莫霍克工業集團 (MHK) 2005 Q4 法說會逐字稿

At this time I would like to welcome everyone to the Mohawk Industries' fourth-quarter 2005 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be question-and-answer session. (OPERATOR INSTRUCTIONS) I will now turn the call over to Mr. Jeff Lorberbaum, Chairman and CEO. Please go ahead, sir.

Thank you very much. Welcome to Mohawk's conference call. With me I have Frank Boykin, our CFO, who will read the Safe Harbor statement.

I would like to remind everyone that our press release and statements we make on this call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which are subject to various risks and uncertainties, including, but not limited to, those set forth in our press release and our filings with the SEC.

Thank you. Mohawk's fourth-quarter net earnings increased by 5% above the prior year to $108 million or $1.59 per share, before a onetime non-cash charge of $34 million for purchase accounting. In accordance with GAAP, net earnings were about $86 million, and diluted earnings per share was $1.26 for the fourth quarter. Net sales for the quarter increased 22% to about $1.8 billion from $1.5 billion in 2004. Unilin positively impacted our results.

Before the onetime non-cash charge of $34 million, adjusted earnings for the year 2005 were $380 million, and earnings per share were $5.63. Net sales for the year increased 13% to $6.6 billion. The sales increase was primarily from internal growth, price increases, and the acquisition of Unilin.

Dramatic increases in the oil and gas costs during the year, along with disruptions caused by hurricanes in the Gulf Coast, significantly impacted our costs throughout the year. Our margins have been reduced by the lag between the costs rising and increasing selling prices. Considering the magnitude of the changes, the industry has managed these unusual times well.

In addition, the rising raw materials created non-cash accounting charges related to LIFO inventory valuation in our Mohawk segment of $0.47 per share for the year and $0.19 per share for the quarter.

On October 31, we continued the next step in our strategy of becoming a total flooring company when we acquired Unilin, a leader in the laminate flooring in both the U.S. and Europe. Unilin is a fully integrated manufacturer in both Europe and the U.S., and a leader in product design a patented technology that creates royalty income.

We also made key investments in increasing capacity, backward integration, consolidation of warehouses, and the acquisition of Unilin to position ourselves for the future. In the first quarter, we anticipate the associated startup costs with these investments to be 9 to $10 million. Frank, would you give our financial review, please?

I would be glad to. Net sales for the quarter were $1,805,000,000, representing a 22% increase over last year's $1,475,000,000. Unilin impacted this increase by about 11%, representing about half of the 22% increase for the quarter and then 3% of the increase of 12% for the year. We had Unilin in our operations for two months during the fourth quarter.

Gross profit for the quarter came in at $455 million or 25% of net sales. Gross profit last year for the fourth quarter was $415 million or 28.2%. Increasing raw material cost and energy cost impacted the quarter, as well as a onetime non-cash inventory adjustment related to the acquisition of Unilin, as Jeff mentioned, for $34 million.

In addition, LIFO charges for the quarter were about $19 million and $47 million for the year. Before these LIFO charges, gross margin would have been 26.3% for the quarter and about 26.7% for the year. If we look at gross margin before both the LIFO charge and the Unilin inventory adjustment, the margin would have been 28.1% for the quarter and 27.3% for the year.

SG&A came in at $290 million for the fourth quarter or 16.1%, improving from last year's fourth quarter of 16.5%. Included in SG&A for the quarter was approximately $12 million of amortization related to intangible assets in connection with the Unilin acquisition. We had previously announced that we were estimating about 72 to $73 million of intangible amortization annually.

Operating income came in at $165 million or 9.2% of net sales, compared to 11.7% of net sales last year in the fourth quarter. The quarter operating income as a percent of net sales would have been about 12.1% without LIFO and without the Unilin inventory adjustment.

Interest came in at about $33 million versus $12 million last year. The higher costs were related to the additional debt we took on in connection with the Unilin acquisition. As a side note, in January of this year, we completed the permanent financing for our Unilin acquisition of about $1.4 billion of five and 10-year bonds.

Income tax expense for the quarter was $47 million. This represented an effective tax rate of about 35.4% compared to 36.2% last year.

Our GAAP net earnings were $86 million, down from last year of $102 million; and our GAAP earnings per share were $1.26 compared to $1.52 last year.

Adjusted net earnings, which would be before the Unilin inventory adjustment, would have been $108 million or a 5% increase and adjusted earnings per share $1.59. We estimate that Unilin added about $0.09 a share to the fourth-quarter earnings per share.

