DIXIE GROUP INC - Annual Report: 2006 (Form 10-K)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)

R ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 30, 2006
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________ to ________.

Commission File Number 0-2585

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

o

Yes

R

No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.

o

Yes

R

No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  R  Yes  o  No

Indicate by check mark if disclosure of delinquent filer pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to the Form 10-K.  R

Indicate by check mark whether the registrant is a large accelerated filer, or a non-accelerated filer.  See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer   o   Accelerated filer    R   Non-accelerated filer     o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

o

Yes

R

No

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K (Continued)

The aggregate market value of the Common Stock held by non-affiliates of the registrant on June 30, 2006 (the last business day of the registrant's most recently completed fiscal second quarter) was approximately $133,500,000.  The aggregate market value was computed by reference to the closing price of the Common Stock on such date.  In making this calculation, the registrant has assumed, without admitting for any purpose, that all executive officers, directors, and holders of more than 10% of a class of outstanding Common Stock, and no other persons, are affiliates.  No market exists for the shares of Class B Common Stock, which is neither registered under Section 12 of the Act nor subject to Section 15(d) of the Act.

Indicate the number of shares outstanding of each of the registrant's classes of Common Stock as of the latest practicable date.

DOCUMENTS INCORPORATED BY REFERENCE

Specified portions of the following document is incorporated by reference:

Proxy Statement of the registrant for annual meeting of shareholders to be held May 2, 2007 (Part III).

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PART I

ITEM 1.     BUSINESS

General

Our business consists principally of marketing, manufacturing and selling carpet and rugs to high-end residential and commercial customers through the Fabrica International, Masland Carpets and the Dixie Home brands.  We utilize a small amount of our manufacturing capacity to process yarns and provide carpet dyeing and finishing services for independent carpet manufacturers.

Our Recent History

Beginning in 1993, we entered the soft floorcovering business, using our carpet yarn business as a base, with the acquisition of Carriage Industries and Masland Carpets.  Over the next seven years we made six additional floorcovering acquisitions concluding with our acquisition of Fabrica International and an interest in the dyeing and finishing operations of Chroma Systems Partners ("Chroma") on July 1, 2000.  Our floorcovering acquisitions were partially financed by selling assets of our textile products businesses.  In 1999, we sold the last of our textile product assets to complete our transformation from the textile products business to a marketer and manufacturer of soft floorcovering products.

During the years 2000 through 2003, our profitability was adversely affected by a significant decline in the factory-built housing industry and operational inefficiencies associated with assimilating acquisitions into our North Georgia carpet operations.  Our commitment to our brands, the upper-end of the floorcovering market and our desire to reduce our outstanding debt, led to the sale of our extrusion operation in 2001 and our North Georgia factory-built housing carpet, needlebond and carpet recycling businesses and related assets in 2003.  In early 2004, we sold a carpet yarn facility located in Ringgold, Georgia that was a significant supplier of spun yarns to our North Georgia carpet operations.

The sale of these businesses and assets allowed us to substantially reduce our debt, diversify our customer base and focus on our core competencies in the upper-end of the soft floorcovering market where we believe we have strong brands and competitive advantages with our style and design capabilities and customer relationships.

Although smaller as a result of these sales, our business is growing, is more profitable and has greater growth potential.  It is concentrated in areas of the soft floorcovering markets where innovative styling, design, color, quality and service, as well as limited distribution, are welcomed and rewarded.  Through Masland, Fabrica, and Dixie Home, we have a significant presence in the high-end of the residential and commercial soft floorcovering markets.  Our brands are well known, highly regarded and complementary; by being differentiated, we offer meaningful alternatives to the discriminating customer.

Our Business Units

We are in one line of business, Carpet Manufacturing.  

Fabrica

Fabrica, founded in 1977, markets and manufactures luxurious residential carpet and custom rugs, at selling prices that we believe are approximately four and one half times the average for the soft floorcovering industry.  Their primary customers are interior decorators and designers, selected retailers and furniture stores, luxury home builders and manufacturers of luxury motor coaches and yachts.  Fabrica is among the leading premium brands in the domestic marketplace and is known for styling innovation and unique colors and patterns.  Fabrica is viewed by the trade as a premier brand and resource for very high-end carpet.  Fabrica also is known as a styling trendsetter and a market leader in the very high-end residential sector.  Fabrica accounted for approximately 18% of our sales in 2006.

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Masland

Masland Carpets, founded in 1866, manufactures and markets residential and commercial products.

Masland Residential markets and manufactures design-driven specialty carpets and rugs for the high-end residential marketplace.  Their residential broadloom carpet products are marketed at selling prices that we believe are approximately more than three and one half times the average for the soft floorcovering industry.  Their products are marketed through the interior design community, as well as to consumers through specialty floorcovering retailers.  Masland Residential accounted for approximately 27% of our sales in 2006.  Masland Residential has strong brand recognition within the upper-end residential market.  Masland Residential competes through innovative styling, color, product design, quality and service.

Masland Contract markets and manufactures broadloom and modular carpet (carpet tiles) for the specified commercial marketplace.  Their commercial products are marketed through the architectural and specifier community and directly to commercial end users, as well as to consumers through specialty floorcovering retailers.  Masland Contract, which began in 1993, accounted for approximately 30% of our sales in 2006.  Masland Contract has strong brand recognition within the upper-end contract market.  Masland Contract competes through innovative styling, color, patterns, quality and service.

Dixie Home

Dixie Home was introduced in 2003 as a brand to provide stylishly designed, differentiated products that offer affordable fashion to residential consumers.  Dixie Home markets an array of tufted broadloom residential carpet to selected retailers and home centers under the Dixie Home and private label brands.  Their objective is to make the Dixie Home brand the products of choice for styling, service and quality in the more moderately priced sector of the high-end broadloom residential carpet market.  Their products are marketed at selling prices which we believe are approximately two times the average for the soft floorcovering industry.  Dixie Home's products have been well received in the marketplace and are expected to have significant growth potential.  Dixie Home accounted for approximately 21% of our sales in 2006.

Industry

The carpet and rug industry has two primary markets, residential and commercial, with the residential market making up the largest portion of the industry's sales.  A substantial portion of industry shipments is made in response to replacement demand.  Residential products consist of broadloom carpets and rugs in a broad range of styles, colors and textures.  Commercial products consist primarily of broadloom carpet and carpet tiles for a variety of institutional applications such as office buildings, restaurant chains, schools and other commercial establishments.  The carpet industry also manufactures carpet for the automotive, recreational vehicle, small boat and other industries.

