The Dixie Group, Inc.
Q3 2014 Earnings Call Transcript

Published: 30 Oct 2014

[Operator:]

Good day, everyone and welcome to The Dixie Group Incorporated Third Quarter 2014 Conference Call. Today's conference is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Chairman and Chief Executive Officer, Dan Frierson. Please go ahead, sir.

[Dan Frierson:]

Thank you, April, and welcome everyone to our third quarter conference call. I have with me Jon Faulkner, our CFO, who will also be participating in the call. Our Safe Harbor statement is included by reference to our Web site and press release. When the year began, we were optimistic that the industry would finally begin to show solid growth for the first time since the downturn of 2009. We stayed as an industry. We continue to experience fits and starts that add up to very low growth if any for the industry. Again, our sales growth for the quarter exceeded that of the industry. Sales in the third quarter last year were up 37% despite the comps being more difficult, our sales for the third quarter this year were up 21%. Without the addition of the Atlas acquisition, our sales were up approximately 8%, while the industry was essentially flat. We had a strong quarter for the residential business. Our residential sales increased nearly 10%, while the market declined slightly. Our commercial business increased 45% over the year ago period and without Atlas was up low single digits. Looking at the year-to-date numbers, we also continued to outperform the industry. Our commercial business excluding Atlas is up 10.7% for the year-to-date and the industry is up low single digits. The residential market is actually down low single digits, but our residential business is up 11%. All of our brands expect Atlas are up for the year and we anticipate Atlas sales will pick up with the introduction of several new products both broadloom and tile, which will be in the market soon manufactured in our new technology. Late in the quarter, we purchased Burtco Enterprises; a marker of customer products for the hospitality market utilizing computerized yarn placement technology. We will integrate Burtco products into our hospitality business going forward. Jon Faulkner will review our financial results after which I will discuss the impact of our facilities restructuring and additions to capacity they've had on our profitability. Jon?

[Jon Faulkner:]

Thank you, Dan. Looking at sales for the quarter, our sales were $109.4 million up 21.2% on a fiscal period basis versus last year. Our total sales without Atlas were up 7.8%, while the industry was flat. Our commercial products were up 45.6%, while the commercial without Atlas was up 1% and the industry was up mid-single digit. Residential products were up 9.8%, while the industry was down in the low-single digit. The quarter gross profit as a percent of sales is 24.2% compared to 24.5% a year ago. Selling and administrative expenses for the third quarter of 2014 was 21.9% of net sales as compared with 22.4% same quarter 2013. Operating income was $528,000 for the quarter as compared to income of $1.8 million a year ago. Adjusting for $2.6 million in facility consolidation, asset impairments, business integration and acquisition related expenses during the period as we implement our previously announced plans to expand capacity, integrate acquisitions and streamline operations, operating income was $3.1 million. The non-GAAP operating income of $3.1 million did not include added restructuring related expenses relative to dual staffing, training, waste control, additional quality inspection and added administrative oversight could have increased our cost during the period. Our restructuring expenses have been more front-end loaded during the period than originally projected. In addition, we have had added expenses to deal moving some of our Atmore dye equipment to our Susan Street dye house to provide better quality and lower cost in Atlas carpet mill as well as additional expenses to decommission Atmore wastewater treatment plant. Therefore, our estimated expenses for the overall plant is up $800,000 to $6.8 million, but our expenditure is anticipated in 2015 are down by over half to $1.1 million from what was previously forecasted. Our interest expense for the quarter was $991,000, our income taxes for the period was a benefit of $101,000. Diluted loss from continuing operations for third quarter of 2014 was $0.01 per share as compared to an income from continuing operations of $0.11 per share in the third quarter of 2013. On a non-GAAP basis, adjusted income from continuing operations is $1,326,000 or $0.08 per share. Looking at our balance sheet, current assets increased $3.9 million during the quarter primarily due to higher levels of trade receivables and deposits on the new machinery and equipment. As projects are completed in the fourth quarter an interim progress funding is converted to permanent financing. The amount of debt classified as current will drop approximately $3.5 million. Capital expenditures and capital leases for the quarter were $7.3 million, while capital assets in business combination Burtco is $2.3 million. Depreciation and amortization was $3.3 million in the quarter. We completed the sale of the Atlas dye house in mid-October receiving approximately $5.5 million of net expenses. We entered into an agreement to purchase our Adairsville distribution center in the fourth quarter for $9.8 million, while extinguishing the current $10.5 million, 10-year lease obligation. We plan to finance to purchase the combination of 10-year mortgage for $8.3 million in cash. 2014, we anticipate operational capital expenditures of $20.9 million, purchase of the Adairsville warehouse of $9.8 million. And conversion of operating lease to capital lease was $2 million. Our planned capital expenditures for 2015 are in the range of $14 million. We ended the quarter with $122.9 million in debt and availability of $35.3 million under our credit agreement. Investor presentation including our non-GAAP information is on our Web site at www.thedixiegroup.com. Dan?

