Mohawk Industries Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 27, 2023

There are 13 speakers on the call.

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

As a reminder, ladies and gentlemen, this which is being recorded today, Friday, October 27, 2023. Thank you. I would now like to introduce Mr. James Brunk. Mr.

Operator

Brunk, you may begin your conference.

Speaker 1

Thank you, Jamie. Good morning, everyone. Welcome to Mohawk Industries' quarterly investor conference call. Joining me on today's call are Jeff Lorbaum, Chairman and Chief Executive Officer and Chris Welborn, President and Chief Operating Officer. Today, we'll update you on the company's Q3 performance and provide guidance for the Q4 of 2023.

Speaker 1

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 release litigation Reform Act of 1995, which is subject to various risks and uncertainties, including, but not limited call to those set forth in our press release and our periodic filings with the Securities and Exchange Commission. This call may include discussion of non GAAP numbers. For For a reconciliation of any non GAAP to GAAP amounts, please refer to our Form 8 ks and press release in the Investors section of our website. I'll now turn the call over to Jeff for his opening remarks.

Speaker 2

Thanks, Jim. In the 3rd quarter, our net sales were 2 point $8,000,000,000 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 A business benefiting from cost reductions, productivity initiatives and lower input costs. Our 3rd 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 offset the Decline in both price and mix, we also faced FX headwinds of approximately $20,000,000 on operating income

Speaker 3

or $0.25 on EPS.

Speaker 2

We are managing our working capital and generated strong free cash flow of $385,000,000 in the quarter and $660,000,000 on a year to date basis. During the quarter, central banks around the world continue 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 the highest level in more than 2 decades, which has suppressed the housing market and limited home renovation activity.

Speaker 2

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 greater impact from these pressures than other sectors given that most flooring purchases are deferrable.

Speaker 4

With the

Speaker 2

high fixed cost 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. The expected housing sector recovery continues to be postponed and we're managing the business to optimize our results and cash flow until it occurs. We're taking actions to increase our volumes while managing margins and operating expenses. We've launched differentiated collections, selectively introduced promotions and expanded our participation in the new construction channel.

Speaker 2

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 only $55,000,000 of which $50,000,000 is non cash. When completed, these initiatives should improve our profitability by $30,000,000 annually by enhancing our productivity, lowering our manufacturing costs and optimizing our production flexibility.

Speaker 2

Our European expansions in insulation and porcelain Labs are currently in operation. Our U. S. Premium laminate and LVT projects are continuing to start up. Expanded production in European laminate and U.

Speaker 2

S. Quartz countertops should begin in the second half of twenty twenty four. As the integration of our acquisitions 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.

Speaker 2

Institutional Shareholder Services is ranked Mohawk as one of the top companies for environmental quality in the durable goods and apparel category. We have significantly exceeded our 25 goals related to decarbonization, waste production and water conservation. We're 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 2 decades of partnership and the fight against breast cancer.

Speaker 2

We've also formalized the Board of Directors selection policy as part of our ongoing commitment to diversity. To learn more, you can read the report online at mohawks sustainability.com. I'll turn the call over to Jim for a review of our Q3 financial performance.

Speaker 1

Thank you, Jeff. Sales for the quarter were just under $2,800,000,000 It's a 5.2% decrease as reported, and the Q3 of 2018 was 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 percent, 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 and A of our 10 Q, which we will file after the call.

Speaker 1

SG and A as a percentage of sales was 19.9% as reported. Excluding one time items 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 a 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 $876,000,000 in the quarter.

Speaker 1

Total non recurring charges was $967,000,000 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 Mobility by approximately $30,000,000 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.

Speaker 1

Interest expense for the quarter was $20,000,000 The year over year increase is due to significant rise in global interest. And other income other expense was income of $8,000,000 Non GAAP tax rate was 20.8% in the current year versus 17.9% in the prior year. We expect Q4 2023's 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 Ceramics sales were just under $1,100,000,000 That's a 0.5% decrease as reported and 6% on a legacy and constant basis.

Speaker 1

The U. S. Business' volume outperformed benefiting from our expanded position in new construction and commercial channel in the quarter. Adjusted operating income was $88,000,000 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, with 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 $960,000,000 That's a decrease of 11.7% as reported 12.2% on a constant basis as higher interest rates and inflation continued to pressure discretionary spending across all product channels.

