Interface Inc (TILE) 2004 Q4 法說會逐字稿

Good morning. My name is Michael, and I will be your conference facilitator. At this time, I would like to welcome everyone to the Interface fourth quarter and full year 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. (OPERATOR INSTRUCTIONS).

I would now like to turn the call over to Mr. Jim Olecki of Financial Dynamics. Please go ahead, Sir.

Thank you, operator. Good morning and welcome to Interface’s fourth quarter and full year 2004 results 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 well as Interface’s business outlook. Patrick will then review the Company’s key performance metrics and 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 website. An archived version of this conference call will also be available through that website.

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 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 “Risk Factors” in the amendment to the Company’s registration statement on Form S4 filed with the Securities and Exchange Commission on June 28, 2004. 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 rerecorded or rebroadcast without Interface’s expressed permission. Your participation on the 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 everyone. Let me begin by saying that I believe the fourth quarter was another good one for Interface, rounding out what I believe to be a turnaround year for our Company.

Our fourth quarter sales were strong, and although we experienced some raw material price increases and higher Sarbanes-Oxley compliance costs, we still managed to improve our operating margin year-over-year. These results were driven by our leadership position in the worldwide modular carpet market, the ongoing recovery in the office market, and the success of our market segmentation efforts and cost control initiatives.

In each quarter of 2004 we achieved year-over-year improvements in both sales and operating income, and similar improvements can be seen in the full year period as sales increased 15 percent and operating income nearly doubled compared to the prior year.

We were very encouraged to see order activity remain high throughout the year, with increasing double-digit growth each quarter, with the fourth quarter being the strongest. This is indicative of the increasing momentum in our industry and our leadership position in the markets we serve.

As I mentioned, that the primary driver of growth in the fourth quarter was sales from our modular business. Interface continues to lead and shape the growth of this market, and we believe we are outpacing the rest of the industry during this recovery period. All signs indicate that the office market is rebounding, and we believe carpet tile is taking share across all commercial segments. In addition, our segmentation strategy has opened up an abundance of opportunity in the non-corporate office commercial market segments, and we believe our success in this effort will continue into 2005.

Within our modular business, strong order flows led to robust results from the U.S. and Asia/Pacific regions and a welcome return of profitability in the Europe business, where the difficult operating conditions are starting to subside, particularly in the U.K. We expect to see continued growth in 2005.

We’re also encouraged by the results from our Bentley Prince Street broadloom business and the signs we’re seeing in that market. Sales in the fourth quarter from this business were up slightly year-over-year. Importantly, this was also a second straight quarter of profitability as our cost-cutting initiatives and improvements in manufacturing efficiencies generated significant operating profitability growth in the fourth quarter of 2004.

While we were disappointed with the results from our fabric business in the fourth quarter, we are pleased with its recovery efforts over the course of this year. During 2004, we experienced a $10 million turnaround in operating profitability despite being negatively impacted by our previously announced restructuring initiatives in this business as well as raw material price increases. Although our restructuring actions have had an impact on the recent performance of this business, we do believe the actions we are taking will generate significant long-term benefits.

In addition, our OEM customers are starting to see signs of improvement in the corporate office market, and our European fabric business is starting to show signs of life. We believe we have worked out the integration issues and raised prices attached to the raw material price increases and currently expect a return to profitability in the first quarter of 2005.

Overall, we are pleased by the fourth quarter results and full year results, and we are encouraged to see that our initiatives are beginning to pay off. While raw material price will remain an issue that we and others will have to confront, we believe that with the proper execution of our business strategy, solid cost control, and a more complete industry recovery, we will make a great deal of progress in 2005. We are committed to ensuring that Interface remains the leading player in the modular marketplace, and we will strive to extend this leadership position into each of our other business segments.

With that, I’ll turn it over to Patrick.

Thank you, Dan, and good morning everyone. I’ll 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 fourth quarter of 2004 increased 14.6 percent year-over-year to $232.6 million compared with $202.9 million in the same period last year. This was the seventh straight quarter in which we realized year-over-year improvement in sales. Currency changes positively impacted sales by approximately $5.1 million on a year-over-year basis.

