Mohawk Industries, Inc. (NYSE:MHK) Q3 2023 Earnings Call Transcript

Mohawk Industries, Inc. (NYSE:MHK) Q3 2023 Earnings Call Transcript October 27, 2023

Operator: Good morning, everyone. My name is Jamie, and I will be your conference operator today. At this time, I would like to welcome everyone to Mohawk Industries Third Quarter 2023 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, Friday, October 27, 2023. Thank you. I would now like to introduce Mr. James Brunk. Mr. Brunk, you may begin your conference.

James Brunk: Thank you, Jamie. Good morning, everyone. Welcome to Mohawk Industries quarterly investor conference 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 will update you on the company’s third quarter performance and provide guidance for the fourth quarter of 2023. 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.

An overhead view of a website displaying the multiple options of flooring products available for purchase.

This call may include discussion of non-GAAP numbers. For a reconciliation of any non-GAAP to GAAP amounts, please refer to our Form 8-K and press release in the Investors section of our website. I will now turn the call over to Jeff for his opening remarks.

Jeff Lorberbaum: Thank you, Jim. In the third quarter, our net sales were $2.8 billion, down approximately 5.2% as reported or 8.1% on a constant and legacy basis, in line with our expectations as our industry faced continued pressures across all regions primarily due to constrained residential investments and tightening of consumer discretionary spending. Our adjusted EPS for the quarter was $2.72 with our margins across the business benefiting from cost reductions, productivity initiatives and lower input costs. Our third quarter performance was seasonally impacted by vacations in Europe, which reduced our sales and earnings versus the prior quarter. Our lower material and energy costs offsets the decline in both price and mix.

We also faced FX headwinds of approximately $20 million on operating income or $0.25 on EPS. We are managing our working capital and generated strong free cash flow of $385 million in the quarter and $660 million on a year-to-date basis. During the quarter, central banks around the world continued to raise interest rates to slow down their economies and reduce inflation. Their actions are affecting new construction and remodeling in both residential and commercial channels, postponing spending on new projects. In the U.S., mortgage rates have climbed to their highest level in more than two decades, which has suppressed the housing market and limited home renovation activity. In Europe, consumers are deferring large purchases such as flooring as a result of higher energy costs, inflation and uncertainty due to the war in Ukraine.

Our industry faces a greater impact from these pressures than other sectors, given that most flooring purchases are deferrable. With the high fixed costs required to produce flooring, competition increases as the industry slows and participants attempt to increase their sales to maximize absorption. As a result, our average selling prices and mix have declined, with the impact partially offset by lower material and energy costs, restructuring benefits and process improvements. Expected housing sector recovery continues to be postponed and we are managing the business to optimize our results and cash flow until it occurs. We are taking actions to increase our volumes, while managing margins and operating expenses. We have launched differentiated collections, selectively introduced promotions and expanded our participation in the new construction channel.

To further enhance our competitive position, we will shut down older ceramic production in Italy and we are converting U.S. rigid LVT production to a direct extrusion process. These restructuring initiatives will result in a non-recurring charge of approximately $55 million of which $50 million is non-cash. When completed, these initiatives should improve our profitability by $30 million annually by enhancing our productivity, lowering our manufacturing costs and optimizing our production flexibility. Our European expansions in insulation and porcelain slabs are currently in operation. Our U.S. premium laminate and LVT projects are continuing to start up. Expanded production in European laminate and U.S. quartz countertops should begin in the second half of 2024.

As the integration of our acquisitions in Mexico and Brazil proceeds, we have consolidated the general management, sales and administrative functions while enhancing the company’s product offering, operational efficiencies and customer base. While the Mexican and Brazilian markets are experiencing reduced demand and margins, we anticipate gaining additional benefits from our acquisitions as these markets recover. In September, we released our 14th Annual Sustainability Report and for the first time we provided Scope 3 emissions. Institutional Shareholder Services is right Mohawk is one of the top companies for environmental quality in the durable goods and apparels category. We have significantly exceeded our 25 goals related to decarbonization, waste reduction and water conservation.

We are lowering our carbon footprint by using more recycled content, increasing our green energy production and expanding our product circularity. We recently received the Susan G. Komen Promise Award for our two decades of partnership in the fight against breast cancer. We have also formalized a Board of Directors selection policy as part of our ongoing commitment to diversity. To learn more, you can read the report online at mohawksustainability.com. I will turn the call over to Jim for a review of our third quarter financial performance.

