Mohawk Industries, Inc. (MHK) Earnings Call Transcript

Good day, and welcome to the Mohawk Industries Third Quarter 2026 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Joe Ahlersmeyer, Vice President of Finance, Investor Relations. Please go ahead.

Thanks, Chloey. Good morning, everyone, and thank you for joining the call. With me today are Paul De Cock, Chief Executive Officer; and Nick Manthey, Chief Financial Officer. Today, management will detail our new strategic and capital allocation framework discuss an update on the company's third quarter performance and provide guidance for the fourth quarter of 2026. I'd like to remind everyone that our press release and statements that we make during this call may include forward-looking statements. which are subject to various risks and uncertainties, including, but not limited to, those set forth in our press release and our filings with the SEC. 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'll now turn the call over to Paul for his opening remarks.

Thank you, Joe. Good morning, everyone, and thank you for joining us today on my first earnings call as CEO. Before we get started, let me first thank Jeff Lorberbaum for his leadership, drive and passion for Mohawk. The leadership transition has been seamless, and we are fortunate to have his continuing support as Chairman. This morning, I will begin with our results for the quarter and the market conditions we are navigating across our businesses, I'll then share my vision for Mohawk, the actions already underway to drive outperformance and what you can expect from me and my leadership team. Let me start with our results. We delivered a solid quarter, and I'm proud of how our teams executed. Our overall operating result was in line with our expectations even as demand softened late in the quarter. The quarter reflected progress in 4 main areas. We grew sales and executed price increases in response to rising inflation. Growth in Global Ceramic was led by U.S. retail and countertops and in Flooring North America by retail and commercial. Flooring Rest of the World sustained pricing gains despite lower market volumes. We acted decisively to offset the impacts of higher underlying inflation with the combination of price, mix and productivity, more than offsetting the impact of higher underlying inflation. We converted our performance into cash, generating cash from operations of $471 million and free cash flow of $390 million in the quarter, bringing our year-to-date free cash flow to $626 million. And we substantially increased share repurchases, returning $261 million to shareholders in the quarter, more than double what we did in the first half. Now let me take you through the performance of our end markets. In our U.S. market, where we generate a little more than half of total company sales, market conditions remain challenging. Following the recent rises in rates, demand weakened exiting the quarter and has remained soft across most products and channels during October, particularly in the builder channel. We are executing well and are focused on improving our leading market positions across all channels. We continue to differentiate our products and service advantages. In residential repair and remodel, which we estimate represents approximately half of our U.S. sales, consumers continue to defer larger projects and the outlook for existing home sales has weakened entering seasonally slower months. Activity through the specialty retail channel is holding up better and improved sequentially while larger format retail point-of-sale trends remained slow. Even in this environment, our retail business grew in the quarter and gained share across most of our product categories, led by residential carpet where adoption of our industry-first asthma and allergen-friendly carpet is exceeding our expectations. Our laminate business continues to outgrow the category on scratch resistance and real wood visuals, our ceramic remodel business improved for a fourth consecutive month and countertops grew on new card designs and our concierge program. Our market-leading accessories assortment continues to build attachment across our hard surface platforms. In residential new construction, which we estimate represents about 1/4 of our U.S. sales, the builder market continues to soften. Single-family starts have fallen with higher mortgage rates and declining builder confidence. Affordability is constraining buyers in most regions and large builders are managing construction costs. This is the most challenging environment across our end markets, and we expect it to remain so in the near term. We added new builder program wins in both ceramic and laminate during the quarter. Our laminate is gaining with homebuilders as a better-performing alternative to LVT, and our stair and accessory solutions are becoming part of builder specifications. While these wins do not fully offset the market decline, they strengthen our position in this important channel, and we expect them to compound when the market improves. Finally, in commercial, which we estimate represents the remaining 1/4 of our U.S. sales, demand is more constructive than residential with repair and remodel activity holding up better than new development. Industry activity among architects and designers is soft as new project awards slowed in August and September. In ceramic, commercial sales