Mohawk Industries, Inc.

Good morning. My name is Lisa, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Mohawk Industries fourth quarter 2019 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. To withdraw your question, please press the pound key. Should anyone need assistance during the conference, please press star zero and an operator will assist you. As a reminder, ladies and gentlemen, this conference is being recorded today, February 14, 2020. Thank you. I would now like to introduce Mr. Ken Hielskamp. You may begin your conference.

Thank you. Good morning, everyone, and welcome to the Mohawk Industries Quarterly Investor Conference Call. Today we'll update you on the company's results for the fourth quarter of 2019 and the full year, as well as provide guidance for the first quarter of this year. 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 by the Private Securities Litigation Reform Act of 1995, which are subject to various risks and uncertainties, including but not limited to those set forth in our press release and the periodic filings with the Securities and Exchange Commission. This call may include a discussion of non-GAAP numbers. For a reconciliation of any non-GAAP to GAAP amounts, please refer to our Form 8K and the press release in the investor section of our website. The key speakers today are Jeff Loeberbaum, Chairman and Chief Executive Officer, Chris Wellborn, Chief Operating Officer, and Glenn Landau, Chief Financial Officer. I will now turn the call over to Jeff for his opening remarks. Jeff?

Thank you, Ken. Our fourth quarter adjusted results were as we expected. with sales flat to last year, operating income of $205 million, or 8.4% of sales, and EPS of $2.25. For the year, our sales were $10 billion, adjusted operating income was $938 million, or 9.4% of sales, and EPS was $10.04. Our cash generation remains strong, with operating and free cash flow for the quarter of about $440 million and $300 million. For the year operating in free cash flow, we're about $1.4 billion and $870 million. Our leverage is approaching historical lows, which provides us the flexibility to pursue additional opportunities. In the period, we bought back approximately $23 million of stock for a total of $375 million since authorized. As we anticipated, our business remained challenged by soft demand greater competition, and reduced production volume. In the U.S., markets continue to be influenced by the strong dollar and the impact of LVT on other product categories. Consumer confidence remains high, and lower U.S. interest rates are positively influencing new and existing home sales. U.S. tariffs on clickable LVT from China were ascended in the fourth quarter, and market pricing has declined for these products. Imports of ceramic tile from China dropped off substantially in the fourth quarter, and shipments from other countries have not offset, which we believe is due to soft demand and a reduction in US ceramic inventories. Competition has increased in our global markets, impacting our pricing and mix as we leverage higher investments in sales and marketing to drive growth. Many countries where we operate are stimulating their economies with lower interest rates to encourage greater consumer spending and economic growth this year. In the near term, we still anticipate continued pressure in our markets and product categories. Throughout the period, we implemented changes to increase sales and reduce costs. We've enhanced our LVT manufacturing in the US and Europe and realigned our US carpet operations. We have decreased our ceramic production and inventories that are taking out a wood flooring plant in the United States and in Europe. We are reducing the complexity of our operations, improving processes to reduce costs, and increasing automation to improve efficiencies. We continue to improve the productivity and volume of our new LVT, US countertop, Russian sheet vinyl, and European carpet tile investments. Our acquisitions in Australia and Brazil are installing state-of-the-art equipment that will expand their product portfolios. We're introducing new design and performance innovations to enhance our market position and broaden our customer base. To promote both new and existing products, we're making higher levels of sales and marketing investments. For a view of our financial performance during the period, I'll turn the call over to Glenn.