Speaker 1

Adjusted operating income was $78,000,000 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 plan assets in the current demand environment. Employing Rest of the World with sales of just over $710,000,000 that's It's a 2.6% decrease as reported and 5% on a constant basis as our 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 Installation products held up best in this environment. Adjusted operating income was $77,000,000 or 10.9 percent.

Speaker 1

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 eliminations were $10,000,000 for the quarter in line with the prior year. Turning to the balance sheet. Cash and cash equivalents for $518,000,000 for the quarter. Driven by strong management of working capital, our free cash flow grew to $385,000,000 in the Q3 and are standing at $660,000,000 on a year to date basis.

Speaker 1

Receivables were just over $1,900,000,000 with a DSO of 59 days, which was in line with the prior year. Inventories were just over $2,500,000,000 The year over year inventory decreased $380,000,000 and excluding the impact of acquisitions, the decrease was $438,000,000 primarily due to a focus reduction in units supported by lower year over year cost. Inventory days also decreased to 125 days from 131 in the prior year. Property, plant and equipment was just shy of 4.8 $1,000,000,000 with Q3 CapEx standing at $127,000,000 with D and A of 150,000,000 Full year 2023 forecast includes a CapEx of just over $620,000,000 at this point. And finally, gross debt was $2,600,000,000 with leverage at 1.5 times adjusted EBITDA.

Speaker 1

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'll turn it over to Chris to review our Q3 operational performance.

Speaker 5

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.

Speaker 5

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 new technologies that provide greater value. We have lowered our distribution costs 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.

Speaker 5

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.

Speaker 5

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.

Speaker 5

In each country, we are utilizing the assets of our legacy session 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 software market and we are introducing new products, merchandising and select promotions to optimize volumes.

Speaker 5

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're also benefiting from improved productivity and Green Energy Production.

Speaker 5

Sales of our higher margin HPL collections are growing as our customer base expands. Our sales and operational synergies are progressing in both our meeting in both our Board and mezzanine acquisitions. Our Insulation business 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.

Speaker 5

In the Q3, 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.

Speaker 5

In our Flooring North America segment, pricing and mix were under additional pressure competition increased across all product categories. The impact on our results was partially offset by lower input costs, restructuring and productivity initiatives. 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.

Speaker 5

We've 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 for our nonwoven flooring acquisition and are expanding their customer relationships. In Resilient, our sheet vinyl collections continue to perform well as a preferred choice for budget oriented consumers.

Speaker 5

As an alternative to PVC based products, we introduced a new resilient polymer core that is more environmentally friendly and scratch resistant. In the Q3, 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 4th quarter to improve service.

Speaker 5

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 Q1. In addition, the proprietary technology we are implementing in these plants will enable us to and introduce unique styling and features to the market. We are expanding our distribution of laminate in the retail and builder channels. Our Rev Wood collections are being more widely accepted as waterproof flooring alternative with superior visuals.

Speaker 5

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 broaden the range of our patented products across all channels. Though U. S.

Speaker 5

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 provides superior performance and design options to architects and designers. Our EcoFlex 1 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 with major retail, healthcare, senior living and real estate development customers.

Speaker 5

I'll return the call to Jeff for his closing remarks.

Speaker 2

Thanks, Chris. In the present industry downturn, we're 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.

Speaker 2

With enhanced products and merchandising, selective promotions and expanded participation in the best performing sales channels, We're maximizing our volumes while managing our margins and operating expenses. Across the enterprise, we're 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 4th quarter adjusted EPS to be between $1.80 $1.90 excluding any non recurring charges.

Speaker 2

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 and 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.

Speaker 2

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'll now be glad to answer your questions.

Operator

Management request that you please limit yourselves to one primary and one follow-up. Our first question today comes from Matthew Bouley from Barclays. Please go ahead with your question.

Speaker 1

And 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 I heard 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. Thank you, Matt. Yes, let me frame that.

Speaker 1

So the cost started gradually falling in late 2022, and it takes usually 3 to month, the flow through our P and L. In Q3, I'll provide some numbers here that also be in our 10 Q. Lower costs led by material and energy totaled $112,000,000 offsetting the weaker price mix of 106,000,000 Now sequentially, costs declined $65,000,000 exceeding the lower price mix of $29,000,000 In the Q4, we would anticipate lower costs should continue to flow through the P and L. Got it. Okay.

Speaker 1

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?

Speaker 1

Thank you.