Gross profit margin in the fourth quarter of 2004 was 29.3 percent compared with 29.9 percent in the same period a year ago. The gross margin decline was primarily the result of higher raw material costs, which we believe caused approximately 50 basis points of margin erosion during the quarter.

SG&A expenses in the fourth quarter of 2004 were $52.9 million, or 22.7 percent of sales, compared to $47.1 million, or 23.2 percent of sales, in the same quarter of last year. The year-over-year increase in absolute terms was due primarily to the increases in expenses as a result of growth in overall sales, Sarbanes-Oxley compliance related expenses of $1.5 million, and $1.4 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 increased 29.7 percent during the fourth quarter to $15.3 million compared with an operating income of $11.8 million in the fourth quarter of last year. Interest expense was $11.3 million in the fourth quarter of 2004, versus $11.4 million in the same period a year ago.

For the fourth quarter of 2004, we reported income from continuing operations of $1.9 million, or $0.04 per share, compared with income from continuing operations of $472,000, or $0.01 per share, in the fourth quarter of 2003.

As Dan mentioned earlier, we are reporting the results of operations for the owned resource dealer businesses as discontinued operations as required by accounting standards. Included in those results are an after-tax operating loss of $2.7 million and a loss on disposal of $3.5 million after-tax related to sales of certain assets in the resource dealer businesses. We believe this move is in the best interest of our Company and our shareholders, and this move is in the best interest of the dealer businesses themselves. The owned dealer model was difficult to execute within our corporate environment, but we believe these businesses are viable operating independently with a reduced cost structure. By exiting the owned distribution businesses, we will also be able to streamline our cost structure and reduce our working capital requirements. While there obviously will be a transition period, we expect it to be accretive to earnings and cash flow.

Now, I would like to give you an update on our previously announced plans to exit the resource dealer businesses. To date, we have addressed 10 of our 15 locations. We have sold 5 and initiated the closure of 5 others. We expect the entire transition to be completed by the end of the second quarter and are committed to making it as seamless to our customers as possible. As we said last quarter, our aligned distribution channel is very much an important part of our strategy, and we remain focused on servicing our customers and opening an additional sales opportunities for our modular and broadloom carpet mills.

Including the impact of our discontinued operations, net loss of the fourth quarter 2004 was $4.4 million, or $0.04 per fully diluted share, compared with a net loss in the fourth quarter of 2003 of $4.1 million, or $0.08 per fully diluted share.

Depreciation and amortization in the fourth quarter of 2004 was $7.1 million versus depreciation and amortization of $8.4 million in the same period a year ago.

Capital expenditures in the fourth quarter were $4.3 million, bringing total capital expenditures for 2004 to $15.8 million. This compares with capital expenditures of $5.1 million in the fourth quarter last year and $16.2 million for all of 2003.

Now, I would like to review some key balance sheet data. During the quarter, we paid down $16 million in debt under our revolver and added $16 million in cash on our balance sheet. At the end of 2004, we had $22.2 million in cash and $60.9 million of additional borrowing capacity under our revolving credit facility.

From a working capital perspective, we managed accounts receivable and inventory levels fairly well. Our average DSO’s during the fourth quarter were consistent with the third at around 55 days, and our inventory turns improved from 4.7 times to 4.8 times.

Now, I’ll go over some of the details from our individual business units. In the fourth quarter of 2004, we continued to see robust activity in our worldwide modular businesses. Sales in this segment were up 21 percent to $151.8 million versus $125.5 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 $19.2 million, or 12.6 percent of sales, versus $13.4 million, or 10.7 percent of sales, a year ago.

Sales in the Bentley Prince Street business increased 1.6 percent for the fourth quarter of 2004 to $31 million versus $30.5 million a year ago. The segment reported an operating profit of $0.3 million compared to an operating profit of $0.1 million in the fourth quarter of 2003.

Sales in our fabrics business increased 3.1 percent overall to $46.1 million compared to sales of $44.7 million a year ago. This business was negatively impacted by integration issues arising out of our restructuring initiatives and higher raw material costs, resulting in an operating loss of $1.0 million compared with an operating loss of $0.9 million in the fourth quarter of last year. However, as Dan mentioned, we expect to see profitable performance from the fabrics business in the first quarter of 2005.

Now, I’ll turn the call back over to Dan.