James Brunk: Thank you, Jeff. Sales for the quarter were just under $2.8 billion. That’s a 5.2% decrease as reported, 8.1% on a constant legacy basis. Higher interest rates and continued inflation has weakened new housing and remodeling activity, negatively impacting our global business with lower volume and price and mix pressures. Gross margin for the quarter was 25% as reported and excluding one-time items, was 26.6%, that’s up 100 basis points versus the prior year, with lower input and energy costs exceeding unfavorable price and mix in the quarter, along with stronger productivity, only partially offset by lower volume and unfavorable FX. The actual detailed amounts of these items will be included in the MD&A of our 10-Q, which we will file after the call.

SG&A as a percentage of sales was 19.9% as reported. Excluding one-time items, it was 18.1%. The dollar increase was primarily attributable to the impact of acquired businesses, investments in new products and marketing to drive increased future sales, unfavorable FX and higher inflation. The operating margin as reported was negative 26.5% and excluding charges was 8.4%, as the company’s current market capitalization, along with challenging economic conditions and higher discount rates resulted in a non-cash goodwill and trade name impairment charge of $876 million in the quarter. Total non-recurring charges was $967 million, primarily related to the impairment of the goodwill and trade names, but in addition to further enhance our competitive position we will shut down older ceramic production in Italy and converting our U.S. rigid LVT production to a direct extrusion process.

These actions should improve our profitability by approximately $30 million annually. Adjusted operating income was 8.4% as I noted. The year-over-year decline was primarily driven by lower sales volume and unfavorable FX, partially offset by the reduction in input and energy costs exceeding the impact of negative price and mix and increased productivity gains which were under pressure due to lower plant utilization. Interest expense for the quarter was $20 million. The year-over-year increase is due to significant rise in global interest rates. Other income, other expense was income of $8 million. Non-GAAP tax rate was 20.8% in the current year versus 17.9% in the prior year. We expect Q4 2023 tax rate to be approximately 17.5% to 18.5%. That gives us an earnings per share on an adjusted basis of $2.72.

Turning to the segments, in Global Ceramic, sales were just under $1.1 billion. That’s a 0.5% decrease as reported and 6% on a legacy and constant basis. The U.S. business volume outperformed benefiting from our expanded positions in new construction and commercial channel in the quarter. Adjusted operating income was $88 million or 8% of sales, a decline versus prior year as the global slowdown in demand and pressure on price mix led to further temporary shutdowns, lower sales volume in addition to the impact of unfavorable FX, partially offset by improving productivity gains and restructuring actions. In Flooring North America, our sales were just over $960 million. That’s a decrease of 11.7% as reported and 12.2% on a constant basis, as higher interest rates and inflation continued to pressure discretionary spending across all print — product channels.

Adjusted operating income was $78 million or 8.1%. The operating margin was in line with prior year as lower input and energy costs offset negative price mix, partially offset by weaker volume and lower productivity due to underutilization of our plant assets in the current demand environment. In Flooring Rest of the World, the sales were just over $710 million. That’s a 2.6% decrease as reported and 5% on a constant basis, as the business has been impacted by low consumer confidence, higher interest rates, inflation and geopolitical events. The business in Australia and New Zealand and our resilient and insulation products held up the best in this environment. Adjusted operating income was $77 million or 10.9%. Our adjusted operating income margin expanded versus prior year as lower input and energy costs offset the weakening price mix, similar to Flooring North America, in addition to the benefits of green energy and fewer temporary plant shutdowns than the prior year, all partially offset by unfavorable FX.

Corporate and eliminations were $10 million for the quarter in line with the prior year. Turning to the balance sheet, cash and cash equivalents were $518 million for the quarter, driven by strong management of working capital, our free cash flow grew to $385 million in the third quarter and they are standing at $660 million on a year-to-date basis. Receivables were just over $1.9 billion with a DSO of 59 days, which was in line with the prior year. Inventories were just over $2.5 billion. The year-over-year Inventory decreased $380 million, and excluding the impact of acquisitions, the decrease was $438 million, primarily due to a focused reduction in units, supported by lower year-over-year costs. Inventory days also decreased to 125 days from 131 days in the prior year.

