The Dixie Group, Inc.
Q3 2013 Earnings Call Transcript

Published: 30 Oct 2013

[Operator:]

Good day, and welcome to the Dixie Group Incorporated Third Quarter 2013 Conference Call. Today's call is being recorded. At this time for opening remarks and introductions, I’d like to turn the call over to the Chairman and Chief Executive Officer, Dan Frierson, please go ahead, sir.

[Daniel K. Frierson:]

Thank you Melissa and welcome everyone to our third quarter conference call. I have with me Jon Faulkner, our Chief Financial Officer. Our Safe Harbor statement is included by reference to both to our website and press release of today. Third quarter sales were up 37% over the prior year’s level. Sales for the quarter exceeded our higher water mark before the 2008 recession. Our residential products grew 35% and commercial products nearly 40% compared to a year ago levels. We think the industry experienced a small single digit improvement in commercial products and the residential business was up high single digits. For the year our sales was 27% and we believe the industry is up in the mid single digits. Performance relative to industry is being driven by a strategy of reinvesting in the business during the downturn in order to take advantage of any changes or improvements in the market place. Fortunately, we feel the improvement began sooner and are more pronounced in the higher end portion of the market. Jon Faulkner will review our third quarter financial results with particular emphasis on the impact of our growth initiatives on our financial results. After his presentation I will comment further on our strategy and current conditions in the industry. Jon?

[Jon A. Faulkner:]

Thank you, Dan. To reiterate our third quarter sales were $90.2 million, up 37.1% versus the same quarter last year. Our commercial products were up 39.8% versus the industry being up in the low single digit. Residential products were up 35% versus the industry being up, we believe in the high-single digits. Overall, we think the industry was up in the mid single digits. Our investment in the growth initiatives we began in 2012 proving successful and supporting our growth. Total amount of these investments was approximately $2.3 million for the quarter and $5.3 million of the year to-date. We anticipate that these initiatives will total $1.4 million in the fourth quarter and $2.4 million for 2014. Detailing the initiatives our Roanoke yarn expansion will be complete in the fourth quarter of 2013. Product conversion of our Colormaster dye line will be complete in the fourth quarter. However, we will install a new dyer on the continuous dye line to double capacity as our growth has exceeded initial expectation. Roanoke yarn space dye line is installed during the third quarter, we’re now qualifying new products for production to begin in the last quarter of 2013. Installed new higher speed equipment to increase capacity of our machine to test wool line during the third quarter with additional equipment to be brought online in the first quarter of 2014. Our Robertex wool acquisition was complete in July. We’ve been realigning operations to integrate it into our overall wool offering with the expectation that the manufacturing realignment should be complete in the first quarter of 2014. These operational initiatives we anticipate increase our cost of sales by approximately $1 million in the fourth quarter and $1.5 million in 2014. We also began rebranding process of Robertex products with the launch of care sell by Fabrica and added Robertex products to our Masland wool offerings to be launched late in the fourth quarter and continuing into 2014. The launch of our commercial brand continuing with new products and sales coverage expanding well into 2014. These sales and marketing efforts will increase our SG&A expense we estimate of approximately $400,000 in the fourth quarter and $900,000 in 2014. Our tax rate was positively affected by $795,000 prior year’s tax credit. Enjoy of these tax credits for qualified research and development expenses. Our tax rate without these credits was 31.6% for the period. The quarter as compared to the same quarter in the prior year, gross profit margin was 24.5% versus the prior year of 25.2%. SG&A for the quarter was 22.4% of sales, a 1.6 below the same quarter a year ago. For the quarter we had an operating income of $1.8 million compared to an income of $820,000 in the same period in 2012. On an adjusted basis our operating income was $4.2 million, 4.6% of net sales was compared to an adjusted operating income for the prior year of 1.7%. Our interest expense was $896,000 compared to $781,000 prior year, difference is due to the higher levels of debt, order increase, working capital means. Out tax shows a credit of $501,000 and the rate without the $795,000 prior year tax credits was 31.6%. Our income from continuing operations was $1.4 million, diluted earnings per share of $0.11. Our adjusted income from continuing operations was $2.2 million with adjusted diluted earnings per share of $0.15. Looking at our balance sheet, our receivables increased $5.1 million during the quarter, inventories were up $10.8 million for the period. Our inventory turns improved on a year-over-year basis by 14%. Working capital increased $7.8 million during the quarter. Capital leases and expenditures were $4.5 million for the period while depreciation and amortization was $2.7 million. Anticipate capital expenditures for 2013 of approximately $13.5 million and depreciation and amortization of $10.5 million. Our debts stood at $107 million at the end of the period, up $12.4 million for the quarter and we ended the quarter with availability under our loan agreement to $26.4 million. Our investor presentation including our non-GAAP information is on our website at www.thedixiegroup.com. Dan?

