Dixie Group Inc (DXYN) 2008 Q4 法說會逐字稿

Good day, everyone, and welcome to The Dixie Group, Incorporated, fourth-quarter 2008 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, Mr. Dan Frierson. Please go ahead.

Thank you, Robbie, and welcome to all of you to our fourth-quarter conference call. With me today is Gary Harmon, our Chief Financial Officer, and Gene Lasater, our Corporate Controller. Our safe harbor statement is included by reference on the website and in the press release.

In the fourth quarter, the US economy experienced tremendous stress and uncertainty. The carpet industry is suffering from the same problems as the economy. The housing bubble and subsequent contraction, along with low consumer confidence, limited credit availability, and the stock market decline, have made for a very uncertain period and a decline in most markets.

Our focus during this period has been to reduce costs to fit the business activity level and improve cash flow. Our first action was to renegotiate and extend our revolver term loan in early fourth quarter. We then began a restructuring of our operations which was designed to lower our costs and improve asset utilization.

During the quarter, our sales declined 22% due to the weakness in our markets. Both our residential and commercial sales were impacted about the same.

Due to the significant decline in business, we are assessing our alternatives for the Fabrica business and are considering the possible sale or, more likely, consolidation into our East Coast facility.

Gary Harmon will review our financial statements, after which I will comment on current conditions and other actions being taken. Gary?

Thank you, Dan. Looking at sales, fourth-quarter sales were $61.9 million, as Dan said, down 22%. For the year, sales were $282.7 million, down 12%.

Looking at just our carpet sales, fourth quarter was down 22%, with residential products being down 21% and commercial products down 22%. For the year, carpet sales were down 11%, with residential products down 13% and commercial products down 7%.

Moving on to gross margins, fourth-quarter gross margins were 26.1% versus 31% a year ago. For the full year, margins were 27.6% versus 30.3% a year ago. The lower gross margins reflect the effect of lower production on fixed-cost absorption and higher raw material and energy costs.

Higher selling prices, lower raw material costs, and cost reductions due to the facilities consolidation and organizational changes should improve margins in 2009.

We incurred $2.3 million of costs in 2008 and expect another $700,000 to $800,000 of costs in the first quarter of 2009 to complete the East Coast tufting consolidation and the organizational and other changes we have made to reduce cost and expenses.

Total employment was reduced 17% last year. The annual savings from these initiatives should be approximately double the cost we incur. 65% of those savings will be reflected in cost of sales and 35% in selling and administrative expenses.

As Dan indicated, we are reviewing our alternatives for the Fabrica business and are considering the possibility of selling the business or, more likely, consolidating it into our East Coast facility beginning in the last half of this year. If implemented, such a consolidation would require a one-time cost in the $3 million to $5 million range, and we would expect less than a one-year payback in benefits from that consolidation. We would reduce employment another 13%.

Selling and administrative expenses as a percentage of sales were 31.3% versus 24% for the fourth quarter, and 26.9% versus 24.6% for fiscal 2008. The increases in these expenses is attributable to lower sales volumes and higher sample expense in the fourth quarter.

Operating income reflected a $33.4 million loss in the fourth quarter and a $28.4 million loss per year as a result, primarily of the lower sales volumes, and $29.9 million of goodwill and asset impairment, and consolidation and severance costs, of which $27.6 million was non-cash.

Interest expense was slightly up in the fourth quarter and down $382,000 for the fiscal year due to lower interest rates. Interest expense for 2009 is expected to be approximately $6 million.

Our effective income tax rate was 9.1% in the fourth quarter and 8.5% for the fiscal 2008. Both of these were benefits primarily due to nondeductible goodwill impairment. We expect the tax rate in 2009 to be 35% to 36%.

Diluted earnings per share excluding the unusual items in the fourth quarter was a $0.33 loss versus a $0.21 profit a year ago. The yearly comparison was $0.28 loss versus a $0.60 profit a year ago. Including the unusual items, the fourth-quarter loss was $2.59 and the yearly loss was $2.50.

Looking at our balance sheet, we ended 2008 with $93.8 million of debt or 46.6% of total capitalization, slightly down from $93.9 million at the end of the third quarter of 2008 and up from $88.6 million at the end of 2007.

We have reduced our total debt by approximately $3.8 million so far in 2009 and expect reductions for the full year 2009 in the $12 million to $16 million. The reduction should result in lower inventories, lower capital expenditures, and income tax refunds.

Selling our Fabrica business or consolidating it into our East Coast facility and selling our California real estate would significantly add to this debt reduction.

Trade accounts receivables were $22.8 million at the end of 2008. That is down $6.5 million from $29.3 million at the end of 2007. Total receivables on our balance sheet were relatively unchanged from the prior year due to increases in other receivables, primarily income taxes.