Thanks, Patrick. In 2004, Interface set the foundation for future growth, and I believe we have led this unprecedented downturn in our industry. We increased overall sales by 15 percent and nearly doubled operating income. We have lessened our dependence on the corporate office market through segmentation but clearly significantly improved since the same time last year. We increased our corporate office market share in all of our businesses. We have created a residential brand in InterfaceFLOR, which has, I believe, exciting prospects. Fabrics realized a turnaround in profitability, and I am confident of significant improvements in 2005. We made a decision to exit the service business and have addressed two-thirds of those locations to date, and we enhanced our position on sustainability, which is driving sales growth.

Now, what are the tenets for success in 2005? I have covered some of these on the last call, but I’ll cover them again. Continue to lead and shape the modular market on a worldwide basis and further reduce our dependence on the office market through segmentation, and increase our share in a rebounding office market. Drive sales in broadloom to improve profitability and absorb overhead. We have significantly lowered the breakeven point, and I believe we are poised to benefit significantly with a sales increase. Complete the exiting of the resource service business by June. Realize the continued operating improvements in the fabrics business to achieve and sustain profitability at the current sales level. Capitalize on our leading position with sustainability, and pay down debt through cash flow.

The biggest challenge in 2005 will be to capitalize on the growth opportunities presented by the modular market, offsetting raw material cost increases through price increases and improved manufacturing efficiencies, and controlling SG&A expenses in this recovery market. If we stay the course and get a little help out of the marketplace and execute, I believe we can achieve much better results in the future.

Now, I’ll put it up for questions.

(OPERATOR INSTRUCTIONS). You first question comes from Sam Darkatsh with Raymond James. Please go ahead with your question.

Good morning. This is Chris Thornsberry on behalf of Sam. Good morning, Dan. Good morning, Patrick. Just a quick question with respect to the broadloom and fabrics businesses, and I was curious, looking at some of the industry data, especially in the commercial broadloom sector, it looks like sales have been growing there in the double-digit range in the last couple of months and you have increased your sales to about 1 percent in this quarter. And also, in fabrics, we’re seeing with the BIFMA numbers coming out, the office market seeing quite a nice little rebound in the last couple of months. And with some of the office furniture manufacturers out there, they’re reporting pretty solid sales results in the last quarter that they reported. I just wanted to know what kind of market share trends are you seeing? Are you losing share in this type of a market or what’s going on there? Why aren’t we seeing kind of a little bit better sales growth in this most recent quarter? And what are your, kind of, outlooks for those businesses?

Yes, I would say that, Chris, if you looked at the broadloom business, we’re at a very high end part of the market segment, and you’re looking at more of the mid to low end when you look at those data points. Our average selling price is $19 a yard in that business, and that part of the market really has not come back that strong. I don’t believe we’re losing share at all on that. I think we grew it 10 percent this year. I actually think we took share. I think the overall market was only up 9 percent.

On the fabric side, we actually tried the BIFMA numbers through our OEM’s. The BIFMA statistics for the year were up 5 percent. Our OEM business was up 5 percent as well, so we tracked that. You know, I believe that we’re tracking the market within our fabric business, and I think you’re right. I think there’s going to be a pretty good upswing hopefully coming in ’05 if the numbers are 8 to 9 percent. If that happens, we should see an increasing business in our fabrics as well.

You mentioned that the broadloom business the breakeven point was significantly lower due to some of the cost reduction efforts you have put in place there. Looking at the run rate now at about a $1.5 million run rate, at what point do you hit breakeven? Is it 135 or 140?

No, we actually break even at around 120, 125. We broke even this year in that business.

Okay, so it’s not at the end of the third -- fourth quarter?

We actually made a little bit of money in the fourth quarter.

Okay.

Yes. We’re right at the point where we’re break even, making a little money, and I think with the increase in sales that that business has a lot of leverage and will generate some nice operating income.

Okay, and just a couple more quick questions from me and then I’ll yield to others. Do you have any insight to what you’ve kind of seen in terms of business trends so far in this quarter? Can you give any color into that?

Yes. I would say that starting the first quarter, business has remained strong. I think the office market is starting to come back and rebound. You know, I think that the trends will continue going into ’05 that we’ve seen in ’04.

