Dixie Group Inc (DXYN) 2008 Q2 法說會逐字稿

Good day and welcome to The Dixie Group second-quarter 2008 conference call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to the Chairman and Chief Executive Officer, Mr. Dan Frierson.

Thank you, Dustin. Welcome, everyone, to our second-quarter conference call. I have with me today Gary Harmon, our Chief Financial Officer and Gene Lasater, our Corporate Controller.

Our Safe Harbor statement is incorporated by reference, being both in the press release and posted on the website.

The first quarter brought little change from the previous quarter's declining home sales, difficult credit conditions, declining consumer confidence, along with rapidly rising raw material and energy costs, which continue to create a cloud over the industry and our business.

Our carpet sales declined by 6.9%, which was better than the industry. Our residential carpet sales were about 5% better than the industry; however, our commercial carpet sales underperformed the industry for the first time in many quarters. This was largely attributable to large sales to one customer in the year-ago quarter. Cost increases during the quarter had a negative impact on results because of the lag in implementing price increases to our customers.

Gary Harmon will now review in detail our financial results, after which I will speak to the residential and commercial carpet markets and current business conditions. Gary?

Thank you, Dan. Looking at sales, second-quarter sales were $77.2 million, down 8.6%. For the six months, sales were $147.9 million, down 6.9%.

Looking at our carpet sales, total carpet sales were down 6.9%, about 1.1 percentage points less than the industry was down. Commercial products were down 4.7%, which was lower than the 1.3% growth the industry experienced and residential products were down 8.2% versus a 13.5% decline for the industry. For the six months, total carpet sales were down 5.2%; commercial products were up 2.2%; and residential products were down 9.3%. All of these were better than the experience we saw in the industry.

Looking at gross margins, the second-quarter gross margins were 29.2% versus 31.1% a year ago. The six-month comparison was 29.2% versus 30.3%. The lower gross margin percentage in 2008 was principally due to higher raw material and energy-related costs and lower fixed cost leverage. During the first half of this year, raw material and energy costs increased over 8% and significantly increased again in July this year. We increased our selling prices late in the first quarter and again in June and July to recoup this higher cost. The increased cost will pressure margins until the new selling prices are fully implemented, which we believe will be in the fourth quarter of this year.

We also implemented cost-reduction initiatives in the second quarter, which reduced our total headcount by approximately 9% and improved our labor productivity.

The selling and administrative expense comparison showed the second quarter at 24.7% of sales versus 24.3% a year ago. For the six months, the comparison was 25.7% versus 25.4%. In actual dollars, selling and administrative expenses were reduced $1.5 million in the second quarter and $2.3 million for the first six months compared with the same period in the prior year. The lower selling and administrative expenses reflect the effect of lower sales volume, our cost-reduction initiatives and tight control of discretionary spending.

Operating income was 4.4% in the second quarter. That is up from 2.2% in the first quarter of this year, but down from 6.7% in the second quarter a year ago. The six-month comparison was 3.4% versus 4.3%. [Marginal] carpet sales more than doubled versus the second quarter a year ago and continue to be additive to our products.

Interest expense decreased $215,000 in the second quarter and $296,000 for the six months due to lower interest rates. We now expect interest expense for the full year to be approximately $6 million.

Looking at income taxes, our effective income tax rate was 36.9% in the second quarter and 37.5% for the first six months of 2008. The effective income tax rate was slightly higher than expected due to the effect of nondeductible expenses on a lower level of taxable income. The effective income tax rate is expected to be between 36.5% and 37% during the last half of this year. Diluted earnings per share from continuing operations, the comparison was $0.10 versus $0.20 for the second quarter and $0.11 versus $0.21 for the six months.

Looking at our balance sheet, we ended the second quarter with total debt of $93.5 million or 39.7% of total capitalization. That is seasonally up $4.9 million from the end of 2007, but down $2.5 million from the end of the second quarter a year ago. We expect that to decline in the last half of the year to the $85 million to $88 million range.

Capital expenditures were $4.9 million during the first six months of 2008 and depreciation and amortization was $7 million. We expect capital expenditures for the 2008 year to be approximately $12 million to $13 million while depreciation and amortization is expected to be a little under $14 million. Expenditures this year are primarily for new testing equipment and manufacturing technology and information systems.

We purchased 112,672 shares of our common stock at an average price of $7.39 per share in the second quarter. In July, we purchased an additional 191,508 shares at an average price of $5.55. Approximately 5.4 million remains available for common stock purchases under our $10 million repurchase authorization. While we have the ability to continue stock repurchases under our credit agreements, we have elected to pause such repurchases due to the economic conditions and other (inaudible). Our intent is to maintain a relatively conservative capital structure during this period of uncertainty.

