Interface Inc (TILE) 2004 Q1 法說會逐字稿

Good morning, ladies and gentlemen. My name is Alexandria and I will be your conference facilitator. At this time I would like to welcome everyone to the Interface first quarter 2004 conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question and answer period. If you would like to ask a question during this time, simply press *1 on your telephone keypad. If you would like to withdraw your question, you may do so by pressing *2. I would now like to turn the conference over to Lindsay Hatton of Financial Dynamics. Ms. Hatton.

Good morning and thank you for joining us. Today I would like to welcome you to the Interface conference call. We're here to discuss the company's results for the first quarter 2004 which were reported yesterday after the close of the market. The press release from yesterday is posted on the investor relations section of the company's website and an archived version of this conference call will be available through that website as well. Hosting the call today from Interface are Dan Hendrix, President and CEO and Patrick Lynch, VP and CFO.

I would like to say a word about procedures before we begin. After management has made its formal remarks we'll take your questions. Please note that during today's conference call management's comments regarding Interface’s business which are not historical information are forward-looking statements.

Forward-looking statement involve a number of risks and uncertainties that can cause actual results to differ materially from any such statements including risks and uncertainties associated with the economic conditions in the commercial interiors industry as well as risks and uncertainties discussed under the heading 'Safe Harbor Compliance Statement for Forward-Looking Statements' in item 1 of the company's most recent annual report on form 10-K. We direct all listeners to that document.

Any forward-looking statements are made pursuant to the Private Securities Litigation Reform Act of 1995. The company assumes no responsibility to update and revise forward-looking statements they've made during this call and caution listeners not to place undue reliance on any such forward-looking statements.

Lastly, please know this call is being recorded for Interface. It contains copyrighted material. It may not be rerecorded or rebroadcast without Interface's express permission. Your participation on the call confirms your consent to the company's taping of it. Now with these formalities without of the way, I would like to turn the call over to Dan Hendrix. Dan, please go ahead.

Thank you. Good morning. In this morning’s call, Patrick and I will discuss Interface’s results for the first quarter. During the quarter we were pleased to see both our business and our industry continue to make steady progress towards recovery. While we realize that there is still much work to be done in order to return our company to its optimum operating levels, we believe that our results for the quarter are evidence of the significant positive momentum in our business. We also think that this bodes well for the remainder of this year.

In my view there are four main key takeaways for this quarter. Number 1, the corporate office market segment showed signs of improvement. Make no mistake, we have a long way to go before we get back to the historical levels of this segment, but the pick-up was evident, especially in our U.S. modular business. And, the corporate office market still represents about two-thirds of our sales, so any increase in activity here can have a significant impact on our earnings.

Number 2, our market segmentation strategy continued to gain traction as first quarter sales were up year-over-year in every one of our segments. Over the past several quarters, our dedication to the expansion and diversification of our targeted end markets has made all the difference in what we have been able to achieve during the prolonged downturn in our industry. We believe these gains are due not only to the overall industry improvement, but also to us taking share in those markets.

Number 3, the first quarter marked the return to profitability of our fabrics business, a very welcome profitability. As you all know, we’ve undertaken extensive and sometimes painful restructuring in this business and we are finally beginning to see the fruits of these labors. We should build on that momentum.

Number 4, perhaps the most encouraging, we experienced a healthy increase in orders during the first quarter. $273m was booked, which is up 19 percent over the first quarter of last year. This was our highest quarterly order level since the second quarter of 2001. We believe that this recovery in our order flow is a positive indication of our business’ growing strength, and also an important sign of an improvement in the industry environment. The team here at Interface is proud of the hard work that has gone into building our company’s flexible and resilient business model. If our results for the first quarter are any indication, we believe that fiscal 2004 will be the year which we begin to realize all the benefits of our hard work. Now I will turn it over to Patrick for some details of the quarter.

Thanks, Dan and good morning, everyone. I will start by reviewing the income statements. Sales in the first quarter of 2004 were $249.2m, compared with $210.2m in the same period last year. The first quarter of 2004 was the fourth straight quarter in which we realized sequential and year-over-year improvement in sales.

Currency changes positively impacted sales by $8m on a year-over-year basis. Additionally, the first quarter of 2004 was a 14-week period, versus a 13-week period in the first quarter of 2003. Because this extra week occurred in January, during the holiday season, our first quarter sales were positively impacted only by approximately $6m to $7m from the extra week.