If we look at the segments for Mohawk, the Mohawk segment sales came in at $1,192,000,000 or an 8% increase over last year's $1,104,000,000. Operating income for the Mohawk segment came in at 9.2% this year for the fourth quarter, compared to 11.2% last year, impacted by raw material and energy costs and the $19 million LIFO charge.

Dal-Tile sales came in at $444 million, a 19% improvement over last year's $372 million for the fourth quarter. Operating income for Dal-Tile was $63 million or 14.3%, up slightly from the 13.9% in last year's fourth quarter. Unilin sales for the quarter, which included again two months of operations, were about $169 million. Then operating income was actually a loss on a GAAP basis of $5 million; however, on an adjusted basis for the Unilin inventory adjustment, it would have been $29 million or about 17%.

Turning to the balance sheet, we had cash on the balance sheet at the end of the year of about $135 million. This included both cash from the Unilin balance sheet as well as certain accounts that are part of our depository sweep program, which include about one days of clearings that were previously included in accounts payable in prior years.

Receivables came in at $849 million, which represents 40 days of sales outstanding, improving from the 41 days of sales outstanding we had last year. Then inventories came in at 1,167,000,000, representing turns of about 4.7 times compared to last year's turns of about 4.2 times. Accounts payable were at $998 million, representing about 60 days outstanding.

Then our total debt was $3.3 billion representing a debt-to-capitalization ratio of about 52%, improving from where we were immediately after the Unilin acquisition, which was in the mid 50 range. Jeff?

Thank you. During the year, we enhanced the management structure of our business. We implemented a new position of Chief Operating Officer, which was filled by Chris Wellborn. Previously Chris was President of the Dal-Tile segment. We realigned our carpet division into two business units, residential and commercial, to increase our focus on the unique needs of each of the channels.

We continued to invest in our people and culture. In 2005, we began our program in the Dal-Tile segment using Lean Six Sigma methods to improve our process and create change. In 2006, we are expanding it to the Mohawk segment. This will increase the analytical and execution ability of our management.

In 2005, we incurred significant inflation in our energy, raw material, and transportation costs. In our Mohawk segment, we increased carpet prices four times during the year, January, April, October, and November. Our materials used in carpet are primarily made from commodity chemicals from oil and gas, and our costs are reflecting changes in those markets.

We're having to manage the resulting volatility on a continuous basis. In the last two years, the industry has changed prices frequently and implemented them on a more timely basis. Given the volatility of the world oil and chemical prices, future costs have been unpredictable. We continue managing our business by reacting to the changes as they occur.

We continued to see a shift between different carpet fibers as value propositions have changed. In the fourth quarter, one of our fiber suppliers sold its assets to a competitor; and we have realigned our supply structure and brand strategy for the future.

We're starting up a new extrusion plant at this time to increase our control of raw materials and costs. It should be fully operational by the end of the first quarter. We've also expanded our yarn processing on the same site, which will increase our efficiency and support the change in mix that is occurring.

We continue with several strategic alignments in our carpet suppliers. With DuPont we have an exclusive polymer we call SmartStrand, which this year we will utilize a corn as a raw material. We also have an alignment with Wear-Dated from Solutia with a unique new Scotchgarded treatment for improved durability and easy cleaning.

We continue with our support of the Stainmaster brand. These combined with Mohawk and Karastan brand give us the strongest consumer positioning in the marketplace.

Our surface products continue to expand with the Mohawk brand. Our ceramic and wood products are growing strongly. We're presently introducing new proprietary technology that makes wood resilient to almost all stains, and even permanent markers wipe clean.

This year will be one of transition for laminate sold under the Mohawk brand, as we introduce new products manufactured by Unilin and offer a broader selection of premium product.

The Mohawk position is further supported by our marketing programs, which increase the profitability and professionalism of our retail customers with unique merchandising, advertising, training, and other services. We continue to enhance the value to our retailers through continuous innovation and marketing, and a complete product selection.

The commercial channels continue to expand as we go into 2006 with carpet [count] growing at a faster rate. We're in the process of constructing a new production line to support our future growth in carpet tile.

Our strategy of having unique brands, products, value propositions, and sales forces for each distribution channel is working well. We're focused on creating unique performance features that differentiate our product offerings.

We've taken steps to improve our distribution system by using satellite positioning and computer routing to provide high service levels and inform our customers of the specific time their deliveries will arrive each day. This automated planning and routing system is also increasing our transportation efficiency.

