Mohawk Industries, Inc. (MHK) Earnings Call Transcript & Summary

Thank you, and good morning. This is John Baugh at Stifel. And welcome to the second day of our Boston Virtual Cross Sector Insight Conference. Happy to kick off this morning with the CFO of Mohawk Industries, Frank Boykin. I'm going to turn it over to Frank, and he's going to make a few opening comments, and then I will follow up with some questions and be looking for questions from the participants on the line. Frank?

Thank you, John, and good morning, everybody. Thank you for each of you for your interest in Mohawk today. As John said, I will open with just a few brief comments, kind of State of the Union at Mohawk and then turn it back over to John. So Mohawk is the world's largest flooring company with $10 billion in revenues last year. With our global footprint, we've got a manufacturing presence in 18 countries and then sales around the globe in more than 170 countries. We have an extremely strong balance sheet with a BBB+ rating and excellent liquidity with our leverage at 1.6x at the end of the first quarter and $1.3 billion of pro forma liquidity at the end of the first quarter. Until March, our first quarter results were in line with our plan when COVID-19 significantly changed our outlook on the quarter and the rest of the year. We are effectively responding to a rapidly changing environment as we have continued to ship and produce product in most locations around the globe but at, as you can imagine, at greatly reduced levels. Residential remodel is the end market that has been most impacted with our project-oriented commercial and new residential markets performing better. In response to everything that's going on in the macro environment, we have reduced capital expenditures. We've cut noncritical expenses, and we put stock purchases on hold. We've executed temporary layoffs and furloughs to balance our production and demand levels. We're evaluating our current long-term market demand and adapting to those changing market conditions as they occur. We will adjust our capacity as needed based on our assessment around the globe. As we move through the second quarter and then into the second half, we are reducing SG&A. We're limiting investments and further strengthening our balance sheet. We issued 2 separate tranches of bonds since the end of the first quarter, a 10-year USD 500 million bond offering and a 7-year EUR 500 million bond offering, both of which will improve our liquidity and push out existing maturities. In April, our sales were down 35% compared to last year. Currently, all of our plants around the world are operating, and most markets around the globe are opening up as retail shops begin selling flooring again. We believe as economies return to normal over time that our business will continue to improve. And we are optimistic about our long-term future at Mohawk Industries. So I will stop with that, John, and turn it back over to you.

Okay. Thanks for that introduction, Frank. And maybe we could start with the U.S. business and focus on your retail, independent retail distribution channel, which is important to you. The question is, are we far enough along in this pandemic to kind of know who made it and who didn't, what the attrition rate was? And I'm particularly interested in light of the small business loans that were available. Did that allow perhaps a lot more of these dealers to survive? What's your AR experience been with them? What's the health of that distribution channel?

So your question is around the U.S. side of the business, I think, John, and the residential remodel part of the business, which is where those smaller specialty retailers are. For the U.S. business, that's probably about 65% or 70% of our total revenues. It's a substantial part of our business. And you are right, there are a lot of smaller, individually owned retail shops around the U.S. that participate in that. The 2 big players, the 2 home centers also participate in it. But more of the business is transacted by those smaller shops. I would say that if you look at how that has evolved over time, those smaller shops have continued to be an important part of the market in both good times and in difficult times. And as an example, when we went through the 2008-2009 recession, the bad debt expense that we incurred was about 0.4% of our total revenues. And that compares to our bad debt expense in the first quarter of this year, which is more normal, at about 0.2%. So I would expect that we would see some of the weaker players go away, just like we saw in the '08 and '09 recession. I would expect that there would be some consolidation among the specialty retailers, just like we saw in '08 and '09. But I would also expect that they would continue to be a very important and very significant part of the U.S. flooring market.

Okay. And then staying on the sort of consumer retail remodel side in the U.S. Is there a discernible difference between those areas where you've more or less stayed open or the virus hasn't been too bad in terms of performance the last few months versus those that were more or less closed that are now beginning to open back up? And is there any kind of pickup you're seeing, particularly in states that were close to construction practically as well as so many other retail locations closed.