Speaker 5

Well, you're 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're responding to conditions with promotions And we also have premium slabs continue to grow and we're optimizing our new slab line. We're also initiating Structuring actions to eliminate older assets and improve our cost and utilization. And then we'll just have to see how the Gas levels out, it's definitely a lot lower than last year.

Speaker 1

All right. Thanks guys. Good luck.

Operator

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

Speaker 4

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'm more curious, I guess, about Global Ceramic there specifically.

Speaker 4

And then As we move into the Q4, how should we think about margins by segment? Is there anything outside of normal seasonality that we should consider there?

Speaker 6

Well,

Speaker 1

in the quarter, the lower material and energy offset price mix And Flooring North America and Flooring Rest of the World, as Global Ceramics still has some higher cost material that is It's flowing through. It should kind of complete hitting the P and L in the Q3.

Speaker 4

Got it. And then any factors we should consider on margin in the 4th quarter outside of sort of normal seasonality?

Speaker 1

No. If you look at the Q4, we still have elevated interest rates and inflation. We anticipate Constrained the discretionary spending with postponed remodeling and home purchases. Remember, obviously, it seasonally slows due to the holidays. Margins are expected to be higher than last year with greater pricing pressure and increased shutdowns.

Speaker 1

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.

Speaker 2

The higher volumes in the quarter We'll leverage the margins as we pick up later. Sorry, that's not this quarter. In the quarter, he got it right. I'm sorry.

Speaker 4

Okay. Thank you. And then as a follow-up, the 620,000,000 In full year CapEx implies a pretty good step up to, I think, around $250,000,000 in the Q4. Is that just timing? Or is there anything going on there in particular that we should consider?

Speaker 1

No, it's really timing as you end the quarter in terms of 2023 between 2023 2024. Our focus continues to be investing and Optimizing the future of the business with the growth investments that we've talked about really making up $200,000,000 $250,000,000 Of that, maintenance CapEx would be another $250,000,000 and then the balance of that budget for the year on cost reductions, product innovation and acquisitions.

Speaker 4

Okay. Thank you, guys.

Operator

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

Speaker 6

Hey, good morning, everybody. Thanks for taking the questions.

Speaker 2

Good morning.

Speaker 6

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 segment. 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?

Speaker 2

We look forward at it. The flooring industry has actually been in a downturn since mid-twenty 22. We believe that we're going to see Consumer confidence will improve and the industry will start to get better. So we see the first half basically as a continuation of where we are with improvement as we go through the year. And then depending upon how strong and when it occurs, we'll determine what the volume is versus this year.

Speaker 6

That's very helpful, Jeff. Appreciate that. So maybe seemingly a follow-up here. From Late 2020 to early 2022, you bought back $1,400,000,000 of your stock, around $170 a There's even a stretch in there where you're buying it at $200 You stopped buying it back last March. And I know there was Cash flow softened, you were investing in CapEx and you had some maturities in there.

Speaker 6

But on several calls now and especially on this when you're talking about the health of the category, your competitive position not having changed much. So just how might an investor who is the incremental buyer of your stock today, reconcile that sentiment with seemingly the hesitancy around buying back their stock right now?

Speaker 2

At the moment, there's still a lot of economic uncertainty in the world. The financing conditions are still difficult. There's regional conflicts that can affect everything. So we believe that at the moment having excess capacity is preferred, but we're continuing to review it and We'd consider buying stock as our visibility improves from where it is today.

Speaker 1

All right. Thank you, Jeff.

Operator

Our next question comes from Susan Maklari from Goldman Sachs. Please go ahead with your question.

Speaker 7

Thank you. Good morning, everyone.

Speaker 5

Good morning. Good morning.

Speaker 7

Jeff, maybe just building off of Joe's question. As you think about 2024, you're going to go to the year with some excess capacity. I know you mentioned that you think the market can improve in the middle of the year, but how do you think about The company specific efforts that you detailed in your remarks around cost cutting in new products and how those will be layered in over the course of 24 and what they could mean for Mohawk?

Speaker 2

Let's see. As we look through it, higher volumes as we go and the business improves, We'll leverage the SG and A and overhead and the productivity will all improve. We expect improvements in the average selling prices as margins expand. Customers start trading up and buying better products. We'll also see benefits from the restructuring and takeouts that will come through when all that occurs.

Speaker 2

And then in addition, we have multiple acquisitions we've done recently. Those have also They've been compressed. Those will also the volume will come up and we expect them to significantly help our performance. And finally, the investments in the growth areas will add to our sales ability as we come out of this. So as we think through the whole thing, we see the margins expanding as the business improves.

