The Sheet Hits the Fan at Pillowtex (News) September 3, 1999

The Sheet Hits the Fan at Pillowtex

By Brian Graney (TMF Panic)
September 3, 1999

Bathroom towels and bedroom sheets maker Pillowtex (NYSE: PTX) was tarred and feathered by investors this morning after the company warned that its earnings in the second half will come in below estimates. The Dallas-based company is expecting EPS between $0.25 and $0.30 for Q3 and between $0.50 and $0.55 for Q4, missing analysts' estimates of $0.86 and $0.82, respectively. That sent the company's stock lower, adding to its 63% descent so far this year.

The main culprits for the shortfall are disruptions related to a major manufacturing systems upgrade at its factories, which were previously fingered as the causes behind lower than expected results in Q1 and Q2. Perhaps fearing that shareholders are growing tired of the same old song and dance quarter after quarter, the company also added a couple of new excuses -- margin erosion and higher sales and marketing expenses due to the rollout of new retail products.

The margin slide is being attributed to efforts by the company to reduce its inventory levels, a thinly veiled admission that stockpiles have gotten out of whack. For folks who have been following Pillowtex's story over the past year, this is not a shocker. Despite the manufacturing upgrades, the company's factories have been able to spit out enough product over the past 18 months to boost inventories 33% to $509 million as of July from $384 million last April. Supplies and raw materials were reined in during Q2 after a build up in Q1, but the company's work-in-process and finished goods inventories have continued to rise.

Things are set to get particularly ugly on the company's statement of cash flows. Last night's warning puts full-year earnings between $1.46 and $1.56 per share, well below the $2.34 per share earnings threshold that trips a 10% dividend payment rate for Pillowtex's convertible preferred stock starting next year, up from the current 3% rate. Also, the company's earnings expectations do not include a $10.1 million one-time dividend adjustment charge that will be taken in conjunction with Pillowtex falling below the EPS trigger number.

The dividend adjustment can be paid out in either cash or in more convertible preferred shares. Either way, the higher dividends and the adjustment will increase cash outflows from financing activities, while the lower net income figures will hamper cash inflows from operating activities. To sate its cash appetite, Pillowtex will be forced to continue selling assets or dip deeper into its revolving bank credit lines, as it did last quarter. The company can probably operate in its current cash devouring mode for a while yet, but at some point that trend will need to come to an end.

With slightly more than $1 billion on its balance sheet compared to $248 million in shareholders' equity, the company will not have a lot of maneuvering room if earnings stay depressed and the present situation develops into a full-scale liquidity crunch. At this point, investors looking at Pillowtex as a potential value play are probably better off staying in bed.

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