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DXYN > SEC Filings for DXYN > Form 10-Q on 6-Nov-2013All Recent SEC Filings

Show all filings for DIXIE GROUP INC

Form 10-Q for DIXIE GROUP INC


6-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition

The following is presented to update the discussion of results of operations and financial condition included in our 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission.

CRITICAL ACCOUNTING POLICIES

Our critical accounting policies were outlined in Management's Discussion and Analysis of Results of Operations and Financial Condition in our 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission. There have been no significant changes to those critical accounting policies subsequent to the date of that report.

OVERVIEW

We believe our upper-end business in the soft floorcovering market is driven more by resale and remodeling of existing homes and commercial facilities versus new construction. While our business was more deeply affected by the economic crisis during the 2008 through 2011 timeframe as it reached the higher end markets where our business is concentrated, we believe our position in the upper end of the markets as well as several of our strategic and tactical initiatives have permitted us to benefit from improved overall economic conditions. We further believe these actions will allow us to take advantage of anticipated growth in the upper-end markets as it occurs.

The strategic and tactical growth initiatives begun in 2012 have enhanced our future prospects and, we believe, have allowed us to return to sustained growth and profitability although several of these actions have increased expenses affecting our operating results. These initiatives, further discussed below, include:

investment in the development of new products based on new yarn systems,

realignment of certain of our broadloom tufting technologies from Atmore, Alabama into our North Georgia Eton facility,

the acquisition of a continuous dyeing facility in North Georgia,

the acquisition of specialized wool rug tufting equipment and its related business,

an opportunistic purchase of certain products from an industry competitor to incorporate into our product line

and changes in both manufacturing and commercial business management.

Additionally during 2013, we continued to expand our synthetic yarn production capabilities to support increasing yarn requirements associated with our growth, we have launched a new commercial brand through selected channels with multi-line interior surfaces sales agents and completed another strategic acquisition in the beginning of our third quarter of 2013 to enhance and expand our wool product offerings.

We have taken advantage of several opportunities to invest in products we believe will further differentiate us from our competition. We have access to two new yarn systems that provide exceptional softness and colorfastness qualities. In addition, we have developed a new "permaset process" for wool which has allowed our designer customers the broadest possible choice of colorations. As a result, during 2012 and continuing into 2013, we invested at an increased rate in sampling initiatives related to these product offerings as compared with historical investment levels. We have seen positive acceptance of our products during 2013.

During 2012, we completed the relocation of certain tufting technologies from our manufacturing facility in Atmore, Alabama to our facility in Eton, Georgia to achieve a more favorable cost structure for the products and markets served from those technologies. Although this realignment resulted in incremental operating costs during 2012, we have seen operational efficiencies and an improved cost structure related to this realignment.

In November 2012, we acquired a continuous carpet dyeing facility in Calhoun, Georgia. The acquisition of this dyeing operation is allowing us to transition certain of our products from our beck dyeing operation in Atmore, Alabama and from other third party commission continuous dyeing operations located in North Georgia. This will allow us to position our business to achieve significant longer-term cost reductions in the dyeing process, better control our inventories and process flow and support future growth. Subsequent to this acquisition and continuing through our first quarter of 2014, we will continue to incur incremental costs as we continue to align, upgrade and expand the equipment and processes in order to better accommodate our product mix and provide for a significant increase in volume with improved efficiencies.

In late November 2012, we acquired certain specialized wool rug tufting equipment and its associated business. During the first quarter of 2013, we completed the relocation of the acquired equipment to our facility in Santa Ana, California and are in the process of supplementing our capacity with additional new equipment. The acquisition is expected to significantly reduce our costs by producing these goods in-house and should allow us to further access and develop other markets and support what we believe to be good growth potential in markets we currently serve. We have experienced start up inefficiencies and incrementally higher costs. We anticipate that operational improvements and increased volume capabilities will be achieved in early 2014.