Our bad debt writeoff remained relatively small in 2008 at about $322,000 or 11 basis points as relationship to sales. But we have seen more customers experiencing financial issues in recent months and increased our bad debt reserve by $285,000 in 2008.

A major focus in all our business is to better utilize inventories this year. Depending on business activity levels, we expect to reduce inventories by up to $15 million in fiscal 2009.

Capital expenditures were $10 million in 2008, down from our 2008 initial plan of $12 million to $14 million. Depreciation and amortization was $13.8 million. We expect 2009 capital expenditures to be in the $7 million range, while depreciation and amortization is expected to be approximately $14 million.

Maintenance capital expense levels are in the $3 million to $4 million range for our business.

Thank you, Gary. We believe our sales volume will continue to decline during the first quarter, which will require us to continue cutting costs. We should begin to feel the impact of lower raw material costs during the quarter; but this will be offset by lower production volume.

We have cut our 2009 capital expenditure level to $7 million, which is half the level of depreciation. We will continue to reduce infrastructure costs, better utilize our working capital, and lower our controllable costs.

We have eliminated the match to our 401(k) for 2009 and have recently instituted salary reductions and reduced employment by 17%, as Gary mentioned, in the last year.

On the positive side, we had an excellent reception to our new residential products and surfaces. The new Masland Avenue collection is a new category of carpet produced on new technology. Our wool collections continue to grow in a very difficult environment, and the new polyester products are off to a good start.

On the commercial side, our modular carpet continues to gain momentum and outperformed the broadloom products.

We also were able to increase prices in 2008; and through these increases and better product mix, our average selling price today is $2.00 greater than a year ago.

The first quarter is usually our most difficult one and normally represents only 22% of our annual sales. We are also reducing inventory during the quarter, so our lack of absorption of fixed cost will adversely impact our results.

As the year progresses, we should see the positive impact of the cost reductions we have put in place, lower utility costs, lower material costs, and better product mix, and hopefully the positive results of our new product introductions.

Again, our plan is to continue cutting costs to fit the size of our business and to manage for improved cash flow. When better times return, we should be prepared to capitalize on improved business conditions.

At this time, we would like to open up the call for any questions that you may have.

(Operator Instructions) Sam Darkatsh, Raymond James.

Sam was unable to make the call, so this is Jeff calling in for Sam.

My first question is, could you talk a little bit about the trend in sales through the fourth quarter, and maybe give us an early look at what the year-over-year declines are looking like so far in Q1?

I think looking at our business and looking at the industry, what we have seen was as the financial crisis began to take form, things began dropping off in September. Were off some in October, but to a much greater degree in November and December.

I think we are seeing that continue into the first quarter. We have seen order entry better in February than it was in January. Candidly, we don't know whether that is a trend or an aberration at this point.

Okay. My second question, the comment you made in the release about returning to profitable operations in 2009, should we read that as on a quarterly basis by the end of '09? Or are you saying that hopefully, given momentum late in the year, you can report a full-year profit?

We are talking about the future, and the future today has probably never been more uncertain. I think we were referring to the fact that we would return to profitability on a quarterly basis.

Obviously, we don't know how business will be the rest of the year. Our plan is to cut cost to fit the current business activity level and to return to profitability on that basis. We did not make a prediction for the year.

Okay. The next question, you mentioned raw materials dropping and getting the benefit there in Q1. Obviously, I realize there are a lot of moving parts. But even with sequentially lower volume in Q4, your gross margin grew as a percentage of sales.

Would it be unreasonable to think that from here gross margin creeps up, even in Q1, given the tailwinds?

Jeff, I am not quite sure what your question is. Could you repeat it, please?

Sure. My question is, even with the drop in volume that you saw in Q4, and obviously a lot of headwinds on the top line, your gross profit was actually up as a percentage of sales.

You are saying relative third quarter?

Correct.

Okay, I didn't understand that.

So I guess what I was wondering is I was surprised there, and was wondering if that is a trend that could continue, and whether or not that is being driven by lower raw material costs.

Certainly, lower raw material costs had an impact there. As you will recall, we had higher raw material prices -- or a price increase in raw materials -- really in June and July of last year.

I would think in the first quarter, with volumes down, that being our slowest quarter, and with the inventory reduction plans that we have in place, that margins probably will suffer. I do think when volumes increase, we obviously ought to be able to achieve gross margins at our historic levels.

Okay. Just have a couple more questions and then I will defer to others. The tax benefit that you mentioned, the $5 million-plus, will that run through the P&L?

No.