declined as projects were deferred, and we are responding by concentrating on the active segments. Hospitality, health care and education are the most active segments and return to office continues to support carpet tiles, driving strong performance in office. Our commercial LVT category continued to build momentum, delivering a sixth consecutive month of order growth while sales of carpet tile, commercial accessories and our rubber platform also grew in the quarter. Now pivoting to Europe. In Europe, which represents approximately 1/3 of our total company sales, consumer demand remains soft, with weak residential activity and showroom traffic, though commercial projects are holding up better. Our premium collections continue to outperform, and in ceramic, our large format and slab offerings are growing. In laminate, our innovation leadership continues to win with customers. European natural gas prices have roughly doubled since the start of the third quarter, and we have responded quickly, bringing our ceramic price increase forward and announcing November price increases in our European panels and installation businesses to recover even higher energy and chemical costs. Outside of the U.S. and Europe, which represents the rest of total company sales, demand remains soft with consumers pressured by inflation and high rates, although we continue to outperform. These market conditions reinforce why our focus must remain on the actions within our control. As the largest flooring and design services company globally, Mohawk has built many unique strengths and advantages, which include our leading market positions, our recognized brands, our innovation expertise, our strong customer relationships and the scale and efficiency of our manufacturing and distribution operations. Our strategy builds upon these strengths and advantages. We are aligning our actions and investments to a strategic framework comprising 4 pillars each supporting our goal of delivering more value to our customers, along with more value per share for our investors. Now let me take you through the 4 pillars. The first pillar is outperforming our markets. This is our catalyst for compounding value creation through demand cycles. We estimate that our industry grows low single digits annually on average over the long term. We participate in cyclical end markets that our team members found ways to succeed and perform against any market backdrop. When the industry is expanding, we must grow faster than the market, and when it is contracting, we will relentlessly pursue share wins that will compound through the next expansion. Our go-to-market approach will be consistent through cycles, focused on the most attractive segments of the market. We will deepen customer relationships and solidify Mohawk as the vendor of choice across all channels. We will use digital tools to create downstream demand and pull our product offerings through the value chain. We are committed to continuously improving our competitive position through expanded partnerships, new customer wins and growth in differentiated routes to market. We will be transparent about conditions, but our focus, like the expectations I have set for our leaders, will be outperformance through cycles and over the long term. The second pillar, product innovation and brand strength, deals with the solutions that drive the first pillar. Innovation is a core competency underpinned by our 3 global innovation hubs, ceramic surfaces in Italy, hard surfaces in Belgium and soft surfaces in the U.S. We own a portfolio of patented technological innovations that further support our advantage. We will continue to build on the strength of our brands, and we see immense opportunities in the evolution of consumer preferences towards high-quality, trusted brands over commoditized offerings. Our focus will be on bringing more distinctive products and solutions to the categories and channels where we can create the greatest value. The third pillar, profitability and operational excellence, is how we will aim to ensure the highest level of service to our customers while we continuously improve margins and incremental returns. We will be defining Mohawk's operating model, building around a culture of productivity, continuous cost improvement and operational excellence supported by strong digital capabilities. We believe our quality and service will extend our competitive lead and deepen our relationships with the retailers, distributors and contractors who sell and install our products. The fourth pillar, cash generation and capital discipline deals with how we convert profitable growth into cash and how effectively we redeploy that capital to enhance shareholder value. We will have a sharp orientation toward cash returns, timing and risk, and this is not unique to capital expenditures. Every dollar of deployable cash we have will pass through a strict framework. From operating expenses to capital investments to inorganic investments, we will invest sufficiently in the core business, exercise discipline in evaluating inorganic opportunities and return capital to shareholders through consistent share repurchases. My team and I are energized by the opportunity ahead and committed to demonstrating strategic traction delivering operationally and deploying capital in ways that meaningfully enhance shareholder value. And with that, I will turn it over to Nick.

