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Mohawk Industries, Inc. (NYSE:MHK)

Q4 2009 Earnings Call Transcript

February 26, 2010 11:00 am ET

Executives

Jeff Lorberbaum – Chairman and CEO

Frank Boykin – CFO

Analysts

Dan Oppenheim – Credit Suisse

Michael Rehaut – JP Morgan

David MacGregor – Longbow Research

David Goldberg – UBS

Ivy Zelman – Zelman Associates

Laura Champine – Cowen and Company

Jeff – Raymond James

Keith Hughes – SunTrust

Siddle [ph] – Redmond Capital

John Baugh – Stifel Nicolaus

Tom Mahoney – Cleveland Research

Alex Mitchell – Scopus Asset Management

Arnold Brief – Goldsmith and Harris

Gray Grantham [ph] – SEACOR Group [ph]

Akash Ghiya – Pine Cobble Capital

Operator

Good morning. My name is Krista and I will be your conference operator today. At this time I would like to welcome everyone to the Mohawk Industries Fourth Quarter 2009 Earnings 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 session. (Operator instructions). As a reminder, ladies and gentlemen, this conference is being recorded today, February 26th, 2010. Thank you.

I would like to introduce Chairman and CEO, Jeff Lorberbaum. Please go ahead.

Jeff Lorberbaum

Good morning and thank you for joining our fourth quarter 2009 conference call. With me on the call is Frank Boykin, our CFO, who’ll review our Safe Harbor statement and later the financial results.

Frank Boykin

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 is 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. This call may include discussion of non-GAAP numbers. You can refer to our press release at the investor information section of our Web site for reconciliation of any non-GAAP to GAAP amounts.

Jeff Lorberbaum

Thank you, Frank. Our fourth quarter earnings per share of $0.29 were better than we anticipated. Earnings per share were $0.56, excluding restructuring charges, primarily related to infrastructure reductions in our Mohawk and Dal-Tile segments. Our restructuring activities included a $30 million charge in the fourth quarter. We expect to record another $5 million in 2010, to complete the equipment relocations from these initiatives. Our earnings exceeded expectations due to cost savings efforts, personnel reductions and restructuring activities.

Fourth quarter sales were 1.3 billion, a 9% decrease from 2008, or 11.1% on a constant exchange rate. Our balance sheet is strong with cash, over 500 million, free cash flow, of almost 570 million for the full year, and a net debt to total capital ratio of 26%. Sales were slightly lower than the third quarter, as the Residential business began to stabilize and comparable periods were lower than last year.

The overall economy continues to improve with 5.7% growth in the fourth quarter, improved consumer confidence and the housing market showing better r results. The commercial sector is under pressure, due to lower new construction and delayed remodeling activity, as corporate profits have declined. This year commercial will continue to decline and should reach a bottom.

Our European businesses impacted similar to the U.S. and is showing some signs of improvement. We believe the economic recovery should positively impact our Residential business later this year in both the U.S. and Europe, offset by a continuing decline in the Commercial business, which lags behind the economic recovery.

Frank, you want to give the financial report?

Frank Boykin

Thank you, Jeff, and good morning, everyone. As Jeff had mentioned, our sales finished at 1.3 billion or 9% down from last year. This is the first time in five quarters that we have seen our decline in the single digits. All segments are down except Europe due to volume and price mix.

Sales are down 11% on a constant exchange rate basis overall. Our gross margin was 25%. However, excluding charges, of $222 million in cost of goods sold our margin was 27%. The improved margin was due to infrastructure reduction, lower raw material costs and ongoing cost cutting actions.

Our SG&A was $295 million, down from last year, excluding restructuring charges in the quarter of $8 million; the SG&A came in at $288 million or 21.3% of sales.

We incurred $30 million of restructuring charges during the quarter, of which $20 million were incurred in Mohawk and 10 million in Dal-Tile. These were primarily related to manufacturing and distribution.

The operating income at $77 million excluding charges was 5.7% of net sales. Overall, our results were good in a very difficult environment. Interest expense was $35 million higher than last year, due to the new bank facility that we put in place earlier in the year.

Our other expense was lower at $1 million than last year’s $18 million due to decreases primarily driven by changes in the exchange rate. Our tax rate for the quarter excluding charges was 5%; however, looking into 2010, we are expecting a tax rate in the 15% range. Earnings per share excluding charges came in at $0.56 a share.

We jump to the segments, starting with the Mohawk segment, sales were $739 million or down 8% from last year, due to lower volumes and changes in mix. As we mentioned earlier, we believe Residential’s at the bottom, and the Commercial segment is still declining.

Operating income excluding charges was $36 million or 4.9% of sales. The margin performance was driven by lower raw material costs and reduction in expenses, offset by decreased volume levels.

In the Dal-Tile segment, sales at $330 million were down 20%, with Residential and Commercial both declining, while Mexico continues to perform well, with slightly ahead on a constant exchange rate basis. Operating income in this segment excluding charges was $21 million or 6.4% of sales.

We were benefited by lower freight, energy and other costs, offset by declining volumes, negative mix and deleveraging from our fixed distribution costs in this segment.

Unilin sales were $298 million, up 2% from last year, with Europe which is primarily residential stabilizing. Sales on a constant exchange rate basis, however, were down 7%. Operating income was $25 million or 8.3%. We had lower freight costs and operational savings that were offset again by decreased volumes. The exchange rate impact was favorable on the margin by $3 million.