[Daniel K. Frierson:]

Thank you, Jon. During the 2008 and 2009 recession we like the industry lost about 40% of our volume and consequently cut cost dramatically in order to survive. Once the industry appeared to stabilize, we decided to invest in the future through new products readily available people talent and equipment that could help us produce differentiated product. As Jon reviewed, we have had a number of initiatives which have been costly in the short term, but have enabled us to grow much faster than the market. Movement of soft fibers such as Stainmaster, TruSoft and the introduction of SolarMax has helped separate us from much of the competition. Also the strong movement to wool products through product introductions and acquisitions has enabled us to grow the wool business at a rate much faster than the market. On the commercial side in the last year, we have launched several collections of more competitive but well styled modular carpets as well as developed and launched the new Avant brand. During the last year, we have introduced more new residential and commercial products than ever before. Consequently, new products are higher percent of our sales than ever before. We have also added more new sales people enabling us to expand our coverage and strengthen our customer relationships. As we look to the future, we are optimistic about our prospects because the housing and commercial markets are gaining momentum. The market reception to our residential and commercial products has been exceptional. Our upper end customer is more confident and willing to spend. We have invested heavily in new products, talented people and equipment to make differentiated products and add capacity to accommodate the growth. We believe both the residential and commercial markets will grow in 2014 and we believe our strategy is working in both markets. As Jon explained in his comments, onetime costs of these initiatives have been significant, but as we move forward, the cost should decline and our profitability consequently should improve. Also we have aggressively taken the advantage of market opportunities as they developed which is our expenditure for introducing and sampling new product has been at an all time high as a percent of sales. We would expect these expenditures to decline as a percent of sales as sales increase and product introductions return to a more normal level. As we look at this year in the first quarter business began to improve and our sales were up 20% over the previous year. During the second quarter, we began to feel the momentum of the industry improvement and our sales were up 26%. During the third quarter, we were able to get more of our new products to market and our sales were up 37%. Obviously at some point the comparison to the year ago quarter will become more difficult. For the fourth quarter of last year, our sales were up 9% over the 2011 fourth quarter. In the fourth quarter to-date, this year, we continue to experience strong momentum with orders and sales up in excess of 30%. At this time we would like to open up the call for questions.

[Operator:]

Thank you. (Operator Instructions) And our first question will come from John Baugh from Stifel Nicolaus.

[John Baugh:]

Good morning Dan, congratulations on a terrific sales results.

[Daniel K. Frierson:]

Thank you, John.

[John Baugh:]

Could you comment, I believe there was a reference to home center channels, well in there and couldn't help but notice some Home Depot ads that have been running about soft? Could you comment on whether you are participating in that program in general and then what you’re seeing on the homes centers in terms of marketing? I know they had pulled back on carpet. It seems to me they are back at it, any color there will be great. Thank you.

[Daniel K. Frierson:]

John, we are not participating in the Home Depot ads or business, we do participate with lows and that business has been, has improved significantly this year and I think the soft fibers have been at the center of that.

[John Baugh:]

Okay. And is the soft revolution some of the trade caller, is that something that you have experienced yourself and is driving your business. And I am curious how that trend is impacted at all by the proliferation of very low priced polyester products in the marketplace?

[Daniel K. Frierson:]

Well, first of all, we can't really speak knowledgeably to the lower end of the market. We don't participate there, but in terms of the soft fiber, it certainly has gained a significant market share both in nylon and polyester and I think we will continue to do so. It's a very attractive product and we think we will gain market share and that's one of the reasons that sample costs have been as high as they have been, is replacing a lot of the older products that are not so.

[John Baugh:]

And then, lastly, any color on the commercial side of the world in terms of what you are seeing and how it's playing out, whether the order trends there. You made a comment about the residential, but I guess you are coming overall order being strong through October and I am curious as whether there is any bifurcation between residential or commercial?

[Daniel K. Frierson:]

We are not seeing any bifurcation. Both our commercial and residential, orders and sales are in excess of 30% and interestingly enough, they are both up for the year very close to the same number in the 27% plus range. So we are not seeing any change there, we will say, you may recall, we changed our management team there about a year and a half ago, we have seen lot of improvement particularly in our modular tile business. So for us the business has been strong, but as best we can tell for the industry, the commercial business is up slightly.