Okay, and this is my last question, quickly, is just what are your kind of best utilization rates by segment, if you could just point to that?

It depends on which business you’re speaking of. If you looked at our U.S. modular business, we’re probably running at 80 percent. We’re adding capacity. That’s coming on stream in the first half of the year, and it’s tufting machines. If you looked at our European business, we’re probably at a 55/60 percent run rate. Asia, we’re probably in the 75 percent run rate. Fabrics is at the 55 to 60, and broadloom, there has been a lot of capacity in that business.

All right. Thank you very much.

Our next question comes from John Baugh, Legg Mason. Please go ahead with your question.

Good morning. Trends look great. The orders look awfully good as well. I’m curious how much of the margin issue you talked about, and you mentioned the raw materials will continue to be an issue in the first quarter, where are you sort of in pricing? What have you--? What did you anticipate say in your last price increase? And did raw materials go up further since then than you expected, and are you going to be able to offset whatever has transpired in the first quarter? Just give us a sense for where you see raw materials impacting your gross margin.

Yes. I would say, John, that the yarn has been going up, as you know, through ’04. But one of the bigger increases happens to be the backing, the plasticisers and so forth, they increased significantly in the third and fourth quarter. We have raised prices in February and in January in our U.S. businesses to offset those, and in Europe. So obviously our strategy is to pass it through with price increases when we get raw material price increases. And I think it’s going to start stabilizing, I hope, with all prices hanging where they are today, so we’ve raised prices already this year.

So by the June quarter if raw materials don’t go up further from here, would you expect that gross margins to at least be neutral on a raw material pricing equation?

Yes, we would.

Okay. And then sort of I guess following up on the problem areas -- obviously, the tile business is excellent, but what sort of goals do you have for the year both on a revenue and maybe EBIT margin basis for Bentley in fabric? And you don’t have to be precise, but what are your expectations there as we kind of walk through the year?

You know, the broadloom business, we want to grow that business this year $10 million. That’s our goal to do that. I think it will come through segmentation and an office market rebound. If we do that, you’ll see margins increasing toward the 5 percent range. If you look at the fabric business, it really is to stabilize it at around a $200 million level and have a 3 to 5 percent kind of operating income business at that level. And if it grows, there is a lot of contribution margin within the fabric business. You’re right there at the point where any increase generates a lot of operating leverage.

Are there issues, Dan, outside of the OEM business from fabrics that are dragging the bulk down?

No, there’s not. We’re actually having a lot of success in other markets that will start actually coming through in ’05. I’m extremely encouraged by the management there with Chris Richard. I think we’ve done a lot of great things in that business. I mean it’s a better business today than it was three years ago as far as the operating side of it, and we just need to get a little bit of help out of the marketplace and execute our segmentation strategy.

And, maybe for you, Patrick, any change in your thoughts and refresh us on what they are for debt reduction in ’05?

Well, it’s always difficult to put my arms around that in ’05 depending on the level of growth that we’re going to experience or are expecting to experience this year. But, you know, we’ve targeted around $20 million that we’re trying to generate this year in 2005. So that’s kind of the ballpark number that we’re looking at, but it’s all contingent on the level of growth that we see.

And if that’s the right assumption for the year, would most of that occur in the fourth quarter again?

Yes.

Okay. Thank you.

(OPERATOR INSTRUCTIONS). Your next question comes from Mike Kender with Citigroup. Please go ahead with your question.

Yes. I was wondering if we could get for ’05 fill us in on some of the, you know, cash sources and uses, particularly CapEx, you know, what you expect from working capital and any cash restructuring costs you expect?

Sure. In ’05, I think CapEx, you know, depreciation and amortization will be about $34 or $33 million, run rate, CapEx is about $25. Of the, I think, working capital will be a use of cash between $10 and $15 million next year. And, I think, at the end of it the dealers, the disposition, you know, we’re going to still realize that $10-plus to $15 million of realization of that working capital next year.

And in terms of the dealer dispositions, how much did you get from the 5 you sold? And is this--? You know, are we talking material numbers or--?

No, I think collectively over the 5, I think it was about $7 million that we have realized from those 5.

Okay. And you talked about 5 were sold, 5 were being closed, and there were 5 others. So what’s that fate of those 5?