Turning to the balance sheet, we finished strong at the end of the year with cash at $531 million. This included $465 million in cash investments, with $367 million of that investment in the U.S. We believe our strong cash position plus additional generation of cash this year will put us in good shape to pay off much of the $500 million of bonds that are due at the end of this year.

Our receivables were $674 million over 51 days, which is up from last year. Our aging, however, remains in good shape. Included in the receivable number is $72 million related to a tax refund receivable that we expect to receive in the first half of this year.

Inventories were $893 million. They were down both sequentially and year-over-year with turns at 4.0 times. Our fixed assets ended at $1.8 billion and included capital expenditures during the quarter of $38 million and depreciation and amortization of $82 million.

For the full year, CapEx was $109 million with D&A of $303 million. We are estimating CapEx this year in 2010 at a $150 million to $160 million and we’re estimating D&A at $300 million. The CapEx estimate includes approximately $50 million to $60 million of strategic investments for expansion in the new geographic areas and new products.

Our debt finished the year at $1.855 billion. However, net debt excluded after deducting cash is $1.323 billion.

The fourth quarter free cash flow was $222 million and the full year free cash flow was $563 million. This was a result of the good job our management team did in controlling expenditures. Net debt to EBITDA came in at 2.2 times

Our tax strategies that we put in place during the year generated about $40 million of tax refunds, earlier in the year. And in addition, we were able to bring over $127 million out of Europe into the U.S. to help us pay off our bonds.

I will turn it back over to Jeff.

Jeff Lorberbaum

Thank you. During 2009, we continued to take aggressive actions to reduce our infrastructure and align the business with industry demand. In 2009, we closed all or part of 16 manufacturing facilities and 27 distribution sites to reduce capacity, improve efficiency and lower costs.

We reduced personnel by about 4,000 and warehousing by almost 4 million square feet. In addition, in the period, we restructured selling and administrative areas by reducing sales personnel and management, consolidation of order centers, better control of sample expenditures and eliminating low value activity.

Compared to last year, excluding cash, our working capital was reduced by over 370 million and capital expenditures were cut to 110 million. In 2009, Mohawk generated significant operating cash flow of 670 million or 12% of sales during the year. The $500 million of bonds due in 2011 will primarily be paid with cash we accumulate.

In spite of this very difficult environment, we are strategically positioning our company for the future. The business has been realigned to current economic conditions. New products have been developed in all segments to enhance our sales and marketing position.

Our expansion outside the U.S. continued, as we grew our geographic participation of Mexico with ceramic tile, laminate in Russia and wood flooring in Western Europe. We continue to enhance the sustainability of our products and manufacturing to minimize our impact on the environment.

Mohawk was recently recognized as a leader for environmental efforts by Newsweek. They ranked Mohawk for “Sustainability” in the “Top 15” of the “Consumer Products Category.”

Our Mohawk segment sales were down 8% which is better than the industry. We are continuing to streamline the business, while reducing the infrastructure and cost in this segment.

In the fourth quarter, we have closed and restructured multiple carpet manufacturing operations, merged our backing facilities, combined carpet and ceramic distribution warehousing and reduced management staffing levels.

With improved processes and better discipline, we have increased our quality and yields in most product areas and reduced logistics costs. With operational changes and plant consolidation we are reducing complexity across the segment, which is lowering costs and inventory.

We have reorganized our customer, product, and logistics management and implemented new systems to enhance our service levels and costs. In the first quarter, we are implementing a price increase of 4$ to 6% to recover raw material costs inflation.

Our regional shows have been successfully completed and our customers are optimistic, so only limited retailers have actually demonstrated an improvement in business.

Our proprietary Smart Strand product, using Triexta fiber have achieved broad consumer acceptance in the marketplace as a high value alternative to nylon and polyester due to superior softness, enhance performance and easy maintenance

And Residential, we are expanding our new EverStrand extra soft polyester, for the price conscious and our Smart Strand and ware data collection for the higher value customers.

We have expanded our value oriented hard surface product to fill specific regional needs and added unique wood laminate and vinyl products for the style and value conscious.

Additional product placement should improve our overall position in a home center channel this year. The Government healthcare and education end markets remain a focus for our Commercial growth opportunity.

Our Dal-Tile sales were down 20% during the quarter. Dal-Tile continues to outperform the industry with our broad product offering and market saturation.

The Commercial industry decline is impacting Dal-Tile more significantly than our other segments.

Our leading design, superior quality and extensive distribution infrastructure distinguish us in the market. We continue to refocus our sales efforts on the Residential channels, which is to recover before commercial. We are introducing more value oriented tile products in the residential market and we recently began limited marketing of a new patented ceramic tile technology, which can be clicked together without using grout for simple installation.

We are gaining share with increased product placements and promotional commitments in the home center channels. In Commercial, we introduced more value products, coordinated collection, and sophisticated color body porcelain, and limestone concrete and wood visuals.

We have also introduced a new technology for commercial, we call “Out Stand.” It has 60% recycle content, more durable surface, greater stain resistance, and antimicrobial protection.

We have launched an advanced finish for stone that protects against stain, bacteria and makes it easier to maintain.

In Mexico, we’ve grown our ceramic sales on a local basis, although market declined last year about 9%. We have accomplished this by expanding our product offering, customer base and commercial specifications. We’re also implementing a 4% price increase in this market. In future, we will require additional production capacity in Mexico to support our growing distribution.