Thank you, Jeff, and good morning, everyone. Moving right into our financial performance and year-over-year bridges, as Jeff shared, in the fourth quarter, total company net sales were $2.4 billion, down 1% compared to prior year as reported, and off approximately 2% on a constant basis, which we define as adjusted for FX and days. For the full year 2019, total company net sales were flat compared to 2018 as reported, and up 2% on a constant basis. Organic growth in the legacy businesses was down 3% in the fourth quarter versus prior year on a constant basis, and down 2% for the full year compared to 2018, also on a constant basis. In terms of earnings, the company's adjusted operating income was $205 million in the fourth quarter, or 8.4%, off 140 basis points from the fourth quarter of last year, largely due to weaker volume and price mix, only partially offset by improved productivity, including lower startup costs. With that said, the company's year-over-year decline in margins improved on a sequential basis by 100 basis points, which now represents four consecutive quarters of improvement. Bridging from the prior year fourth quarter, adjusted operating earnings were impacted by, number one, lower overall volume of $10 million, largely in our global ceramic and flooring North America segments, and associated market-related downtime costs of $4 million, all taken in global ceramics to match our supply with our demand. Number two, a modest increase in inflation of $3 million due to higher wages and benefits partially offset by lower raw materials. Number three, an erosion of price mix of $24 million, largely in our Flooring the Rest of the World segment, following easing input costs, and $11 million higher spending in SG&A and other due to investments in sales talent and marketing to drive sales. Moving to the positive offset, productivity, including lower startup costs, swung positive by $16 million versus last year due to better utilization and non-repeating one-time items. For the full year, adjusted operating income was $938 million, or 9.4% of sales, off 250 basis points from prior year. Staying at the enterprise level, adjusted SG&A per net sales was 19.1% in the quarter, excluding unusual items, up 180 basis points year over year, due to higher sales, marketing, and merchandising expenses to roll out new products and to grow in new markets. Inflation, acquisition, lower volume, and one-time charges also impacted the quarter. For the full year, adjusted SG&A was 18.4% of sales, up 100 basis points year over year. And just to be clear, relative to the rollback of tariffs on clickable LVT product from China, prior to tariffs, we had already raised inventory significantly and have since reduced purchases in 2019 as we reduced inventory and ramped up our U.S. production. We also have purchased from other countries in this period, so the total gross rebate amounted to $13.5 million, which is in our guidance, spread over three quarters, and largely offset by inventory value on hand. Special and unusual items in the fourth quarter consisted of a $50 million charge for restructuring and integration costs, of which most was non-cash. and divided relatively evenly among completing U.S. carpet realignment and right-sizing the company's wood manufacturing footprint in flooring North America and flooring the rest of the world, as well as a $136 million one-time tax benefit associated with the consolidation of business activities in Europe within a single operating entity to improve management and increase efficiencies, also reducing the company's tax rate somewhat in 2019. For the full year, total restructuring and integration charges taken for actions in Flooring North America and Flooring the rest of the world were $111 million, of which approximately $41 million was cash. And as we have said, the cash cost associated with carpet restructuring of approximately $30 million will be recovered as operational savings as lower costs pass through inventory in the first half of this year, reaching full run rate in the third quarter. Adjusted EBITDA was $363 million or 15% before interest expense of $11 million. For the full year, adjusted EBITDA was $1.5 billion or 15.3%. The effective tax rate on a non-GAAP basis was 18.9% in the fourth quarter and 20.6% for the full year of 2019. Finally, adjusted net earnings per share was $2.25 in the quarter and down from $2.53, or 11% versus last year. And for the full year, adjusted net earnings per share was $10.04, down from $12.33 versus 2018. Now let me turn to the segments, and I'm only going to speak to the fourth quarter here. The global ceramics segment delivered net sales of $858 million, flat versus prior year as reported, or a decrease of 1.5% on a constant basis. Looking only at our legacy businesses, sales decreased approximately 4% on a constant basis. Operating income on an adjusted basis was $54 million, or 6.3% of net sales, down from a 10.1 margin last year, primarily due to increased competition and weaker demand in the U.S., coupled with higher inflation. So compared to last year at the segment level, inflation was $16 million higher, driven by higher wages and materials and benefits. Volume was off $14 million, inclusive of $4 million of downtime. Sales, marketing, and other costs were up $5 million. Price mix slipped $4 million, and this was all partially offset by improved productivity and lower startup costs of $6 million. FX in the quarter was neutral. Let's move to Florida and North America. The business showed better overall performance with sales of $936 million, down 4% versus last year as reported, and down 5% on a constant basis. as continued weakness in soft surfaces were partially offset by continued growth in LBT. Operating income on an adjusted basis was $69 million or 7.4% of net sales in the fourth quarter. Bridging from last year, volume was down $17 million versus last year and accounted for the majority of the deficit. Price mix lagged prior year by approximately $6 million. Rural material cost decreases offset increases in wages and benefits keeping inflation flat and productivity less reduced startup costs was better by 6 million. Moving to flooring the rest of the world, the segment had a solid quarter with sales of $630 million up 2.6% versus last year as reported and 3.7% on a constant basis. Looking just at the legacy business, sales were up 1.5% on a constant basis. Adjusted operating income came in at 89 million or 14.2% of sales in the quarter. an increase of 140 basis points versus last year in a very competitive environment, mainly as a result of increased volume. Going to the bridge, volume was better by 18 million. Price mix slipped by 15 million, but was largely offset by relief in overall inflation of 11 million, driven by lower input costs. Productivity, including lower startup costs, was 3 million. and investments in sales, product marketing, and other were $6 million higher in the quarter. FX was again neutral for the quarter. Finally, at the corporate level, expenses and eliminations drove an operating loss of $8 million with a full year cost of $40 million. Speaking now to the balance sheet, receivables ended the quarter at $1.5 billion with day sales outstanding up due to changes in geographic and channel mix. Inventories ended the quarter at approximately $2.3 billion or 134 days, higher in days versus prior year, by approximately six days, but relatively flattened dollars as we continue to adjust our production to match our sales. Fixed assets for the quarter ended at $4.7 billion on capital expenditures of $140 million in the period, lower than depreciation and amortization, which was $154 million. So for the full year, CapEx was at $545 million, lower than our DNA of $576 million as we efficiently managed our Q4 project spend in each of our segments. Total debt was $2.6 billion at the end of the quarter, down approximately $200 million versus the third quarter, with leverage declining 1.6 to 1.6 times debt to adjusted EBITDA. Wrapping up, the balance sheet is strong and getting stronger, with free cash flow of $300 million in the quarter, totaling $873 million in 2019, capping off a very solid year in overall cash generation. So with that, Chris, I'll turn it over to you.

