莫霍克工業集團 (MHK) 2007 Q2 法說會逐字稿

Good morning, my name is Crystal and I will be your conference operator today. At this time I would like to welcome everyone to the Mohawk Industries second quarter conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. (Operator Instructions) This conference is being recorded today, July 20, 2007. Thank you.

I would now like to turn the conference over to Mr. Jeff Lorberbaum, Chairman and CEO. Mr Lorberbaum, you may begin your conference.

Thank you. Welcome to Mohawk's second quarter conference call. With me I have Frank Boykin, our CFO. Would you please read the Safe Harbor statement?

Sure. I'd 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 periodic filings with the Securities and Exchange Commission. Thank you.

I'm pleased with Mohawk's second quarter results given the difficult environment the U.S. flooring industry is experiencing. The second quarter net earnings were $115 million and earnings per share was $1.68, both about 4% below last year. Net sales for the period were about $2 billion, a decrease of about 4%. The Company continues to generate strong cash flow paying down debt of $208 million and improving a debt to capital ratio to 38%. The U.S. flooring industry continued its cyclical downturn with soft sales in both the residential new and remodeling categories. The U.S. commercial business continued performing better than the residential business. We do not see any indications presently of a significant change in the U.S. industry.

Many of our U.S. manufacturing facilities are operating at low capacities generating unabsorbed overhead costs. We're controlling production levels to match sales and inventory requirements. The European business maintained its strong growth and performance partially offsetting the cyclical downturn in the U.S. market. We raised prices in many product categories in both the U.S. and Europe to pass through rising material, energy, and transportation costs. The unpredictability of future costs and demand make the outlook difficult to predict. Frank, would you give our financial report, please?

Okay. Our net sales for the quarter were $1.977 billion or 4% down from the previous year. Our Unilin segment continued its growth with Dal-Tile coming in flat, but improving sequentially from the first quarter. Mohawk sales were down, continuing to be impacted by residential flooring. Our gross profit came in at 28.2%, down from 28.8% in the prior year. This decline was primarily due to lower volume in the U.S. and higher raw material costs in our carpet segment. SG&A came in at 18.1%, up slightly from the 17.9% of last year. Our dollars were down, but we had a slightly higher percentage of net sales and that was impacted by the amortization of the Unilin goodwill as well as less leverage on lower sales this quarter. Operating income came in at 10% versus 10.8% last year, with interest and other expenses coming in at $36 million compared to $44 million last year.

Our interest was down due to continued debt paydown. Other income and expense was more favorable this year due to foreign exchange gains. We did not receive any refunds from U.S. customs in this quarter. Income taxes came in at $46 million or an effective tax rate of 28.8%. This was an improvement over last year's rate of 33.4% due primarily to the difference in mix between our North American and our European businesses. We're currently estimating that our effective rate for the full year will be at about 30%. Our earnings per share came in at $1.68, 4% below last year. The Mohawk segment sales, at $1.1 billion, were 10% below last year, as I had stated before, impacted by the softness in the residential new and remodeled business. Operating income at 5.4% of sales compares to 8% last year, down due to volume declines and higher raw material costs.

The Dal-Tile sales came in at $505 million, about flat with last year. Residential new business decline impacted Dal-Tile, but they did turn in a good performance considering the environment that they're in. Operating income came in at 13.7% compared to 14.6% for the quarter. And on the Unilin segment, sales came in at $364 million, up 16% from the prior year. If we look at sales increase using a constant exchange rate, it was up 11%. Europe continued to turn in strong performances in this quarter. Operating income was 22.5%, up from the 19% last year. The foreign exchange impact was about $5 million favorable to the operating income for the quarter. Our corporate segment turned in operating income a loss of about $13 million compared to $10 million last year. It is higher this year due to timing, but we're still looking at $35 million for the full year for this segment.

