Mohawk Industries, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; comparisons are to the periods ended July 1, 2017. The company manufactures and markets flooring products through Global Ceramic, Flooring North America and Flooring Rest of World (ROW).
Financial performance and liquidity
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $2,577.0m | $2,453.0m | $4,989.2m | $4,673.7m |
| Gross profit / margin | $766.6m / 29.7% | $779.1m / 31.8% | $1,471.2m / 29.5% | $1,459.5m / 31.2% |
| Operating income / margin | $326.3m / 12.7% | $355.8m / 14.5% | $594.7m / 11.9% | $630.6m / 13.5% |
| Net earnings attributable to Mohawk | $196.6m | $260.7m | $405.4m | $461.2m |
| Diluted EPS | $2.62 | $3.48 | $5.41 | $6.17 |
| Operating cash flow | — | $621.0m | $413.9m |
Q2 sales grew 5.1%; first-half sales rose 6.8%. Growth reflected favorable foreign exchange, pricing/product mix and volume. First-half sales growth included about $47m from acquisitions. Despite higher sales, operating income fell 8.3% in Q2 and 5.7% in the first half; net earnings fell 24.6% and 12.1%, respectively. Q2 effective tax rate was 37.6% versus 24.0%; first-half rate was 29.0% versus 24.6%.
At June 30, cash and equivalents were $518.2m, including $495.7m held outside the U.S. Total debt was $3,030.5m ($1,146.5m current and $1,884.0m long-term); cash less total debt was approximately negative $2,512m. Current assets were $4,773.7m and current liabilities $2,736.1m. The company had $616.3m available under its $1.8bn senior credit facility after facility usage and commercial paper. Commercial paper outstanding was $1,069.2m. First-half capital expenditures were $498.4m.
Operating cash flow increased $207.1m year over year, which management attributed primarily to working-capital timing. Investing activities used $485.9m, including capital spending; financing activities provided $308.0m. Cash increased by $433.3m during the half. Approximately 60% of debt was floating-rate; a one-percentage-point rate increase would raise interest expense by an estimated $4.6m for a quarter and $9.1m for six months.
Segment results and material changes
- Global Ceramic: Q2 sales rose 2.9% to $929.3m, while operating income fell to $134.8m from $152.6m. First-half sales rose 7.0% to $1,805.8m; operating income declined to $248.2m from $268.6m.
- Flooring NA: Q2 sales rose 1.7% to $1,057.6m, while operating income fell to $100.7m from $127.5m. First-half sales rose 1.4% to $2,007.9m; operating income declined to $175.4m from $219.6m.
- Flooring ROW: Q2 sales rose 15.7% to $590.1m and operating income increased to $100.2m from $86.1m. First-half sales rose 16.8% to $1,175.4m; operating income increased to $189.2m from $162.1m.
Management cited inflation as the principal earnings pressure: approximately $62m of higher inflation costs in Q2 and $115m in the first half, including higher material costs. Startup costs associated with capacity and market-expansion projects were about $8m in Q2 and $17m in the first half. Price/mix, productivity initiatives and investment-related savings partly offset these pressures. First-half restructuring, acquisition and integration costs were $38.1m, versus $19.9m a year earlier.
Outlook, transactions and risks
- Management expected local-market sales growth to continue in 2018, notwithstanding lower revenue from intellectual-property contracts that expired in 2017; the lost contracts were projected to reduce operating income by $35m–$40m.
- The company planned approximately $780m of 2018 capital investment, including about $280m in the remainder of the year. Management expected $30m–$35m of increased startup costs from the investment program. Projects include U.S. and European LVT expansion and added ceramic, laminate, carpet tile, vinyl and countertop capacity.
- Godfrey Hirst Group was acquired on July 2, 2018, after quarter-end, for approximately A$556m (about $411.9m at June 30 exchange rates). Its results were to be reported in Flooring ROW; purchase accounting was still preliminary.
- Q2 tax expense included a $54.7m net charge related to updated estimates under the U.S. deemed repatriation transition tax. The provisional transition-tax liability was $206.0m at June 30; the company was still evaluating aspects of U.S. tax reform, including GILTI.
- Two Alabama water-board lawsuits concerning the company’s historical use of perfluorinated compounds in carpet manufacturing remained pending. The company said it had never manufactured the compounds; loss beyond amounts accrued could not be estimated. Belgian tax appeals remained possible despite favorable lower-court rulings for 2005–2010; property liens securing potential payment were in place and did not affect operations.
- Other notable exposures include inflation and the ability to recover input-cost increases through pricing, foreign-exchange movements, floating-rate debt, acquisition integration and execution of a sizable capital program. Management stated cash, operating cash generation and credit availability should cover needs for at least the next 12 months. Disclosure controls were deemed effective.
Investor verification priorities
- Track whether pricing and productivity gains offset inflation, particularly materials, and whether margins recover across Global Ceramic and Flooring NA.
- Compare actual capital spending and startup costs with the $780m plan and assess returns from the capacity expansions.
- Verify Godfrey Hirst purchase accounting, integration progress, funding and contribution to Flooring ROW.
- Monitor commercial-paper refinancing, available credit capacity, floating-rate exposure and cash held outside the U.S.
- Follow final U.S. tax-reform calculations and the transition-tax liability, plus developments in the Alabama litigation and Belgian tax appeals.