The Dixie Group, Inc.
Q2 2013 Earnings Call Transcript

Published: 31 Jul 2013

[Operator:]

Good day, ladies and gentlemen, and welcome to the Dixie Group Incorporated second quarter 2013 conference call. Just a reminder, today's call is being recorded. For opening remarks and introductions, I pleasure to turn the call over to the Chairman and Chief Executive Officer, Dan Frierson. Dan, please go ahead.

[Daniel Frierson:]

Welcome, everyone, to our call. I have with me today Jon Faulkner, our Vice President and Chief Financial Officer. Our Safe Harbor statement is included by reference to both our website and press release. The second quarter was one of strong performance, both residentially and commercial. Dixie had year-over-year sales improvement of 26%, with sales growth in all areas of the business. Our sales growth in the residential business was 27% compared with the same period a year ago. We believe the residential market grew in the high-single digits during the quarter, with market strengthening as the quarter progressed. It appears that the residential carpet market is now being positively impacted by the improvement in the housing sector. Therefore, our commercial business increased 21% versus the second quarter of 2012. This increase was in comparison to the commercial market being up slightly. All of our brands had solid sales increases during the quarter, which indicates the higher-end business continues to improve. Jon Faulkner will review our second quarter financial results, after which I will comment further on the current business conditions and the industry in general. Jon?

[Jon Faulkner:]

Thank you, Dan. Second quarter sales were $83.6 million, up 25.6% versus the same quarter last year. As I said, total sales were up 25.6%, where we believe the industry was up in the mid-single digits. Our commercial products were up 20.6%, where the industry we believe is up only slightly. Our residential products were up 26.6%, while the industry was up in the high-single digits. We outperformed the residential and commercial markets for the quarter. Our residential growth was a combination of continued strength in our mass merchant area, positive impact of our successful integration of the Gulistan products purchased late last year, strong growth of our Stainmaster, TruSoft and SolarMax products, and continued growth in our wool business. We saw a strengthening in the residential market price as the quarter progressed. Our commercial business had significant growth relative to the market only being up modestly. We continue to have double-digit growth in both our broadloom and modular carpet tile product category. Our continued investment in new products processes and people is allowing us to continue to gain market share at the upper-end of the market. For the quarter, gross profit margin dollars were up $6.6 million or 42% as compared with the year ago and as a percent of sales gross profit margin was 26.7% versus a prior year of 23.6%. Operating income of $3.3 million was 3.9% of sales. Due to the high rates of sales growth and the continuing cost of our Roanoke yarn plant expansions, integration of the Colormaster dye house and Crown Rug acquisitions and the higher sampling expenses negatively impacted operating income by over $1 million during the quarter. These costs should decline as we go throughout the year. SG&A for the quarter was 22.5% of sales or 1.1 percentage points below the same quarter to prior year. Our interest expense was $869,000 compared to $762,000 in the prior year. The difference is due to higher levels of debt. Our tax benefit rate was 27%. Our normal rate for the second half borrowing any out-of-periods credits or change in valuation allowances should be 30%. Our second quarter income from continuing operations was $1.7 million as compared to a loss of $404,000 the year prior. Diluted income from continuing operations for the quarter was $0.13 per share as compared to a loss of $0.03 per share in the second quarter of 2012. Looking at our balance sheet, on a year-over-year basis, our receivables increased $12.2 million and the sales increased to 25.6% compared to the prior year. Inventories grew up $6.7 million and 9.2% versus the prior year. Our inventory turns improved 11% on a year-over-year basis. Our working capital increased $12.6 million versus the prior year primarily due to higher receivables. Capital leases and expenditures were $3.4 million for the period. Our depreciation and amortization was $2.6 million. Anticipate capital expenditures for 2013 of approximately $13.5 million and depreciation and amortization of $10.3 million. Our debts stood at $94.6 million at the end of the period, up $7.9 million for the quarter. We ended the quarter with availability under our loan agreements of $25 million. We have completed the modification of our senior credit facilities to increase our revolver from a $110 million to $130 million to support our continued growth. Our updated investor presentation is on the web at www.thedixiegroup.com. Dan?

