Interface Inc (TILE) 2004 Q3 法說會逐字稿

Good morning. My name is Mitch and I will be your conference facilitator today. At this time I would like to welcome everyone to the Interface Inc. third quarter 2004 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during that time, simply press star then the number 1 on your telephone keypad. If you would like to withdraw your question, press star then the number 2.

Thank you. I would now like to turn the call over to Mr. Jim Olecki of Financial Dynamics.

Thank you operator. Good morning and welcome to Interface's third quarter 2004 result conference call. Joining us from the company are Dan Hendrix, president and chief executive officer and Patrick Lynch, vice president and chief financial officer. Dan will review highlights from the quarter as we as Interface's business outlook. Patrick will then review the company's key performance metrics and the financial results. We will then have time for any questions.

If you have not yet received a copy of the results release which was issued yesterday after the close of the market, please call Financial Dynamics at 212-850-5600 or you can get a copy off of the investor relations section of Interface's Web site. An archived version of this conference call will also be available through that Web site. Before we begin the formal remarks, 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 statements involve a number of risks and uncertainties that could cause offer 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 caution 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 rebroadcast without Interface's express permission. Your participation on this call confirms your consent to the company's taping of it. With these formalities out of the way I would like to turn the call over to Dan Hendrix. Please go ahead, sir.

Thank you, Jim and good morning to everyone and congratulations to Boston. First I am going to run through the highlights from the quarter and then I'll comment on our plans for our own resource dealer business. Please note that it is required by accounting standards with discussion of results on this call except for net loss excludes the discontinued operations. Patrick will discuss the financial details later on this call.

The third quarter was another strong quarter for Interface. Our top line growth continues to be driven by the success of our market segmentation efforts as well as the continued gradually recovery in the corporate office market. During the quarter we were encouraged to see order activity remain high with double digit increases for the third straight quarter in a row reflecting the increasing momentum we are experiencing in our market segmentation initiatives. For the quarter orders rose 18 percent to $239 million compared with the same quarter last year. As I mentioned earlier, those numbers do not include the discontinued operations. While we continue to grow our top line, our commitment to controlling costs has give us significant operating leverage and led to a considerable increase in operating income. Operating income increased 43 percent year over year in the third quarter and income from continuing operations was $2.4 million, or five cents per share.

The primary driver, once again, for the third quarter was sales from our worldwide modular business, which grew 13 percent year over year in the third quarter. Interface continues to lead and shape the growth of the worldwide modular carpet market. Our segmentation strategy has more than doubled our opportunity in the commercial market segments. We saw some encouraging growth in education, retail, government and residential markets during the quarter. Within the modular market we saw strong results in the United States and Asia Pacific regions as our modular business continues to benefit from strong order flows.

Europe also had a welcomed strong quarter in the third, although it continues to be affected by difficult operating conditions in that region.

Our fabric business also benefited from the gradual improvements in the corporate office market. Its sales were up 5 percent, primarily due to improvements in the contract market which is comprised of our office furniture OEM customers. Unfortunately the profit of this business was negatively impacted by a few hitches in the integration of our fabrics operation which is part of our previously announced restructuring initiatives in this business as well as raw material price increases. We believe we have worked out the integration issues, we have raised prices to factor in the raw material price increases and we believe the fourth quarter will return to profitability.

Sales from our Bentley Prince Street Broadloom business increased 12 percent year over year which we believe outpaced others in the high-end commercial market for broadloom. Importantly, through the strategic initiatives we've been implementing over the past several quarters we were able to return this segment to operating profitability in the third quarter and we anticipate a profitable fourth quarter as well.

I would now like to discuss our plans for our resource dealer businesses. As you saw in last night's release we have decided to exit the owned distribution business. We simply had to stop the losses in this business. We believe this move is in the best interests of our company, in our shareholders and we also believe this move is in the best interests of the dealer businesses themselves. The owned-dealer model was tough to execute within out corporate environment and we believe these businesses are viable operating independently with a reduced cost base. By exiting the owned distribution businesses we also will be able to streamline our cost structure and reduce our working capital requirements. While there obviously will be a transition factor, we do not anticipate losing any mill(ph) sales from this action and we expect it will be accretive to earnings and cash flow next year.

With those comments I'll turn it over to Patrick.

Thank you, Dan and good morning everyone. I will start by reviewing the income statement. As Dan mentioned, the results I'm about to review, with the exception of net loss, exclude the owned-resource dealer businesses. Sales in the third quarter of 2004 increased 11.7 percent year over year to $222.8 million compared with $199.5 million in the same period last year. This was the sixth straight quarter in which we realized sequential and year over year improvement in sales. Currency changes positively impacted sales by approximately $4.5 million on a year over year basis.

