Interface Inc (TILE) 2004 Q2 法說會逐字稿

Good morning. My name is Christy, and I will be your conference facilitator. At this time, I would like to welcome everyone to the Interface, Inc. Second 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 that time, simply press "*", then the number "1" on your telephone keypad. If you would like to withdraw your question, press "*", then the number "2" on your telephone keypad.

I would now like to turn today's conference over to Mr. Jim Malecki (ph) with Financial Dynamics.

Good morning and welcome to the Interface conference call. We're here to discuss the company's results for the second quarter 2004, which were reported yesterday after the close of the market. If you have not yet received a copy of the press release, please call Financial Dynamics at 212-850-5752 or you can get a copy off the company's Investor Relations Web site. An archived version of this conference call will be available through that web site, as well.

Hosting the call today from Interface are Dan Hendrix, President and Chief Executive Officer, and Patrick Lynch, Vice President and Chief Financial Officer. During this morning's call, George will review highlights from the quarter and Patrick will then review -- provide details on the financials. We will then have time for any questions.

Please note that in today's conference call, management's comments regarding Interface's business which are not historical information are forward-looking statements. Forward-looking statements involve a number of risks and uncertainties that could 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 Statements 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 or revise forward-looking statements that they've made during this call and cautions listeners not to place undue reliance on any such forward-looking statements.

Lastly, please note that this call is being recorded for Interface. It contains copyrighted material. It may not be re-recorded or re-broadcast without Interface's express permission. Your participation on the call confirms your consent to the company's taping of it. With these formalities out of the way, I'd like to turn the call over to Dan Hendrix. Dan, please go ahead.

Thank you, Jim. Good morning, everyone. The second quarter was another encouraging quarter for Interface, as we achieved both year-over-year and sequential improvement in sales for the fifth quarter in a row. Our market segmentation strategy continues to create top-line growth, and our focus on cost control is resulting in significant leverage in our operating model. We remain committed to these strategies, and we are confident that they will ensure the long-term prosperity of our company.

During the quarter, we were very encouraged to see double-digit increases in orders for the second quarter in a row. Orders rose 13% to $258 million compared with the same quarter last year, and this trend has continued into the third quarter. Revenues for the second quarter increased 9% to $254 million compared to $234 million last year.

In addition, the higher revenue level, coupled with additional cost savings, led to a considerable increase in operating income. We essentially reached the break-even level in earnings versus a net loss of over $5 million a year ago, and we believe we have positioned the company for a return to profitability.

Our growth in the second quarter was primarily driven by the strength of our U.S. Modular business which posted record sales for the second quarter, significantly outpacing the industry. In the U.S., our market segmentation strategy continues to gain momentum, and we made significant progress capturing market share in the education, retail, and government segments during the quarter.

Our performance also was positively affected by the ongoing gradual recovery in the corporate office market, which is still a substantial portion of our business, as well as general improvement in the overall industry. I'll also note that we experienced similar robust results in Asia-Pacific markets during the second quarter, as our Modular business in this region continued to benefit from strong order flows and market share gains in the commercial market.

In our Fabrics business, we enjoyed a second consecutive quarter of operating profitability primarily as a result of the restructuring initiatives we implemented last year, and we expect to build on this momentum going forward.

While there's still room for much improvement in the results of our Broadloom business, we continued to gain market share in the high-end commercial space, a clear sign of our leadership position in this business. We expect this segment to return to operating profitability, in the third quarter, and we are confident that our strategic initiatives will result in a meaningful improvement in this business.

Overall, we are very encouraged by our results for the second quarter and the first half of 2004 and believe the momentum will continue through the remainder of this year. We look forward to capitalizing on the leverage we've created as the turnaround that appears to be taking shape as it further develops. Now I'll turn it over to Patrick for more details on the quarter.

Thank you, Dan, and good morning, everyone. I'll start with the income statement. As Dan mentioned, sales in the second quarter of 2004 increased 9% to $254.1 million, compared with $234 million in the same period last year. This was the fifth straight quarter in which we realized sequential and year-over-year improvement in sales. Currency changes positively impacted sales by approximately $3 million on a year-over-year basis.

