractors at our service centers. We are introducing higher-value products, including polished, mosaics, decorative wall, and antimicrobial collections to improve our mix. We are focusing on the fastest growing channels and implementing advanced technology to make doing business with us faster, easier, and more profitable for our customers. Across the business, our plants are running at higher levels, and we have increased our productivity with our restructuring actions. Escalating freight costs have hurt our margins, and we are raising prices to offset. Our quartz plant is improving its productivity, and we are introducing more sophisticated vane collections, which are increasing our mix and should enhance our margins. In the period, the ice storm that hit the Southwest temporarily stopped production at most of our manufacturing facilities by interrupting our electricity and natural gas supply. The facilities have all recovered and are operating as expected, improving our service. Our European ceramic business delivered a strong performance in a quarter, with productivity, improving mix, and greater consumer demand. Sales grew substantially in southern Europe and in our export markets, led by robust residential business and with some improvement in commercial projects. Our operations are running at high rates to satisfy the greater demand and improve service, leveraging our cost and enhancing our results. We are increasing our production levels through improvements in our processes and equipment, as well as optimizing product flows to support growth and enhance our mix. Our ceramic businesses in Mexico, Brazil, and Russia are all benefiting from lower interest rates and expanded credit, which are driving greater home remodeling and housing sales. In all three businesses, our order backlog is high, and we are allocating production as necessary. We have streamlined our product offering and enhanced our planning strategies to optimize service. Our inventory levels are low, and we are maximizing our output by enhancing our manufacturing and scheduling processes. In Brazil and Mexico, we are increasing capacity this year to improve our sales and mix. In Russia, we are optimizing our tile production and ramping up our new premium sanitary wear plant to meet growing demand. Sanitary wear complements our floor and wall tile offering and allows our owned and franchised stores to provide a more complete solution to satisfy our customer needs. Given higher market demand and our increased sales, we are reviewing the expansion of our ceramic capacities. With that, I'll return the call to Jeff.

Thank you, Chris. As we progress through the year, we anticipate... that historically low interest rates, government actions, and fewer pandemic restrictions should improve our markets around the world. We foresee the present robust residential trends continuing, with commercial sales slowly improving in the second period. Across the enterprise, we will increase product introductions that provide additional features to strengthen our offering and margins. We're enhancing our manufacturing operations to increase our volume and efficiencies while executing our ongoing cost savings programs. Our suppliers indicate that material availability should improve from the first quarter, though some operations could still face supply constraints. We are managing challenging labor markets in some of our U.S. communities, and supplemental federal unemployment programs could interfere with staffing to maximize those operations. If raw materials, energy, and transportation costs continue to rise, further price increases could be required around the world. Given these factors, we anticipate our second quarter adjusted EPS to be 357 to 367, excluding any restructuring charges. Currently, our strong backlog reflects the escalated levels of residential demand across the globe. We're introducing new product innovations to enhance our offering and optimizing our production to improve our service. We're preparing for an improvement in commercial projects, anticipating an economic expansion and a return to normal business investments. With strong liquidity and historically low leverage, we will increase our capital investments and take advantage of opportunities to expand. We'll now be glad to take your questions.

Ladies and gentlemen, at this time, if you would like to ask a question, please press star, then the number one on your telephone keypad. Management requests that you limit your questions to one primary and one follow-up. Please hold while we compile the Q&A roster. Your first question is from the line of Keith Hughes with the Truist.

Thank you. I know you don't normally like to talk more than one quarter ahead, but you have an unusual period, so I thought I'd give it a try. Do you anticipate, despite some more difficult comps, increased volume in products year over year, and also in margins, given you've got even tougher margin comps. Do you think you'll be able to push the ball forward on margins in the second half?