[John Baugh:]

Great. Thanks for taking my questions.

[Daniel K. Frierson:]

Thank you, John, good to talk to you.

[Operator:]

And our next question will come from Matthew Dodson with JWest LLC.

[Matthew Dodson:]

Can you talk a little bit about, so originally in the year, you were going to level load your sampling costs and they are going to equal for four quarters, and now, in this quarter you put an additional 700,000 in. I guess, can you just help us understand at all or can you give us a sense of what you think you are doing sampling costs next year and would you be willing to share at all what you are going do totally in sampling costs this year?

[Daniel K. Frierson:]

Let me comment generally, and then I will turn over to Jon. But obviously, we don't break out specific costs, particularly by that period or whatever. But I will say we tend to, sampling cost depends on the opportunities we see ahead of us. And acquisition of Robertex certainly has influenced what we have done with samples. But Jon, I will turn the question over to you.

[Jon A. Faulkner:]

Matthew, actually the sample cost, anything related to the acquisitions got closed in the third quarter. Those numbers were affected because of that, but in addition as we have gone throughout the year, we have made some adjustments to our overall expenditures. So, our initial estimate beginning the year turned out to be a little lower than what we are actually going to spend to raise that for the second half of the year. Anticipating 2014, I believe that our sample cost will come down next year as a percentage of our sales relative to this year.

[Matthew Dodson:]

Do you think they will come down an absolute dollars?

[Jon A. Faulkner:]

I think they will be flat to down.

[Matthew Dodson:]

Flat to down. And then, can I just ask you a follow up on the $5.3 million, so you are saying in the press release that approximately $5.3 year to-date that includes extra sampling cost and it also includes some of the initiatives you took in the gross margin to improve gross margins, is that correct?

[Jon A. Faulkner:]

Yes. Let me review that to make sure it's clear. If you look at the, quarter to-date of the $2.3 million, $1.6 million of that was in the selling expense, was in the cost to console, and the balance was in SG&A. In the fourth quarter, we anticipate million dollars in additional cost of goods sold and $40,000 additional selling expense for total of $1.4 million. Over the year, we anticipate $5 million in additional cost to goods sold expenditures and $1.6 million additional SG&A expense for total $6.6 or almost $6.7 million.

[Matthew Dodson:]

Got it. And the 6.6 additional in SG&A was on top of --?

[Jon A. Faulkner:]

That’s combined cost to goods sold and SG&A, it’s only 1.6 in SG&A.

[Matthew Dodson:]

Yes, the 1.6 is a combined or an additional amount of what you had planned at the beginning of the year for sampling cost, is that correct?

[Daniel K. Frierson:]

That is not just sampling.

[Jon A. Faulkner:]

It's more than sampling. It's a launch of our --

[Matthew Dodson:]

Sales people etcetera.

[Jon A. Faulkner:]

Yes and the introduction of our new products under the Robertex acquisition.

[Matthew Dodson:]

Okay. The last question, if you back out the $1.6 million that you had in the COGS, I mean, gross margins would have been 170 basis points or almost 180 basis points better. If we think about next year and obviously sales are, if you think about gross margins next year, I mean, can that put you kind in the 28%, 29% gross margin? Can we think about that, kind of for next year or is that too aggressive?

[Jon A. Faulkner:]

I think, like a adjusted gross margins that we have for the year, an indicator of gross margin going into next year. Recognizing, we still anticipate $1.5 million of additional COGS expense next year, and $900,000 of selling or to reduce that but as a run rate, as a percentage of sales reasonable our expectations for a gross profit margin. Additional leverage will boost that sum but I don't know that it would go to the numbers you described.

[Matthew Dodson:]

Okay. And can you talk a little bit, just what you think, over time, what you think you can drive Op margin to?

[Jon A. Faulkner:]

Yes. Operating income, we have always said that we would like to be in that 7% to 9% range long-term, but we are really not there at this point in time.

[Matthew Dodson:]

Great. Thanks for your time.

[Operator:]

Your next question will come from Tom Lewis, with Highroad Value Research.

[Tom Lewis:]

Hi, good afternoon.

[Daniel K. Frierson:]

Hello Tom.

[Tom Lewis:]

Yes, hi. First question, with respect to capital spending, I mean, I would guess that the somewhat -- that the elevated level we are at now to bring on all this new capabilities, carries on over some in the next year, but might you give us a sense of, once we get past that, what the new normal level of capital spending might be for you. Say relative to what you are looking for this year or say where it was more recently?

