Mohawk Industries Inc Q2 FY2021 Earnings Call

Good morning. My name is Twanda, and I will be your conference operator today. At this time, I would like to welcome everyone to Mohawk Industries Second Quarter 2021 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. As a reminder, ladies and gentlemen, this conference is being recorded today, Friday, July 30, 2021. I would now like to introduce your speaker for today, Mr. James Brunk. Mr. Brunk, you may begin your conference.

Thank you, Twanda. Good morning, everyone, and welcome to Mohawk Industries' quarterly investor call. Joining me on today's call are Jeff Lorberbaum, Chairman and Chief Executive Officer; and Chris Wellborn, President and Chief Operating Officer. Today, we'll update you on the Company's second 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 set forth in our press release and our periodic filings with the Securities and Exchange Commission. This call may include the discussion of non-GAAP numbers. For a reconciliation of non-GAAP to GAAP amounts, please refer to our Form 8-K and press release in the Investors section of our website. Now I will turn the call over to Jeff for his opening remarks. Jeff?

Thank you, Jim. In the second quarter, we generated revenue of approximately $3 billion, the highest quarterly sales of any period in our company’s history. Our sales increased significantly over last year when the pandemic interrupted the global economy. Our adjusted EPS of $4.45 was the highest on record for any quarter. Our success is the result of the extraordinary efforts of all of our team members across the world, demonstrating a dedication and resilience to overcome the challenges that we have faced. We greatly appreciate what they have been able to achieve. Our second quarter results were significantly stronger than we had anticipated across all our businesses, with sales building on the momentum from our first period. In the quarter, our operating margin expanded to their highest level in the last four years as we leveraged our operational and SG&A expenses. The actions we have taken to simplify our product offering, enhance our productivity and restructure our costs are benefiting our results. We have delivered almost $95 million of the anticipated $100 million to $110 million in savings from our restructuring initiatives. Across the enterprise, we continue to respond to rising material, energy and transportation costs by increasing prices and optimizing manufacturing and logistics. During the quarter, most of our manufacturing ran at capacity, or we were limited by material supply and labor availability. Raw material constraints in many of our operations led to unplanned production shutdowns during the period. Overall, we successfully managed interruptions that impeded our normal operations as well as regional manufacturing and customer closings related to COVID regulations in local areas. Our inventory levels increased slightly in the period, primarily reflecting higher material costs. Rising freight costs and limited shipping capacity impacted our material costs, the availability of imported products, local shipments to customers and international exports. Presently, we do not anticipate near-term relief from these constraints. All of our markets continue to show strength with robust housing sales and remodeling investments across the world. Commercial projects are increasing as the global economy improves and businesses gain confidence to expand and remodel. Inventory levels in most channels remain low, and our sales backlog is above our historical levels. To improve our sales mix and efficiencies, we will introduce more new products with enhanced features and lower production complexity in the second half of the year. To alleviate manufacturing constraints, we have approved new capital investments of approximately $650 million to increase our production, with most taking 12 to 18 months to fully implement. In the second quarter, we purchased $142 million of our stock at an average price of $2.08 for a total amount of approximately $830 million since we initiated the program. With our strong balance sheet and historically low leverage, we are reviewing additional investments to expand our sales and profitability. Jim will now cover the second quarter financials.