Okay, so that is just cash. So the 35% to 36% guidance is the tax that will show up on the P&L?

Yes.

Okay. What is the timing of the $5 million tax benefit?

Early second quarter.

Okay. Okay, those are all my questions. Thank you.

John Baugh, Stifel Nicolaus.

Good morning. I know you don't have covenants, but could you just maybe elaborate on what is the largest or the closest financial constraint in terms of, I guess, liquidity? Put another way, how much money can you lose before you run into that, an issue?

It is really a asset-backed facility, so there is a borrowing base with inventories and receivables. At the end of December we had $11.4 million availability. So, you know, that is the real issue. There are some things you could do, but that is where it is at.

John, that really speaks to obviously managing our business for cash flow.

So, you have an $11 million roughly available; and then the plan is to reduce debt another $12 million to $16 million. Does the plan to bring down inventories -- and presumably receivables will fall, too -- with the asset-backed facility tighten further the availability? How does that all flush out?

Well, as inventories go down, the borrowing base goes down; but not as much as the cash that you receive from reducing your inventories.

I'm sorry, repeat that.

As your inventories go down, your borrowing base does go down, but not as much as the cash you would receive from liquidating those inventories.

Okay.

So you gain, but not to the full extent of the inventory reduction.

Okay, okay. Then, I mean, any sense of -- or any guidance on, obviously, you're not certain which direction you are taking with Fabrica. But describe the facility in California. What are commercial real estate people telling you that could be worse in this kind of environment?

John, rather than go directly to that, we had appraisals done last year, which I think are probably worth about as much as the paper they were printed on in today's environment. But let's go back a minute to discuss Fabrica.

When we bought Fabrica in 2000, we shared a dye house and finishing plant with two other partners. One of those partners subsequently or very soon thereafter was purchased and got out of that partnership.

That left one other partner. That partner in 2004 elected to leave that facility, and we ended up with the entire facility. And candidly, have tried to increase volume through the facility in order to absorb the fixed cost there and better utilize it.

It is pretty apparent if we were having trouble doing that in '06 and '07 and '08, that with the decline in volumes that situation has gotten more difficult.

We do think the Fabrica business has a lot of value. It has a lot of value to us, if we move it back East. So we have stated here that we think that cost of moving it back would be in the $3 million to $5 million range and there would be less than a year's payout on doing that.

So we see a lot of different opportunities with Fabrica. Staying the way it is, is not the ideal position for it. As you will recall, it is in two facilities. We also are considering moving into the one facility. So there are several options on the table; and in the interest of full disclosure, felt like we needed to say what we were doing; but no final decision has been made yet.

Okay, but I guess it is fair to assume that one of two events will occur. You will either sell it, the division, or consolidate it back East. In either event, the larger facility I assume will be sold in either event. But you don't want to venture a guess on the magnitude of that?

No, I don't think to would be appropriate at this time to do that.

Okay. Assuming Fabrica is consolidated and/or sold and the tufting -- I dream about a day when volumes are actually up. What kind of capacity will you have left in the upturn, as you see it, with these steps?

John, I share your dreams and are anxious for them to be realized. We still have ample capacity. We have made great strides in improving our productivity in our existing facilities.

Also, in the carpet industry, as you know, capacity is rarely the constraint. We can add capacity pretty quickly and easily if we need it. But there is ample capacity within our four walls today.

So you would not want to put a number on it? I mean, before having to add back, what you could do with the proposed consolidations?

I would rather not. It is so different. I mean, as you know, it depends on whether you are talking yarn manufacturing, tufting manufacturing, [pit] capacity, finishing. We have ample capacity throughout the whole chain, and we could dramatically increase our business before that is a constraint.

Okay, all right. The trajectory of the commercial business as we have entered the first quarter, is that --? You mentioned you have seen better orders in February than January. I am curious. Is that on the residential side? Are you actually seeing that on the commercial side as well?

John, I think that is probably on both sides. But if I had to -- I think underlying your question is sort of -- what is the trajectory of the residential business and the commercial business? I believe for the next year or so the trajectory of the residential business is going to be better than the commercial business, particularly the corporate commercial.

Now fortunately we do participate pretty extensively in the hospitality business and the store planning business, as well as the healthcare and some other markets. So we may not be impacted as much as some others. But clearly the commercial business has slowed dramatically, and I think it will take it longer -- or traditionally it has taken it longer to come back.

All right. Thank you for the answers.

(Operator Instructions) Arnold Brief, Goldsmith & Harris.

Could you give us some idea of what your breakeven looks like after you are done with the various consolidations? And you could exclude Fabrica or include it, your plans one way or the other, just as long as you specify what you are doing.