Looking at the balance sheet, receivables came in at $968 million, about 42 days which is consistent with last year. Inventories at $1.229 billion, turns at about 4.1 times compared to 4.2 times last year. Fixed assets at $1.9 billion were the result of capital expenditures during the quarter of $35 million and depreciation and amortization came in at $75 million. We're estimating our total capital expenditures for the year to be $220 million to $250 million and depreciation and amortization to be just above $300 million. Our debt, our total debt for the quarter ended up at $2.501 billion. We had about $300 million of bonds that matured during the quarter that we rolled over into our bank facility. And we will pay this out with our cash flow over the course of the year. Our debt to capitalization ratio, as Jeff had mentioned, came in at 38%, debt to EBITDA at 2.2 times, and then we paid down just over $200 million of debt for the quarter. Jeff?

Thank you. The U.S. economy's expected to continue with reasonable growth for the foreseeable future. Employment levels remain high with growing income levels. Mortgage rates are historically good, but the lenders are tightening requirements. Home selling prices are still under pressure with slow new and existing home sales. The Mohawk segment is continuing the trends from the first quarter. The carpet industry's rate of decline may have stabilized during the quarter. Our comps in the third quarter will become easier as the third period last year started the industry's dramatic decline in sales. Residential new construction is still suffering from excess housing inventory and remodeling is declining from slow existing home sales, falling home selling prices, and lower discretionary remodeling expenditures. The environment is reducing the average mix and increasing the promotional activity.

Commercial sales are stronger than residential, with modular tiles continuing to gain share. This increase in modular is raising the average unit price and is an alternative to broadloom. We're expanding our modular offerings with our new and [cycle-back] to capitalize on these trends. As raw materials have increased commercial prices, new engineered products are being introduced to maintain price points and meet existing budgets. The Mohawk segment is focussed on controlling expenses, inventory, and maximizing productivity. Raw material costs increased during the quarter and we announced a carpet price increase in May of 4% to 6%, which we begin implementing in June. We announced price increases at many of our hard surface products to cover higher distribution costs.

To reduce our logistics cost, many initiatives are being implemented, such as increased direct shipments to customers, consolidation of distribution points, and improved inventory management. The Dal-Tile segment for the quarter was slightly below last year, sales were slightly below last year. We believe we are performing better than the industry due to earlier investments in sales, products, and marketing. Commercial sales are offsetting some of the weaknesses in the residential. More emphasis is being placed on specifying commercial products with large accounts, which is adding new sales. Selected price increases were implemented in the period and surcharges are being added to cover increased transportation and energy costs. The distribution points we put up last year are adding incremental sales and should continue to expand. This year we'll remodel about 35 existing service locations and add four new sites. In 10 locations we're testing a new system to improve our service of installation tools and materials.

We're reducing our controllable SG&A costs, but the margins are lower due to infrastructure investments to grow sales and distribution points and sales personnel and unabsorbed overhead from lower production schedules. Our Dal-Tile team is implementing many initiatives to reduce cost, improve efficiencies and working capital. We're increasing production as we ship products to our own facilities, which were previously sourced externally. Our Unilin segment continued its strong performance for the quarter with sales up 16% over last year. The European economy's strong, while the U.S. residential markets remain weak. The strong euro positively impacted sales by 5% and operating income by $5 million. Our U.S. manufacturing plant is operating at higher levels than last year and costs are improving. Additional equipment's being purchased and will be operational next spring. This will increase our capacity and add capabilities to produce more sophisticated products in the United States.

Our European sales were good in all product categories. Price increases were implemented in many products to cover rising material and energy costs. Sales of accessories are improving as our new patented moldings are reaching the market. Our roofing and other wood business is also doing well with the rest of the European economy. Sales to eastern Europe and Russia are growing as those economies expand. Our patents continue to gain strength and we entered new license agreements growing revenues. Unilin's results were the best ever and we anticipate future results to be more in line with historical. We are continuing to pursue companies who infringe on our patented technology. We announced an agreement to acquire four pre-finished wood plants from Columbia Forest Products, which is a current supplier. Two solid wood plants and one engineered are in the United States and one engineered plant is in Malaysia.

