# MOHAWK INDUSTRIES INC (MHK) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from MOHAWK INDUSTRIES INC's 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/851968/000085196822000026/mhk-20211231.htm
Accession: 0000851968-22-000026
Filing date: 2022-02-23
Report date: 2021-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/MHK/
All MD&A years: /company/MHK/mda/
Next year: /company/MHK/mda/fy2022/ (FY 2022)

Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The following discussion and analysis of the Company’s Results of Operations includes a comparison of fiscal 2021 to fiscal 2020. A similar discussion and analysis that compares fiscal 2020 to fiscal 2019 may be found in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of the Company’s Form 10-K for the fiscal year ended December 31, 2020.

During the past two decades, the Company has grown significantly. Its current geographic breadth and diverse product offering are reflected in three reporting segments: Global Ceramic; Flooring North America (“Flooring NA”); and Flooring Rest of the World (“Flooring ROW”). The Global Ceramic Segment designs, manufactures, sources and markets a broad line of ceramic tile, porcelain tile, natural stone tile and other products including natural stone, porcelain slabs and quartz countertops, which it distributes primarily in North America, Europe, Brazil and Russia through various selling channels, which include company-owned stores, independent distributors and home centers. The Flooring NA Segment designs, manufactures, sources and markets its floor covering products, including broadloom carpet, carpet tile, carpet cushion, rugs, laminate, vinyl products, including luxury vinyl tile (“LVT”) and sheet vinyl, and wood flooring, all of which it distributes through its network of regional distribution centers and satellite warehouses using Company-operated trucks, common carriers or rail transportation. The Segment’s product lines are sold through various channels, including independent floor covering retailers, independent distributors, home centers, mass merchandisers, department stores, shop at home, online retailers, buying groups, commercial contractors and commercial end users. The Flooring ROW Segment designs, manufactures, sources, licenses and markets laminate, vinyl products, including LVT and sheet vinyl, wood flooring, roofing panels, insulation boards, medium-density fiberboard (“MDF”) and chipboards, which it distributes primarily in Europe, Russia, Australia and New Zealand through various channels, including independent floor covering retailers, independent distributors, company-owned distributors, home centers, commercial contractors and commercial end users.

Mohawk is a significant supplier of every major flooring category with manufacturing operations in 18 nations and sales in approximately 170 countries. Based on its annual sales, the Company believes it is the world’s largest flooring manufacturer. A majority of the Company’s long-lived assets are located in the United States and Europe, which are also the Company’s primary markets. Additionally, the Company maintains operations in the United Kingdom, Russia, Mexico, Australia, New Zealand, Brazil and other parts of the world. The Company is a leading provider of flooring for residential and commercial markets and has earned significant recognition for its innovation in design and performance as well as sustainability.

Due to its global footprint, Mohawk’s business is sensitive to macroeconomic events in the United States and abroad. The current environment has placed unprecedented demands on the Company’s operations as the COVID-19 pandemic has caused disruptions to the Company’s markets and operations around the world. While the near-term economic and financial impact of the COVID-19 pandemic is improving in its residential markets, the Company expects that it will continue to see fluctuating demand across a number of its markets. During 2020, the Company completed actions prompted by the evolving COVID-19 pandemic to enhance future performance including site closings, other facility and product rationalizations and workforce reductions. These global actions delivered savings of approximately $110 million in the aggregate in 2020 and 2021, with costs of approximately $168 million.

During 2021, inflation in materials, energy, transportation and labor has impacted the Company’s profitability across all segments. Mohawk has, to some extent, offset the impact of inflationary pressures through multiple pricing actions across product categories and geographies; improved mix from sales of higher-value, differentiated products; and productivity gains in manufacturing and logistics. In the near future, the Company might not foresee significant changes in these external pressures, which could have an adverse impact on the Company’s results. In Europe, natural gas prices accelerated at an unprecedented pace due to supply shortages and are presently more than five times higher than last year. Given the unexpected acceleration of natural gas expenses, the European flooring industry will require some time to align product prices with higher energy costs, which could result from pricing actions, de-escalation of energy costs or a combination of the two factors. The duration of the natural gas price spike is unpredictable, and the Company will explore all options to manage the impact of energy inflation while continuing to deliver service to customers, but this energy inflation could impact future results of operations.