In the fourth quarter, Dal-Tile was continuing to reduce costs throughout the organization, with lower staffing and infrastructure levels.

We closed our Dallas ceramic tile manufacturing and a quarry tile line to improve our efficiencies and lower costs.

Our logistics operations have closed or reduced seven distribution points utilizing lower transportation cost modes and increased direct shipments with large orders. We are in the process of implementing new internal systems for both our major warehouses and local service centers. We’re about 50% complete and are seeing improvement in customer management, working capital, service and productivity.

Unilin sales improved 2% as reported or declined 7% on a constant exchange rate. Our operating margin for the quarter was 9% and our EBITDA margin was 22%.

Although business conditions remain difficult in both Europe and the U.S., we believe the laminate and wood products may have reached the bottom of the cycle.

We believe the European market may improve more rapidly than the U.S., since European customers rely less on credit and housing, has not contracted as severely.

We are pursuing multiple strategies to maximize our laminate sales, including new product introductions at lower prices, additional technological invasion, geographic expansion, and increased business in the DIY channel.

We plan to develop additional business through the distribution we acquired in the UK in 2009. Continued growth of our European wood business with an expanded product offering and increased presence in Russia with local manufacturing.

We introduced lower priced laminate products with enhanced styling, a new edging process that creates more realistic visual, and a patented scratch protection, which has been added to a significant part of our overall product line.

Demand for our board products was depressed during the fourth quarter and prices have declined due to excess capacity in the markets. Currently, demand in Europe is improving for our board products, which will increase utilization rate in the first quarter. Increases in board prices are being implemented, but they will lag cost changes in the first quarter.

We have started marketing a new wall board product that uses our patented click system. Production of our new installation board is beginning, while we obtain additional technical certificates for the individual markets. Over the next couple of years, installation board will provide another value-added niche category for Unilin segment.

At Unilin, we have also implemented many cost reductions to lower SG&A, reduce manufacturing costs, and manage inventory levels, while further investing in product innovation.

The first quarter is seasonally the lowest quarter of the year. The Residential category should improve through the year, while the commercial business faces significant headwind.

We are implementing a price increase in carpet and wood products to offset the rising costs, but the lag will negatively impact the first quarter. As the economy improves, raw materials should increase more and additional price increases may be required.

Total interest costs in 2010 will be higher from rate increases and our new agreement. Mohawk consolidated results in the first quarter will be negatively impacted by a weaker Euro.

Our first quarter guidance for earnings is $0.10 to $0.20 per share, which excludes any restructuring charges. This year, the first quarter will include four more shipping days than 2009.

The economy improved in the fourth quarter and continued growth as expected throughout 2010. After our seasonally slower first quarter future periods will improve as we move through the year. The improvements we have implemented and the realization of price increases will benefit us in future quarters. We have just been through the most difficult economic decline we have ever experienced in the flooring industry.

As we come out of this cycle and return to a more normal environment, we will be a better company with an improved management team, a better balance sheet, lower leverage and a much leaner structure. We believe the Company is well-positioned for good earnings growth and to increase shareholder value in the future.

With that, we will be glad to take questions.

Question-and-Answer Session

Operator

(Operator instructions). Our first question comes from the line of Dan Oppenheim from Credit Suisse. Your line is now open.

Dan Oppenheim – Credit Suisse

Great, thanks very much. Just wondering if you can talk a little bit more about the Dal-Tile segment in terms of the margins there. And you talked about the negative mix impact into the Commercial. As you think about going forward, how much in terms of the new product introductions there do you think can sort of help the margins in that area? How much is just the overall commercial environment going to be a drag on that, just if you can talk about that business?

Frank Boykin

As with the rest of the business, the sales are down significantly, about 20%. We believe the ceramic industry is down in the mid-20s and we have done better than that. We are suffering in a same mix decline else is that the customers are trading down in product.

At the same time we are more aggressively going after lower price product sales to run the facilities than we normally would. You see the distribution system that we have that really provided dramatic market advantages and has allowed us to have as larger market share as we have, but that continues to have a negative leverage on us, because we can’t decrease the cost of the distribution as rapidly as the other.

Looking forward, with the pricing, we are trying to do the most we can to put us in place to maximize our Residential business over the next 12 months because we think that we will turn more positive. We continue investing in new products and innovation to drive the business there. The commercial, we believe, still going be a drag on the business throughout the year. And it’s really a question of how fast the commercial declines and the timing of it and the timing of the improvement in Residential and how it’s all going to balance out during the year.

Dan Oppenheim – Credit Suisse

Great, okay, thanks very much. I was wondering also about in terms of the thoughts on cash flow, you’ve done a great job with the cash flow generation. As you think about 2010 you have talked about the debt, but also as you think about acquisition opportunities, where would you look at that in terms of geography or where do you think the product line would most benefit?

Frank Boykin

I am not sure about your question, Dan. Are you asking about strategic initiatives geographically or what cash flows –

Dan Oppenheim – Credit Suisse

In terms based on the strong cash flow generation you’ve had, what will the priority be in terms of just the balance sheet versus delta and acquisitions here?

Frank Boykin

I think our primary focus right now is to continue to focus on the balance sheet and pay down debt. We got this $500 million payment is coming up at the end of the year. As I mentioned earlier, between the cash we’ve got on the balance sheet now and what we think we’d be able to generate this year, we should be able to pay a substantial amount of the $500 million down with cash that we’ve got and maybe roll over a little bit in our revolver, but our focus is continuing to be primarily on strengthening the balance sheet.

