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| MHK > SEC Filings for MHK > Form 10-Q on 12-Nov-2008 | All Recent SEC Filings |
12-Nov-2008
Quarterly Report
Overview
The Company is a leading producer of floor covering products for residential and commercial applications in the U.S. and Europe with net sales in 2007 of $7.6 billion. The Company is the second largest carpet and rug manufacturer, a leading manufacturer, marketer and distributor of ceramic tile, natural stone and hardwood flooring in the U.S. and a leading producer of laminate flooring in the U.S. and Europe.
The Company has three reporting segments, the Mohawk segment, the Dal-Tile segment and the Unilin segment. The Mohawk segment manufactures, markets and distributes its product lines primarily in North America, which include carpet, rugs, pad, ceramic tile, hardwood, resilient and laminate, through its network of regional distribution centers and satellite warehouses using company-operated trucks, common carrier or rail transportation. The segment product lines are sold through various selling channels, which include floor covering retailers, home centers, mass merchandisers, department stores, independent distributors, commercial dealers and commercial end users. The Dal-Tile segment manufactures, markets and distributes its product lines primarily in North America, which include ceramic tile, porcelain tile and stone products, through its network of regional distribution centers and approximately 250 company-operated sales service centers using company-operated trucks, common carriers or rail transportation. The segment product lines are purchased by floor covering retailers, home centers, independent distributors, tile specialty dealers, tile contractors, and commercial end users. The Unilin segment manufactures, markets and distributes its product lines primarily in North America and Europe, which include laminate flooring, wood flooring, medium-density fiberboard, roofing systems and other wood products through various selling channels, which include retailers, home centers, independent distributors, contractors, and commercial users.
The Company reported net loss of $1,484.8 million or diluted (loss) earnings per share ("EPS") of ($21.70) for the third quarter of 2008, compared to net earnings of $122.1 million or $1.78 EPS for the third quarter of 2007. The change in EPS resulted primarily from a preliminary $1,418.9 million pre-tax impairment charge to reduce the carrying amount of goodwill and other intangibles, a charge of $253 million to record a tax valuation allowance against the carrying amount of a deferred tax asset recognized in the fourth quarter of 2007, lower sales volumes, which the Company believes is attributable to slowing U.S. residential housing, commercial and European demand, and rising raw material and energy costs.
The Company reported net loss of $1,330.6 million or diluted (loss) EPS of ($19.45) for the nine months ended September 27, 2008, compared to net earnings of $327.7 million or $4.79 EPS for the same period of 2007. The change in EPS resulted primarily from a preliminary $1,418.9 million pre-tax impairment charge to reduce the carrying amount of goodwill and other intangibles, a charge of $253 million to record a tax valuation allowance against the carrying amount of a deferred tax asset recognized in the fourth quarter of 2007, lower sales volumes, which the Company believes is attributable to slowing U.S. residential housing, commercial and European demand, and rising raw material and energy costs.
Results of Operations
Quarter Ended September 27, 2008, as Compared with Quarter Ended September 29, 2007
Net Sales
Net sales for the quarter ended September 27, 2008 were $1,763.0 million, reflecting a decrease of $174.7 million, or 9.0%, from the $1,937.7 million reported for the quarter ended September 29, 2007. The decrease was primarily driven by a decline in sales volumes of approximately $228 million due to the continued decline in the U.S. residential market, softening commercial demand and slowing European demand, partially offset by a benefit of approximately $43 million due to the net effect of price increases and product mix and a benefit of approximately $23 million due to favorable foreign exchange rates.
Mohawk Segment - Net sales decreased $122.9 million, or 11.4%, to $953.8 million in the current quarter compared to $1,076.7 million in the third quarter of 2007. The decrease was primarily driven by a decline in sales volumes of approximately $153 million due to the continued decline in the U.S. residential market and
softening commercial demand, partially offset by a benefit of approximately $42 million due to the net effect of price increases and product mix.
Dal-Tile Segment - Net sales decreased $25.4 million, or 5.1%, to $472.0 million in the current quarter compared to $497.4 million in the third quarter of 2007. The decrease was primarily driven by a decline in sales volumes of approximately $21 million due to the continued decline in the U.S. residential market and negative price and product mix of $4 million, net, as customers trade down.