Let's see if I can give you some qualitative views of things. You know, we've already provided the second quarter guidance in which we believe the present trends will continue under the second quarter. And in the second quarter also included expected supply limitations that are going on. We're raising our prices and we expect to run all the facilities at high rates. As you look into the second half, the third quarter, we think residential sales will continue to remain good. We think commercial demand will improve. Our production rates should continue to increase. Those sales in some areas could be constrained by capacity or supply that we talked about a few minutes ago. Last year, Just to remind you, you know, the market strengthened as it went in. It'll make the COPs higher in the third quarter. Also remember, in Europe, people take summer vacations in the third period, and it impacts both our resident, both our rest of world and ceramic segments, sales and margins as historical. Sales could also be impacted by changing consumer behavior or other government actions with COVID. As you go into the fourth quarter, remember we have six fewer days than last year, and we do expect more normal seasonality this year and production levels than occurred last year. For the full year, if you look at it, we expect strong improvement in sales and income. We see SG&A being leveraged and operational improvements also helping our margins. With the higher growth, we are evaluating, you know, raising the capital investments for both this year and next, and we're in the process of thinking it through. And a tax rate, as he said, will go up from last year to about 21 and a half to 22 and a half. That's it.

Okay. And just final question. You've talked a lot about your laminate growth. I believe you used the phrase record setting in the release. That growth in laminate, is that? taking share from other laminate producers, or is this a case where it's actually making a dent on LVT or other product sales?

Keith, the market has become a clickable flooring market with LVT, laminate, and wood alternatives. Our laminate is waterproof with better features and is expanding in all channels, and we're importing laminate from other plants and adding capacity to satisfy it.

So would that be – it's just a clickable share gain? Is that a way to say it?

It's really that people are looking at – they go into the stores, and they see them all, and they're being presented all as the same as alternatives. Now, the other part that's happening is we focus on the premium part, so we have a waterproof story that's equal with LVT, and the visuals and things are better than the other products that they're offering. So it's really growing the category. The category is improving and then premium laminate is really being expanded and we're really limited by our capacity. This year we've substantially increased our production in the U.S. plants and we're importing products from plants around the world and we still can't satisfy the growth. By the end of the year we'll have a new line that will be up and running which will give us a lot more production.

Okay, thank you.

Your next question is from the line of Phil Ng with Jefferies.

Hey, guys. Jeff, I guess bigger picture, after seeing pretty noticeable declines in carpet for the last few years, it looks like you saw really strong growth and then participated with the strength you're seeing in R&R and new construction. If we look out to 2022 and let's say if we see a mid-single-digit growth environment for R&R, for example, What type of growth could you see carpet and ceramic putting up?

I think what you're seeing is the whole category of flooring is increasing, and so all the categories are growing. I still think that the carpet will lose share, but it's in a much higher growth market, which is causing it. But the other side, we still have the whole commercial carpet business, which is really at low levels, and as it picks up, We have higher margins in it because they're more differentiated products, and that's going to help as we go forward both in it and as well as the ceramic categories as you go through.

Got it. It's really helpful. Based on your QQ guidance, it looks like your margins is holding up pretty well, and certainly you've been really proactive on pricing and may go out with more price increases. Based on what you have out there and the traction you're seeing, Do you feel pretty good that, you know, pricing alone should, like, fully offset inflation this year? And do you envision any, you know, at least timing mismatches throughout the year?

Well, we're doing everything we can to keep it aligned. As you know, the materials, energy, and transportation continue to rise. They're flowing through inventory, and we're raising prices as we see it. You know, we're having to react to the changing prices in our supply base and every month we get a different view of it than we had the month before. We are trying to push through price increases to align with it, and so far it looks like we're doing reasonably well at that. Some products we've actually increased three times already, and all we can do is keep reviewing what's going on and keep making adjustments.

Okay. That's pretty encouraging. Appreciate it. Thank you.

Your next question is from the line of Susan McLaury with Goldman Sachs.

Good morning. My first question is around the LDT facility in the U.S. Can you give us some update on how that's coming through and how that's expected to kind of add to this demand that you're seeing there?

Yeah, so just to start out, the European operations are operating well and continue to improve our costs and margins. We have people in the United States over there on a continuous from Europe, and they're implementing the demonstrative processes that we have there, and we're improving our speeds and yields. It's been disrupted both in the U.S. and Europe at the moment. The PVC supply is limited both in the U.S. and in Europe, and we expect it to get better, but it's causing us not to run the plants to optimize them at this minute.

