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Executives

Daniel K. Frierson – Chairman of the Board & Chief Executive Officer

Gary A. Harmon – Chief Financial Officer & Vice President

D. Eugene Lasater – Controller

Analysts

Sam Darkatsh – Raymond James

Todd Schwartzmann – Sidoti & Company, LLC

Tom Lewis – Century Management

Bruce Baughman – Franklin Advisory Services

John Baugh – Stifel Nicolaus & Company, Inc.

Arnold Brief – Goldsmith & Harris, Inc.

The Dixie Group, Inc. (DXYN) Q4 2007 Earnings Call February 26, 2008 11:00 AM ET

Operator

Good day and welcome to the Dixie Group, Inc. year end 2007 conference call. Today’s call is being recorded. And at this time for opening remarks and introductions I’d like to turn the call over to the Chairman and Chief Executive Officer Mr. Dan Frierson. Please go ahead sir.

Daniel K. Frierson

Welcome everyone to our fourth quarter and year end conference call. I have with me Gary Harmon our chief financial officer and Gene Lasater our corporate controller. Our Safe Harbor statement is incorporated by reference. It is both in the press release and posted on our website. The industry continues to suffer from a dramatic decline in new housing and home resales as well as the general tightening of credit availability. The result has been another year of declines in units and dollars for the carpet industry. The industry reported carpet sales declined 6.5% in the fourth quarter and 8% for the year. During the same period our sales continued to outperform those of the industry with year-over-year carpet sales comparisons that were flat for the fourth quarter and down 2.8% for the full year. We are pleased that gross margins improved in both dollars and a percent of sales for the fourth quarter and full year. We believe it is also significant that without the pension merger expense incurred in the fourth quarter and the abnormally low tax rates in the fourth quarter a year ago, our fourth quarter 2007 operating income and income from continuing operations were better than those of the prior year.

Gary Harmon will review our financial results after which I will speak to our market segments and current business conditions.

Gary A. Harmon

Fourth quarter sales were $79.5 million down less than 1%. For the year sales were $320.8 million down 3.1%. Fourth quarter carpet sales were relatively flat in total with residential products down 5.4%, commercial products were up 11% and our carpet tile sales were $2.7 million. The industry during the fourth quarter showed residential sales down 11.1% and commercial sales up 1.4%. For the fiscal year 2007 carpet sales were down 2.8% with residential products being down 9.1%, commercial products grew 10.5% during this period. The industry reflected residential sales down 13.1% and commercial up 1.6%.

Gross margin improved $600,000 in the fourth quarter, the percentage comparison was 31% versus 30%. For fiscal 2 07, the gross margin improved $1.4 million, the percentage comparison was 30.3 versus 28.9%. Gross margin dollars and percents improved due to our carpet tile operations which was profitable in the fourth quarter, higher selling prices, better product mix and operational improvements. Our suppliers increased raw material costs in early February this year. We increased our selling prices to pass along higher raw material and other costs. The higher cost will negatively affect our margins for several months until the new selling prices are fully implemented. The first quarter will also be affected by seasonally low sales that normally occur in the first quarter of each year.

Selling and administrative expenses as a percentage of sales were 24% versus 23.5% for the fourth quarter and 24.6% versus 22.9% for the year. Despite the softness in our business we have continued to invest in new products, information systems and our selling and marketing infrastructure. While these investments should benefit the future they increased selling and administrative expenses in 2007.

Operating income was 5% of sales in the fourth quarter of 2007 and was reduced by 1.9 percentage points due to the pension plan merger versus 6.2% a year ago. The yearly comparison was 5.2% versus 5%. Pension merger and termination expenses reduced our operating income by one half of a percentage point in 2007 and one percentage point in 2006. In the fourth quarter of 2007 we recorded $1.5 million of principally non-cash prior services expenses related to the merger of our only remaining defined benefit pension plan. In the second quarter of 2006 we recorded $3.2 million of expenses to terminate a legacy defined benefit pension plan. As a result of the merger and termination we are no longer responsible for any defined benefit retirement plans. Ongoing contributions for pensions are expected to be less than $300,000 annually or about $200,000 below our average pension cost for the last two years.