Gross profit margin in the second quarter of 2004 was 29%, compared with 27.7% in the same period a year ago and 29% in the first quarter of 2004. The sequential gross margin improvement was largely driven by higher absorption of fixed manufacturing costs due to increased sales volumes, as well as improved manufacturing efficiencies in our Fabrics business.

SG&A expense in the second quarter of 2004 were $61.8 million or 24.3% of sales, compared to $58.7 million or 25.1% of sales in the same quarter of last year and $62.8 million or 25.2% of sales in the first quarter of 2004.

The year-over-year increase was due primarily to the increase in sales expense as a result of growth in overall sales, investments in marketing expenses targeted specifically at market segments, and a $1 million currency impact year-over-year. As you can see, however, our cost savings initiatives have allowed us to reduce SG&A as a percentage of overall sales.

Operating income during the second quarter of 2004 was $11.9 million, compared with an operating income of $3.7 million in the second quarter of last year which included $2.5 million in restructuring charges. Operating income was $9.5 million in the first quarter of 2004. Interest expense was $11.5 million in the second quarter of 2004, versus $10.2 million in the same period a year ago due primarily to increased borrowings during the period.

For the second quarter of 2004, the company reported net loss of $0.2 million, or zero cents per share, compared with a net loss of $5.4 million, or 11 cents per share, in the second quarter of 2003, which included 3 cents per share associated with discontinued operations as well as 3 cents per share associated with restructuring initiatives.

Depreciation and amortization in the second quarter of 2004 was $9 million, versus depreciation and amortization of $9 million in the same period a year ago. Capital expenditures in the second quarter were $3.4 million, compared with capital expenditures of $3.8 million in the same quarter last year.

Now, I'd like to review some key balance sheet data. At the end of the second quarter, we had $14.8 million in cash and $53 million of additional borrowing capacity under our revolving credit facility. From a working capital perspective, we managed accounts receivables and inventory levels fairly well. Accounts receivable increased $5.5 million since the end of the first quarter, but our DSO levels only went up slightly from 62.5 days in the first quarter of 2004 to $63.1 in the second quarter.

Inventory levels declined slightly from the first quarter of 2004, and our inventory turns improved from 4.4 at the end of the first quarter to 4.5 at the end of the second quarter. These are steps in the right direction, but there's still much room for improvement.

Now I'll go over some details from our individual business units. In the second quarter of 2004, we continued to see robust activity in our worldwide Modular businesses. Sales in this segment were up 13% to $134.1 million, versus $118.8 million in the same quarter last year, largely as a result of the ongoing successes in our market segmentation strategy and the improving conditions in our U.S. corporate office market.

We saw particularly strong sales in education, retail, and government segments. The increase in sales led to higher operating profits from this segment, with operating profits coming in at $13.3 million or 10% of sales versus $9.3 million or 8% of sales a year ago.

Sales in the Bentley Prince Street business were essentially flat versus the second quarter of 2004 at $29.2 million versus $29.3 million a year ago. Segment reported an operating loss of $0.6 million, compared to the operating loss of $0.4 million in the second quarter of 2003.

The loss in the second quarter this year was a result of two primary factors, the under-absorption of fixed manufacturing costs, as we lowered our production volume in order to reduce inventories and, increased investment in sales and marketing initiatives, specifically targeted at the healthcare intended improvement segments.

We are pleased to report that the performance of our Fabrics business has significantly improved. As Dan mentioned previously, a combination of improving market conditions, better manufacturing discipline, and benefits of the restructuring initiatives begun in 2003 have yielded significant improvement in operating profits in this segment. Sales in this segment were $48.9 million, compared to $46.1 million a year ago, while operating profits increased to $1.4 million or 2.8% of sales from an operating loss of $2.5 million in the second quarter of 2003.

Our distribution channel continues to struggle due to difficult operating conditions over the past several quarters. We're making every effort to reverse this trend or, at least minimize its effect. Sales in this business were $38.9 million compared to $38 million last year.

However, this segment reported an operating loss for 2004 in the second quarter of $2.4 million, compared to an operating loss of $1.1 million a year ago. We continue to explore ways to cut our losses throughout our distribution channel. These options include possible headcount reductions, divestitures, and even shutdowns of particular locations, if necessary. Now, I'd like to turn the call back over to Dan.