The Unilin U.S. business unit will operate the wood business and market both wood and laminate product categories. The plants are currently experiencing losses, but the business is expected to be accretive after the first year. We have begun to develop an integration and transition plan for this business, which will be implementing after the acquisition is completed, most likely in the third quarter. A one-time noncash purchase accounting charge is expected with the acquisition and should not be material to the Company. After the acquisition, Mohawk will be the second largest producer in the pre-finished wood category, which is expected to grow between 6% to 8% over time. The transaction is subject to customary government approvals and closing conditions. We continue to investigate acquisition opportunities in the United States and elsewhere to enhance our business and broaden our geographical exposure. We're focussed on environmental stewardship and will present our many initiatives under program identified as Greenworks.

This program includes recycling, both post consumer and industrial waste, utilizing bio-based raw materials and energy, and reducing water usage, energy consumption, and emissions. Examples of these initiatives include -- recycling old carpet, waste wood, and over 3 billion plastic bottles each year; using recycled tires and door mats; reducing water consumption in half in the last 10 years; producing carpet from fiber which uses corn as a major building block; and generating energy from bio-waste rather than oil for manufacturing. Greenworks is beneficial for our customers, our community, and the environment. During the period, no additional payments were received from U.S. customs for refunds of duty. In the future, we expect additional payments, though the timing and amount are not known at this point. The Company expects the U.S. residential environment to continue to be difficult during the third quarter.

The management team is committed to maintaining the proper balance between cost-cutting and being prepared for a future turn around. Based on these factors, the guidance for the third quarter of 2007 is $1.61 to $1.70 earnings per share. With that, we'll be glad to take questions.

(Operator Instructions) Your first question comes from the line of Eric Bosshard with Cleveland Research.

Good morning.

Good morning, Eric.

Jeff, can you first talk about demand momentum? You commented that the guidance assumes weak results, but I think you also commented that you thought things had stabilized. Just tell us a little bit about what you're seeing within the business right now and where you think it goes from here in terms of demand.

When we look at the industry over the last nine months, it does look like that we bottomed out in the rate of decline. And so based on that, we're assuming we're at the bottom and we're hoping it will improve as we go forward, but we'll have to see how is it happen. At the moment we're basically seeing a continuation of what we saw in the second quarter. There's some, as you put in price increases, it makes a little difficult to see the incoming business volume, because usually there's an uptick in business and then there's a slight decline after it starts going in to make up for it because the customers don't need anymore product. That's all been going on. But we're assuming at this point it's going to continue as we have been seeing until we see a significant change in the result.

Okay. Secondly, within Unilin, again the business performed better on the margin line and again you commented that it's not going to be sustained at this level, something we've heard before. The up side in margin in the quarter, can you talk a little bit about what contributed to that and why it isn't going to be sustained at this level?

You first started out with that the European economy is growing better than we expected and the strong growth in Europe. That's resulted in stronger volume growth. It's resulted in the ability to pass through price increases that we had. The overall sales in the category were up double digits, which helped cover the overhead structures better, which helped us there. All the product categories have improved within the piece as we look at it. And so the combination of all those things resulted in an extremely good quarter. Now normally you don't have all parts of the business and all pieces doing well at the same moment. And every part of the business showed increases both in sales and margins. And it's difficult to assume those things will continue on an ongoing basis.

Your next question comes from the line of Michael Rehaut with JPMorgan.

Hi, good morning. Thanks.

Morning.

First question just to look at Unilin from another angle, if I could. You did about, excluding the foreign currency translation or gains in the margins, you had about $16 million or $17 million of incremental profit on $11 million of incremental sales if you look at 2Q versus 1Q. I don't know if this is the exact right way to look at it, but what's going on with that variance to get such an incremental pop on margin from incremental sales? Are there mixed differences that typically you sell different types of higher margin product in the second quarter? Or are you getting just tremendous pricing? What are the -- some of the bigger gives and takes there?

Well, one of the -- pricing was a big impact on it. Mix, you're right, different product categories was a big impact. FX you took out and that was also a big impact. Those are the top two or three that come to mind for me.

Okay. Agreed.

Your next question comes from the line of Dan Oppenheim with Banc of America.