Gross profit margin in the third quarter of 2004 was 29.4 percent compare to 28.7 percent in the same period a year ago. The gross margin improvement was largely driven by higher absorption of fixed manufacturing costs due to the increased sales volume. However, these advances have been offset by higher raw material costs which we believe caused 5-10 basis points of margin erosion during the quarter.

SG&A expense in the third quarter of 2004 were $49.7 million, or 22.3 percent of sales, compared to $46.3 million, or 23.2 percent of sales in the same quarter last year. The year over year increase in absolute terms was due primarily to the increase in expenses as a result of growth in overall sales, investment in marketing expenses targeting specific market segment and a $1.2 million currency impact year over year. As you can see, however, our cost saving initiatives have allowed us to reduce SG&A as a percentage of overall sales.

Operating income increased 45.3 percent during the third quarter to $15.9 million, compared to an operating income of $11.1 million in the third quarter of last year. Interest expense was $11.4 million in the third quarter of 2004 versus $11 million in the same period a year ago. For the third quarter of 2004 we reported income from continuing operations of $2.4 million, or five cents per share compared with income from continuing operations of $146,000, or zero cents per share in the third quarter of 2003.

As required by accounting standard, we are recording the results of operations for the owned resource dealer businesses as discontinued operations. Included in those results are an operating loss of $4.1 million and write-downs for the impairment of assets and goodwill of $17.5 million and $29 million, respectively.

To date we have addressed five of our 15 owned locations. We have sold three and we have initiated the wind-down of two others. We have several transactions in the works and we expect to have those completed by the end of the year. We expect to have the entire transition completed by the end of the second quarter next year. It is important to note that our line distribution channel, currently comprised of 78 dealer locations which we do not own, is still very much an important part of our strategy. Our primary focus is to transition the businesses of these owned locations so that it will be seamless to our customers. After the transition we will continue to service our customers through our line and independent distribution channels. Over time we believe this will serve to open up additional sales opportunities for our modular and broadloom carpet lines.

As a result, the net loss for the third quarter of 2004 was $47.8, or 92 cents per share, compared with a net loss in the third quarter of 2003 of $13.4 million, or 27 cents per share. Depreciation and amortization in the third quarter of 2004 was $8.4 million versus depreciation and amortization of $7.4 million in the same period a year ago. Capital expenditures in the quarter were $2.1 million compared with capital expenditures of $2.8 million in the same quarter last year.

I'd now like to review some key balance sheet data. At the end of this 2004 third quarter we had $19.7 million in cash and $51 million of additional borrowing capacity under our revolving credit facility. From a working capital perspective me manage accounts receivable and inventory levels fairly well. Accounts receivable increased $2 million since the end of the second quarter, but our DSO levels dropped from 59.6 to 55.9 days in the third. Inventory levels declined by $10.1 million from the second quarter and our overall inventory includes from 3.8 turns as the end of the second quarter to 4.7 at the end of the third.

As a result, we were able to increase our cash balance by $5 million despite making nearly $20 million of interest payments during the quarter.

Now I would like to go over some details from our individual business units. In the third quarter of 2004 we continued to see robust activity in our worldwide modular businesses. Sales in this segment were up $13.3 million - excuse me, were up 13.3 percent to $141.3 million, versus $124.7 million in the same quarter last year, largely, as a result of the ongoing successes in our market segmentation strategy and the gradually improving conditions in the U.S. corporate office market. The increase in sales led to higher operating profits from this segment, with operating profits coming in at $17.3 million, or 12.2 percent of sales, versus $12.1 million, or 9.7 percent of sales a year ago. Sales in the Bentley Prince Street business increased to 12 percent in the third quarter of 2004 to $31.8 million versus $28.4 million a year ago. The segment reported an operating profit of $0.7 million, compared to operating profit of $1 million in the third quarter of 2003.

Sales in our fabrics business increased 4.9 percent overall to $46.7 million compared to sales of $44.5 million a year ago. Most of the sales increase came from the office furniture OEM customers where we saw an increase in year-over-year sales in the quarter. As Dan mentioned previously, however, this business was negatively impacted by integration issues arising out of our restructuring initiatives, resulting in an operating loss of $1.6 million, which was on par with the operating loss in the third quarter last year. We expect to see profitable performance from the fabrics business in the fourth quarter.

Now I'll turn the call back over to Dan.