[Jon A. Faulkner:]

Well, our expected capital expenditures this year we are in the $13.5 million range. And in the short term, looking into 2014, I would expect them to be in that range, maybe even a little higher but in that range. Over the long-term, I expect that our depreciation, amortization in our capital expenditure to come in line with one another. We under spent during the downturn – so we are little bit overspending now, but over the long-term we expect those to balance out.

[Tom Lewis:]

All right. And Dan, I was wondering if, other than, what we can read about in terms of some of the larger players taking out capacity. Can you talk, how, five, six, seven really tough years have evolved the competitive landscape for you there?

[Daniel K. Frierson:]

Tom, I am not exactly sure what you are looking for there, but I think clearly we really began investing back in the business before our number of our competitors did. And quite honestly, it did have a negative impact on our profitability there, the last couple of years, but we think, it was well worthwhile doing looking at the business strategically in long term and we are getting to the point where it is beginning to show up on the bottom line as well. If you look at industry from peak to trough, was off about 40%. We were off about 40%. Our trailing 12 months are up about 58% in the industry somewhere than 10% range. So, I think clearly the strategy is working and our emphasis this next year is really in bringing that to the bottom line.

[Tom Lewis:]

Okay. Well, I kind of, what I was wondering, if it would be fair to assume that a difficult stretch of time, over a difficult stretch of time like that, competitors. Smaller competitors, the ones that if you are not up close and personal -- every day, we are not aware of, just on around anymore or really not as competitive as they used to be?

[Daniel K. Frierson:]

I think that the industry is competitive in the lower and mid price ranges it's ever been. I think, we have seen the entrance of a couple move mills. We have seen a couple of mills go by the wayside, but I wouldn't say people are weakened. The big companies in the business, the two biggest Shaw and Mohawk, I think are as competitive as they have ever been.

[Tom Lewis:]

Okay, well, that's – I would think so. So, I guess just so, finally it's been a long and winding road in that group, really like to say thank you very much to you and your whole team for all your hard work in sticking with it.

[Daniel K. Frierson:]

Well, thank you for sticking with us.

[Tom Lewis:]

Yes. All right, bye.

[Operator:]

Next we will take a question from Ethan Steinberg with SG Capital.

[Ethan Steinberg:]

Hey guys, congratulations on the results and execution, thanks for taking the call. So, I am little confused like couple things, I haven't had time to completely go through. So sorry to do this on the conference call, but I want to make sure, I am thinking about it correctly. The adjusted operating income of $4.1 or almost $4.2 million and 4.6%, that's backing out the $1.6 million in – sort of integration cost?

[Jon A. Faulkner:]

Yes, we are backing out, both in the COGS and in the SG&A expenses, as well as the tax effects and – I am sorry, operating income. Yes, those two items were backed out and during the period we had $2.4 million of those of numbers $1.6 in COGS and $800,000 in selling.

[Ethan Steinberg:]

Got it. Okay. And then you are saying, it's going to be $1.4 in the December ended quarter and then drops a lot next year to one million and four hundred for the whole year?

[Jon A. Faulkner:]

A million five – no, one million and four hundred for fourth-quarter, 1.4 total, and one million five and nine hundred or 2.4 million for next year or the entire year.

[Ethan Steinberg:]

Got you, okay. And then I guess, I want to just make sure, I am thinking about it correctly, so we grew a revenue about $25 million on a year-over-year basis, and that adjusted operating income grew about $3 million, was there anything else in the expense structure that won’t necessarily repeat?

[Daniel K. Frierson:]

Ethan, I think we indicated earlier that we did see opportunities in the marketplace and therefore we have spent a lot more aggressively in terms of hiring sales people and developing and introducing product at a level that's higher than we would think we would have going forward in more normal times.

[Ethan Steinberg:]

Yes. Clearly it's paying off. So it's a good investment but I guess I am just trying to get a sense of is that goes to more normalized environment, how much do you think would drop through if you grew the revenue $25 million or $10 million, just wondering what that drop through should look like when you are not in such a high investment phase?

[Jon A. Faulkner:]

We are not in such a high investment phase. Our goal is to be in the 20% to 25% range, I think in the near term it maybe more than 15% leverage ratio just because we do have – we capture what we thought was a onetime expenses, but we didn’t capture all of the expenses of the growth in this period. So as we go forward, our leverage ratio again we think we are going to be in the short term in the 15% range, for longer term our goal is in that 20% or 25% range.