I mean, yes, I mean, as you would imagine, as the retail shops around the country have opened up more, the business has improved. And so for those regions that had the more dramatic, draconian shutdowns and that have already opened back up, we are seeing limited improvement. Having said that, it's still early in the process, and we're going to have to see how all this plays out over time with both the virus and the consumer. But as you might imagine, around the globe, as different countries are opening up, more and more of that is happening. And I would expect to see that favorably impact our sales more and more as we move through this quarter and into the second half.

Great. And then saying one more U.S.-centric question. I'm thinking about the commercial side of your business, which, correct me if I'm wrong, is somewhere in a 25-plus percent part of your U.S. business. And then the new residential construction business, which has lagged the housing starts by a good 90 days plus. Would there be an expectation that, that business could actually decline as we go through the next few months given some of the lag or lead times where you've already seen a bottom in those markets and actually you're seeing sequential improvement? What would be your expectation for those 2 end markets?

Yes. I would point to history, John. We have said on the call and then since the call that, the first quarter call, that those project-oriented end markets, commercial and new residential, performed better early on as we moved through March and into the April time period. In the last recession, commercial tended to perform better in the early part of the recession but then lagged as we came out of the recession from the other end markets. And so I would not be surprised to see that same thing happening here. But having said that about new residential homes, there continues to be a shortage. The inventory is lower, I think, than most people expect that it should be. So again, that's kind of one of the question marks, and we'll have to see how that plays out over time.

Okay. And then maybe shifting to Europe and/or other parts of the world. They started opening their economies, and Europe, at least, a little bit ahead of us. And the recent news, at least I've read headlines, have been that the virus has not spread broadly speaking. So any color you can add on in terms of what you're seeing, both in terms of your manufacturing operations as well as demand in various parts of Europe?

Well, as I said in my opening comments, I think all of our manufacturing is up and running today, even in Italy, although at greatly reduced levels. And we had continued to ship, I think, through most of the time, even in Italy. And so to step back and look at the European continent in total, some of the countries just like here in the U.S., some of the states opened up earlier and some of them opened up later. So you've kind of got a mixed bag there, I would say. As you might imagine, Italy was one of the last to open up. And so it would be lagging behind what we've got in the central and northern part of the continent over there with Belgium and the Netherlands. So it's kind of a mixed bag there.

Okay. And then maybe you could touch on inputs. I assume with oil having contracted, what are you seeing on the chemicals front? And how do you anticipate that flowing through your P&L, particularly in the second half of this year?

Well, you're absolutely right. If you look at our carpet business, the product, carpet, a substantial part of that is raw materials and almost all those raw materials are petroleum-based. And so our costs over the years have gone up and down in connection with how oil moves. And there is always a lag in good times and in bad times from when oil goes down to when we see that in our P&L from reduced raw material cost because of inventory turn and just the supply chain of getting those lower cost to our raw materials. We saw in the first quarter some positive benefits from lower raw materials as a result of that. And I would expect that in the second quarter, we would see more benefit from lower raw materials. However, because we've seen such a significant decline in the sales in the second quarter, that has a big impact on how much of those lower raw materials flow through to the P&L, off the balance sheet and onto the P&L. So I would expect to see more benefit in the second half than what we see in the first half and with the second quarter probably be the lowest quarter in terms of raw material benefit there. The other side of that equation is what's going to happen with pricing in that environment. And for those that are new to the company, we generally hold on to pricing for some period of time when raw materials go down, but we are in a competitive industry and our pricing tends to, the industry tends to let out some of that advantage over time. And so I would expect the same thing to happen here. But we'll have to see how it evolves in this current environment that we're in.

Okay. Fair enough. Maybe you could talk sort of previrus. Mohawk has battled a number of issues the last couple of years. I won't rehash them all. Among the key ones, though, the switch that we've seen to LVT has certainly been an issue. Rightsizing capacity in carpet has been an issue. Maybe you could touch on 2 or 3 things that Mohawk has been working on previrus and update us on the progress of the production of LVT, for example, and getting the costs down in carpet or any other areas you want to more touch on?