Gross profit margin in the first quarter of 2004 was 29 percent, compared with 26.5 percent in the same period a year ago, and 27.7 percent in the fourth quarter of 2003. Gross margin improvement was largely driven by increased fixed manufacturing cost absorption due to the increased volume, as well as the improved manufacturing efficiencies.

SG&A expense in the first quarter of 2004 were $62.8m, or 25.2 percent of sales, compared with $57m, or 27.1 percent of sales in the same quarter of last year, and $58.4m, or 24.1 percent of sales in the fourth quarter of 2003. The year-over-year increase was due primarily to additional sales and marketing expenses as a result of our growth in sales, and a $2.2m currency impact year-over-year.

Operating income during the first quarter of 2004 was $9.5m, compared with an operating loss of $3.4m in the fourth quarter of last year, which included $2.1m in restructuring charges, and operating income of $7.1m in the fourth quarter of 2003, which included $1.6m in restructuring charges.

Interest expense was $11.8m in the first quarter of 2004 versus $10.2m in the same period a year ago. The increase was due largely to increased borrowings during the quarter and a higher overall borrowing rate of interest compared with the prior year.

Net loss for the first quarter of 2004 was $3m, or 6 cents per share, which includes the equivalent of approximately 2 cents a share of costs associated with our bond issuance in the first quarter. This compares with a net loss of $10.4m or 21 cents per share in the first quarter of 2003. Depreciation and amortization in the first quarter was $9.8m. This compares with depreciation and amortization of $9.2m in the same period a year ago.

Capital expenditures in the first quarter were $6m, compared with capital expenditures of $4.6m in the same quarter last year.

Now I would like to review some key balance sheet data. At the end of the first quarter we had $17m in cash, we had $50m of available borrowing capacity under our revolving credit facility. We had $15m in borrowings under the revolving credit facility at the end of the first quarter. The primary use of cash for us during the quarter was for inventories, which was largely in response to increased order activity during the quarter, as well as the seasonal building that generally occurs during the first quarter.

Now I will go over some of the details from our individual business units. In the first quarter we continue to see robust activity in our worldwide modular businesses. Sales in this business were up 23.9 percent versus the same quarter last year, largely as a result of the improving conditions in the U.S. corporate office market and the ongoing successes in our market segmentation strategy.

As in prior quarters, we saw particularly good results in the education, hospitality and health care segments. Although our broadloom business continues to operate under difficult market conditions, we are able to drive top line growth in this business during the first quarter of 2004 as a result of improving office market and the success of our market segmentation strategy.

Sales in the broadloom business increased 24.3 percent versus the first quarter of 2003. It’s overall profitability level also improved year-over-year, primarily as a result of increase fixed manufacturing cost absorption from increased volume, as well as prudent cost management during the quarter. We are pleased to report that performance in the our fabrics business has significantly improved. During the first quarter, this business continued to benefit from the restructuring initiative that we put in place to strengthen and streamline operations, which resulted in its return to operating profitability.

It is clear that our service business has experienced some particularly difficult operating conditions over the past several quarters and we are making every effort to reverse this trend. Despite the 18 percent year-over-year sales improvement during the first quarter, this business continued to struggle due to increased pricing pressure that negatively impacted gross margins. Now I will turn the call back over to Dan.

Thanks, Patrick. In last quarter’s conference call, I reviewed key strategic objectives that we identified as our company’s main guiding tenants both now and going forward. As you will recall, the purpose of these strategic objectives is to prepare our business for ongoing growth and continued operational excellence. It is clear to me that the implementation of these objectives has had a meaningful positive impact on the performance of our business. As we look ahead to the remaining quarters of this year, we want to build on the positive momentum we have established in this quarter so we can return to profitability.

Before I conclude, I want to give you a quick update on an exciting development with Interface Floor, our residential modular business. You already know that we’ve been test-marketing Interface Floor product in the Atlanta area at Lowe’s home improvement stores for the past few quarters. Today I am pleased to announce that we have been given approval for a roll out to sell Interface Floor in all Lowe’s home improvement stores nationwide, which is over 1,000 stores. Most stores will feature Interface Floor as a special-order program, while the Atlanta and Los Angeles markets will be testing an inventory program, supported by Lowe’s advertising campaign. While it is still too early to try to quantify the potential impact of these programs, we think it is a big step forward for this new idea in residential floor covering. We also believe this is a representative of the many encouraging trends that exist throughout our business, and we look forward to maintaining this positive momentum the rest of 2004 and beyond. I would like to thank each of you for your continued support of Interface, and now I will open the call up for questions.