Thank you, Jeff. For the quarter, our sales were $2.954 billion, an increase of 44% as reported and 38% on a constant basis. All segments showed significant year-over-year growth versus Q2 of 2020, which was the period we were most impacted by the pandemic shutdowns. Gross margin for the quarter was 30.5% as reported or 30.7% excluding charges, increasing from 21.4% in the prior year. The increase in gross profit was a result of higher volume and productivity, improved price mix, reduction of last year's temporary shutdowns due to the pandemic and favorable FX, partially offset by the increasing inflation. SG&A as reported was 16.9% of sales or 16.8% versus 19.7% in the prior year, both excluding charges as a result of strong leverage by the business on the sharp increase in volume. The absolute year-over-year dollar increase was primarily due to higher volume, normal operating costs previously curtailed by the pandemic, impact of FX, increased product development costs and inflation. Operating margin as reported was 13.7% with restructuring charges of approximately $7 million. Our restructuring savings are on track as we have recorded approximately $95 million of the planned $100 million to $110 million savings. Operating margin excluding charges of 13.9%, improving from 1.7% in the prior year, was driven by the stronger volume, improved price mix, productivity actions, and the reduction of the temporary shutdowns, partially offset by the higher inflation and increased product development costs. Interest for the quarter was $15 million. Other income, other expense was $11 million income, primarily a result of the settlement of foreign non-income tax contingency and other miscellaneous items. Income tax rate as reported was 16% and 22.5% on a non-GAAP basis versus a credit of 2.5% in the prior year. We expect the full-year rates to be between 21.5% and 22.5%. Net earnings as reported were $336 million for an earnings per share of $4.82. Earnings per share excluding charges was $4.45. Turning to the segments, the Global Ceramic segment has sales of just over $1 billion, an increase of 38% as reported or 34% on a constant basis with strong geographic growth across our business led by Mexico, Brazil and Europe. Operating margin excluding charges was 13.2%, a significant increase from the low point of 2020 at 0.5%. The earnings improvement was a result of strengthening volume and productivity, favorable price mix, and the reduction of the temporary shutdowns, partially offset by increasing inflation. Flooring North America had sales of just under $1.1 billion or a 35% increase driven by strong residential demand with commercial channels continuing its growth versus prior year, but still below historic levels. The segment experienced solid growth across all product lines led by residential carpet, LVT, and laminate. Operating income excluding charges was 11.2% and similar to Global Ceramic, a significant increase from the 2020 margin trough. The operating income improvement was also driven by the increase in volume, strengthening productivity, improvement in price mix with the reduction of temporary shutdowns, partially offset by higher inflation. Lastly, Flooring Rest of the World with sales of just over $830 million, 68% improvement as reported or 50% on a constant basis, as continued strength in residential remodeling and new home construction drove improvement across all product groups led by resilient panels, laminate and our soft surface business in Australia and New Zealand. Operating margin excluding charges of 19.7% and similar to our other segments was a significant increase from prior years' low point of 11.9%. The main drivers were consistent; they had higher volume, favorable impact from price mix with the reduction of temporary shutdowns, and favorable FX, partially offset by increasing inflation. Corporate and eliminations came in at $12 million and expect full-year 2021 to be approximately $45 million. Turning to the balance sheet, cash and short-term investments are approximately $1.4 billion with free cash flow of $226 million in the quarter. Receivables are just over $2 billion and an improvement in DSO to 53 days versus 64 days in the prior year. Inventories for the quarter were just shy of $2.1 billion, an increase of approximately $160 million or 8% from the prior year, or increasing $85 million or 4% compared to Q1 2021. Inventory days remained historically low at 99 days versus 126 days in the prior year. Property, plant and equipment were just shy of $4.5 billion and CapEx for the quarter was $113 million with D&A of $148 million. Full-year CapEx has been increased to approximately $700 million to strengthen future growth with full-year D&A projected to be approximately $580 million. Overall, the balance sheet and cash flow remained very strong with gross debt of $2.7 billion, total cash and short-term investments of approximately $1.4 billion, and leverage at 0.7x to adjusted EBITDA. And with that, I'll turn it over to Chris Wellborn to cover our operational review.

