Dixie Group Inc (DXYN) 2010 Q3 法說會逐字稿

Good day and welcome to the Dixie Group Third Quarter 2010 Conference Call. Today's call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to the Chairman and Chief Executive Officer, Mr. Dan Frierson. Please go ahead, sir.

Thank you, Lauren, and welcome everyone to our third quarter conference call. I have with me today Jon Faulkner, our Chief Financial Officer. Our Safe Harbor Statement is included by reference to our website and our press release. During the third quarter the industry experienced a slight increase in sales, 2%, and a slight decrease in units, 1.6%. The surprise was that commercial sales were up nearly 8% and residential sales were down approximately 2%.

Carpet sales for Dixie in the third quarter were up 11.9% with commercial sales up 2.9% and residential sales up 16.3%.

After experiencing business improvement in the January through May timeframe, we began gearing up for higher volumes. The June through August period was slower than anticipated and led to higher costs and consequently lower margins. Margins were also impacted by our sales mix which shifted to more value-oriented products in the third quarter.

Jon Faulkner will now review our third quarter financial results after which I will comment on market conditions and our outlook for the future. Jon?

Thank you, Dan. Our third quarter sales were $56.7 million, up 12.3% versus last year, but down from $59.1 million in the second quarter. Historically the third quarter is our second lowest sales quarter.

For the quarter, the total carpet sales for Dixie were up 11.9% versus the industry being up 2%. Our commercial products were up 2.9% versus the industry being up 7.8%. Residential products were up 16.3% while the industry was actually down 1.9%. Both residential and commercial sales were seasonally lower, down 4% in the second quarter, though improved over last year. The softening we first noticed in June continued throughout the early part of the quarter, with sales slowing among the higher price points faster in our more value-priced goods.

We saw barbell recovery in the third quarter with our Masland and Fabrica wool lines and our "woven look" Masland Avenue products continuing to show growth at the upper end of the market. Our more value-priced Dixie Home Stainmaster and DuraSilk polyester products continued strong growth at lower price points. Early in the fourth quarter we are seeing improved growth in our upper and nylon product lines.

The third quarter gross margin was 22.2%, down from 25.8% in the second quarter and down from 26.9% in the same quarter of the prior year. Gross margin was negatively affected in the quarter as a result of significantly higher manufacturing costs incurred during the quarter, due primarily to inefficiencies created and excess costs incurred to appropriately staff our operations to support higher volumes in a more diverse product mix.

We hired additional production staff, having seen strong order activity in the January through May timeframes, anticipating a stronger recovery throughout the summer. However, our order activity dropped significantly in the June through August timeframe, thus causing excess cost during this time period. We have been able to utilize this higher production output as the fall season has had higher levels of demand starting in September.

Carpet production was down 2.5% versus the second quarter and up 30% versus prior year due to higher sales. Inventory turns improved by 20% versus a year ago, but down 3% versus second quarter due to lower sales. Inventory [saw an] increase to $59.4 million, up $200,000 versus the prior quarter. Expenses associated with the consolidation of our west coast operations were $304,000 during the quarter. We are still attempting to rent our Pullman facility.

Looking at our selling and administrative expenses, the third quarter comparison of SG&A was a decrease of $730,000 or 24.9% versus 29.4% a year ago. Versus the prior period, the comparison was 24.9% versus 25.4% in the second quarter.

The operating loss in the quarter, $1.9 million, compared to a loss of $1.7 million in 2009. Excluding the effect of facility consolidation, the loss is $1.6 million in the current quarter versus $1.1 million in the prior year quarter.

Our interest expense decreased $443,000 in the third quarter versus the prior year due to lower interest rates and debt levels. The effective income tax benefit rate was 34.1% in the quarter. Our rate for the year-to-date is 34.7%.

The effective income tax rate differed from the expected 36% rate principally due to permanent tax differences.

Diluted earnings per share from continuing operations was a $0.15 loss in the third quarter versus a $0.16 loss for the same quarter last year.

We ended the quarter with total debt of $67.5 million, up $5.5 million for the quarter and down $9.7 million from the same time a year ago.

Capital expenditures were $1.1 million for the quarter, and depreciation and amortization was $2.9 million. We expect capital expenditures for 2010 to be approximately $2.5 million while depreciation and amortization is expected to be approximately $11.6 million.

We ended the quarter with availability under our loan agreements of $7.2 million, although currently our availability is $9.2 million.

Thank you, Jon. We are cautiously optimistic about the fourth quarter and next year. in the third quarter we were pleased to see our selling and administrative costs decline in dollars and as a percentage of sales. We continue reducing selling and administrative costs which will have a positive impact going forward.

We are also better utilizing our investment in inventory with improved inventory turns. Our capital expenditures will continue to be significantly below our level of depreciation until market conditions are materially different.

Despite the third quarter issues, we continue to be committed to operational improvement and ongoing cost control. We believe the broader market for luxury goods is improving and feel our performance relative to the industry is indicative of this trend. Industry carpet sales year-to-date are up 0.3%. And our carpet sales are up 10.5%. The relative performance in units is even more impressive. Industry units are up 0.2% for the year and our volume unit is up in excess of 25%.

As we enter the fourth quarter, order entry which began to improve in September and sales are continuing to demonstrate strength. We are experiencing solid growth in the commercial market led by modular products. The strength of the commercial business is focused on the replacement or refurbishment in the market with improvement in the government, hospitality and corporate sectors. Our commercial carpet sales for the first five weeks of the fourth quarter are up 25% over a year ago, led by strong modular activity.

On the residential side, each of our brands, Fabrica, Masland and Dixie Home is experiencing stronger sales for the fall season. And sales are also up in the fourth quarter approximately 25%. Therefore our total carpet sales through the first five weeks of the quarter have increased approximately 25% compared to a year ago.

