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Dixie Group Inc (NASDAQ:DXYN)

Q2 2014 Results Earnings Conference Call

July 28, 2014, 11:00 am ET

Executives

Dan Frierson - Chairman of the Board, Chief Executive Officer

Jon Faulkner - Vice President, Chief Financial Officer

Analysts

Adam Rudiger - Wells Fargo Securities

Sam Darkatsh - Raymond James

Les Sulewski - Sidoti & Company

Operator

Good day, ladies and gentlemen, and welcome to The Dixie Group Incorporated second quarter 2014 conference call. Today's conference is being recorded.

At this time for opening remarks and introductions, I would turn the conference over to the Chairman and Chief Executive Officer, Mr. Dan Frierson. Please go ahead, sir.

Dan Frierson

Thank you, Kelsey, and welcome everyone to our second quarter conference call. I have with me Jon Faulkner, our Chief Financial Officer. Our Safe Harbor statement is included by reference both through our website and press release.

The investments we have been making to grow our business had a very positive impact on our second quarter sales as we continued our strong growth relative to the industry. Our sales for the quarter were up 29.4% in total, and 14.8%, not including the acquisition of Atlas Carpet Mills. Our residential products increased 13.7% from last year's second quarter and we believe the industry was flat.

Sales of commercial products were up 24% compared with the year ago period without Atlas, or 83.5% including Atlas this year. We believe the industry was up low to mid single-digits. All of our brands, other than Atlas, were up in the second quarter on a year-over-year basis. We anticipate Atlas sales will begin improving with the introduction of new products later in the year.

Jon Faulkner will review our second quarter financial results, after which I will discuss our business going forward. Jon?

Jon Faulkner

Thank you, Dan. Looking at sales. For the quarter, our sales were $108.2 million, gain up 29.4% on a fiscal period versus last year. For the quarter, gross profit as a percent of sales was week at 24.6% as compared to 26.7% a year ago. On a non-GAAP basis, excluding acquisitions and manufacturing integration related costs, our gross profit percentage for the second quarter was 24.8%.

Other expenses that are not adjusted in the non-GAAP presentation were over $800,000 of expense related to higher than normal workers' compensation expense related to an accident that occurred while installing equipment to accommodate the Atlas dye house consolidation and lower operating efficiencies early in the quarter. Had these operation expenses been included in the non-GAAP presentation, our gross profit would have been 25.5%.

Selling and administrative expenses for the second quarter of 2014 was 22.5% of net sales as compared with 22.5% of the same quarter in 2013. High expense ratio was partially due to approximately $269,000 in cost related to re-branding of our Robertex product line and the Avant brand launch and $554,000 in Atlas acquisition related costs. Without these added expenses, our selling and administrative expenses was 22.1%.

Operating income was $440,000 for the quarter as compared to income of $3.3 million a year ago. Adjusting for $2.2 million in facility consolidation, asset impairment 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 $2.7 million. Once again, the non-GAAP operating income of $2.7 million does not include the unusual workers' compensation expense and lower efficiencies early in the quarter. That would have increased non-GAAP operating income to $3.5 million.

We are most of the way through the merging of the Atlas dye house into our Susan Street facility. We have entered into an agreement to sell the Atlas dye house and have adjusted the Atlas purchase gain in the opening balance sheet, just showing it in the year-to-date results only. In May, we began the consolidation plan for our East Coast distribution network. We opened our Adairsville distribution center in mid-June and will continue to move finished goods into the facility throughout the summer.

The next step our plan is to convert our Eton finished goods facility into storage for work-in-process. In addition, we announced in June the decision to shutdown our Atmore carpet and yarn dye processes. Carpet dyeing operation was shutdown in July and the yarn dye operation will be shutdown in early August. We have scheduled the details of these restructuring plans in our press release.

Our interest expense for the quarter at $1.1 million included the higher cost due to the Tranche B advance loan of our revolver as part of the Atlas acquisition. That loan was repaid in June and we anticipate lower interest rates going forward due to higher levels of availability under our bank revolver.

Our income taxes for the period was a benefit of $66,000. The tax in the period included a true up to a higher rate and $117,000 charge due to the expiration of an unvested market based stock grant. Our normal rate going forward at reasonable levels of profitability should be in the 38% range.

Diluted loss from continuing operations for the second quarter of 2014 was $0.04 per share, as compared to an income from continuing operations of $0.13 per share in the second quarter of 2013.

Looking at our balance sheet. Our receivables increased $3.4 million during the quarter, inventories increased $1.7 million, capital expenditures and leases were $2.2 million as compared to depreciation and amortization of $3.3 million. We anticipate including the ColorPoint tufting equipment for Atlas, capital expenditures for 2014 of approximately $19 million and depreciation and amortization approximately $12.7 million.

We refinanced existing operating leases we entered into during the downturn into capital leases to lower our financing costs during the period. This $2 million of capital expenditures is not included in the $19 million mentioned above.

