The Dixie Group, Inc.
Q1 2013 Earnings Call Transcript

Published: 1 May 2013

[Operator:]

Good day and welcome to the Dixie Group Incorporated First Quarter 2013 Conference Call. Today’s call is being recorded. At this time for opening remarks and introductions and 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, Melissa. And welcome to our first quarter conference call with me is Jon Faulkner our Chief Financial Officer. I would like to include the Safe Harbor statement my reference to both our press release and our website. The first quarter trends tend to be most – the first quarter tends to be our most difficult one and last year in 2012, it was stronger than usual. Despite these factors we were able to show significant improvement this year. Our sales were up 20% compared with 2012 and we started the year on a profitable note. We had sales growth in all our residential brands and the commercial business increased 13%. We believe the investments we have made in the business over the last few years are positioning us to outperform the industry. Our residential business saw the continuation of significant growth than the wool business. Solid growth in our polyester products and strong performance in our Stainmaster nylon products. Gulistan products which we acquired late last year along with our TruSoft and SolarMax products helped boost our sales in the mass merchant and specialty retail market. Mass and commercial under new leadership is again outperforming the industry. In our new towel products are leading the way. Jon Faulkner will review our first quarter financials after which I will comment on the industry in general and our current business. Jon?

[Jon Faulkner:]

Thank you, Dan. Our first quarter sales were $75.4 million up 20% versus the first quarter of last year. For the quarter as I said, our total sales were 20%, while the industry we believe was in the low single digit. Our commercial products were up 13.1% while the industry we believe was also up in the low single digit. Our residential products were up 21.1% and we believe the industry was 7 point. We outperformed the residential and commercial markets for the quarter. For the first quarter, the residential growth was a combination of sales momentum in our mass merchant area increases from the successful integration of the Gulistan products purchased late last year growth of our Stainmaster TruSoft and SolarMax products and growth in our wool business. Our expectations at the mass merchant category will have lower growth in the second half of the year; we should still continue the strong growth on our specialty retail market. Commercial business is up notable strength in the modular carpet cover product. Our continued investments in new products processes and people is allowing us to gain market share at the upper hand. For the quarter, gross profit margin dollars were up $2.7 million 17.2% as compared with the year ago and as a percent of sales operating margin was 24.4% as compared to 25.0% in the prior year. We have manufacturing cost impact on our gross profit for the integration of the Colormaster dye house, our Crown Rug acquisition and expansion of our Eton facility was 794,000 during the quarter. These integration caused decline to go throughout the year. SG&A for the quarter was 22.4% of sales or 1.6% below the same quarter to prior year. And interest expense was $995,000 compared to $726,000 in the prior year and the difference is due to higher levels of debt. Our tax benefit rate was 3.4% due to federal rate of 28.1% and the one time inclusion of a $157,000 of 2012 tax credits that Congress passed in the first quarter of 2013 as well as $202,000 of non-tax insurance proceeds during the period. Our income from continuing operations was $651,000 as compared to a loss of $104,000 the year prior. (Diluted) income from continuing operations for the first quarter was $0.05 per share compared to a loss of $0.01 per share in 2012. Looking at our balance sheet, our receivables increased $7.7 million or 24% and the sales increased 20% compared to the prior year. Our inventories were flat. Our inventory turns improved 12% versus same period in the prior year. Working capital increased $2.9 million primarily due to higher receivables. Capital leases and capital expenditures were $2.6 million for the period, our depreciation and amortization was $2.5 million. Anticipate capital expenditures for 2013 of approximately $10 million and depreciation and amortization of $10.1 million. Our debts stood at $86.8 million at the end of the period up $2.5 million for the quarter. We ended the quarter with availability under our loan agreements of $21.3 million. We completed the modification of our loan agreement that’s 10 million of additional borrowing base as well as extended term of our loan to March 2018 from September 2016 and lowering the borrowing rate by 25 basis points. Our updated investor presentation is on our website at www.thedixiegroup.com. Dan?

