Dixie Group, Inc. (NASDAQ:DXYN ) Q3 2021 Earnings Conference Call November 12, 2021 11:00 AM ET

Daniel Frierson - Chairman & CEO

Allen Danzey - VP & CFO

Derek Maupin - Hodges Capital Management

Michael Hughes - SGF Capital

Good day, and welcome to the Dixie Group Inc. 2021 Third Quarter Earnings Conference Call. Today's call is being recorded. [Operator Instructions]. At this time, for opening remarks and introductions, I would like to turn the call over to the Chairman and Chief Executive Officer, Dan Frierson. Please go ahead, sir.

Thank you, John, and welcome, everyone, to our third quarter conference call. Our Safe Harbor statement is included by reference both to our website and press release.

For the third quarter of 2021, the company's continuing operations had net sales of approximately $89 million and income of $5.6 million. Our net sales for the third quarter of 2020 were approximately $70 million with net income of $175,000.

With the sale of our commercial business, the third quarter was the beginning of our company as a residential floor covering only focus. The sale of our commercial business did not include our manufacturing facilities in Atmore and Saraland, Alabama.

With the availability of labor, very constrained throughout the country, we have been moving residential production into these facilities, which has enhanced our ability to service our customers and grow our business.

During the quarter, we continued to gain market share and became -- and began significant changes, which we believe will enhance our future prospects. Net sales of our residential flooring products were up 27%, comparing favorably to the industry, which we believe was up high single digits.

For the first 9 months of the year, our total net sales of residential products were up 44% over the same period in the prior year. This significant year-over-year increase in the net sales of our residential floor covering products was the result of the impact of COVID-19 pandemic in 2020 and strong growth in new and existing home sales and home remodeling in 2021.

Allen Danzey, our CFO, will review our financial results, after which I will have additional comments.

Thank you, Dan. As Dan just discussed, this was another good quarter for the company, driven by strong consumer demand in the residential market and higher operating margins. We had net sales from continuing operations in the quarter of $89.3 million, that was a 27% increase over the comparative sales of $70 million in the third quarter of 2020.

This put our total net sales for the first 9 months of the year, $252 million, an increase of 44% over the first 9 months of the COVID-impacted year of 2020. Gross profit margins for the quarter was 27.9% of net sales compared to 24.5% in the third quarter of 2020.

As we are increasing pricing in line with higher costs in our raw materials, we saw a benefit of higher -- of current period higher revenues matching against the prior period lower actual costs. As the higher raw material costs roll through production, we anticipate our operating margins to return more in line with recent comparative results.

Selling and administrative costs in the third quarter of 2021 ended at $18.1 million or 20.3% of net sales. This compares favorably to 21.7% in the same period of the prior year. Prior period was affected by the onset of the pandemic, after which we began a reduction in selling and administrative expenses as part of our COVID-19 response plan. We've held on to many of those reductions, while strategically investing in the growth of our residential markets.

Our operating income on the quarter of $6.8 million or 7.7% of net sales compared to an operating income of $1.5 million in the third quarter of 2020. For the current quarter, we incurred $1.2 million in interest expense as a reduction from the third quarter amount in 2020 of $1.6 million, the 2020 amount of interest expense was $1.6 million compared to the $1.2 million in 2021.

The decreased interest as a result of our financing initiatives in the fourth quarter of 2020 and our continued efforts towards debt reduction. Our year-over-year debt reduced from $78.2 million in the third quarter of 2020 to $60.4 million in the current quarter.

Heavy contributor to that debt reduction was during the third quarter the sale of our commercial operations. On September 13, we sold our commercial operations for $20.5 million. As part of the purchase agreement, we've retained the open trade receivables at the point of sales, low cash deposits and certain inventories and fixed assets.

The gain recorded for the sale of the business was $2.7 million and is reflected within our discontinued operations on our operating statement. We look forward to focusing on the new structure of our business as we realign the production in our facilities to meet the increased demand for our residential products.