Thanks, Paul, and good morning, everyone. In a moment, I will talk about our capital deployment priorities in support of our newly defined strategy. But first, let me cover the results and outlook for the fourth quarter as well as a few preliminary planning assumptions for 2027. Net sales for the third quarter were $2.8 billion, up 1% as reported and essentially flat adjusting for foreign exchange and an extra shipping day. Volumes were down 4% due to soft market demand while the combination of price and mix was up 4% as we benefited from price increases to offset the impacts of inflation along with positive mix. Net earnings for the quarter were $163 million or 5.9% of net sales. Adjusted EBITDA was $353 million and adjusted EBITDA margin was 12.7%. Operating income was $188 million and adjusted operating income was $200 million, down $5 million versus the prior year. The combination of price and mix of $85 million and productivity gains of $47 million was sufficient to offset underlying input cost inflation of approximately $117 million, which was in line with our expectations. Earnings per share was $2.72 and adjusted earnings per share was $2.72. Now turning to the segments. In Global Ceramic, net sales were $1.1 billion, up 2% and up slightly, excluding favorable currency and an additional shipping day. Volumes were down 1% on a constant basis despite the soft market conditions impacting demand across geographies. Price/mix improved 2%, benefiting from our inflation-driven price increases as well as positive mix. Operating income was $66 million and adjusted operating income was $74 million or 6.5% of sales, a decrease of 160 basis points versus the prior year, driven by $53 million of underlying inflation, primarily from higher energy and fuel costs, partially offset by price/mix of $19 million and productivity of $22 million. Year-to-date, the combination of price, mix and productivity of $108 million has offset the majority of the $117 million of underlying inflation impacting Global Ceramic. In Flooring North America, net sales were $950 million, up 1%. Excluding the 2% benefit from an additional shipping day versus the prior year, adjusted net sales were down less than 1%. And Volumes declined approximately 3% on a constant basis and price/mix improved by approximately 3%, benefiting from our inflation-driven price actions and positive mix. Operating income was $72 million and adjusted operating income was $77 million or 8.1% of net sales, up 80 basis points year-over-year. Productivity gains of $24 million, price and mix of $15 million and tariff refunds of $10 million were partially offset by underlying inflation of $25 million. The combination of lower constant volumes and an extra shipping day was a $3 million net headwind. During both the third quarter and year-to-date, price, mix and productivity collectively have been sufficient to fully offset total underlying inflation, and we expect that to continue through the fourth quarter. In Flooring Rest of World, net sales were $707 million, down approximately 1%. Excluding unfavorable currency of less than 1% and an additional shipping day, adjusted net sales declined approximately 2%. Volumes were down approximately 10% on a constant basis, primarily due to soft market demand. Strong gains in price and mix continued from the second quarter into the third, contributing approximately 7% of sales growth, the result of price increases implemented earlier this year. Operating income was $66 million and adjusted operating income was $66 million or 9.3% of sales, up 100 basis points as positive price and mix of approximately $51 million were partially offset by inflation of approximately $35 million and a combined $14 million net headwind from lower constant volumes and an extra shipping day. Year-to-date, the combination of price, mix and productivity has more than offset total inflation, though in the fourth quarter, we expect these to be more in line as higher costs work through inventory. Now turning to cash flow and capital deployment. In the quarter, cash from operations was $471 million, and capital expenditures were $81 million, resulting in third quarter free cash flow generation of $390 million, up 26% versus the prior year. That brings our year-to-date free cash flow to $626 million, up 78% versus the prior year. We now anticipate the full year 2026 capital expenditures of approximately $445 million versus our prior expectation of $460 million. We returned $261 million to shareholders in the quarter through repurchases, reducing our outstanding shares by more than 3%, while our net debt leverage improved sequentially to 0.7x at the end of the quarter. Thus far in the fourth quarter, we have already returned an additional $34 million to shareholders, completing the previous share repurchase authorization. Now turning to our outlook. On the second quarter call, we shared the following assumptions with you. We had assumed soft market conditions. Demand remained challenging and weakened further as we exited the quarter. We had indicated that sales could decline sequentially by more than typical seasonality, which played out as anticipated as volumes normalized following the initial placement benefit in the second quarter. We'd also expect that our pricing actions, along with productivity would be sufficient to offset inflation for the year, and our year-to-date execution has positioned us well to deliver that. And finally, we allow for the possibility that inflation could rise further. And as it has, we have responded appropriately. So looking ahead to the fourth quarter, which has 4 fewer shipping days versus the prior year and 3 fewer days versus the third quarter of the current year, we assume flowing market conditions will remain challenging, and our outlook reflects recent trends that suggest demand will be softer in the fourth quarter relative to the third. We anticipate single-digit adjusted net sales growth versus the prior year. Our total underlying inflation on a year-over-year basis is expected to be similar to the third quarter, and we are committed to fully offsetting inflation through the combination of price, mix and productivity actions. Together, we expect the fourth quarter -- altogether, we expect fourth quarter adjusted earnings per share to be between $1.35 and $1.45. Further assumptions embedded in this guidance can be found in our earnings release. Now turning to some thoughts going into next year. We'll provide a more formal outlook in our February call, but we feel it is important to provide some planning assumptions. On demand, we are planning for market volumes to decline next year. Assuming that backdrop, we believe we can continue to outperform. Setting aside tariff refunds that we received during 2026, our underlying cost of sales inflation accelerated from low single digits in the first half of 2026 to mid-single digits in the third quarter and is expected to remain up mid-single digits in the fourth quarter. We will carry the same rate of underlying cost of sales inflation into early 2027, and we have taken actions across the business that we believe position us to keep up with inflation and continue offsetting it on a dollar-for-dollar basis. Three things support that belief. First, carryover benefits realized from realized pricing we announced earlier this year as well as new pricing actions we are taking now. Second, mix improvement across many products and geographies. And finally, productivity initiatives that we expect will improve our cost structure. Next year, we expect to continue generating strong free cash flow as we have in recent years, benefiting from solid operational performance, focused working capital management and lower capital expenditures. As we move forward, we are committed to a disciplined and consistent deployment of this capital in support of our strategic framework. Now let me outline our capital deployment priorities. First, we will invest in the highest returning organic opportunities to sustain our core strengths and enable our strategy. This includes maintenance, productivity initiatives and innovation projects. With limited need for any added capacity, we estimate the baseline capital expenditure needs of the business to be approximately $375 million annually. Second, we will be disciplined in evaluating bolt-on inorganic investments that align with our growth strategy. And third, capital that is not deployed in support of the above will be returned consistently through share repurchases. The Board of Directors has approved a new $500 million share repurchase authorization, enabling us to continue executing on this priority. In addition, we will maintain a strong and efficient balance sheet with a long-term net debt to adjusted EBITDA target of up to 2x, subject to a continuous assessment of cyclical risk and a commitment to our investment-grade ratings. Taken together, this framework is designed to give us the flexibility to invest through the cycle while ensuring that the stable and durable cash flow generated by our business is allocated purposefully towards creating the greatest long-term value for shareholders. And with that, I'll turn it back to Paul.