Unilin Segment - Net sales decreased $20.6 million, or 5.4%, to $357.8 million in the current quarter compared to $378.4 million in the third quarter of 2007. The decrease was driven by a decline in sales volumes of approximately $54 million due to the continued decline in the U.S. residential market and slowing European demand, partially offset by a benefit of approximately $23 million due to favorable foreign exchange rates and increased sales of approximately $12 million from the wood flooring acquisition completed in the third quarter of 2007 ("Wood Acquisition").
Gross profit
Gross profit for the third quarter of 2008 was $439.1 million (24.9% of net sales) and represented a decrease of $106.3 million, or 19.5%, compared to gross profit of $545.4 million (28.1% of net sales) for the prior year's third quarter. Gross profit in the current quarter was unfavorably impacted by approximately $76 million in increased costs for raw materials and energy, net of cost savings initiatives and approximately $66 million resulting from a decline in sales volume.
Selling, general and administrative expenses
Selling, general and administrative expenses for the third quarter of 2008 were $321.3 million (18.2% of net sales), reflecting a decrease of $23.3 million, or 6.8%, compared to $344.6 million (17.8% of net sales) for the prior year's third quarter. The decrease in SG&A is attributable to various cost savings initiatives implemented by the Company, offset by $4 million due to unfavorable foreign exchange rates.
Impairment of goodwill and intangibles
During the third quarter of 2008, the Company recorded a preliminary $1,418.9 million ($1,307.4 million net of tax) impairment charge to reduce the carrying amount of the Company's goodwill and intangible assets to their estimated fair value based upon the results of an interim impairment test. The Company performed an interim impairment test because of a prolonged decline in the Company's market capitalization which the Company believes is primarily a result of the weakness in the U.S. residential housing market and the slowing European economy. During the third quarter of 2008, the Company concluded that the weakness in the U.S. residential housing market is likely to persist based on its review of, among other things, sequential quarterly housing starts, recent turmoil surrounding the nation's largest mortgage lenders, the potential negative impact on the availability of mortgage financing and housing start forecasts published by national home builder associations pushing recovery in the U.S. residential housing market further out in 2009. The total impairment included $253.6 million in the Mohawk segment, $531.9 million in the Dal-Tile segment and $633.4 million in the Unilin segment. If, in the future, the Company's market capitalization and/or the estimated fair value of the Company's reporting units were to decline further, it may be necessary to record an additional impairment charge.
Operating (loss) income
Operating loss for the third quarter of 2008 was $1,301.1 million reflecting a decrease of $1,501.9 million compared to operating income of $200.8 million (10.4% of net sales) in the third quarter of 2007. The decrease was primarily driven by the recognition of a preliminary impairment of goodwill and other intangibles of $1,418.9 million, a decline in sales volumes of approximately $66 million and rising costs for raw materials and energy of approximately $51 million, net of cost savings initiatives, partially offset by a benefit of approximately $51 million due to the net effect of price increases and product mix.
Mohawk Segment - Operating loss was $224.4 million in the third quarter of 2008 reflecting a decrease of $301.4 million compared to operating income of $77.0 million (7.2% of segment net sales) in the third quarter of 2007. The decrease was primarily due to the preliminary impairment of goodwill and other intangibles of $253.6 million, a decline in sales volumes of approximately $36 million and rising costs for raw materials and energy of approximately $39 million, net of cost savings initiatives, partially offset by a benefit of approximately $41 million due to the net effect of price increases and product mix.
Dal-Tile Segment - Operating loss was $479.9 million in the third quarter of 2008 reflecting a decrease of $543.0 million compared to operating income of $63.1 million (12.7% of segment net sales) for the third quarter of 2007. The decrease was primarily due to the preliminary impairment of goodwill of approximately $531.9 million, rising costs for raw materials and energy of approximately $9 million, net of cost savings initiatives, and a decline in sales volumes of approximately $7 million, partially offset by a benefit of approximately $8 million due to the net effect of price increases and product mix.
Unilin Segment - Operating loss was $592.5 million in the third quarter of 2008 reflecting a decrease of $663.5 million compared to operating income of $71.0 million (18.8% of segment net sales) for the third quarter of 2007. The decrease was primarily due to the preliminary impairment of goodwill and other intangibles of approximately $633.4 million, a decline in sales volumes of approximately $24 million and rising costs for raw materials and energy of approximately $10 million, net of cost savings initiatives.
Interest expense
Interest expense for the third quarter of 2008 was $30.5 million compared to $37.5 million in the third quarter of 2007. The decrease in interest expense was directly related to lower average debt levels in the current quarter when compared to the third quarter of 2007.