Speaker 7

Okay. That's helpful color. And then as part of that, you've mentioned that the macro in some of these markets, especially some of your newer markets is hopefully maybe taking a bit of a turn for the better next year. As you think about the opportunities in some Those areas and those categories, anything that is interesting to you or that we should be thinking about over the next year and a half or so?

Speaker 2

If you look at Latin America, in this cycle, they actually raised rates more aggressively in the rest of the world and further. So we're actually starting to see them starting to lower rates and we think there could be significant rate decrease is in Mexico and Brazil, even this year. So those things, they may come out of this earlier than others. The Business in Australia has held up better for us. There's a less competitive environment in the marketplace and we've been able to hold on to Margins a little better.

Speaker 2

Europe is really difficult to know what's going to happen. The consumer confidence remains low And it's going to take something to help it move and different than the United States and Europe, the average Workers got much higher increases, so they covered more of inflation than we do. So it's really a confidence issue in Europe.

Speaker 7

Okay. Thank you for the color and good luck with everything.

Speaker 4

Thank you, Susan.

Operator

Our next question comes from Stephen Kim from Evercore. Please go ahead with your question.

Speaker 8

Yes, thanks very much guys. Appreciate all the color you've given so far. Jeff, you've laid out pretty clearly in both your press release and what you've said today, the factors that drive your business to be rather cyclical. Right now, you've got a lot of challenges that are coming from All quarters, as competitors try to leverage their fixed costs in a tough market and drive pricing and all that. And then also on the way up, everything gets better.

Speaker 8

I think you just were talking about with Susan. More broadly, my question is, how important is it to you to drive changes in your business that may deliberately Reduce this embedded cyclicality in your business over the longer haul?

Speaker 2

Well, the cyclicality is based on the really two things. One is how sensitive we are to interest rates and Then the other part is these high capital fixed costs at the industry, including our company, our competitors, And we tend to move up and down trying to minimize these things. I think if you're going to stay in the industry, it's part of it. Now we're getting to other things like the insulation business that we're in, in Europe. It doesn't have as much The fixed costs are much less for instance and the margins hold up better in it.

Speaker 2

So we're in different business and different categories that react differently today.

Speaker 1

And remember, these are not purchases that are canceled, these are deferred. So You see a pent up demand and with the aging stock of housing and as Jeff said in prepared Remarks, the building just being behind the need for housing, we feel like we're in a great position Over that mid to longer term.

Speaker 2

For the 1st 2 or 3 years after this thing is over, the pent up demand for houses, for Housing for improvements and remodeling that hasn't been done. We don't lose it. It just comes back later.

Speaker 8

Yes. There's no I certainly agree that there's a somewhat longer term rebound on the way. And so getting to that, I think you were I think Joe was asking about the timing of a rebound, or maybe somebody else. But You talked about it with the U. S.

Speaker 8

I think you said you're looking for you're bracing for a tough one, first half next year, you think by mid year, It's going to material. Let's say you're right and it does actually start to materialize by mid year. I'm curious how you are planning to run your carrier inventory levels. I think of relatively higher levels of inventory as being something that leads to strong service levels as soon as demand rebounds. And I'm curious as to whether you're planning around inventory in the U.

Speaker 8

S. Particularly is going to be such that you sort of allow yourself to build inventories Carry higher inventories and maybe normal in anticipation of wanting to try to provide strong service levels Maybe at the beginning of 3Q. And then also could you just broaden your view beyond the U. S. To let's say Europe and LatAm, do you similarly think mid year next year is where we may see a turn?

Speaker 2

Let's start with the first part. The inventory levels are based on 2 things. 1 is what the market is and the other is in our ability to respond. Given the low volume rates we're at presently, we have a significant upside in capacity to react to it. And so we probably won't build much inventory until we see it coming.

Speaker 2

And then we think we have the ability to utilize the Capacity that we already have to solve it, to satisfy it as it goes up. On the other side, the different regions, I think that this possible Latin America will come out of this first. And then Europe is a little hard to know. I would guess Europe may trail the U. S.

Speaker 2

If I had to pick, Latin America may come out of it earlier, U. S. In the middle and maybe Europe A little later, but they might present guess, but we'll have to see how it evolves.

Speaker 1

And Stephen, one thing on your original question And as well, the restructuring actions that we're taking, part of that is to lower and permanently lower our cost structure, which then does to help us in good times and bad.