The Carpet and Rug Institute (the "CRI") is the national trade association representing carpet and rug manufacturers.  Information compiled by the CRI suggests that the domestic carpet and rug industry is comprised of fewer than 100 manufacturers, with a significant majority of the industry's production concentrated in a limited number of manufacturers.  The industry has continued to consolidate in recent years.  We believe that this consolidation provides us with opportunities to capitalize on our competitive strengths in selected markets where innovative styling, design, product differentiation, focused service and limited distribution can add value.

Competition

The floorcovering industry is highly competitive.  We compete with other carpet manufacturers and rug manufacturers and other types of floorcoverings.  Despite the industry consolidation, a large number of smaller manufacturers remain.  We believe our products are among the leaders in styling and design in the high-end residential and high-end commercial carpet markets.  However, a number of manufacturers produce competitive products and some of these manufacturers have greater financial resources than we do.

We believe the principal competitive factors in our primary floorcovering markets are innovative styling, color, product design, quality and service.  In the high-end residential and high-end commercial markets, carpet competes with various other types of floorcoverings.

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We believe we have competitive advantages in several areas.  We have an attractive portfolio of brands that we believe are well known, highly regarded by customers and complementary; by being differentiated, we offer meaningful alternatives to the discriminating customer.  In addition, we have established longstanding relationships with key suppliers in our industry and customers in most of our markets.  Finally, our reputation for innovative design excellence and our experienced management team enhance our competitive position.  See "Risk Factors" in Item 1A of this report.

Backlog

Sales order backlog is not material to an understanding of our business, due to relatively short lead times for order fulfillment for the markets served by the vast majority of our products.

Trademarks

Our floorcovering businesses own a variety of trademarks under which our products are marketed.  Among such trademarks, the names "Masland" "Fabrica" and "Dixie Home" are of greatest importance to our business.  We believe that we have taken adequate steps to protect our interest in all significant trademarks.

Customer and Product Concentration

No single customer accounts for more than 10 percent of our sales and we do not make a significant amount of sales to foreign countries.  We do not believe that we have any single class of products that accounts for more than 10 percent of our sales.  However, our sales may be classified by significant markets, and such information for the past three years is summarized as follows:

Seasonality

Our sales volumes historically have normally reached their highest levels in the fourth quarter (approximately 28% of our annual sales) and their lowest levels in the first quarter (approximately 22% of our annual sales), with the remaining sales being distributed relatively equally between the second and third quarters.  Working capital requirements have normally reached their highest levels in the second and third quarters of the year.

Environmental

Our operations are subject to federal, state and local laws and regulations relating to the generation, storage, handling, emission, transportation and discharge of materials into the environment.  The costs of complying with environmental protection laws and regulations have not had a material adverse impact on our financial condition or results of operations in the past and are not expected to have a material adverse impact in the future.  See "Risk Factors” in Item 1A of this report.

Raw Materials

We obtain our raw materials from a number of domestic suppliers.  Man-made yarns are purchased from major chemical companies.  Where possible, we pass raw material price increases through to our customers; however, there can be no assurance that price increases can be passed through to customers and that increases in raw material prices will not have an adverse effect on our profitability.  See "Risk Factors” in Item 1A of this report.  We purchased a significant portion of our raw materials (nylon yarn) from one supplier.  We believe there are other sources of nylon yarn; however, an unanticipated termination or interruption of our supply arrangements could adversely affect our supply arrangements and could be material.  See "Risk Factors” in Item 1A of this report.

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Utilities

We use electricity as our principal energy source, with oil or natural gas used in some facilities for finishing operations as well as heating.  We have not experienced any material problem in obtaining adequate supplies of electricity, natural gas or oil.  Energy shortages of extended duration could have an adverse effect on our operations, and price volatility could negatively impact future earnings.  See "Risk Factors” in Item 1A of this report.

Working Capital

We are required to maintain significant levels of inventory in order to provide the enhanced service levels demanded by the nature of our business and our customers, and to ensure timely delivery of our products.  Consistent and dependable sources of liquidity are required to maintain such inventory levels.  Failure to maintain appropriate levels of inventory could materially adversely affect our relationships with our customers and adversely affect our business.

Employment Level

We employ approximately 1,500 associates in our continuing operations.

Available Information

Our internet address is www.thedixiegroup.com.  We make the following reports filed by us with the Securities and Exchange Commission available, free of charge, on our website under the heading "Investor Relations":

1.  annual reports on Form 10-K;
2.  quarterly reports on Form 10-Q;
3.  current reports on Form 8-K; and
4.  amendments to the foregoing reports.

The contents of our website are not a part of this report.

ITEM 1A.     RISK FACTORS

In addition to the other information provided in this Report, the following risk factors should be considered when evaluating results of our operations, future prospects and an investment in shares of our Common Stock.  Any of these factors could cause our actual financial results to differ materially from our historical results, and could give rise to events that might have a material adverse effect on our business, financial condition and results of operations.

The floorcovering industry is cyclical and prolonged declines in residential or commercial construction activity or corporate remodeling and refurbishment could have a material adverse effect on our business.

The U.S. floorcovering industry is cyclical and is influenced by a number of general economic factors.  The floorcovering industry in general is dependent on residential and commercial construction activity, including new construction as well as remodeling. New construction is cyclical in nature. To a somewhat lesser degree, this also is true with residential and commercial remodeling.  A prolonged decline in any of these industries could have a material adverse effect on our business, financial condition and results of operations. The level of activity in these industries is significantly affected by numerous factors, all of which are beyond our control, including among others:

·

consumer confidence;
·

housing demand;
·

financing availability;
·

national and local economic conditions;
·

interest rates;
·

employment levels;
·

changes in disposable income;
·

commercial rental vacancy rates; and
·

federal and state income tax policies.

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Our product concentration in the higher-end of the residential and commercial markets could significantly affect the impact of these factors on our business.

We face intense competition in our industry, which could decrease demand for our products and could have a material adverse effect on our profitability.

The floorcovering industry is highly competitive.  We face competition from a number of domestic manufacturers and independent distributors of floorcovering products and, in certain product areas, foreign manufacturers.  There has been significant consolidation within the floorcovering industry during recent years that has caused a number of our existing and potential competitors to be larger and have greater resources and access to capital than we do.  Maintaining our competitive position may require us to make substantial additional investments in our product development efforts, manufacturing facilities, distribution network and sales and marketing activities, which may be limited by our access to capital, as well as restrictions set forth in our credit facilities.  Competitive pressures may also result in decreased demand for our products and in the loss of market share.  In addition, we face, and will continue to face, pressure on sales prices of our products from competitors.  As a result of any of these factors, there could be a material adverse effect on our sales and profitability.

Raw material prices may increase.