Income tax expense
Income tax expense was $148.9 million for the third quarter of 2008 compared to $42.0 million, or 25.6% of earnings before income taxes, for the prior year's third quarter. The change in the tax rate is principally due to the impact on pre-tax earnings of a preliminary impairment of non-deductible goodwill and the recognition of a valuation allowance of $253 million against the deferred tax benefit described below.
In the fourth quarter of 2007, the Company moved the intellectual property and treasury operations of an indirectly owned European entity to a new office in another jurisdiction in Europe. The Company also indirectly owned a holding company in the new jurisdiction that provided certain treasury functions to Unilin and the move allowed for the consolidation of the historical intellectual property and treasury operations to be combined with those of the holding company's treasury operations in a single jurisdiction in order to integrate and streamline the operations, to facilitate international acquisitions and to improve tax and cost efficiencies. This restructuring resulted in a step up in the subsidiary's taxable basis of its intellectual property. The step up relates primarily to intangible assets which will be amortized over 10 years for tax purposes. During the fourth quarter of 2007, the Company evaluated the evidence for recognition of the deferred tax asset created through the restructuring and determined that, based on the available evidence, the deferred tax asset would more likely than not be realized. The deferred tax asset recognized at December 31, 2007 was approximately $245 million and the related income tax benefit recognized in the financial statements was approximately $272 million.
During the third quarter of 2008, the Company reassessed the need for a valuation allowance against its deferred tax assets. Cash flows have decreased from that projected as of December 31, 2007, primarily due to the slowing worldwide economy and declining sales volume. The Company determined that, given the current and expected economic conditions and the corresponding reductions in cash flows, its ability to realize the benefit of the deferred tax asset related to the European step up transaction described above as well as tax losses generated in the same jurisdiction was not more likely than not. Accordingly the Company recorded a valuation allowance against the deferred tax asset in the amount of $253 million during the quarter ended September 27, 2008.
Nine Months Ended September 27, 2008, as Compared with Nine Months Ended September 29, 2007
Net Sales
Net sales for the nine months ended September 27, 2008 were $5,341.2 million, reflecting a decrease of $437.6 million, or 7.6%, from the $5,778.8 million reported for the nine months ended September 29, 2007. The decrease was primarily driven by a decline in sales volumes of approximately $660 million due to the continued decline in the U.S. residential markets, softening commercial demand and slowing European demand, partially offset by a benefit of approximately $135 million due to the net effect of price increases and product mix, and a benefit of approximately $80 million due to favorable foreign exchange rates.
Mohawk Segment - Net sales decreased $410.5 million, or 12.7%, to $2,827.3 million in the current nine months compared to $3,237.8 million in the first nine months of 2007. The decrease was primarily driven by a decline in sales volumes of approximately $486 million due to the continued decline in the U.S. residential market and softening commercial demand, partially offset by a benefit of approximately $94 million due to the net effect of price increases and product mix.
Dal-Tile Segment - Net sales decreased $67.0 million, or 4.6%, to $1,402.6 million in the current nine months compared to $1,469.6 million in the first nine months of 2007. This decrease was primarily driven by a decline in sales volumes of approximately $88 million due to the continued decline in the U.S. residential market, partially offset by a benefit of approximately $21 million due to the net effect of price increases and product mix.
Unilin Segment - Net sales increased $79.0 million, or 7.2%, to $1,173.1 million in the current nine months compared to $1,094.1 million in the first nine months of 2007. The increase in net sales was driven by a benefit of approximately $84 million due to the Wood Acquisition, a benefit of approximately $80 million due to favorable foreign exchange rates and a benefit of approximately $21 million due to the net effect of price increases and product mix, partially offset by a decline in sales volumes of approximately $86 million due to the continued decline in the U.S. residential market and slowing European demand.
Gross profit
Gross profit for the first nine months of 2008 was $1,381.8 million (25.9% of net sales) and represented a decrease of $243.7 million, or 15.0%, compared to gross profit of $1,625.5 million (28.1% of net sales) for the prior year's first nine months. Gross profit was unfavorably impacted by increasing costs for raw materials and energy of approximately $213 million, net of cost savings initiatives, and a decline in volumes of approximately $181 million, partially offset by the net effect of price increases and product mix of approximately $153 million.
Selling, general and administrative expenses
Selling, general and administrative expenses for the first nine months of 2008 were $993.6 million (18.6% of net sales), reflecting a decrease of $62.3 million, or 5.9%, compared to $1,055.9 million (18.3% of net sales) for the prior year's first nine months. The decrease in SG&A is attributable to various cost savings initiatives implemented by the Company, offset by $21 million of unfavorable foreign exchange. The increase in selling, general and administrative expenses as a percentage of net sales was primarily attributable to leveraging over lower net sales.