Hi, this is actually [Mike Dahn] for Dan. How are you guys? Just a couple of questions on kind of what you're seeing on the pricing side. It looks like you implemented the price increases and it seems from, at least our conversations with others, that competitors followed suit. Have you seen anything on the -- have you seen any customers start to push back on that as we continue to see weakness on housing? And are you seeing any of your competitors also begin to cut back on pricing in an attempt to grab market share here?

I think you have to separate out the general conditions and the price increase. The general conditions with the pressures on it, there have been throughout the year more promoting going on and pricing pressures, which are continuing basis of the business given the environment we're in. Now, second to that, there was a price increase announced. And the price increase we announced in May to start implementing in June, all indications that we have from customers we talked to is that our competitors are implementing price increases that are similar. Those price increases are flowing through the marketplace. And we don't see any change in that as we speak.

If you look at pricing on a net net basis. If you take into account the promotional activity, would you say that it's still up? Or would you say that the promotions are having the effect of coming out to flat net net pricing?

The promotions were going on at the same rates before the pricing increase. So the pricing increase is on top of whatever was going on in the marketplace as we announced it. I haven't seen a significant change in the promotions. On the other hand, all the pricing is on top of those levels.

Your next question comes from the line of Keith Hughes with SunTrust.

Thank you. In the carpet business, where do you stand now in carpet inventory, either sequentially or year-over-year?

I think we have to dig out the numbers.

Okay. Let me ask another question while you're digging that out. Is it a question is they up or they down? The carpet industry, do you have any feel in dollars and units what it did in the second quarter?

Your first question, Keith, was the carpet inventories were up or down versus a year ago?

Right.

Yes, they're down.

Was it down similar to what sales was down?

Not quite, but close.

I guess my real question is fundamental. We at the point now in inventory where if what Jeff had said earlier, demand stays roughly where it is, you won't have to be taking anymore inventory adjustments, manufacturing time adjustments?

There's two parts. One is if the level stays where it is, we won't have to reduce the base inventories.

That's my question.

The second piece is if it stays where it is, we still have much more -- we have more capacity than we need to operate at these sales levels of the industry.

Okay. That answers it. Do you have the industry, do you know those numbers?

From the industry, I think was down on average about 9% in units for the second quarter.

Your next question comes from the line of David MacGregor with Longbow Research.

Yes, good morning, gentlemen.

Good morning, David.

Can you just talk about the extent to which Columbia Forest Products is losing money at this point and what the magnitude of the loss would be that you'd have to absorb until you get that to an accretive state?

Yes, I think that our estimate on the first year, and it's fairly broad at this point, is that the loss is going to be somewhere between $7 million and $15 million in the first year, as we take the various initiatives to get it in place and moving forward. We're going to do a lot of different things in the strategy of it. We're going to broaden out some of the product offerings as they go. We think that we can increase the amount of product they're producing for Mohawk. We think that we can improve their cost position and quality position in the marketplace. We're going to have to put some additional capital in the business to improve the cost position even more. We think we can introduce their products into some new channels they're not getting to, as well as improve some of their design and technical capability as we go through. And various things -- some of the things will take up to two years to execute.

And those were pretax numbers, David.

Those are pretax, understood. But you have a fairly high level of conviction that you can get this to an accretive state within, I guess, the second year.

Correct.

Okay. Good. And then the other question I had for you, if you could just give us a breakdown on each of the three segments what your commercial versus residential revenue mix might be, that'd be helpful. Thanks.

We don't have that in front of us this minute. We don't give it out by segment. Historically, it's around 25% of the total. And at high level, the Unilin business basically doesn't participate in it. The laminate business is not going to the commercial segments today. The Dal-Tile business has a higher level of commercial than the Mohawk does, so it would be higher than the average and Mohawk would be somewhere less than the average.

Okay. Your next question comes from the line of Laura Champine with Morgan Keegan.

Good morning.

Morning.

By buying Columbia, I think you now have a high single digit percentage share in the wood business. But typically your preference has been to operate it closer to 30% share. Should I look at the Columbia acquisition as completing what you need to do in hardwood? Or are you still looking at that segment for potential acquisitions?