Those, I think 3 will be sold and 2 could be shut down.

Okay. That’s all I have. Thank you.

Your next question comes from David Horn(ph) with Perennial Investors(ph). Please go ahead with your question.

Morning, guys. Actually, it’s Curtis Hines(ph) with Perennial(ph). How are you? I have a couple of quick questions. Could you clarify, you just made a statement to the previous caller, maybe two callers ago, what was the $20 million? Was that the estimated debt reduction--?

Targeted pre-cash flow for ’05.

And then I think you were just breaking out the pieces. Could you do that again for me?

Yes. CapEx of $25, depreciation/amortization of about $34, the working capital use of $10 to $15, and positive source of cash from the disposition of the dealers in ’05 of $10 to $15 million.

Okay. So I guess the difference, just back again below peers(ph), is that income of $10 million or so?

Presumably.

We’re not forecasting.

We’re not giving any guidance.

I understand. So, second question -- I had thought that the contribution margin on the modular business was higher than what was experienced in the fourth quarter. Could you clarify for me if that is not the case or why there wasn’t more leverage on the income of we’ll say $10 million of sales sequentially?

Part of it, -- there are two pieces to that. One is we had the raw material price increases, that Patrick alluded to, that hit margins of about 50 basis points. And the other is you have a pretty good currency gain in the fourth quarter as the euro continued to increase, and we only benefit from a margin flow through on those sales.

I would also like to point out two other things -- is production levels in the fourth quarter were less than they were in the third for two reasons. Really, we had 4 fewer kind of manufacturing days in the fourth versus the third associated with some holidays as well as inventory reduction targets that we had in the fourth quarter. If you were to exclude the currency impact on the balance sheet, inventories were actually down sequentially $3 to $4 million. The currency and the euro had a significant impact, so it looks as though that the inventories are up on a sequential basis by about $2 million, but in reality they’re down $3 to $4 million.

Was the capacity utilization in the fourth quarter more one-time in nature?

It was, yes. That’s correct.

And my second question has to do with, you know, you’re targeting $20 million of debt reduction, which I think is excellent, but right now, you know, even -- the quarter up 77 percent of your EBITDA was consumed to pay interest expense. I guess the question is what can we do to pay down debt faster than just 20million next year?

Expand our EBITDA. That’s our goal, to increase -- as the marketplace increases that we execute our strategy of segmentation, we’re going to increase sales and we’re going to increase EBITDA.

But if, I mean, $10 million roughly is the net income implied by ’05, that means that our shares are trading at over 40 times earnings. Doesn’t it make sense that at that price take some equity and pay down debt to reduce the debt burden and make the business safer to run?

Our strategy is to increase EBITDA and use that to pay down debt.

And do you think that--?

And I think we can do that. That $10 million is your number.

Okay, thank you very much.

(OPERATOR INSTRUCTIONS). Your next question comes from Tom Wong(ph) with Oak Hill(ph). Please go ahead with your question.

Hi. Good morning. Congratulations on a good quarter. I just want to see if you could give us a little bit of update in terms of the competitive landscape, especially on the carpet tile front.

I would say the landscape really hasn’t changed a whole lot. I mean, everybody that’s in the commercial market pretty much are in the modular market. The big players have been in it for a while. Mohawk, Shaw, Tandis(ph), Milliken -- you know, you’ve got good competition and the market is expanding, which is great. And I don’t think -- there has not really been a change in the marketplace.

From a pricing standpoint, given the newer entrants or increased competitive activity in carpet tile, have you seen any trends in pricing?

Well, there have always been price predators in this marketplace. There has always been our competition that are predators pricing their product, you know, $2 and $3 below our product, and we always lead with design and innovation and we typically hold our price. It’s a specified market.

And do you mind reminding me what the current contract is with your lead designers?

Are you talking about with David Oakey?

Yes.

Yes. It goes for another 2 years. There is an option to extend it another 5 years, and we’re in, I believe, very good shape with him.

Great. Thank you very much.

At this time, there are no further questions. Mr. Hendrix, are there any closing remarks, Sir?

I would just like to thank everybody for listening to the call, and I’m looking forward to 2005. Thank you.

This concludes the Interface fourth quarter and full year 2004 conference call. You may now disconnect.