Property, plant and equipment was just shy of $4.8 billion with Q3 CapEx standing at $127 million with D&A of $150 million. Full year 2023 forecast includes the CapEx of just over $620 million at this point. And finally, gross debt was $2.6 billion, with leverage at 1.5 times adjusted EBITDA. This positions the business to take full advantage of the rebound that historically follows a downturn like we are experiencing today. Now, with that, I will turn it over to Chris to review our Q3 operational performance.

Chris Wellborn: Thanks, Jim. In Global Ceramic, our business outperformed due to our innovative product introductions and higher service levels. With this, we expanded our positions in the new home construction and commercial channels. Residential remodeling was slower due to lower home sales and postponed projects. Our investments in new decorating technology, polishing and mosaics are providing domestic alternatives to premium imported ceramic. We are expanding our sales to regional builders, as well as kitchen and bath retailers with our coordinated tile and countertop collections. To further expand our quartz countertop sales, we are introducing more stylized collections, utilizing tech — new technologies that provide greater value.

We have lowered our distribution cost by shipping more product directly from our plants and bypassing our regional warehouses. In our European Ceramic business, retail traffic and new construction are being affected by economic uncertainty. In Southern Europe where our business is concentrated, the economies are under greater pressure. Across all channels, low industry volume is creating more intense competition and we are responding with specific price promotions by geography and channel to gain additional sales. Natural gas prices have declined by 80% from their peak and we have reset our pricing to align with energy costs. While volumes have declined across most product types, sales of our premium porcelain slabs continue to grow and we are optimizing our recent capacity expansion.

We continue to adjust inventory and production to align with changing market conditions. To contain cost, we have increased productivity, reduced overhead and implemented alternative formulations. In Latin America, we have reduced our cost structures to adapt to slower more competitive markets with Mexico being less affected. Our margins are being impacted by lower industry pricing, partially offset by declining energy costs. Inflation in both Mexico and Brazil is receding and central banks are beginning to lower interest rates in response with further reductions expected this year. We are integrating our acquisitions in both countries and making significant progress in executing our sales, product and manufacturing synergies. To increase our distribution, we are gaining customer commitments to expand sales across all channels and price points using the combined product portfolio.

In each country we are utilizing the assets of our legacy business and acquisitions to broaden our product offering. We have completed the information systems conversion in Mexico and the system consolidation in Brazil will be completed by the end of the year, enabling further operational improvements. In Flooring Rest of World, our margins benefited from declines in energy and raw material costs, partially offset by lower price and mix. Sheet vinyl continues to outperform other categories as it provides a lower cost alternative and we have increased production to meet higher demand. With operational improvements underway, our Eastern European sheet vinyl acquisition is delivering higher style products and increased sales. Our laminate and LVT sales are under pressure in the softer market and we are introducing new products, merchandising and select promotions to optimize volumes.

We have executed the restructuring to support the conversion of our residential LVT offering from flexible to rigid cores, which is positively impacting our results. We are pursuing additional flooring sales, reducing costs and aligning production with demand to manage the current conditions. Our panels business has slowed due to a decline in remodeling activity, construction projects and industrial demand. Lower industry sales are affecting both our selling prices and volumes. Our material costs are declining and we are also benefiting from improved productivity and green energy production. Sales of our higher margin HBO collections are growing as our customer base expands. Our sales and operational synergies are progressing in both our board and mezzanine acquisitions.

Our insulation business position is positioned for longer term growth as governments require greater energy conservation for new construction and remodeling. Insulation is less impacted than our other product categories as consumers and businesses invest to minimize their energy costs. Industry pricing has declined, along with input costs with regional variation caused by new plants coming online. In the third quarter, our volume improved and our margins were in line with the prior year. In Australia and New Zealand, the industry slowed during the quarter and our sales in both countries were down slightly. Our results were impacted by mix pressure in the residential channels as consumers sought lower cost flooring options to maintain their project budgets.

To increase sales and protect our margins, we are introducing enhanced collections across fiber categories, elevating the market of our high-end products and implementing targeted promotions to meet evolving demand. Commercial sales in New Zealand remains strong and our broad product offering is helping us secure larger specified projects. In our Flooring North America segment, pricing and mix were under additional pressure as competition increased across all product categories. The impact on our results was partially offset by lower input costs, restructuring and productivity initiatives. To expand our retail presence in all flooring categories, we continue to invest in both products and merchandising systems. We are increasing our participation in the new home construction channel with regional and national builders.