Our goal is to have a large share of the wood business. We believe this is a big second step. One was we've been selling product the last few years. This will give us a vertically integrated position. The capacity is underutilized significantly, which will allow us to participate and grow the business in the category with the assets that we own. Other alternatives could be to look at other higher-end businesses. They participate in more of the medium to lower price product categories. So there's still opportunities in the higher-end category that we haven't covered at this point other than from a distribution standpoint.

Your next question comes from the line of John Baugh with Stifel Nicolaus.

Thank you, good morning. And let me be the first to say good job in a really tough environment.

Thank you, John.

Can we drill down on Mohawk division, 5.4% EBIT, that's certainly low relative to your standards for the seasonally second quarter. How much, if you can break it out to some degree, is under-absorption, how much was the raw material increase versus the relief you got in pricing, because I know that lags. And then the other factors in there. Or put another way, how do we look at EBIT margins in the second half of that year in light of the fact that the year-over-year declines in revenue should lessen with what happened a year ago. You've got pricing more in place, et cetera.

I think that our internal expectations are for the margins to improve as we go through the year. That unless we get some big surprises, we're expecting the margins to go up from here. We have more controls over our SG&A costs and more controls over our sampling. We did significant drops of product in the first half trying to get the business more balanced with the present conditions that are going on. So our internal pieces, without giving you the exact number, are to show improvement as we go through the year.

And is commercial, which I know is performing better, but is commercial within the carpet segment showing year-over-year gains in profit margins in carpet? Is it flat? Is it down less than what residential's down?

The commercial business, as you look at it, we believe the industry is flat to down a little bit in units and that most of the growth is going into the modular category, so that the broadloom piece -- some of the broadloom is being shifted to modular. So depending upon your mix of each of the pieces as you go through, you're going to end up with a different answer. Our modular piece is less than the industry average. We're growing it. Over the past year, we are growing it and we continue to grow it and we think it's got a lot of potential to grow even more and we're putting more investments into new backs, new capacities, new product categories as we go through. And so we think that it has an opportunity to grow much faster than the piece.

Your next question comes from the line of Shaheen Shaheen with Mohawk Industries.

I want to congratulate you on the great job that you're doing. Where are the Columbia plants located in this country?

They are in -- they have plants -- most of them are in West Virginia, Arkansas, and then one plant's in Malaysia.

And how do you see the wood business completing the total business of laminate, carpet, tile, and so on?

The wood business is the last category that we have that we aren't vertically integrated. So it gives us a vertically integrated position. We see that there are synergies between it and all the various other parts of the business in broadening out our offering to all the various customers. That in many cases we think that we can market and merchandise the wood in conjunction with our laminate business, which is why we put it under the Unilin operating business in the United States. And then on the long-term, we see that wood looks like it, at least the pre-finished wood, is going to continue to grow at fairly strong rates once we get through the cyclical downturn.

Will it have the click feature, that patented Unilin feature in it as well? Are you planning on that?

Today, the click systems in wood are being utilized. They are still a small part of the total wood business in the industry. But they are growing and we do license other options to other companies to sell wood, as well.

Your next question comes from the line of [Chris Bannins] with Wachovia Securities.

Hey, guys, how's it going?

Hey, Chris.

Good.

Couple of questions here. Just wondering if you could quantify or maybe give us a better idea of Unilin's top-line growth, like domestically versus that of Europe ex-FX expense?

Most of the growth in the quarter was in the European business. If you look at the laminate business, it's all sold through the residential business, which is under great pressure in the industry. We don't have any industry numbers to know exactly what the U.S. industry's growing, but we know that all the pieces are under great pressure. And our belief is that they're all negative and we're not sure whether laminate is flat or negative a little bit or up a little bit. We don't have any data, but it's going to be impacted by the same pieces.

Okay. And then if you could just comment a little bit, maybe give us a little bit more color on how business trended in the quarter on some of the major product categories, i.e. something like carpet, ceramic tile, and maybe laminate. If you saw any differences from the beginning of the quarter towards the end, that kind of stuff.