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The Company believes it has the experience and resources necessary to capitalize on opportunities that will arise given projected strength in residential new construction and remodeling and forecasts for lower inflation, improved global supply chain issues and eventual pandemic containment. The Company also believes it is well positioned with a strong balance sheet and limited debt. Based on its current liquidity and available credit, the Company is in a position to finance internal investments, acquisitions and/or additional stock purchases. Finally, the Company is applying recommendations of local health authorities with procedures that minimize COVID-19 pandemic exposure risk for employees, suppliers, customers and other stakeholders. For information on risk that could impact the Company’s results, please refer to “Risk Factors” in Part I, Item 1A of this Form 10-K.

Since becoming a publicly traded company in April 1992, Mohawk has grown both organically and through strategic and bolt-on acquisitions. The Company’s most recent major acquisitions were in 2018: Godfrey Hirst, the largest floor covering manufacturer in Australia and New Zealand; and Eliane, a leading manufacturer and exporter of ceramic tile in Brazil. Mohawk has completed a number of smaller acquisitions during the past three years; many of which expanded the Company’s hard surface flooring distribution in Europe. During 2021, the Company purchased an Irish insulation manufacturer that complemented its existing insulation production and distribution in Ireland and the U.K. and a French MDF production plant that added additional capacity and product offerings.

In 2021, the Company invested $676.1 million in capital projects to expand capacities, create differentiated products, and improve productivity.  The largest investments during this period were ceramic tile capacity increases in Brazil, Italy, and Russia; premium laminate capacity increases in North America and Europe; LVT in North America; and countertop expansions in North America and Europe. In 2022, the Company plans to invest an additional amount of approximately $800 million to complete existing projects and commence new initiatives. The Company plans to invest in cost reduction initiatives, upgrades in recent acquisitions and previously initiated expansion projects as well as maintenance across the businesses. The main investment areas include the Company’s LVT portfolio to upgrade its product offering and improve profitability; premium water-proof laminate in North America and Europe; ceramic capacity increases in Brazil, Italy, and Russia; and countertop expansion in North America and Europe.

Net earnings attributable to the Company were $1,033.2 million, or diluted EPS of $14.94 for 2021 compared to net earnings attributable to the Company of $515.6 million, or diluted EPS of $7.22 for 2020. The change in EPS was primarily attributable to the favorable net impact of price and product mix, the favorable net impact of higher volumes, productivity gains, lower restructuring, acquisition and integration-related costs, the favorable impact due to fewer short-term manufacturing disruptions and the favorable net impact from foreign exchange rates, partially offset by higher inflation, higher costs associated with investments in new product development and marketing costs and higher startup costs. The Company’s operations and net earnings for 2020 were affected by broader economic conditions related to the COVID-19 pandemic. In particular, the Company experienced decreasing demand during the first six months of 2020 and increased costs associated with short-term reductions in manufacturing output. The Company believes that a number of circumstances may impact trends in 2022, including the continuation of the COVID-19 pandemic, impacts to material availability due to disruptions in the global supply chain and inflation, but the extent and duration of such impact cannot be predicted.

For the year ended December 31, 2021, the Company generated $1,309.1 million of cash from operating activities. As of December 31, 2021, the Company had cash and cash equivalents of $268.9 million, of which $68.4 million was in the United States and $200.5 million was in foreign countries, in addition to $323.0 million in short-term investments. On October 19, 2021, the Company redeemed at par the 2.00% Senior Notes, originally due on January 14, 2022, and paid the remaining €500 million outstanding principal of the 2.00% Senior Notes, plus any unpaid interest, utilizing cash on hand.

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Results of Operations

Following are the results of operations for the last two years:

[[GREPCENT_TABLE]]
[["","For the Years Ended December 31,"],["","2021","","2020"],["","(In millions)"],["Statement of operations data:"],["Net sales","$","11,200.6","","","100.0","%","","9,552.2","","","100.0","%"],["Cost of sales (1)","7,931.9","","","70.8","%","","7,121.5","","","74.6","%"],["Gross profit","3,268.7","","","29.2","%","","2,430.7","","","25.4","%"],["Selling, general and administrative expenses (2)","1,933.7","","","17.3","%","","1,794.7","","","18.8","%"],["Operating income","1,335.0","","","11.9","%","","636.0","","","6.7","%"],["Interest expense","57.3","","","0.5","%","","52.4","","","0.5","%"],["Other income (3)","(12.2)","","","(0.1)","%","","(0.8)","","","0.0","%"],["Earnings before income taxes","1,290.0","","","11.5","%","","584.4","","","6.1","%"],["Income tax expense (4)","256.4","","","2.3","%","","68.6","","","0.7","%"],["Net earnings including noncontrolling interests","1,033.5","","","9.2","%","","515.7","","","5.4","%"],["Less: Net earnings attributable to noncontrolling interests","0.4","","","0.0","%","","0.1","","","0.0","%"],["Net earnings attributable to Mohawk Industries, Inc.","$","1,033.2","","","9.2","%","","515.6","","","5.4","%"],["(1) Cost of sales includes:"],["Restructuring, acquisition and integration-related charges","$","18.4","","","0.2","%","","102.4","","","1.1","%"],["Acquisition inventory step-up","1.7","","","0.0","%","","\u2014","","","\u2014","%"],["Other charges","\u2014","","","\u2014","%","","24.5","","","0.3","%"],["(2) Selling, general and administrative expenses include:"],["Restructuring, acquisition and integration-related charges","5.2","","","0.0","%","","26.5","","","0.3","%"],["Other charges","\u2014","","","\u2014","%","","10.1","","","0.1","%"],["(3) Other expense (income) includes:"],["Resolution of foreign non-income tax contingencies","(6.2)","","","(0.1)","%","","\u2014","","","\u2014","%"],["Other charges","(0.5)","","","0.0","%","","3.3","","","0.0","%"],["(4) Income tax expense (income) includes:"],["One-time tax planning election","(22.2)","","","(0.2)","%","","\u2014","","","\u2014","%"],["Income tax effect on resolution of foreign non-income tax contingencies","2.3","","","0.0","%","","\u2014","","","\u2014","%"],["Other charges","0.9","","","0.0","%","","0.3","","","0.0","%"]]
[[/GREPCENT_TABLE]]

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Year Ended December 31, 2021, as Compared with Year Ended December 31, 2020

Net sales

Net sales for 2021 were $11,200.6 million, reflecting an increase of $1,648.4 million, or 17.3%, from the $9,552.2 million reported for 2020. The increase was primarily attributable to the favorable net impact of price and product mix of approximately $792 million, higher volumes of approximately $739 million, and the favorable net impact from foreign exchange rates of approximately $160 million, partially offset by the unfavorable impact from one less shipping day for 2021 of approximately $42 million. In 2020, the Company’s global sales were affected by broader economic conditions related to the COVID-19 pandemic. In particular, the Company experienced decreasing demand during the first six months of 2020.

Global Ceramic Segment—Net sales increased $484.5 million, or 14.1%, to $3,917.3 million for 2021, compared to $3,432.8 million for 2020. The increase was primarily attributable to the favorable net impact of price and product mix of approximately $239 million, higher volumes of approximately $236 million and the favorable net impact from foreign exchange rates of approximately $22 million, partially offset by the unfavorable impact from one less shipping day for 2021 of approximately $12 million.

Flooring NA Segment—Net sales increased $522.3 million, or 14.5%, to $4,116.4 million for 2021, compared to $3,594.1 million for 2020. The increase was attributable to the favorable net impact of price and product mix of approximately $269 million and higher volumes of approximately $275 million, partially offset by the unfavorable impact from one less shipping day for 2021 of approximately $21 million.

Flooring ROW Segment—Net sales increased $641.5 million, or 25.4%, to $3,166.9 million for 2021, compared to $2,525.4 million for 2020. The increase was primarily attributable to the favorable net impact of price and product mix of approximately $284 million, higher volumes of approximately $228 million and the favorable net impact from foreign exchange rates of approximately $138 million, partially offset by the unfavorable impact from one less shipping day for 2021 of approximately $9 million.

Quarterly net sales and the percentage changes in net sales by quarter for 2021 versus 2020 were as follows (dollars in millions):

[[GREPCENT_TABLE]]
[["","2021","","2020","","Change"],["First quarter","$","2,669.0","","","2,285.8","","","16.8","%"],["Second quarter","2,953.8","","","2,049.8","","","44.1","%"],["Third quarter","2,817.0","","","2,574.9","","","9.4","%"],["Fourth quarter","2,760.7","","","2,641.8","","","4.5","%"],["Total year","$","11,200.6","","","9,552.2","","","17.3","%"]]
[[/GREPCENT_TABLE]]