Thanks, Patrick. The things that we find most encouraging about our results year-to-date are the operating leverage that we've created in our company. For example, comparing the second quarter of this year to the same period last year, our sales improved by 9%, but our operating income improved by over 90%, excluding the restructuring charge in the second quarter last year. We believe our sales improvements have outpaced the overall U.S. industry, which leads us to believe we're gaining market share.

Although the corporate office market is still far from a full recovery to its historical levels, we do believe it's pulled off the bottom and it's progressing in the right direction. And lastly, our residential business, Interface FLOR, is ahead of schedule, energized and creating a lot of excitement in its industry, particularly with the Lowe's rollout that we previously discussed with you.

Our focus going forward will be to continue our market segmentation efforts, that's not anything new, and our cost control initiatives. We remain confident about Interface's growth prospects and we believe the company is well positioned to capitalize on the eventual rebound in the overall industry. I'd like to thank each of you personally for your continued support of Interface. Now I'll open the call up for questions.

Thank you. [OPERATOR INSTRUCTIONS] Your first question is from Lee Brading of Wachovia Securities.

Hi, guys. How are you doing?

Good morning, Lee.

I just had a couple of areas I wanted to focus on. First was I think, Dan, in your opening comments you mentioned the Broadloom business expecting to see a return to profitability in Q3. And, I wanted to just touch on the assumptions and also to see where that compares to Q3 last year. Was that group -- I assume that group was negative in Q3 last year.

Actually it was slightly positive last year.

OK. What -- are you assuming a flat revenue?

A slight increase in revenues. We're also doing some things in the plant to increase the absorption rates in that business. Some of the segmentation initiatives in the BPS collection, which is our (inaudible) improvement business, continues to grow. We've done very well in the healthcare institutional and markets in education, and we think those initiatives will continue to deliver some results. And, then I think the office market is going to gradually continue to improve, and we'll take a share of that, as well.

And speaking of grabbing share, you mentioned on the Modular side that you believe in education, retail, and government you're grabbing share. Are you taking it from other hard surface providers or is it soft surface?

I would say that it's a combination of both, Lee. You know, this new i2 collection, which is the random collection, really fits well in the retail space and education markets. And, you know, it's just taking share. It's a great product for that application.

OK. And are you seeing ...

We also started this initiative, you know, 2.5 years ago, and now we've got a lot of momentum with marketing materials, products, and dedicated sales people. So, all of that now is starting to pay the dividends in those market segments.

Thank you.

Thank you.

Your next question is from Sam Darkatsh of Raymond James.

Good morning, Dan. Good morning, Patrick. I was in and out, unfortunately, during your prepared remarks, so if you've addressed this, I apologize. Patrick, do you have a sense of -- in Fabrics what the impact of the -- of some of the quality issues that were hanging on the piece-dyed process and will that go away in the near-term in terms of Q3?

We think so, Sam. I think we've finally gotten our arms around the manufacturing issues that we've had as part of the closure of certain sites. It probably cost us, you know, somewhere between a half-million and three-quarters of a million dollars in the quarter that we anticipate that we'll realize the benefit in the next quarter....

Were you running -- either in early July or end of June, were you running at better quality rates or is it just a step function kind of thing?

Absolutely. The trend (inaudible) was continued throughout the second quarter.

June was the best month of the three, Sam.

OK. Second question, this is more a housekeeping. What tax rate should we assume when the OI (ph) is positive?

Roughly 37 to 38%.

OK. And, given the price increases that were instituted, I guess, late Q1 -- early Q2, I'm guessing that order rates in Q1 were perhaps a little inflated from pre-buying. Do you think that there are -- that there is a similar -- given the fact I'm guessing you're going to be raising prices along with the industry here in July and August, do you think there's going to be a similar dynamic with the current order trends or do you think that's more of a pure number?

I would say that -- well, you know, we probably pulled in $10 million to $15 million in the first quarter with the price increase. That typically happens. And, we'll pull in some business in the third quarter, but it won't be that dramatic because we didn't really raise the prices until - I mean we raised them the beginning of the quarter in the third quarter and the end in the first quarter, so the third quarter will be a very true number.