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On June 30, 2013, we completed the acquisition of Robertex Associates, Inc., a high-end manufacturer of specialty wool floorcovering products marketed under the names of "Robertex" and "Carousel". This acquisition will allow us to strengthen our position in our wool product line where we have seen strong growth, although these products appeal to a more select and discriminating customer base. The purchase price of the acquisition was approximately $6.3 million, plus an amount based on a change in working capital against a benchmark amount and additional consideration contingent upon growth in gross margins of selected products for five years subsequent to the acquisition. In order to appropriately support the increased wool business, we are realigning certain manufacturing equipment in this facility and infrastructure across our Company related to wool products. As our wool production capabilities are being expanded and enhanced, we are developing new products and investing in increased product sampling for these products. Until such time that all of these actions have been completed and products are in the field, there will be a negative effect on our results.

To support our growth, we have continued to expand our Roanoke, Alabama yarn production facility. As a result, we have undertaken an expansion of our production capabilities with the addition of equipment in 2013. The costs associated with the expansion of our production capabilities and the training and retention of qualified associates has negatively affected operations during this period.

RESULTS OF OPERATIONS

The following table sets forth certain elements of our continuing operating
results as a percentage of net sales for the periods indicated:
                                          Three Months Ended                  Nine Months Ended
                                   September 28,     September 29,    September 28,      September 29,
                                        2013              2012             2013              2012
Net sales                                100.0 %            100.0 %         100.0 %           100.0 %
Cost of sales                             75.5 %             74.8 %          74.8 %            75.4 %
Gross profit                              24.5 %             25.2 %          25.2 %            24.6 %
Selling and administrative expense        22.4 %             24.0 %          22.5 %            23.8 %
Other operating expense, net               0.1 %              0.0 %           0.0 %             0.0 %
Operating income                           2.0 %              1.2 %           2.7 %             0.8 %

Net Sales. Net sales for the quarter ended September 28, 2013 were $90.2 million compared with net sales of $65.8 million for the year-earlier quarter, or an increase 37.1%. Net sales in the first nine months of 2013 were $249.3 million compared with net sales of $195.2 million in the first nine months of 2012, an increase of 27.7%. In the third quarter of 2013, residential carpet sales reflected an increase of 35.0% and net sales of commercial carpet increased 39.8% compared with the third quarter of 2012. Residential carpet sales increased 27.7% and commercial net sales increased 24.9% in the first nine months of 2013 compared with the first nine months of 2012. Our residential sales in the third quarter and first nine months of 2013, compared with the prior-year period, included increased sales in our higher-end channels and our mass merchant channels of distribution. Our commercial business is more heavily concentrated in specified project-oriented business which, we believe, was positively affected by general economic improvements in the quarterly and year-to-date periods in 2013 compared with the prior year periods in 2012. Additionally, we believe we have been positively affected by new products and marketing initiatives implemented by new leadership in our commercial business in late 2012.

Cost of Sales. Cost of sales as a percentage of net sales was 75.5% in the third quarter of 2013 compared with 74.8% in the third quarter of 2012. Cost of sales was 74.8% in the first nine months of 2013 compared with 75.4% in the first nine months of 2012. The third quarter and first nine months of 2013 were positively affected compared to the prior-year periods due to the tufting production realignment to our Eton facility. We have seen benefit from operational efficiency related to the acquisition of the Colormaster continuous dyeing facility in late 2012, although we have incurred certain incremental costs related to start-up of the facility and certain start-up costs related to acquisition of specialized tufting equipment at our Susan Street facility in late 2012. Additionally, incremental costs have been incurred in 2013 as a result of the yarn production expansion at our Roanoke, Alabama facility to support our increasing carpet growth as well as realignment and start-up costs related to the third quarter 2013 acquisition of the Calhoun wool manufacturing facility. The 2012 periods included the effects of costs incurred related to the Eton machinery realignments as well as higher expenses due to the development of carpet products incorporating new fibers.

Gross Profit. Gross profit dollars increased $5.5 million in the third quarter of 2013 compared with the third quarter 2012 and increased $14.8 million in the first nine months of 2013 compared with the same period in 2012 primarily reflecting the effects of the increased sales volume.