Thank you, Gary. It is obvious the residential market continues to be impacted adversely by the current environment. The bright spot for us has been the acceptance and sales of our new wool products from Masland and Fabrica. The relative price of oil has improved with petrochemical prices escalating rapidly and the environmental story is connecting with consumers. By concentrating in this area, we believe we will become a major factor in the wool category. Our dedicated salesforce and product development capabilities have already put us in a strong position in this important segment of the market.

The commercial market continues to be stronger than the residential market. The growth has been fueled primarily by the growth of modular carpet or carpet tile. Our growth in carpet tile continues to meet expectations and it has become a source of profitability, as well as growth. We continue to expect growth in our commercial carpet business this year and trust we will outperform the market.

The second quarter was a time of reflection and action. We lowered costs significantly by reducing headcount by 9% and improving operating performance. We will continue these efforts until we see top-line growth. We increased our prices in June to offset the higher costs, which we were experiencing and unfortunately, it was necessary to take this action again in July to offset additional cost increases. The increase of $3.1 million in our LIFO reserve in the second quarter is indicative of the magnitude of our cost increases. We have lowered our capital expenditures. We continue investing in equipment that will differentiate us in the marketplace. This is essential to our being able to help our customers become more profitable.

We recently were recognized by Floor Covering News as the best company with which to do business in our smaller company category. This award is voted on by thousands of customers and recognizes the company that is best at delivering on their promises of design, service and value. Our customers, suppliers and associates continue to be very supportive and helpful in a difficult environment.

Despite the issues surrounding us, we are optimistic about our ability to continue gaining marketshare and improve our position for the future. Last year, the second quarter was the strongest for us, so comparisons with year-ago levels should improve. We are also encouraged by the recent decline in oil and commodity prices. Hopefully, this will break the spiral of continuous cost increases.

At this time, we would like to open up the meeting -- the call for questions.

(OPERATOR INSTRUCTIONS). Sam Darkatsh, Raymond James.

Good morning, how are you, folks?

Fine, Sam.

A couple of questions here. First off, Dan, pricing versus units in the quarter, it appears as though you guys gained share again in terms of dollars. Did you gain share in units or were you raising your prices more so than the industry raised their prices?

Sam, we don't separate that on a quarterly basis, but let me give you just a couple of indicators. Our selling price per square yard in the second quarter was right at $22. That is up about 9% from the previous year.

When we look at sales and units, there are a couple of things you need to take into account. One, our efforts in modular are higher priced than broadloom. Our efforts in wool are higher priced than our nylon broadloom and we decreased, as you know, in the home center. Therefore, our units and dollars do not track consistently. But going back to '05 and looking at our units in dollars -- well, particularly looking at units -- our units are just barely off maybe 1% and the industry is closer to 9% or 10%. And I think you have to look at it more than just on a quarterly basis because of large commercial transactions as well.

That's very helpful. Thank you. The next couple of questions I have for you have to do with the balance sheet. It is just real -- I know that the stock isn't always all that liquid and so you're going to get some inefficiencies on that, but it's just real curious to me how the stock continues to trade at levels below tangible book, and, at least from my vantage point, it looks like the tangible book is fairly stated if not understated. You were talking about your LIFO reserve being up -- was it $3 million or so?

Yes.

What is the overall LIFO reserve now, if you can give me a sense, if you could?

Let me look at that real quick. I don't have the overall right in front of me. But it is a little under $14 million.

$14 million. So you have got $1.00 a share in LIFO reserves here. Your inventory is understated by that. What else -- I mean there is no debt covenants to speak of. Is that correct, Gary?

(inaudible).

Is there something in the -- your PP&E is -- I am guessing most of that is Masland, which you would have bought, what, 15 some odd years ago. I am just trying to get a sense of is there anything in the tangible book that would give an investor pause as to how legitimate it might be.

I think our PP&E is fairly stated. We depreciate buildings over 10 to 40 years and equipment and other on three to ten years. Most of it will be equipment on 10 years. It is probably 35% to 40% real estate and the rest is (inaudible) and equipment. We have added a lot of equipment over the last few years and upgraded at Masland. So I wouldn't overstate that we bought it in '93 and most of the original assets, (inaudible) equipment, are fully depreciated. There have been some upgrades, but it is not (inaudible) other than what I would consider fairly.

Any issues with your receivables? Are you noticing uncollectibility issues arising or what are you seeing there?

We are very comfortable -- we have had historically a very low bad debt level of actual bad debt. Actually, so far, this year, our bad debts are slightly below what we saw last year. I think we're very comfortable with the receivables that are very diversified.

