Business context and reporting period
Mohawk Industries, Inc. is a global flooring manufacturer operating through Global Ceramic, Flooring North America (Flooring NA), and Flooring Rest of the World (Flooring ROW). This unaudited Form 10-Q covers the three and nine months ended October 1, 2016, compared with the periods ended October 3, 2015.
Financial performance and position
| Metric | Three months | Nine months |
|---|---|---|
| Net sales | $2.294 billion; up 6.7% | $6.777 billion; up 11.6% |
| Gross profit / margin | $726.6 million / 31.7%, versus 30.8% | $2.122 billion / 31.3%, versus 29.4% |
| Operating income / margin | $378.3 million / 16.5%, versus $288.7 million / 13.4% | $974.7 million / 14.4%, versus $588.3 million / 9.7% |
| Net earnings attributable to Mohawk | $269.9 million, versus $214.9 million | $696.6 million, versus $423.7 million |
| Diluted EPS | $3.62, versus $2.89 | $9.34, versus $5.73 |
| Interest expense | $9.4 million, versus $19.3 million | $32.1 million, versus $52.6 million |
For the third quarter, sales growth reflected higher volume, including acquisition and legacy volume, partly offset by fewer shipping days and unfavorable foreign exchange. Across the segments, quarterly sales were $822.0 million for Global Ceramic, $1.009 billion for Flooring NA, and $463.5 million for Flooring ROW. Segment operating income was $136.0 million, $170.5 million, and $81.8 million, respectively.
For the first nine months, operating cash flow was $984.7 million, versus $657.0 million. Capital expenditures were $460.8 million, versus $352.1 million; cash after capital expenditures was approximately $523.9 million. Investing cash outflow totaled $460.8 million, compared with $1.564 billion in 2015, which included $1.212 billion of acquisitions. Financing cash outflow was $501.2 million. Cash at October 1 was $112.1 million, up from $81.7 million at year-end 2015.
Total debt carrying value was $2.714 billion, including $1.548 billion classified as current and $1.166 billion long-term. The $1.8 billion revolving credit facility had $752.7 million available after commercial paper and other usage; commercial paper outstanding was $990.4 million. The separate $500 million receivables securitization facility was fully utilized. Current assets were $3.576 billion and current liabilities $2.983 billion. Management said cash, operating cash generation, and available facilities should cover capital, working-capital, and debt-service needs for the next 12 months.
Material changes and unusual items
- Quarterly operating income and EPS improved year over year, supported by sales volume, capital-investment and cost-reduction savings, lower input costs, and lower interest expense. Gross margin rose 90 basis points in the quarter and 190 basis points year to date.
- Mohawk received $90 million in August 2016 from settlement of a long-running contract dispute; related litigation and appeals were dismissed. The receipt materially benefited reported SG&A and operating results.
- The company recorded a $47.9 million non-cash impairment after deciding to discontinue the Lees commercial brand. The charge partly offset the contract settlement benefit.
- Nine-month comparison also benefited from the absence of the $125 million polyurethane-foam litigation settlement and defense charge recorded in 2015. Management attributed nine-month growth additionally to higher volume, cost savings, and lower material costs.
- Interest expense declined following repayment of the remaining $645.6 million of 6.125% senior notes in January 2016 and lower-rate commercial-paper borrowings.
Outlook, risks and contingencies
Management expected fourth-quarter 2016 capital spending of $140–$190 million and full-year spending of $600–$650 million. It anticipated continued strength in the U.S. market as housing starts and remodeling recovered, while noting challenging European macroeconomic conditions and continued translation pressure from a strong U.S. dollar. The filing provides no specific earnings or revenue guidance.
Risks include economic and flooring-industry conditions, competition, raw-material and energy costs, foreign exchange, execution of acquisitions and investments, product claims, litigation, and tax matters. A new Gadsden, Alabama, lawsuit alleges harm related to past use of perfluorinated compounds; Mohawk says it did not manufacture the chemicals and intends to defend the case. Belgian tax assessments remain disputed and under appeal; a lien was placed on certain Belgian properties as security, without interfering with operations. The company says it cannot estimate any loss beyond amounts accrued. Most polyurethane-foam cases have been settled; one request for reconsideration remained pending.
Disclosure controls were deemed ineffective at a reasonable-assurance level due to a material weakness in documenting inventory oversight at two divisions, specifically monitoring cycle counts and obsolete-inventory valuation. Management said additional controls supported the reported inventory balances and described a remediation plan requiring evidence of monitoring, but the weakness will not be considered remediated until controls operate as designed for a sufficient period.
Investor verification priorities
- Assess how much reported earnings improvement depends on the nonrecurring $90 million settlement and the prior-year $125 million litigation charge, versus recurring volume and cost improvements.
- Track remediation and independent-auditor reporting on the inventory-control material weakness, and verify any resulting inventory adjustments.
- Monitor working-capital needs, capital spending, short-term commercial-paper refinancing, and the December 2016 securitization-facility renewal.
- Follow outcomes of the Belgian tax appeal and Gadsden litigation, including any effect on cash flows or results.
- Evaluate the sustainability of margins amid foreign-exchange exposure, competitive pricing and product-mix pressure, and input-cost changes.