Thank you, Jim. For the period, our Flooring Rest of the World segment sales increased 68% as reported and 50% on a constant basis. Operating margins expanded to 19.7% due to higher volume, pricing and mix improvements, and a reduction of COVID restrictions, partially offset by inflation. Flooring Rest of the World outperformed our other segments with all their major product categories improved significantly as residential sales expanded in all regions. We have implemented multiple price increases in most product categories to cover inflation in materials and freight. Raw material supplies are problematic and have impacted our LVT production and sales the most. We anticipate material and freight challenges will continue to impact our business in the third quarter. Sales of our high-end laminate continue to grow dramatically as our proprietary products are being widely accepted as a waterproof alternative to LVT and wood. We are beginning to introduce our next generation of laminate at premium levels with collections featuring handcrafted visuals. We are increasing our production in Europe with new capacity coming online and further capacity expansion projects are being initiated. Our laminate business in Russia and Brazil are growing strongly as we enhance our offering and expand our distribution. We recently completed the acquisition of a laminate distributor in the UK that will improve our position in the market. Our LVT sales growth was strong during the period and would have been higher if material shortages had not interrupted manufacturing. To compensate for material inflation, we have increased prices, and we expect further increases will be required as our costs continue to rise. We are significantly expanding sales of our rigid LVT collections with our patented water-tight joints that prevent moisture from penetrating the floor. Our manufacturing operations have made substantial progress, improving throughputs, material costs and yields. Our production in the third quarter will continue to be limited by material availability. Our sheet vinyl sales rebounded strongly as retail stores opened in our primary markets. Our sheet vinyl distribution in Russia has expanded, and we are maximizing production to meet the growing demand. Our wood plant in Malaysia has been idle since the government instituted lockdowns to address surging COVID rates. Wood is a small product category for us, so the sales impact in the third quarter will be limited. We are awaiting permits to complete the acquisition of a plant that reduces wood veneers to lower our costs. Our Australian and New Zealand flooring businesses delivered excellent results with sales and margins exceeding our expectations. The residential business was strong, with hard surface products leading the growth. Carpet sales are strengthening with our national consumer advertising, enhanced merchandising and the launch of a new high-end wool and triexta collections that improved our mix. Most of our facilities operated at a high level, with increased volumes benefiting our results. As in all of our markets, commercial sales have not recovered to their pre-pandemic levels, so the Australian government has lockdown specific regions to contain the spread of COVID, which has not meaningfully impacted our business. Our European insulation sales grew even though chemical shortages limited our production. Our margins are recovering after we implemented price increases to cover rising material costs. We have announced an additional price increase for the third quarter to offset further raw material inflation. We anticipate chemical supplies to remain tight and could impact our future sales. To expand our existing insulation business in Ireland and the UK, we have signed an agreement to acquire an insulation manufacturer, which is pending government approval. Our panels business is running at full capacity, and so far we have been able to manage material shortages without interruptions to our operations. We have raised prices and improved our mix with higher value decorative products. To enhance our results, we are expanding our offering of premium products as well as our project specification team. To enhance our panel offering, we are commissioning a new line that creates unique surfaces and visuals to differentiate our offering in the market. For the period, our Flooring North America segment’s sales increased 35%, and adjusted margins expanded to 11.2% due to higher volume, productivity, pricing and mix improvements, and fewer COVID interruptions partially offset by inflation. Our business trends continued from the first quarter, with sales growth being driven by residential remodeling and new construction. Commercial sales continue to improve though the channel remains below pre-pandemic levels. Through the period, our order rate remained strong, and our sales backlog remains above historical levels. We are maximizing output at our facilities to support higher sales and improve our service. During the quarter, our production levels were hindered by local labor shortages and material supply, particularly in LVT, sheet vinyl and carpet. Ocean freight constraints delayed receipt of our imported products, impacting our sales, inventories and service levels. We implemented price increases as our material and transportation costs increased, and we have announced additional pricing actions as inflation continues. Our restructuring initiatives are improving efficiencies as planned, and we should realize additional savings in the third quarter. Our residential carpet sales continued their growth trend across all channels with consumers investing in home improvement projects. Sales of our proprietary SmartStrand franchise expanded with our new collections being well accepted. Our EverStrand polyester collections are expanding by providing enhanced value, styling and environmental sustainability. Our carpet sales have been limited by personnel shortages in our operations, and we are implementing many actions to increase our staffing and productivity. We have improved our efficiencies by rationalizing low-volume SKUs and streamlining our operational strategies. Our commercial sales have improved as businesses increase remodeling and new construction projects. Both carpet tile and hard surface products grew with healthcare, senior living, education and government recovering faster. So down slightly from record levels, the June Architectural Billing Index had a fifth consecutive month of expansion, indicating the continued strengthening of new commercial development and renovation projects. With realistic visuals and waterproof performance, our premium laminate collections are growing substantially. To support higher demand, we have implemented many process improvements to maximize our U.S. production and are importing products from our global operations. Our laminate expansion remains on schedule and should be operational by the end of this year. Our new line will produce the next generation of Redwood, which is already being introduced in Europe. To support the growth of our laminate business, our U.S. MDF operation completed investments to increase our volume and lower our costs. Our new waterproof Ultrawood collections are being launched as a high-performance alternative to typical engineered wood floors. Our LVT and sheet vinyl sales continue to increase, with growth in the residential, retail and new construction channels. Our LVT and sheet vinyl growth and plant productivity were impacted by disruptions in supply that stopped our operations and delays in imported LVT caused by transportation constraints. We have enhanced our LVT offering with more realistic visuals, proprietary water-tight joints and improved stain and scratch resistance. Our U.S. operations implemented process enhancements that have increased our speeds and throughput. When material availability increases, we should see further improvement in our domestic manufacturing, which will support our recent product launches. For the period, our Global Ceramic segment’s sales increased 38% as reported and 34% on a constant basis. Adjusted margins expanded to 13.2% due to higher volume, productivity, pricing and mix improvements and fewer COVID disruptions, partially offset by inflation. Our ceramic businesses around the world have greatly improved, with strength in the residential channel and increasing commercial sales. All of them have low inventories, which impacted our sales growth and service levels. We have initiated expansion plans to increase our capacity and mix in Mexico, Brazil, Russia and Europe. Our ceramic businesses continue to raise prices to cover material, energy and transportation inflation. Our U.S. ceramic business is strengthening, and we are implementing price increases to cover material and freight inflation. We are improving our product mix with new shapes, sizes and surface structures. We are reengineering our products to improve material cost and productivity. Our restructuring projects have been fully implemented and are providing the expected benefits. Our countertop sales and mix continued to improve as we expand our premium offer with new technologies. In the period, our mechanical failure temporarily reduced production, which has been repaired. We have initiated the expansion of our plant to further grow our countertop business. Our Mexican and Brazilian ceramic businesses are very strong, with our residential business in both regions at historically high levels and commercial still recovering. Due to capacity constraints, our facilities could not fulfill customer demand, so we are allocating our production. We have executed multiple price increases to offset energy and material inflation. We are expanding operations in Mexico this quarter, and we have initiated new investments to increase capacity in Brazil. Our European ceramic business delivered strong sales and profitability as pricing, product mix and productivity improved our margins. We increased sales of our premium products, including slabs, small sizes, outdoor and antibacterial collections. Commercial sales trends are starting to improve though they remain below historical levels. We are selectively increasing prices to recover material, energy and freight inflation. During the period, our operations ran at high levels with improved efficiencies and increased throughputs. We continued to rationalize low-volume SKUs to optimize our operations. To support our sales of high-end collections, we have initiated expansion projects, some of which will take through next year to complete. Our ceramic sales in Russia were robust across all channels with our direct sales to customers through our owned stores and new construction projects outperforming. We have announced price increases to cover rising inflation. During the period, our manufacturing operations ran at capacity to respond to accelerated sales with inventory remaining below historical levels. Due to present capacity limitations, we are focusing on optimizing our product mix. We have initiated expansion plans with new production expected in the second half of next year. Sales of our new sanitary ware products are expanding primarily through our owned and franchised retail stores as our manufacturing ramps up. With that, I'll return the call to Jeff.