Okay. That's helpful. And then as a follow-up, you know, you've obviously been making progress in terms of a lot of the cost-cutting and the productivity initiatives that you set out last year. Can you give us some more color on where you are with that and how we should be thinking about that flowing through for the second quarter? And then in the back half of the year as well, especially as we anniversary some of that.

Okay, Susan. So we have made significant progress. As we said, we've We've seen about 75 million of the 100 and 110 million that we had planned. Certainties that impact, favorably impact, are cost and margins. We'll complete as we go through the balance of the year. I would expect that Q2 would have the most as we anniversary those restructuring actions from Q2 of 2020. And so if you look at the added savings of somewhere between $25 and $35 million, those are included in our full-year projections.

Just remember that the $75 million is embedded in the prior quarters, so the comparisons already have it embedded in it, the first $75 million.

Right. Okay. That's helpful. Thank you, and good luck with everything.

Thank you, Susan. Your next question is from the line of Tim with Baird.

Yeah, hey, everybody. Good morning. Maybe just the first question is how you're thinking about investments. And, you know, SG&A has run a little bit lower than sales over the last, you know, couple quarters. And so just as you think over the next 12 to 18 months, where are some of the biggest opportunities for you guys to bring some SG&A investment back into the business?

You're right with the SG&A. It's been lower. We're going to have to start increasing the SG&A, but for the top line growth, the goal is to grow the SG&A lower than the growth rate at the top so we get leverage out of it and still satisfy the need to bring new products to market and at the same time to support the expanding sales on the top.

Okay. Okay. So you'll bring some back but be able to leverage it. Okay. And then just on the M&A environment, I mean, your balance sheet is probably in the best shape it's been in years. Can you just give us an update on the M&A environment and kind of how that's progressing, if there's any sort of opportunities out there for you to take advantage of?

As you said, the balance sheet is in good position. We have the ability to invest significant amounts of money. We're looking for the right opportunities at the right prices to make sure that we can get the returns we need all the time, and you never know when those things are going to get through an agreement that takes a while, but there are things available, and we'll talk to the people.

Okay. Okay. Appreciate the time.

Thank you, Tim.

Your next question is from the line of Stephen Kim with Evacor ISI.

Thank you very much, guys. You know, historically, Jim, you guys have given sort of the breakout input cost, volume, productivity in terms of the benefits of operating income. I was curious if you were able to give us the rundown on that.

As I said, Stephen, you'll get it in our MD&A because we will file our 10-Q later today. Was there one specific one that you were looking for?

No, that's okay. We've just – No, that's fine. Well, I guess we'll have to wait. That's fine. Let me then ask you a question, if I could, about your comment about making potentially more capital investments if you're evaluating some opportunities. I was curious if you could give us a hint at which segments you're evaluating the most opportunities in. And related to that, in Laminate, you talked about just a tremendous amount of demand in North America. where you're expanding capacity already. How much are you expanding that capacity, you know, both in North America and Europe? And are you confident at this point that it's enough?

Let's see if I can answer that one. To start out with, the businesses, the pieces that have the most limitations right now would be U.S. laminate, our European board businesses, and our ceramic businesses outside the U.S. and Europe. would be the ones that are the most constrained at this point. We have new capacity coming in this year to add to both the U.S. and European laminate. In the U.S., I think it's around $130 million, $140 million of additional capacity. I don't remember the number in Europe. We have new equipment coming in to both Brazil and Mexican operations in ceramic, and we have a lot of ongoing optimization in our LVT production, which will increase it. And there's other things in that, but those are the big ones.

Yeah, no, that's very helpful. Thanks a lot for that. And then lastly for me is just margins. You know, you mentioned that 1Q was a bit of an unusual quarter seasonally, and a lot of those things I would imagine benefited your margins in 1Q. Usually margins rise sequentially into 2Q, and I'm wondering if you think that that is expected to happen again this year, or would you potentially see margins down just because of some unusual seasonality that's happening this year?

You're right. Quarter one was seasonally stronger, which does temper the increase as you go through. The foreign rest of the world, which we said, the first quarter margins was positively affected by product mix, lower marketing expenses, and increased days. So that one's going to – That one's not going to stay at those levels. And then we have the first quarter, remember, this year has 5% more days. So when you think about the historic relationship, the second quarter usually has more days than the first quarter. This year it's going to reverse, so it changes the relationship. So you have to keep all that in perspective when you're looking at the trend line.