Jeff Lorberbaum

With that we have the plant we’re going to put up in Russia we’re going to invest in, we’re behind where we thought it’d have been a little bit, because we actually have site picked up and the seller backed out. So we think we will execute that this year. We are looking at other things but I don’t know what’s that will come to fruition or not in other markets and places. We talked a little bit about the ceramic business in Mexico, as our business grows there, we will need new capacity. At this point we probably won’t start the plant until way late this year or next year. So it won’t have much of an effect on the cash this year. And then we continue to look at other opportunities on as they come up.

Dan Oppenheim – Credit Suisse

Great, thanks very much.

Frank Boykin

You’re welcome.

Operator

Your next question comes from the line of Michael Rehaut from JP Morgan. Your line is now open.

Frank Boykin

Good morning, Mike.

Michael Rehaut – JP Morgan

Good morning, thanks. A couple of quick questions. First, you mentioned the 4% to 6% price increase that was something where you know last quarter, there was a delay in that area. And I was wondering, if you can give us any color in terms of your level of confidence there, if you’ve received any initial feedback and what that might mean when if it is fully implemented in terms of a cost recovery, marginalized on the carpet segment in the second quarter?

Jeff Lorberbaum

At this point we are knee deep into it. We are aggressively implementing it throughout the marketplace. As usual, it will take some period to implement through all the different channels and the timing. It does appear that it’s going through the market. As usual, we will have, we won’t achieve all that we stood out to be with the 4% to 6%, so it will end up something less than that on average. We still have the mix changes that are going on in the business, which is impacting the average selling price as we sell customers, lower value products or lower cost products to try to maintain some of the price points. So I mean all is going forward, all indications are that we will execute it.

Michael Rehaut – JP Morgan

Okay, great. And second, on the laminate strategy, you continue to talk about, doing things more perhaps lower end then you just mentioned greater volume and throughput. Do you have a sense of given the changes in margin over the last couple of years, what type of impact that might have for 2010 as you see some of that strategy realized?

Jeff Lorberbaum

There’s two separate pieces; one is the industry mix changing in the industry that’s going on and a compression of margins in various products that we sell in the marketplace as one subtle problems which the whole industry has. The second is that we have primarily focused our business on the medium-to-high end of the business, by maximizing the value of the innovation which we spent a tremendous amount of time creating in the marketplace.

And what’s happened as we go through this cycle, the lower price points and value have become more important, we have reduced the pricing of some of our products and introductions in the marketplace to do that, and we think that we have to take a more aggressive stand in participating in the DIY channels than we have been. We are doing it across all geographies and we don’t have a single strategy, it’s customer-specific and geographic-specific to meet each market. It will be at lower margins than our historical business.

On the other hand we’re expecting delivery of the circle goes through for the higher price points to be improve in sales as we go forward. We’ve always said that over the long-term we had expected our margins in the category to decline from their original highs they were at, as we keep expanding the marketplace.

And this year, I don’t know if it will have a significant impact that takes a long time to change a strategy.

Michael Rehaut – JP Morgan

Okay, thank you.

Frank Boykin

You’re welcome.

Operator

Your next question comes from the line of David MacGregor from Longbow Research. Your line is now open.

David MacGregor – Longbow Research

Yes, good morning everyone.

Jeff Lorberbaum

Good morning.

David MacGregor – Longbow Research

Can you just recap for us by how much have you reduced your cost since you began your rightsizing?

Frank Boykin

I think SG&A is probably down two years ago by $200 million at.

David MacGregor – Longbow Research

Okay. And within COGS? The fix cost component and what have you been able to pick up in yield on the variables.

Jeff Lorberbaum

It’s hard to tell given all the mix change and the products, the different products and categories were. I wouldn’t even know how to give you a single answer that made me sense.

David MacGregor – Longbow Research

Can we talk about from a fixed cost standpoint, what you think your fixed costs may have come down by…?

Jeff Lorberbaum

Do you have an estimate how many people we’ve reduced.

Frank Boykin

I think overall we’ve cut 25%, 26% of our work force across the whole company.

David MacGregor – Longbow Research

Okay. Maybe I have a follow-up with you afterwards, Frank, offline.

Frank Boykin

Yes, we could talk.

David MacGregor – Longbow Research

I guess, just follow-up, how should we think about your incremental margins by segment in 2010?

Jeff Lorberbaum

The real question we have to answer in 2010 is what the volumes going to be. And as we’ve tried to analyze our own business it’s really got to do with how far the commercial business declines and the timing and depth of it and then in our plans we are anticipating that the residential businesses hit bottom, will actually improve, as we go through the year, so depending upon the timing of those two pieces it’s going to determine what the top-line is going to be.

We think we’ve put in place a lot of things on the cost side to reduce the cost structures so the real question is going to be the volume related to the cost structures and then if we get any surprises, during the year over from material and commodity costs as we go through. We have proven that we can continually pass those through, but as you go through these, I don’t know exactly what commodity costs are going be. Our estimates aren’t good for one week in a row year-on-year of advance.

David MacGregor – Longbow Research

Sounded like from your comments that you thought that your ability to fully recover cost inflation this year might be limited, just maybe from a timing standpoint in the price pass-through are going to lag behind raw materials, and you talked about the further raw material side of the year, I don’t want to put words in your mouth, but does that sort of speak to narrow our contribution margins in 2010?