Thanks, Glenn. In our global ceramic segment, most of our markets faced a combination of soft demand and excess industry capacity that is compressing market prices and margins. During the quarter, our U.S. ceramic business remained under pressure from LVT taking share in high industry inventories from ceramic purchases ahead of tariffs. Additionally, to line our own inventory levels, we meaningfully reduced production in our North American ceramic plants, which increased our costs. We have started to see some trends that should benefit our business in 2020. Compared to the prior year, fourth quarter, total U.S. ceramic imports declined 17%, with Chinese ceramic imports falling 90%. Lower interest rates and improving new and existing home sales should also benefit the market this year. To improve our sales, we are rolling out multiple new products and adding sales representatives and design consultants in major markets. Our new collections aimed at replacing imports are gaining momentum. To increase productivity and reduce costs for our customers, we have streamlined ordering processes and made picking up orders at our service centers faster and easier. We continue to enhance our showrooms and galleries to better communicate the beauty and performance of our ceramic products. During the fourth quarter, we initiated manufacturing of our new click tile in multiple sizes and designs. Our proprietary product has been tested in both residential and commercial applications, and has received positive reviews for faster and less expensive installation that is able to be walked on the same day. We are launching click tile at our trade show this quarter and have already received commitments from major customers. We are expanding our mosaic and wall tile offerings to meet growing demand for these categories. Our quartz countertop sales continue to increase as we ramp up the productivity and throughput at our new Tennessee plant. We're developing more sophisticated visuals to enhance our manufactured quartz collections and improve our margins. Sales of our large porcelain slabs from Europe are growing, and we are increasing the sales of Daltal-branded LVT products. In Mexico, the economy continued to face headwinds due to uncertainty around U.S. trade, with the overall construction activity declining in the fourth quarter. We are gaining share by expanding our brands, distribution, and product offerings with larger sizes, porcelain products, and more comprehensive wall tile collection. We are increasing our participation in the commercial market and enlarging our base of stores that exclusively sell our products. Despite a soft economy in Brazil, we had good sales growth during the period due to our strong brand and product offering. In December, we initiated production on a new porcelain tile line that produces larger sizes to expand our premium offerings. To increase our sales in other South American countries, we are updating our showrooms and expanding distribution. The southern European economies remain slow, impacting our primary ceramic markets and industry pricing. In this environment, we increased our volume, even as lagging consumer confidence reduced demand in the larger retail remodeling channel. We are expanding our activities in the commercial channels as well as outdoor products. To extend our style leadership, we are introducing new premium products with the surface structures aligned with the printed design to create more realistic visuals. Our medium price products have enhanced our results with new sizes and visuals. Sales of our porcelain slabs grew dramatically from a small base during 2019, with the products gaining greater utilization in traditional areas as well as for countertops. We are increasing our inventories at our regional warehouses in Poland, Greece, and Romania to expand our customer base with faster local service. We continue to specialize our plants by product type to optimize our cost and improve our competitive position. In Russia, we grow our ceramic sales in a soft market. Our growth was driven by our unique business model that includes the industry's most comprehensive premium offering, a national distribution network, owned and franchised retail stores, and the strongest project specification organization in the industry. To further strengthen our position in 2020, we expect to expand the stores that exclusively sell our products to more than 400 locations across the country. To support our growth, we are starting up additional porcelain production to make super large sizes and a new plant to produce coordinated premium sanitary ware. In our Flory North America segment, we have executed many initiatives to align the business with the present market conditions. We faced a challenging market with LVT growth continuing to impact sales of other product categories. As expected, our pricing and mix remained under pressure as customers traded down and lower production levels raised the cost. Lower raw material costs during the period were offset by a more competitive environment. We streamlined our infrastructure by closing three plants consolidating high-cost operations, and reducing wood manufacturing. The effects of these actions will increase and flow through the inventory with full cost benefit in the third period. To reduce costs, we have implemented numerous process improvements, executed machine modifications, and increased our recycled polyester production. We are leveraging automation and equipment advances to produce comparable volumes with a smaller manufacturing footprint. In the period, our residential carpet sales performed best in the new home construction and multifamily channels. Our new carpet introductions were well received at the National Flooring Trade Show, and they will be in the marketplace early 2020. We are leveraging our strengths in design and fiber technology to deliver differentiated new collections in both premium and value categories. In the luxury and super soft categories, we have extended our multicolor and pattern capabilities in our proprietary SmartStrand silk collections. ColorMax Mohawk's exclusive color blending technology is rapidly growing in the marketplace with its natural palette that coordinates with wood and stone looks. We've increased our recycled polyester fiber capacity to expand our participation in the fastest growing carpet category. In commercial, we are coordinating the colors and stylings of our carpet and LVT collections to enhance the design options. We have introduced award-winning collections for schools and workplaces with nature-based designs. To increase our focus by channel, we are expanding our commercial sales organization and enhancing their skills. We continue to invest in new design capabilities, proprietary carpet tile backings, and a material manufacturing to create greater value for customers and improve our costs. We have increased the production and speeds of our LVT operations, and ongoing initiatives will further improve formulations and throughput. We are now operating at similar speeds to our European LVT operations. During the period, U.S. tariffs on click LVT were removed, and the market has adjusted pricing to reflect this change. To expand our price points and highlight our unique visuals and features, we are introducing new collections for both the residential and commercial markets. Our expanded premium, pergo, and kerosene collections have been well-received at trade shows due to their leading visuals and styling. The virus in China is postponing some production startups, and it could potentially disrupt some LVT service depending on when shipments resume. Sales of our waterproof laminate products are expanding across most channels, and we anticipate continued market growth due to their realistic appearance, durability, and ease of installation. The detailed visuals and performance features of our premium laminate collections are increasingly being used as alternatives for both wood and LVT. To support higher laminate sales, we are upgrading our HDF board production to increase capacity and reduce cost. Our flooring rest of world segment continued to deliver strong results in the period. The segment's business is less exposed to those European countries which are having more economic difficulties. Across the segment, our investments in product innovation, cost improvements, acquisitions, and new businesses strengthen our results. We're outperforming the European laminate market with our focus on premium products that are more realistic with unique features. Sales of our new laminate collection are ramping up quickly due to an enhanced level of sophistication. In the period, we absorbed higher marketing costs to support this introduction. We announced the consolidation of our wood manufacturing to our facility in Malaysia, which will improve our cost and flexibility to better service our customers. Our LVT sales grew as our new manufacturing productivity significantly improved. To further enhance our plant performance, we are implementing specific initiatives to improve throughput, material cost, and waste. To utilize our growing capacity, we are introducing new rigid collections that are being well received in the retail, DIY, and commercial channels. We are expanding our LBT offering through our European distribution system to broaden our specialty store penetration. Our sheet vinyl sales increased primarily from strong growth in Russia. The Russian plant is operating well and positively contributing to our results. Our European carpet tile business is expanding from a small base by increasing our sales organization and introducing higher value products to the market. Our panels business continues to perform well as we introduce higher value products to improve our mix. We are increasing the use of recycled wood to benefit our cost and the environment. The expansion of our glue plant is operating well and is contributing positively to our results. We're also installing a second waste-to-energy plant to reduce our cost and increase recycling. This year, our insulation business had good results with higher sales volume, even as declining material costs considerably lowered market prices. In Australia and New Zealand, we had good performance. We are launching many new carpet collections and multiple fiber to enhance our residential offerings. Our herd surface products had strong growth with LVT outperforming. New carpet tile collections are being introduced to support our new commercial carpet tile line that is being constructed. With that, I'll return the call to you, Jeff.