We're presently consolidating our hard surface warehousing into a new distribution center in North Georgia. Our home products are moving out of 11 leased buildings into a new facility as we speak. Both of these will improve our costs and service level.

Our product sales are now on filament and polyester carpets, and commercial carpet tile, as well as hard surface flooring are increasing; while our products [that are now on staple] and polypropylenes carpets and home products were softer.

The momentum in our Dal-Tile segment continues. Harold Turk, who was previously our Executive Vice President of Dal-Tile, has been promoted to the role of President. We have significantly enhanced our style and design, which is positively affecting our sales and product mix in this segment.

The stone product sales are increasing as well, and we have recently acquired a small stone distributor in Florida. We continue to invest in our Dal-Tile segment by upgrading our merchandising, adding service centers, increasing sales personnel, expanding our retail distribution, and building new design centers.

We have completed our Mexican plant expansion and are ramping up production. The original Muskogee investment is presently operating efficiently and at full capacity. The second expansion is in progress and should be complete in the second half of this year. It will add more glazed tile capacity as well as a new product with the color embedded in the clay body, which is a higher value product. Combined, these expansions will increase our ceramic production capacity by about 20%.

Dal-Tile is also affected by the rise in natural gas and trucking costs. We have been offsetting these increases with productivity increases and price increases. We continue to improve Dal-Tile's service level by improving inventory availability and reducing the time to deliver to our customers.

We closed the Unilin acquisition the end of October. The Unilin management is continuing to operate the business. We have recently announced that Paul de Cock will assume responsibility for the U.S. laminate business unit, which will include the Mohawk branded sales. Paul was responsible for all sales and marketing of laminate flooring and has prior operational experience in the MDF manufacturing.

He and his sales management team will operate out of our Dal-Tile headquarters in Dallas. This will allow us to leverage the Dal-Tile and Mohawk infrastructure to maximize Unilin's performance. Paul will continue to report to the Unilin organization in Europe.

New laminate products are being introduced under the Mohawk brand in the first half. We are increasing the product development staff to support designing unique products for both the Quick Step and Mohawk brands in the U.S. market.

We're training the Mohawk sales team how to communicate the attributes of our new laminate products. We are introducing increasing our distribution of the Quick Step and private-labeled products, and we are developing specialized product for the commercial market in the United States.

The U.S. laminate plant construction has been completed and we're in the process of training the personnel to reach full production. The European business appears to be improving. Higher wood, energy, and resin prices are affecting our costs in this business as well. We're implementing price increases in our boards to offset these increases. We have completed the startup of a new resin plant in Europe, and it's operating above expectations.

Our laminate patent continued to gain strength, and we have signed new agreements with both laminate and wood flooring producers. We continue to defend our patent aggressively in the marketplace.

Our balance sheet has strengthened, with our debt-to-capitalization ratio improving to 52% at December 31. We repaid about $230 million of debt since the end of the third quarter. Additionally, working capital as a percent of sales declined from 20% to 18% at the end of 2005.

The economy appears to be strengthening, with employment increasing. Consumer confidence is improving. Short-term interest rates look like they are possibly leveling out. Oil, natural gas, and chemical prices still remain unpredictable and may affect our costs. Our fourth-quarter price increases should be fully implemented during the second quarter. We anticipate the flooring industry improving in 2005, led by the commercial and residential redecorating categories.

Stock options were presently not expensed in prior periods, and we estimate an additional charge of about $0.04 per share in the first quarter. After considering these factors, our earnings forecast for the first quarter in 2006 is from $1.17 to $1.26.

We're well positioned in all distribution channels of flooring markets and in each of the individual product categories. Our customers continue to be positive about the prospects for 2006, despite the expected softening in the new residential construction market. Mohawk continues to focus on bringing fashionable products that represent excellent value to our customers. With that, we will be glad to take questions.

(OPERATOR INSTRUCTIONS) Keith Hughes with Robinson Humphrey.

Two questions. First, Jeff, your ending commentary there on market conditions, are you seeing in the last six weeks or so any kind of improvement in the residential replacement market? It's been kind of mediocre for some time now.

It is really difficult to get a good handle on it. If you look back in the prior couple of years, we had increases in raw materials that we had announced in the first period of the year; and this year, we had the increases in the prior period. So that is making it a little difficult on our comparisons.

At the same time we have our markets where we're running these various markets that are hitting different moments in time. We're really having a difficult time getting a handle on where it is. As you know, this is the slowest part of the year, and it is usually slower and it ramps up during this period. So it's too early for us to really give a definitive answer to where we think the business level is at.