Thanks, Chris. The global economy should continue to improve due to low interest rates, government stimulus and the success of COVID vaccines. Around the world, flooring sales trends remain favorable with residential remodeling and new construction at high levels and commercial projects strengthening. In the third period, we expect our strong sales to continue, with our typical seasonal slowing from the second quarter. We will expand the introduction of new products with additional features and increase our investments to enhance our future sales and mix. Material, energy and transportation inflation is expected to continue and will require further pricing actions to offset. Most of our facilities will operate at high utilization rates though ongoing material and local labor constraints will limit our production. Our Global Ceramic and Flooring Rest of the World segments will observe their European vacation schedules in the third quarter, which reduces production and increases costs in the period. In many countries, future government actions to contain COVID remain a risk and could impact our business. Given these factors, we anticipate our third quarter adjusted EPS to be between $3.71 and $3.81, excluding any restructuring charges. We entered this year with uncertainty about COVID, the economic recovery, home renovation and new construction. Our business is stronger than we had anticipated, and we are increasing investments to support additional growth and improve efficiencies. Longer term, housing sales and remodeling are expected to remain at a historical high level, apartment renovation should accelerate as rent deferment expires and investments in commercial projects should continue to strengthen. We are expanding our operations and introducing new innovations to maximize our results. Our balance sheet is strong, and we are exploring additional internal projects and acquisition opportunities. We'll now be glad to take your questions.