[Ethan Steinberg:]

Okay. So that it's still – it grows sequentially from here even going to 15 is a nice step up.

[Jon A. Faulkner:]

Yes.

[Ethan Steinberg:]

Okay. And then I am also just curious you said that the comparison was against 9% last year and Q4 and it's up 30% month, I guess yes, quarter to-date which is a big number. Is the comparison of that 9% pretty even for October? Was it harder or easier than the 9% for the quarter?

[Jon A. Faulkner:]

Ethan, if you go back two years ago, our sales were strongest in October and first part of November and then they trailed off in the second half between the holiday season between Thanks Giving and -- last year our sales were pretty much strong throughout the entire quarter. And so I don’t know what the seasonality will be this year, but we did have little unusual seasonality last year and that it was – really it was a good October, but what happened was November and December came in much stronger. I mean, historically whatever expected.

[Ethan Steinberg:]

Okay, right. And there is nothing with the mix or margin of what you are seeing in October that is different than what we saw in the third quarter?

[Daniel K. Frierson:]

It’s a continuation – some of the new products as we indicated really began to impact sales in the third quarter really like second quarter and third quarter and we are seeing the continuation of that so the mix is not materially different in the fourth quarter than the third quarter.

[Ethan Steinberg:]

Okay. Well great. Nice job guys, thanks for taking the questions.

[Daniel K. Frierson:]

Thank you.

[Operator:]

(Operator Instructions) And our next question will come from Josh Goldberg with G2 Investment Partners.

[Josh Goldberg:]

Hey guys, thanks for the strong results. Just so I understand through the third quarter I guess the first 45 days you were tracking roughly around 30%, you said in one of your presentations. Can you at the --

[Daniel K. Frierson:]

At the fourth quarter, Josh.

[Josh Goldberg:]

Yes and then in August you had a presentation on your website, you said you were tracking on 30. And you end up doing closer to 37 or over 37 for the quarter. Does that imply for the last 45 days business actually got stronger and I’ve a follow up?

[Daniel K. Frierson:]

Josh, our business, particularly the commercial business sometimes comes in lumps and we try to level those out a little bit. I don’t recall – I don’t think it was thickly stronger, but somewhat but we did have good order entry from the start and as we have indicated this quarter both order and wool sales are up in excess of 30%, but as Jon pointed out, last year, we had a strong November, December. So we don’t know where we will end up for the quarter.

[Josh Goldberg:]

Okay. And then in terms of the acquisition, Robertex’s acquisition, how much that add in terms of revenue for the quarter?

[Jon A. Faulkner:]

We’ve not relayed those numbers and that acquisition was the combination of additional wool sales but also it allowed us to bring inside operations which we currently had to outsource. So it was a combination of things, but we have not released those sales and do not break up our wool sales separately.

[Josh Goldberg:]

Okay. Was there anything sort of effective mix this quarter that let you down on the gross margin side besides onetime items or is it commercial business little bit lower than the gross margin mix versus your residential side?

[Jon A. Faulkner:]

Actually, our mixed really had no major changes and the average between the two businesses are very similar. They are both upper end and lower end of each business are very comparable and the average of both business is comparable.

[Daniel K. Frierson:]

Remembering our lower end is still very much upper end in the market for us.

[Josh Goldberg:]

Right. And just so I am clear, so if you have a lower cost of goods sold addition in the fourth quarter, this onetime cost that you’re incurring, all those being equal and keeping the mix as it is and look to trends where they are, you would expect your gross margin percentage to be higher than the 261 [ph] in the third quarter to something closer to maybe what you did in the June quarter 267 [ph] or 27%, is that fair to say?

[Jon A. Faulkner:]

It could be, yes. Again adjusted gross profit margin it was really, we let people see what we think of more normal profit margin is, but again, I don’t know what the sales volume will be for the quarter whether it will be additional leverage on that.

[Josh Goldberg:]

Okay. Got you, great. Thank you so much.

[Daniel K. Frierson:]

Thank you, Josh.

[Operator:]

And at this time we have no further questions in the queue and I would like to turn the call back over to our presenters for any additional or closing remarks.

[Daniel K. Frierson:]

Thank you, Melissa and thank all of you for being on the call. Obviously, we are very pleased with the sales increase and we continue to see strength in the fourth quarter as we did in the third quarter. Our objective in the fourth quarter and going forward is to bring more of that increase in sales to the bottom line. I look forward to talking with you next quarter.

[Operator:]

That does conclude our conference for today. Thank you for your participation.