Jeff Lorberbaum

First, we started talking about the first quarter. And the first quarter we postponed the increase in the carpet side. So, we are probably a two months or more behind where I’d like to be. So that’s going to definitely impact the first quarter, we’ve had the wood prices were raising up, they’re going to pass through them. So what we’re hoping is somewhere into the second quarter we’ll get caught up with those and then the next question is what happens with future increases and I don’t know whether they’re going to come or not.

David MacGregor – Longbow Research

Just final question, you downsized a lot. How should we think about full capacity revenue now for Mohawk and Dal? I think your peak Mohawk’s revenues is in 1.25 billion per quarter, I think Dal topped over 500 million per quarter, but there has been a lot of capacity reductions since then. I just wonder if you could help think a little based on the asset configuration you’re working towards, what would be a peak revenue.

Jeff Lorberbaum

We’ve taken out a lot of assets and pieces on the other hand we’ve mark ball pieces, so we have the ability to push the sales level back up substantially before we hit a top. Each product and each business is a little different in the ceramic business. We used to import over 30% of our sales. So as we went down, we decreased the amount or importing. So we could actually go back and start importing in between.

You hear us talking about an investment in Mexico, so that starts up, additional capacity can be pushed back to the U.S. as we started out as we go through, at some point we’ll go through the cycle. I don’t think we’re going to have a capacity limited problem, we’re going to have a revenues limited by the consumers and how fast the peak picks up over the next few years.

David MacGregor – Longbow Research

Thank you very much.

Operator

Your next question comes from the line of David Goldberg from UBS. Your line is now open.

David Goldberg – UBS

Thanks, good morning, everybody.

Frank Boykin

Good morning.

David Goldberg – UBS

First question, Jeff, on your comments, seem like you were getting somewhat comfortable that 2010 was going be the trough in the commercial market. I am just kind of wondering what that is based on and if you think there is some risk that a downturn in commercial could last a little bit longer.

Jeff Lorberbaum

We gather all the same public data that you do and we try to analyze it. Our people are under the expectation that it might possibly should end up this year. If you take the decline somewhere in the neighborhood of 20% or more this year, you take another, pick a number, mid-teens is that 12% to 15% next year, you have a 35% decline, we’re just expecting that might be near the bottom of it.

David Goldberg – UBS

Okay. The follow-up question I had was about the efforts to create more environmentally sound products and more priced a little more attractive consumers from an environmental perspective, and I’m trying to understand how you guys think about, how buyers receive those products, whether you’re able to charge a premium price and whether that’s helping you gain share and really the question is are you able to charge some sort of premium for those kind of products?

Frank Boykin

You have to decide what channels you are going into. If you look in the commercial business, where businesses are being pushed to be environmentally friendly, you can get a premium for those and you can take different actions in order to try to do those, when you get in a Residential business, the consumers like them, they feel good, they want them, but there’s limited price opportunities, so you have to be able to provide competitive alternatives at similar prices. On some occasions it can have some marketing advantages or some slight pieces, but you have to be able to do that at a competitive cost basis.

David Goldberg – UBS

Got it, thank you.

Operator

Your next question comes from the line of Ivy Zelman from Zelman Associates. Your line is now open.

Ivy Zelman – Zelman Associates

Good morning, guys.

Frank Boykin

Good morning.

Ivy Zelman – Zelman Associates

Couple of questions, first is looking at the price action you’ve implemented. When we have the September price increase that the industry delayed or you send it, part of that we understood is that the new housing market was pushing backwards for you, now were into rate prices as a new competitor versus Shaw [ph] as you’re typical to operate in, wondering if new construction with the home builders, will they be willing to accept that price increase or do you not even go with them with the price increase, that’s the first question.

And then the second question just relates to the benefit of any you maybe seeing some foreclosure activity as many investors are into ventures or trying to be refurbished, these investors have become home owners, maybe starting to refurbish these homes than itself, and you can help us with any shed a new light on that?

Jeff Lorberbaum

The raw materials in the carpet industry make up such a large percentage of the costs that as they change historically the industry has pushed them through and we pushed them through all the various channels with different timing with them. We are doing the same this time and there is no channel that wants them and nobody likes them, so we’re still in a process of implementing them we expect them to deep push through at the marketplace. The second question –

Frank Boykin

On the foreclosures we have a hard time determining where our products end up. So we have a hard time.

Jeff Lorberbaum

They all look alike to us, it’s just another remodeling order as far as we can see.

Ivy Zelman – Zelman Associates

Got it. And STAINMASTER, does that have any, what bearing would the STAINMASTER now, exclusive with Lowe’s is going to have on the industry in your opinion?.

Jeff Lorberbaum

What you have is, in the past year, as we keep saying as there’s a compression of the price point. And so as STAINMASTER was positioned at the high end, they were losing share, so their goal was to try to improve their share to marketplace, so they did that through giving limited distribution to one of their customers. And that’s the strategy they have taken and we’ll try to help the customer go in any direction he wants to satisfy his needs.

Ivy Zelman – Zelman Associates

Okay. Thanks, Jeff, thanks Frank.

Frank Boykin

Okay, you’re welcome.

Operator

Your next question comes from the line of Laura Champine from Cowen and Company. Your line is now open.

Laura Champine – Cowen and Company

Good morning. Jeff, you mentioned that the carpet increase was postponed a couple of months in Q1. I know that at the end of the year, both you and your competitor were talking about really needing a price increase as soon as possible. What changed to push that increase back?