Certainly, sir. (Operator instructions) Our first question is from Keith Hughes; SunTrust Robinson Humphrey.

Can you hear me now?

Yes.

Okay, sorry. I wanted to talk briefly about broadloom as well as fabrics. You had some great – you talked about revenue growth in the quarters. I guess, what kind of growth do we need to get to get real meaningful profits above this low, single-digit type operating numbers from that type of unit?

I would say in the fabrics business, Keith, that we will continue to see the benefits of all the rationalizations that we’ve done there. We didn’t get the full benefit in the first quarter, we actually ended up shutting down Aberdeen in March.

So you still were running it.

Right. Going forward we should see the benefits of all of the cost-cutting that’s occurred in that business.

You just need some more volume in fabrics, is that it?

Yes, today if you have a $50m business today in fabrics and you will get single-digit operating income. If you pick that up from a quarterly basis from $50m to $55m you would get to the 10 percent kind of level.

Okay, but how about on broadloom? You had nice growth there.

Broadloom is the same situation. The business is running at a $27m, $28m clip today. It needs to get somewhere around $30m, $31m to have some meaningful contributions.

Do you have a better feel of once you get the volumes in those businesses, what type of operating margins we should expect?

We’ve created a model that says if you get the broadloom business to $150m you’ve got a 10 percent kind of operating income level. I think if you get the fabrics business to $55m to $60m level that you’ve got a double-digit operating as well.

Okay. And in terms of pricing, I assume you had a price increase sometime during the quarter, is that correct?

We had it in March, we did.

Was that on tile as well as broadloom?

Yes, both.

And how about fabrics?

we are contemplating a price increase in fabrics today.

Okay, great, thank you.

Thank you.

Our next question is from Sam Darcash; Raymond James.

Good morning, Dan, good morning, Patrick.

Hi, Sam.

Dan, at what point do you begin to look at deleveraging a little bit with the cash on your balance sheet?

Every day we consider what we are going to do to deleverage the company, Sam. I mean, as far as the stock price –

No, I’m sorry, as far as repurchasing the bonds that are outstanding. I should have rephrased, I’m sorry.

Okay. Well we would look at it when we get comfortable on the balance sheet, $50m cash, we would start looking at that.

Okay. And looking at your order book, I guess if I look back in time it looks like the orders that you see on a quarterly basis, generally speaking very broadly, they equate to roughly a quarter’s worth of shipments. Taking a look at your current order book, what do you think the lead time is with that, looking at it from top to bottom?

I would say you are right in that. The one thing that is changing is you are seeing more major projects come through which have longer lead times, so you sometimes can’t equate last quarter’s to the next quarter. So I would say that the backlog does usually translate and we expect the second quarter to be a good quarter. I can’t give you a number, obviously we don’t do projections. I think the backlog going into this quarter bodes very well for the second quarter.

Do you think that the backlog was higher because of the price increase, a little pre-buying ahead of that, or –

There’s a little bit of that, but there’s not a lot. Generally take a few orders, two weeks’ orders in in those two businesses, but that sort of pans out in the first three or four weeks. April has been good as well. And mind too that the price increase that came into place in 2004 was during the exact same week in 2003, so you have a corresponding, it’s comparable, absolutely, from that standpoint.

You mentioned leveling off or leveraging off on a prior question, perhaps raising prices in fabrics. Is there a point in time where your offering – I know your offering is much higher end than some of the offerings from the Asian peers. Is there a point in time where you can’t raise prices too, too much because of the Asian competition, or is that really not much of an issue for you?

The Asian competition is not an issue with what we do. We have 24 hour, 48 hour delivery requirements. We play with the OEMs that really don’t have Asian products that they bring in to service them. We don’t compete with Asia.

So that won’t be a significant contributor or factor with respect to your pricing decisions in fabrics?

No.