[Dan Frierson:]

Thank you, Jon. During the 2008 to 2010 period, we like the rest of the industry concentrated our efforts on reducing costs and right-sizing our operations and organization to the level of business activity which we were experiencing. Due to the lack of investment in our industry in 2011 and 2012, we sensed an opportunity to grow our business by investing in new fibers, new technology and new products. Our plan was to grow our business faster than the industry by taking advantage of the opportunities which we perceived in the marketplace generally and the high-end specifically. To accomplish this, we concentrated on bringing out more new products than usual. And sales began to increase faster than we had anticipated. In order to accommodate this growth, we accelerated our plans to increase capacity and restructure our manufacturing and distribution operation. Literally, every one of our facilities has been impacted by this restructuring of existing plant and adding capacity. In addition, we have made a number of acquisitions to enhance our market position and add specific capabilities which strengthens our market position. In the last half of 2013, our sales increased by 35% which clearly was not sustainable, that caused us to accelerate further the restructuring activities, so we could support additional growth in the future. These changes also accelerated capital expenditures for this year, which are now expected to be $30.7 million. In the third quarter alone, we have expensed $2.6 million on facility consolidation, asset impairment, business integration and acquisition related expenses. These one-time costs have had a significant impact on our operating income. In addition to these non-GAAP expenses we have experienced significant disruption in our operation. As Jon pointed out, including dual staffing, training, waste control, additional quality inspection and added administrative oversight, which have further increased our cost during the period. There have also been significant cost incurred and increasing our number of associates at Dixie. Since the beginning of 2012, we have added through internal growth and acquisitions 43% to our head count. The acceleration of the restructuring means that most of the non-GAAP and other related expenses will have been incurred by the end of 2014 this year. For next year, we are spreading out the implementation of the remaining restructuring projects to minimize the disruption in our facilities. We are now in a position to concentrate on improving operations, which should return our margins to more historical level. As we look back at the post-recession period since 2009, we have seen our sales increase by 85% while the industry has grown by less than 15%. Although this is considerable cost to profitability in the short-term, we believe it will prove to be the right thing to do for our shareholders. Looking at 2015, slowing down the last few projects will spread the restructuring cost throughout the year. This is an effort to minimize the noise in our gross profit margins. We have had too many non-measurable disruption cost going through our numbers. Therefore, we are modifying our plans to limit the disruption at anyone point in time by making more gradual changes to the operation. Also, our capital expenditures for next year at $14 million will be less than half of this year's level. Looking at the sales rate in the fourth quarter, we have a very tough comparison to the fourth quarter of 2013 when growth of nearly 35% as compared to the fourth quarter of 2012. And it was led by a very strong October. For the first three weeks of the quarter, total sales are up about 6% and residential is positive in the low-single digits. Commercial without Atlas is lagging against a very strong October in 2013. Business activity levels remained strong and October will be our toughest comp for the quarter. At this time, we would like to open up the call for questions.

[Operator:]

Thank you. (Operator Instructions) And we will first hear from Adam Rudiger of Wells Fargo Securities.