The cost of raw materials has a significant impact on our profitability.  In particular, our business requires the purchase of large volumes of nylon yarn, synthetic backing, latex, and dyes.  Increases in the cost of these raw materials could materially adversely affect our business, results of operations and financial condition if we are unable to pass these increases through to our customers.  We believe we are successful in passing along raw material and other costs as they may occur; however, there can be no assurance that we will successfully recover such increases in cost.

Unanticipated termination or interruption of our arrangements with third-party suppliers of nylon yarn could have a material adverse effect on us.

Nylon yarn is the principal raw material used in our floorcovering products.  A significant portion of nylon yarn is purchased from one supplier.  We believe there are other sources of nylon yarns; however, an unanticipated termination or interruption of our supply arrangements could adversely affect our supply arrangements and could be material.

We may be responsible for environmental cleanup costs.

Various federal, state and local environmental laws govern the use of our facilities. These laws govern such matters as:

·

Discharges to air and water;

·

Handling and disposal of solid and hazardous substances and waste; and

·

Remediation of contamination from releases of hazardous substances in our facilities and off-site disposal locations.

Our operations also are governed by laws relating to workplace safety and worker health, which, among other things, establish noise standards and regulate the use of hazardous materials and chemicals in the workplace.  We have taken, and will continue to take, steps to comply with these laws. If we fail to comply with present or future environmental or safety regulations, we could be subject to future liabilities.  However, we cannot insure that complying with these environmental or health and safety laws and requirements will not adversely affect our business, results of operations and financial condition.  Future laws, ordinances or regulations could give rise to additional compliance or remediation costs that could have a material adverse effect on our business, results of operations and financial condition.

Acts of Terrorism.

Our business could be materially adversely affected as a result of international conflicts or acts of terrorism.  Terrorist acts or acts of war may cause damage or disruption to our facilities, employees, customers, suppliers, and distributors, which could have a material adverse effect on our business, results of operations or financial condition.  Such conflicts also may cause damage or disruption to transportation and communication systems and to our ability to manage logistics in such an environment, including receipt of supplies and distribution of products.

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Unanticipated Business Interruptions.

Our business could be adversely affected if a significant portion of our plant, equipment or operations were damaged or interrupted by a casualty, condemnation, utility service, work stoppage or other event beyond our control.  Such an event could have a material adverse effect on our business, results of operations and financial condition.

ITEM 1B.     UNRESOLVED STAFF COMMENTS

None.

ITEM 2.     PROPERTIES

The following table lists the Company's facilities according to location, type of operation and approximate total floor space as of February 12, 2007:

*  Leased properties

In addition to the facilities listed above, the Company leases various office spaces.

In our opinion, our manufacturing facilities are well maintained and our machinery is efficient and competitive.  Operations of our facilities generally vary between 120 and 168 hours per week.  Substantially all of our owned properties are subject to mortgages, which secure the outstanding borrowings under our senior credit facilities.

ITEM 3.    LEGAL PROCEEDINGS

There are no material pending legal proceedings to which the Company or its subsidiaries are a party or of which any of its property is the subject.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of the shareholders during the fourth quarter 2006.

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PART II

ITEM 5.     MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company's Common Stock trades on the NASDAQ Global Market under the symbol DXYN.  No market exists for the Company's Class B Common Stock.

As of February 12, 2007, the total number of holders of the Company's Common Stock was approximately 4,850, including an estimated 4,300 shareholders who hold the Company's Common Stock in nominee names, but excluding approximately 925 participants in the Company's 401(k) plan who may direct the voting of the shares allocated to their accounts.  The total number of holders of the Company's Class B Common Stock was 12.

Recent Sales of Unregistered Securities

None.

Quarterly Financial Data, Dividends and Price Range of Common Stock

Following are quarterly financial data, dividends and price range of Common Stock for the four quarterly periods in the years ended December 30, 2006 and December 31, 2005.  Totals of the quarterly information for each of the years reflected below may not necessarily equal the annual totals.  The discussion of restrictions on payment of dividends is included in Note G to the Consolidated Financial Statements included herein.

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THE DIXIE GROUP, INC.
QUARTERLY FINANCIAL DATA, DIVIDENDS AND PRICE RANGE OF COMMON STOCK
(unaudited)
(dollars in thousands, except per share data)

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Shareholder Return Performance Presentation

The Company has elected to compare its performance to two different industry indexes published by Dow Jones, Inc.  The first of these is the Dow Jones Furnishings Index, which is composed of 9 publicly traded companies classified by Dow Jones in the furnishings industry.  The second is the Dow Jones Building Materials & Fixtures Index, which is composed of 7 publicly traded companies classified by Dow Jones in the building materials and fixtures industry.

In accordance with SEC rules, set forth below is a line graph comparing the yearly change in the cumulative total shareholder return on the Company’s Common Stock against the total return of the Standard & Poor’s 600 Stock Index, plus both the Dow Jones Furnishings Index and the Dow Jones Building Materials & Fixtures Index, in each case for the five year period ended December 31, 2006.  The comparison assumes that $100.00 was invested on December 31, 2001, in each of the Company’s Common Stock, the S&P 600 Index, and each of the two Peer Groups, and assumes the reinvestment of dividends.

The foregoing shareholder performance presentation shall not be deemed "soliciting material" or to be "filed" with the Commission subject to Regulation 14A, or subject to the liabilities of Section 18 of the Exchange Act.

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ITEM 6.   SELECTED FINANCIAL DATA

(1)

 Includes the results of operations of Chroma Systems Partners subsequent to November 7, 2004.

(2)

 Includes impairment, other charges and debt extinguishment costs that resulted from the sale of our North Georgia operations during 2003.  These items reduced operating income by $11,366, income (loss) from continuing operations before income taxes by $21,073 and income (loss) from continuing operations by $13,445, or $1.14 per basic and diluted share.

(3)

Includes impairment and other charges of $3,614 and a gain from the sale of an extrusion yarn facility of $6,901.  These items increased operating income by $3,287.

(4)

Excludes discontinued operations.

(5)

The approximate number of record holders of the Company's Common Stock for 2002 through 2006 includes Management's estimate of shareholders who held the Company's Common Stock in nominee names as follows:  2002 - 2,000 shareholders; 2003 - 2,100 shareholders; 2004 - 2,100 shareholders; 2005 - 4,500 shareholders; 2006 - 4,300 shareholders.

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ITEM 7.     MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this report.

OVERVIEW

Our business is concentrated in areas of the soft floorcovering market where innovative styling, design, color, quality and service as well as limited distribution are welcomed and rewarded.  Through our Fabrica, Masland Residential, Masland Contract and Dixie Home brands, we have a significant presence in the high-end of the soft floorcovering market.  We utilize a small amount of our manufacturing capacity to process plied and heat-set filament yarns and provide carpet dyeing and finishing services for independent carpet manufacturers.