Gross profit

Gross profit for 2021 was $3,268.7 million (29.2% of net sales), an increase of $838.0 million or 34.5%, compared to gross profit of $2,430.7 million (25.4% of net sales) for 2020. As a percentage of net sales, gross profit increased 380 basis points. The increase in gross profit dollars was primarily attributable to the favorable net impact of price and product mix of approximately $593 million, productivity gains of approximately $263 million, higher volumes of approximately $257 million, lower restructuring, acquisition and integration-related costs of approximately $107 million, the favorable impact of approximately $90 million due to fewer short-term manufacturing disruptions and the favorable net impact from foreign exchange rates of approximately $55 million, partially offset by higher inflation of approximately $524 million and approximately $4 million of higher startup cost. As previously discussed, the Company’s operations for the period did not reflect normal seasonality in 2020 and were affected by broader economic conditions related to the COVID-19 pandemic. In particular, the Company experienced increased costs associated with short-term reductions in manufacturing output in addition to decreased demand during the first six months of 2020.

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Selling, general and administrative expenses

Selling, general and administrative expenses for 2021 were $1,933.7 million (17.3% of net sales), an increase of $139.0 million or 7.7% compared to $1,794.7 million (18.8% of net sales) for 2020. As a percentage of net sales, selling, general and administrative expenses decreased 150 basis points. The increase in selling, general and administrative expenses in dollars was primarily attributable to an increase in costs that were curtailed in 2020 due to the COVID-19 pandemic of approximately $54 million, higher volumes of approximately $45 million, higher inflation costs of approximately $35 million, the unfavorable net impact from foreign exchange rates of approximately $20 million, higher costs associated with investments in new product development and marketing costs of approximately $9 million and the unfavorable net impact of price and product mix of approximately $7 million, partially offset by the lower restructuring, acquisition and integration-related costs of approximately $31 million.

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Operating income

Operating income for 2021 was $1,335.0 million (11.9% of net sales) reflecting an increase of $699.0 million, or 109.9%, compared to operating income of $636.0 million (6.7% of net sales) for 2020. The increase in operating income was primarily attributable to approximately $586 million due to the favorable net impact of price and product mix, higher volumes of approximately $212 million, productivity gains of approximately $209 million, the impact of lower restructuring, acquisition and integration-related costs of approximately $138 million, the favorable impact due to fewer short-term manufacturing disruptions of approximately $90 million and the favorable net impact from foreign exchange rates of approximately $34 million, partially offset by higher inflation costs of approximately $559 million, higher costs associated with investments in new product development and marketing costs of approximately $9 million and higher startup costs of approximately $4 million. As previously discussed, the Company’s operations for 2020 were negatively impacted by disruptions from the COVID-19 pandemic resulting in decreased demand during the first six months of 2020 and increased costs associated with short-term reductions in manufacturing output.

Global Ceramic Segment—Operating income was $403.1 million (10.3% of segment net sales) for 2021 reflecting an increase of $235.4 million, or 140.3%, compared to operating income of $167.7 million (4.9% of segment net sales) for 2020. The increase in operating income was primarily attributable to the favorable net impact of price and product mix of approximately $167 million, higher productivity gains of approximately $82 million, lower restructuring, acquisition and integration-related costs of approximately $63 million, higher volumes of approximately $62 million and the favorable impact due to fewer short-term manufacturing disruptions of approximately $38 million, partially offset by higher inflation costs of approximately $173 million and higher costs associated with investments in new product development and marketing costs of approximately $9 million.

Flooring NA Segment—Operating income was $407.6 million (9.9% of segment net sales) for 2021 reflecting an increase of $260.2 million, or 176.5%, compared to operating income of $147.4 million (4.1% of segment net sales) for 2020. The increase in operating income was primarily attributable to the favorable net impact of price and product mix of approximately $177 million, higher productivity gains of approximately $135 million, higher volumes of approximately $66 million, the favorable impact due to fewer short-term manufacturing disruptions of approximately $39 million and lower restructuring, acquisition and integration-related costs of approximately $34 million, partially offset by higher inflation costs of approximately $189 million.

Flooring ROW Segment—Operating income was $571.1 million (18.0% of segment net sales) for 2021 reflecting an increase of $204.2 million, or 55.7%, compared to operating income of $366.9 million (14.5% of segment net sales) for 2020. The increase in operating income was primarily attributable to the favorable net impact of price and product mix of approximately $242 million, higher volumes of approximately $84 million, lower restructuring, acquisition and integration-related costs of approximately $36 million, the favorable net impact from foreign exchange rates of approximately $35 million and the favorable impact due to fewer short-term manufacturing disruptions of approximately $14 million, partially offset by higher inflation costs of approximately $193 million, an increase in costs that were curtailed due to the COVID-19 pandemic of approximately $7 million and higher startup costs of $4 million.