[Adam Rudiger:]

Hi. Good morning. Thanks for taking my question. Dan, I wanted to follow up on the comment you just made somewhat in your closing remarks about some of the growth initiatives in the shorter term impact to earnings and you said longer term be a benefit. I was wondering, if you could address that a little bit more particularly in 2015 and in light of the spreading out of the integration your doing, if you could just comment on what kind of gross margin trends or trajectory we could expect for 2015.

[Jon Faulkner:]

Hi. Adam, this is Jon. We anticipate that it will be the middle of the year before our gross margins get back, we were confident that they don't have so much noise in them. We will be spreading the restructuring cost throughout the year just about $1.1 million we anticipate, but the goal is to – those items which are – have operational impact should be largely done by the first half. But we are – margins should get back to more historical levels north of 25% again.

[Adam Rudiger:]

Okay. So north of 25% after half way through the year probably?

[Jon Faulkner:]

In the second half of the year.

[Adam Rudiger:]

Okay. That's helpful.

[Jon Faulkner:]

And the other comment I was going to make is that fourth quarter of 2014 we'll still have rather significant noise in the numbers as we fill the transition in Adairsville, and installing additional equipment in Susan Street.

[Adam Rudiger:]

Okay. Second question was just – if you could address the commercial revenue as opposed to the market you just lost a little share, you can talk about whether or not that's a hard comparisons or is there something else going on there?

[Dan Frierson:]

Adam, I think it's – last year we had some unusually large business in the third quarter and early fourth quarter and October of fourth quarter. Obviously, that's not repeating this year and therefore the comps are difficult. But our activity level remained strong and we don't see that as a long-term issue.

[Adam Rudiger:]

Okay. Thanks for taking the questions.

[Dan Frierson:]

Thank you.

[Operator:]

And next we will hear from Jason Bernzweig of Zelman Capital.

[Jason Bernzweig:]

Hi. Good morning. Thanks for taking my question. Really appreciate a lot of the color you guys shared around the acquisitions and integration and capacity expansions. Curious, if we can – if you can help us do a little bit of contrast, I mean, when you look back through this period, you have been acquisitive, you've made a lot of changes to operations internally. Can you talk about where you are with respect to current capacity utilization and what your revenues could grow to on the current asset configuration? And when you look back to the prior peak period of 2005, 2006, 2007, you mentioned mid 20s gross margin I think you peaked out like – something like 29 to 30, with EBITDA margins around 10. You are bigger company, you should have more efficiencies, are those types of margins foreseeable as we kind of go through the cycle?

[Jon Faulkner:]

Hi. First of all, on the capacity. We should once we finish moving everything we should be able to grow somewhere in the 30% to 50% range depending on what product types what areas we grow in. The whole idea of the restructuring in terms of distribution was to give us more distribution space for residential business and in also free up space for additional tucked in equipment in our Eaton and Atmore operation both of which will be gaining. In terms of margins, margins will increase and there is no reason not to expect that they can be in up at high 20s. I don't know that we would arrear back to that 30% range in our peak.

[Jason Bernzweig:]

Okay, appreciate that. From an EBITDA margin standpoint is the return to 10 or maybe better?

[Jon Faulkner:]

10 would be, I think the upper end of that.

[Jason Bernzweig:]

Thank you. And then just in terms of – you guys the sales significantly outpacing the industry, wonder if we can get some clarification on that because it's one thing to be taking a lot of market share, but I'm also wondering if there is somewhat of a bifurcation in the market with strength at the high-end as we have seen a lot of consumer products today. When you do cater the high-end versus taking share from competitors at the high-end, can you provide some color on that?

[Dan Frierson:]

Yes. We would agree with you that our market is bifurcated just like most market seem to be. The high-end has done very well. Low-end has done very well. The middle has struggled from the last couple of years. The overall market therefore has not grown a lot, but I'm convinced then we have no empirical data to support this, but I'm convinced the upper end has grown significantly and we have a large market share there. And I think that's one of the things that has allowed us to grow as rapidly as we have. Our average selling price on a residential side for instance is about 3x the industry average. That's middle price. So again, we are in the upper end. We brought out four products right when the market started turning down, that those four products have grown significantly during this whole period, again, catering to the very high-end of the marketplace. So I think what we have seen has been very similar of what you have seen in other markets.