Net income in the quarter was $6.4 million, giving us an earnings per share of $0.40. For the fiscal year-to-date, we reported a net income of $7.8 million and earnings per share of $0.49. Looking at the balance sheet. At the end of September 2021, the higher sales demand drove our increases in net receivables of $9.1 million when compared to the same quarter in the prior year.

Inventories increased over prior year by $15.3 million and accounts payable and accrued expenses increased $12.2 million, both as a result of the higher sales volume and increased cost of our raw materials. Capital equipment acquisitions, including those funded by cash and financing, was approximately $2 million in the quarter.

We anticipate capital expenditures for 2021 to be approximately $5 million and depreciation and amortization of approximately $10 million. Quarter end, our borrowing availability under our long-term credit agreement was $54.1 million.

To see our investor presentation, please go to our website at www.dixiegroup.com and click on our Investors tab. Dan?

Thank you, Allen. During the third quarter, the availability of labor, materials and transportation became even more challenging, which resulted in higher costs and created service issues for the industry.

The departure of Stainmaster for the residential market also represents a major change, but one which offers opportunity for growth and repositioning. We are implementing strategies to help our customers transition to our new brands EnVision 6,6 and EnVision Solution SD Pet solutions. Our TRUCOR brand has continued to grow even more rapidly than the luxury vinyl flooring market. With additional cutting-edge products and focus on domestic sourcing, we feel we can continue growing faster than the marketplace.

As part of our commitment to the upper end of the decorative market, we're bringing in 2 new -- bringing out 2 new collections to the market. Our Masland 1866 and Fabrica decor product offerings bring a large number of fresh and distinctive looks, which are designed to complement our offering for the design community. Our residential business in the third quarter continued to be very strong. As noted, our sales were 27% ahead of the same period in the prior year, including sales of soft surface products that were up over 20% and hard surface up over 70%.

Our order entry remained well above year ago levels throughout the quarter. In hard services, we launched TRUCOR Applause, our new domestically sourced SBC offering with 8 SKUs. It has quickly generated a significant level of interest and order activity in the market, and we're working with our vendor to maximize production on these SKUs. We also launched our TRUCOR 3DP program with 16 SKUs, including wood and stone looks.

TRUCOR 3DP features high residential -- high-resolution digital printing directly on an SPC core instead of the traditional film used in most SPC and WPC products. TRUCOR 3DP is waterproof and can be easily installed over most existing hard surface floors and subfloors with minimal preparation. The additional benefits of this technology include sharp realistic visuals, virtual elimination of pattern repeats found in film-based products and a highly durable AC5 scratch resistance rating. We're continuing to vest -- to invest in our hard surface business.

As part of the transitioning away from Stainmaster, 217 retail stores have joined our new Premier Flooring Center network. Through the PFC program, we delivered a turnkey solution for retailers who had been closely aligned with the Stainmaster brand in the past. With the tagline, it matters where you buy flooring, the PFC program offers a best-in-class selling system, which promotes higher tickets and higher retail margins. It also highlights the benefits of high-quality carpets made with type 6,6 nylon and refreshes the showroom with up-to-date merchandising and messaging. The PFC program has been very well received.

As Allen discussed, our results as a residential flooring company were better in the third quarter. Despite challenges from inflation, material availability and transitioning away from Stainmaster, we remain optimistic for the future. New home construction, home resales and residential remodeling are projected to remain robust. We believe the focusing of our company on residential flooring, utilizing the remaining assets of our commercial production has positioned us for growth going forward. During this period, we have maintained capital expenditures at about half of our depreciation and amortization level. Allen mentioned our debt reduction. Over the last 36 months, we have reduced debt by $81 million or approximately $2.25 million a month.

In summary, during the quarter, our sales of residential carpet increased 27% compared to a year ago, which was up significantly more than the industry as was our sales year-to-date, up 44% when the industry, we think, was up in the mid-20s range. We have several growth initiatives that are doing very well. First, in response to the sale of Stainmaster brand to Lowe's, we're implementing our PFC program to transition our customers to our EnVision 6,6 and EnVisionSD Pet Solutions brands.