[Daniel Frierson:]

Thank you, Jon. I think the best way to describe the late second quarter and early third quarter is a rising tide lifts all boats. I believe the improvement we've experienced in the housing sector is beginning to have an impact on the carpet industry. Residential carpet business usually lags housing improvement by about a year and we're now feeling this impact in the carpet business. We're also feeling the momentum increased in the commercial market as the replacement business improves and modular continues to gain market share. Operationally, we have spent the last few years preparing for this growth. We've expanded our yarn capacity significantly to be able to service the improved demand with quality in differentiated yarns. We have also expanded our North Georgia tufting operation and added equipment that enables us to maintain our position as a style and design leader in the marketplace. The purchase of the Colormaster continues dyeing operation and ensures that we can service the increase in business at a competitive cost and continue to be a leader in color for our discerning customers. All of these news are intended to position our company for growth, from an operational perspective, for both the residential and commercial markets. With this growth in line, we are increasing our capital expenditures this year to $13.5 million to better service our customers. From a product standpoint, we have continued to increase the introduction and sampling of new products to enhance our market position. Our investment in Stainmaster, TruSoft and SolarMax products has positioned us well for the movement to soft products. Commercially, we are focused on several new modular product offerings, which have been unusually successful in the marketplace. We have also added sales representatives in both the residential and commercial brands to improve our market presence and penetration. Our recent acquisition of Robertex is intended to add to our wool offering, enhance our wool process and capabilities and expand our ability to innovate in this category. Our wool business continues to grow and has helped position us with the design community. On the commercial side, this quarter we are in the process of launching a new brand, Avant is primarily focused on the modular office market. Avant utilizes edgier use of patterns, textures and colors combined with the marketing campaign, promoting local and regional artisans. We anticipate Avant will have a positive impact on our sales next year. Obviously, all of these initiatives, which I've mentioned have had a negative impact on operating margins. However, the improved volume we're now experiencing is beginning to have a positive impact on the bottomline. And as these initiatives gain momentum, the cost will decline. The improved margins we are experiencing are an indication that this trend is working. In the first quarter, business began to improve and sales were up 20% over the previous year. During the second quarter, we began to feel the momentum of the industry improve and our sales were up 26% over the previous year. Sales and orders continue to reflect a strengthening market in the third quarter. Sales to date in the third quarter are somewhat above the second quarter year-over-year improvement percentages. This time, we would like to open up the call for questions.

[Operator:]

(Operator Instructions) And we'll go first to Sam Darkatsh with Raymond James.

[Sam Darkatsh:]

With the really high growth rates come some times, some growing trends and some high-class problems, I did notice the capital expenditures are going higher. You've got to be pretty much just about at capacity at least from a labor standpoint. And certainly, I'm guessing your yarn is also filled up too. How would you ascertain or categorize your utilization rate right now, Dan. What is the prospect of continuing to leverage gross margins going forward and understanding that the integration cost also roll off.

[Daniel Frierson:]

Let me reply to your capacity question and I'll ask Jon to reply to the margin question. Capacity standpoint, we still are adding capacity in our yarn facility. We will not be up to full capacity there with trained operators and running all of these new equipment that we have bought there until sometime in the fourth quarter. So we do have additional capacity coming on stream-layer and are able to supplement that with other sources and have capability of adding additional capacity their fairly easily. So we don't see that as a problem at this point, at capacity issue. In tufting, we have added additional tufting equipment. And we have ample capacity there. In most of the categories, we are adding some machines and we'll continue to add machines that help us differentiate our product in the marketplace. In terms of dyeing, we obviously still have capacity there at our dyeing facility in Atmore, Alabama. We also will be adding or upgrading the drying and putting in a new dryer in our dyeing facility in December, which will almost double our capacity layer. So fortunately we've invested a lot in the last several years in capacity at various parts of our business, and that is not a major issue. Also I should add on West Coast, with our Fabrica operation, there is ample capacity there, tufting, dyeing and finishing. So we don't see that as something that will slowdown our growth at this point. And certainly we hope to challenge the capacity we have, and I think that obviously the more we can do that, the better our results should look. And let me ask Jon to reply to your margin question.