Interest expense

Interest expense was $57.3 million for 2021, reflecting an increase of $4.9 million compared to interest expense of $52.4 million for 2020. During the second quarter of 2020, the Company issued new long-term debt to strengthen its liquidity position during the early months of the COVID-19 pandemic, which shifted the Company from a mix of fixed and floating rate debt, with a lower average interest rate, to more fixed rate debt, which carries a higher average interest rate. The higher average interest rate impacted interest expense for all of 2021 compared to a portion of 2020, with the impact partially offset by the early redemption of the €500.0 million 2.00% Senior Notes in October 2021 and the prepayment of the Term Loan Facility of $500.0 million in May 2020.

Other expense (income)

Other income was $12.2 million for 2021, reflecting a favorable change of $11.4 million compared to other income of $0.8 million for 2020. The change was primarily attributable to the resolution of foreign non-income tax contingencies of $6.2 million, favorable net impact of foreign exchange rates of $1.5 million, an impairment charge of $3.6 million related to the Company’s net investment in a joint venture in Brazil during 2020 and other miscellaneous items.

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Income tax expense

For 2021, the Company recorded income tax expense of $256.4 million on earnings before income taxes of $1,290.0 million for an effective tax rate of 19.9%, as compared to an income tax expense of $68.6 million on earnings before income taxes of $584.4 million, resulting in an effective tax rate of 11.7% for 2020. In 2021, the Company was impacted by significant pre-tax income differences between the 2020 and 2021 periods that was a result of the recovery from the COVID-19 pandemic, a one-time Italian step-up benefit allowing for the realignment of tax asset values, and carryback rate differential in the U.S. In 2020, the Company realized a $33.8 million carryback rate differential in the U.S. and had a $10.3 million tax benefit from a foreign exchange loss on previously taxed earnings distributed during the year.

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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, commercial paper, bank credit lines, term and senior notes and credit terms from suppliers. As of December 31, 2021, the Company had a total of $1,184.7 million available under its Senior Credit Facility. The Company also maintains local currency revolving lines of credit and other credit facilities to provide liquidity to its businesses around the world.  None of such local facilities are material in amount.

Net cash provided by operating activities for the year ended 2021 was $1,309.1 million, compared to net cash provided by operating activities of $1,769.8 million for the year ended 2020. This decrease of $460.7 million was primarily attributable to changes in working capital, partially offset by higher net earnings.

Net cash used in investing activities for the year ended 2021 was $556.8 million compared to net cash used in investing activities of $954.8 million for the year ended 2020. The decrease was primarily due to the increase in the redemptions of short-term investments of $772.6 million (net of purchases of short-term investments), partially offset by the increase of capital expenditures of $250.6 million and an increase in acquisitions of $124.0 million.

Net cash used in financing activities for the year ended 2021 was $1,232.2 million compared to net cash used in financing activities of $188.2 million for the year ended 2020. The change in cash used in financing is primarily attributable to the lower proceeds from the Senior Notes of $1,667.6 million (net of repayments of $605.3 million) and higher share repurchases of $711.7 million, partially offset by the reduced net pay down on commercial paper of $1,310.3 million.

On September 16, 2021, the Company’s Board of Directors approved a new share repurchase program, authorizing the Company to repurchase up to $500 million of its common stock. This was in addition to the previously approved 2020 Share Repurchase Program. For the twelve months ended December 31, 2021, the Company purchased $900.3 million of its common stock, exhausting the $437.2 million remaining under the 2020 Share Repurchase Program, and utilizing $463.1 million under the 2021 Share Repurchase Program. As of December 31, 2021, there remained $36.8 million authorized under the 2021 Share Repurchase Program.

On February 10, 2022, the Company's Board of Directors approved a new share repurchase program, authorizing the Company to repurchase up to $500 million of its common stock. As of February 10, 2022, there remained zero authorized under the 2021 Share Repurchase Program.

As of December 31, 2021, the Company had cash of $268.9 million, of which $200.5 million was held outside the United States. In addition to its cash on hand, the Company also had short-term investments of $323.0 million as of December 31, 2021. The Company plans to permanently reinvest the cash held outside the United States. The Company believes that its cash and cash equivalents, and short-term investments on hand, cash generated from operations and availability under its Senior Credit Facility will be sufficient to meet its planned capital expenditures, further working capital investment and debt servicing requirements over the next twelve months.