Interest expense was down $198,000 in the fourth quarter and $866,000 for the year due to lower levels of debt, lower interest rates and a higher level of capitalized interest in 2007. Interest expense for 2008 is expected to be approximately $6.2 million. Our effective income tax rate was 32.5% in the fourth quarter of 2 07 and 35.3% for fiscal 2007 compared with 9.8% in the fourth quarter of 2006 and 18.4% for fiscal 2 06. The effective income tax rates in 2 06 were well below normal rates we expect principally due to adjustments to our tax contingency reserves for federal and state income tax examinations including an expired statute of limitations. The effect of the income tax adjustments increased income from continuing operations from diluted share in 2006 by $0.06 for the fourth quarter and $0.13 for the year. We expect the effective income tax rate to be between 35 and 36% in 2008.

The diluted earnings per share from continuing operations, a fourth quarter comparison was $0.14 per share versus $0.25. The yearly comparison was $0.52 versus $0.61. Pension, merger and termination expenses and income tax adjustments negatively affected the comparison of diluted earnings per share by $0.14 in the fourth quarter and $0.05 for the fiscal year. Looking at our balance sheet we ended 2007 with $88.6 million of total debt or 38.4% total capitalization. That’s down from $89 million or 39.6% of total capitalization at the end of 2006. Total debt is expected to increased $7 to $10 million in the first and second quarters of this year and decline to the mid to low $80 million range by the end of 2008.

Capital expenditure was $16.7 million in 2007 and depreciation and amortization was $12.9 million. We expect 2008 capital expenditures to be in the $12 to $14 million range while depreciation and amortization is expected to be slightly below $14 million. In the fourth quarter of 2007 we repurchased 78,000 shares of our common stock at an average price per share of $9.29. For fiscal 2007 a 157,000 shares were repurchased at an average price of $9.91. This year through February 22nd we had repurchased another 69,000 shares at an average price of $8.14 bringing our total purchases since the inception of the stock repurchase program to 226,000 shares at an average price of $9.38 per share.

Daniel K. Frierson

As the industry has continued to weaken we have continued to invest in the future. We believe this will position us well when better conditions arrive. The residential market has been particularly difficult and it is still unclear when it will begin to rebound. The first quarter could be the low point for the industry in sales and profitability because the retail business is normally slower in the first quarter than the rest of the year. The higher raw material and other costs will also impact us negatively and the carpet price increases will not be fully implemented until later in the year. The first quarter and 2008 will be a challenging period for the residential carpet business. Despite these difficulties we believe we can continue to grow our market share. At Fabrica and Masland we have introduced new wool collections in addition to our normal nylon introductions. At Dixie Home we introduced our new lifestyle collection and are currently shipping samples in to the field. We are also selectively adding to our sales force to increase market penetration. We believe our continued investment in new technology, new products and people will help separate us from the competition in the residential market.

The commercial market grew again in 2007 and is off to a good start this year. Our commercial business grew 10.5% last year and we’re optimistic about 2008. We have placed more new broadloom product into the field and our tile business is gaining momentum. It is now a contributor to our bottom line.

Our capital expenditures are planned to be at a lower level this year but will continue to be focused on equipment and processes that enable us to differentiate ourselves in the marketplace. Our margin improvement is a reflection of our ability to develop and market desirable products for the markets we serve and also the result of better operational and cost control. We continue to have confidence that the upper end of the market will perform better than the market in general and plan to be positioned to take advantage of market opportunities as they arise.

We invested $16.7 million in capital expenditures in 2007, almost $4 million higher than depreciation and amortization. We also purchased a 157,000 shares of our common stock for $1.6 million. With the merger of our only remaining defined benefit retirement plan into a multi employer plan late last year we no longer sponsor any defined benefit retirement plans. Thus, despite the downturn we strengthened our balance sheet, grew stockholders’ equity to $142.1 million, reduced total debt to $88.6 million or 38.4% of total capitalization.