If we look in the fall, it looked like the industry picked up a little bit towards the end of the year. We will have to see how it goes.

Okay. Frank, the LIFO charge, is it $19 million in the fourth quarter, or $0.19?

Both, $19 million and $0.19.

And then 47 for the year? Are those charges going to move down here in the first quarter?

I'm sorry, one more time.

In the first quarter, we see a LIFO charge of that level or will it start winding down as we head into '06?

We would like you to tell us.

It depends (multiple speakers). It depends on inflation and it also depends on -- the index we use is an externally generated index. So it is hard to really predict where it's going to be. We have got our best prediction built into our estimate, though.

Okay. If we think about it more from a 10,000 foot level, if you head into a period where raw material costs are just flat, eventually that is going to move away to a zero number. Is that conceptually right?

Yes, that's right. I guess the way from that level to look at it is, if costs continue to go up, we will have continued charges. If costs flatten out, then we should have no charges. And if costs go down, then we should see some of this amount that we have charged in prior periods come back as a benefit.

Margaret Whelan with UBS.

Can we get some more detail on Unilin? Specifically, the seasonality of the business? What you are anticipating in terms of the sales and the contribution to earnings for the year? Maybe on a quarterly basis. I know you don't want to give us specifics, but just to help us model.

I don't have it in front of me, the seasonality number. If you want to give Frank a call back later, we will try to give you some of view of the seasonality. We don't have that information in front of us right now.

Also in terms of the option expense, what is the total going to be for the year?

Will you ask the question again?

Your option expense of $0.04 for the first quarter (multiple speakers)?

It's probably going to be about $0.15 or so for the year.

For the year? Okay. Next question is on the business trends into February.

As we just tried to tell Keith, we're having a difficult time analyzing the numbers because the difference in our market timings, the difference in price increasing timings, and at the very lowest part of the year. So we're having a difficult time ourselves prognosticating the future business levels.

Our assumptions for the year, we think that the industry will be above last year in total. We believe that it will be led by the commercial and the remodeling parts of the business, with some softening in the new construction business.

Then there are specific segments such as multifamily that we expect to be good and others as we go through. But we think the industry in total will be up, with those things offsetting the slight decline in the new construction market.

Okay, thank you.

Eric Bosshard with Midwest Research.

Two things. First of all, the Unilin operating margin, if you back out the step-up in inventory, looks like it was around 17% this quarter. Can you help us understand? I guess I had thought of this business as sort of a low, mid 20s kind of operating margin business. In the fourth quarter, were there some factors that kept that margin where it was? Or just help us understand how we ought to interpret that stated operating margin from Unilin?

Yes, when we filed an 8-K back in early January with the Unilin historical numbers in there; and then we also had some explanations in there about what we expected going forward; and then described the amortization of intangibles that we were estimating. So if you looked at the historical numbers prior to us acquiring them, it would be in the mid -- the operating margins would have been in low, mid to low 20% range.

But then, we are estimating about 72 or $73 million annually of amortization expense. So once you consider that, that puts you closer to where we are.

This 17 in the quarter is the run rate we ought to be thinking about for '06?

I think what we had said is that looking at where the operating margins were, at the end of the 10-month period of October, we expected the margins to decline slightly from there. Could be a 1.5 point decline. And then you've got to consider the amortization in addition to that.

Okay.

I can walk you through in a little more detail if you need to off-line, but --.

But is there something seasonally that in the fourth -- the two months you had in the fourth quarter, that that margin should be materially different than the margin experience in '06?

No.

Okay, great. Secondly, is there a way to at all quantify? You've got capacity additions and warehouse additions and capacity additions and resident additions; and there is a lot of projects going on that sound like they involve brick and mortar. Have you been able to put your arms around that at all to get a sense of -- here is the earnings impact we're having at the start-up of these facilities and the timing in which we will endure that impact before we start to get some benefit from it?

At the first of the conference call overview, we said that we expect the impact to be 9 to $10 million in the first quarter. If you go back in the fourth quarter, it was probably in the range of 5 to $7 million. I mean in the fourth quarter of last year, coming into this.

Many of these projects will be up and operating by the end of the first quarter. So many of the costs will fall off. At the same time, we have the new Muskogee addition that is going to start up in the third quarter of the year. So we will start the training and pieces for it in the second quarter. All of these things we have taken into account in our best guesses of the earnings estimate.

The 9 to $10 million is more than just the U.S. laminate facility; it is a lot of this other stuff that is going on as well?