On the carpet side, some of it was obfuscated by the price increase. When we announce price increases you get a lift of some people who try to buy ahead of it, so it is difficult how to interpret that into the long-term trends 'til after it flows through, which will take us a little bit more time to have a clear view of it. The other businesses, I think that we're expecting them to be better in the second half, but we're still waiting to see. And we're hoping that they're going to be better. But we really don't have any clear indications of that at this moment.

(Operator Instructions) And your next question comes from the line of Stephen East with Pali Capital.

Good morning, guys.

Good morning.

Jeff, going back to John's question on the Mohawk raw materials. If you look at about a 250 basis point drop in [up] margins, how much of that would you all characterize between under-absorption versus last year and raw material -- increased raw materials versus last year?

We don't have those numbers in front of us. The raw materials were going up and so that did impact it. You have all kinds of changes. Not only do you have those, you have the mix shift from different product categories. You have a degrading of the quality that's going on, you have the pressure on the -- as you would suspect, there is more pressure on the low to medium price points of the category. There is a change in products, as nylon staple has declined, moving to other categories. You have polyester, as the values increase polyester is growing. You have polypropylene that's tending to play in the narrower range of products than it has historically.

So you have not only the industry conditions, you have a dramatic shift in the mix of products that are being sold through the industry, all impacting the pieces. At the same time, we more aggressively dropped products during the first half in the carpet industry and we pushed those through the discounting of pieces to move the various products as you go through. We think we put in place management techniques to manage the sampling expenses better as we go into the second half and keep those versus historical more in line. And we're managing through the industry cycle as best we can.

Okay. If you just had to look at it from a gut perspective and say, all right, throwing mix into the equation. We're down, we've got mix, we've got raw material costs, we've got under-absorbed overhead, et cetera, how would you sort of rank order those as the most important impacts year-over-year?

I think I would give the unabsorbed overheads would be the most significant one. I would put some of the cost pressures of either pricing or mix. They are all -- pricing, mix, promotions of the whole industry is probably the second piece all together, with a litany of others.

You have a follow-up question from the line of David MacGregor with Longbow Research.

Just a couple of quick things. You had talked about the 4% to 6% price increase in the carpet segment. You did allude to pricing initiatives in Dal, but you didn't quantify those for us. Can you give us a sense of what is was you were pursuing and what you think your traction was?

The price increase in Dal that we actually initiated was on selected products, it wasn't across all the various product categories. So I would assume it is limited in the total, maybe 1%, because you have to average it out across all the pieces. But in the Dal-Tile side, we -- a large part of the costs that go up are because of the weight and the transportation. And we have surcharges that we add to the product that we started sometime ago when the transportation costs started going up and energy costs. Each period we recalculate how those do and those allow us to pass through the changes in a lot of the costs outside the price increases.

You also have a follow-up question from the line of John Baugh with Stifel Nicolaus.

Yes. The follow-up is basically when you look at the pricing environment that we're in today in the wood category, what do you think -- what's your long range thesis on wood pricing as we look at imports, the engineered versus solids. I understand solids are under a lot of pressure. And how does that affect your strategy with Columbia or anything else that you're going to be doing?

Okay. The solid wood category first. As you have the unfinished marketplace, which is flat and will probably decline -- continue declining as a proportion of the total business play. That piece we will still not participate in on a going forward basis. So most -- you have a lot of pressure in it because there's no differentiation and it is sold as a commodity. We believe that the solid wood piece that is pre-finished will hold its own, maybe grow a little bit, but not most. And most of the growth will be in the engineered category on a going forward basis, which we think we're well-positioned to participate in both from a U.S. manufacturing point as well as from an offshore manufacturing point. And we continue to purchase product from other suppliers where it makes sense around the world.

Thank you. We have reached the allotted time for questions and answers. Are there any closing remarks?

We're in a difficult cyclical environment that the business we tend to end up with pent-up demand as we go through these cycles. We don't have any indication of when the cycle's going to end. But as historical, it will end and we think we'll be well-positioned as we move on to the next stage of the economy and environment. Thank you for joining us at our second quarter conference call.

This concludes today's conference call. You may now disconnect.