[Dan Frierson:]

Thank you, Jon. The housing industry turns to be a good indicator of our future business. During the first quarter, the housing market continued to move in the right direction as evidenced by some of the following trends. Housing starts and permits continue increasing and we’re over the 1 million rates for the first time since 2008. Inventory of both new and existing homes is below demand. Affordability is high even with prices increasing. Employment and household formation are both moving in a positive direction. Big builders are reporting a large year-over-year gains and foreclosures are decreasing. With these trends in motion, it is only a matter of time until the carpet industry experiences upward momentum. One would expect to see this happen sometime in the last half of this year. Let’s take a look at what is happened to our industry since the downturn of 2008 and 2009. 2009 our industry declined in sales by about 40% from its peak which actually was in 2006. Dixie also experienced a sales decline of about 40% from its peak. Obviously, survival was the first instinct for most industry players. Because of the downturn was so prolonged, it was very difficult to know when the bottom was reached. Every company had to go through its version of rightsizing in order to get cost in line with sales and future prospects. In addition to the difficult economic period, our industry was also going through some other major changes. Polyester filament has come from nowhere and now it’s about 50% for the residential business. At the same time, soft products have grown significantly and now represent a large portion of the residential products being offered at retail. These and other changes have meant that investment in new products and the business was required to maintain one’s position. Difficult periods are tough for all players but due offer opportunity to improve one’s position relative to the industry. Our plan has been to continue investing in product, people and where needed productive capability. These investments have better positioned us to become more important to our customers and supplier. In the last year, we have concentrated investments in the following areas. With people, we have hired a number of individuals with both technical and/or creative capability to enhance our operations and our product capability. We also have hired a significant number of new sales people to improve our market coverage and penetration. We’ve added more sales people than ever before. In terms of assets, we’ve added over 40% to our yarn capability or additional tufting machines and purchased Colormaster which gives us continuous dying capability. These investments have enabled us to be more competitive and enhanced our product offering. In terms of products, we’ve introduced a record number of products to enhance our position as a style, design and color leader in the industry. Investments we’ve made obviously have had a negative impact on our earnings but it allowed us to improve our position and grow faster than the industry. The growth in the industry since 2009 is about 7%. But, we at Dixie have experienced growth of 39%. In the first quarter of this year as John pointed out, our sales grew 20% and we believe the industry was up mid-to-low single digits. As John has pointed out, the cost and disruptions of the investments is declining and we should be in a better position to take advantage of our sales increases by bringing a larger portion of the increases to the bottom-line. Unlike last year, sales and orders in the first four and a half weeks of the second quarter have continued to show the same percentage growth that we experienced in the first quarter. At this time, we would like to open up the call for questions.

[Operator:]

Thank you. (Operator Instructions). And our first question comes from Sam Darkatsh from Raymond James.

[Sam Darkatsh:]

Good morning, Dan, good morning Jon, how are you?

[Dan Frierson:]

Hi, Sam. How are you?

[Sam Darkatsh:]

I’m doing fine, thank you. Dan, you just mentioned that the – your April residential and commercial orders are up double digits, I think that’s terrific and that suggest that at least for your business things continue to be going quite well. How would you characterize the industry retail traffic in April versus Q1 versus March, there has been some anecdotes that it might not as – bit as strong as what you’re seeing?

[Dan Frierson:]

Sam, yeah, I think any comments we would have would be anecdotal, certainly not factual in terms of the industry. We think there has a little slow down in traffic but that’s I don't think there is anything there that we can really hang our head on. We have certainly seen in our sales and order entry as I mentioned we have continued at the rate of increase that we had in the first quarter and quite honestly that’s really the best parameter. We have or the only numbers that we have that we can go back.

[Sam Darkatsh:]

Second question, then I will defer to others. You talked about pricing Dan, obviously, there has been a fair amount of price increases in the industry, talk about your pricing strategy why it may differ and do you believe it’s going to affect your market share positively going forward with obviously your consumer is a little less price sensitive than in the normal competent participant?

[Dan Frierson:]

Sam, obviously the industry went through a raw material increases and therefore price increases on carpet in the first quarter and on those product categories where we had price increases we did increase our price. If we didn’t have price increases, we did not but I think from all week until the price increases seem to have and passed through and in a fact and behind us.

[Sam Darkatsh:]

Is there a way you can quantify your estimate, what the benefit of price was for you in the quarter year-on-year and in sales and/or margins?

[Jon Faulkner:]

Hi, Sam, at this point in time, I don't really think there is a (good way) across to break that out. Because our mix has shifted. The whole introduction of soft products that are basically all new products and those new products obviously you start with the price having already put into them the raw material cost to anticipate having.

[Sam Darkatsh:]

So your ASP, is it, is it up or down than on a year-on-year basis? Including the mix, your overall ASPs or?

[Jon Faulkner:]

You look at it and say that in the commercial business they’re up and in the residential business they’re flat.

[Sam Darkatsh:]

And you’re suggesting that a lot of that is mix as opposed to price itself?