It is the moving into the warehouse with the home products business. It is moving the hard surface into a new warehouse. It's starting up a new extrusion plant. It is starting up a new yarn processing plant. And it is the Unilin business start-up.

And the ceramic.

And the Mexican ceramic, just to name a few. To name the big ones.

So that is what that encapsulates. Perfect, that was what I was looking for. Thank you very much.

(OPERATOR INSTRUCTIONS) Michael Rehaut with JPMorgan.

If we could just look at the Unilin business a little bit more. You talked about getting some good results out of Europe, business improving there. I was wondering if, in terms of '06, you could kind of give us an update on if you still expect sort of a double-digit growth on the U.S. portion of the business from the laminate side? I guess it's a third of the business. And if you expect this improvement in Europe to continue; and maybe I think you talked about that being like a low single digit type grower. So?

We are still in the same place that we were before. That we expected the European business to grow 2% to 4%; and that we expected the U.S. business to grow in double digits. Part of it is the transition. Another piece of the laminate business is hooked to the Mohawk brand business. That is going to take us a transition period to put the new products in, to get them into the field.

We probably will not see any -- there could be some negative changes in the mid-term piece as you're moving out of some and into others. We won't see the benefit till sometime in the second half from the Mohawk side of the business.

Great. Then just a follow-up on the ceramic tile business. Obviously, it continues to do extremely well. As the new capacity comes online, is that something where there might be a jump in sales? In terms of perhaps you have been capacity constrained and you've been leaving some money on the table. Or should we continue to expect kind of this type of double-digit, midteens rate; and this capacity addition will just kind of be a -- evenly support that growth over the next 12 to 18 months?

You have to remember that we use worldwide sourcing on our ceramic business to supplement our own production. So as our capacity moves up and down, what we do is we use other vendors from around the world to support our growth needs. So what this is, will be basically supporting the additional growth.

If you look at the 20%, at the growth rate we have had, and basically it is just filling up what our growth rate is plus a little bit as you go through. So I don't think that you'll see a significant change in the business. It is more related to the ongoing increase of the business and the investments we keep making in the business.

On the other hand, I think it would be quite aggressive to project out 20% growth rates in a mature business on an ongoing basis.

Okay. Just lastly then, on that point you made, Jeff, in terms of replacing perhaps some of the sourced product that you're doing right now, would you get a margin benefit from that? Are your sourced sales at a lower margin than your manufactured sales on the ceramic side?

We would expect to have some improvement in margins. But what we do is -- like the last expansion we put in Muskogee. What happened is our margins have improved slightly, but we keep investing the money in the future business and in our activities of new products, more salespeople, more distribution.

So we are making a choice to reinvest the monies in the growth of the business. So we are not projecting substantial margin increases, what we're doing is continuing investing the money to keep the business growing.

Great, thank you.

[Mark Reder] with PartnerRe.

In the fourth quarter, I see you generated cash from operating activities, $132 million; and you had capital expenditures of $97 million, which meant that free cash flow was about $35 million. Is that a figure that we can use as a run rate for your free cash flow for the next few quarters?

You know, we've got timing issues there of capital expenditures and working capital. So you know, I think you have got to consider seasonality there.

Okay, I'm sort of just trying to model how you pay down debt this year. Do you have a year-end debt target?

We have not disclosed that.

Okay, what about since CapEx seemed like it was heavy in the fourth quarter, do you have any (multiple speakers)?

I can tell you what we are forecasting for our CapEx for the year.

Okay.

We are estimating that to be $300 million.

300 million, okay. As far as just paying down debt, any thoughts on issuing equity to pay down debt?

At the present time, we expect to continue paying down debt from internally generated cash flow and better management of our inventories as we go forward. If you look historically, we have paid down a lot of debt rather rapidly. We expect the same thing to continue on a forward basis.

Just to remind you, we paid down $230 million of debt in the fourth quarter.

Okay. Just any thoughts on additional acquisitions?

At this point, our focus is on reducing our debt level. Any acquisitions we do will be small relative to our business as we get the debt levels back to where we think we would like them to be on a long-term basis.

Great. Just one last question, on the D&A run rate for the year. Do you have that with the combined operations?

No, it is built into our estimates of earnings per share.

At this time, there are no further questions. Mr. Lorberbaum, are there any closing remarks?

Thank you very much. We think that we have had a good year considering the circumstances we have been in. We think we look forward to this year, and thank you for being with us.

Thank you. This concludes the conference. You may now disconnect.