Okay. And last question, with respect to inventories, how much of the inventories do you view as excess at this point? I mean, excess is a bad word because it depends on whether you see it coming through via orders, but how much of it do you think is excess, and is there going to be any fixed cost absorption issues going forward in the next couple quarters?

I don’t think so, not with our order activity, Sam. I would say that we have a plan to try to bring that $16m increase down to somewhere around $10m in the second quarter.

$12m of the $16m was built in our modular businesses that have the order levels to support that inventory level going into the second quarter, so where the inventory was built was where we wanted the inventory to be built in those respective businesses.

Okay. Starting to feel better, I’m guessing.

Feel a lot better, a lot better than last year.

I hear you. Okay, thanks.

Our next question is from Mike Kinder of Citigroup.

Yes, a couple questions. One is on the revolver, obviously you use the two to finance the inventory build up in the first quarter. Where should – should we assume this is the peak revolver draw, or should we see a little bit more in June?

I would consider this the peak, Mike. Our first quarter is generally our heaviest use of cash as it relates to prepaids, insurance payments, so on and so forth. This is the peak, in the first quarter.

We also had three bond interest payments that we paid in the first quarter.

Yes, add an incremental interest of about $8m during the first quarter, Mike. A couple reasons, one was the 730’s that generally are paid on April 1st fell into the fiscal first quarter this year. That generally falls into the second quarter, as well as the stub period associated with the refinancing of the 9.5 that also generally falls into the second quarter had to be paid in the first quarter as well. You had about $8m in interest paid out in the first quarter.

And on the services business, you referenced costs being up and basically that overcoming the positive impact of higher volumes, can you talk about those costs? What are the major issues that hit you there?

The issue is that pricing gets a lot sharper when there is less business, and so you’ve got competition on price to install a square yard of carpet.

Okay, so basically installation costs haven’t gone up, it’s just pricing pressure?

Pricing wars.

Okay, and the last question was on currency you said that it was an $8m positive to sales, what about the bottom line?

It’s only a couple hundred thousand, Mike, less than $200,000.

Great, thank you.

Our next question is from Lee Brading of Wachovia Securities.

Hey guys. I wonder if you could expand a little bit geographically, if you could talk North America versus Europe, some of the trends you are seeing?

If you looked at our modular business, the Asia Pacific business actually had the biggest increase, we were very pleased with what is going on in the Asia Pacific and we think those trends will continue. The next biggest increase was the U.S. modular business, we actually were up bigger than the market was up, we took share in that business.

The whole paradigm shift from broadloom to modular is happening in the other segments, and we are driving that and helping lead and shape that, so we think that the modular business will continue to show some positive growth so when the office market comes back in any significant amount then we will obviously benefit from that.

The European business, the U.K. is showing signs of life, Continental Europe showing sort of the same things, it is pretty dismal economic climate there.

In regard to going forward on working capital, I think in the past you talked about a 10-15 potential, obviously top line is a lot better than it was in the past. Do you still think that is reasonable or are you looking at more of a neutral bias?

I’m looking more towards a neutral bias, Lee. I think the 10-15 was on a t3 to 4 percent revenue growth, I think there was an opportunity to drive some of the inventory turns to bring down those levels, but on a 20 percent order increase it is going to be difficult. I think it will be a good day’s work to keep inventory levels flat in this environment, I would look towards more neutral.

And then on the capex side, you said you spent $6m this quarter. Any guidance for the year?

I think we’re still going to be around the 18 to 20 range. We had some things that came up that we purchased in the first half that kind of spiked the first quarter capex. That won’t continue through the balance of the year.

And lastly, here. With regard to SG&A, yes it did grow in conjunction with sales. Can you break out the fixed component versus the variable in that? I am just trying to get an idea of the ability to leverage that going forward. Do you look at it being in this ballpark of 62, kind of flat going forward, or should we see an increasing –

I would see it at around the 62 level going forward.

Thank you.

Our next question is from Robert Manowitz of UBS.

Hi, good morning. Congrats on the quarter. First a follow up to the pre-buying question earlier. Can you talk about the order trends in January, February, March year-over-year, how they progressed? And then also, how are things progressing into April?

We don’t really give that kind of breakdown, I will say that they progressed January, if you looked at the build up, January is usually the slowest month and March is usually the best month, and that came through. As far as April goes, the activity has continued to be strong.