We continue to introduce new hard surface products to our rapidly growing TRUCOR collection of products. We'll be expanding our products in the decorative category through our Masland 1866 and Fabrica decor offerings. The momentum of our sales by residential products has continued into the fourth quarter. For the first 5 weeks of the quarter, our sales are up approximately 20% from year ago levels, and the fourth quarter of last year was very strong. At this time, we would like to open up the call to questions.

[Operator Instructions]. Our first question comes from the line of Derek Maupin with Hodges Capital.

Dan, Allen, congratulations on the quarter.

As far as gross margins, how should we think about those going forward? I know you indicated you're seeing a lot of raw material inflation as well as logistics, but kind of maybe timing of price increases and what you think you can offset?

Yes. We certainly not willing to provide any forward-looking or projections in that area, but just talking a little bit about what we've experienced in the quarter. As you know, this year, we've been hit, as so many of people have, high cost increases in our raw materials, and we've been implementing price increases on our products and have seen timing issues going both ways, certainly as we're getting the price increases in there to recoup the costs on the raw materials, sometimes there's some delays around that.

In the quarter, we saw a benefit of some timing-related issues on our cost of methodology that allowed our actual costs to come in with the prior lower period costs matching up against some higher revenues from the current quarter.

We'd expect that would level out to something more, as I said, comparatively to a historically recent margins. But it's difficult to tell as we get more efficiencies in our operations, as we're looking to capitalize the -- from the divestiture of the commercial business, having more capacity in particularly our Atmore plant to be able to fulfill more of the demand around our residential products.

And as we continue to see more cost increases come in on our raw materials, it's difficult to predict in this environment, but I believe in the third quarter, we certainly saw a benefit of a timing issue there, and we'll look forward to the third and fourth quarter to continue to respond to pricing cost increases and continue to try to drive our margins.

Derek, I think we had 5 or 6 increases, perfect price increases during the year. Obviously, a lot of different costs have gone up, everything from labor to transportation to raw materials. We're also seeing a major switch from our Stainmaster products to actually 4 other raw material sources.

So there are a lot of moving parts here. It's very difficult to predict. But we would hope next year that we don't have as much inflation as we had this year. But clearly, when that inflationary pressure is there, the industry has been increasing prices. And virtually, every mill has announced a price increase for either December or early January.

Maybe a question on the resets given what's going on with Stainmaster. One, do you think this is giving you an opportunity to get in front of customers and maybe take a little incremental market share? And maybe second part of that on the labor side, as you indicated, you moved some employees over to the residential, maybe just a little bit more color on being able to meet those customers' demands versus some of your competitors that could not deliver?

Well, to be specific on Stainmaster, we're moving away as rapidly as we can. It takes time to replicate products that are already in the marketplace. And in new products, of course, would be introduced with other fiber sources. We feel like we do have the fiber sources to replace the Stainmaster products, and we will do it as rapidly as possible.

Obviously, that's not an easy task, and there may be some bumps in the road there. But net-net, we think we'll be in a much stronger position. We'll have more suppliers, more diversity of supplier, and I think we'll be in a better position.

In terms of the commercial folks that are now in the residential area, our Atmore plant was where our commercial products were produced. The plant and most of the equipment there was not part of the transaction of selling the commercial business, and therefore, we can utilize those people and those assets to serve -- help service our residential business.

And labor today is a major factor in the whole industry, particularly in North Georgia. Unemployment rates are extremely low. And I would say capacity constraints have really impacted virtually every carpet mill in North Georgia.

So we see this as an opportunity to utilize the people and the machinery that we have and the assets we have in Atmore to grow our residential business.

And maybe last question for me. You've done a tremendous job as far as bringing down the leverage on the balance sheet. Is it -- will that still be a focus going forward? Is there a certain level that you'd like to get to as far as the balance sheet goes?

