1 SHAW FINANCIAL LITERACY Overview March 24, 2015

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SHAW FINANCIAL LITERACYOverview

March 24, 2015

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Objectives

• Continue to learn about the 5 Business Drivers (Cash, Growth, Profit, Assets, People)

• Learn about Shaw specific financial terms and concepts

• Learn key financial measurements

• Learn about the Shaw income statement

• We will not attempt to make you an Accountant

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Agenda

JIM KIRKPATRICK – VP Corporate Finance

•Shaw Reporting Structure

•Key Terms and Concepts

•Reporting Books

ALAN HUNDLEY – Corporate Controller

•Shaw Key Financial Measures

BRENT WILLIAMS – Assistant Controller

•Income Statement Overview

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Shaw Structure and Overview

• Reporting Entities – Not to be confused with divisions.– Shaw Manufacturing, Sales, and Distribution

– Spectra (also includes Shaw Sports Turf, Shaw Grass and Southwest Greens International)

– SCG Australia

– Clear Path Recycling (JV)

– Sports Complex Holdings, LLC

– Shaw Industries SARL (includes all Asia Pacific entities – China, Singapore, Hong Kong, India)

– Shaw Chile Limitada

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SHAW SPORTS TURF – BALTIMORE RAVENS

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Southwest Greens InternationalCustomer Install in Atlanta

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Jack Nicklaus’ house in Florida – 100% turf!

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Joint Ventures

• Terza – Mexican manufacturer of carpet and rugs

• Watershed Geosynthetics (f.k.a Closure Turf) – Sells and installation of turf systems to cap landfills, coal ash ponds and protect levee systems

• GeoHay - Sells erosion control materials made of recycled materials

• Clear Path Recycling – Recycles plastic bottles into polyester flake

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9Watershed Geosynthetics - Crazy Horse Landfill in California

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Watershed Geosynthetics - HydroTurf Lake Bank ProtectionTerminus Wake Park @ LakePointe

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GeoHay Erosion Control Barriers

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Key Terms and Concepts

• GAAP

• Revenue Recognition Policy

• The Matching Principle

• EBIT / EBITDA

• Net Divisional Contribution

• Eliminations

• The Flash Report

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GAAPGAAP• Generally Accepted Accounting Principles

• Convergence with IFRS (International ‘GAAP’)

• GAAP – 25,000 pages of guidance; IFRS – only 2,000 pages

• IFRS involves significant judgment

• Significant changes upcoming related to the accounting for leases and revenue recognition

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Revenue Recognition PolicyRevenue Recognition Policy

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The Matching PrincipleThe Matching Principle

•Report expenses on the income statement in the same period as the related revenue•Example: In December, Shaw purchases $750 of adhesives from a supplier and sells them to a customer for $1,000. In January, the $750 invoice from the supplier arrives and Shaw pays it.•Since the $1,000 revenue is recognized in December, the $750 expense must also be recognized (accrued) in December.•Question – what if we paid commission in January on the sale?

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Key Terms and Concepts (continued)

EBIT and EBITDAEBIT and EBITDA

• EBIT = Earnings Before Interest and Taxes

• At Shaw, our term of Operating Income = EBIT

• Basically, EBIT is Net Income adding back Tax Provision and Interest Expense

• Why talk about EBIT?

• EBITDA = Earnings Before Interest, Taxes, Depreciation and Amortization

• Shaw versus Mohawk: We have $0 debt, Mohawk has $2.3 Billion in debt. Shaw has minimal interest, Mohawk has $98 million in interest expense

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Net Divisional Contribution (“NDC”)Net Divisional Contribution (“NDC”)

•Net Sales less Cost of Sales Less Selling Expenses

Net Sales

-Cost of Sales

= Gross Margin

-Selling Expenses

= Net Divisional Contribution

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Intercompany EliminationsIntercompany Eliminations

•Involve transactions between companies that are members of the same group.•Example: Shaw sells $1,000 of carpet to Spectra. Spectra sells the carpet to the customer for $1,500. What is the revenue that should be recognized?