Thank you, Nick. Let me close with the thesis because it is simple. Our markets will recover, but we are not waiting for that recovery to act. Our focus is on outperforming in any market, leading with our innovation and brands, driving operational excellence and converting profit into cash and turning cash into value per share. The strength that built this company remain firmly in place. The discipline around them gets sharper. Our framework for investing and deploying our capital is clear. We will return cash to shareholders where it does not earn a high incremental return. And with that, we are happy to answer your questions.

[Operator Instructions] The first question today comes from Phil Ng with Jefferies.

Paul, Nick, congrats on your new roles and a lot of exciting news today. I guess, Paul, to kind of kick things off, when allocating capital to different business units going forward, how is that process perhaps different now from a guardrail standpoint, the decision-making process? And then when you've laid out the CapEx framework for the next few years, it's about 80% of what you guided earlier in the year. Is that enough to kind of drive growth as the market recovers? Is there a big R&D piece that we need to appreciate as you kind of get back on that growth not going forward?

Phil, I'll take the first part, and then Nick can follow up on the second part. So we have provided our capital allocation framework and it's really built around disciplined investment and high return on capital. I think our job as capital allocators is as important as our operating responsibilities at Mohawk, and the value creation that we will generate is directly tied to the incremental returns we generate on the capital we deploy. And so we are hyper-focused on cash returns around the globe in all our businesses, and we'll be very disciplined and consistent in how we allocate our cash. And the whole leadership team has bought into this cash-based mindset.