Okay. Well, that's a pretty open-ended question there. I'll give it a shot, and then you can prod me in another direction if I need to do that. Let me start with LVT, luxury vinyl tile, for those that are new to our business. That is a relatively new product in the market here, both in our U.S. and in our European flooring markets. LVT, most of what is sold now in the U.S. is manufactured over in China. That may be 80% to 85% of what's sold here. The LVT category has grown significantly over the last several years, taking share from other product categories. Carpet has been significantly impacted. Ceramic has been significantly impacted. We have 2 manufacturing lines here in the U.S. The newer one is probably about 2 or 3 years up and running. And it is new technology compared to what the Chinese are using, lower cost, lower labor content. And so we think that once we have that up, it's up and running now. But once we have that optimized that we're going to be lower cost or as lower cost as what's being landed here out of China with more kind of design and styling options that we can put in place with that. But because it's new technology, it's taken a bit longer to get it to where we'd like it to be. And I would say, today, we think that we have stabilized the manufacturing process there. Productivity and cost had both improved in the first quarter. Output, daily output rates have been going up. So it's all moving in the right direction, still not where we need it. A lot of the expertise, the technical expertise to continue to make the modifications to that line are over in our European operations because they're a bit ahead of us. They've got similar line, same technology over in Europe. But because of the travel problems, it's slowed that process down a little bit. But we are still making progress there. And our strategy with LVT going forward is to have kind of a balance between what we manufacture locally and what we source. We think that's kind of the best way to give us flexibility to increase or decrease our capacity as that market continues to evolve. One of the, as I mentioned, categories that was most significantly impacted over the last 2 or 3 years by that was ceramic tile here in the U.S. There are 2 things that have impacted ceramic that had been the most significant impact to ceramic. One is the LVT phenomenon and then the other is imports and exchange rates have been up and down. But the Chinese participation up until a couple of quarters ago in the U.S. market had been pretty significant. And so those 2 headwinds, let's say, we've been significantly focused on those within ceramic. I think we made some pretty good progress on both fronts, getting new products out into the marketplace to help on the LVT side, on the import side. About 40% of that market historically had been from imports, with most of that historically coming out of China. However, with the tariffs and duties that had been put in place by Washington, we have seen a significant decline, almost down to 0 imports coming from China. And overall imports, recent industry data shows that they're down about 18%. And so that's a positive for us. But there's still some dislocation going on within the market as the competition transition out of China into other countries there. And then, of course, the virus has added some more complexity to the whole process there. It certainly in the first 2 months of the quarter felt like that the North American ceramic business was gaining some momentum and making progress against those headwinds there. And we'll see how things evolve as we move through the rest of this quarter and the second half.

Okay. That's helpful. Frank, I've got a question from the audience, and it is, what is the LVT penetration in commercial and new residential construction versus the repair and remodel market? I'm assuming that question is oriented to the U.S. marketplace.

Yes. LVT, we're seeing it in both the commercial and in the residential markets. I'm not sure I know exactly what the penetration is at this point. I would say, I would guess, I wouldn't hold me to this. I would guess that in the commercial market, it's probably somewhere in the low to mid-teens and growing. It's a very popular product within that marketplace there and has been readily accepted, particularly in some end markets like hospitality, which is kind of dead in the water right now, but there have been some end markets that it's been more successful than in others. And then in new residential, I think it's just beginning to make inroads. That's usually a more difficult market to put new products in place. But I would expect over time that it will continue to grow in both of those end markets.

Okay. You mentioned you are, I don't know, canvassing your global footprint and assessing what level of capacity you need, I presume, for the foreseeable 2-, 3-, 4-year period or so. Where are you in that journey? And I realize it's a different answer maybe by every market. But if you could somehow address it from a very high level, do you have enough insight yet to determine what needs to be? And I don't know what you furloughed versus cut at this point, but that would be a good way to sort of think about furlough, temporary; cuts, permanent. Where are you in that journey across the spectrum of the company?

I would say we're right in the middle of it, John. We've not announced any kind of significant restructuring through the first quarter or where we are into the second quarter here. As I said in my opening comments, we're definitely looking at trying to understand what long-term market demand is going to be and how we might need to adjust in our different end markets for that. I think if you look back at our experience in '08 and '09, much slower, longer decline there, and we definitely took out a fair amount of capacity. We also tried to balance that in terms of where we thought demand was going to come back. And so this is obviously a much steeper and quicker decline. And the big question is, how far is it going to come back up. And so that's the math that we're trying to go through right now and trying to forecast where we think things are going to settle down. So I would say, we're just in the middle of it and stay tuned. And we'll see where we end up. I will say that, starting at the top, with Jeff, our leadership is very focused on doing what we can to rightsize and take cost out where we think long term it's needed but to balance that with where we think long-term demand is going to be and not take too much out. And I think if you go back and look at our history, we've done a pretty good job of that. And so we're in the middle of that process right now.