Jeff Lorberbaum

I think you misunderstood. It got pushed back in the fourth quarter. We had originally tried to do at a couple months earlier. And it got pushed back. One of our large competitors didn’t like the timing of it. So he, so the Company postponed it and we followed suit. But, we are implementing that in the first quarter. So I think it was last year that the postponement was not this year.

Laura Champine – Cowen and Company

Okay, got it. And Frank you mentioned that you probably laid off a quarter your workforce in the last few years how much of that came last year? And what is the change that you expect in headcount for the whole company in 2010?

Frank Boykin

I think last year is about 4,000 and we have not really talked about this year.

Jeff Lorberbaum

This year we hope we’re in the right position going in.

Laura Champine – Cowen and Company

Can you talk about the reductions in the sense of capacity per square foot or per yard and have you taken down capacity as much as you have taken down work force? And where do you expect total capacity to be at the end of the year?

Jeff Lorberbaum

The capacity that we’re utilizing is actually down more than the workforce because we’re not working the same hours that we have historically. So, beside the people coming down, you have lower hours that you’ve done. Looking over the whole business in different pieces, that one is hard to do because they’re all over the place. There’s so many parts and pieces. Just pulling a number out of the air, I would guess that this year we’re probably going to run anywhere from 70% to 80%. As a general rule, we’re going to have pieces that are significantly higher and pieces that are lower.

Laura Champine – Cowen and Company

Got it, thank you.

Frank Boykin

Okay.

Operator

Your next question comes from the line of Sam Darkatsh from Raymond James. Your line is open.

Jeff – Raymond James

Hey, this is Jeff [ph], calling in for Sam. Thank you for taking my question. My question goes back to the cost savings also the recognize over the past couple years especially in SG&A. And I know a lot of that has been permanent cost take out, but I imagine there’s also a component there that is just discretionary temporary lower discretionary costs. And so I guess my question is do you expect to see any of that come back in 2010?

Jeff Lorberbaum

I would guess that discretionary pieces are limited to the total. As you come into different market, the discretionary pieces are going to be, if you think business is going to be significantly better, do you want to start aggressively, introducing more products, putting more investments and with your customers, do you want to increasing the sales force, ahead of the curve to take advantage of it. So those decisions will be made as the thing comes up. If you decide you want to wait for it to turn up and then bring them in as it goes up or you want to lead it a little bit so that you can have better performance in the marketplace. We will have to make those decisions as they occur on a case by case basis.

Jeff – Raymond James

Okay. And then so is a follow up, I guess, would it be correct then to say that if we assume, just say, we assume moderate sales growth in 2010, would you expect to see the normal early cyclical leverage in SG&A?

Frank Boykin

Yes.

Jeff – Raymond James

That wouldn’t be surprised at all.

Jeff Boykin

Yes.

Jeff – Raymond James

Okay, great, thank you.

Operator

Your next question comes from the line of Keith Hughes from SunTrust. Your line is now open.

Keith Hughes – SunTrust

Just a follow-up on your comments, you had talked about some higher board prices for Unilin, I guess A) is that in Europe and B) is that a function of lower capacity on the continent or just increased demand for the boards?.

Jeff Lorberbaum

The board business has been struggling dramatically over the past years, as the capacity has way outstripped the markets. There have been shutdowns of plants across the continent that has reduced capacity, there have been capacity taken off and so the pricings in the board industry has been, we said multiple times, has been close to cash costs across the pieces as happens in a cyclical downturns.

What we’re seeing now is it looks like that there’s some inventory build back, it looks like there’s going to be some increased capacity utilization going into the first quarter across the industry, which is a good thing. What’s happening is that the raw material prices in wood are going up, so, we’re going to lose some of the upside into the chasing the raw material lag. And if it there should be some better capacity utilization and depending upon how the year turns out, we could start seeing the recovery of some of the margins in that industry.

Keith Hughes – SunTrust

And you’ve talked about European improving probably before the U.S. and consumer, if I look at the Unilin segment, it’s down 6%, 7% taken our currency, what was Europe in that mix year-over-year?

Frank Boykin

I’ll have to get back to you on that, Keith, if you’re going to call me separately, we don’t have that here in front of us.

Keith Hughes – SunTrust

That’s all for me. Thank you.

Operator

Your next question comes from the line of Eero Redmond [ph], Redmond Capital. Your line is now open.

Frank Boykin

Hello?

Jeff Lorberbaum

Operator, can you help us?

Operator

Mr. Redmond, your line is open.

Siddle – Redmond Capital

Hi. This is Siddle [ph]. Just wanted to talk about your cash flow, it is a tough year and you generated a lot of cash as usual. Could you elaborate on what the cash complications were on income statement and especially from the inventory side of things? And just talking about inventory liquidation, impact on the income statement and versus cash flow.

Frank Boykin

Your question is how much our inventory sound? Or how much of the inventories impact our cash flow?

Siddle – Redmond Capital

That’s one, but I just wanted to understand how the inventory liquidation and what it is, how it impacts the income statement as well?

Frank Boykin

Inventories impacted cash flow positively about $280 million for the year.

Siddle – Redmond Capital

Okay. And could you talk about if it had any impact on income statement?

Frank Boykin

Well, to the extent that our volumes are down, that impact the income statement.

Siddle – Redmond Capital

And could you just elaborate on that how does it – because it is a significant draw down, so that’s why I wanted to understand how much impact it had on margins?

Frank Boykin

Why don’t you give me a call back after this so that maybe I can walk you through that because it’s going to take a while.