[Jon Faulkner:]

I would expect that to be more mix because we’ve seen, for instance we have seen our some of our strongest growth at wool. We’ve also seen very strong growth at more moderate price points. And so, yeah and really mix within categories; we’ve not seen any degradation of price in any one particular categories and more mix changes if not

[Sam Darkatsh:]

And there is not a way to breakout what like-for-like excuse, what pricing was on like-for-like excuse on a companywide or a vertical basis?

[Jon Faulkner:]

I guess we could do that we’ve not done that at this moment in time now. I don't have that any information with me at this moment.

[Sam Darkatsh:]

Oh, okay. Thank you, gentlemen. I appreciate it.

[Operator:]

Your next question will come from Arnold Brief from Goldsmith & Harris.

[Arnie Brief:]

Yeah, you had a great quarter with sales; I was a little surprised that with that kind of sales increase your gross margins are better even adjusting for the cost of the plan integration. Was your price cost wag there in terms your raw material than your price increases, does there anything affecting the gross margin in the first quarter that won’t be there, the rest of the year, I’m excluding the integration cost?

[Dan Frierson:]

Arnie excluding the integration costs, there were some obviously lag and always is. We’re on LIFO and when we have a price increase, raw material it takes us about, to get that all the way through and yet and our cost it goes through immediately. So, there were some lag there but that one (inaudible).

[Arnie Brief:]

Well, could you discuss your gross margins in general than a little bit of –

[Jon Faulkner:]

Arnie, it’s, it’s…

[Arnie Brief:]

Is there a change in mix that would preclude you from showing gross margins more commensurate with the sales that you’re getting now? I mean, I know you got some changes, but you’ve got wool in commercial it should be helping like I would think?

[Jon Faulkner:]

Yes, Arnie. We will say this that as we go throughout the year the growth we had in the first quarter was higher in the mass merchant category as other categories take a larger percentage of share. We should see some improvement from mix throughout the year. But again it’s pretty volatile because we have a very broad range of product categories. But I would say that we tend to see an improvement in margin as we go throughout the year.

[Arnie Brief:]

I know you discussed this on your last conference call, I just don’t have in front of me. The sampling expenses, I think there we’re going to go decline later in the year and be flat in next year. Do you refresh my memory there?

[Jon Faulkner:]

Sample expenses are up year-over- year.

[Dan Frierson:]

Transition.

[Jon Faulkner:]

Oh, the transition expenses, I’m sorry.

[Arnie Brief:]

No, the sampling expenses.

[Jon Faulkner:]

Oh, sampling expenses are up year-over- year. We level our sample expenses throughout the year. So, what you saw in the first quarter SG&A included a one-fourth of the sampling expenses for the year. They are not adjusted by quarter. As we get in to future years, I would anticipate our sample expense as a percentage of our sales not to drop as we continue both growth and in absolute dollars, as we make adjustments. But we have been through very heavy period of sampling expenses this year as well as we have for the last couple of years. This is our highest year backlog.

[Arnie Brief:]

Okay. And the integration expenses you indicated declined as you went through the year. Could you be a little more specific there?

[Jon Faulkner:]

Well, we told you about $1.9 million we thought for the year. We have had about $800,000, I think $1.9 million is still a reasonable number and that will be primarily in the second and third quarters and then should be pretty much over by the fourth quarter.

[Arnie Brief:]

Okay. So, that’s pretty much the same as you had indicated.

[Jon Faulkner:]

Right.

[Arnie Brief:]

I guess the bottom-line there has been sufficient change in the industry that would be fair to say that even if you got back to your peak sales levels, your gross margins would not be capable of getting back to your peak gross margins?

[Jon Faulkner:]

I think it’s unlikely.

[Arnie Brief:]

It’s like a mix or raw material costs or whatever?

[Jon Faulkner:]

We were at 30 points in our peak margins and I would expect us to be higher than we are to-date clearly. But I think 30 points would be very difficult as a company totally back to peak.

[Dan Frierson:]

Arnie, that's very mix related. For instances the two areas that have grown the fastest in the first quarter were wool in the very high-end and polyester the lowest end. So it's somewhat difficult to answer your question. We tend to focus on the differential between gross margin and selling costs. And I think we also are seeing selling costs come down as our sales increase. So I think the delta there is really where we focus our energy and effort and we're certainly hopeful that those can get, that delta can get back to more normal levels.