Secondly, did you guys look at some sort of measure of capacity utilization? And whatever measure you use, can you share with us the first quarter this year versus last year?

I would say we are probably running below 50 percent last year, this year we are probably in the 55 to 60 percent, depending on the business.

And then lastly, congrats on the Lowe’s business. Does that require some sort of inventory buyout?

We don’t have a situation where we buy it back from them, if you are referring to that. There is a little bit of inventory build that we put in place to service that business.

You don’t have to buyout an existing competitor’s inventory?

We are the first people in Lowe’s with modular carpet.

Okay, thanks very much.

Our next question is from Larry Taylor of CSFB.

Thanks. A number of my questions have actually been asked and answered already, but if I heard you correctly you are saying you don’t anticipate any significant use of working capital to build out this Lowe’s program?

That’s correct. And one point that needs to be clarified is that the southern store rollout will be largely a point of purchase kind of program that would not require inventory. We will inventory the two test markets in Los Angeles and in Atlanta that will have advertising campaigns behind those two programs. The initial roll out will not include an inventory program in a majority of the stores.

And obviously you can’t give us too much detail on margins with that product line relative, but when you think of them relative to your other ones, can you give us some sense of where it falls on the spectrum?

It is less than our commercial, obviously. I don’t want to give pricing that we have in that business.

Still, that’s helpful. I wonder if you can spend a minute talking about some alternatives with respect to this service business which continues to be difficult here, just sort of what are some of the things that you have on the table, potentially, to resolve those issues?

There is a rising tide situation with our service business. In other words, when business conditions improve that business will improve, so the drag on earnings will be less going forward. We are also exploring how to reduce our exposure in that service business and there are some options on the table, we wouldn’t discuss those on this call.

Great. I wonder if you can give us any more specific sense of the growth by product segment, I mean by end segment, end market so to speak; for example, health care, education, hospitality.

I will rank the markets for you where we see the biggest opportunities. Obviously the biggest opportunities is if the office market comes back, that’s still, you know, two-thirds of our business. The next biggest opportunity is education, and we are having a lot of success in K through 12 as well as higher education with both our broadloom and our modular products. We think that will show significant growth this year.

The next biggest piece is actually health care where we are doing pretty well with health care in modular and in broadloom, and then hospitality to me is one that is in the neophyte stages of modular carpet, but our product fits perfectly into what goes on in hospitality and we have a lot of success with the Hyatt and we are creating I think a lot of opportunity with other hotels to increase that business, and I look for hospitality to be a pretty big part of our business over the next five years.

Thank you very much.

Thank you.

Our next question is from Brian Krugg of Wodell and Reid.

Actually, mine’s been answered. Thank you.

Our next question is from Ray Bauer of CSFB.

Hi, I was just wondering if you could elaborate a little bit on the Lowe’s announcement. I am just trying to understand the difference between what happens, I believe the two markets, Atlanta and Los Angeles versus all the Lowe stores in other locations.

One thing that Lowe’s does is they want to know what drives the product in the store, so we are doing test markets in Los Angeles and Atlanta with advertisements that Lowe’s has not done yet. So there’s an advertising campaign to figure out what moves the needle, but they also want to do an online purchase, you actually have a display of the product and so forth, but they don’t inventory it.

Okay, so the difference between if I go to a Los Angeles location versus a Cincinnati location is that there is inventory at the Los Angeles facility, but there isn’t at the Cincinnati location?

Right, and there is going to be advertising supporting that.

Only in the Atlanta and Los Angeles ones? There’s only advertising supporting the Atlanta and Los Angeles, is that correct?

That’s correct.

Okay, great. And just a second question is, can you just update us on your cash tax situation? It looks like you guys will be profitable on an EPS basis later on in this year. Where does your NOL stand?

Well we have sufficient NOLs to cover any of the taxes that would be paid in 2004 on a profitability, although there will be some cash taxes paid in Europe, less than $2m.

Terrific. Thank you.

Our next question is from John Baugh of Wachovia.

Good morning.

Hi John, I thought you disappeared on us.

Well I had another conference call so I’m in late, but my question related to fabrics. You did a tremendous job on the operating income line. If I adjust it for the extra week what looked like flat sales. Is that all cost reduction and tell us kind of what you are seeing in the cubical market from a vendor perspective.