[Jon Faulkner:]

Sam, relative to the integration cost and manufacturing, mostly continue to decline somewhat below the radar in this quarter, but I expect still to have those costs in the third quarter. Our sampling expense year-over-year will probably be similar to what it was in this quarter. So we'll see a decline from that number we had, but it will be a gradual decline throughout the end of the year. And then looking into next quarter, by the next year, I would expect that we have leverage and our volume will continue to see margin improvement going into 2014.

[Sam Darkatsh:]

So all in, what would you peg your incremental margin from an operating line on volumes right now, just to ballpark it?

[Jon Faulkner:]

Incremental, taking out those integration expenses and the sampling expenses are just pure incremental. I would say we're between 20% and 25%.

[Sam Darkatsh:]

Second question would be this. It's very encouraging that you're mentioning that July is up, even stronger than the average growth rate of Q2. Can you remind us what the year-on-year comparisons are in August and September versus July? Do the comparisons get more difficult for you, do they get easier or roughly the same?

[Daniel Frierson:]

I'd say they're roughly the same, Sam.

[Sam Darkatsh:]

And last question would be, you're saying that you're seeing evidence of industry accelerating, not only through the quarter, but through July as well. Or as you're suggesting that it's just what you're seeing and it maybe more difficult for you to determine what the industry shipment data looks like?

[Daniel Frierson:]

We have data going through the second quarter and that substantiates what we are experiencing or feeling, so that through the end of the second quarter, we feel is very understandable and quite accurate. Anything beyond that is anecdotal, but I would say we are seeing continued improvement. And what we can tell in the business, a number of our people that are meeting right now, and what we pick up is the business continues to improve particularly in the residential area. You asked about capacity, and I responded, I did not respond to polyester, because that's a smaller percentage of our business, a relatively smaller percent. But I think in the industry we are seeing a tightness of availability of polyester, fiber or extruded product. And that is certainly indicative of the business, the industry improving.

[Operator:]

We'll go next to Arnold Brief with Goldsmith & Harris.

[Arnold Brief:]

Looking at a little bit, but could you give us your best guess on the tax rate and capital expenditures for 2014?

[Jon Faulkner:]

Arnie, in 2014, a normal tax rate would be in the 32% range. Capital expenditures could be similar to what we have this year, maybe slightly lower. I will say that we are at some state valuation allowances, Arnie, that will turn some time, this year or next year, until we may have an unusual rate occur at some point during that time period, because of the state valuation allowances, but borrowing that or any unusual credits, the normal rate would be 32%.

[Arnold Brief:]

And just seasonally, if I'm going back from memory, but seasonally isn't the second half of the year, normally stronger than the first half? We certainly think the March quarter is usually the lowest quarter?

[Jon Faulkner:]

Arnie, usually our second quarter and fourth quarter are the two best quarters.

[Arnold Brief:]

And the third quarter is usually better than March, so that would indicate the second half sales, is normally higher than the first half.

[Daniel Frierson:]

Yes, but this year the second quarter was obviously relatively strong. Third quarter looks like it will be. Too early to tell about fourth quarter, but our business tends to be best in the fourth quarter.

[Arnold Brief:]

So normally without making a forecast, but normally your second half sales are better than your first half?

[Daniel Frierson:]

Yes.

[Arnold Brief:]

You mentioned the unusual expenses a couple of times in the declining, but you've given us numbers for the first and second quarter. Could you give us how that all those unusual expenses, if you total them up without trying to itemize them, how they look through the third and fourth quarter?

[Daniel Frierson:]

We had over $1 million in second quarter between sampling and manufacturing changes. Third quarter I would expect that decline and be a little less than that, and by the fourth quarter they will be rail down from their, I would say, more like half that number or less.

[Operator:]

We'll go next to Matthew Dodson with JWest LLC.

[Matthew Dodson:]

Could you just help us understand on the gross margin side? So in the first quarter, you had integration cost of about $800,000, which affected your gross margin. Your gross margin grew sequentially, phenomenally, 230 basis points. Can you talk about how much you had in the integration cost?

[Jon Faulkner:]

Of that $1 million about half of that was integration cost.

[Matthew Dodson:]

So would you talk about the $1 million and expenses? Are you saying that they are both in SG&A and in COGS?