Our debt stood at €114.7 million at the end of the period, down $17.9 million for the quarter. We paid off the Tranche B loan over advance on June 30, the Monday after the quarter ended. We ended the quarter with availability under our loan agreements of $46.5 million. Currently, our availability under our loan agreements after repaying the Tranche B loan is $37.8 million.

Our investor presentation including our non-GAAP information is on our website at www.thedixiegroup.com. Dan?

Dan Frierson

Thank you, Jon. Over the last few years, we have embarked on an ambitious plan to grow our business and improve our profitability. There has been no area of our company that has not been impacted. At the same time, we have made strategic acquisitions to improve our operations and enhance our market position.

In 2012, we began the expansion with our yarn operation, which has been increased by over 40%. We also reopened our Eton tufting facility with the focus of growing our residential business. In 2012, we also brought new management into our Masland Contract business with a special focus on growing our modular tile business.

Later in 2012, we purchased a continuous dyeing operation from Milliken to lower our cost and support growth of the residential business. We also purchased Crown Rugs to enhance our offering of wool rugs.

In 2013, we purchased Robertex, a leading wool carpets supplier to continue our growth in the wool market. We also launched the new commercial carpet brand, Avant, to helped grow our commercial business. Later in 2013 we expanded our continuous dye operations to give us ample capacity for growth. In addition, we purchased and started up a space dye operation to give us greater product capability.

In early 2014, we entered into a joint venture with Desso Carpet to sell into the hospitality market in this country, which gives us access to woven Axminster wool carpet. We also began selling some of Desso's unique and innovative products into the modular tile market.

In March, we purchased Atlas Carpet to increase our presence in the upper end of the commercial market. In the second quarter, we merged their dyeing into our existing operations in California. During the second quarter, we also began opening a new distribution center in North Georgia, which increases our space for product without increasing our cost. And lastly, we are closing our yarn and carpet dyeing in Atmore and are moving the dyeing to lower cost facilities.

Obviously, all of these moves have been done to help support our aggressive growth over the last few years. As we complete these restructuring plans, our profitability should improve significantly. Our organization has responded to these changes very well, but there have been significant upfront costs in making these things happen.

Current business conditions are showing some improvement in the residential and commercial marketplace. The remodeling sector seems to be driving this improvement, and we believe that is generally positive for the upper end business.

During the second quarter, most industry players announced and implemented a carpet price increase to reflect the cost increases which we have experienced. The results of the increase should begin to be seen in the third quarter.

Last year, the second half of the year was particular strong for us. Last year's third quarter, which is usually about the same as the second quarter, was up 8% over the second quarter and was up 37% over the previous year's third quarter. Despite this, we are experiencing growth so far in July and anticipate we will have growth in the third and fourth quarters and continue to gain market share.

Through the first four weeks of July, our sales were up 19%, and excluding Atlas sales, are up 6%. We believe as the distractions from our many initiatives pass, our cost will come down and our margins will improve.

The numerous operating initiatives and acquisitions impacted our balance sheet and we felt a secondary stock offering would be the prudent thing to do. A successful completion of the offering leaves us in a strong position to grow organically or by acquisition.

At this time, we would be glad to answer questions.

Question-and-Answer Session

Operator

(Operator Instructions). We will go to Adam Rudiger with Wells Fargo Securities.

Adam Rudiger - Wells Fargo Securities

Hi, good morning. Thanks for taking my question. In your press release, you mentioned you still have some work to do in order to get to what you called acceptable margins later in the year. I was wondering if you could be a little more specific and talk about what acceptable means to you, both in terms of gross margins and SG&A to sales, and then comment on what you think really you need to do to accomplish those goals?

Jon Faulkner

Adam, we have consistently targeted that we think 7% operating income is a reasonable expectation for the company. If you look at that, that would involve improving both our gross margins and lowering our SG&A. I think if you look at the operating initiatives, it's very hard to capture all the things that are going on relative to the changes that we have internal to the company, but as those restructuring plans come down, you should see margins pick up and then we ought to see a drop in SG&A as we fully absorb the higher cost structure we have in place for higher level of sales. Particular, I think, our residential business is a little ahead. We really started that growth plan in 2010 and we really were late 2012, 2013 starting the growth plan on the commercial side. That growth plan really will come to fruition, I expect, over the next year or so.

Dan Frierson

In addition, Adam, we did have price increase, which we implemented late second quarter and early third quarter, which should impact the latter part of the year.

Adam Rudiger - Wells Fargo Securities

Is your expectation that you think you can get to that 7% any time during 2015?

Dan Frierson

I think in the first half of 2015, we will still have a fair amount of restructuring. We will be shutting down our rug operation and moving into a building we already own, which is the last piece of that integration. And so I expect we would probably achieve that would be in the latter half of 2015.

Adam Rudiger - Wells Fargo Securities

Okay, and then just commenting, just real quick, asking about general environment. Helpful to hear you talk about the normal seasonal impact in the second quarter, third quarter and the changes last year. If you excess, and I am just looking at the 6% year-over-year change and so far this quarter would suggest a decent slowdown, but if you would ignore last year's comparisons and you discount the look at your business and how it has been trending in June and July, do you think that you just discern any difference in July versus the second quarter?