Impairment of goodwill and intangibles
During the third quarter of 2008, the Company recorded a preliminary $1,418.9 million ($1,307.4 million net of tax) impairment charge to reduce the carrying amount of the Company's goodwill and intangible assets to their estimated fair value based upon the results of an interim impairment test. The Company performed an interim impairment test because of a prolonged decline in the Company's market capitalization which the Company believes is primarily a result of the weakness in the U.S. residential housing market and the slowing European economy. During the third quarter of 2008, the Company concluded that the weakness in the U.S. residential housing market is likely to persist based on its review of, among other things, sequential quarterly
housing starts, recent turmoil surrounding the nation's largest mortgage lenders, the potential negative impact on the availability of mortgage financing and housing start forecasts published by national home builder associations pushing recovery in the U.S. residential housing market further out in 2009. The total impairment included $253.6 million in the Mohawk segment, $531.9 million in the Dal-Tile segment and $633.4 million in the Unilin segment. If, in the future, the Company's market capitalization and/or the estimated fair value of the Company's reporting units were to decline further, it may be necessary to record an additional impairment charge.
Operating (loss) income
Operating loss for the first nine months of 2008 was $1,030.7 million reflecting a decrease of $1,600.3 million compared to operating income of $569.6 million (9.9% of net sales) in the first nine months of 2007. The decrease was primarily driven by the recognition of a preliminary impairment of goodwill and other intangibles of $1,418.9 million, a decline in sales volumes of approximately $177 million and rising costs for raw materials and energy of approximately $108 million, net of cost savings initiatives, partially offset by a benefit of approximately $128 million due to the net effect of price increases and product mix.
Mohawk Segment - Operating loss was $167.5 million in the first nine months of 2008 reflecting a decrease of $352.7 million compared to operating income of $185.2 million (5.7% of segment net sales) in the first nine months of 2007. The decrease was primarily due to the preliminary impairment of goodwill and other intangibles of $253.6 million, a decline in sales volumes of approximately $94 million and rising costs for raw materials and energy of approximately $51 million, net of cost savings initiatives, partially offset by a benefit of approximately $70 million due to the net effect of price increases and product mix.
Dal-Tile Segment - Operating loss was $364.8 million in the first nine months of 2008 reflecting a decrease of $561.7 million compared to operating income of $196.9 million (13.4% of segment net sales) for the first nine months of 2007. The decrease was primarily due to the preliminary impairment of goodwill of $531.9 million, rising costs for raw materials and energy of approximately $34 million, net of cost savings initiatives, and a decline in sales volumes of approximately $30 million, partially offset by a benefit of approximately $39 million due to the net effect of price increases and product mix.
Unilin Segment - Operating loss was $482.5 million in the first nine months of 2008 reflecting a decrease of $695.8 million compared to operating income of $213.3 million (19.5% of segment net sales) for the first nine months of 2007. The decrease was primarily due to the preliminary impairment of goodwill and other intangibles of $633.4 million, a decline in sales volumes of approximately $54 million and rising costs for raw materials and energy of approximately $33 million, net of cost savings initiatives, partially offset by a benefit of approximately $20 million due to the net effect of price increases and product mix.
Interest expense
Interest expense for the first nine months of 2008 was $97.0 million compared to $118.2 million for the first nine months of 2007. The decrease in interest expense was directly related to lower average debt levels in the first nine months of 2008 when compared to the first nine months of 2007.
Income tax expense
Income tax expense was $194.2 million for the first nine months of 2008 compared to $132.2 million, or 28.7% of earnings before income taxes, for the prior year's first nine months. The change in the tax rate is principally due to the impact on pre-tax earnings of a preliminary impairment of non-deductible goodwill and the recognition of a valuation allowance of $253 million against the deferred tax benefit described above.
Liquidity and Capital Resources
The Company's primary capital requirements are for working capital, capital expenditures and acquisitions. The Company's capital needs are met primarily through a combination of internally generated funds, bank credit lines, term and senior notes, the sale of trade receivables and credit terms from suppliers.