[Jon Faulkner:]

Yes. In COGS, it's about half of it. And the other half is in SG&A.

[Matthew Dodson:]

So you had about $500,000 basically in COGS for the integration and that integration expense will continue into Q3 and then dissipate in Q4?

[Jon Faulkner:]

Yes.

[Matthew Dodson:]

And then, I guess, can you help us understand, on the SG&A side, and I guess, you said earlier this year that you were going to level load your sampling costs throughout the year. They were going to be equal in each quarter? So is it because you saw demand accelerate or did the customer come to you that you had to accelerate sampling cost in Q2?

[Daniel Frierson:]

Well, we've done a couple of things. We've also hired additional sales people both on the commercial side and the residential side. That's been part of our cost increase. And the sample cost is a little ahead of where we thought we were going to be because business has been better generally. It's not a thicker customer, it's just business has been more robust than we thought it was going to be. Therefore we put more into sample expense and we think that's paying dividends.

[Matthew Dodson:]

And so how do we think about sampling costs in the back half? Do they go down from Q2 in an absolute dollar basis or do they stay at these elevated Q2 levels.

[Jon Faulkner:]

They may elevate a little bit because of the Robertex acquisition. But other than that they would be pretty level.

[Daniel Frierson:]

On an absolute dollar basis, yes.

[Matthew Dodson:]

And then the other question that I have for you, just relative to the SG&A because it was lot higher than we thought it would be. Because your performance has been so strong, did you book any reserves for bonus accruals et cetera in Q2?

[Daniel Frierson:]

Yes, we did. And they are up significantly through the prior year.

[Matthew Dodson:]

So can you give us how much you've booked for bonus accrual in Q2?

[Daniel Frierson:]

No, we don't really go into that information. There are also some accrual for the 401k for everyone in the company that was impacted, going to be at a higher level than we had originally thought.

[Operator:]

We'll take our next question from Ethan Steinberg with SG Capital.

[Ethan Steinberg:]

I think just about everything got answered I'm a little confused how to allocate that $1 million. So roughly, $500 was in COGS, and had to do with what you've laid out before with the equipment?

[Daniel Frierson:]

That's correct.

[Ethan Steinberg:]

And then how do you expect that to trend over the next couple of quarters.

[Daniel Frierson:]

Again, it will be down slightly in third quarter and then to trial off pretty significantly in the fourth quarter.

[Ethan Steinberg:]

And then was there anything else unusual in the gross margin that sort of helped or herded or as what we saw in the quarter pretty indicative of how it should behave on this kind of revenue trajectory?

[Daniel Frierson:]

We think the mix in the second quarter was pretty indicative of where we are today and where we see things going forward. Obviously, the ultimate consumer decides what our mix is, but it really had more to do with improved operations than it did in product, if you follow what I'm saying. We're running it at higher volumes and we've been able to improve our operations significantly.

[Ethan Steinberg:]

And then the 500 extra or greater amount SG&A, that's sampling and hiring?

[Daniel Frierson:]

Yes, correct.

[Ethan Steinberg:]

And so the SG&A did go up a lot more than that. Was that the bonus accrual or what else drove that up so much sequentially?

[Jon Faulkner:]

As I mention, the 401k and bonus accrual and things of that sort.

[Ethan Steinberg:]

And then are those accruals just essentially, catch you up to the end of June or did you accrue enough, to cover you for some of the second half as well?

[Jon Faulkner:]

We accrue as we go throughout the year, but they are accrued at a rate, which is indicative of what we believe will be the total year results. So they caught us up through the second quarter, but we will continue that right in the second half.

[Ethan Steinberg:]

So that's what I wanted to just make sure I understand is that, so if you had at another quarter similar results it would be just as high, there wasn't a decent amount of catch up from Q1 that you had to accrue in that June quarter?

[Daniel Frierson:]

We don't give those numbers. But there was some catch up from first quarter.

[Ethan Steinberg:]

And was there anything else in SG&A that was higher or lower than you guys really would have expected it to be?

[Daniel Frierson:]

Not really.

[Operator:]

We'll take a follow-up now from Arnold Brief with Goldsmith & Harris.

[Arnold Brief:]

Just a couple of quick ones. Do you anticipate any unusual expenses in integrating the July acquisition?