Speaker 3

Okay.

Speaker 8

Yes, makes sense. Thanks very much guys.

Operator

Our next question comes from Keith Hughes from Truist. Please go ahead with your question.

Speaker 3

Thank you. A question on the change your LVT production, your rigid to direct expansion, subject to direct extrusion. Can you talk A little bit more about that. What kind of cost savings and how long it's going to take to do the conversion?

Speaker 5

Yes, Keith, our Georgia Rigid production is

Speaker 3

presently being converted to direct extrusion to lower

Speaker 5

our cost. We're also We're also installing new technology in both plants that will provide unique styling and features. And these changes will give us more flexibility to ship the products from both the East and West plants and we will have savings of more than $20,000,000 annually when executed.

Speaker 3

And will this change all of your rigid LVT production to this method or is this a partial conversion?

Speaker 5

No, it will all be changed to this.

Speaker 3

Okay. And does this drive just more efficient machine time or how do you get the savings Conference.

Speaker 5

Well, we're changing from a heated press technology to an extrusion process and this allows for a lower cost formulation and is just currently in the startup phase. We should be substantially operational in Q1.

Speaker 3

Okay. All right. Thank you very much.

Operator

And our next question comes from Phil Ng from Jefferies. Please go ahead with your question.

Speaker 9

Hey guys. Energy prices have kind of bounced off the bottom. Are you starting to see any upwards pressure on your input costs more broadly. I know it's somewhat tied to oil. Appreciate there's a lag.

Speaker 9

And have you started seeing your price mix in your different respective business stabilize here? Or there's still some pressure as we kind of look forward?

Speaker 2

Let's see if we can answer a few different ways. One is, we think that The material costs have probably bottomed at this point as well as there's a good chance maybe the pricing is also maybe bottomed, But we'll have to see. As the oil and energy prices go up, is The basic cost of it, but also supply and demand. So I'm not sure how it's going to actually flow through given the low demand of the Industry and categories using the different chemicals, it may take a little longer for it to flow through this time than normal. Usually as we come out The recession, what happens is the demand goes up and then the chemicals have to recover their Margins as it goes through and when that occurs, we have to pass through the increase in costs as it happens.

Speaker 9

Okay. That's helpful. And then a few more questions on LVT. With the investment you're making on the extruding side and with Mexicali coming online early next year, How does your product stack up from a cost and quality standpoint versus imports coming out of Asia? And does your LVT manufacturing business now at this point, Early next year stack up from a margin standpoint versus North American Flooring, is it accretive, neutral, still a headwind?

Speaker 9

How should we think about all those things?

Speaker 5

Let me see. First of all, we think the new products that we're coming out with And the LVT are going to especially at the high end, we're going to be definitely competitive with imports.

Speaker 2

The pricing has declined substantially in import prices with both lower freight as As well as lower material costs, our U. S. Manufactured costs are also coming down with it. We still have other things going on like service disruptions from China, given the U. S.

Speaker 2

Impeding the different pieces. And so next year, our margin should expand and we expect the profitability of the business to improve.

Speaker 5

And we also introduced a new resilient polymer core that's environmentally friendly with superior scratch resistance that's doing really well.

Speaker 9

Okay. And some of the friction you mentioned in terms of imports coming in from Asia, how does that position Mohawk especially as you ramp up some of this Domestic capacity, is it a good guy or just probably your cost goes up because at the end of the day you're still importing from Asia, maybe not directly from China.

Speaker 2

The combination of both as you would suspect. The lower cost We're getting through with the imports that we do. We're also getting lower costs here as the material costs fall and energy prices here fall also. On the other hand, competition increased with the lower volumes and the pricing has come down

Speaker 4

at the same time.

Speaker 9

Okay. Appreciate all the great color. Thank you.

Operator

Our next question comes from Michael Rehaut from JPMorgan. Please go ahead with your question.

Speaker 3

Hi, guys. This is Andrew O'Neill on for Mike. Thanks for taking my question. I appreciate you guys shouting this out in your press release. I just wanted to ask maybe from a pricing standpoint, any markets in particular that you have concerns for that price Will fall more significantly or maybe even vice versa?

Speaker 2

Most of the markets matter of fact, all the markets we're in, the pricing has declined. You have a combination of The cost of the materials coming down, the energy prices coming down and these unabsorbed overhead that we've talked about the industry, so the pricing has come down. The question is, is it at the bottom today and or will it go down or not? We think it may be at the bottom as we And as the things improve going forward, we think that there'll be pressure Once the industry improves to increase the material prices from our supply base and we'll react to that when it occurs, but that's usually after the industry does. At the with us.