Selling and Administrative Expenses. Selling and administrative expenses decreased 1.6% as a percentage of sales in the third quarter of 2013 compared with the same period in 2012 and decreased 1.3% as a percent of sales in the first nine months of 2013 compared with the first nine months of 2012. The lower selling and administrative expenses as a percentage of sales is primarily a result of the effect of the fixed component of these costs on higher levels of sales in the third quarter and first nine

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months of 2013 compared with the prior-year periods. We did not realize the full effect of leverage in our results due to the effect of incremental product sampling costs related to new product initiatives.

Other Operating (Income) Expense, Net. Other operating (income) expense, net was not significant in either the third quarter or first nine months of 2013 or the comparable periods in 2012.

Operating Income. We reported operating income of $1.8 million in the third quarter of 2013 compared with operating income of $820 thousand in the third quarter of 2012. Operating income was $6.8 million in the first nine months of 2013 compared with operating income of $1.4 million in the first nine months of 2012. Operating results in the 2013 reporting periods were positively affected by the higher sales volume and operational improvements, net of incremental start-up costs associated with the acquisitions in late 2012 and the new initiatives in 2013 discussed above. The third quarter and first nine months of 2013 included incremental costs of over $2.3 million and approximately $5.3 million, respectively. We anticipate incremental costs related to these initiatives of approximately $1.4 million in our fourth quarter of 2013 and approximately $2.4 million primarily in 2014. Results in the third quarter and first nine months of 2012 were negatively affected by incremental equipment relocation expenses of $307 thousand and $854 thousand, respectively.

Interest Expense. Interest expense increased $115 thousand in the third quarter of 2013 and $490 thousand for the first nine months of 2013, respectively compared with the same periods in 2012. The increases are principally a result of higher levels of debt in the 2013 periods primarily as a result of debt incurred for the acquisition of the Colormaster continuous dyeing facility in the latter part of 2012, the third quarter 2013 acquisition of "Robertex" and increases in working capital to support the higher levels of business activity.

Other (Income) Expense, Net. Other (income) expense, net in the third quarter and first nine months of 2013 was not significant while other income in the third quarter and first nine months of 2012 included a gain of $187 thousand from a sale of other non-operating assets.

Income Tax Provision (Benefit). Our effective income tax rates are based upon estimated annual tax rates. The effective tax rates in the third quarter and first nine months of 2013 differed from statutory rates primarily due to the recognition of $795 thousand of federal and state tax credits primarily related to research and development credits for the years of 2009 through 2012. Additionally, the effective tax rate for the first nine months of 2013 included the recognition of certain 2012 federal tax credits required to be recognized in the first quarter of 2013 and the effects of a non-taxable settlement gain related to company-owned insurance in the first quarter of 2013. The difference between the effective rates and the statutory rates for the three and nine months ended September 29, 2012 was primarily due to changes to the provision as the result of differences recognized in our income tax return filing compared with earlier estimated amounts as well as the utilization of certain state tax net operating loss carryforwards that resulted in the reversal of the valuation allowance related to their utilization.

Income (Loss) from Continuing Operations. We had income from continuing operations of $1.4 million, or $0.11 per diluted share, in the third quarter of 2013 compared with income from continuing operations of $269 thousand, or $0.02 per diluted share, in the third quarter of 2012. Continuing operations reflected income of $3.8 million, or $0.28 per diluted share, for the first nine months of 2013 compared with a loss from continuing operations of $240 thousand, or $0.02 per diluted share, in the first nine months of 2012.

Net Income (Loss). Discontinued operations reflected a loss of $20 thousand, or $0.00 per diluted share, in the third quarter of 2013 compared with a loss of $167 thousand, or $0.01 per diluted share, in the same period in 2012. Discontinued operations reflected a loss of $67 thousand, or $0.01 per diluted share, in the first nine months of 2013 compared with a loss of $272 thousand, or $0.02 per diluted share, in the first nine months of 2012. Including discontinued operations, we had net income of $1.4 million, or $0.11 per diluted share, in the third quarter of 2013 compared with net income of $102 thousand, or $0.01 per diluted share, in the third quarter of 2012. The first nine months of 2013 reflected net income of $3.7 million, or $0.27 per diluted share, compared with a net loss of $512 thousand, or $0.04 per diluted share, in the comparable nine month period in 2012.