Yep, got it. Thank you very much, guys.

Thank you.

Your next question is from the line of Eric Bossard with Cleveland Research.

You talked about relative to your original expectations for the quarter that rest of the world was better. You didn't totally characterize the flooring North America in ceramic. What I'm curious about is within those two businesses, anything that notably limited the growth of those in the quarter that changes and the growth can accelerate in the coming quarters.

I can speak to US ceramic. The US ceramic was stronger in residential, while our commercial is just starting to improve. And then in the first quarter, we were negatively impacted by the storm, which interrupted electricity and gas supply and we estimate at least 15 to $20 million sales impact. Our margins improve with productivity and restructuring and we're raising prices to offset transportation going forward.

In the other North American businesses, we did have limitations on the availability of product to satisfy the pieces. You heard about the laminate we've been trying to do. The LVT was also impacted by lack of supply of PVC to run the plants as hard. The imported products are all coming in late, so we lost sales in those as we go through. And then in the carpet manufacturing, in some of the markets, we're having trouble finding the labor to run the plants. So our raw materials and some of our production has been limited by labor. If we're trying to do everything we can to improve that, which includes training programs on one side, and we've actually picked up and moved some equipment from one local market to another plant to have more labor availability. So all those things impacted it and We've built that all into the projection in the second quarter. On the other hand, we still believe we're going to have supply limitations. The chemicals coming out of the Texas area are all in limited supply. We don't know exactly how. We think the supply is going to get better, but we'll have to see how it goes.

Okay, that's helpful. And then secondly, just curious on your inventory situation and perhaps the channel inventory and as much as you have visibility to that, you know, your sales are up a good bit, your inventories are down year over year on your balance sheet. How do you think about rebuilding inventory, your inventory or channel inventory? How important or relevant is that? And when do you think that might happen?

So, I'll start with the inventory sequentially. As I noted, we did increase by about $84 million, which was impacted by a combination of volume inflation and FX. And if you remember back in February, we talked about that we thought the inventory would increase somewhere between 5% and 10% from 2020 year end to 2021 year end. We would now expect that to actually be more than 10% with the combination of the higher sales and inflation, even though that we do believe that the terms will stay higher than historic levels. In terms of the channel inventory, we do believe the inventory remains low with most of our customers. And this should actually help the near term demand. In addition, we are working, obviously, to try to improve and increase our service as we go through the quarter as well.

I spoke to several of our large customers this week, and their business is as strong as – some have been in business for 40 years. It's as strong as I've ever seen it. The customers, some of them are being limited by their ability to install it, most of them. So, in addition – We haven't been able to fill the channel like they would like, and our service, instead of being immediate, in some cases it's taking a little while to get there. Now, it's not impacting them that much because they couldn't install it if we could ship it all the more. So I think the point is that the backlogs are good, the demand is good, and we have to get them aligned, and it should be good through the second quarter, and at this point I can't see why the third quarter wouldn't be also good.

Great. That's helpful. Thank you.

Your next question is from the line of Truman Patterson with Wolf Research.

Hi. Good morning, guys, and thanks for taking my question. Just wanted to follow up on foreign Russell World margins. You know, very strong op margin in 1Q at 21%. And, Jeff, you know... you suggested that we shouldn't use this kind of 21% as a new base going forward, right? But when I look at the second quarter, it seems like you all should still be generating very strong leverage from the sales growth. So I'm just hoping you can help walk us through or frame, you know, some of the costs that might be coming back online in the back part of the year, the European vacations. Just seeing if you can give a little bit more color there.

Okay. So the first quarter, one is that the sales are stronger just as we said at everything else coming into it. So, but we do see the sales and margins increasing all year for the growing rest of world. As we said, it benefited from lower marketing expenses. So we're going to have to ramp up the marketing expenses as we go through the year to higher levels. So that's going to impact it. You're going to have the product mix was really favorable in the first quarter and we don't see that maintaining itself in the mix between different channels and products. And then the increased days also help by getting greater leverage through it as we go through. The margins for the year are going to be better than last year. They just won't be at that level as we go through. The third quarter, if you go back historically and look at the business, you'll see that the rest of world margins in sales, the second quarter is the highest usually for the year, and it's because of those vacations. If you go back and look at historical, you'll see a trend line that you should use as a base to start.