Looking forward although the industry is experiencing a difficult period and the first quarter will certainly be trying, we are encouraged by several factors namely, we had consistently favorable sales comparisons to the industry, we’ve had positive market reception to our new products, our tile products obviously are beginning to take hold, Dixie Home & Office is off the ground and doing well, the wool collections from Masland and Fabrica are also being well received and our new lifestyles collection from Dixie Home is beginning to get into the marketplace. We also are encouraged by the average selling prices in 2007 being up 4% over the previous year and we’ve increased prices in the first quarter of this year to recoup raw material and other cost increases. We had higher gross margins last year at 30.3% up from 28.9% in 2006 and we continue to see operational improvements in the area of quality, manufacturing and distribution efficiencies and material utilization.

At this time we would like to open up the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Sam Darkatsh with Raymond James.

Sam Darkatsh – Raymond James

Looking at your production now Dan, your facilities are you running just one shift at this point? What’s your level of utilization and do you think if things continue at least on the residential side, do you think you may have to rationalize some production capacity?

Daniel K. Frierson

Sam, we’re running all of the same shifts we were running last year currently. We obviously have capacity to grow our business. Our results or shipments so far this year are off slightly from last year. We do think first quarters going to be a very difficult period but that things will improve after that. Seasonally, they tend to and we don’t think this year will be different from that perspective. But, we do think the entire year will be a difficult year so what we are doing is certainly watching our inventories, planning our business better, running fewer hours but not fewer shifts.

Sam Darkatsh – Raymond James

Okay so what you’re saying is that your hard capacity, you feel fine with and you don’t feel you need to adjust hard capacity at this point?

Daniel K. Frierson

No, we do not.

Sam Darkatsh – Raymond James

Okay. When you’re saying that the first quarter or the first half is going to be a real challenge are you suspecting that the change in sales on a year-on-year basis would be similar to the change on the year-on-year sales in the first half of 07 down mid single? Or, are we looking at similar run rates in terms of declines as we saw in the second half of 07?

Daniel K. Frierson

I don’t have a good answer for you. Obviously, if we knew where business was going to be for the industry we would be able to plan our business better but, our thinking at this time is that business will be more difficult in the first half with comparisons to the prior year than it will be in the second half.

Sam Darkatsh – Raymond James

Well, then I’ll ask the question this way and if this was in your prepared remarks and I missed it, I apologize. Through the first seven or eight weeks of Q1 is your business running down low single digit? Down mid single digit? How should we look at that at least from what you’ve gone through here so far in the quarter?

Daniel K. Frierson

It’s down low single digits.

Sam Darkatsh – Raymond James

Okay. Any slowdown that you’re seeing in commercial at all or is it still the demand quite robust and the order book looking solid?

Daniel K. Frierson

The commercial business has been pretty strong for us. We do think the industry slowed down towards the end of the year and may not be as robust as it was but remember our tile business is really just beginning to ramp up and was profitable in the fourth quarter and we’re seeing that business continue to grow pretty significantly but our broadloom business is growing as well so we’re very encouraged by our commercial business and again, how it’s done compared to the rest of the industry.

Operator

We’ll take our next question from Todd Schwartzman with Sidoti & Company.

Todd Schwartzmann – Sidoti & Company, LLC

A couple of things, who is the plan sponsor of the multi employer plan?

Daniel K. Frierson

It is the union that represents the folks in our Atmore plan Unite.

Todd Schwartzmann – Sidoti & Company, LLC

And, I think I missed the numbers but I think Gary you were giving the expected, or maybe it was you Dan, the going forward pension expense, I think you threw out a number of $300,000 is that correct?

Gary A. Harmon

That’s what we expect it to be, our contributions. And, as I said, that’s about $200,000 below what we have averaged for the last two years.

Todd Schwartzmann – Sidoti & Company, LLC

So that is basically exclusively a cost of outsourcing, if you will?

Daniel K. Frierson

No, I wouldn’t call it that. That’s the payment we make into the multi employer plan based on our union contract. I’m not exactly sure what your question is.

Todd Schwartzmann – Sidoti & Company, LLC

Well, in terms of not the employer contributions but the administrative cost of having this third party take the onus off you guys as sponsor, is that negligible? Or, is that a real cost that perhaps we should net out from the expected savings?

Gary A. Harmon

That’s all inclusive in the $300,000.

Todd Schwartzmann – Sidoti & Company, LLC

Okay. So, going forward let’s say for 2008 assuming the top line is flat should we think about SG&A a more normal number around maybe $18 or a little more towards the end of the year on a quarterly basis?