LIQUIDITY AND CAPITAL RESOURCES

During the nine months ended September 28, 2013, debt increased $17.8 million under our senior credit line and other financing agreements, $3.8 million of seller-financed debt related to the Robertex acquisition and $1.3 million related to assets acquired under capitalized leases for a total increase in debt of $22.8 million. The funded debt increase of $17.8 million was used to finance our operations, including $4.9 million in cash used in operating activities, $8.7 million in property, plant and equipment purchases, $2.2 million related to the Robertex acquisition, $1.1 million to fund outstanding checks, $461 thousand related to debt payments for capitalized leases and $388 thousand related to debt issuance costs.

Working capital increased $19.6 million in the first nine months of 2013. The increase was principally attributable to an increase in accounts receivable of $15.7 million from the seasonably low period in December, a period when operations and shipments are limited due to the observance of holidays yet collections of accounts receivables continue, and the stronger sales in the third quarter of 2013 compared with our fourth quarter of 2012. Also, inventories increased $18.2 million primarily to support the higher levels of business. The working capital increase from accounts receivable and inventories was partially mitigated by an increase in accounts payable of $11.6 million primarily as a result of an increase in trade payables related to an increase in raw

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materials inventories and accrued expenses of $4.7 million primarily related to customer related activity associated with our sales growth. Such costs include advance customer deposits for custom products, claims reserves and customer rebates.

Capital asset acquisitions for the nine months ended September 28, 2013 were $10.5 million, including $8.7 million through funded debt and $1.8 million of equipment acquired under capitalized leases, while depreciation and amortization was $7.8 million. We expect capital expenditures and capital leases combined to be approximately $13.5 million in 2013 for normal capital expenditures while depreciation and amortization is expected to be approximately $10.5 million. Planned capital expenditures in 2013 are primarily for production related equipment.

Debt Facilities

On April 1, 2013, we amended our secured senior revolving credit facility (the "amended senior credit facility"). The amended senior credit facility extends the maturity date of the facility to April 1, 2018 and provides for a maximum of $110.0 million of revolving credit, subject to borrowing base availability, including limited amounts of credit in the form of letters of credit and swingline loans. The borrowing base is equal to specified percentages of our eligible accounts receivable, inventories, fixed assets and real property less reserves established, from time to time, by the administrative agent under the facility.

At our election, revolving loans under the amended senior credit facility bear interest at annual rates equal to either (a) LIBOR for 1, 2 or 3 month periods, as we select, plus an applicable margin of either 1.50%, 1.75% or 2.00%, or (b) the higher of the prime rate, the Federal Funds rate plus 0.5%, or a daily LIBOR rate plus 1.00%, plus an applicable margin of either 0.50%, 0.75% or 1.00%. The applicable margin is determined based on availability under the amended senior credit facility with margins increasing as availability decreases. We also pay an unused line fee on the average amount by which the aggregate commitments exceed utilization of the senior credit facility equal to 0.375% per annum.

The amended senior credit facility includes certain affirmative and negative covenants that impose restrictions on our financial and business operations, including limitations on debt, liens, investments, fundamental changes in our business, asset dispositions, dividends and other similar restricted payments, transactions with affiliates, payments and modifications of certain existing debt, future negative pledges, and changes in the nature of our business. We are also required to maintain a fixed charge coverage ratio of 1.1 to 1.0 during any period that borrowing availability is less than $12.1 million.

On July 1, 2013, in connection with the acquisition of Robertex, we entered into a Fourth Amendment to our senior credit facility to include the relevant assets in our borrowing base, as well as, allow for a $4.0 million seller-financed note within the Robertex securities purchase agreement.