Thanks Patrick. Overall we were encouraged by our results for the third quarter and the progress we are making with our strategic initiatives. Our goals for the remainder of the year are the following. First to continue to lead and shape the growth of the worldwide modular corporate market. As you all know, this is our core business. It is expanding and we plan to make the most of it. Some of you may have seen the "Floor Focus" magazine that came out with its annual survey of the top 250 design firms in the United States in the October edition. For the sixth straight year, carpet tile was voted the number one hot product. An impressive 58 percent of the designers surveyed said that they would expect to find more carpet tile in 2004. The same survey has our Interface brand, which is primarily our modular foreign brand ranked number one in the category of best overall experience among all carpet manufacturers.

"Floor Focus" calls this quote, "the greatest honor a designer can bestow upon his or her suppliers. Interface also was ranked either first or second in each of the five survey component survey categories of service, quality, design, performance and value. We are very proud to be honored by our customers in this survey and we thank them for their support.

Second built upon the third quarter results of Bentley Prince Street, our broadloom business. In return to operating profitability in the third quarter and we need to build on this momentum to get this business back to an 8 percent operating profit margin. Bentley Price Street remains a leader in the broadloom arena. It finished number one in the "Floor Focus" survey for the design category and was third in best overall experience.

Third, turn the quarter on the fabrics business. In the third quarter it saw a welcome return in sales and we have to complete the job of integrating this operation and getting its cost structure in line to get back to operating profits of 10 percent each and every quarter in this business.

Fourth, capitalize on our leadership in the area of sustainability. One trend in our industry over the past few years is that customers are paying more and more attention to the impacts that they choices make on the environment. This trend is evident by the fact that a few years ago the same "Floor Focus" survey I mentioned did not touch on the area of sustainability. Today it has two categories, green leaders and green kudos and Interface was ranked number one in both.

Fifth, last but not least we will focus on generating cash to pay down debt. As many of you may know, the fourth quarter is typically our best quarter from a cash generation standpoint. I would like to thank all of our stakeholders for sticking with us through the market downturn and these very difficult times and I want you to know that I truly believe better times are around the corner.

Now I'll take questions.

Ladies and gentlemen, at this time I would like to remind you in order to ask a question please press star 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Robert Manowitz with UBS.

Hi, good morning.

Good morning.

Patrick, I was wondering if you could help us understand a little bit the cash implications of the exit from source Americas, I guess in three ways. First kind of quantifying the working capital reduction, two, maybe give us a rough estimate of the magnitude of the proceeds of sales as you unwind-

Sure. I think there's probably $25 million in working capital tied up in this business today that we'll realize through the transition and I think there's probably $10 million or so of potential severance or lease costs and future losses but that will come out to offset that $25 million. I think it could be you know 15-20 escrow positive as we exit this business.

So the 15-20 is a net non-bearing-

That's right and there's 25 of working capital and 10 million of future lawsuits and other shutdown costs.

Okay. Great and then on the same topic you talk a little bit of the terms - about the terms you expect to enter as you sale these locations. Will there be seller financing - expect any sort of volume agreements? What sort of terms?

Well you know I'm reluctant to get into to much of the details because I'm sure we've got several deals that are currently in progress and I'm sure that they will also be aware of this information. I don't want to get into to much of the details, but we have thus far not provided any seller financing of any significance and that the volume agreements have not been discussed either in any significance, but I'm reluctant to go into to much detail. So I won't right now.

There won't be volume agreements.

I'm sorry.

There won't be volume agreements, so I can tell you that.

Right okay. Last question. Just on the operating income line was there a positive impact from FX?

Negligible - been a couple hundred thousand dollars.

Right. Great quarter. Thanks a lot.

Your next question comes from the line of John Baugh with Legg Mason.

Good morning. Congratulations.

Thank you.

Welcome back John.

Thank you. Good to be back. Couple of quick things. Could you talk about within the modular segment how your did versus the U.S. in terms of both revenue growth adjusting for the currency as well as giving me some kind of sense of operating margin performance in Europe versus the U.S. again all within the modular segment?

We don't really break all that out John. We try and avoid that from a competitive standpoint. I will tell you that the U.S. modular business and Asia modular business were up significantly when the European business was flat.

Okay. Of the $4.5 million of currency that helped. Was most of that falling in the modular segment?

Most-- that's correct.

Okay and then - the segmentation seems to be working. You talked in the past about percentage of business that's non-corporate. Can you guess as to where that was in the third quarter and relate that to a year ago or the start of the year or some reference point?

The-Patrick can you get that?

My gist of it John is we're moving to 50% of corporate office and 50% of non-corporate office.

Yeah it is about mid-50's at this point John. Corporate versus non-Corporate.

A year ago it would have been probably 65. The office market.