During the five year period ending December 30, 2006, our carpet sales grew at a compounded annual growth rate of 12.6% in dollars and 12.7% in units, significantly faster than the sales of the carpet industry. During this five year period the compounded annual growth rate of carpet sales for the industry was 4.1% in dollars and its units sold declined by 0.7%.  We believe our focus on high-end markets, which appear to be growing faster than the overall carpet industry, and our dedication to the development of new and differentiated products are responsible for much of our revenue growth.

The rapid growth of our carpet business increased the complexity of our operations, significantly overtaxed our manufacturing, distribution and operating capabilities and created a number of issues - all of which increased cost, particularly in the second half of 2005 and the first half of 2006.  We addressed these issues by adding facilities and making a number of changes in our existing facilities and management to simplify our operations and reduce cost in the future.  We began seeing the benefits of these changes in the third and fourth quarters of 2006.

CRITICAL ACCOUNTING POLICIES

Certain estimates and assumptions are made when preparing our financial statements.  These estimates and assumptions affect various matters, including:

?

Amounts reported for assets and liabilities in our Consolidated Balance Sheets at the dates of the financial statements, and

?

Amounts reported for revenues and expenses in our Consolidated Statements of Operations during the reporting periods presented.

Estimates involve judgments with respect to, among other things, future economic factors that are difficult to predict.  As a result, actual amounts could differ from estimates made in preparing the financial statements.

The Securities and Exchange Commission ("SEC") has issued disclosure guidance requiring management to identify its most critical accounting policies as defined by such guidance.  Such critical accounting policies are those that are both most important to the portrayal of our financial condition and results and the application of which requires our most difficult, subjective, and complex judgments.  Although estimates have not been materially different from actual experience, our estimates pertain to inherently uncertain matters that could result in material differences in subsequent periods.

We believe application of the following accounting policies require significant judgments and estimates in preparing our Consolidated Financial Statements and represent our critical accounting policies.  Other significant accounting policies are discussed in Note A to our Consolidated Financial Statements.

·

Revenue recognition.  Revenues, including shipping and handling amounts, are recognized when the following criteria are met:  persuasive evidence of an agreement exists, delivery has occurred or services have been rendered, price to the buyer is fixed and determinable, and collectibility is reasonably assured.  Delivery is not considered to have occurred until the customer takes title and assumes the risks and rewards of ownership, which is generally on the date of shipment.  At the time revenue is recognized, we record a provision for the estimated amount of future returns based primarily on historical experience and any known trends or conditions that exist at the time revenue is recognized.

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·

Accounts receivable.  We provide allowances for expected cash discounts, returns, claims and doubtful accounts based upon historical experience and periodic evaluation of the financial condition of our customers.  If the financial condition of our customers significantly deteriorates, or other factors impair their ability to pay their debts, credit losses could differ from allowances recorded in our Consolidated Financial Statements.

·

Customer claims and product warranties.  We provide varying warranties related to our products against manufacturing defects and specific performance standards.  We record reserves for the estimated costs of defective products and failure to meet applicable performance standards.  The levels of reserves are established based primarily upon historical experience and our evaluation of known claims.  Because our evaluations are primarily based on historical experience, actual results could differ from the reserves used in our Consolidated Financial Statements.

·

Inventories.  Inventories are stated at the lower of cost or market.  Cost is determined using the last-in, first-out method (LIFO), which generally matches current costs of inventory sold with current revenues, for substantially all inventories.  Reserves are also established to adjust inventories that are off-quality, aged or obsolete to their estimated fair market value.  Inventories on hand are compared against anticipated future usage in order to evaluate obsolescence and excessive quantities.  Additionally, rates of recoverability per unit of off-quality, obsolete or excessive inventory are estimated based on historical rates of recoverability and other known conditions or circumstances that may affect future recoverability.  Actual results could differ from assumptions used to value our inventory.

·

Goodwill.  Goodwill is subject to annual impairment testing.  The impairment tests are based on determining the fair value of the underlying assets and businesses to which the goodwill applies based on estimates of future cash flows, which require judgments and assumptions about future economic factors that are difficult to predict and in some cases beyond our control.  Changes in our judgments and assumptions about future economic factors could materially change our estimate of values and could materially impact the value of goodwill and our Consolidated Financial Statements.

·

Self-insured accruals.  We estimate the costs to settle claims related to our self-insured medical, dental and workers' compensation plans.  These estimates include costs to settle known claims, as well as incurred and unreported claims.  The estimated costs of known and unreported claims are based on historical experience.  Actual results could differ from assumptions used to estimate these accruals.

·

Deferred tax assets and liabilities.  We recognize deferred tax assets and liabilities for the future tax consequences of differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted income tax rates that will be applicable in future periods when the temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities due to a change in income tax rates is recognized in earnings in the period that the change in income tax rates is enacted.  Taxing jurisdictions could retroactively disagree with our tax treatment of various items in a manner that could affect the tax treatment of such items going forward.  Accounting rules require these future effects to be evaluated using existing laws, rules and regulations, each of which is subject to change.

SHARE-BASED COMPENSATION

We adopted Statement of Financial Accounting Standards No. 123(R), "Share-Based Payments" effective January 1, 2006.  Prior to January 1, 2006, we accounted for share-based payments using Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"), as permitted by SFAS No. 123, and accordingly, did not record compensation expense for stock options.  

We did not modify existing stock-based awards prior to adoption of the new accounting statement and used the modified prospective method to account for compensation expense for share-based payments for periods after the date of adoption for (a) all unvested stock-based awards granted prior to January 1, 2006, based on the estimated grant-date fair value in accordance with previous guidance, and (b) all awards granted after January 1, 2006, based on the estimated grant-date fair value in accordance with the new provisions.  All stock-based awards granted prior to adoption of the new standard, and some of the awards granted after the adoption of the new standard, were not subject to a market condition.  Accordingly, we used the Black-Scholes option-pricing model to determine the grant-date fair value of these awards, both prior to and after adoption of the new

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statement.  The grant-date fair value of awards granted after the adoption of the new standard that are subject to a market condition were determined using a binomial model.  Because we used the modified prospective method to adopt the new standard and the estimated forfeiture method was used under SFAS No. 123 prior to the adoption of SFAS No. 123(R), there was no cumulative effect on our Consolidated Financial Statements as a result of the adoption of SFAS 123(R).  

