Business context and reporting period
Mohawk Industries, Inc. designs, manufactures, sources and distributes flooring and related products through its Carpet, Ceramic, and Laminate and Wood segments. This unaudited Form 10-Q covers the quarter and nine months ended September 28, 2013, compared with the periods ended September 29, 2012. Results include Pergo from January 10, Marazzi from April 3, and Spano from May 3, 2013; consequently, year-over-year growth reflects acquisitions as well as changes in legacy operations.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $1,961.5m | $1,473.5m | $5,424.7m | $4,352.3m |
| Gross profit | $516.9m | $372.8m | $1,408.0m | $1,120.7m |
| Gross margin | 26.4% | 25.3% | 26.0% | 25.8% |
| Operating income | $175.9m | $104.0m | $395.9m | $283.6m |
| Operating margin | 9.0% | 7.1% | 7.3% | 6.5% |
| Net earnings attributable to Mohawk | $119.1m | $70.3m | $254.1m | $183.9m |
| Diluted EPS | $1.63 | $1.01 | $3.53 | $2.66 |
| Interest expense | $25.6m | $18.0m | $70.1m | $59.3m |
| Effective tax rate | 19.4% | 17.9% | 19.7% | 18.1% |
Q3 sales rose 33.1%; management attributed about $447m of the increase primarily to acquisitions, about $27m to price and product mix, and about $14m to foreign exchange. For the nine months, sales increased 24.6%, including approximately $974m from higher volume, primarily acquisitions. Earnings growth also reflected productivity, legacy sales volume, favorable price and mix, and lower amortization; higher input costs, interest, restructuring and acquisition costs, and Marazzi inventory step-up partly offset these benefits.
Q3 segment results: Carpet sales were $772.8m and operating income $68.8m (8.9% margin); Ceramic sales were $767.0m and operating income $75.9m (9.9%); Laminate and Wood sales were $450.7m and operating income $39.0m (8.7%). Ceramic and Laminate and Wood growth was substantially acquisition-related. Carpet’s increase was modest and primarily reflected improved price and mix.
Cash flow, balance sheet and liquidity
- For the first nine months, operating cash flow was $327.0m, versus $298.5m a year earlier. Investing cash outflow was $705.0m, including $449.5m for acquisitions and $255.5m for capital expenditures. Financing cash outflow was $3.9m.
- Cash was $63.6m at September 28, 2013, down from $477.7m at December 31, 2012. Current assets were $3,188.5m and current liabilities $1,385.2m (working capital of approximately $1,803.2m).
- Carrying debt, including current maturities, was $2,346.4m, compared with $1,382.9m at year-end 2012. The company reported $456.1m available under its new $1.0bn revolving facility; utilization included borrowings and letters of credit. Its $300m accounts-receivable securitization facility was fully utilized.
- The company issued $600m of 3.85% senior notes due 2023. The new five-year revolving facility requires interest coverage of at least 3.0:1 and net leverage no greater than 3.75:1. Management stated that cash, operating cash generation, and available credit should cover capital expenditure, working capital and debt-service needs over the next 12 months.
Material changes, outlook and risks
- Major acquisitions expanded the business and materially changed the scale and composition of reported sales, assets and debt. Marazzi contributed Q3 sales of $299.0m and nine-month sales of $608.8m. Its purchase-price allocation remained preliminary. The company is marketing the acquired, non-core sanitary ware business and classified it as discontinued operations.
- Restructuring, acquisition transaction and integration costs totaled $75.6m for the first nine months ($32.4m in cost of sales and $43.1m in SG&A). Marazzi inventory fair-value step-up charges were approximately $31.0m for the nine months. Remaining restructuring liabilities were $25.9m, expected to be paid over four years.
- Management expected remaining-2013 capital spending of approximately $130m–$150m, primarily for equipment, geographic capacity and manufacturing efficiency. No specific earnings or sales guidance was provided. Management noted that raw-material, energy and fuel cost increases may not always be recoverable through pricing; industry performance is also sensitive to housing, construction, consumer spending and economic conditions.
- Risks include acquisition integration, competition, input-cost inflation, foreign operations and currency movements, and litigation and tax matters. U.S. and Canadian polyurethane-foam antitrust cases seek unspecified damages, including treble damages; the company denies the allegations and cannot estimate losses beyond amounts accrued. Belgian tax authorities issued assessments for 2005 and 2009 totaling €81.7m, excluding possible interest and penalties, and proposed adjustments for additional years. The company contests the positions; it said outcomes could materially affect results, liquidity or cash flow in a period.
- Approximately 64% of debt was fixed-rate and 36% floating-rate; management said a one-percentage-point change in floating rates would not materially affect results. Disclosure controls were assessed as effective at a reasonable assurance level; integration of Marazzi was incorporated into internal controls.
Important facts for investors to verify
- How much of continuing sales and earnings growth is organic, and whether acquisition synergies and productivity gains are being realized.
- Final purchase-price allocations, integration costs, and the performance and disposition of the sanitary ware business.
- Debt levels, covenant headroom, facility availability, and the company’s ability to generate cash while funding acquisitions and planned capital spending.
- Exposure and developments in the polyurethane-foam litigation and Belgian tax disputes, including any changes to accruals or estimated outcomes.
- Whether pricing and productivity can offset raw-material, energy and other input-cost increases across the segments.