Thank you, Chris. Market conditions remain challenging across most of our businesses and geographies. In response, we're adjusting our business strategies, enhancing our product offering, and restructuring operations. They're increasing our investments in sales and marketing, expanding our commercial participation, and enhancing both our premium and value collections. We are bringing new product innovations and categories to the market that will broaden our distribution into new channels and geographies. Our new LVT countertop sheet vinyl and carpet tile plants are improving their productivity as we invest to expand our customer base and sales volume. Our LVT manufacturing capacity grows with higher speeds and efficiencies. We are enhancing designs and features and increasing sales of our rigid and flexible offering. We are limiting the traditional inventory build that we typically do in the first quarter as we manage our production with market demand. Taking all this into account, our EPS guidance for the first quarter of 2020 is $1.90 to $2, excluding any one-time charges. LVT growth, exchange rates, and excess global capacity continue as headwinds for our business. We are executing specific initiatives to adapt to shifting consumer preferences, changing markets, and competitive pressure. For the full year of 2020, we expect that our actions to increase sales and distribution, reduce costs, and enhance utilization of our new plants will deliver improved results year over year, with performance accelerating during the second half of the year. Our balance sheet should continue to improve with ongoing cash generation, and we remain focused on delivering long-term value to our shareholders. We'll now be glad to take your questions.