[Jason Bernzweig:]

Okay. I appreciate that. And on the commercial side, it sounds like maybe for the near term in your business you have underperformed the market. But, you seem to be developing a strategy on that front particularly with Atlas. And can you talk about some of your plans in that business and what do you think of potential is there?

[Dan Frierson:]

Well, there also we are in the upper-end of the business. And Atlas would be the best example of that. They are very much in the high-end of the business. We certainly plan to prove new technology and new products as well as more cost efficient modular manufacturing to grow their business in 2015. There was a delay in their product introductions this year with the acquisition. But, they have begun getting into the marketplace in the fourth quarter and I think you will see them very aggressive with new really differentiated product. Masland Contract has grown rapidly on the modular side, continues to do so. I mentioned we had a couple of large contracts in the third quarter in October of last year, which made the comps difficult. But, our business level activity is good and we anticipate growth there going forward as well. We also just purchased Burtco recently and we will – they have a unique technology that is very well received in the hospitality business and we will be simulating that into our hospitality business over the next couple of months. So we are attacking the commercial side on several fronts, and feel like we will see growth there just as we have on the residential side again, in the higher part of the business.

[Jason Bernzweig:]

In terms of that end market, I mean obviously, we have been in our residential recovery for sometime, I think a lot of people who follow the non-residential market would say that only in the past couple of quarters that we really started to turn up in construction in non-residential assets both on new res and a little bit of repair model. How do you feel about that end market in general, do you feel like we are in the front end of an impending more aggressive recovery or do you not have that level of visibility/

[Dan Frierson:]

You are talking about the commercial side?

[Jason Bernzweig:]

The commercial side, yes.

[Dan Frierson:]

I think you almost have to break it down in the markets. Hospitality we think is beginning a multi-year run. We think corporate is beginning to improve. So yes, you almost have to look at it by market, but overall yes, but remember we tend to be more in the refurbish or replacement business than in either new housing on the residential side or new construction on the commercial side. So it's not necessarily to add to new construction in either market. The higher end tends to be [more] (ph) to refurbishment than to new construction.

[Jason Bernzweig:]

There is significant pent-up demand in the refurbishment end of the market similar to the home improvement trend we are seeing today?

[Dan Frierson:]

Well, certainly, any historical data you look at would tell you that there has been a demand because the last couple of years starting in really late 2008 and definitely in 2009 market declined pretty precipitously and really hadn't recovered to the levels that one would think would be applicable. We look at fixed investment which is new construction and refurbishment in both markets – both residential and commercial. And commercial is a 2.9% of GDP and the 60-year average is more like 3.5% or 3.4%. Residential is at 3.1% and average since 1969 is 4.5%. So we think there is ways to go. We don't think we would come back and reach the peaks that we reached right before the downturn however.

[Jason Bernzweig:]

We follow the same numbers. We agree with that assessment completely. So if I can just summarize what I think you just shared is, after we get through some of this restructuring, you think there could be as much as 50% upside in the sales as we move through the cycle on the current asset configuration and many 100s of basis points of margin expansion back to the prior peak levels or towards them?

[Dan Frierson:]

That is a possibility.

[Jason Bernzweig:]

Okay. Appreciate that color. Thank you very much.

[Dan Frierson:]

Thank you.

[Operator:]

And next we will hear from Tom Lewis of High Road Value Research.

[Tom Lewis:]

Hey, good morning.

[Dan Frierson:]

Good morning, Tom.

[Tom Lewis:]

First question, can you give us a – shed a little light on what you are seeing on the raw material front and how that's likely to play out in the year ahead. And if were petrochemicals to decline – continue to decline, or what point might that become a problem for you?

