Mohawk Industries, Inc. — Q2 2010 Form 10-Q
Reporting period: Quarter ended July 3, 2010; comparisons are with the quarter ended June 27, 2009. Six-month comparisons are with the six months ended June 27, 2009. Financial statement amounts below are in millions, except per-share data.
Business context and results
Mohawk manufactures and distributes floor-covering products through its Mohawk, Dal-Tile and Unilin segments. Management described overall economic conditions as more stable than during the downturn, but housing activity remained volatile and the commercial real estate market weak.
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net sales | $1,400.1 | $1,406.0 | $2,747.3 | $2,614.4 |
| Gross profit | $374.8 | $367.4 | $716.0 | $521.1 |
| Gross margin | 26.8% | 26.1% | 26.1% | 19.9% |
| Operating income (loss) | $89.7 | $74.7 | $143.3 | $(71.2) |
| Operating margin | 6.4% | 5.3% | 5.2% | (2.7%) |
| Interest expense | $39.0 | $30.0 | $72.9 | $60.2 |
| Net earnings (loss) attributable to Mohawk | $68.1 | $46.3 | $88.6 | $(59.6) |
| Diluted EPS | $0.99 | $0.67 | $1.29 | $(0.87) |
Material changes and segment performance
- Q2 sales were essentially flat year over year. Higher volume of about $23 million was offset by roughly $16 million from price and product mix and $13 million from unfavorable foreign exchange.
- Q2 gross and operating margins improved, which management attributed mainly to prior-year restructuring, cost savings and productivity improvements. Operating income also benefited from lower restructuring charges; higher manufacturing costs and unfavorable currency partly offset gains.
- For the first half, sales increased 5.1%, but 2009 sales included a $110.2 million carpet sales allowance. The prior-year period also included a $12.4 million inventory write-off and about $62 million of unfavorable raw-material cost effects. These items materially affect year-over-year comparisons.
- Q2 segment sales and operating income: Mohawk $747.6 million and $26.3 million; Dal-Tile $363.6 million and $28.1 million; Unilin $308.4 million and $42.3 million. Unilin grew sales 10.2% and operating income 36.0%; Mohawk sales declined 2.6% while operating income rose; Dal-Tile sales declined 3.5% and operating income declined.
- Q2 Mohawk EPS benefited substantially from an approximately $30 million tax benefit related to settling tax contingencies. This makes reported earnings growth less indicative of underlying operating improvement.
Cash flow, debt and liquidity
- Six-month operating cash flow was $89.0 million, down from $269.5 million. Management cited higher working-capital needs as inventory levels stabilized; inventories rose to $965.8 million from $893.0 million at year-end.
- Six-month capital spending was $47.1 million. The company forecast $110–$135 million of capital spending for the remainder of 2010, excluding acquisitions.
- Cash and cash equivalents were $342.7 million at July 3, versus $531.5 million at December 31, 2009. Total debt was approximately $1.654 billion, down from $1.854 billion; $351.3 million was classified as current on the balance sheet.
- The $600 million asset-based revolving credit facility had $487.1 million available, after $112.9 million of letters of credit and other usage. It includes covenants, including a 1.1:1 fixed-charge coverage requirement when unused availability falls below a specified threshold.
- Approximately $300 million of 5.75% notes remained due January 15, 2011; $400 million of 7.20% notes were due April 2012. The ABL facility’s maturity may accelerate to October 15, 2010 if the 2011 notes are not repaid, refinanced, defeased or adequately reserved for. Management believed cash and facility availability would suffice, while cautioning that this was not assured.
- Interest expense rose partly because of higher borrowing costs and rating-related note-rate increases. The company reported an aggregate 0.75% increase in note rates following 2009 downgrades, adding about $9 million in annual interest expense.
Outlook, contingencies and unusual items
- No specific revenue or earnings guidance was provided. Management cited uncertain housing starts and resales, intense competition, pricing pressure, and fluctuating raw-material and energy costs. The company said it generally seeks to pass through cost increases, but may not be able to do so promptly or fully.
- Hurricane Alex flooding temporarily interrupted the Dal-Tile plant in Monterrey, Mexico. Most equipment was operating by the end of July, with full capacity expected in the latter part of Q3. Management did not expect a material effect on second-half results or financial position, although insurance-proceeds timing could affect a quarter.
- After quarter-end, on July 6, Mohawk completed an approximately $80 million equity investment in a Chinese ceramic-tile manufacturer and distributor, funded with available cash in Europe.
- The company settled IRS tax matters for 1999–2006 during Q2, paying $23.6 million and expecting an additional approximately $10 million payment before year-end. It reversed $8.9 million of accrued tax interest and penalties in the first half. The reported tax benefit related to settlements was approximately $30 million.
- A wage-related putative class action was settled and approved by the court in July 2010; Mohawk had accrued its portion in a prior year. The insurer may terminate the settlement if claims are filed by a majority of claimants.
- Restructuring charges were $8.9 million in the first half, compared with $15.9 million in the prior-year period. Remaining restructuring costs were expected to be paid over one to six years.
- The company warned that demand could weaken again and identified risks including refinancing and covenant compliance, credit-rating changes, raw-material supply and inflation, currency movements, litigation and product warranties, environmental obligations, acquisitions, and possible asset impairment.
Investor verification priorities
- Separate recurring operating performance from the approximately $30 million tax-contingency benefit and from unusual 2009 charges when assessing earnings comparisons.
- Confirm the refinancing, repayment or reserve plan for the 5.75% notes due January 2011 and its implications for the ABL facility’s accelerated maturity provisions.
- Track operating cash flow, inventory and receivables, given the sharp decline in first-half operating cash generation and increased working-capital requirements.
- Monitor segment pricing, volume and margins, especially commercial-market exposure in Mohawk and price/mix pressure at Dal-Tile.
- Verify the Monterrey facility’s return to full capacity, the timing and recovery of insurance proceeds, and the effect of the China investment on cash and future results.