Okay. Okay, thanks for that. And for clarity, you were specifically talking about margin expansion for the full year, not necessarily each quarter?

On rest of the world. That's correct.

Okay. Okay. And then on LVT, seems like you're making some pretty good progress on the internal manufacturing, you know, both at U.S. and Europe. But could you remind us again how much, you know, capacity in dollar terms you think you'll be at when everything's running at full capacity? And part B, just, you know, along with your third-party, you know, LVT imports, any idea what your market share might be running at in LVT in the U.S.?

So our manufactured capacity is over a billion dollars, and we get it all optimized, and we're headed towards that. We're using imported supplies to give us additional capacity that we need, and broaden the marketplace. We're reviewing long-term what we do long-term to go from here. We haven't concluded at this point.

What else? I would say right now, Truman, we are growing with the market in the U.S., even though we still have shared gain. We're not 100% sure what the market is, but we think we're growing at least as fast as the market.

Okay. Okay. Thank you, and good luck on the upcoming quarter.

Thank you.

Your next question is from the line of Justin Spear with Zellman and Associates.

Good morning. Thanks, guys. One question I have in terms of mapping out future plans, I know maybe you can't speak to details, but rewinding a few years, you've made the decision to do a lot of greenfield investment, internal investment, I guess, as opposed to going out and doing a lot of M&A. I guess as you look at it today, how should we think about maybe prospective growth projects and maybe give us a sense for the range of magnitude of potential CapEx projects and or M&A in terms of capital priorities?

I think you're ahead of us a little bit. We're in the middle of this study. Some of the things from the first time we put in New machinery that hadn't been run by anybody was a learning curve. We went into new markets and products like countertops we never made before. We went into new geographies. We put up plants in Russia in a new product category. We had no customers, so it took us longer to get them. But, I mean, we put in ceramic countertops in Europe. It's in our plan to expand it. Our Russian... A Russian vinyl plant we just put a third shift on. It's making as much money as anything else that we have in the business. So we got them all together. It just took us longer. LVT, we're in the last steps of it to get it up where we want to. So, you know, when you greenfield and do stuff outside the normal, it's going to take longer. We haven't put the plans together so far. The plans are all around how to expand existing businesses and existing geographies which an existing equipment is operating, so we don't anticipate having the same things to overcome. On the other side, we're also looking at, you know, what can we do to step change the business at the same time? So we haven't got far enough along on that one to decide. We really didn't expect the economies and the business to be doing as well this year, and we're really looking at things we planned in 22 and 23 and pulling them in.

That's helpful. One other question I had is just, you know, I think the topic that you're at right now across most of the earnings calls has been supply chain and commodity prices, input, transportation prices. Is there any context you can give us in terms of what your commodity basket is up and maybe when you expect the most, I guess, extreme part of that year over year headwind to flow through your income statement? So I guess the two questions, how much is your basket up and when do we start seeing the most extreme market? part of that lag into your P&L.

So we're just like everybody else. It started rising in the fourth quarter. We have about three and a half to four months of inventory, call it, around numbers. So it flows through then. So some of it fitting in the first quarter. The biggest part is going to show up in the second quarter, which we're trying to get the prices aligned with it. And in the third quarter, You know, it's going to be more of it, and we still don't even know how high it's going to inflate as yet. So they're all working through. We think we've got the pricing in the marketplace, the timing to hit when it's going to show up in the P&L, and we're doing everything we can to manage it as we go through. And last question.

I'm sorry.

The increase in the thing, we think – We're raising things around numbers 3% to 8%, and there's some things that are 25%. So it's all over the board.

And is the reception to these price increases consistent across all categories?

The marketplace is pushing prices through everywhere. All our competitors and we have the same increases in raw materials. For the most part, as we said, the supply through the channels are low. So, you know, it's easier than the historical to push them through at this point.