Speaker 2

At the same time, you have the world events with oil and gas and how that affects everything. That one's anybody's guess and we just have to react to it.

Speaker 3

Thanks, Jeff. I guess in terms of lower input costs and energy costs, are you seeing any further sequential lines into next quarter and maybe any thoughts on next year and how quickly pricing has been aligned with energy prices?

Speaker 1

Again, from a total material and energy costs in the Q4 versus the prior year, We should continue to see the positive impact of the flow through to the P and L, offsetting the lower price mix, that's from a year over year perspective.

Speaker 3

Thanks. I appreciate that.

Operator

Our next question comes from Adam Baumgarten from Zelman. Please go ahead with your question.

Speaker 3

Hey, guys. Just one for me. Good morning. Just wondering if the recent carpet payment terms and the removal of some of the discounts you guys have historically had as an industry will have a positive impact on the Flooring North America segment going forward?

Speaker 2

The industry has changed some of the terms within it. Depending upon where you are, it has Help the margins a little bit. We are staying aligned with our customers in many cases and We didn't try to push through an increase like some of the other guys did. So we're trying to use it to improve our position within

Speaker 3

Conference. Okay, got it. Thank you.

Operator

Our Our next question comes from Kathryn Thompson from Thompson Research Group. Please go ahead with your question.

Speaker 10

Hi. Thank you for taking my question today. Just focusing on the commercial end market, you looked at some resi focused stocks, Trade of better on less bad news this year, early this year. And then you fast forward to this week, you had We're commercial focused, ceiling manufacturer also trade up on less bad news in the commercial space or relatively less bad news. What are you seeing in terms of your pipeline of your business in North America with commercial end market?

Speaker 10

And what have you done to shift your business and focus towards certain end markets that are performing relatively better than the Traditional Office and Retail. Thank you.

Speaker 2

Commercial business is holding up better than the residential business. We are seeing softening in the market in different categories. The ABI index, which predicts the new parts coming online is showing declines. So as in other recessions, typically a year to year And a half later, the commercial starts softening as the commercial projects finish up. So we're starting to see that.

Speaker 2

On the other hand, in commercial, you have a much more differentiated product offering. So the pricing is more resilient than it is in the residential business. In the different categories, Government, senior care, hospitality, restaurants are all doing better and we're emphasizing our participation in those.

Speaker 10

Okay. Yes. I have a full understanding of the timing difference between residential and non res. It was really and it was helpful to some extent, but just Getting a better understanding of that mix shift for you. And now, tell me, importantly, what does it look like going Board because for instance, we're having industry contacts are saying, listen, we're starting to see projects being not just postponed, but canceled, But we're able to shift mix to adjust.

Speaker 10

One other follow-up question. As you have obviously made a lot of efforts Over the past trailing 12 months to right size operations and to make various restructuring charges. But Stepping back and look at the bigger picture, from a long term standpoint, What is the industrial logic for having the global footprint As you manage your business going forward, what's the argument for keeping the global footprint as it is currently? Thanks very much.

Speaker 2

The global footprint allows us to participate in the same categories across the world. It allows us to leverage The knowledge of what we can do with product innovation, styling design, distribution concepts in order to optimize the businesses. And the businesses that we have such as ceramic, We used the we have different businesses that are in high, medium and low. The high ones lead it and then it It flows down through to the other ones to help us increase our mix and distribution in the business. In different businesses we get into, we can help if they're strong in residential, we can help them show how to maximize their commercial business.

Speaker 2

We have other categories that we get benefits out of just the processes, running warehouses and Distribution Information Systems. So there's a lot of synergies that you can do to help the acquired businesses.

Speaker 10

Okay, great. Thank you.

Operator

Our next question comes from Truman Patterson from Wolfe Research. Please go ahead with your question.

Speaker 3

Hey, good morning everyone and thanks for taking my questions. First, whenever I'm looking at the 4th quarter EPS guidance sequentially versus 3Q, It implies a bit worse than normal seasonal decline. I'm just hoping you could help us discuss From a high level, the buckets that got worse throughout the quarter that really led to that guide? And then also, I believe you mentioned Brazil, Australia, but are there any areas, product categories, pricing, etcetera, where you're perhaps seeing some stability, if you will.