See Note 10. Long-Term Debt, of the notes to the Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K for further discussion of the Company’s long-term debt. The Company may continue, from time to time, to retire its outstanding debt through cash purchases in the open market, privately negotiated transactions or otherwise. Such repurchases, if any, will depend on prevailing market conditions, the Company’s liquidity requirements, contractual restrictions and other factors. The amount involved may be material.

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Contractual obligations and commitments

The following is a summary of the Company’s future minimum payments under contractual obligations and commitments as of December 31, 2021 (in millions):

[[GREPCENT_TABLE]]
[["","Total","","2022","","2023","","2024","","2025","","2026","","Thereafter"],["Contractual obligations and commitments:"],["Long-term debt, including current maturities","$","2,333.4","","","624.5","","","610.0","","","8.4","","","7.1","","","4.8","","","1,078.6"],["Interest payments on long-term debt and finance leases (1)","234.1","","","30.8","","","28.6","","","28.5","","","28.4","","","28.3","","","89.4"],["Operating leases","427.2","","","120.8","","","98.8","","","73.9","","","56.9","","","40.5","","","36.5"],["Purchase commitments (2)","496.2","","","247.9","","","30.4","","","30.4","","","30.4","","","30.4","","","126.7"],["Expected pension contributions (3)","3.8","","","3.8","","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Uncertain tax positions (4)","6.2","","","6.2","","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Guarantees (5)","41.8","","","18.6","","","5.2","","","5.1","","","5.1","","","5.1","","","2.7"],["Total","$","3,542.7","","","1,052.6","","","773.0","","","146.3","","","127.9","","","109.1","","","1,333.9"]]
[[/GREPCENT_TABLE]]

(1)For fixed rate debt, the Company calculated interest based on the applicable rates and payment dates. For variable rate debt, the Company estimated average outstanding balances for the respective periods and applied interest rates in effect as of December 31, 2021 to these balances.

(2)Includes volume commitments for primarily raw material purchases.

(3)Includes the estimated pension contributions for 2022 only, as the Company is unable to estimate the pension contributions beyond 2022. The Company’s projected benefit obligation and plan assets as of December 31, 2021 were $80.3 million and $65.1 million, respectively. The projected benefit obligation liability has not been presented in the table above due to uncertainty as to amounts and timing regarding future payments.

(4)Excludes $53.4 million of non-current accrued income tax liabilities and related interest and penalties for uncertain tax positions. These liabilities have not been presented in the table above due to uncertainty as to amounts and timing regarding future payments.

(5)Includes bank guarantees and letters of credit.

Critical Accounting Policies

In preparing the consolidated financial statements in conformity with U.S. generally accepted accounting principles, 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 included in Part II, Item 8 of this Form 10-K. Some of those significant accounting policies require the Company to make subjective or complex judgments or estimates. Critical accounting estimates are defined as those that are both most important to the portrayal of a company’s financial condition and results and require management’s most difficult, subjective, or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.

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The Company believes the following accounting policies require it to use judgments and estimates in preparing its consolidated financial statements and represent critical accounting policies.

•Accounts receivable and revenue recognition. The Company recognizes revenues when it satisfies performance obligations as evidenced by the transfer of control of the promised goods to customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods. The nature of the promised goods are ceramic, stone, carpet, resilient, laminate, wood and other flooring products. Payment is typically received 90 days or less from the invoice date. The Company adjusts the amounts of revenue for expected cash discounts, sales allowances, returns, and claims, based upon historical experience. The Company adjusts accounts receivable for doubtful account allowances based upon relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount, periodic evaluation of specific customer accounts, and the aging of accounts receivable. If the Company expects the financial condition of the Company’s customers to deteriorate based on current conditions or reasonable and supportable forecasts, additional allowances may be required. A 10% change in the Company’s allowance for discounts, returns, claims and doubtful accounts would have affected net earnings by approximately $6 million for the year ended December 31, 2021.

•Inventories are stated at the lower of cost or market (net realizable value). Inventories are stated at the lower of cost or market (net realizable value). Cost has been determined using the first-in first-out method (“FIFO”). Costs included in inventory include raw materials, direct and indirect labor and employee benefits, depreciation, general manufacturing overhead and various other costs of manufacturing. Market, with respect to all inventories, is replacement cost or net realizable value. Inventories on hand are compared against anticipated future usage, which is a function of historical usage, anticipated future selling price, expected sales below cost, excessive quantities and an evaluation for obsolescence. Actual results could differ from assumptions used to value obsolete inventory, excessive inventory or inventory expected to be sold below cost, and a 10% change in the Company’s assumptions for excess or obsolete inventory would have affected net earnings by approximately $13 million for the year ended December 31, 2021.