Okay and that's of the total corporation right in terms of looking at your end markets for the total corporation?

That's right.

Okay and maybe just a little additional color on the residential piece what you're working on both in terms of tile and the broad loom and what you might expect to see or if you want talk about government or education or other specifics - I'm trying to look at 12 months.

I would say that the - I'm trying to paint a landscape here for you. I think the upside that we have in the modular business in the non-office segments are - in the education market, retail space even hospitality in the next 12 months we expect to see some nice growth come out of those markets. If you looked at the residential - the Interface Four which is the modular carpet tile for the home. We've had a lot of success with own catalogue sales, web sales. Our run rate is going to be probably $10 million by the time we end the year.

We're rolling out again a 1,000 stores in Lowe's starting in October and ending at the end of November. We really don't have big sense of how that's going to turn out and we're hoping for the best, but we're actually not hyping that. I will tell you that we're very encourage as far as what's going on at Lowe's but we just don't know.

(inaudible) House and Home we rolled that out last year. We're not having a lot of success in it. We've hired somebody that knows that market really well and we're introducing new products in that market and I think we'll have much better success next year.

And my last question. You mentioned raw materials having a very minor you know looks like impact. Does that mean that you just haven't seen much in the way of raw material increases year-to-date or does it mean you have but you passed it all along and is there any increase pending here in the fourth quarter?

We've had four yarn price increases this year. We've raised our prices in conjunction with those yarn price increases. I would tell - we just raised our fabrics business as well. It's having a negative impact. We are raising prices and there's a timeline when we raise prices and try and recapture those increases, but historically we've raised prices with raw material increases.

Anything pending Dan in the fourth quarter on raw material hikes?

I don't think we'll see a lot on the yarn side, but we'll see.

Good luck. Thank you.

Thank you.

Your next question comes from Keith Hughes with SunTrust Robinson Humphrey.

Thank you. You talked earlier about some profitability targets that have raw linen and fabrics. Are those achievable next year if you have sufficient volume or is it going to take longer than that?

I would say - you know you've got to get broad linen business to 150 million to hit those numbers and I think our run rate - if we can disclose it - $120-125-

Currently?

Currently.

Yeah okay.

Fabric business. I think you can get there within an 18-month period.

And are you starting to see or hear of a lot more competition with the quotas or supposed quotas ending in this year in textiles? Do you expect that to be a problem?

No.

Thank you.

Thank you.

Your next question comes from the line of Mike Kender with CitiGroup.

Yes, I was wondering if you could give us some color on your October order trends?

October order trends have been good. I've been tracking what we've seen in the third quarter.

Okay and also just a CapEx for our fourth quarter in'05?

Probably another $3-4 million in CapEx in the quarter and I would envision CapEx for next year to be in the $18-20 million range.

Okay great. Thank you.

Thank you.

Your next question comes from the line of Jeff Kuginars with Solomon Brothers Asset Management.

Good morning. Can you hear me?

Yes.

Hey Jeff.

Can you comment what the - I admit this, but can you comment what the LTM EBITDA concentration was from the resource vision?

You know I have about $8.0 million negative EBITDA.

For the LTM?

Yeah. It's about that. I think it'll be about 10 - it'll probably be $8.0 million accretive next year from an EBITDA basis. I haven't gone back and actually calculated the EBITDA on an LTM basis, but on a forward basis I think it should be accretive to EBITDA about $8.0 million next year. If that helps.

Right okay and what percentage of your sales go through this internal operation?

$35 million this year.

Okay.

Of that, we - the $35 million or mil sales that goes through the channel we think a lot of that is actually specified by the mil sales rep as well. We've gotten out of markets where we've had a known dealer. Jeff we've actually increased business because a lot of dealers feel like they're getting - the competition is there and try and specify your product.

Right, okay. The press release mentioned good trends in retail, education, government, residental. Can you comment about how you performed in the corporate market - in the healthcare?

Yes, corporate markets and healthcare markets were also up. Corporate - we saw a pretty nice move in corporate compared to where it's been. It think it was up almost eight or nine percent.

Okay alright, terrific. Thanks very much.

Thank you.

Thank you.

Your next question comes from the line of Brian Krug with Waddell & Reed.

All of my questions have been answered. Thanks.

Thank you.

Once again ladies and gentlemen, I would like to remind everyone if you would like to ask a question, please press star then the number one on your telephone keypad. Your next question comes from the line of David Horn with Perennial Partners.

Good morning gentlemen: Can you say again what expect CapEx to be for 2005?

Eighteen to twenty.