So the order rate that you're seeing now in July is pretty pure?

Yes. Oh, it's not an impact of the price increase.

That was what my question was. OK. And, then I guess my final question -- more of a broad-based question -- what do you think -- you know, Corporate is coming back a little bit but perhaps a slower pace than prior expectations. What do you think is the driver here? What types of indicators are you looking at beyond orders -- incoming orders that might signal a more firmer rebound?

What we're seeing, Sam, is we're actually seeing design firms and architectural firms hiring people. They've got a lot of projects on the drawing board. You still have the scenario where they tend to push out the projects, but you're actually seeing a lot more project activity.

Obviously, that helps drive our business when you have projects. A year ago, there wasn't a lot of project work out there, today there's a lot of activity in the project work. And it's a matter of corporations deciding to spend the money.

Gotcha , thank you.

The activity is significantly increased.

Thank you.

Your next question is from Mike Hender of CitiGroup.

Yes, had a couple questions. One is on the modular business, you said that sales were up 13%. How did that split out Europe versus North America. Was the U.S. business up more?

We don't give out those pieces Mike, I would tell you that the U.S. piece was obviously a lion's share of that growth.

And, the other question was on free cash flow. Your working capital went up during the quarter, sales went up. What should we see in the second half? Should we see, continue to be a user of cash, or should we see that reverse and we start generating some free cash flow?

You should see that trend reverse in the second half of the year, Mike, principally in inventory, predominantly in Europe where we build for the holiday season. So the second half should be, working capital should be positive.

Any feel for how much we should see net debt move between now and year-end?

It's too difficult to tell right now.

OK, thank you.

Your next question is from Robert Manowitz of UBS.

Hi, good morning, congrats on the quarter. Just one follow up to Mike's question, how substantial will the inventory be for the Lowe's rollout, is that going to be meaningful?

We've actually increased inventories over $1 million for the residential business and, you know, it's all new to us. So, I think we've pretty much got it to the level that we need it. We may increase another $1 million, but it's not a $4 or $5 million increase at all.

OK, and then, just as you look at that opportunity, I know it's early in the process, but what do you think it could be at the end of the day in terms of market size?

We're not trying to project that. I will say that the whole activity around Interface floor is great. Lowe's projects certain per store, and we're going to roll it out in all thousand stores. But we don't know yet, and I'd really hate to give a number out there that we have to track again.

OK, fair enough. Last question, on your fabrics business, you gave kind of two drivers to the top line, a growing market, and also your marketing efforts, or market conditions and your marketing efforts. What did the category do in your opinion. Was it up 6%, or are you guys gaining share, or?

I would say that category was up 6% and we were up, actually we're up, I guess 8 or 9% in that category.

Great, thanks a lot.

I think we're taking some share.

Excellent, thanks a lot.

Thanks.

Your next question is from Howard Kelly of SunTrust Robinson Humphreys.

Good morning guys, just to confirm, you are seeing some pricing power in the Broadland business?

When you say pricing power, our average selling price in our Broadland business is almost $19.00 a yard. We play at the very top of that segmentation...

OK.

Not in the bottom segment.

Fair enough, thank you.

I want to clarify the last question that I had on the fabrics business, we're actually 6.1%, but we exited a residential business. If you looked at our core business, it's actually up about 9%, that's where I came up with the 9% growth. It's offset by the decline in the residential fees.

Your next question is from Larry Taylor of Credit Suisse First Boston.

Good morning, a number of my questions have been asked, but maybe a little more color on the distribution service side of things. What's sort of timeframe do you think might be appropriate to think about how you would resolve...?

We're looking at it in the second half to try and get the roadmap of where we're headed with that. It's 15 different locations that we're dealing with and each one of them have a different set of issues. And, so it is dealing with a list of things and options that we have, but the number one is to obviously continue to improve operating income of that business. But I would say we'll have a lot more color in the second half of this year.

OK, and then in the education and government areas, can you give us a more concrete sense of, you known, the absolute level of growth there?