Siddle – Redmond Capital

Okay, thank you.

Operator

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

John Baugh – Stifel Nicolaus

Thank you. Job well done. Couple of quick ones. Could you comment on the Mohawk side, there’s things other than carpet there, so, I’m curious did they perform roughly the same down 8%? And then within carpet itself, I assume the commercial was down somewhere 15%, maybe 20% range, which would imply the residential was pretty close to flat, maybe down slightly year-over-year. I am just curious if that’s the case. And if you expect residential maybe go positive in the first quarter?

Jeff Lorberbaum

We don’t give out the specifics of each piece, but yet we can give you a flavor of it. You have the right direction. The residential business is doing much better than the commercial, the commercial business is up substantially, our surface pieces, the wood business that would be have a high portion and new construction would be of the most following the construction business in it. I am missing other pieces.

John Baugh – Stifel Nicolaus

So Jeff does your carpet actually do better than down 8% on the Mohawk hard surface was off more than 8%?

Jeff Lorberbaum

On the industry number which I assume you have, showed that the industry was down 7% in units, about 14% in dollars. So that’s a reflection of what’s going on in the world. We think we did a little better.

John Baugh – Stifel Nicolaus

And then, Frank, if sales were roughly flat in '10 just as a starting point, what would working capital do?

Frank Boykin

It would probably be flat.

John Baugh – Stifel Nicolaus

Okay, great. And then that 40 million, I think was a quarterly D&A number for Unilin, what will that number look like quarterly or annually for '010 and how much of that is the acquisition and amortization?

Jeff Lorberbaum

I believe it’s going to be about the same in '10 as it is in '09 both for D&A in total and amortization on a standalone basis, John. (inaudible).

John Baugh – Stifel Nicolaus

It doesn’t step down.

Jeff Lorberbaum

Not yet, not yet.

John Baugh – Stifel Nicolaus

Okay, great, thank you much, good luck.

Operator

Your next question comes from the line of Eric Bosshard from Cleveland Research. Your line is now open.

Tom Mahoney – Cleveland Research

Hi, guys, this is Tom Mahoney calling in for Eric, today. As you talk about Residential improving through the year, how do you think about new construction versus the remodel trends you’re seeing?

Jeff Lorberbaum

Start out that the new construction business is almost came to a halt last year, so any, any improvement over that is going to show up in the piece. You have to understand that we are, the last product, to go in. So things that were started in January, will see either mid year or third quarter at the soonest. So as that picks up, we will see some benefit of that one as we go through the year from the low points.

The Residential side it was also at a very low point and the expectation is that consumer confidence will improve, at all these existing homes that are trading hands in either to get them out of bankruptcy or wherever they went to, there’s going to be more remodeling going those and a combination of those things with an improved economy we expect to help us. We don’t know the exact timing of it, but as we move through the year we’re expecting it to improve because of that.

Tom Mahoney – Cleveland Research

Got you. And then, you guys were talking about better positioning at the home centers and maybe some more partnerships there, can you talk on the trends you’ve seen there and maybe a read on, what you see as underlying demand versus the promotions driving the business there?

Frank Boykin

The home center channel seems to have done better during this downturn than the specialty store channel across most of the product categories. They tend to focus on more value products and promoting value as a general statement. So as people’s pocket books got stressed they appeared to be better. They have gone aggressively advertising and marketing products to try to improve their position in the marketplace. And we have an aggressive to try to participate and improve our position within the stores and based on the commitments we have, we think that we will have a better business through the channel.

Tom Mahoney – Cleveland Research

Makes sense, thank you.

Operator

Your next question comes from the line of Alex Mitchell from Scopus Asset Management. Your line is open.

Alex Mitchell – Scopus Asset Management

Good morning, guys.

Frank Boykin

Good morning.

Alex Mitchell – Scopus Asset Management

I just want to follow-up on your comment about the laminate business, coming out of the trough. And specifically, if you can comment on how you see licensing income and all of that, as long that gets better?

Jeff Lorberbaum

The laminate industry has been going through the same declines as every other product in the industry. We think it’s at the bottom. Depending upon which market and geography you’re at, there’s different pricing strategy going on by the different groups. With that I guess our strategy has been to participate more in some of the lower price points than to extend our channels into some of the DIY channels that we have had limited to minimal participation in and we are putting through different strategies to take advantage of that.

As it goes back, in all categories our mix in all product categories has declined, as we have participated in lower price product categories and all products to try to maximize our share of the business. So, as the industry has declined, we’ve tried to participate in some more of that and we would in all product categories.

From the licensing piece, much of our licensing revenues are based on the industry demands so as the industry slows down, our licensing revenues also change related to those. We have had increasing success in licensing, Chinese manufacturers, which years ago would have been unheard of. But, we are getting better at influencing those things and we have had some Chinese licenses and we continue to go after more.

Alex Mitchell – Scopus Asset Management

Okay. So as laminate gets better, would licensing keep pace where the percentage of licensing, where you were historically or how would that change?

Jeff Lorberbaum

It’s not going to go per cent by per cent, but as the industry goes up and down we tend to go up and down, too.

Frank Boykin

Generally speaking, it's going to follow the volume of the industry, but the other thing I remember too is when you have new customers, you put in place for one with license, you got some times some initial upfront fees that are paid, so that could kind of distort the numbers from year-to-year.

Alex Mitchell – Scopus Asset Management

Okay, well, thank you very much.