It looks to me like with some improvement in gross margins due to lower raw material costs for the year, and some cuts in SG&A, that you can make money down around $250 million. Am I far off?

Arnie, it is really a moving target. As business declines we have taken out more costs to fix to the size of the business. So I think that is really a moving target.

But I would think at that level we wouldn't have any problems, if we were steady at that level, being profitable.

You answered the one question on the credit line. $11 million availability; it declines with inventories and receivables, but not as much as the inventory reduction.

But with the inventory reductions you have planned, it seems to me you're not going to have an awful lot left on that credit line. Am I mistaken?

I think -- well to start with, it's $11.4 million, and we have $5.1 million cash. That just increases the availability [that cash]. So that increases.

Then if we can reduce debt to the extent we expect to, I think we will be in fairly good shape on availability.

Is the -- understanding that Fabrica has excess capacity, but from trying to interpret what you said I have sort of come to the conclusion that you would rather consolidate it in the East Coast if that is possible. But to do that you have to get out of the California real estate, otherwise it is not feasible to move the plant and still have those costs out in California.

So selling the whole facility with the business is your last alternative and your fallback plan kind of thing. Is that sort of an accurate interpretation? In other words, this is almost a financial decision, not a strategic one.

Well, obviously, it becomes a financial decision, Arnie, but let me be clear. The larger facility, the big facility on the West Coast we own and candidly could carry it for some period of time at very little carrying cost on that facility. So it isn't dependent on the sale of that building to bring back the business into the East Coast.

But obviously if someone were interested enough in the business overall, we would certainly consider that. But we think it is much more likely that we will end up moving that capacity, that production, back to the East. It's a good margin business and an excellent brand and we feel like we could continue to build on it.

So we are looking at both options, and with a very open mind as to what would make the most sense for us as a Company.

I guess I am a little confused on it, because I am sure I am coming to some wrong conclusions. But correct me where I'm wrong.

Fabrica is obviously West Coast based in terms of production. It is also, as I remember, higher, very high-priced residential carpet, which for the most part served the California market where you had a lot of high-priced real estate.

Moving it into the East Coast, it's obvious you save a lot of production cost. But wouldn't you end up shipping an awful lot of the product back to California?

Arnie, their business is split pretty evenly between the East and the West.

Okay. All right. Could you give us a little more guidance on your gross margin? Do you think you can get back to historical levels on lower volume once the low-cost inventory starts to roll through, assuming the price increases hold?

Arnie, I think we have already stated several things there. But let's remember, first quarter we're cutting inventories; it is traditionally the smallest --

No, I'm thinking on an annual basis, not the first quarter.

Well, obviously, if we are cutting costs and have lower raw material and utility cost, then we ought to be able to improve our margins at lower activity levels.

Even with the lower activity?

Yes.

Okay. And you are planning -- if you look at fourth-quarter sales, considering how bad November-December was, and again not looking at the first quarter isolated but the year as a whole, is it conceivable to you that your run rate in the fourth quarter could get any worse on an annual basis?

Arnie, this whole contraction and economic situation this country is in today is difficult to predict. We do not make projections.

Okay. I guess what I am trying to get somebody to talk about is that it seems to me the economy can't turn up without housing; and it seems to me that almost every program the government is focused on is aimed at the intent of improving housing. With housing prices down 15%, 20% and mortgage rates going to 4.5% to 4.75% or wherever they're going to bottom out, it just seems to me that people are awfully bearish on an industry which has an awful lot of financial help aimed at it.

Arnie, I would agree with you; and at some point we will look back on this as a very, very difficult period we all went through. But I don't know when that improvement is going to come.

I think we have been pretty clear that what we are doing is cutting costs, managing for cash so that we will make it through this difficult period, and then be able to take advantage of the improved conditions when it comes about. And I think then we can be back at historical margins.

One last question and then I will get off. Can you give us some feel for what is happening at the competitive level? I know that, obviously, Mohawk and Shaw are going to survive all this, and they have a very large share of market. But there are still smaller competitors out there that must be a lot worse shape than you.

Do you see some major dropouts in the industry, any consolidation?

This industry has consolidated so much already that I don't think you will see major consolidation. There are some smaller players that have had some difficulty, but we have not seen any major dropout at this time.

Thank you.

Thank you and with that we have no further questions. I would like to turn the program back over to Mr. Frierson for any additional or closing comments.

Thank you very much, and thank all of you for being with us this morning for our fourth-quarter conference call. Obviously, we are going through a very difficult period economically in this country and certainly in our industry.

Our intent as I have mentioned already is to continue to cut our cost to fit the size of our business and manage for cash flow until we understand better or see better times. Again, thank you and see you next quarter.

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