Gary A. Harmon

Todd, I don’t really see any significant reduction in the dollar amount of SG&A expenses. As I said, we’ve continued to invest in new products and our marketing and selling infrastructure and we don’t see significant reductions. Now, we do hope that growth will allow us to better leverage that cost.

Todd Schwartzmann – Sidoti & Company, LLC

And as far as those sales people the incremental sales people that you’ve added and will add is that exclusively a variable cost?

Gary A. Harmon

That would be basically a variable cost but generally there’s some guarantees with the new people until they get their feet on the ground.

Daniel K. Frierson

We’ve been adding people annually the last couple of years Todd and this is not unusual for us. Remember Dixie Home is really still ramping up as a business and that’s where the bulk of the additions would be, would be in the Dixie Home area. This is consistent with what we’ve been doing and there is upfront cost of adding people, no question but the payout is pretty quick.

Todd Schwartzmann – Sidoti & Company, LLC

Once in place the compensation structure is consistent with what you guys have been doing?

Daniel K. Frierson

Absolutely.

Todd Schwartzmann – Sidoti & Company, LLC

Okay. Did you quantify your price increases?

Daniel K. Frierson

No, we did not.

Todd Schwartzmann – Sidoti & Company, LLC

For the raw material hikes in ball park terms?

Daniel K. Frierson

Well, in all fairness as we looked it was not just fiber increases it was utility increase, latex increases, backing increases, medical care cost increases. We really bundled all of those together and increased our selling prices to cover the cost increases we had in 07.

Todd Schwartzmann – Sidoti & Company, LLC

How long should that take to fully stick? Or, let me put it another way, when do expect or how much of those stated increases do you expect to be fully realized?

Daniel K. Frierson

Todd, we increased prices in early February, early to mid February. It will take obviously on new orders. Really you’ll begin to see the impact early second quarter and it should be fully impactful by the end of second quarter.

Todd Schwartzmann – Sidoti & Company, LLC

Great. On the modular, is there any customer categories, industries or geographic segments of strength of weakness? Any pockets you’d care to talk about in terms of acceptance to the product and demand?

Daniel K. Frierson

We’ve had good acceptance literally everywhere but we’re at this point so small it’s very difficult to really quantify one area versus another. But, the acceptance of our carpet tiles which are most attractive and quite honestly higher end than most tile out there with more texture seem to have been very well accepted and we’re very encouraged. We’re also bringing out additional styles in our tile line.

Todd Schwartzmann – Sidoti & Company, LLC

I hope you could give a little more color on the commercial side overall. For example, what do you make of the recent report of service sector and white collar job contraction? Just in general what are you seeing on the commercial side demand wise?

Daniel K. Frierson

We’re seeing commercial business stay strong. Our back order position there which is more relevant on the commercial side than it is on the residential side has grown in the last couple of months. That’s not untypical however when you have a price increase. But, our order entry and shipments of commercial product continue to be strong.

Todd Schwartzmann – Sidoti & Company, LLC

So you’re not too concerned about the jobs picture for the next 12 months or so?

Daniel K. Frierson

I think that you can make a case that by the time the residential business comes back the commercial business may slow down.

Operator

Next we’ll go to Tom Lewis with Century Management.

Tom Lewis – Century Management

First question, should we be concerned, you said that you announced price increase early February but should we be concerned, was that telegraphed in a way that it may have effected customer’s tendency to buy ahead of a price increase back into December say and so add to the difficulty of revenue in the first quarter?

Daniel K. Frierson

Tom, that’s difficult to say. We did announce it I think early January but the industry had announced some before that so I think pretty well the retail community new a price increase was coming.

Tom Lewis – Century Management

So you might have gotten a little help in December from that?

Daniel K. Frierson

Yeah but we certainly didn’t see a spike in orders. We did see a little on the commercial side as I mentioned earlier which is more typical but on the residential side remember, we don’t sell carpet until somebody has a firm order and is ready to install. So, we didn’t see that kind of uptick that you might normally see.

Tom Lewis – Century Management

Okay. Can you remind us what the carpet tile loss is on starting that up were costing us through the first three quarter of the last year?