On July 30, 2013, we entered into a Fifth Amendment to our senior credit facility. The amendment increased the size of the revolver portion of the credit facility by $20.0 million to a maximum of $130.0 million (contingent on availability). In addition, the amendment provided for an increase in the fixed asset and real property borrowing bases, an increase in the level of the availability "trigger level" to $14.4 million from $12.1 million, and extended the term of the facility to August 1, 2018.

We can use the proceeds of the amended senior credit facility for general corporate purposes, including financing acquisitions and refinancing other indebtedness. As of September 28, 2013, the unused borrowing availability under the amended senior credit facility was $26.4 million.

On April 1, 2013, in connection with the amended senior credit facility, we terminated our five-year $11.1 million mortgage loan which had a balance of $9.8 million. The mortgage loan was secured by our Susan Street real estate and liens secondary to the senior credit facility. The mortgage loan was scheduled to mature on September 13, 2016. The mortgage loan bore interest at a variable rate equal to one month LIBOR plus 3.00% and was payable in equal monthly installments of principal of $61 thousand, plus interest calculated on the declining balance of the mortgage loan, with a final payment of $7.4 million due on maturity.

Income Taxes

During the quarter ended September 28, 2013, we recognized $795 thousand of federal and state tax credits primarily related to research and development credits for the years of 2009 through 2012. Additionally, we are assessing the numerous factors, including current and future earnings assumptions by taxing jurisdictions, to determine if and to what degree, previously established state income tax valuation reserves may need to be reversed. We expect to conclude our analysis before the end of 2013.

Commitments

Subsequent to our quarter-ended September 28, 2013, on October 31, 2013, we entered into a warehouse operating lease agreement in North Georgia for a ten year term to begin on May 1, 2014 with a total cost of approximately $8.0 million over the term of the agreement. Due to the significant growth we have experienced and the dependence on several outside locations currently under separate arrangements, we will be able to realign our inventories to better serve our customers and operations as well as eliminate the existing outside arrangements as the term of such arrangements expire.

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RECENT ACCOUNTING PRONOUNCEMENTS

In June 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2011-05, "Comprehensive Income (Topic 220): Presentation of Comprehensive Income". This ASU eliminated the option to report other comprehensive income and its components in the statement of stockholders' equity and required the presentation of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. We adopted this ASU in December 2011 and presented the components of other comprehensive income in a separate statement following the statement of operations. In December 2011, the FASB issued ASU 2011-12, "Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05". ASU 2011-12 deferred the changes in ASU 2011-05 that relate to the presentation of reclassification adjustments to other comprehensive income. In February 2013, the FASB issued ASU No. 2013-02, "Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income". ASU 2013-02 requires us to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, we are required to present significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income. ASU 2013-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2012. As the new standard does not change the current requirements for reporting net income or other comprehensive income in the financial statements, the adoption of this ASU did not have a material effect on our Consolidated Condensed Financial Statements.

In December 2011, the FASB issued ASU No. 2011-11, "Balance Sheet (Topic 210):
Disclosures about Offsetting Assets and Liabilities." The amendments in this ASU require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. In January 2013, the FASB issued ASU No. 2013-01, "Balance Sheet (Topic 210)-Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities". The ASU clarifies that ordinary trade receivables are not in the scope of ASU No. 2011-11. ASU No. 2011-11 applies only to derivatives, repurchase agreements and reverse purchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with specific criteria contained in the Codification or subject to a master netting arrangement or similar agreement. The effective date is the same as the effective date of ASU 2011-11. We do not expect that the adoption of these ASUs will have a material effect on our Consolidated Condensed Financial Statements.

In July 2012, the FASB issued ASU No. 2012-02, "Intangibles--Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment." This ASU states that an entity has the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with Codification Subtopic 350-30, "Intangibles--Goodwill and Other, General Intangibles Other than Goodwill." Under the guidance in this ASU, an entity also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period. The amendments in this ASU are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The adoption of this ASU did not have a . . .

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