Shaw Revenue $1,000

Spectra Revenue $1,500

Total Revenue $2,500

Elimination (1,000)

Net Revenue $1,500

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The Flash ReportThe Flash Report

•Daily Report that is delivered to our senior leaders •Reports Daily, Monthly and Quarterly Orders and Shipments as compared to prior year and budget•Reports Square Yards, ANSP and Gross Margin percent•Report is also broken down by selling company and region

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The Flash Report

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The Reporting Books

• Blue Book (Preliminary)

• Blue Book (Final) – provided to Berkshire

• Red Book – Residential

• Purple Book - Contract

• Yellow Book – Hard Surfaces

• Orange Book – Home Centers

• Black Book – Spectra

• Gray Book - Budget

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Shaw Financial Literacy

Shaw’s Key Financial Measures

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Shaw Key Metrics

• Revenues

• Gross Margin

• Inventory Turns

• Days Sales Outstanding (“DSO”)

• Days Payables Outstanding (“DPO” or “DCO”)

• Cash Flow or Free Cash Flow

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Shaw Key Metrics

• Financial Statements

– Comparative Income Statements• Actual vs Budget and Prior Year

– Balance Sheet

– Statement of Free Cash Flows

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Shaw Key Metrics (continued)

Income Statement – RevenuesIncome Statement – Revenues•High-level:

– Units shipped during period

– Average Net Selling Price (ANSP)

•Deeper dive:

– Product Mix (Carpet/Hardsurface, Tile/Broadloom, Wood/Resilient, Commodity/High End, Mature/Emerging)

– Market Mix (Residential/Commercial, Retail/Builder/ Domestic/International)

– Orders vs Shipments (what about the weather?)

•Drivers:

– Housing Starts and Sales, Interest Rates, Unemployment

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Income Statement - RevenuesIncome Statement - Revenues•Notes:

– Shifts and trends in Revenue drive strategic direction

– Economic changes in 2006 and 2007 changed the flooring industry radically - Focus shifted to cost control and cost reduction (plant closings, layoffs, etc)

– Currently, Revenue Growth is linked to our Business Strategy

– Growth provides opportunities for our associates and our communities.

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Income Statement - Gross MarginIncome Statement - Gross Margin•High-level:

– Net Sales less Cost of Sales– Cost of Sales: For the products sold (shipped) during the period, all

costs associated with getting products ready for sale.

•Deeper Dive: – Shaw uses standard costing methodology: Inventories are valued at an

estimated cost (updated quarterly) that is intended to reflect actual cost– Standard Cost of Sales: As inventory is sold, the value on the balance

sheet is relieved and charged to Cost of Sales at the standard cost

– Purchase Price Variance (PPV): The extent to which the actual cost of raw materials purchased during the period do not equal the standard cost

– Operating Variance (OPV): The extent to which the actual cost of the products manufactured during the period do not equal the standard cost

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Income Statement - Gross MarginIncome Statement - Gross Margin•Drivers:

– Mix of products sold during the period: (high-end carpet tile vs commodity product to a home center)

– Variances from Standard (OPV and PPV): always the “wild-cards” in our Income Statement.

• PPV is driven by Oil and other Petrochemical markets as well as other not so obvious factors – Fertilizer as an example

• OPV is driven by many factors, the largest being the number of units produced during the period because every plant has a certain amount of fixed cost

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Income Statement – Selling, General and Admin Income Statement – Selling, General and Admin •High-level - Selling Cost:

– Personnel, Travel & Entertainment, Advertising, Sample Cost, and Freight Out to Customers (Net of Freight Charges to Customers)

•Drivers: – Headcount and travel, variable compensation, sample programs and

timing, profitability on customer deliveries

•High-level - General and Administrative: – Primarily personnel, occupancy, and software cost. Also includes Bad

Debt Expense.

– Includes Information Services, Facilities, Accounting, Customer Service, Financial Services, etc.

•Drivers: – Headcount and Systems are the main drivers (Largely a Fixed Cost)

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Balance Sheet – Balance Sheet – •Key Metrics and Management Focal Points Include:

– Cash Management – Receivables / Payables Management – Inventory Control

•Key Metrics around Cash Management: – Cash on hand - forecasting and optimizing– Administrative Efficiencies (Collection and Disbursement

Methods)– Days Sales Outstanding (DSO)– Days Cost Outstanding (DCO) (also referred

to as Days Payable Outstanding (DPO)

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Balance Sheet – InventoriesBalance Sheet – Inventories

•Key Metrics around Inventory Control:

– Balance on Hand – Dollars and Quantities

– Count adjustments and shrink

– Valuation Adjustments (lower of actual cost or market value)

– Carrying Cost

– Inventory Turns

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Inventory TurnsInventory Turns•High-level:

– Cost of Sales / Avg Inventory = Number of Turns Per Year– 365 / Number of Turns = Days of Inventory on Hand– Lower turns = cash trapped on the balance sheet– Higher turns = lower inventory and potential service issues,

always seeking a balance•Drivers:

– Cost of Sales – Inventory Levels

•Note:– Increasing inventory turns is a key corporate imperative of

2015

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Days Sales Outstanding (“DSO”)Days Sales Outstanding (“DSO”)•High Level:

– Revenues / Average Receivables = DSO– Higher DSO = cash trapped on the balance sheet

Drivers:– Customer payment terms (longer = higher DSO)– Special invoicing promotions – Highly negotiable– Often driven by competitive situations– Often “traded” for revenue volume or selling price

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Days Cost Outstanding (“DCO”)Days Cost Outstanding (“DCO”)

•High Level:– Cost of Sales / Average Payables = DCO– Higher value means more cash is retained on the

balance sheet

•Drivers:– Payment terms for our suppliers

•Note:– Balancing DCO with DSO was a stated corporate

imperative in 2014.