Thank you, ladies and gentlemen. At this time, if you would like to ask a question, please press star, then the number one on your keypad. Management requests that you limit your questions to one primary and one follow-up. If you have additional questions, you may re-enter the queue again by pressing star 1 on your telephone keypad. And our first question today comes from the line of Philip Ng from Jefferies. Your line is open.

Good morning. Your comments on LVT in Europe sounded pretty promising on the manufacturing front, so I'm just curious, are you making money with that line yet? And with the success you're seeing on the manufacturing front out there, are you still on track to break even in North America early 2020?

In Europe, we have Three lines. The two old ones are operating as we expect and are doing well. The third one is not at the level we'd like it to, but it's improving, and we expect it to be profitable as we go through the year, as well as the U.S. line.

Okay. Any more color in terms of the timing on the U.S. line in terms of getting profitable?

It's going to happen during the year.

Okay. And then just one last one for me on the cash flow. Glenn, you were kind enough to give us free cash flow guidance last year. Any color on how we should think about 2020, some of the big moving pieces, whether it's working capital, CapEx, and then just giving your balance sheets in really good shape and cash flow still quite strong? Are you guys open to buying back more stock?

Well, let me speak to the first part of that, and I'll just say that we had a great cash flow year, and we expect cash flow to remain strong into next year, and the ability to improve our balance sheet is apparent.

What about on buybacks?

On buybacks, Jeff? The buybacks, we have $125 million left. We'll continue buying against it, and we'll evaluate it when we use it up.

Okay. All right. Thanks a lot.

And our next question comes from the line of Michael Rehout from J.P. Morgan. Your line is open. Good morning, Mike.

Thanks. Good morning, everyone. First question, you know, I appreciate the kind of directional guidance for the year in terms of your outlook for improved results with acceleration in the back half. I was curious as to, you know, what that assumes from a top-line perspective for you know, either by segment or on a consolidated basis, but just trying to get a sense of how you're thinking about sales growth for the year and, you know, if also there would be an acceleration in the back half there.

Listen, I appreciate you'd like more detailed information, but we give quarter guidance and we give you a direction, but we don't detail the rest of it, and we're not going to do it now.

All right. I had to try, I guess, but I appreciate that. I guess, secondly, you know, you've increased or you continue to, you know, take action around some of the restructuring. And, you know, this is kind of an ongoing story as you continue to adjust the conditions. You know, we've heard about the consolidation of the carpet operations going back to the, you know, the first half of 2019. You know, I think initially, you know, the expectations were around some of those benefits coming through in the back half of 19. And obviously, as you shut those plants down, you know, we would presume that there's some amount of cost benefit on the onset. So just trying to understand how those costs are flowing through or at least the cost savings are flowing through. You highlighted the fact that there's things that are in inventory that continue to need to be worked through. But at the same time, I would have thought that some of those cost benefits might have come even in the back half of 2019.

Well, like we said, Mike, really we finished the carpet restructuring largely in the back half of 2019. And due to the timing of implementation and the inventory flow through of the costs, we're talking about a full run rate impact in the third quarter. Yeah, there's a slow ramp up, but the full impact that's meaningful will be closer to the start of the third quarter.

Okay, great.

Thanks very much.

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

Hi, thanks for taking my questions and for all the details so far. First question, Glenn, thanks for outlining the LVT rebates. I guess just asking more specifically, so I guess it's 15 cents roughly in terms of benefits for the year. You said spread over three quarters. How much is included in the first quarter?

The first quarter is the lion's share, but it's over three quarters.

It's offsetting the inventories. We have high inventories that you have with long supply chains, and so the majority of it is going to offset the price decreases that we've already implemented, and as the inventory flows through, they match up.

It's in our guidance. It's spread over three quarters, and like Jeff's saying, it's largely offset by the inventory value on hand.

Okay, that's helpful. And just the second question following up on that would be just given the price declines following the exclusions, you're saying it's offsetting the rebates in the first few quarters. But on a go-forward basis, since the rebates kind of go away, the price declines, I guess – How should we think about the net effect beyond the initial quarter or two where you have the offset from the rebates?

I think the way we need to think about it is they're roughly offsetting.

Since we raised inventory prior to the tariffs, most of the inventory we sold in the year came from old pieces. And we still have large inventories of what we've been purchasing through the period. And so it's offsetting that.

Right. I guess, sorry, just where I was going with that. If market pricing has reset lower, are you saying that is only impacting the legacy inventory or is this a go forward impact from lower market pricing as well?

The market pricing has gone down on clickable LVP, and I don't see any reason it's going to change. And the price of the products we're buying have gone down, too. So the new prices are in line with the new selling prices and costs are aligned.

So to the extent we're buying it, it's pretty much offset.

Right, right. Got it. Okay. Thank you.

Our next question comes from the line of John Bao from Stiefel. Your line is open.