Across the segment, we are implementing many projects to reduce costs, improve efficiencies and maximize material utilization. We are reengineering products with alternative materials and increasing recycled content. We have completed many of our restructuring initiatives to lower our cost and better align with current conditions. In residential carpet, to improve our mix, we are expanding our premium collections, which provide superior styling and features for the more discerning consumer. For the value conscious homeowners, we are increasing our environmentally-friendly recycled polyester offering. We have completed the integration of our non-woven flooring acquisition and are expanding their customer relationships. In resilient, our sheet vinyl collections continued to perform well as a preferred choice for budget oriented consumers.

As an alternative to PVC-based products, we introduced a new resilient polymer core that is more environmentally-friendly and scratch resistant. In the third quarter, our imported LVT sales were disrupted by U.S. customs actions and to satisfy customer orders we substituted higher cost alternatives. We anticipate an increase in LVT inventories in the fourth quarter to improve service. We are continuing to ramp up our West Coast LVT production and the new extrusion process in Georgia. We anticipate both projects will be substantially operational in the first quarter. In addition, the proprietary technology we are implementing in these plants will enable us to introduce unique styling and features to the market. We are expanding our distribution of laminate in the retail and builder channels, our RevWood collections are being more widely accepted as waterproof flooring alternative with superior visuals.

Our new laminate product launches have been well received as consumers seek premium visuals at accessible price points. We are offering selective promotions to improve volumes in a soft market. Our trim and stair accessories business is growing as we broadened the range of our re-patented products across all channels. Though U.S. commercial activity slowed in the quarter as financing became more difficult, our commercial performance is holding up better than residential, led by the hospitality sector. Our carbon-neutral product collections with industry-leading recycled content provide superior performance and design options to architects and designers. Our EcoFlex ONE carpet tile technology is gaining rapid adoption in the specifier community due to its acoustics, comfort and ease of installation.

We are expanding the sales and distribution of our recent flooring accessories acquisition through our existing commercial partners. Our business development group has leveraged our product and service advantages to cultivate new relationships with major retail, healthcare, senior living and real estate development customers. I will return the call to Jeff for his closing remarks.

Jeff Lorberbaum: Thanks, Chris. In the present industry downturn, we are managing the controllable aspects of our business while adjusting to regional market conditions. In all of our geographies, elevated interest rates and persistent inflation are restricting consumer discretionary spending, resulting in postponed remodeling projects and new home purchases. Similar pressures are beginning to reduce commercial investments as business sentiment declines. Competition for sales to utilize plant capacity is increasing in all of our markets and lower input costs should offset the impact. With enhanced products and merchandising, selective promotions and expanded participation in the best performing sales channels, we are maximizing our volumes while managing our margins and operating expenses.

Across the enterprise we are implementing productivity cost reductions and restructuring initiatives to lower our expenses and improve our results. We continue to manage our working capital management to optimize our cash flow. We expect foreign exchange rates to continue to be an earnings headwind. Given these factors, we anticipate our fourth quarter adjusted EPS to be between $1.80 and $1.90, excluding any non-recurring charges. With this, our full year 2023 adjusted EPS should exceed $9. Historically, the flooring industry undergoes greater cyclical peaks and troughs than other building products due to its postponable nature. Our business fundamentals remain strong and we will benefit from significant pent-up demand when the industry rebounds.

Given the aging U.S. housing stock, more than 80% of homeowners who responded to recent JPMorgan surveys indicated they are planning renovation projects in the near-term. In addition, after years of construction trailing demand, substantial new homebuilding will be required for many years to come. Commercial activity will expand as the economic outlook improves. As the world’s largest flooring provider, Mohawk is well positioned to capitalize on these opportunities. We will now be glad to answer your questions.

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Q&A Session

Operator: [Operator Instructions] Our first question today comes from Matthew Bouley from Barclays. Please go ahead with your question.

Matthew Bouley: Hey. Good morning, everyone. Thanks for taking the question. Did I hear you correctly that the reduction in input costs actually exceeded the decline in price mix during the quarter? I guess, correct me if I misheard that. But how do you anticipate price mix versus cost to play out into 4Q and perhaps any early thoughts on 2024 there? Thank you.