Thank you. Our first question comes from the line of Eric Bosshard with Cleveland Research. Your line is open.

Good morning.

Good morning.

Wondering – two things, first of all, in terms of the increased capital and the increased capacity investments that you talked about over the next 12 to 18 months, you've got some stuff that shows up at the end of this year. But in terms of product categories or regions, where you have the most conviction, where are you adding capacity?

We are adding capacity in the constrained parts of the business all over the world. Our production has been at capacity, but at the same time, one thing to note is that we are still limited by constraints. Some of the limitations are labor and materials rather than capacity to fix to run it, and we also have problems with delayed products from imports. The $650 million that we're going to put in, the biggest pieces are in laminate, ceramic, and countertops, but there are a number of other areas included. And when you get through that, the capital forecast for this year is being raised to $700 million and $450 million of the $600 million will be in next year.

Okay. That's helpful. And then secondly, in terms of the third quarter, the earnings guidance is helpful. Just wondering if you could help us at all in terms of the sales guidance, your commentary of typical seasonal slowing, does that suggest that we should look at 3Q revenues relative to 2Q revenues to reflect the normal 2Q to 3Q step down? Or is there something that would change the way that path has traveled historically?

In the third quarter, we expect sales trends to continue from the second quarter. The operations will still run strong, and we are assuming the business in residential will keep going with commercial improvement. The European non-U.S. business, especially in Europe always slows with a normal holiday period as we go through. And you might not know, but some non-U.S. businesses have become a larger part of our results and the holidays have become a bigger impact over the years as we have continued to expand outside the U.S. With that, we still have material supply, labor, and transportation constraints. We don't believe the pricing actions we have are enough, and our inflation keeps rising. So we expect to keep implementing more increases in prices.

Thank you.

Thank you. Our next question comes from the line of Mike Dahl with RBC Capital Markets. Your line is open.

All right. Thanks for taking my questions. Jeff, first question, I wanted to follow-up on the CapEx and just clarify, I think you said $450 million of the $600 million. I don't know if you meant $450 million of the $650 million, but just trying to figure out that. Next, I guess the question would be when you look out to 2022 between the carryover from these new investments and your normal CapEx. How should we be thinking about CapEx in 2022? And to the point about not all of these constraints are physical capacity, some of it is labor, some of it is materials. CapEx is a very long-term decision, and these are temporary constraints or even temporary demand tailwinds. How do you think about that balance and the conviction to add the capacity?

The pieces that are temporary constraints, we're not increasing those. We are leaving those alone. The things we are increasing are those where we’ve exceeded our capacity. This year, the sales are much higher than we anticipated coming into the year. The capital before was around $550 million. Of the $650 million, I should raise this year to $700 million, and then approximately $450 million of that will go over to next year. We're going to go through our final planning in the rest of this year, we haven't finalized the budget for next year yet.

Okay. That's really helpful. Thanks for the additional detail. My second question, just back on the price cost. I guess your comments that the current pricing actions aren't quite enough given the escalation in costs and you're implementing more pricing. How should we think about the lag and what's embedded in guidance? Do you assume that will be price cost negative in 3Q before a catch-up in 4Q? Will you stay ahead of costs in 3Q or is it neutral? Just a little more color on kind of order of magnitude of cost and whether or when you'll be back to price cost neutral or positive?

In the second quarter, we were able to cover the inflation, which you'll see in the numbers that we publish later. We’ve raised prices across the business and we keep announcing new increases. Our energy, materials, and freight continue to rise, and we wake up with new increases. We think we've announced enough for what we know and the timing of them works together. We put all that into the estimate that we think we're going to get them close. And then with a mix, as we raise prices in the marketplace, some customers in both residential and commercial might start trading down.

Okay. Thanks, Jeff. Appreciate the color.

Thank you. Our next question comes from the line of Adam Baumgarten with Zelman. Your line is open.

Hey. Good morning, everyone.

Good morning.