Hi, John. Thank you and good morning. Two quick questions. One, do you have a rough guess on a revenue or sales basis what your market share of the USLVT market is?

Yes, but we don't give out specific details on product categories.

Okay. Would you have a guess, Jeff, as to when you see out into the future? you know, reaching parity or any kind of, you know, rough idea, timeline?

I don't understand the question.

Well, I presume your share of U.S. LBT sales is lower than your share sort of of the flooring market in general. So my question is, when would you see Mohawk in LBT, whether it's imported or made in the U.S. sort of match up the shares of carpet, ceramic, laminate, all put together.

It's continuing to increase, but I don't have a date when the two will match up.

Okay. Secondly, really quickly, you mentioned imports of ceramic from around the world into the U.S. down 17% in Q4. Could you just remind us, sort of on a normal, typical year, how much imports account as a percentage of U.S. consumption?

Thank you. Imports are a huge part of the ceramic market, maybe 70%, 75%. It's a huge part.

Great. Thank you very much. Good luck. Thanks, John.

Our next question comes from the line of Justin Skier from Selman Associates. Your line is open.

I appreciate it. Just wanted to start, just get a sense from you, because the removal of the CLIC LVT tariff was fairly recent, but I think we understand the deflationary aspect of that in the near term, but how did that affect demand for LVT, and what's your view for price and demand for the non-LVT categories in the fourth quarter and what's expected in the first quarter at a high level?

Yeah. There are no details of that available today. Our guess is that LVT has approximately about a $3.5 billion part of the industry. It's growing. We think that the growth rate is slowing as the base gets bigger as we go through. It's impacting the growth rate of the other products within it as you go through. I'm not sure we have the details that you're looking for.

Okay. So I'll just keep our eye on that. But I guess within your guidance, as you unpack that, there's obviously some conservatism around maybe production rates slowing. And then the other element is the variable in SG&A investment. So SG&A was up about 9.5% in the fourth quarter, up 7% for the full year. I'm just trying to get a sense for what your SG&A investment will be in 2020, recognizing that you have some cost tailwinds from restructuring efforts, but you're also investing in the business. I'm just trying to get a sense for how much SG&A will be up or down next year.

Well, 2020 will be higher due to the full-year impact of our investments. We do expect higher sales in the second half. And that's the target of these investments. We'll evaluate as we go through the year, and we'll adjust as necessary depending on the sales.

Excellent. And the last question for me is just I didn't catch it, but on the ceramic tile bridge, what was the price mix and what was the productivity and startup cost elements of the bridge?

Yes. Repeat the question.

The bridge, the EBIT bridge that you gave, I didn't hear price mix or the productivity elements of the ceramic tile.

The ceramic tile. So on ceramic, the price mix was slipped by $4 million.

Down by $4 million?

Price mix slipped by $4 million, and overall productivity and lower startups costs offset that. That was $6 million. Perfect.

Just a little more comment on the SG&A in the U.S., We're expanding the commercial sales forces. We're building markets for quartz countertops, roofing, and LVT. In Europe, we're developing a new commercial sales organization to sell LVT vinyl and carpet tile. We've invested in regional distributors, which we purchased our distribution in different pieces, which all the costs go into SG&A, but it's offset by higher sales and margins. In Russia, we've talked about increasing stores, so there's a lot of activities of which those are only some of them.

So these are growth investments, and just ultimately, so you're not pulling in the reins. You're digging in to invest to grow, and ultimately, you think that'll really manifest itself in better growth in the second half. Above market growth, you think?

I mean, the markets, we're investing to expand the areas which we think we can expand, and We'll monitor as we go through the year, and we also have all the new product categories and the new businesses. You have to put the salespeople in before you get the sales for them and the marketing monies.

That makes sense. Thank you.

And due to time constraints and to allow everyone to ask a question, going further forward, please allow yourself one question. Our next question comes from the line of Matthew Boulay from Barclays. Your line is open. Hey, Matt.

Hey, thank you for taking my question. Can you just provide a little more color on the comment you made around how the virus in China is impacting the startup of LVT production and how that's flowing to you guys? Because obviously you're ramping your own capacity. I guess the question is how reliant is Mohawk on this startup capacity in China for your 2020 plans? Thank you.

The information is less than perfect at this point. They go on holiday for the new year, then the people come back. So the people are not coming back at the rate they would normally come back. There are some operations have started, some are in partial things, and some haven't started at all. And The question is, how is all that going to line up and when is it going to start? Nobody has a clear view of what it's going to be. Given we have inventories in line, we can last a while before it has any impact on the business and we're having to monitor it to see what's going to happen. In our business, we do buy product from other countries and we manufacture ourselves, so it has less impact on us than the rest of the industry, but the whole industry has the the potential of slower service, depending upon what happens.

Great. Thanks for the detail, Jeff.

And our next question comes from the line of Susan McCleary from Goldman Sachs. Your line is open.