Jon Faulkner

Adam, not really, but we had a very strong, in particular, commercial quarter in the third quarter last year with some very large orders and our residential business is up much better than the 6% and we anticipate commercial to be up better than it is, once we pass this period when we had some large orders.

Adam Rudiger - Wells Fargo Securities

Okay, Thanks for taking my questions.

Dan Frierson

Thank you, Adam.

Operator

(Operator Instructions). We will move on to Sam Darkatsh with Raymond James.

Sam Darkatsh - Raymond James

Good morning Dan, Jon. How are you?

Dan Frierson

Fine. How are you, Sam?

Sam Darkatsh - Raymond James

I am doing well. Thank you. Just two clarification questions. The workers' comp item, Jon, I know you said in combination with some of the inefficiencies, the combination of the two or $800,000 of items, but just the workers' comp item alone, could you help quantify that a little bit?

Jon Faulkner

We don't break that number out, obviously because of there is other considerations involved, but between those two it was $800,000.

Sam Darkatsh - Raymond James

Okay, and one slide 28 of your presentation that I am looking at here, you have a year-to-date 2014 seasonally adjusted to represent an annual run rate of $407 million for year-to-date 2014. My guess, since you are talking about expectations for growth in the back half, as that does not necessarily represent your expectations for sales for the year. That's correct?

Jon Faulkner

That, Sam --

Dan Frierson

That's a safe assumption.

Jon Faulkner

That's correct. Mathematically, it was Dixie without Atlas using our historical seasonality percentages plus the Atlas add-on and so you are right. That's a safe assumption.

Sam Darkatsh - Raymond James

Okay, Thank you. That makes it much more clear. Thank you.

Operator

(Operator Instructions). We will move on to Les Sulewski with Sidoti & Company

Les Sulewski - Sidoti & Company

Good morning, gentlemen. Thank you for taking my questions.

Dan Frierson

Good morning.

Les Sulewski - Sidoti & Company

First, I wanted to start out with, looking at you press release, comment on the sale of the Atlas dye house and that's expected to flow into the third quarter. So have you found a buyer for that? And you know, how does that work out into our balance sheet?

Jon Faulkner

Okay. Les, what we had to do is, because we do have a contract for sale, it still has a contingency period that will run through early August and we anticipate the sale will occur late August or early September, but since we do have a contract for sale, we went back to the opening balance sheet and if you will notice the gain on Atlas on a year-to-date basis, now it says $10.5 million, it was originally $8.7 million.

The differences on that gain is primarily due to the balance sheet adjustment that we made relative to the Atlas purchase. That because it was in the opening balance sheet, we reflect it in the year-to-date results, not in the second quarter or third quarter. So we have already taking into account the anticipated purchase price and profit we would make on that transaction in the opening balance sheet in Q1.

As we get later in the year, we will continue to probably have some small adjustments to the opening balance sheet, which we will continue to come back and adjust the gain relative to Q1 until the end of the year. By the end of the year, we expect to have completed all of the analysis to finalize that gain on sale.

Les Sulewski - Sidoti & Company

Okay. So is this how it impacted the first quarter? If you look at the page 37 of your investor presentation, and I see your topline there is $4.4 million, income from continuing operations as reported, was this number changed or adjusted?

Jon Faulkner

Yes. That number was changed. It was $3.8 million in the first quarter.

Les Sulewski - Sidoti & Company

I see. Okay.

Jon Faulkner

Yes. But we had to restate first quarter as a result of that and that's that restatement. That's why, if you take the year-to-date results and pull out second quarter, you will see that effect of that restatement, but basically that boiled down to two items. It was the change in the taxes and the changes in the gain on purchase of Atlas.

Les Sulewski - Sidoti & Company

Okay. I follow. Thank you. And then, one other thing. You mentioned about the industry price increases. Can you comment a little bit more on that? What kind of percentage rates or increases are we expecting and then just a little bit more color on that, if you could?

Jon Faulkner

I think price will be effective throughout third quarter. It will be fully effective in the second quarter. And we expect the magnitude of that could be in the low single-digits. And it's a little different by market segment, et cetera, but overall you are in that 1% to 2% range.

Dan Frierson

Most industry players have announced and implemented price increases, and as Jon said, we would expect that to be in the low to mid single digits impact over time.

Les Sulewski - Sidoti & Company

Okay. Thank you, gentlemen. That's very helpful.

Dan Frierson

Thank you.

Operator

Mr. Frierson, we have no further questions. I will turn the conference back to you for closing or additional remarks.

Dan Frierson

Thank you very much, Kelsey, and let me just say, we are glad to have you with us. We appreciate your support and I look forward to talking with you next quarter.

Operator

Again, ladies and gentlemen, that does conclude our conference for today. We thank you all for your participation.

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