Gary A. Harmon

Sure, I’ve got something here I think. The loss for the year of 2 06 was about $2.5 million. 07 it was probably –

Daniel K. Frierson

It was right at $1 million, a little over $1 million for nine months of loss.

Tom Lewis – Century Management

For nine months of loss?

Daniel K. Frierson

Yeah.

Tom Lewis – Century Management

Alright. Okay. Dan, you referenced strength in broadloom commercial, was that just a reflection of being able to get into accounts that – I remember having a conversation about folks that didn’t want to talk to you if you didn’t have a tile product or was there more to it than that? Or is it that at all?

Daniel K. Frierson

I think that’s part of it Tom and we did have that discussion. Also, I think our group has done an exceptional job with new products which has been well received. I do think our broadloom commercial business is much stronger than the market generally. So, I have to give our fellows credit for developing new, beautiful, differentiated product that has been well received in the marketplace.

Operator

Next we’ll go to Bruce Baughman with Franklin Advisory Services.

Bruce Baughman – Franklin Advisory Services

A couple of very general questions, did you give us an EBITDA number?

Gary A. Harmon

No, we didn’t. We did give you the depreciation.

Bruce Baughman – Franklin Advisory Services

What was the depreciation for 07?

Gary A. Harmon

Which was 12.9, I believe.

Bruce Baughman – Franklin Advisory Services

Okay. And when we get a cash flow statement is the company going to be free cash flow positive after cap ex for the full year?

Gary A. Harmon

Yes.

Bruce Baughman – Franklin Advisory Services

Okay. Would it be your expectation based on whatever level of visibility you have at present that that will be true for 2008 as well?

Gary A. Harmon

It is what we would expect.

Bruce Baughman – Franklin Advisory Services

Okay. Then in a general sense I’m always happy to see companies buy back stock below book but – and I know you paid down debt a little bit during the year but, how much confidence do you have based on the outlook and the financial strength of the company to be buying back stock?

Daniel K. Frierson

Bruce, we felt like the acquisition of stock was a good investment for the company and for our shareholders. We have been going through a very difficult period for the industry but we certainly have outperformed the industry and we feel when business does improve that our business will improve disproportionately well and therefore we think the acquisition of stock is a good investment.

Bruce Baughman – Franklin Advisory Services

Okay. If you found money under a desk drawer or something would you buy back stock today or would you pay down a little bit of debt? That’s really my question.

Daniel K. Frierson

We have repeatedly said that we are comfortable with our debt level and the 30 to 40% of total cap. We’re at 38% now, we obviously would prefer to see that a little lower.

Operator

Next up we’ll go to John Baugh with Stifel Nicolaus.

John Baugh – Stifel Nicolaus & Company, Inc.

When do you anniversary your large home center account in terms of sales fall off?

Daniel K. Frierson

John we anniversaried that in the fourth quarter and we’re no longer seeing a drag due to that. About 95% of our decline in sales last year was due to the decline in sales with one customer. But, today that customer is up.

John Baugh – Stifel Nicolaus & Company, Inc.

Interesting. Okay. Anything that’s unusual or truly different about this price increase and your ability to pass it along than the prior 10 or something we’ve had in the last three or four years?

Daniel K. Frierson

Well, again we have no customer that’s over 3% of our sales so passing on price increases is not automatic but it’s certainly easier than it use to be when we had a concentration in a few accounts back four or five years ago. So, the price increase did go into effect in February and obviously there are home centers and builders that are under a lot of pressure but other than that I would say things have gone extremely well and not materially different than previously.

John Baugh – Stifel Nicolaus & Company, Inc.

Okay. Then, last question is as you look at your mix of residential business say in your Masland and Fabrica business, let’s just stick with those two, are you seeing any mix deterioration? Is that customer trading down at all?

Daniel K. Frierson

You know the customer may be but we may not be getting the trade down. Actually, our average selling price, as I mentioned, was up in 07 over 06. And, we have introduced product into the field, particularly our wool collections at Masland and Fabrica, Masland’s got into the field in August and has been a significant contributor already. The average selling prices there are in the $40 to $50 per square yard mill price. So, my answer to you is no but I’m not sure we’d be the ones to see that.

John Baugh – Stifel Nicolaus & Company, Inc.