Perfect. Thank you, guys. Really appreciate it.

The next question is from the line of Michael Rehaut with the JPMorgan.

Thanks. Good morning, everyone. Thanks for taking my questions. First, I just wanted to get a little better sense of, you know, price mix for the different businesses. And, you know, more specifically, you know, thinking about mix here, which has been an issue over the last year or two, I'd say particularly more in ceramic and foreign North America. Could you just give us a better sense? Obviously, when you talk about price mix on the whole, you've had sort of price increases in the market and that influences the price part of price mix, but if you could give us a sense of how mix itself is going for both ceramic and Flooring North America, and if that's changed at all so far this year versus the prior year or two.

Michael, I'll just comment on ceramic. One of the things that is impacting mix at the moment is we have a stronger residential business, and the commercial business is just starting to to come back. And typically our pricing would be a little higher on the commercial side.

So that's also impacting the other, well, we have large commercial businesses. The commercial is doing better, but it's still way below where it was. And in all the businesses, the commercial has higher margins because the products are more differentiated. So we have significant opportunity over the next, I don't know where it's going to be, year, year and a half as those move back to normal. Um, Our higher margin products categories are there, so that will help everything.

Well, and I appreciate that. I mean, I guess also what I'm thinking about here is, you know, within the residential sphere, you know, over the last couple of years with LDT coming on, you know, that's caused some mixed challenges in your other flooring categories like carpet or ceramic, perhaps to better compete with LDT. So I was wondering within the residential product portfolio as well, if you've seen any change in mix for the better or worse, or if it's stabilized.

Let's see if I can answer that. It's much more complex. So what you have is things going on. So in the carpet business, you have polyester carpets, which are lower-priced carpets growing as a share of the market. So that's impacting the mix. Second is at the moment you have different channels growing so the new construction business is growing rapidly and it tends to use lower quality products than the remodeling part of the business. The remodeling part of the business is picking up and doing well and that's helping to mix in the other direction. And then you have the commercial side which has the highest margins versus it and the sales are low, so it's impacting the mix as you go through it. They're all moving at the same time, and then we'll just have to see how they evolve.

No thoughts in terms of the overall net impact?

We're expecting the mix to improve through the year. The question is, the remodeling business comes Because what happens is that the remodeling is higher margin than the builder. The builder is picked up earlier, and the remodeling piece is doing better. So we're hoping that we're going to get a mix improvement as we go through the year.

And couple that, Mike, with commercial improving. You'll get also the benefit of the favorable mix as well.

Right. That's helpful. Just secondly, I guess, on the second quarter guidance – You talked a little bit about how you expect the foreign rest of world margins to maybe come in from this 21%. But in terms of sales versus margin, you talked about increasing your production rates. There's still a lot of pent-up demand out there. You won't be in the summer months that impact your European businesses. So is it fair to expect sales on an absolute dollar basis to be greater than in the second quarter, that the second quarter should be greater than the first quarter, all those things considered?

Yeah, the second quarter should be higher than the first quarter. I won't have the same differential on the piece because you have the 5% more days in the first one that you didn't have, so the comparisons versus historical aren't exactly the same. But we expect the sales to go up. At the same time, because the inventories are so low, we're limited to how much we can ship out. But we're trying to get the capacities up. And then you throw on top of it, you have the supply piece, which we're not 100% sure how much we're going to get. Other than that, it's easy.

Your next questioner is from the line. That's Matthew Doley with Barclays.

Hey, good afternoon. Thank you for taking the questions. I actually wanted to follow up on the last one around seasonality. It was touched on earlier with the margins into Q2, given what you're implying. You know, I appreciate everything you said, the unusual seasonal strength of Q1 and the shipping days issue. You know, but is there anything else when talking about the margins that might be a greater sequential headwind, and specifically I'm thinking of price-cost as just being, you know, materially different in the second quarter versus what you got in the first quarter? Thank you.

I'll just comment on the, again, on foreign rest of the world. Q1 benefited from lower marketing expenses, improved product mix, and increased days, which caused a greater margin in that business.