[Arnie Brief:]

Let me be more specific. If I recall, I'm going off of memory now. So you could either correct my memory or provided if I understood the answer. But if I remember right, many years ago your goal taking that gross margin and the SG&A and delta and all that was 10% operating margin which is not unusual for a well run business, is that a goal that is still attainable. And I’m remembering the goal properly and is it still attainable?

[Dan Frierson:]

I think the goal is in that 8% to 10% range. And we certainly hope and think that over 10 that is attainable.

[Arnie Brief:]

Okay, that will do. Thank you very much.

[Dan Frierson:]

Thank you, Arnie

[Operator:]

Our next question will come from Keith Hughes from SunTrust.

[Keith Hughes:]

Thank you. Want to get back to some of your statements in the prepared text and about the soft product and its gain. How much of your business would you consider in the soft genre if we can call that and what do you think it is in the industry right now?

[Dan Frierson:]

Well, again, there is no good data on the industry and even in our situation a lot of it is new products that are just getting off the ground. If you are talking about dollar sales, you are talking about percent of our displays. I think you're going to be looking at different numbers. But soft has become a real standard. You had obviously the two major mills in the industry certainly pushing soft, both their own drivers and one case Stainmaster, TruSoft. So it's becoming a big percentage of the new products and that's probably a better way to look at it. I can’t give you a good percentage number. But it’s certainly significant and it’s certainly growing and there also are various stages of soft or soft products that are a little different from each other. So, it depends on what all you put in those categories, but Soft is certainly gaining retail space and we have tried to take advantage of that through TruSoft and some other products and gain more space at retail.

[Keith Hughes:]

And price was, most of this comes in mid-to-high type price points, which are the samples you’re seeing?

[Dan Frierson:]

The softer fiber tends not to be quite as bulky and therefore less apparent value. So, it tends to be reaching hear (technical difficulty).

[Keith Hughes:]

Well, thank you.

[Dan Frierson:]

Thank you, Keith.

[Operator:]

(Operator Instructions) And our next question will come from Matthew Dodson from JWest LLC.

[Matthew Dodson:]

Yes. Can you and maybe don’t break this out, but you talked about your sampling cost evenly weighed them for each quarter. Can you tell us by any chance what your sampling costs were of SG&A this quarter and if you could, you tell me what’s your sampling costs were of SG&A in your fourth quarter in December?

[Dan Frierson:]

We do not break that out, but I will add one bit of color. We did have some additional sampling costs in the last half of last year because of the soft products that we are not projected when we started the year. So, in the fourth quarter we had higher cost than we did in the first quarter on sampling cost last year.

[Matthew Dodson:]

Okay. How about if I could go at it a little differently this way? So, obviously if we go in to the June quarter seasonally that’s the stronger period of time and your sales should be up sequentially from the March quarter. And I guess, the question I would have is sampling cost will be even with Q1. So, as a percentage of sales they will be down. What is the variable cost nature of SG&A than that we can think about? I mean at some point you’re going to start to get a lot of leverage in your SG&A. I mean if you look at it just from fourth quarter to the first quarter your SG&A in dollars was basically down a 1000 and your sales were up $4.3 million.

[Dan Frierson:]

I’m going to ask Jon to address that, but I will say over the last year or two, our sample cost has been what I would call higher than a normal rate due to the many different new fibers being introduced, due to the changes that were taking place in the industry and due to the opportunity we saw to grow the business. So I would tend to agree that as a percent of sales -- and we do not give that percent, we would see it going down in the future.

[Matthew Dodson:]

Okay.

[Jon Faulkner:]

Our selling expenses. First of all, our G&A tends to be heavily driven by just normal inflation for salaries and that kind of thing, bulk of it is salaries. The selling expenses, remember all of our sales people are on commission. So that tends to be driven primarily, by sales volume. Whereas, the rest of our selling expenses are primarily, driven by our sample expenses. And --

[Matthew Dodson:]

Right. So -- I mean, exactly. And so, if I would think about you have FICA, you have all those kind of expenses in Q1. It seems like SG&A would have been higher in absolute dollars than Q4, because you had sales that were higher. So you would have paid higher commissions, you would have FICA expenses, but yet it was slightly down. So is that because from a run rate, that sampling I guess. Can you give us any sense of what sampling is, is it 20% of SG&A, is it 15% or not?

[Jon Faulkner:]

Let me kind of hit it in other way. I will give you some insight. If you look basically at our SG&A as a percentage of the total basically, 3/4 of it is related to selling.

[Matthew Dodson:]

Okay

[Jon Faulkner:]

And about half of the selling is variable to some degree.