Yes. Thanks, Phil. And regarding your your comment around CapEx, we've provided in the past that roughly about 80% of our spend this year is focused on maintenance, productivity and innovation. So that all stays fully funded. Maintenance and safety are obviously mission-critical and innovation and productivity are persistent enablers of our business. And so all of these are important, and that's why we've grouped them. Our current footprint position us well to support volumes in a multiyear demand recovery scenario. So I think we feel comfortable with that.

Helpful. And then honestly, the concern here is obviously energy price is great that's really dialed up. Remind us, just given the lag, when does that flow through? Is it going to kick in largely in 1Q? And it's pretty impressive that you're expecting price plus productivity to offset that. So any color you're comfortable sharing guidance in terms of early feedback in terms of pricing and support from competitors, certainly, it's still a pretty challenging demand environment right now?

Yes. On the first part, given our inventory turns, the input prices flow through our P&L on an average of 4 to 5 months later, and that will vary by -- a little bit by business and product. For context, input prices stepped up in the first half of the year. And so when you look at our underlying cost of sales inflation, it went from low single digits in the first half of the year to mid-single digits in the third quarter, and it's expected to remain there both in the fourth quarter and entering next year. So the key point there is we've taken actions in the business to offset inflation, and that's a combination of the pricing actions some mix improvements in productivity, and that's both in the third quarter and year-to-date, and we intend to continue that.

The next question comes from Michael Reha with Melius Research.

Wanted to zero in first on the 4Q outlook and just confirm the on a smaller detail side that the 4 less shipping days that represents about a 6% year-over-year headwind. But secondly, more bigger picture, against the soft market backdrop, you're expecting core sales to grow low single digits. I just want to understand where that strength is coming from? If you could give a little more color if it's across all 3 segments? Or are there particular end markets that you feel like that you're executing some share gains or relative strength?

Yes. Thanks, Mike. I'll take the first part of that and Paul add some color. Just in terms of the shipping days versus prior year, that's really the largest single factor in EPS versus prior year. We have 4 fewer days. So we have 61 versus 65 to be precise, and that represents about a 6% headwind. And so you're correct that we expect adjusted net sales to be up low single digits in the fourth quarter, and that is days and FX adjusted consistent with how we define that in our release.

Yes. And then from the demand in some of our end markets, we really see new construction to be the most impacted here in the short term by the higher interest rates, and we even see greater impact in multifamily with lower starts and permits. Our retail business grew, and we gained share. And so that's really a bright spot. The teams are executing well in our retail business. And I would say the same on the commercial side. Our commercial business has outperformed residential for years in current market circumstances. And when you look at commercial, it's really driven by renovation projects rather than new construction activity, and we have performed well in that segment.

Great. Secondly, just on the capital allocation framework that you laid out, going from 0.7 leverage net debt to EBITDA to 2x implies a pretty big potential for incremental share repurchase. Just wanted to get your sense of the timing, let's say, of getting to that 2x leverage? Is that something that you would anticipate could happen relatively quickly, like over the next 12 months or maybe a longer time frame?

Thanks, Mike. So we aren't going to guide to specific timing, and we're not committing to a specific pace. But I'd point you to a couple of things. We repurchased $261 million in the third quarter. And so that's a demonstration of our commitment to deploy capital through share repurchases. We also said that we'd be consistent in our repurchase. And so given, as you mentioned, our leverage ratio and the free cash flow generation of the business, we have capital to deploy above that over time.

The next question comes from Stephen Kim with Evercore.

I'm going to follow up on that leverage question that Mike was just asking about. I'm curious about the 2x. Is that a firm ceiling or not? How long would you be willing to stay above that level in the event of a M&A transaction that took you above that? Or is your intention to even with any opportunistic M&A to still stay below that? And relatedly, I assume you have some sort of level of leverage that you regard as appropriate given the current environment. I know you've indicated you'd be dynamically evaluating and then so forth. But at this state, if we were to see a situation like today at some point in the future, what would you regard as appropriate generally leverage target at that time?

Yes. So thanks, Steve. Our balance sheet is in a strong place. Maybe to answer the second part of your question, we'll be sensible about how much leverage we carry from a risk management perspective. That said, we believe it could be more efficient and we'd be comfortable operating up to 2x net debt to adjusted EBITDA over time. So think of it as more of a ceiling. Even in down markets, we've generated very strong and durable free cash flow and we'll continue to do that. And so as I mentioned earlier, we're not going to commit to a specific pace, only that it will move higher over time as we deploy cash flow.