The SG&A in all the businesses is going to go up to support the higher level of sales. We're going to put more new products out. So it's going to go up where we should still get some leverage. We're trying to keep it below the volume increase, but we're trying to put enough in it to support not only this year, but to keep the business increasing in next year as we go through. When you compare the last year, we were more stingy in the investments we were making. because we didn't know what the economy was going to be. So that's going to increase. You need to think about the margins. The cyclicality of the piece, you have to keep, you know, when you look at first quarter versus second, you almost have to take 5% off the first quarter to compare it, to get it in the same relationship before you start. And then I just keep reminding people that We've seen some of the models that they don't take into consideration the European vacations, which affect both the rest of the world and the ceramic business in the third quarter.

And when you step back again for the full year, we expect strong improvement in sales and income. We'll see that leverage at SG&A, and then we'll also get the operational improvements as well.

Yeah, no, that's great, Collar, and understood. Second quick one is just on the production rates in the quarter, you know, seemingly high and above normal seasonality. I'm just curious on, you know, how that might impact your fixed cost absorption this year relative to normal. You know, does that therefore mean that the incremental margins on volume might be higher than it typically is as you deliver on these inventories you're producing today? Thank you.

It does help. And it will continue to help. Now, we haven't talked about all this stuff going on, even where we are with COVID and pieces. We still have higher absenteeism. The labor is not as so hard to manage. We're paying overtime to get people in. So there's other costs that are also impacting the business, trying to get as much volume through the place. And then the fall, really, as we come out of the year, the question is going to be, Last year, we ran hard all the way through the fourth quarter, all the way to the end. And the question is going to be, what does business look like when we get there? It's too early to tell. I'm hoping it's going to be strong all the way through.

Got it. Well, great. Thank you for the call.

Your final question is from the line of Katherine Thompson with Thompson Research.

Hi. Thank you for taking my questions today. Focusing on the port congestion, which has been an issue for many companies along the value chain. Could you give us an update how you're managing this port congestion and more specifically thoughts on are you increasing inventory or distribution space? How are you able to meet growing demand in light of the port congestion? And just help us understand the cost. increasing costs with the storage and transportation ability to plan for the future. Thank you.

Like everyone else, the delays are there and the costs are there. In some cases, the freight costs are four times higher than they were in what we call normal, or where they were. So there's a huge impact on the cost pieces that have to be added into the products. Then the delays are anywhere. It could be four weeks to eight week delays in it. We are ordering things earlier to try to get them in line. It's getting a little better as the stuff starts landing from where we have, but we're still chasing it as we go through. At this point, we're assuming that the transportation is going to stay like this for quite a while and we're trying to align the purchases and the timing of it to get them here.

We'll see how it works out. Have you stepped up and renegotiated rates? Because one of the things that we're hearing is you're going back, there's several different companies that are going back and renegotiating rates, and that has allowed them to get more space on ships. Has that been your experience?

I can't say that we're getting more space. We have put together orders, and the orders are getting put on the ships with delays in them, and we're adding the delays to the piece to try to align it. And the prices that we're paying are high.

Okay. I'll follow up on that later. In the follow-up on just the ripple effect of the Texas freeze question, understand that the key products, resins, were significantly disrupted. Where do we stand today in terms of the resolution of that?

From the supply side, we're still in the middle of it. We have things that we're buying. I mean, we're sending trucks down. It's coming off their lines, and we're picking it up and moving it down the same day to try to keep the plants running. So, I mean, the problems are still there. It affects anything that's a chemical, from glues in one business to resins in another. And the indications are that it's getting better. What the hard part is, all the customers like us are ordering more, so the capacities are constrained, even though they're getting better. And it's difficult to tell what are you going to get, what percent of what you're going to get, when you're going to get. That's it. And we're just... plain as it goes and begging for every one we can get.

Okay, great. Thanks very much.

We appreciate you being on the call. The markets are strong. We're improving our performance of our businesses. We're well positioned in the business and we're managing all the disruptions as best as possible. And We think we're going to have a good year, but we have to manage through all these things, which makes it a little more unpredictable because of the supply base and all the things we've been talking about. We appreciate you joining us, and have a good day.

This concludes the Mohawk Industries first quarter 2021 conference call. Thank you for your participation. You may now disconnect.