At December 30, 2006, unvested stock options and shares of restricted stock awards are expected to vest over the next six and one half years.  The compensation expense associated with these awards was $662 thousand in 2006.  On March 2, 2007, restricted stock with a grant-date fair value of approximately $1.4 million that will vest over the next 2 years to 20 years was awarded under our 2006 stock incentive plan.  The compensation expense for all unvested stock options and restricted stock, including the awards granted in 2007, is expected to be $1.1 million in 2007, $831 thousand in 2008, $676 thousand in 2009 and $1.1 million thereafter.  No stock options were granted in 2006 and we do not expect to grant any stock options in 2007.

RESULTS OF OPERATIONS

Our discussion and analysis of financial condition and results of operations is based on our Consolidated Financial Statements that were prepared in accordance with U. S. generally accepted accounting principles.  The following table sets forth certain elements of our continuing operations as a percentage of net sales for the periods indicated:

Fiscal Year Ended December 30, 2006 (52 weeks), Compared with Fiscal Year Ended December 31, 2005 (53 weeks)

Net Sales.  Net sales for the year ended December 30, 2006 increased 3.9% to $331.1 million.  Net sales of our carpet products increased 4.7% and net sales related to our carpet yarn and carpet dyeing and finishing services decreased 7.4%.  Compared with 2005, net sales of residential carpet increased 4.1% and net sales of commercial carpet increased 5.9%.  Our 2006 net sales were negatively affected by significant weakness in the carpet industry during the third and fourth quarters of the year and one less operating week in 2006, compared with 2005.  Adjusting for the extra operating week in 2005, our net sales of carpet products rose 6.7% in dollars and 7.9% in units in 2006, compared to the previous year.  Our carpet sales continued to outpace the carpet industry, where 2006 sales of carpet declined 0.6% in dollars and 6.5% in units, compared with the prior year.

We believe the improvement in our net sales is principally attributable to our focus on high-end markets and the new and differentiated products we have developed over the past several years. Our ancillary sales of carpet yarn and carpet dyeing and finishing services are not significant to our core business and their decrease had less than a 0.5% effect on our total net sales.

Cost of Sales.  The increase in cost of sales as a percentage of sales in 2006, compared with 2005, was principally attributable to costs related to start-up a new tufting and modular/carpet tile operations, higher levels of off-quality production and settlement expenses related to the termination of a legacy defined benefit retirement plan during the first half of the year.  A significant portion of the quality issues were related to outsourcing of tufting production prior to June when our new tufting facility began operating on a full schedule.  The year-over-year comparison was also affected by LIFO inventory liquidations that reduced cost of sales by $297 thousand in 2006 and $389 thousand in 2005.  

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Gross Profit.  The 1.5 percentage point decline in gross profit was attributable to the cost increases described above.

Selling and Administrative Expenses.  Selling and administrative expenses were down $864 thousand in 2006, compared with 2005, due to tight control of discretionary spending.  The decrease of these expenses as a percentage of net sales to 22.9% in 2006, compared with 24.1% in 2005, reflects the effect of lower levels of spending and higher net sales in 2006.

Other Operating Income.  Other operating income increased $78 thousand in 2006 due to insurance settlements and refunds that more than offset lower gains from the sale of operating assets.

Other Operating Expense.  Other operating expense increased $298 thousand in 2006 primarily as a result of losses recognized from the impairment of certain operating assets.

Operating Income.  Operating income was $19.5 million, or 5.9% of sales in 2006, compared with $19.8 million, or 6.2% of sales in 2005.

Interest Expense.  Interest expense increased $1.3 million in 2006 primarily as a result of higher levels of debt.

Other Income.  Other income decreased $157 thousand in 2006 principally as a result of a gain on the sale of real estate in 2005 that did not repeat in 2006.

Other Expense.  Other expense was not significant in 2006 or 2005.

Income Tax Provision.  Our effective income tax rate was 22.7% in 2006, compared with 30.9% in 2005.  The change in the effective tax rates is principally due to reductions in our tax contingency reserve due to favorable resolution of federal and state tax examinations and expirations of tax statute of limitations.  We also were able to utilize more state and federal income tax credits in 2006.

Net Income.  Income from continuing operations was $9.8 million, or $0.75 per diluted share in 2006, compared with $10.0 million, or $0.77 per diluted share in 2005.  Results related to discontinued operations reflected a loss of $2.1 million, or $0.16 per diluted share in 2006, compared to income of $173 thousand, or $0.02 per diluted share, in 2005.  The loss from discontinued operations in 2006 was principally the result of the termination of a legacy defined benefit pension plan that had been frozen as to new benefits since 1993. Including discontinued operations, net income was $7.7 million, or $0.59 per diluted share in 2006, compared with $10.1 million, or $0.79 per diluted share, in 2005.

Fiscal Year Ended December 31, 2005 (53 weeks), Compared with Fiscal Year Ended December 25, 2004 (52 weeks)

Net Sales.  Net sales for the year ended December 31, 2005 increased 9.1% to $318.5 million.  Net sales of carpet products increased 9.9% and net sales of carpet yarn and dyeing and finishing services decreased 2.5%.  Compared with 2004, net sales of residential carpet products increased 8.8% and net sales of commercial carpet products increased 12.3%.  Net sales in 2005 were positively affected by one more operating week than in the 2004 year.  Adjusting for the extra operating week in 2005, net sales of carpet products rose 7.8%, in 2005, compared with the previous year.  Over half of the total improvement in net sales was attributable to the Dixie Home collection of residential products.  A significant portion of the growth in our carpet business resulted from increased selling prices enacted during 2005 in response to raw material and other cost increases.  The decrease in carpet yarn sales is principally a result of carpet yarn sourcing arrangements in the prior year associated with the sale of our North Georgia operations that did not continue into 2005.

Cost of Sales.  Cost of sales was 69.7% of net sales in 2005 compared with 65.9% in 2004.  The increase in cost as a percentage of net sales in 2005 reflects the effect of our rapid growth, higher raw material, energy and other costs and weather related disruptions on our operations.  The rapid growth of our carpet business experienced in recent years increased the complexity of our operations, significantly overtaxed our manufacturing, distribution and operational capabilities, and had a negative impact on customer service, product quality and manufacturing efficiencies.  To improve service to our customers, we added associates, lengthened operating schedules, and increased production outsourcing - all of which increased costs in 2005.  To simplify our East Coast manufacturing and distribution operations and consolidate our West Coast operations, we added

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staff and moved inventory to two new distribution centers and started a new tufting manufacturing operation.  While the cost to staff and build the infrastructure of these new facilities was incurred in 2005, these actions should simplify our operations and reduce cost in the future.  Lags in passing higher raw material and utility costs through to our customers also significantly impacted our costs in 2005.  The year-over-year comparison was also affected by LIFO inventory liquidations that reduced cost of sales by $389 thousand, or one tenth of a percentage point in 2005 and $2.3 million, or eight tenths of a percentage point in 2004.