•Acquisition Accounting. The fair value of the consideration the Company pays for each new acquisition is allocated to tangible assets and identifiable intangible assets, liabilities assumed, any noncontrolling interest in the acquired entity and goodwill.  The accounting for acquisitions involves a considerable amount of judgment and estimate, including the fair value of certain forms of consideration; fair value of acquired intangible assets involving projections of future revenues and cash flows that are then either discounted at an estimated discount rate or measured at an estimated royalty rate; fair value of other acquired assets and assumed liabilities, including potential contingencies; and the useful lives of the acquired assets. The assumptions used are determined at the time of the acquisition in accordance with accepted valuation models.  Projections are developed using internal forecasts, available industry and market data and estimates of long-term rates of growth for the business. The impact of prior or future acquisitions on the Company’s financial position or results of operations may be materially impacted by the change in or initial selection of assumptions and estimates.  See Note 2, Acquisitions included in Part II, Item 8 of this Form 10-K for further discussion of business combination accounting valuation methodology and assumptions.  

•Goodwill and other intangibles. Goodwill is tested annually for impairment in the fourth quarter or earlier upon the occurrence of certain events or substantive changes in circumstances. The Company considers the relationship between its market capitalization and its book value, among other factors, when reviewing for indicators of impairment. The goodwill impairment tests are based on determining the fair value of the specified reporting units based on management judgments and assumptions using the discounted cash flows and comparable company market valuation approaches. The Company has identified Global Ceramic, Flooring NA and Flooring ROW as its reporting units for the purposes of allocating goodwill and intangibles as well as assessing impairments. The valuation approaches are subject to key judgments and assumptions that are sensitive to change such as judgments and assumptions about appropriate sales growth rates, operating margins, weighted average cost of capital (“WACC”), and comparable company market multiples. When developing these key judgments and assumptions, the Company considers economic, operational and market conditions that could impact the fair value of the reporting unit. However, estimates are inherently uncertain and represent only management’s reasonable expectations regarding future developments. These estimates and the judgments and assumptions upon which the estimates are based will, in all likelihood, differ in some respects from actual future results. Should a significant or prolonged deterioration in economic conditions occur, such as declines in spending for new construction, remodeling and replacement activities; the inability to pass increases in the costs of raw materials and fuel on to customers; or a decline in comparable company market multiples, then key judgments and assumptions could be impacted. Generally, a decline in estimated after tax cash flows greater than approximately 24% to 43% or a percentage increase of approximately 22% to 60% in WACC or a significant or prolonged decline in market capitalization could result in an additional indication of impairment.

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The impairment test for intangible assets not subject to amortization involves a comparison of the estimated fair value of the intangible asset with its carrying value. If the carrying value of the intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. Significant judgments inherent in this analysis include assumptions about appropriate sales growth rates, royalty rates, WACC and the amount of expected future cash flows. These judgments and assumptions are subject to the variability discussed above.

The impairment evaluation for indefinite lived intangible assets, which for the Company are its trademarks, is conducted on the first day of the fourth quarter of each year, or more frequently if events or changes in circumstances indicate that an asset might be impaired. The determination of fair value used in the impairment evaluation is based on discounted estimates of future sales projections attributable to ownership of the trademarks. Significant judgments inherent in this analysis include assumptions about appropriate sales growth rates, royalty rates, WACC and the amount of expected future cash flows. The judgments and assumptions used in the estimate of fair value are generally consistent with past performance and are also consistent with the projections and assumptions that are used in operating plans. Such assumptions are subject to change as a result of changing economic and competitive conditions. The determination of fair value is highly sensitive to differences between estimated and actual cash flows and changes in the related discount rate used to evaluate the fair value of the trademarks. Estimated cash flows are sensitive to changes in the economy among other things.

The Company reviews its long-lived asset groups, which include intangible assets subject to amortization, which for the Company are its patents and customer relationships, for impairment whenever events or changes in circumstances indicate that the carrying amount of such asset groups may not be recoverable. Recoverability of asset groups to be held and used is measured by a comparison of the carrying amount of long-lived assets to future undiscounted net cash flows expected to be generated by these asset groups. If such asset groups are considered to be impaired, the impairment recognized is the amount by which the carrying amount of the asset group exceeds the fair value of the asset group. Assets held for sale are reported at the lower of the carrying amount or fair value less estimated costs of disposal and are no longer depreciated.