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Inventory Turns, DSO, DPO Recap:Inventory Turns, DSO, DPO Recap:

Ratio: Involves: If High: If Low:

Inventory Turns

Asset Good Bad

Inventory Days

Asset Bad Good

DSO Asset Bad Good

DPO Liability Good Bad

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Cash Flow StatementCash Flow Statement•High Level: Statement that calculates the cash impact of operating and financing activities.

– Based on changes in asset and liability accounts combined with results from operations.

– Positive Cash Flows obviously good

•Drivers:

– Decreases in Inventory or Receivables

– Increases in Accounts Payable

– Increases in Net Income

•2014 Initiative – Extended Terms and Supply Chain Finance

•2014 Record Amount of Capital Expenditures

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Shaw Financial Literacy

Example Income Statement

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““Blue Book”Blue Book”

•Shaw’s financial statements

•You will also hear the term “P&L” (Profit & Loss), which is the same as the Income Statement.

•Reference the example page that has been distributed.

•All numbers are fictitious.

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Gross to Net Sales

“CARP”

Mostly Contractual

Key Measure

Everything indexed to Net Sales

Compare to Budget and Prior

Year

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Cost of Sales

Often hear “Margin at Standard”, which is Net Sales minus Cost at Standard, and is normally expressed as a percentage of Net Sales, so 33.81% in this example.

Is 30.7% Gross Margin “good”?

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What would a 10% increase in Net Sales mean for this business?• $275k in additional gross margin

($8,948 X 10% X 30.71%)

• Could actually be higher since some costs are fixed and thus do not increase proportionately with sales.

• Could also be lower if we sold for a lower price mix.

What about a 1 percentage point (100 basis point) increase in gross margin?• $89k in additional gross margin

($8,948 X 1%)

We really like to have both.

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Selling Expenses

If we added a salesperson, with a total cost of $100k per year for salary, commissions, travel, and benefits, what impact does that have on the percent of sales?• it would increase the percentage of Net Sales by 1.1% if this were an

annual P&L ($100k / $8,948k)

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Net Divisional Contribution

• Often called “NDC”, this is the “bottom-line” of a division.

• Another Key Measure

• Computed as Gross Margin minus Selling Expenses

• We must have a high enough NDC to cover remaining administrative costs and taxes.

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General & Administrative (G&A)

Overhead cost that supports the entire company vs. any single division.•Includes groups like: IS/IT, Financial Services, Accounting, Customer Service, etc.•Not directly related to making, handling or selling products

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Operating Income

Represents the net earnings from ongoing operations.

Operating Income a.k.a. “EBIT”

Another Key Measure

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Interest, Nonrecurring, Miscellaneous & Tax

Other Expense (Income) reflects items that do not relate to day-to-day operations.•Miscellaneous Income is $48k•Nonrecurring Charges would reflect cost of one-time events such as shutting down a plant.

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Supplemental Information

•While not a standard line on a P&L, we want to know our ANSP for Carpet and Hard Surfaces.

Conforming to GAAP Requirements

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So What?•We establish an annual plan in this format.

•Compare against it on a daily basis (via the flash report).

•Compare across product lines, divisions, markets, etc.

•Target areas/lines for improvement; Five Key Imperatives:– Grow Sales (Driver = Growth)

– Achieve identified operational improvement goals (Driver = Profit)

– Improve Inventory Turns by 0.5X (Driver = Cash and Assets)

– Achieve Hardwood improvement goals (Driver = Profit)

– Successfully startup Plants EG [Evergreen Ringgold], and RP [LVT] (Driver = Growth, Assets, People and Profit)

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Who all thinks you know which line on the income statement you fall under?

What can you and I do to help improve results?• Can you sell more? At a higher price?• Can you reduce cost of manufacturing? Shipping?• Can you reduce administrative cost?

Who could you ask if you are unsure?

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Questions?

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Documents

1 SHAW FINANCIAL LITERACY Overview March 24, 2015