James Brunk: Thank you, Matt. Yeah. Let me frame that. So the cost started gradually falling in late 2022 and it takes usually three months to six months to flow through our P&L. In Q3 and I will provide some numbers here that will also be in our 10-Q, lower costs led by material and energy totaled $112 million, offsetting the weaker price mix of $106 million. Now sequentially, cost declined $65 million, exceeding the lower price mix of $29 million. In the fourth quarter, we would anticipate lower costs should continue to flow through the P&L.

Matthew Bouley: Got it. Okay. That’s super helpful. Thank you for that, Jim. Then, secondly, you mentioned, maybe zooming into Europe and natural gas and ceramic there specifically, I know you mentioned, certainly the costs have come down quite a bit from the extreme levels last year, but now European natural gas seems like it’s creeping higher again clearly in a market that seems like it’s a little more competitive. So, how do you anticipate specifically cost and price playing out in that market, European ceramic? Thank you.

Jeff Lorberbaum: Well, the — you are correct that the cost for gas has come down a lot, but in Europe, the business continues to face pressure with declining retail traffic and new construction. We are responding to conditions with promotions and we also have premium slabs continue to grow and we are optimizing our new slab line. We are also initiating restructuring actions to eliminate older assets and improve our cost and utilization. And then we will just have to see how the gas levels out, it’s definitely a lot lower than last year.

Matthew Bouley: All right. Thanks guys. Good luck.

Jeff Lorberbaum: Thank you.

Operator: Our next question comes from John Lovallo from UBS. Please go ahead with your question.

John Lovallo: Good morning, guys. Thank you for taking my questions. Maybe just following up on Matt there, did the lower material and input costs offset the declines in price mix across segments in the quarter. I am more curious, I guess, about Global Ceramic there specifically. And then as we move into the fourth quarter, how should we think about margins by segment, is there anything outside of normal seasonality that we should consider there.

James Brunk: Well, in the quarter, the lower material and energy offset price mix in Flooring North America and Flooring Rest of the World. As Global Ceramics still has some higher cost material that is flowing through, it should kind of complete hitting the P&L in the third quarter.

John Lovallo: Got it. And then any factors we should consider on margin in the fourth quarter outside of sort of normal seasonality?

James Brunk: No. If you look at the fourth quarter, we still have elevated interest rates and inflation, we anticipate constrained discretionary spending with postponed remodeling and home purchases. Remember, obviously, it’s seasonally slows due to the holidays. Margins are expected to be higher than last year with greater pricing pressure and increased shutdowns. We do anticipate lower input costs, as I noted, and we should be continuing to implement productivity and cost reductions, and don’t forget, foreign exchange, we anticipate will continue to be a headwind in the quarter.

Jeff Lorberbaum: The higher volumes in the quarter deleverage the margins as we pick up later, sorry, that’s not this quarter. In the quarter, you have got it right, I am sorry.

John Lovallo: Okay. Thank you. And then as a follow-up, the $620 million in full year CapEx implies a pretty good step-up I think around $250 million in the fourth quarter. Is that just timing or is there anything going on there in particular that we should consider?

James Brunk: It’s really timing. As we end the quarter, in terms of 2023 — between 2023 and 2024, our focus continues to be investing and optimizing the future of the business with the growth investments that we have talked about really making up $200 million to $250 million. Of that maintenance CapEx would be another $250 million and then the balance of that budget for the year are on cost reductions, product innovation and acquisitions.

John Lovallo: Okay. Thank you, guys.

Operator: Our next question comes from Joe Ahlersmeyer from Deutsche Bank. Please go ahead with your question.

Joe Ahlersmeyer: Hey. Good morning, everybody. Thanks for taking the questions.

Jeff Lorberbaum: Good morning.

Joe Ahlersmeyer: A couple of peers of yours have offered some early assumptions on residential U.S. end-markets into next year, might call it a flattish outlook on balance. And for simplicity, let’s just maybe take the international markets aside for a second and the commercial as well and just talk about North America residential across your segments. Question is, I guess, do you agree with that assessment that the market could be relatively flat next year within that and what the sources of upside and downside to that might be?