I would say traditionally, we've been pretty comfortable in the 30% to 35% debt to capitalization, and we're a little above that still. So we will continue trying to bring our debt down.

Our next question comes from the line of Mike Hughes with SGF Capital.

First, a detailed question on the balance sheet. As of the end of the September quarter, there was $10.4 million in current assets related to discontinued ops and $3.6 million in long-term assets for discontinued ops. What happens to those 2 line items going forward?

The assets, as we mentioned, we retained the accounts receivables from the business as well as some of the inventories and the fixed assets. Of course, the accounts receivable we are collecting on, and we'll expect to see that diminish significantly by end of the year. And then the fixed assets and inventory, we are also working to dispose off sell into the market at the best obtainable value that will take a little bit more of a process just working through that into the market, but the expectation is that those items would be taken care of, I guess, for like a better terminology around it, within the next couple of quarters.

As far as the liabilities, there are some ongoing liabilities we have as far as fully responsibilities, former employee responsibilities as well. But for most part of those are open liabilities that are paid off rapidly in the quarter and would be significantly decreased by the end of the year.

Mike, let me clarify on the fixed assets. Those were assets that were used in the commercial business that cannot or aren't appropriately used in the residential business. Many of the assets that were in those facilities can be used in the residential business, but these are ones that will not be used in the residential business.

Okay. Great. And then the SG&A at $18.1 million in the quarter, is that a good run rate going forward? I was just curious if there was maybe some onetime cost to some of these resets from Stainmaster to your own branding?

There were no onetime, in particular, cost. We've had some different issues throughout the year that have delayed timing of some costs as we went to France impact earlier in the year. But in general, those are -- there's nothing outstanding as far as any one particular large cost or item in there. But as we continue to look at our plan for the next year and develop our strategy around building our residential business, we certainly would reassess our commitment and investment into the sales marketing and other selling areas.

Okay. And your sales have been exceptional the last few quarters. Just curious, this quarter, was there any channel fill dynamic just related to the resets on the Stainmaster or can we think of kind of point of sale at the same levels as you're selling?

Mike, we're a little different from some other suppliers to the industry. Basically, we do not sell a lot of stock. So there are very little channel filling. 90 -- over 90% of our sales occur when a end consumer, usually a lady, places an order with a retailer, and we get an order for a cut, a certain size. So we're not selling a lot -- there's not a lot of channel fill possibility for us. It's very small.

Okay. I appreciate it. And then just last question, not to get into a cost accounting discussion, but I think you're on LIFO. So I was a little bit surprised how strong the gross margins were in the quarter. So can you just maybe flush that issue out a little bit more?

As you said, I mean, you really get into some cost accounting as far as our methodology and capturing actual costs and applying those. The LIFO calculation for the quarter, as you mentioned, for many companies right now, you're seeing an income deferral into LIFO as we're seeing this inflationary impact. For us, there were a number of things with our LIFO situation as far as the movement with the commercial business and the $11.5 million of inventory that was moved off the books at that point.

In general, for continuing operations after a result of all the movement there, LIFO was relatively flat from quarter-to-quarter on our estimation of the LIFO calculation for the quarter. The real movement around the cost, again, as we calculate our actual cost is really timing driven as far as getting the price increases in place and having some prior period actual cost inventory rolling through. So we -- again, it's the unique benefit on the quarter that we expect to settle down a little bit as we get moving forward in the fourth quarter.

Mike, I think once the queue is available, you will notice that the LIFO reserve at the end of second quarter was almost identical to what it was at the end of the third quarter, and that is up, I think, around $6 million from year end.

With no further questions in the queue, I will now turn the call back over to Dan Frierson for any additional or closing remarks.

Thank you, John. Third quarter was a sort of a watershed quarter for us getting out of the commercial business concentrating totally on residential, both hard and soft surface with a number of initiatives to grow our business and with assets and people available to help grow our business. So we're looking forward to the future and appreciate you being with us. Thank you.

Ladies and gentlemen, that will conclude today's conference. Thank you, again, for your participation. Have a great day.