Gross Profit.  The 3.8 percentage point decline in gross profit was attributable to the cost increases described above.

Selling and Administrative Expenses.  Selling and administrative expenses increased $3.7 million in 2005, but decreased as a percentage of net sales to 24.1% in 2006, compared with 25.1% in 2004.  The percentage decrease is primarily attributable to the higher sales volume.

Other Operating Income.  Other operating income increased $283 thousand in 2005 principally due to gains from the sale of operating equipment.

Other Operating Expense.  Other operating expense decreased $583 thousand in 2005 primarily as a result of costs related to a contract dispute in 2004 that did not repeat in 2005.

Operating Income.  Operating income was $19.8 million, or 6.2% of sales in 2005, compared with $25.6 million, or 8.8% of sales in 2004.

Interest Expense.  Interest expense increased $823 thousand in 2005 as a result of higher levels of debt and higher interest rates.

Other Income.  Other income decreased $814 thousand in 2005 principally as a result of earnings from an unconsolidated subsidiary and the favorable settlement of a vendor dispute in 2004, most of which did not repeat in 2005.

Income Tax Provision.  Our effective income tax rate was 31.0% for 2005, compared with 35.9% for 2004.  The change in the effective tax rates is principally due to reductions in our tax contingency reserve, greater utilization of state income tax credits and the deduction for domestic manufacturing/production activities that became effective in 2005.

Net Income.  Income from continuing operations was $10.0 million, or $0.77 per diluted share in 2005, compared with $14.0 million, or $1.12 per diluted share in 2004.  Results related to discontinued operations reflected income of $173 thousand, or $0.02 per diluted share in 2005, compared to a loss of $1.7 million, or $0.14 per diluted share in 2004.  The discontinued operations loss in 2004 principally consisted of workers' compensation costs associated with businesses sold in 2003 and 2004 and the loss on the sale of a spun yarn facility in 2004.  Including discontinued operations, net income was $10.1 million, or $0.79 per diluted share in 2005, compared with $12.3 million, or $0.98 per diluted share in 2004.

LIQUIDITY AND CAPITAL RESOURCES

During the three-year period ended December 30, 2006, cash generated from operating activities was $36.3 million. These funds we supplemented with $11.1 of additional borrowings under our credit facilities, $11.4 million of available cash, $7.5 million from the sale of assets and $4.7 million from the exercise of stock options.  These funds were used to fund our operations, purchase $57.2 million of property, plant and equipment, pay $10.2 million of taxes related to the sale of a business and pay $3.4 million of additional purchase price consideration related to a previous business acquisition.

During the three years ended December 30, 2006, accounts receivable increased $1.8 million and inventories increased $18.8 million to support our sales growth.  Accounts payable and accrued expenses decreased during this period by $21.9 million as a result of the sale of a significant portion of our business in late 2003.  The accounts payables, accrued expenses and income taxes related to the assets sold were retained by the Company and paid in 2004.

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In June 2006, we terminated a legacy defined benefit pension plan and distributed the plan's assets to participants.  Approximately $2.6 million of cash was used to fully fund the pension plan in order to complete the plan's termination and asset distribution.

Capital expenditures were $16.5 million in 2006 and depreciation and amortization was $11.5 million.  Capital expenditures in 2006 were primarily for equipment installed in our new tufting facility, new manufacturing technology in our other carpet operations and investments in information systems.  We expect capital expenditures to be approximately $14.0 million to $17.0 million in 2007, and depreciation and amortization is expected to be approximately $12.9 million.  The 2007 capital expenditures will be primarily for newer manufacturing technology and to a lesser extent, information systems.

In 2006, we amended our senior loan and security agreement to increase the revolving credit portion of the facility, change certain definitions in the agreement to facilitate the increase in revolving credit and reduce credit spreads applicable to borrowings under the agreement.  As amended, the senior loan and security agreement matures on May 11, 2010 and at December 30, 2006 provides us with $77.7 million of credit, consisting of $60 million of revolving credit and a $17.7 million term loan facility.  The term loan is payable in monthly principal installments of $142 thousand and is due May 11, 2010.

Interest rates available under the senior loan and security agreement may be selected from a number of options that effectively allow us to borrow at rates ranging from the lender's prime rate to the lender's prime rate plus 0.50% for base rate loans, or at rates ranging from LIBOR plus 1.00% to LIBOR plus 2.75% for LIBOR loans.  The weighted-average interest rate on borrowings outstanding under this agreement was 6.99% at December 30, 2006 and 6.60% at December 31, 2005.  Commitment fees ranging from 0.25% to 0.375% per annum are payable on the average daily unused balance of the revolving credit facility.  The interest rate on borrowings under the senior loan and security agreement are fixed by an interest rate swap arrangement, that effectively fixes $30.0 million of borrowings under the agreement at 4.79% plus the applicable credit spreads.  The levels of our accounts receivable and inventory limit borrowing availability under the revolving credit facility.  The facility is secured by a first priority lien on substantially all of our assets.

The senior loan and security agreement generally permits dividends and repurchases of our Common Stock up to an aggregate annual amount of $3.0 million and such distributions in excess of $3.0 million annually as may be made under conditions specified in the agreement.  The agreement also contains covenants that could limit future acquisitions.  The unused borrowing capacity under the senior credit facility on February 8, 2007 was approximately $23.0 million.

In 2006, $6.5 million of capital expenditures were financed by equipment financing notes.  Our $9.3 million of equipment financing notes have terms ranging from five to seven years, are secured by the specific equipment financed, bear interest ranging from 5.55% to 6.94% and are due in monthly installments of principal and interest of $206 thousand through February 2010 and monthly installments of principal and interest ranging from $157 thousand to $23 thousand from March 2010 through February 2013.  The notes do not have financial covenants.

Our $5.2 million of capitalized lease obligations have terms ranging from five to six years, are secured by the specific equipment leased, bear interest ranging from 5.93% to 7.27% and are due in monthly installments of principal and interest of $135 thousand through January 2010 and monthly installments of principal and interest ranging from $110 thousand to $11 thousand from February 2010 through June 2011.  One of the lease obligations requires a final installment of $200 thousand at the end of its lease term in July 2010.  The capitalized leases do not have financial covenants.

Our $6.8 million mortgage note payable is secured by real property, is payable in monthly principal installments ranging from $17 thousand to $28 thousand during its remaining term and matures on March 2013.  The mortgage note bears interest based at LIBOR plus 2.0% and the interest rate is fixed at 6.54% through its maturity date by an interest rate swap arrangement.