Hi, Susan.

Good morning. I wondered if you could talk a little bit about how you're thinking about of inflation and raw materials as we go through the year. I know that you said it was a $3 million benefit as it related to the consolidated business in the fourth quarter, but how are you thinking about that as we look to 2020?

The raw material prices in general, mostly the oil-related products, have come down. At the same time, there's more aggressive pricing in the marketplace, and we're assuming that the market prices are going to continue to reflect the decreases, mostly in the commodity categories, and we're going to continue to participate in an aggressive manner. We'll have to see how competition reacts. In some of the other places we've had, in Europe, for instance, we had prices on our insulation boards come down dramatically, but so have the prices of the products. So we're assuming, given the excess capacities in the world today, that the changes will be reflected in market prices.

Okay, thank you. And our next question comes from the line of Selden Clark from Deutsche Bank. Your line is open.

Good morning.

Hey, thanks for the question. Just given all the moving parts with your various product rollouts and investments in SG&A and just how the timing of these investments relate to your production ramp. When should we expect to see some operating leverage show up on the SG&A side?

In the second half, we're expecting to see some benefits from the actions we're taking, and we'll keep reevaluating them, and depending upon how the markets change, we'll continue to adjust.

And are those operating leverage, are those savings tied to operating leverage or purely cost, that kind of $30 million you're targeting?

The $30 million of restructuring is more about cost.

You're tying the restructuring piece with the marketing investments. They're separate.

Right. So I'm just trying to ask, like, when you should start to see some operating leverage on the SG&A side.

We're expecting to see more of the benefits about in the third quarter and the second half, we keep saying. Got it. Okay. Appreciate the question. Thanks.

Our next question comes from the line of Tim Woosh from Baird. Your line is open.

Hey, guys. Good morning. Just a clarification. So SG&A is up and is expected to be up over the next few quarters as you're investing to grow sales, but But gross profit was actually up in Q4 for the first time in, I think, six or seven quarters. So should we expect that gross profit can actually grow a little bit, and you're reinvesting that in SG&A now, and that's really what's driving some of the year-over-year EBIT margin compression? Is that the right way to look at it?

You can answer what he wants.

Well, I think we stated it broadly. We expect 2020 to improve over this year. Our overall results back-end weighted to the second half, and that's broad-based. It's based on our initiatives and the pass-through of the costs. So SG&A, you know, is a function of that, and ultimately the trend should continue.

On the cost side, we're expecting the restructuring pieces we've done to benefit At the same time, the increased volume through the new plants should reduce the cost and help the margins in those also.

Okay. Okay. That sounds good. And then just to sneak another one in, what's the cost inflation outlook in ceramic?

Again, we've talked about that several times in ceramic, and that's really overseas inflation. That is largely some raw material but energy costs that are driven by, you know, the Eastern European facilities and fixed government pricing.

Yeah, I think in Europe we expect maybe a little relief on some of the energy increases this year.

Okay. Okay, thanks.

Our next question comes from the line of Keith Hughes from SunTrust. Your line is open.

Thanks. Questions on North America Ceramic. In light of the fall in imports, as you had identified, is that, I guess my question is, where does the channel inventory stand now? When do you think that will be more balanced? I know it's been out of, it's been over inventory for some time.

Keith, we don't know, we don't have the data to see the inventory exactly. What we know is that the imports, which is a huge piece of the market, came down 17%. in the quarter and the imports from China dropped off altogether. So we expect that it's a combination of inventories in the channel coming down and softness in the market.

Is this still something that's going to affect the first half, I would assume, Chris?

It's just hard to tell because all we can really see is the amount of inventory coming in to the country. but we don't have a sense yet exactly the size of the inventory in the channel. I understand.

Thank you.

Thank you.

Our next question comes from the line of Michael Wood from Nomura Instanet. Your line is open.

Good morning. Hi, good morning. I just wanted to talk about that ceramics import data. You know, if I look at it historically, it is down considerably fourth quarter year over year, although it's still higher than the fourth quarter in 17 and 16. So I'm just curious how you're looking at the level of imports and how you're thinking where it should be. I mean, is this a level, a healthy amount of import activity currently that we can sustain?

Well, what we believe is that as you got into 2019 and when the tariffs were announced on the Chinese product, prior to those going to effect, there was, we believe, a significant increase in pre-buys related to that. In addition, as they replaced the Chinese inventory with other countries, you had a combination of Chinese inventories in the system plus new product that they were purchasing to replace it, which elevated those inventories and sort of we believe gave a sort of a false view of how much the industry was growing. We don't know exactly last year, but we think it probably declined Three to five percent, but it's just a guess.

Okay, thank you.

Our next question comes from the line of Truman Patterson from Wells Fargo. Your line is open.