Okay. I guess, let me ask another question about your leverage. You got a couple of debt maturities, I think, coming up in the next couple of years. Are you planning to refinance those? Or would you be willing to take on additional debt in order to bring leverage into whatever targeted range you have at the time?

Aside from free cash flow, we have a range of options to manage liquidity as we execute on our capital deployment priorities. So we have flexibility in the near term, and we'll work through the right capital structure over the long term.

But specifically, with respect to those maturities, would your expectation be to refinance those?

Yes, I think we'll manage as we go through. We obviously are doing planning. And so we will work through the right capital structure, and we believe we have the right level of flexibility. I'd just reinforce the net leverage target is up to 2.0.

The next question comes from Adam Baumgarten with Vertical Research Partners.

Just on sort of the current portfolio of businesses you guys have, do you expect to take a hard look at that and maybe divest some potentially underperforming assets over time?

Yes, we are beginning a comprehensive portfolio analysis of our businesses. And so every business will go through the same screen. We'll look at market attractiveness, we'll look at the competitive advantages we have in each of those businesses, we'll look at cash profitability and also return on invested capital, and then we'll reposition some of the businesses. We might have to fix some of the businesses. We might have to rethink some of the businesses that fall short of our expectations. And we will share our conclusions if we have decisions to communicate on the future calls.

Okay. Great. And then just on the days impact in 4Q, you're pretty straightforward on the 6% top line hit. But can you remind us how we should think about the EBIT impact there? Should we use sort of where margins are in terms of the flow-through? Or should it be more of a sort of incremental or decremental margin, I guess, in this case?

I think it's similar incremental decremental to what we provided in the past in the past in that 20% to 30% range, given Q4 is a seasonally slower quarter and a smaller quarter, it might be slightly worse. But I'd say, think about it in terms of the decremental margins.

Next question comes from Trevor Allinson with Wolfe Research.

Question on your expectations for price, mix and productivity to again offset inflation headwinds as we get into 1Q '27. You've got January price increase out there across categories in the U.S. You talked about some pricing internationally. How should we think about the realization necessary on those increases to offset inflation? Are you expecting to be similar to what you saw over the summer for those increases? Or just how should we think about what you need to get in order to offset those inflation headwinds as we step into early next year?

Yes, you're correct that we had to announce further increases given the inflationary environment. And our expectation is that the realization on these future increases will be in line with our expectations on the past increases. We believe the whole industry needs to absorb the same inflation, and we need pricing to recover it. And so if inflation keeps rising, we will have to take further actions as we have throughout the year, and our teams have really been doing a fantastic job implementing those increases and supporting our efforts to keep up with inflation .

And, Trevor, just to reinforce the point you made earlier of the offset to inflation is really a combination of price, mix and productivity. And so we're -- our intent is to offset that on a dollar-for-dollar basis.

Okay. And then second question is related to what you just mentioned, Nick, on the mix side. You've had a number of price increase announcements. Can you talk about how elasticity or any trade down has played out versus what you would expect? I think you called out mix as being a positive tailwind. So just any color there? And are there any elasticity or trade down headwinds expected as you push more pricing over the next year?

Trevor, thank you for the question. I will take that one. So broadly speaking, we don't expect our increases to meaningfully impact the consumer demand. I think the market right now has an overhang on housing affordability and consumer confidence. And so I think these trends are more influential on the short-term intent to purchase floors than really the list plies of flooring on the shelf. And specifically to mix, what you normally see in highly inflationary environments is that you see slight demixing in the different categories, but we've been able to outperform that through our innovations and new placements and new product strategies that we put out in the market. And so we've been able to offset that market mix, I would say, with strong delivery of innovation in our markets.

The next question comes from John Lovallo with UBS.

Maybe starting off just on the 4-point plan, Curious with each of the different facets, some seem a little bit more short-dated than perhaps some of the others. Curious if you have kind of a basic time line of how you're thinking about achieving kind of the full run rate or full -- hitting full stride for each of these components?