It is significant. I mean, it is the major contributor of our growth. We tend not to want to give that out due to competition. But, it is a significant part of our growth potential.

OK, thanks very much.

Thank you.

Thank you.

Your next question is from Jeff Kobolars (ph) of Solomon Brothers Asset Management.

Hi, good quarter. I'm curious about the cost increase you're seeing in the raw materials. What has your experience been in the second quarter and what's it looking like in the third quarter?

We've had several raw material products increases announced Jeff, and we've also raised prices to offset that. There's always a timing delay in that, in other words, you've got orders on the books where the raw material price increase hit. But our tendency since I've been here, which is 20 years, is to offset that with price increases and we'll continue to go down that road. It does impact you a little bit on timing for us. It'll probably cost us 20 basis points in the second quarter.

OK, great, and then the corporate overhead, it was a positive $0.2 million in the second quarter and there's a negative $1.5 million last year second quarter? What's behind that?

Well, you know, we allocate based on sales, and so the sales increase it reduces the allocation.

All right, thank you.

(inaudible) within the business unit.

Thanks very much.

Once again, I would like to remind everyone, in order to ask a question, please press "*" then the number "1" on your telephone keypad. Your next question is from Brian Edwards of Soloman Brothers Asset Management.

Good morning.

Morning.

We were just trying to get our arms around the potential for the Lowe's rollout. And I was wondering if you could give us a sense of what the sales have been to date in the stores in which the products are currently being offered?

Actually, they're fairly minor because we've only been in test stores in 15 stores, and so now we're rolling out nationally. So, we don't really know the impact of the national rollout yet. We're trying not to put a number out there until we know more about...

Is there anything you can give us to help us kind of create our roadmap --?

I would hate to do that, next quarter we'll have a much better idea of that and hopefully we can address. I understand your frustration on that, and we just don't want to try and quantify it yet until we have a lot more color.

OK, no problem. Second question is, I know you've given an estimate for your tax rate, but you guys have a fairly sizeable NOL, is that correct?

Right.

So what do you anticipate you're--

Cash taxes.

The cash taxes for next year?

Couple million dollars.

I'm sorry?

Couple million dollars.

Couple million dollars. OK, and how big is the NOL at this point?

I think gross is $50 million.

OK, great, and the final question is in terms of the cost savings. Are there still some cost saving actions that you've implemented, that haven't yet reflected in the numbers, or do you think most of those cost savings are already reflected in the current numbers?

We're obviously always looking at how to reduce costs. I would say that in the fabric business with this quarter coming, the third quarter, we'll see the full benefit of it. We were phasing people out during the second quarter and pretty much got through that whole rationalization. There's not a big next rationalization step that's on the horizon right now, but we're continuing to figure out how to reduce our footprint.

Great, thank you very much.

Your next question is from David Horn (ph) of Perennial Partners.

Good morning gentlemen, I'm just curious, what was cash flow for the quarter?

Cash flow was a negative $4 million pre cash.

OK, and then what was the working capital conglomerate of that?

It's a use of about $1 million.

All right, and there was $3.4 million of CapEx.

That's right, excuse me. It was a use of about $6 million when I add up those.

Of working capital, and the working capital use will reverse itself in the second half?

Yes.

So, for the year, what are you targeting, contribution to cash flow as far as our working capital is concerned?

I knew you were going to try and tie me down to a particular number. It's difficult to tell what the top line is going to do. All I can tell you is we're continuing to reduce our DSO and our inventory levels.

I'd like to, you know, see working capital get back. I think, you know, there are still currently $5 million or so that we can take out of receivables and out of inventory, but it's going to be difficult with this growing business to manage those inventory levels.

But, we don't want to starve this business going forward, but at the same time, we recognize the need to reduce our debt and de-lever. But, we've got a growth business here and we're trying to manage that effectively. So, it's very difficult for me to tell you what I think working capital is going to be based on the current order trends in the (inaudible) business.

Thank you.

Sure.

There are no further questions at this time. I would now like to turn the call back over to management for any closing remarks.

I just want to thank everybody for hanging with us, and talk to you next quarter.

This concludes today's Interface Incorporated Second Quarter 2004 Conference Call. You may now disconnect.