Cash flows provided by operations for the first nine months of 2008 were $371.5 million compared to cash flows provided by operations of $601.8 million for the first nine months of 2007. The decrease in operating cash flows for the first nine months of 2008 as compared to the first nine months of 2007 is primarily attributable to lower earnings from declining business conditions, the timing of receipts due to a calendar shift in the fourth quarter of 2007 as compared to 2006, a change in customer mix and lower accounts payable and accruals due to lower volumes, partially offset by lower inventory levels.
Net cash used in investing activities for the first nine months of 2008 was $163.7 million compared to $240.6 million for the first nine months of 2007. The increase is due to an increase in and the timing of additional plant capital spending during 2008 as compared to 2007. Capital spending during the remainder of 2008 for the Mohawk, Dal-Tile and Unilin segments combined, excluding acquisitions, is expected to range from $45 million to $55 million, and will be used primarily to purchase equipment and to streamline manufacturing capacity.
Net cash used in financing activities for the first nine months of 2008 was $235.4 million compared to net cash used in financing activities of $344.1 million for the same period in 2007. The Company has paid down approximately $233 million of debt during the first nine months of 2008.
During the third quarter of 2008 the Company's $750 million revolving credit facility was impacted by the bankruptcy of Lehman Brothers Holdings Inc ("Lehman"). As a result of the bankruptcy, the Company can no longer utilize its Lehman credit commitment of $100 million, thus reducing the Company's borrowing availability by $100 million. The Company believes the remaining banks in its revolving credit facility are stable and that the remaining availability is adequate to meet its liquidity requirements.
At September 27, 2008, a total of $427.7 million was available under the Company's revolving credit facility, which excludes the Lehman credit commitment of $100 million. The amount used under the revolving credit facility at September 27, 2008 was $222.3 million. The amount used under the revolving credit facility is composed of $119.5 million of borrowings, $55.6 million of standby letters of credit guaranteeing the Company's industrial revenue bonds and $47.2 million of standby letters of credit related to various insurance contracts and foreign vendor commitments. The Company's $750 million revolving credit facility matures on October 28, 2010 and bears interest, at the Company's option, at (i) the greater of (x) prime rate or (y) the overnight federal funds rate plus 0.50%, or (ii) Libor plus an indexed amount based on the Company's senior, unsecured, long-term debt rating.
At September 27, 2008, a total of $190 million (USD equivalent) was available under the Company's €130 million Euro revolving credit facility. This facility is available to the Company's European subsidiaries and guaranteed by the Company. The facility matures on November 8, 2010 and bears interest at Euribor plus an indexed amount based on the Company's senior, unsecured, long-term debt rating.
The Company has an on-balance sheet trade accounts receivable securitization agreement ("Securitization Facility"). At September 27, 2008, the Company had $50.0 million outstanding secured by trade receivables. On July 28, 2008, the Company amended and restated the Securitization Facility, reduced total availability from $350.0 million to $250.0 million due to its adequate liquidity position, and extended the term until July 2009.
On January 17, 2006, the Company issued $500.0 million aggregate principal amount of 5.750% notes due 2011 and $900.0 million aggregate principal amount of 6.125% notes due 2016. Interest payable on each series of the notes is subject to adjustment if either Moody's Investors Service, Inc. or Standard & Poor's Ratings Services, or both, downgrades the rating they have assigned to the notes. Each rating agency downgrade results in a 0.25% increase in the interest rate, subject to a maximum increase of 1% per rating agency. If later the rating of these notes improves, then the interest rates would be reduced accordingly. Each 0.25% increase in the interest rate of these notes would increase the Company's interest expense by approximately $3.5 million per year. To date, there have been no adjustments to the interest rate of these notes. However, on November 7, 2008, Moody's Investors Service, Inc. announced that it placed the Company's Baa3 long term rating on review for possible downgrade.
Contractual Obligations
There have been no significant changes to the Company's contractual obligations as disclosed in the Company's 2007 Annual Report filed on Form 10-K.
Critical Accounting Policies and Estimates
In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the U.S., the Company must make decisions which impact the reported amounts of assets, liabilities, revenues and expenses, and related disclosures. Such decisions include the selection of appropriate accounting principles to be applied and the assumptions on which to base accounting estimates. In reaching such decisions, the Company applies judgment based on its understanding and analysis of the relevant circumstances and historical experience. Actual amounts could differ from those estimated at the time the consolidated financial statements are prepared.
The Company's significant accounting policies are described in Note 1 to the Consolidated Financial Statements in its 2007 Form 10-K. Some of those significant accounting policies require the Company to make subjective or complex judgments or estimates. Critical accounting policies are defined as . . .
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