Operator

Your next question comes from the line of Arnold Brief with Goldsmith and Harris. Your line is now open.

Arnold Brief – Goldsmith and Harris

Two quick questions, one, you took a lot of initiatives in 2009 to cut costs. And those efforts transpired and you went through the year. Although the event may have been completed, not all the cost savings were actually realized in '09.

Could you give us some idea how much of the cost savings will flow through into 2010 from initiatives that we’ve taken in '09? The second question is given what’s happened globally, could you elaborate a little bit more on, if and what, you’re doing to capitalize or to get participate in the growth of Asia, which would balance your cyclical aspects a little bit more given the growth?

Jeff Lorberbaum

Let’s start with the second one and we will see the first one. In Asia, we basically have very limited participation, as we speak. We have moved into eastern Europe with our laminate business. We are looking at putting a laminate manufacturing plant up in Russia. We have had conversations in both Russia and China with either acquisitions or green field, other options that we are looking at and various product category. We continue to look at those to decide how to participate in the marketplace without creating unreasonable risks. As we go through and we will continue following those that would not surprise me, at some point if we had an acquisition or some other method of getting in and various product categories in those markets.

Frank Boykin

On the cost savings activities we incurred, as you probably know, about a little bit over $60 million in costs related to restructuring in 2009. And we are estimating that we will see a pay back on those costs over about a year and year and a half or so. We’ve realized probably some portion of that this year, but we should see more of that next year. And that’s really what we’ve disclosed so far.

Arnold Brief – Goldsmith and Harris

Would you say you’re looking at Asia as a major strategic initiative at this point?

Jeff Lorberbaum

Yes.

Arnold Brief – Goldsmith and Harris

Thank you.

Operator

Your next question comes from the line of Gray Grantham [ph] from SEACOR Group [ph]. Your line is now open.

Gray Grantham – SEACOR Group

Thanks, good morning guys.

Frank Boykin

Morning.

Gray Grantham – SEACOR Group

I was wondering if you can provide a little bit more color on the logistics and plans to address the 2011 and 2012 maturities, my understanding is the new ABL facility has early maturities figures, if those, 2011 or 2012 maturities are not addressed by certain dates, I know you guys are sitting on a chunk of cash now, but I assume as business improves you will need some of that also for working capital. Any info you can provide on your thoughts there?

Frank Boykin

As I was trying to say earlier, I think with the 2011 maturities, if 500 million that’s due at the end of this year, we got to have it set aside into the ABL requirements by beginning of the fourth quarter. I think we will be able to pay off most of that with cash. We either have or we’re going to generate and then take whatever shortfall we have rolls into the ABL. And then the 2012 maturities out I guess about two years from now, we’re going to have to look at alternatives such as the bond market at some point probably.

Gray Grantham – SEACOR Group

Okay. So, for the 2011, then you’re basically expecting just to set aside the cash and basically go and (inaudible).

Frank Boykin

For a lot of it, yes.

Gray Grantham – SEACOR Group

Yes, okay, great, thank you.

Frank Boykin

You’re welcome.

Operator

Your next question comes from the line of Akash Ghiya from Pine Cobble Capital. Your line is open.

Akash Ghiya – Pine Cobble Capital

Hi guys, thanks for taking my question. Just a couple of questions if I can go back to the raw material side again. First, can you remind us forward purchase or hedging your costs?

Frank Boykin

No. That’s an easy one.

Akash Ghiya – Pine Cobble Capital

Okay. So then I guess second, what’s the typical delay between the spot price and the price you guys pay. And I guess the reason I’m asking the question is if you take the Mohawk segment, as a separate segment, and would get through your major raw material costs that increases with stock prices of trade are massive, so, if we take spot, you assume, spot prices don’t move throughout 2010, nylon prices are up, sort of 35% plus, polypropylene 30%, polyesters, 50%,when we should see that for the through end, how should it delays due to the accounting?.

Jeff Lorberbaum

A lot of our raw materials in carpet as we backward integrated, go up and down with the marketplace and the lead times are relatively short, with that you then have our inventory levels in between are roughly a quarter, so they get postponed by about a quarter, and we have to keep these value and then deciding when to raise prices based on those prices, if you have been watching those things over the past two or three years, as we do, you will know that what those future things are six months and nine months out, many times have no relationship to what happens when you get there in either direction. So, we continue watching those things and we will have to decide how to react to them as they occur.

Frank Boykin

So our raw materials we buy them in the fourth quarter and they will impact our P&L in the first quarter.

Akash Ghiya – Pine Cobble Capital

Okay. So I guess if I heard you correctly, there is no benefit you’re seeing in the fourth quarter from I guess if you look at the increase in raw material between the third quarter and fourth quarter, the spot prices would suggest raw materials going up –

Frank Boykin

We’re FIFO inventory, right?

Akash Ghiya – Pine Cobble Capital

That’s right. How much benefit did you guys see the result of that accounting treatment?

Frank Boykin

The benefit, it is just, just, we don’t measure it that way. We buy it and then we use it. That’s very much do the P&L.

Akash Ghiya – Pine Cobble Capital

Okay, thank you.

Operator

There are no further questions at this time. I turn the call back over to the presenters for any closing remarks.

Jeff Lorberbaum

We appreciate you joining us. We think we’re positioned well for the future. And we will continue reacting to what happens in the marketplace. Thank you for joining us.

Operator

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

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Source: Mohawk Industries, Inc. Q4 2009 Earnings Call Transcript
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