Just maybe touching on the laminate business. It appears there's been a really meaningful surge in demand there over the last – it seems like year or so. How much of that is due to some of the technological advances that you've seen and how much of that is due to maybe shortages in LVT supply?

Let's start out with first. What happened is you had LVT growing dramatically, and one of the main features of it was waterproof. In the marketplace, there are multiple options. Our laminate with the technologies we have is a good or better alternative to many others in the waterproof category. That's causing it to grow. It's also been going into different channels, used in remodeling and new houses at a much higher rate than in the past. We have unique technologies that give us differentiated features and visuals, which is why we are adding capacity at the end of this year in the U.S. and as part of the $650 million.

Which is the reason why we're adding the capacity at the end of this year in the U.S and that's why we had a plan as part of the $650 million that Jeff talked about both in the U.S. and in Europe in the future years.

Got it. Thanks. And then just on that mix down comments you made, Jeff, are you seeing it more pronounced in certain categories over others?

It's hard to tell. I mean, it's not moving around, and some people just have budgets and they trade down.

Got it. Thanks.

Thank you. Our next question comes from the line of Susan Maklari with Goldman Sachs. Your line is open.

Thank you. Good morning, everyone. My first question is, Jeff, I know you gave some third quarter guidance in your comments. But can you help us think about how the third quarter versus the fourth quarter may come together this year just given the comps that we're facing and some of the seasonality that you talked about in the business? Any kind of color or guidance there for the next few quarters would be helpful.

In the third quarter, we do expect the same sales trends to continue. Operations are running at high levels. With all the constraints, we don't know how they're going to happen in the third quarter; we've built in our best guesses of supply and labor and transportation. But it's a moving target. As you go from there into the fourth quarter, it is typically softer as people go into the holidays. This year, we have 6% less days. That will impact the sales and margins. Compared to last year, there was a rebound, but this year it's difficult to predict.

Okay. That's very helpful color. Thank you. My follow-up question is, in the last few quarters, you have purchased about $400 million or almost $400 million of your stock. When you think about the capital allocation on the increased spend on capacity that you announced today, where do buybacks kind of fall within that? What's your appetite to continue buying back the stock at these levels?

Well, given our balance sheet, we have a lot of options. And at the moment, we bought $140 million last quarter. I think we have about $170 million still open on the acquisition, but the primary pieces are where we started in the constrained businesses and reducing costs, which is the $650 million. We'll do more when we finalize the plan for next year and the second half of this year to keep broadening the product offering.

Okay. All right. Thank you for that. Good luck.

Thank you. Our next question comes from the line of Michael Rehaut with JPMorgan. Your line is open.

Hi. Thanks. Good morning, everyone. Just wanted to clarify some of your earlier comments, Jeff, around how to think about the third quarter. You mentioned that you expect sales trends to continue, but at the same time, an increase in vacation time, particularly in Europe. I think there might be an ability to misinterpret those statements. If you say sales trends, it's a little bit more qualitative and maybe even on a year-over-year basis. But I think people are just trying to understand on an absolute dollar basis, are you suggesting that on an absolute dollar basis 3Q revenue should be similar to 2Q or indeed as I think you’re trying to say at least in Global Ceramic and Flooring Rest of the World, we should be modeling in some type of sequential dollar decline due to the vacations.

What’s confusing is I say the sales trends are continuing, which means I believe the business has the same strength that will go like that. The second part is there is a seasonality that impacts sales levels. The non-U.S. businesses, especially in Europe, have a much larger impact now than they did five years ago, so when they step down, the entire category steps down, which will reduce sales levels and total from the third quarter, having a negative impact on sales and margins. This will be lower because of the normal seasonality.

Okay. I think I understand. The second question, I just wanted to circle back also and clarify a little bit to the best possible on the CapEx outlook for 2022. It sounds like you're basically saying that of the $650 million, $450 million is expected next year. So you're doing roughly $200 million of that this year. So that's a delta of another $250 million higher sequentially year-to-year. Are we to take from that, that total CapEx all-in should be something closer to $900 million to $1 billion? Jim, I don't know a better way to answer this is just kind of reviewing with us your basic maintenance CapEx, but I think we're looking at a decent range of outcome to at least as people are trying to figure this out. So any type of better range would be helpful.