[Jon Faulkner:]

Arnie, we will have slightly higher sampling expense in the second half of the year. That will be offset by, of course, earnings that we'll get from that acquisition. But that will be slightly higher in the second half.

[Arnold Brief:]

No write-offs or anything unusual or some proportion of it?

[Daniel Frierson:]

No, Arnie. We are very excited about the acquisition of Robertex. It really enhances our acquisition in the wool business and makes us a major player there along with the business we've been developing at both Masland and Fabrica. What we will do there is move the Robertex products into the Masland plant and the Carousel products will become part of the Fabrica alliance. So it really will enhance our wool offering and I think the design can help our position, enhance our position in the design community.

[Arnold Brief:]

And now just to go back a little bit, I hate to keep rehashing this, but just give me a little bit of a curve here. We were talking about sampling expenses expiring, declining in the second half of the year and I guess into 2014, but then you indicated, you also included in those unusual expenses, the increment of the sales people, which I didn't quiet realize, because those expenses I would assume will continue at a high level on the one hand, on the other hand I would assume they would become more productive on the sales line. Could you elaborate a little bit on that?

[Daniel Frierson:]

We have added sales people and we'll continue to add sales people. If you recall it in the late last year, we took on some Gulistan products, when they went out of business and hired a number of their sales people. I think they are very seasoned people and have hit the ground running. And I think that will seize to be as big an issue or a bigger factor.

[Arnold Brief:]

Last question. Just to refresh my memory, could you review a little bit what happened with price and raw material costs in the second quarter? And how that looks going into the second half of the year?

[Jon Faulkner:]

There hasn't been a lot of change in the raw material costs. They have been a little up and little down, but no dramatic movement there. And we don't anticipate any now, but all what it is you never really know for sure borrowing some unforeseen thing, but we don't anticipate any major changes there.

[Arnold Brief:]

What I'm trying to recall, there was some raw material costs if you remember late in this first period and you were still playing a little catch up on price in the second period, that it took you while?

[Daniel Frierson:]

Not major, polyester was early in the year, and polyesters are a smaller percentage of our total business. So the impact for us was not that great.

[Arnold Brief:]

So your second quarter price raw material relationship was fairly normal through the whole quarter?

[Jon Faulkner:]

Yes.

[Operator:]

We will take the follow-up now from Matthew Dodson with JWest LLC.

[Matthew Dodson:]

So if you back out the $500,000 that you had in the integration cost in the gross margin, your gross margin would have been like 27.2. And I guess, the question that I have for you is that kind of a good run rate at this kind of volume level? And the other question I would have for you, do you get more productivity once the integration costs are gone? And then the last question is do you think you get an improvement in gross margin if volumes intended to build?

[Jon Faulkner:]

First of all, I think the integration cost that we gave you, when you back those out, that accurately reflects a normal rate for this sales level. I would say as we grow our sales beyond that, there is going to be additional leverage. But again, that would be assuming mix basically the same as it is today. One thing we do have is a pretty wide range on both the commercial and residential side in terms of sales mix, not from the high-to-low end, but assuming that says the same, we will continue to get additional leverage as we grow beyond that point.

[Matthew Dodson:]

So I mean as you go through the cycle and the changes that you've made and I understand mixes, the issues, et cetera. But I mean do you think that you guys could get to the high 20s, kind of, in gross margin. I mean is there any reason why, if you're doing $90 million or $100 million in sales in a quarter that you can't be, kind of, knocking on 30s door for gross margin or is that just too ambitious?

[Daniel Frierson:]

Matt, that is somewhat obviously product dependent as Jon pointed out. But that would be our objective.

[Operator:]

Gentlemen, with that there are no other questions in queue at this time. I'll turn it back to you for closing remarks.

[Jon Faulkner:]

Thank you. And thank all of you for being on the call. We look forward to sharing with you again at the end of third quarter where we are. It does appear that the industry is beginning to show improvement. And we certainly want to be sure that we continue to outperform the industry and gain market share. Thank you very much. Goodbye.

[Operator:]

Ladies and gentlemen, thank you for your participation. This does conclude today's conference. Have a great rest of your day.