Hi, Truman. Hi, good morning, guys, and thanks for taking my question. I appreciate it. The question for me, the capacity that you all have coming online, previously earlier last year, you said you had about 1.2 billion coming online in 2019 and 2020. Could you just give us an update of how much is coming online in 2020 and possibly 2021? Remind us which products and categories. And then just one item for clarification. The LVT rebate, if I'm hearing you correctly, in the first quarter, it'll probably be, you know, somewhere around maybe a 10-cent benefit to EPS.

Well, again, what we said is that's the total rebate, which will be largely offset by inventory and lower pricing. So, again, it's immaterial, but it's in the guidance.

Okay. And then the capacity.

The new plants, are they – are the different pieces. We have LVT, which is still ramping up. It'll ramp up all through this year. We have the Russian sheet vinyl plant, which is running. It's positively helping the business now, but it still has, it's only used about 30% of the capacity as we push it into the marketplace. We have the carpet towel business, which we're developing a an entire commercial sales organization, which is also going to sell vinyl and LBT in Europe. So it's ramping up. It takes a while to develop the customers and pieces. We've put in new capacity in Brazil to put in higher-end products, and yet we have capacity in Eastern Europe to make low-end ceramic, which expands our market there, is ramping up. We have the quartz plant in the United States that's running about three shifts today, but it's building inventory and also pushing it in. Over time, it will go to four shifts in the productivity and inventories. The productivity and throughput will go up. In all of them, we have to get the mix aligned because you start out selling more lower quality products to get more volume through the plants, and it's going to take time to develop those as we go through. So they're all working through the system at different rates.

Okay, thank you. Is that still about $1.2 billion that you're bringing online over the next couple of years?

I mean, part of it's already on. So what's happening is some of the upside is getting offset by decreases in our legacy businesses. So the legacy businesses have declines, and it's offsetting some of the gains in the new pieces.

Okay, thank you. Thank you.

Our next question comes from the line of Catherine Thompson from Thompson Research Group. Your line is open.

Hey, this is actually Brian Barrows on for Catherine. Thank you for taking my question. I want to ask a follow-up on the coronavirus and I guess the supply chain impact. TRG industry contacts are telling us that the supply chain has not really yet been meaningfully impacted. but if the manufacturing stoppages are extended another three to four weeks, that could then impact shipments about three to five months from now. I actually wanted to see if you guys think that logic makes sense, and maybe any color on what you're hearing from manufacturers from either Vietnam or South Korea on the impact to their supply chain.

I think that's close to what we said. We said that Right now it's difficult to say how fast it's going to come up, that there are huge inventories in the chain over different times, that it depends on each piece. So typically there's anywhere from four to seven months of inventory through the channels and the stuff coming through. And in that you have some that have low parts and some that have high parts across the industry. So depending upon what it is, And each piece and how fast the part comes up, you know, depends on the time. There could be people in the channel with less than that, and they could be impacted, you know, with a few weeks' worth of delays. The non-Chinese production in the surrounding countries, some of it or a significant part of it also uses inputs coming out of China. So if the inputs don't come up, it could affect those also. So at this point, it's really difficult to know what's going to happen and the impact. And it depends on the inventory levels of any individual SKUs at this point. Most people, when they buy from there, there's the Chinese New Year where they shut down. So you have the product that was bought in anticipation of that still flowing across the water coming in. And so it still comes back to how fast it's going to pick up. And, you know, what's the timing of the new production coming up? And nobody has any idea.

Got it. Thanks for the call.

Our next question comes from the line of John Laballo from Bank of America. Your line is open.

Hey, guys. Thank you for fitting me in here. I just want to make sure that I understand. Your outlook seems to imply year-over-year operating margin expansion, at least in 3Q and 4Qs. Is that correct?

Yes.

Thanks. And our final question today comes from the line of Laura Champine from Loop Capital. Your line is open.

Thanks for taking my question. If we look at your new production of LVT in the US, how competitively do you think you'll be able to price that product relative to Chinese competition? And how does that influence your ability to get close to full capacity by the end of the year?

We think when it's fully optimized that we'll be able to compete with the world marketplaces. At the same time, our goal isn't to sell all commodity product. Our goal is to sell value-added products and have a higher average mix, which will allow us to meet the return goals that we want.

Got it. Thank you.

I would now like to turn the call back over to Mr. Laborbaum for closing remarks.

We're reacting to the market conditions. We see excess capacities in the market continuing, and we'll have to continue to react to competition in the marketplaces as they evolve. There are a lot of indicators that many of the markets around the world are expecting the economies to get better and improve. We have a lot of A lot going on to increase the utilization of our new plants, which we think will help the second half as the throughputs go up, which will allow the cost to come down, and also the mix to improve over time. We think we're doing the right things to react to the market and invest in the categories to increase our business level during these times. We appreciate you taking your time and listening to us. Have a nice day.

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