In the fourth quarter, unlike the third quarter, the sales mix for commercial products has returned to a more normal historical mix of product offerings. The residential product mix has also improved for the fourth quarter.

We are seeing growth in the very high end Fabrica and Masland wool products and the Masland Avenue "woven look" products. Stainmaster nylon products are currently experiencing increased demand as are our DuraSilk Dixie Home products.

In the last two years we have introduced a record number of products and as conditions improve I believe we will continue to outpace the industry. The strong start of the fourth quarter is certainly encouraging, however there is no assurance that this rate of growth will be sustainable. Actually, anecdotal evidence indicates the commercial market continues to improve but the residential business is still challenged. Our overriding commitment is to return to profitability while focusing on the segments of the market which will enable us to grow our business.

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

Thank you, sir. (Operator Instructions). We will take our first question from Keith Hughes with Sun Trust. Please go ahead.

Thank you. Your comments on October were a little surprising, particularly given that 25% number you said in residential. So my question is, number one, if we look at the shipments so far quarter to date, is heavily toward growth in Masland and Fabrica versus Dixie Home, and based on your conversation with retailers, what do you think is going on in the last four or five weeks in the channel?

Keith, we have seen it pretty much across the board. We have certainly seen it in Fabrica, we have seen it in Masland, probably more so though at Dixie Home than either Masland or Fabrica. But to your question as to what we are hearing from retailers, I think we are hearing that traffic is not improving, that it is relatively flat, and that the industry is probably experiencing flat to slightly up relative to a year ago.

So this is like some share gain for you in the month?

Typically our fourth quarter is our best quarter, if we go back historically. So we would expect to do a little better than the industry in the fourth quarter. I do think though we are also experiencing improvement in luxury goods and the higher end part of the market and that is fueling part of this as well.

One specific question on Dixie -- given the mix that you have right now, are there any other sub-parts of the flooring market that we would expect you to get into any time soon?

No, Keith. No plans at this time.

Okay. Thank you.

And our next question comes from Sam Darkatsh with Raymond James. Please go ahead.

Good morning Dan. Good morning Jon. How are you?

Fine, Sam.

A few questions here. First off, also related to the October, the encouraging October trends. Does November and December get much more difficult on a comparison basis versus October, perhaps?

November is a little more difficult. December would not be, looking at last year's numbers for those two months. I would say our order entry in October remain good and we go into November with relatively speaking the same backorder position we had in October.

Second question -- Jon, can you quantify approximately the effect of the inefficiencies that were seen in Q3 upon gross margins and are they entirely gone or will there be some carryover into Q4 gross margins?

Sam, the degradation in margins was, the largest percentage of it were operational inefficiencies. We have done a number of things we have changed in terms of operating patterns. So we should eliminate a large percentage of those. A little bit of that was due to mix change, a little less favorable mix. But I would say three-quarters of the inefficiency or the variances were really due to the operational inefficiency and I suspect that most of them are gone in the fourth quarter.

We had a very good second quarter; I don't know that we would achieve quite the throughput rates we had in the second quarter but I would expect we would be close to that?

Now when you are talking about the variances, are you talking sequential variances or year-on-year variances?

Sequential.

Okay. And what do you peg your maintenance CapEx at? Can you sustain a $2 million to $3 million CapEx budget indefinitely?

Yes. At least for the next four to five years.

Is that the plan, all else equal?

Yes. There is no new technology on the market that would significantly change our plans at this point in time.

And last question. Dan, how would you categorize the promotional environment at this point? Particularly in the residential side which is still showing pretty lackluster demand trends broadly.

Sam, as I indicated, the residential side we think is still a challenge. I have met with a number of retailers and buying groups in the last week or two and we are not getting any encouragement that business is improving significantly.

From a promotional standpoint though?

Oh, excuse me. If that is your --

The thrust of my question is how rational pricing is in the industry and whether you are seeing people begin to get a little more aggressive?

Well, on the residential side, remember, our average selling price is still about three times the industry average. So we are not one that would be the best barometer of what is happening in the promotional end. But, anecdotally I would say that there probably is activity going on in the promotional end at this point. But we are not really geared to that part of the business.

Thank you very much.

Okay.

(Operator Instructions). Our next question comes from Arnold Brief with Goldsmith & Harris.

Two questions, I guess. One, I guess, to basically redo Sam's question. Your breakeven obviously went up a lot in the third quarter. Are you saying that it should get back to the second quarter levels as we go into the fourth quarter in 2011? And I have one other question.

Yes, that would be our anticipation.

And the second question is, off the top of my head I just don't remember what your mix is in terms of cut orders and roll orders. I assume it is mostly cut. Retailers don't really carry inventory. So, an increase in orders would really be reflecting demand at their level, wouldn't it? Unless you do a lot more business in roll orders than I remember.

Arnie, your memory is good. We do very little roll order business. I would say 90-some odd percent, probably higher than 95% is cut order. And we don't get an order until a consumer has purchased the carpet. That is on the residential side.

There is no guarantee that demand will continue, but your orders basically reflect pretty closely what is going on at retail as opposed to any retail inventory fluctuations?

There is virtually no inventory or very little inventory at retail -- our goods.

I knew that but I just wanted to confirm it. Thank you.

Thanks Arnie. Good to hear your voice.

At this time I would like to turn the conference back over to Mr. Frierson for any additional or closing remarks, sir.

Thank you very much for being with us today. As we indicated, the third quarter was a challenge for us. We feel like the issues that arose then have largely been resolved. We do feel like business activity level for the upper end of the market has improved. Again, we don't know what that portends for the future, but certainly it has been an improvement in the October/early November timeframe.

Thank you for joining us. Good bye.

This concludes today's conference. Thank you for your participation.