Sam, there also, our days outstanding are about the same as a year ago. Remember, we do business in the upper end of the market and those customers tend to be better capitalized and longer-term players. So I think there have been some issues in the credit area with what I would call a C or D player, but that is not where we tend to do business.

Okay, yes. I guess a cursory look at the balance sheet, it looks pretty -- looks pretty okay and that is not even giving you any credit for the goodwill on the balance sheet, which would be for brands and customer lists and all that kind of thing. So that is okay. Thank you both. I appreciate it.

Thank you, Sam.

(OPERATOR INSTRUCTIONS). Arnold Brief, Goldsmith & Harris.

Yes, could you give us the price increases [into] have been announced fairly close to the time of the cost increases. It may have taken a little longer to implement, but the announcement seems to be fairly close to when you have been hit with a higher cost. The question is how do you think that is going to work in reverse? Oil is down quite a bit. When would the raw material price declines, if any -- how closely do you think they would follow oil? And do you see or hear of any talk about some relief as you get into August and September from higher raw material costs?

Arnie, I queried one of our suppliers earlier this morning on that very subject. So far, and you have to remember that it has to work its way through intermediate chemicals and so forth. We have seen no decreases and I think it would take a while before those would work their way through the system. But at this point, we have not seen that and candidly, we don't have any experience in lowering prices in the marketplace. So we are not sure how all this will play out, but obviously we would much prefer to be in an environment that is not continually raising costs and prices where we, being on LIFO, are hit with the cost immediately, but have a lag in implementing the price increase.

Have you seen any inability of some smaller competitors to manage their business in this environment?

There have been one or two that have had some issues, but not significant.

Not widespread? Thank you.

Thank you.

Robert Moses, RGM Capital.

Good morning. Dan, you had mentioned quarterly comparisons and just wanted to try to understand that a bit. So if you were down in total revenue kind of 5% in the first quarter, and call it 8.5% in the second, while you don't have a crystal ball, did you indicate that second quarter was just unusually strong and tough comparison and maybe we would see a little bit less of that in the third and fourth at least at this point?

That would be what we would anticipate, Rob. Obviously, you never know, but the second quarter of last year was our best quarter by far and therefore, the comparisons ought to get somewhat easier. We did also have one very large commercial customer who did not repeat at that kind of level this year. So our anticipation is that the comps should become easier, not more difficult.

And Dan, just from a historical perspective since you've gone through a few of these cycles, I guess what was it, about the third quarter of '05 just in terms of kind of when things were very strong for the industry as a whole. I mean you held up a bit better than that obviously for Dixie, but for the industry, we are now kind of three years into it, is that about right?

That is correct. The high point in terms of quarters was the third quarter of '05.

Okay, so tough to get a sense here, but your gut is that we are kind of bouncing along the bottom here a bit?

I think that is a good way to say it. It is very difficult to predict when things will improve, but everybody we are talking to seems to indicate that they think we are bouncing along the bottom and we anticipate that, at some point, that that will begin to improve. I might also mention that the numbers just came out for Floor Covering Weekly on '07 and it's very interesting that carpet gained marketshare last year in floor covering products.

Interesting.

And that is contrary to what has been going on for several years before that.

Okay. Maybe either, Dan or Gary, you could just talk about gross margin, kind of running at 29% and you said there are two culprits. One is kind of higher energy costs, as well as when you have revenue down, you are not running your plan as hard. Could you kind of just give us a sense -- I guess you did a bit on the 8% increase, but kind of if we had stabled costs and didn't have the LIFO hit, would we be talking a point, two points, three points higher of gross margin?

Hard to quantify exactly, but obviously, we do have a lag on getting selling prices up versus the higher costs. Costs did go up again in July, so we think it will till the end of the year or at least the fourth quarter before all of the selling price catches up and that could be a percent or two.

Okay. But you would expect to take kind of another LIFO reserve hit in the third quarter at this point?

Yes.

Okay. That is all I have. Thanks very much.

Stanley Elliott, Stifel Nicolaus.

Good morning, thank you for taking my call. A quick question. You said that tile was profitable. Could you guys quantify that? I know it is a small piece of the business.

We haven't been given those numbers.

Okay, Fair enough. Any sort of production issues, anything like that on the tile that we should be aware of?

No, we have had no issues from a manufacturing or quality standpoint there.

Good deal. Thank you very much.

Gentlemen, there appear to be no further questions at this time.

Well, again, thank you for joining us for our conference call. We are all waiting to finish this bumping along the bottom and have the market improve and in the meantime, we will continue cutting costs and working operationally to improve our results and position us in the marketplace for growth when the market comes back. Thank you very much.

That does conclude today's conference call. Thank you for your participation and you may disconnect at this time.