Okay. Fair enough. I got another question from the participants. And it relates to LVT capacity, which I know is primarily in China, but we are seeing capacity being built in the U.S. and other parts of the world. Is there any kind of a shakeout or a change in what you're seeing in terms of capacity being built particularly by smaller players over the last few years? Is it waning? Is the overall category not growing quite as fast on a percentage basis with maybe the law of big numbers there? Any sense of where capacity is LVT versus demand and whether there's any shakeout coming?

Well, the LVT market continues to grow. But as it gets bigger, I imagine the growth rate slows. And so I think that's what we're experiencing here in the U.S. and the European markets. Really, the markets are very different in terms of local competition. Here in the U.S., there had been a number of people that had been rumored to kind of starting up capacity and selling locally produced product into the U.S. market. And I know for sure, there's 1 or 2, 1 commercial player and 1 residential player. They don't have significant production capacity as far as I understand. And then there are some rumors of some other Chinese coming in with their own local technology into the U.S. market. So at this point, it's still dominated by imports. I would expect to see that continue for some time. And these other players, it remains to be seen how competitive they can be in this market. In Europe, it's kind of a different animal. Whereas they're about 80% to 85% imports here in the U.S. market. I think in Europe it's, for sure, less than 50%. And they've got a number of local manufacturers over there that have been up and running for some time, including our business, one of the first to get into the LVT business over there in Europe. And so you don't see the presence of Chinese or other importers over there near like what you do over here in the U.S. And so my guess is, you're going to continue to see that same kind of local production kind of dominance in the European market as it grows and evolves.

Maybe a different way to come at that question. When you look at your sourced business of LVT in the United States and/or Europe to the degree you're doing it, is the margin profile still very attractive, less attractive, but less attractive than it was? Just curious as to, of course, we've had a lot of noise with the tariffs and now the exclusions. I assume that's all sort of settling out, although we've got another date in August to see if that is extended. But any sense on the profitability of sourcing LVT in the U.S. and around the globe?

Well, I can't speak for around the globe because we're not sourcing anything over in Europe. But here in the U.S., yes, our sourced product is still a profitable business for us. The expectation is, as we continue to improve the manufacturing process, like I spoke to earlier, that it, too, will reach comparable margins is what we're seeing on the sourced side. So we have said from the start, 3 years ago, 4 years ago, that we would expect the U.S. LVT market that as the market grew, as the demand grew here in the U.S. and more competition came in that we would see pricing pressure over time would pressure margins. And we also expect that as we get our production up and running, we'll continue to improve our production process even after we've got it optimized and take cost out and remain just like we do with our other products over time, remain with strong margins. That's how I would expect our manufacturing to evolve over time. But overall, I think margins are going to be fine long term in that product category.

Okay. And sneaking in one last one from the participants quickly, Frank, as we're close to the appointed hour. Any preliminary thoughts on the commercial side of the business, particularly office market, which is at least half of the commercial business with all the work at home stuff? Are you nervous about the structural changes to that business going forward?

Yes. I mean, that's the question mark, right? I mean, how is our economy and society going to evolve in the aftermath of all of this. And we just don't know, right? We don't know what we don't know about both the health side of it and like I said earlier, how consumers and workers are going to respond, I guess. So I'm not going to give you an answer. But I guess the flip side of that, this is kind of speculative at this point. The flip side of that would be, if there are more people working at home, and I've heard this in my own family, where they're spending more time in their house, there is, you would think, a higher likelihood that they would want to invest more in their house. And so that could cut both ways. And I think it's too early to say right now. We're just going to have to watch it and respond as the market changes.

Fair enough. All right. That will be it, Frank. I want to thank you so much for participating and your time. We look forward to monitoring your progress. Thanks again for participating.

Okay. Thank you, John. And I'd also like to thank all the participants for your interest in our company.