I would say that a lot of it was rationalization, we took out costs. We rationalized total plants in that business. We also, on the top line, have exited the residential fabric business which was about a $20m business that was not very profitable, and we are replacing that with a profitable contract fabric business. So you have a growth within the contract fabric market that doesn’t show up on the overall business. We’re seeing sort of what the OEMs are saying, we actually can look into our fabric orders and the activity is better. The statistics are up then I think we are pretty much tied to what that industry is telling Wall Street, but the activity is better.

And then I apologize again, you may have addressed this, it’s just a quick comment on the sort of a cost price relationship within carpet, with all of the inflation we’ve seen in raw materials, what the impact of that was in Q1 and the expectations in Q2?

We didn’t really see an impact in Q1 on that, we had a price increase that got put through in March, and we had a price increase ourselves in March and we raised prices the last time we had a price increase, so we think we’ve offset the increase from a raw material standpoint within the carpet business with price increases. We don’t anticipate it having a negative impact.

Thank you, good luck.

Our next question is from Pamela Wilson of WL Roth.

Could you give us an estimate on what you think the sales potential is for new product in the Lowe’s store per store?

It’s really too early to really factor that out, but we will report it as it comes to us.

Okay. And then the services business, is there any reason why you have to be in that business?

Well you have to have an aligned dedicated channel, we believe in that from a strategic standpoint, it is very important to have an aligned channel that is dedicated to you, so that’s why we’ve created this owned and aligned channel. I think you can benefit either way if you own it as far as –

Our next question is from Jeff Kobalaugh of Solomon Brothers Asset Management.

I’m all set. No questions. Thanks.

(Operator instructions) Your next question is from Keith Hughes of Robinson Humphrey.

Yes, now that you are getting some orders back in, do you think you will get back to giving us more concrete earnings guidance, at least a quarter ahead, moving forward?

We will take that under advisement, Keith.

I appreciate it, thanks.

Our next question is from David Horn of Perennial Partners.

Good morning, gentlemen. Can you just please reiterate what the impact was on sales for the currency as well as the additional week, as well as what that impact would be on operating income if you remove them?

The currency impact on a year-over-year basis had about an $8m impact on sales, increase in sales. Overall profitability would have had less than a couple hundred thousand dollars because you are translating a much lower base there. The extra week, which our best estimate of what really that extra week contributed was about $6m to $7m of incremental sales that happened – the extra week occurred in January, largely during the holiday season. It’s kind of difficult to kind of get your arms around what the cost impact was there, but it had a $1.5b overall impact to us in the quarter. It was fairly negligible.

Thank you.

Our next question is from Nicholas Sartizi of Schapman Capital Management.

Good morning. I was wondering if you could give us some more color on your progress towards the non-commercial markets, particularly hospitality, education and health care. If you could also give a sense as to how much of your growth there was your taking share versus growth in the underlying markets? Thanks.

I would say that we are having a lot of success in all those markets. Education to me is – this will be, the buying season is starting in the second quarter, and we are specified on a lot of business and I think we are going to see some pretty exciting results come out of the education market for us, both in broadloom and in carpet tile. Hospitality, we’re pioneering a new concept, modular carpet into the hotels. There is a lot of energy around that, I would say three years from now it will be a significant part of our segmentation strategy, we are getting ready to invest in that kind of stuff. The hospitality and modular carpet. Retail space, we haven’t talked about that, but we are actually having success there. And health care as well, we’ve got a new product line for health care. In modular we’ve been having a lot of success. All of those market segments that we embarked on in 2001 we are starting to see the fruits of product development as well as in sales and marketing.

And how would you characterize, taking away your market share gains, how would you characterize the underlying market there?

I would say the underlying markets are really – I’ve heard of carpet numbers, that the carpet market was up 8 to 9 percent. I would say those markets probably are up single digit as well. And education is probably flat because of the funding issues there. It still is a pretty good marketplace.

And I’m sorry, and on hospitality, any more progress with the Hyatt chain?

We’ve got product in the Hyatt, we’re selling other Hyatt stores product and we are now taking that concept to other hotels.

Thanks.

Gentlemen, there are no further questions at this time.

Thank you.

Ladies and gentlemen, thank you for your participation in today’s Interface first quarter 2004 conference call. This concludes today’s call. You may now disconnect.