Speaker 2

You covered a lot of ground. Let's see if I can get most of it. So starting out with the elevated interest rates Inflation are constraining the spending and is postponing the remodeling and home purchases. Our assumptions are that it's more difficult in the period. You're also in the time where the seasonality, so there's more holidays, Given the control of the inventories and lack of need for manufacturing ahead, there's more shutdowns being planned in the period.

Speaker 2

We are assuming increasing pressure in commercial in the 4th quarter versus the 3rd quarter. The margins on a year over year are higher than they were, but we think there's still going to be this greater pressure and Unless covering the absorbed overheads as we control the inventories and working capital, We're implementing productivity and cost reductions and then we expect the foreign exchange, our present assumptions are that it's a similar headwind What was happening in the Q3? Yes. So sequentially,

Speaker 1

that gap that you're talking about, if you look back over time From 2018 forward, you've got mid-twenty percent difference from Q3 to Q4. It's a little bit more This year, in our implied in our guidance, and I'd say the additional shutdowns and the Foreign exchange, certainly are 2 headwinds that may be a little bit unusual than prior years.

Speaker 2

Another also difference is in normal years, we would normally pull the inventory down In the end of the Q3, the start of the Q4 and then be building back as we come out of that quarter. So we're not doing that didn't happen this year.

Speaker 3

Okay. Thanks for that. And then just wanted to follow-up on kind of a prior question. You all have been generating a lot of cash flow this year, dollars 2,600,000,000 in debt. It seems pretty manageable.

Speaker 3

And And Jeff, I think you mentioned earlier that perhaps you might not step into share repurchase today. I'm just hoping you could discuss potential for M and A, Any geographies or product categories of focus as well as how you might balance that With your own current valuation of your share price, balance M and A in lieu of share repurchases?

Speaker 2

1st, before we get into the new M and A, we have the 2 Acquisitions we've done in Brazil and Mexico, which we are integrating and taking costs out. We have 3 or 4 bolt on acquisitions that are also being put together with the business. All of those should give us significant upside as we come up and the volumes go up in the businesses. As we come out of this in the future, You're correct that the value of the business today allows to Purchase of stock and give significant opportunity, which we consider as soon as we make sure there's not another A worldwide problem that's about to occur with all the events going on as we go through, and then we'll have to see what that looks like versus other alternatives that arise.

Speaker 3

As another way, any M and A deals flowing across your desk, Are those valuations more attractive than your current valuation for Mohawk?

Speaker 2

The only businesses that tend to sell in this environment are ones that are seriously distressed and don't have any options. At these valuations, most companies don't do many don't try to sell their businesses.

Speaker 3

Okay, perfect. Thank you.

Operator

Our next question comes from Laura Champine from Loop Capital. Please go ahead with your question.

Speaker 11

Thanks for taking my question. You called out in your press Elyse, the negative impact on Europe from the conflict in Ukraine. Can you give us more information on the Russian business? What are your plans for that? And is that business a material hit to earnings this year?

Speaker 5

Well, the answer is no to that. But in Russia, we're all following we're following all the sanctions. We're adjusting our strategies to be to adjust to these more difficult market conditions. We're also leveraging our leading styling and distribution to maximize our sales in that market.

Speaker 1

Remember that's Russia is less than all the Russian businesses together are less than 5% of our business.

Speaker 11

Understood. Thank you.

Operator

Our next question comes from Eric Bouchard from Cleveland Research. Please go ahead with your question.

Speaker 3

Thank you. Two things. First of all, Jeff, you've talked about this being the bottom of price And then a potential improvement in the middle of 'twenty four. I'm just curious what you're seeing in the business now that supports both of those thoughts?

Speaker 2

First is the pricing decreases are following the material costs and material costs we believe are at a bottom. So we believe that will change the pricing from falling significantly more going forward. And then what was the other part of the question?

Speaker 3

The second part was the comment about the first half Being similar to today and then the path for improvement in the back half of twenty twenty four, what you're seeing in the business today that informs that?

Speaker 2

I guess that we don't have a crystal ball any more than you do. We're making the assumption that the present circumstances Continue we believe we have line of sight into the Q1. After that, given the dynamics that's going on in the world, anything could happen. That's it. What we're

Speaker 1

kind of quoting there is there's numerous people that have come out and said that you'll see Some strengthening in the back half of the year, but again, you can get an argument going the other way as well. So it's really one scenario,

Speaker 3

call. And then secondly, the goodwill write off is A component of that or I'm just curious the catalyst for this, is there some component of this that relates to a reduced future earnings of the business or are there other dynamics with Explain.