Okay and out of curiosity, I mean depreciation has exceeded CapEx now for sometime. Do you see the trend continuing?

Yes, at least through '05 and '06. I think that should be the case.

And what is it that's going on in the company or in the business that has allowed this to happen?

If you go back to the let's say '95 to 2000 area we were spending one and half and sometimes two times depreciation. We built a lot of brick and mortar. We created a lot of capacity within our company. Currently we're running at - on a blended rate probably 60% of capacity. So we'll invest in new technology that's out there but we really don't have invest in capacity to grow our business to get 10% a year.

Okay and then after '06 should this differential level off?

I think it will get close - it'll close - the gap will close, but I don't know that it will be neutral.

And can you just walk me through the cash flow generation for the quarter?

In the current period?

Yes.

The cash flow from operations was about $12 million. We reduced inventories about ten. Generated a little cash - or use cash from accounts receivable is a big use of cash and accounts payables and accruals we paid about $20 million in interest. CapEx was due although we got some proceeds from some asset sales during the quarter. We generated about $5 million but we increased our cash balance by about $5.0 million during the quarter.

And can you just repeat the savings from getting out of the dealer business?

I think it will be EBIT accretive by about $10 million next year and EBITDA accretive about eight.

And the working capital saves?

There's probably $25 million tied up today. We'll realize most of that and we'll use 10 so the next cash proceeds should be about 15.

Thank you.

With some upside.

Thank you.

Thank you.

Once again ladies and gentlemen, I would like to remind everyone in order to ask a question, please press star then the number one on your telephone keypad. Your next question comes from the line of Walter Branson with Regimen Capital.

Thank you. As your results continue to improve do you expect to give any thought towards refinancing your high cost - high coupon debt?

That's always on our radar screen. We always look at what it takes to reduce our costs to capital.

Thank you.

Your next question comes from the line of Mark Degenhart with Oppenheimer Capital.

Good morning guys. Congratulations on a good quarter.

Mark.

Couple of things. Can you give us a sense of what's going on with the sales force especially on the new markets initiatives? Second question. Update on capacity utilization across different areas which would tie in--

What we could see is build out our sales force in broad loom and in modular as well. We are now looking how to expand into a hospitality market. We've expanded as you know in the education market and the retail space market-

Can you give us some numbers on each of those areas?

Excuse me.

Can you give us a sense of numbers in each of those areas?

I hate to give out all this competitive data Mark. I just - our competitors really listen to what we do say (inaudible) I am less apt to do that now than I used to be. We need to increase the sales force so we're increasing the sales force to go after each segment.

Okay. To your point about CapEx spending high a couple of years ago. Could you give us a sense of what capacity utilization is?

It depends on the business we're running in our broad loom business. We're probably running at 50% capacity in our U.S. modular. We're probably running 80% capacity. We actually have new tufting machines which is the bottleneck that we're breaking. They're being installed as we speak. In Asia Pacific we're running probably around 75% capacity. We're also installing machines in Asia as well.

Okay and last-

Probably running fifty--

Okay and last question. Hurricanes. Were they any impact at all positive or negative? Positive in terms of generating sales where damage occurred and negative in terms of disrupting operations in anyway?

I would say that we're tied more tied to the commercial than residential so we didn't get a benefit from a lot of the renovation and refurbishment that's going on. Hopefully, Interface Four we'll get some of that benefit as we roll it out in a lot of stores. From an operations standpoint, I don't think it was that disruptive for us commercially. I mean Florida's a nice market for us - doesn't have the material with that.

Okay and last question. What impact does the rollout (inaudible) have on sales in the quarter as you just put inventory into their stores?

We'll actually there's not - they're only going to inventory in California and in Atlanta and on the West Coast. No it's not going to have a major impact on inventory. We've already built inventory to the tune of about $9.0 million for the residential Interface Four product line. That will be a major impact on inventories, but it's a wait and see as well. We're going to ramp up the service in that business and then we'll see.

Okay thank you.

Thank you.

Your final question comes from the line of David Warren:

Gentlemen I just had one more question. The market has had a nice run at this point and you're really making progress in the business. The one thing that's holding the stock back is the debt load at this point. What are your thoughts on doing an equity offer?

That's not right now on our radar screen. I think the stock's pretty cheap where it is today. We're going to generate some nice free cash flow if profitability improves. So I'm not inclined to go out into the markets right now.

Okay thank you.

Thank you.

At this time gentlemen, there are no additional questions. Do you have any closing comments?

Thank you.

We'll talk to you next quarter.

Ladies and gentlemen, this concludes today's Interface Incorporated Third Quarter 2004 Results Conference. You may now disconnect.