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Our $22.2 million convertible subordinated debentures bear interest at 7% payable semi-annually, are due in 2012, and are convertible by the holder into shares of our Common Stock at an effective conversion price of $32.20 per share, subject to adjustment under certain circumstances.  Mandatory sinking fund payments, which commenced May 15, 1998, retire $2.5 million principal amount of the debentures annually and approximately 86% of the debentures prior to maturity.  The convertible debentures are subordinated in right of payment to all of our other indebtedness.

Interest payments for our continuing operations were $7.2 million in 2006, $5.6 million in 2005, and $5.8 million in 2004.  Interest capitalized was $243 thousand in 2006 and $151 thousand in 2005.

The following table contains a summary of the Company's future minimum payments under contractual obligations as of December 30, 2006.

⁽¹⁾ Variable rates used were those in effect at December 30, 2006.

We believe our operating cash flows, credit availability under our senior loan and security agreement and other sources of financing are adequate to finance our normal liquidity requirements.

Future Income Tax Considerations.   We do not anticipate that cash outlays for income taxes will be materially different than our provision for income taxes during the next three fiscal years.  Net operating loss and income tax credit carryforwards in the amount of approximately $1.0 million are expected to be utilized in the future.

RECENT ACCOUNTING PRONOUNCEMENTS

In July 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48").  FIN 48 clarified the accounting for uncertainty in income taxes recognized in financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes."  The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  It also provides guidance on accounting for adjustments of a previously recognized tax position, classification, interest and penalties, taxes in interim periods and disclosure requirements.  FIN 48 is effective for fiscal years beginning after December 15, 2006.  We do not expect the adoption of FIN 48 to have a material effect on our financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, "Fair Value Measurements" ("SFAS No. 157").  SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements.  SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years.  We are currently in the process of evaluating the impact of SFAS No. 157 on our financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statement No. 87, 88, 106 and 132(R)" ("SFAS No. 158").  SFAS No. 158 requires recognition of the funded status of benefit plans in statements of financial position.  It also requires recognition in other comprehensive income of changes in the funding status of such plans during the year a change occurs, as well as modifies the timing of

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reporting and disclosure requirements.  SFAS No. 158 is effective for recognition of funding status and disclosures as of the end of the fiscal year ending after December 15, 2006.  The measurement of defined benefit plan assets and benefit obligations under SFAS No. 158 is effective for fiscal years ending after December 15, 2008.  The adoption of SFAS No. 158 resulted in decreasing other liabilities associated with our postretirement plans by $1,381 and increasing accumulated other comprehensive income by $856, net of $525 of deferred taxes.  The adoption of SFAS No. 158 did not have an effect on our defined benefit retirement plan (See Note J).

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities", including an amendment of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities".  SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value.  The objective of which is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.  Eligible items for the measurement option include all recognized financial assets and liabilities except: investments in subsidiaries, interests in variable interest entities, employers' and plans' obligations for pension benefits, assets and liabilities recognized under leases, deposit liabilities, financial instruments that are a component of shareholder’s equity.  Also included are firm commitments that involve only financial instruments, nonfinancial insurance contracts and warranties and host financial instruments.  The statement permits all entities to choose at specified election dates, after which the entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings, at each subsequent reporting date.  The fair value option may be applied instrument by instrument; however, the election is irrevocable and is applied only to entire instruments and not to portions of instruments.  SFAS No. 159 is effective for fiscal years beginning after November 15, 2007.  We do not expect the adoption of this statement to have a material effect on our financial position or results of operations.

CERTAIN FACTORS AFFECTING THE COMPANY'S PERFORMANCE

In addition to the other information provided in this Report, the risk factors included in Item 1A should be considered when evaluating results of our operations, future prospects and an investment in shares of our Common Stock.  Any of these factors could cause our actual financial results to differ materially from our historical results, and could give rise to events that might have a material adverse effect on our business, financial condition and results of operations.

FORWARD-LOOKING INFORMATION

This Report contains statements that may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended.  These statements include the use of terms or phrases that include such terms as "expects," "estimated," "projects," "believes," "anticipates," "intends," and similar terms and phrases.  Such terms or phrases relate to, among other matters, our future financial performance, business prospects, growth strategies or liquidity.  The following important factors may affect our future results and could cause those results to differ materially from our historical results.  These factors include, in addition to those "Risk Factors" detailed in Item 1A of this report, the cost and availability of capital, raw material and transportation costs related to petroleum price levels, the cost and availability of energy supplies, the loss of a significant customer or group of customers, materially adverse changes in economic conditions generally in carpet, rug and floorcovering markets we serve and other risks detailed from time to time in our filings with the Securities and Exchange Commission.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Dollars in thousands)

The Company's earnings, cash flows and financial position are exposed to market risks relating to interest rates.  It is the Company's policy to minimize its exposure to adverse changes in interest rates and manage interest rate risks inherent in funding the Company with debt.  The Company addresses this financial exposure through a risk management program that includes maintaining a mix of fixed and floating rate debt and the use of derivative financial instruments.

At December 30, 2006, the Company had an interest rate swap agreement on its mortgage note payable with a notional amount equal to the outstanding balance of the mortgage note ($6,770 at December 30, 2006) which expires in March of 2013.  Under the interest rate swap agreement, the Company pays a fixed rate of 4.54% of interest times the notional amount and receives in return an amount equal to a specified variable rate of interest

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times the same notional amount.  The swap agreement effectively fixes the interest rate on the mortgage note payable at 6.54%.

On October 11, 2005, the Company entered into an interest rate swap agreement with a notional amount of $30,000 through May 11, 2010.  Under the interest rate swap agreement, the Company pays a fixed rate of interest of 4.79% times the notional amount and receives in return a specified variable rate of interest times the same notional amount.  The interest rate swap agreement is linked to the Company's variable rate debt and is considered a highly effective hedge.

At December 30, 2006, $15,542, or approximately 17% of the Company's total debt, was subject to floating interest rates.  A 10% fluctuation in the variable interest rates applicable to this floating rate debt would have had an annual after-tax impact of approximately $73.

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The supplementary financial information required by ITEM 302 of Regulation S-K is included in PART II, ITEM 5 of this report and the Financial Statements are included in a separate section of this report.

ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.   CONTROLS AND PROCEDURES

(a)

Evaluation of Disclosure Controls and Procedures.  Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as such terms are defined in Rules 13(a)-15(e) and 15(d)-15(e)) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of December 30, 2006, the date of the financial statements included in this Form 10-K (the "Evaluation Date").  Based on such evaluation, such officers have concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company that is required to be included in our periodic filings under the Exchange Act.