But like I know in your builder business out in California you were sort of the upgrade for the $2 million track home or whatever. I would think at least in that segment you are seeing a loss of some business? True? Not, true?

Daniel K. Frierson

I’m not sure we’re seeing any more loss than others but, it’s significant. You know, those home builders are off 40, 50% and our business consequently with the builder community, particularly in the west is off significantly. That’s the one area where we’re off the most.

Operator

(Operator Instructions) We’ll go next to Arnold Brief with Goldsmith & Harris.

Arnold Brief – Goldsmith & Harris, Inc.

I apologize but I got distracted, when you mentioned $10.5 million loss and a $1 million loss in 07 were you referring to the tile business or something else?

Gary A. Harmon

We had $1.5 million of expenses for merging a pension plan.

Arnold Brief – Goldsmith & Harris, Inc.

No, no I know that.

Daniel K. Frierson

You’re asking about the tile?

Arnold Brief – Goldsmith & Harris, Inc.

Well, I got distracted and I just picked up on the tail end of you said something about a $1 million loss in 07 and a $10.5 million loss in 06.

Daniel K. Frierson

No. We said a $2.6 million loss in 06.

Gary A. Harmon

[Inaudible] in 07 for the first nine months.

Arnold Brief – Goldsmith & Harris, Inc.

Was $1 million?

Daniel K. Frierson

Yes.

Arnold Brief – Goldsmith & Harris, Inc.

And you’re referring to what, the tile business?

Gary A. Harmon

Yes.

Daniel K. Frierson

The tile business but it was profitable in the fourth quarter.

Arnold Brief – Goldsmith & Harris, Inc.

Okay. So you loss a little less than $1 million in 07 and you would expect it to be profitable in 08?

Daniel K. Frierson

Yes.

Gary A. Harmon

Yes.

Arnold Brief – Goldsmith & Harris, Inc.

And based on the fourth quarter sales rate, something in the area of $10 million in revenues would not be out of line?

Daniel K. Frierson

For 08?

Arnold Brief – Goldsmith & Harris, Inc.

Yeah. Ballpark.

Daniel K. Frierson

We certainly believe that’s doable.

Arnold Brief – Goldsmith & Harris, Inc.

Okay. It’s a little bit unusual, I know what oil prices are doing but to see price increases in a industry this weak is almost unheard of. Do you think these price increases can hold, on the raw material, fiber?

Daniel K. Frierson

Ernie, raw material is 60 some odd percent of your total cost and when raw material goes up its really mandatory it be passed along.

Arnold Brief – Goldsmith & Harris, Inc.

No, I know it can be passed along. I’m saying, do you think the cost increase to you can hold in light of weakness of demand from the carpet manufacturers? The fiber increase, do you think that can hold in light of the weakness?

Daniel K. Frierson

As long as oil stays where it is, yes.

Arnold Brief – Goldsmith & Harris, Inc.

Okay. I’m not a strong proponent of buying back stock. I think I’d rather see companies use the money to grow their business but, in your case you’re selling below book, earning money and increasing market share is one of the most unusual combinations I’ve seen for some time. Is there any way or plans to get even more aggressive with the buyback program?

Daniel K. Frierson

Ernie not at this time however, we’ve been buying really all that was available under the rules under which we have to buy in the marketplace. We have not had anyone approach us to sell us stock directly in a different way. So, we are doing what we can do today under the current rules.

Arnold Brief – Goldsmith & Harris, Inc.

How about your sample expense in 07 versus 06, are they going to go up or down?

Gary A. Harmon

You’re talking 08 versus 07?

Arnold Brief – Goldsmith & Harris, Inc.

Yeah, I’m sorry.

Gary A. Harmon

I think they’ll be similar.

Arnold Brief – Goldsmith & Harris, Inc.

Similar?

Gary A. Harmon

Yes.

Operator

Thank you and at this time we have no further questions. I’d like to turn the call back over to Mr. Frierson for any additional or closing comments.

Daniel K. Frierson

We appreciate all of you being with us for our fourth quarter and year end conference call. We look forward to our next conference call with you. Thank you.

Operator

That does conclude today’s conference. You may disconnect your lines at this time.

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Source: Dixie Group Q4 2007 Earnings Call Transcript
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