Speaker 1

Eric, it really starts with the volatility on the macro side, the higher Interest rates inflation, deterioration in the market condition negatively impacted our business, Which reduced our market capitalization. Then you go through an internal review of the Stock price compared to that triggered the goodwill impairment that was required. Remember that's a non cash charge in the quarter and it's across all the segments. There'll be more detail for you to see in the 10 Q that's filed after the call.

Speaker 2

Okay. Thank you.

Operator

Our next question comes from Raf Jedrashik from Bank of America. Please go ahead with your question.

Speaker 12

Hi. Thanks for taking my questions. It's brief. So the first thing I wanted to ask is just what are you seeing in terms of industry capacity, particularly in the U. S?

Speaker 12

Are you seeing Are there competitors start to pull back in any of the segments? Or are you seeing any foreign competition continuing to add capacity?

Speaker 2

Across all the different categories, there have been capacity taken out of some pieces of the industry in different places. In LVT over the past year, there have been some increases in capacity in the U. S. Marketplace. What else was the rest of the question?

Speaker 12

Are you seeing any of The foreign competitors open capacity in the U. S, is there any incremental capacity investments there? And then are any of the domestic manufacturers reducing capacity on categories like carpet or hardwood?

Speaker 5

Well, back and just to comment in ceramic, there have been a couple that have added new plants. But in generally, the Capacity that's in the United States is slightly underutilized, I would say, in ceramic.

Speaker 2

In the ceramic one, Probably about 50 in excess of 50% is imported. So there's Some of the foreign companies are opening some capacity here, which he's talking about. LVT would be similar to the same situation, whether some of the foreign ones have opened up capacity here, trying to find ways to optimize their service levels from where they are. And then some of the other product categories, there have been some capacities taken out of the industry.

Speaker 12

Okay, got it. That's helpful. And then just on the new construction outlook, Can you just remind us your exposure to multifamily versus single family? And then what you're seeing on between those two segments.

Speaker 2

Not sure I have those numbers in front of me. The new construction homebuilding, I think is around 20%, 25% of our business. I don't have the number in front of me of the multifamily piece.

Speaker 1

Yes. We don't have that. We don't usually break that out. We included in the new construction number that Jeff quoted.

Speaker 2

It's either in the new construction number or it's in the remodeling number as it gets Replaced as we go forward.

Speaker 12

Is there if it seems like based on what Kind of homebuilders are saying now that you will still see single family construction probably rise next year. But it looks like the multifamily outlook is pretty soft and we could see some pretty significant declines. Do you have The meaningful exposure on the multifamily side. I mean, is there any margin difference between single family and multifamily? Quarter?

Speaker 12

Is it relatively small compared to single family?

Speaker 2

Multifamily typically is lower. They typically use lower quality products in the single family home construction. On the other hand, the multifamily gets replaced Much more frequently, typically after they change over tenants in it, Depends on where they are and what it could be replaced every few years, where the home new building could be a 7 to 10 year cycle. So There's a big difference in replacement cycles as well as the quality of products going into each.

Speaker 1

As we've said earlier, we see Expanding presence in U. S. Ceramic and new construction and the commercial channels And also in Flooring North America as well. Our relationship with the builders is stronger.

Speaker 2

The other thing you mentioned, the multifamily, the new starts are coming, but the typical multifamily takes Minimum of a year and a half and could be 2.5 years to finish. There is a huge number of projects that are coming through that haven't been finished yet And our product category is the last one to go in.

Speaker 1

Yes. So similar to commercial, it has a long tail to be completed.

Speaker 12

Got it. So there's still a backlog there. It's very helpful. Thank you.

Speaker 1

Yes, correct. Thank you.

Operator

And ladies and gentlemen, at this time, we'll be concluding today's question and answer session. I'd like to turn the floor back over to Mr. Lorberbaum, for closing remarks.

Speaker 2

We're managing the controllable costs that we've been discussing. We continue to react to changing market conditions, which are volatile. We see significant upside when the market returns, and We think we're well positioning ourselves for that to occur. We appreciate you joining us. Have a great day.

Speaker 3

Call.

Operator

And ladies and gentlemen, with that, we'll conclude today's conference call. We thank you for attending today's presentation. You may now disconnect your lines.

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Earnings Conference Call
Mohawk Industries Q3 2023
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