(b)

Changes in Internal Control over Financial Reporting.  During the last fiscal quarter, there have not been any changes in our internal control over financial reporting that have materially affected or are reasonably likely to materially affect our internal controls over financial reporting.

MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13(a)-15(f) and 15(d)-15(f).

Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations.  Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures.  Internal control over financial reporting also can be circumvented by collusion or improper management override.  Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.  These inherent limitations are known features of the financial reporting process; therefore, it is possible to design into process safeguards to reduce, though not eliminate, this risk.

We conducted, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on our evaluation under such framework, our management concluded that our internal control over financial reporting was effective as of December 30, 2006.

Our management's assessment of the effectiveness of our internal control over financial reporting as of December 30, 2006 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which is included elsewhere herein.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of The Dixie Group, Inc.

We have audited management's assessment, included in the accompanying Management's Report on Internal Control over Financial Reporting, that The Dixie Group, Inc. maintained effective internal control over financial reporting as of December 30, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria).  The Dixie Group, Inc.'s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting.  Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.  Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management's assessment that The Dixie Group, Inc. maintained effective internal control over financial reporting as of December 30, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, The Dixie Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 30, 2006, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of The Dixie Group, Inc. as of December 30, 2006 and December 31, 2005 and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 30, 2006, of The Dixie Group, Inc. and our report dated March 5, 2007, expressed an unqualified opinion thereon.

Atlanta, Georgia
March 5, 2007

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ITEM 9B.   OTHER INFORMATION

None.

PART III

ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The sections entitled "Information about Nominees for Director" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement of the registrant for the annual meeting of shareholders to be held May 2, 2007 are incorporated herein by reference.  Information regarding the executive officers of the registrant is presented in PART I of this report.

The Company has adopted a Code of Business Conduct and Ethics (the "Code of Ethics") which applies to its principal executive officer, principal financial officer and principal accounting officer or controller, and any persons performing similar functions.  A copy of the Code of Ethics is incorporated by reference as Exhibit 14 to this Report.

Audit Committee Financial Expert

The Board has determined that John W. Murrey, III is an audit committee financial expert as defined by Item 401(h) of Regulation S-K of the Securities Exchange Act of 1934, as amended, and is independent within the meaning of Item 7(d)(3)(iv) of Schedule 14A of the Securities Exchange Act of 1934. For a brief listing of Mr. Murrey's relevant experience, please refer to the "Election of Directors" section of the Company's Proxy Statement.

Audit Committee

The Company has a standing audit committee.  At December 30, 2006, members of the Company's audit committee are John W. Murrey, III, Chairman, J. Don Brock, Walter W. Hubbard and Lowry F. Kline.

ITEM 11.    EXECUTIVE COMPENSATION

The section entitled "Compensation Discussion and Analysis", "Executive Compensation Information" and "Director Compensation" in the Proxy Statement of the registrant for the annual meeting of shareholders to be held May 2, 2007 is incorporated herein by reference.

ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The section entitled "Principal Shareholders", as well as the beneficial ownership table (and accompanying notes) in the Proxy Statement of the registrant for the annual meeting of shareholders to be May 2, 2007 is incorporated herein by reference.

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Equity Compensation Plan Information as of December 30, 2006

The following table sets forth information as to the Company's equity compensation plans as of the end of the Company's 2006 fiscal year:

⁽¹⁾

Does not include 57,990 shares of Common Stock issued pursuant to restricted stock grants under the Company's 2000 Stock Incentive Plan, with a weighted-average grant date value of $17.86 per share or 149,000 shares of Common Stock issued pursuant to restricted stock grants under the Company's 2006 Stock Awards Plan, with a weighted-average grant date value of $12.68 per share.

⁽²⁾

Includes the aggregate weighted-average of (i) the exercise price per share for outstanding options to purchase 1,029,597 shares of Common Stock under the Company's 2000 Stock Incentive Plan and (ii) the price per share of the Common Stock on the grant date for each of 36,442 Performance Units issued under the Directors' Stock Plan (each unit equivalent to one share of Common Stock).

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The section entitled "Certain Transactions Between the Company and Directors and Officers" in the Proxy Statement of the registrant for the annual meeting of shareholders to be held May 2, 2007 is incorporated herein by reference.

ITEM 14.     PRINCIPAL ACCOUNTING FEES AND SERVICES

The section entitled "Audit Fees Discussion" in the Proxy Statement of the Registrant for the Annual Meeting of Shareholders to be held May 2, 2007 is incorporated herein by reference.

PART IV.

ITEM 15.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

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ANNUAL REPORT ON FORM 10-K

ITEM 8, ITEM 15(a)(1) AND (2) AND ITEM 15(c)

LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES

FINANCIAL STATEMENTS

FINANCIAL STATEMENT SCHEDULES

YEAR ENDED DECEMBER 30, 2006

THE DIXIE GROUP, INC.

CHATTANOOGA, TENNESSEE

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FORM 10-K - ITEM 15(a)(1) and (2)

THE DIXIE GROUP, INC. AND SUBSIDIARIES

LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES

The following consolidated financial statements of The Dixie Group, Inc. and subsidiaries are included in Item 8:

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets - December 30, 2006 and December 31, 2005

Consolidated Statements of Operations - Years ended December 30, 2006, December 31, 2005, and December 25, 2004

Consolidated Statements of Cash Flows - Years ended December 30, 2006, December 31, 2005, and December 25, 2004

Consolidated Statements of Stockholders' Equity - Years ended December 30, 2006, December 31, 2005, and December 25, 2004

Notes to Consolidated Financial Statements

The following Consolidated Financial Statement schedule of The Dixie Group, Inc. and subsidiaries is included in Item 15(d):

Schedule II - Valuation and qualifying accounts

All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions, or are inapplicable, or the information is otherwise shown in the financial statements or notes thereto, and therefore have been omitted.

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of The Dixie Group, Inc.

We have audited the accompanying consolidated balance sheets of The Dixie Group, Inc. as of December 30, 2006 and December 31, 2005, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 30, 2006. Our audits also included the financial statement schedule listed in the Index at Item 15(a).  These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Dixie Group, Inc. at December 30, 2006 and December 31, 2005, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 30, 2006, in conformity with U. S. generally accepted accounting principles.  Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note A to the consolidated financial statements, in 2006 the Company changed its methods of accounting for share-based compensation and postretirement benefit plans.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of The Dixie Group, Inc.'s internal control over financial reporting as of December 30, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 5, 2007 expressed an unqualified opinion thereon.

Atlanta, Georgia

March 5, 2007

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THE DIXIE GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(dollars in thousands)

Page 30

 THE DIXIE GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

Page 31

THE DIXIE GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)