[Matthew Dodson:]

Okay. Got it. And then, the rest is potentially what these costs that are going to go down over time of the sampling expenses, right?

[Jon Faulkner:]

It would be sampling. And then, just within selling we have like a more fixed selling expenses, which are sales management that type, which are more driven by normal salary increases and to some degree the compensation – other compensation expenses related to sales. But strictly, truly variable portion which you know is going to move directly with sales and it is going to be say about half of that.

[Matthew Dodson:]

Got it. And then, so may I ask another follow-up to one of the other person's questions relative to gross margin. So if you would not have those integration expenses, basically your gross margins would have been about a 100 basis points higher, is that roughly right?

[Jon Faulkner:]

Yeah. That is right.

[Matthew Dodson:]

Okay. And then, so the question I would have for you is, are the integration expenses the same in dollars in Q2 and when did the integration expenses update?

[Jon Faulkner:]

Basically it’s about $1.9 million for the year. We had 800 in the first quarter, the balance of that the $1.1 million should be split roughly equal between second and third year end, ought to be largely upon in the fourth quarter.

[Matthew Dodson:]

Okay, great. And then the last question I have for you and this is just a little bit of just try to get the insight interest expense, interest expense went up sequentially a little more than $100,000?

[Jon Faulkner:]

Yes, but due to debt levels, is the main change.

[Matthew Dodson:]

And was that your working capital I assume because orders were so strong?

[Jon Faulkner:]

That is correct.

[Dan Frierson:]

Well, acquisition of Colormaster as well.

[Jon Faulkner:]

Well, yeah excuse me. We had the acquisition late in the quarter of Colormaster.

[Dan Frierson:]

Late in the year.

[Jon Faulkner:]

Late in the fourth quarter. It was really the – net debt went about the middle of November, they had a little more due to increase because of acquisition of our Crown Rug which was in December and then the main driver was the increase in receivables in the first quarter.

[Matthew Dodson:]

Got it. And so this million dollar run rate do you think a decent run rate going forward or not?

[Jon Faulkner:]

I would say that’s a fair run rate.

[Matthew Dodson:]

Okay. And I promise this is my last question. I know you have a punch of NOLs. I assume that income tax was primarily state, is that true and then should the tax rate be about you know somewhere in the 3% to 5% then for the fourth fiscal year if you do make money each quarter?

[Jon Faulkner:]

I’ve not run forward but if you look going forward on a normal rate, we’re going to be in that low 30% rate in terms of book tax.

[Matthew Dodson:]

Yeah.

[Jon Faulkner:]

In terms of cash obviously well, we comped pretty much than 2012, we have utilized most of our NOLs. The only thing we have really left is that we do have a 100% reserve against several of our state taxes and would be turning those reserves around as we are profitable and then has to do with state tax credits in particular parts of the country.

[Matthew Dodson:]

Got it. And, and then I do promise this is my last question. The other gentleman asked about gross margins and he said before he talked, you had said you can get to 30% and obviously you’re 25% right now and I think you guys stated that maybe that’s 28% to 30% but the question I have for you is…

[Dan Frierson:]

Excuse me that was not the question or the answer. What we said was the delta between gross margin and selling was in the 8% to 10% range.

[Matthew Dodson:]

Okay.

[Jon Faulkner:]

What we’re saying is operating margin of 8% to 10%...

[Matthew Dodson:]

Okay, 8%, okay. So, what is the key though for gross margins to go up because I assume you’re at low utilization still relative in your factories and I assume once you get to higher utilizations you get good incremental cost absorption on the fixed cost? Is that true or not or can you help us understand that at all?

[Jon Faulkner:]

That is true. But remember, a large percentage of our cost is in raw material and that is strictly a variable cost. And but we will get some additional leverage there and we will get some additional leverage on our SG&A cost between the two of those where we shoot for that 8% to 10% range operating margin.

[Matthew Dodson:]

Okay, great. Thank you so much.

[Dan Frierson:]

Thank you for all your questions.

[Operator:]

And at this time, we have no further questions in the queue. I’ll turn it back over to our presenters for any additional or closing remarks.

[Dan Frierson:]

Melissa, thank you. And I want to thank all those that listened in and asked questions. Obviously, we’re happier with the first quarter than we’ve been in a while but we still have a long way to go to as it pointed out to get to the profitability levels that feel are reflective of where we ought to be. Thank you for listening and see you next quarter.

[Operator:]

That does conclude our conference for today. Thank you for your participation. You may now disconnect.