You understand when we told you. The plan next year – what we did this year, we stopped in the middle of the year and said, this is not as we had planned. We can't wait until our normal planning period in order to start changing the capacities to support our business. So we took everybody and identified the things that we wanted to do and what we hadn't done. And we still have to go through the planning process to decide what we want to do more than that next year. There is the normal maintenance and safety, typically around $200 million. It could be more or less. We haven't decided yet.

Okay. One last clarification on the tax rate, if I could. You guided to 21.5% to 22.5%, does that include the benefit in the second quarter because that would kind of point you to a mid-20s tax rate or does it exclude that benefit?

It excludes that benefit, so the non-GAAP rate in Q2 was 22.5%, and the full-year is the 21.5% to 22.5%. I would expect based on the seasonality of the tax rate for Q3 to be slightly higher than Q4.

Great. Thank you.

You're welcome.

Thank you. Our next question comes from the line of Keith Hughes with Truist. Your line is open.

Thank you. You had talked in the release about the second quarter being a record quarter, which is correct. If you look within Flooring North America, your revenues are slightly above the 2017, but margins are still below. Just my question is what's the difference first then? What do you need to do to get those back up to the historic peaks and operating margin?

The margins did improve, as you said, from volume, pricing and costs. The things going on now include commercial sales, which are higher. We didn't have all this inflation we're fighting now, nor did we have labor shortages. We are running short runs in the factories trying to keep service as well as we can, which is causing inefficiencies as we go through. The competition is more fierce today than it was in the past.

Thank you. Our next question comes from the line of Stephen Kim with Evercore. Your line is open.

Thanks very much guys. Nice results. And appreciate the outlook here. The capacity expansion program, wanted to get a sense for how much of a sales opportunity you think that $650 million might offer you? And then, as it does come in over the next 12 to 18 months, a lot of times there's some startup costs that come with that. I wanted to ensure we're thinking about that modest offset properly. I remember just looking back from 2014 to 2017, you kind of run $10 million to $15 million a year, not a lot. I just wanted – to get a sense for what the offset might be as this capacity comes online, is that a reasonable range to be thinking about?

The $650 million will translate into somewhere around 6% to 7% of our total business sales, round numbers to give you general direction. Yes, there's always startup costs that come along with it. But most of this involves known technologies being put in existing facilities or existing businesses; we shouldn't have some of the learning curves.

Yes. That's very helpful. Yes, it makes a lot of sense. When we talk about Flooring Rest of the World, obviously it's been a big contributor to the positive upside enterprises we've been seeing – for about four quarters now, I think this business has been the fastest grower. And I know this is an area that has many different business lines in it. And I know you've called out a number of them. And I know that you've also added a lot of capacity there over the years. But the step-up that we've seen in the last four quarters is pretty significant. And so what I wanted to try to understand is do you attribute the step-up we've seen in sales, in Flooring Rest of the World, excluding the impact of acquisitions, but just the actual step-up in organic growth, to be due to the bringing on of certain capacity or certain business lines that were not there previously, or do you see it as just post-COVID, there was a big surge in demand really pretty much across the business?

The Rest of the World performance is strong. Sales and income are at high levels. Most of the operations are running near capacity, which helps our cost structures. Our product mix is improving from ongoing efforts, and we are aggressively trying to raise prices. We've put in a new plant in Russia to produce sheet vinyl, now running seven days a week. We bought the Australian and New Zealand business and have been working to enhance the product line. We've invested to grow our share dramatically in hard surfaces. And all of those investments are supporting growth.

Yes. Really just sounds like the fulfillment of your longer-term plan that you've had there and then executing. As we go forward into the future, it seems like there's still a lot of growth opportunities for Flooring Rest of the World. Should we be expecting that segment to continue to outpace the other segments on a volume growth basis?

It's going to be hard to keep up the growth rates they’ve been at. Those are exceptional. We are investing in the laminate line, which will add about $125 million to $150 million of new capacity in laminate. We keep investing in the other pieces. I'm not sure we can stay at the growth rates, but commercial is a higher margin business and as it comes back, the margins in there will enhance as we are investing.

Thank you. Our next question comes from the line of Kathryn Thompson with Thompson Research. Your line is open.