The Company conducted its annual assessment of goodwill and indefinite lived intangibles on the first day of the fourth quarter and no impairment was indicated for 2021. While the Company has concluded that neither goodwill nor any of its indefinite-lived intangible assets were impaired during the year ended December 31, 2021, a prolonged pandemic could impact the Company’s assumptions utilized in the determination of the estimated fair values of the Company’s reporting units and indefinite-lived intangible assets significantly enough to trigger an impairment.

•Income taxes. The Company’s effective tax rate is based on its income, statutory tax rates and tax planning opportunities available in the jurisdictions in which it operates. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in determining the Company’s tax expense and in evaluating the Company’s tax positions. Deferred tax assets represent amounts available to reduce income taxes payable on taxable income in a future period. The Company evaluates the recoverability of these future tax benefits by assessing the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. These sources of income inherently rely on estimates, including business forecasts and other projections of financial results over an extended period of time. In the event that the Company is not able to realize all or a portion of its deferred tax assets in the future, a valuation allowance is provided. The Company would recognize such amounts through a charge to income in the period in which that determination is made or when tax law changes are enacted. For further information regarding the Company’s valuation allowances, see Note 15, Income Taxes included in Part II, Item 8 of this Form 10-K.

In the ordinary course of business there is inherent uncertainty in quantifying the Company’s income tax positions. The Company assesses its income tax positions and records tax benefits for all years subject to examination based upon the Company’s evaluation of the facts, circumstances and information available as of the reporting date. For those tax positions where it is more likely than not that a tax benefit will be sustained, the Company has recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information, as required by the provisions of the Financial Accounting Standards Board (“FASB”) FASB Accounting Standards Codification Topic (“ASC”) 740-10. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit has been recognized in the consolidated financial statements. For further information regarding the Company’s uncertain tax positions, see Note 15, Income Taxes included in Part II, Item 8 of this Form 10-K.

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•Environmental and legal accruals. Environmental and legal accruals are estimates based on judgments made by the Company relating to ongoing environmental and legal proceedings, as disclosed in the Company’s consolidated financial statements. In determining whether a liability is probable and reasonably estimable, the Company consults with its internal experts. The Company believes that the amounts recorded in the accompanying financial statements are based on the best estimates and judgments available to it.

Recent Accounting Pronouncements

See Note 1(y), “Summary of Significant Accounting Policies”, of the Company’s accompanying audited Consolidated Financial Statements in Part II, Item 8 of this Form 10-K for a description of recent accounting pronouncements including the dates, or expected dates of adoption, and effects, or expected effects, on the Company’s disclosures, results of operations and financial condition.

Impact of Inflation

Inflation affects the Company’s manufacturing costs, distribution costs and operating expenses. The Company expects raw material prices, many of which are petroleum-based, to fluctuate based upon worldwide supply and demand of commodities utilized in the Company’s production processes. Although the Company attempts to pass on increases in raw material, labor, energy and fuel-related costs to its customers, the Company’s ability to do so is dependent upon the rate and magnitude of any increase, competitive pressures and market conditions for the Company’s products. There have been in the past, and may be in the future, periods of time during which increases in these costs cannot be fully recovered. In the past, the Company has often been able to enhance productivity and develop new product innovations to help offset increases in costs resulting from inflation in its operations.

Seasonality

The Company is a calendar year-end company. With respect to its Global Ceramic Segment, the second quarter typically sees higher net sales, followed by the third and first quarters, while the fourth quarter shows weaker net sales. For the segment’s operating income, generally, the second quarter shows stronger earnings, followed by third and first quarters, and the fourth quarter shows weaker earnings. The Flooring NA Segment’s second quarter typically produces higher net sales followed by moderate third and fourth quarters, and a weaker first quarter. For the segment’s operating income, historically, the third quarter shows stronger earnings, followed by second and fourth quarters, and a weaker first quarter. The Flooring ROW Segment’s second quarter historically typically produces higher net sales followed by moderate fourth and third quarters, and a weaker first quarter. For the segment’s operating income, generally, the second quarter shows stronger earnings, followed by first and third quarters, and the fourth quarter shows weaker earnings.

The COVID-19 pandemic has created significant volatility in the global economy and has led to unpredictable economic activity and impacted the supply chain for raw materials and sourced finished goods. The Company expects the impact of the COVID-19 pandemic to continue to impact normal seasonality trends into 2022, but the extent and duration of such impact cannot be predicted.

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