[Dan Frierson:]

Tom, we have seen very little movement on raw materials in the last year or so. Few increases here; few decreases there, but no significant movement. I don't know that obviously with all being down, we are not sure what impact that's going to have on intermediate chemicals which is what is our feedstock. But, if there were downturns, I don't think or reductions, I don't think that would be a big issue. So I guess at this point, we are not concerned about that although you would think if all were to stay down for a significant period of time there maybe some reductions.

[Tom Lewis:]

But, it's not really an issue in play right now. Okay, good. Second of all, with respect to Burtco, I mean it reached kind of like this is essentially a technology and specialized equipment purchase that you made or is there more to it within that, did you pick up market price in store, maybe there is something about Burtco product that those of us that don't lived on the hospitality world don't appreciate the people there do. Could you shed a little light on that for us please?

[Dan Frierson:]

Well, to try and put in perspective that the CYP equipment typically makes product that are used in hospitality right under Owen products. It's usually more expensive and higher priced than normal [tucked in] (ph) product. It is very specialized equipment. It is a little – production is slower. But, it makes some very beautiful products that simulate Owen products. So it just puts us in a product category where we haven't been and what it does it allows our sales people to have a more complete bag of tricks if they go into call on the hospitality business.

[Tom Lewis:]

Okay. And finally, with respect to the 43% head count growth that you referenced, I get this – is that predominantly driven by acquisition or to what extent does this reflect having a higher than normal level of people that are relatively new on their job and need training, but if you stick with it for a couple of quarters it gets better.

[Dan Frierson:]

I think it's more driven by internal growth than it is acquisition.

[Tom Lewis:]

Okay. Those are – go ahead.

[Dan Frierson:]

So when as required a lot of training, a lot of development, when someone comes in as new – you feel like you can train them over a period of time. But it takes a significant period of time before they are truly productive and operating at optimum levels. But, most of this has been in our facilities and in our sales forces. Very little of it in what I would call G&A.

[Tom Lewis:]

Okay. So its one of those things that's holding this bag now, but we stick with it and a year from now what's – it's not an issue any more.

[Dan Frierson:]

That's correct. That's correct.

[Tom Lewis:]

Yes.

[Dan Frierson:]

A big increase in head count in really less than two years.

[Tom Lewis:]

Yes. Now, that is substantial. All right, well, that does it for me. Thanks a lot guys.

[Dan Frierson:]

Thank you, Tom.

[Operator:]

And next you will hear from Les Sulewski of Sidoti & Company.

[Brian Kinstlinger:]

Hi, guys this is Brian in for Les. Thanks for taking my call.

[Dan Frierson:]

Hey, Brian.

[Brian Kinstlinger:]

Can you talk a little bit more about pricing during the quarter and have they given impact as freight cost been?

[Dan Frierson:]

Let me talk about product and then I will ask Jon to talk about freight. From a product standpoint we have not seen major changes in pricing. We had some increases earlier in the year, but in the third quarter we didn't see – we had some in – it went up in late second quarter became effective in third quarter. So we have had a price increase but I don't foresee any going forward at this point. And as to freight Jon?

[Jon Faulkner:]

We have seen increasing freight rates and of course, what we typically do is for our customers they normally obtain the freight bill either we tack it on and they – we add it to their bill or they are paying it directly. Our raw materials that has been less of an impact, it is basically full truckload type deliver. But, we are seeing an increase and have made adjustments where necessary and the claims not much across the board.

[Brian Kinstlinger:]

All right. Thank you very much.

[Dan Frierson:]

Thank you.

[Operator:]

(Operator Instructions) And with no further questions in queue, I will now turn the call back over to Dan Frierson for any additional or closing comments.

[Dan Frierson:]

Thank you, April, and thank all of you for being on the call. Obviously, we feel like we are coming to not the end, but the end of the massive changes we have been going through in the last two years and particularly this year at Dixie. And next year it would be much – our restructuring would be at a much lower level and spread throughout the year. But, we appreciate you being with us and look forward to talking to you in the future.

[Operator:]

And ladies and gentlemen, that does conclude today's conference. Thank you all for your participation.