Hey, it’s actually Brian on for Kathryn. Thanks for taking my questions. I just wanted to start with – you mentioned that sales were significantly stronger than anticipated going into the quarter. I guess, is there any specific segment or product to call out here? Kind of is it a case that strong is getting stronger? Or was there kind of more than expected momentum in areas that had previously been weaker, like say commercial?

We projected what we thought it would be coming into the quarter, and it surprised us how strong it was and maintained itself in the United States and across the entire world. The residential is driving the whole thing, but commercial is improving quarter-to-quarter and picking up. It’s difficult to predict how the trends will go.

I guess would you characterize it as the residential side was stronger than expected or the commercial or a combination of the two?

The residential is driving the whole thing, but commercial is improving.

Thank you. Our next question comes from the line of Phil Ng with Jefferies. Your line is open.

Hey, congrats on a really strong quarter and great execution guys. Jeff, I guess, material shortages will certainly free up in time, so that will help. But you mentioned, you're sold out in certain products. So just curious how much headroom do you have for growth next year as you kind of ramp up some of this capacity?

It's different by business and category. As you said, presently in some of the businesses, labor is a major problem, and in others, it's transportation. We actually have stuff and can't get it moved around to the customers fast enough. In some cases, we have imported products delayed. We have capacity issues. We have other businesses that, if we could get people to show up for work, we could increase production dramatically.

Got it. That's super helpful. Jeff, I was curious to hear what you're seeing and hearing from your different channel partners. We've certainly seen the builders run orders lately and we've seen some normalization of trends in retail. So curious how have orders patterns been tracking between these channels, and when we look out, is it going to have an impact on the mix?

On housing sales, we see them continuing at high levels. The houses that were purchased over the last year are in various stages of remodeling. People in rentals that haven't been paying rents will most likely remodel them for the next people. The commercial parts of the business are slowly improving; it takes time to put it in a budget and start them. The trends look good. We don't know if we have enough materials to run the place tomorrow in some cases.

Thank you. Our next question comes from the line of Laura Champine with Loop Capital. Your line is open.

Thank you. Jeff, I really wanted to follow-up on the comments you just made. It seems like your inventories are tight in terms of units because of all these production complications. Do you have line of sight as to when you'll have your inventories in unit terms back where you want them, and what's the plan to offset these production difficulties?

We expect to increase inventories, but we are struggling with the labor and material flows. We need inventories higher to hit service levels. The demand stays high; there’s a chance we won't be able to build inventory until we hit the end of the year. It depends on the constraints and availability; we can't give you a clear answer.

Do you think that gross margins are sustainable given that you've taken a lot of pricing? That's got to be a tailwind, but you've probably given up some in productivity you've just mentioned. And how should we think about your gross margin trajectory into next year?

The goal is to improve the business at the topline and improve the margins as we go through. The margins this year will be up substantially with the higher demand and improved costs. The second quarter was a really high period because of operations running wide open. As we go out next year, we think it will improve, but it really depends on demand, material pricing and competitive environment.

Thank you. Our next question comes from the line of Truman Patterson with Wolfe Research. Your line is open.

Hey, good morning, and thanks for taking my question. First just wanted to touch on M&A. Could you all discuss the environment and the potential pipeline there? And could you just possibly balance these thoughts with the organic or the decision to invest in organic capital investments of the $650 million I imagine in the product categories you're expanding? Just figured we'd get your updated thoughts.

The internal investments are where we see the trends and demand; that’s the basis of our investments. We continue to evaluate M&A opportunities; valuations are high, making it difficult in this environment. We are ready to buy businesses if we can identify them at the right valuation. The focus is on finding those that can add significant value.

Okay. Thanks for that. I'm just hoping on this next question that you can just give us either a tour around the world or your product portfolio. We're hearing of very strong pricing power and incremental price hikes in the channels. Just hoping you can quantify some of that by product or geography.

All of the businesses that we have are experiencing dramatic increases in costs. Our competitors are in the same position. The market competition is such that everyone's pushing amounts through; we’ll keep adjusting as required.

Thank you. Ladies and gentlemen, in the interest of time, I would now like to turn the call back over to Mr. Lorberbaum for closing remarks.

Business is in good shape. We think the conditions going forward are positive and we're trying to take advantage of the opportunities. We appreciate you listening and have a good day.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.