Interface Inc (TILE) 2005 Q2 法說會逐字稿

Good morning. My name is Chrystal and I will be your conference facilitator today. At this time I would like to welcome everyone to Interface's second quarter 2005 results conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to Mr. Jim Olecki. Sir, you may begin.

Thank you, operator. Good morning and welcome to Interface's second quarter 2005 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 the financial results. We will then have time for any questions.

If you have not yet received the 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 An archived version of this conference call will also be available through that Web site.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 risk 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 their heading Safe Harbor Compliance Statement for Forward-Looking Statements in item 1 of the company's most recent annual report on Form 10-K filed with the Securities and Exchange Commission. 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 be re-recorded or rebroadcast 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. Please go ahead, sir.

Thank you, Jim and good morning to everyone. The second quarter is what I will call a true breakout quarter for Interface as orders, sales, operating income, and income from continuing operations all experienced strong, double-digit growth compared with the prior period. The top line growth continues to be driven by our leadership position in the worldwide modular carpet market, the ongoing recovery in the corporate office market and the success of our segmentation efforts.

Our cost management efforts are also paying dividends, allowing us to make additional investment in sales, and marketing to help drive the top line and increase profitability across nearly all of our businesses. More importantly, gross margins also improved year-over-year as raw material prices stabilized during the quarter and allowed the price increases that we have been instituting over the past few months to take hold and catch up with prior cost increases.

Within our modular business, strong order flows led to robust results across all of our regions. Worldwide our modular sales were up 20% led by double-digit increases across each of our modular divisions, Asia Pacific, the Americas, and Europe. Our segmentation strategy continues to work well around the world and we capitalized on segments across our core office markets. And we believe this trend will continue throughout the second half of the year.

Now on to Bentley Prince Street, once again contributed to operating profits during the quarter and operation of this business has never been better. Our cost cutting initiatives and improvements in manufacturing efficiencies have given us the leverage needed to take advantage of future top line growth. Revenues in the fabric business increased 6% during the quarter driven by the gradual improvement in the corporate office market. Orders also remained strong entering the third quarter with our OEM customers. That is, our systems furniture customers are now seeing positive trends in the market as well.

We reduced inventories in our fabric business by $5 million during the quarter, which impacted operating income due to under absorption of fixed overhead. But we now have matched inventory levels with order activity. And we expect profitability in this business to be better in the second half of the year than in the first half. Lastly, in line with our stated timeframe we have now completed the divestiture of our dealer business. It is now done. As a result we anticipate additional cost structure efficiencies and improvements in our cash flow for the second half of 2005.

Going forward, we will continue to leverage the leading position of our core modular carpet business, enhancing our presence in all market segments around the world. At the same time we will continue making improvements in our fabrics and broadloom business throughout the year to bolster their profitability. In addition we plan to substantially expand capacity in our Asian and U.S. modular carpet plants to relieve capacity bottlenecks caused by growing demand. We expect this to result in a $15 million capital expenditure over the next two years.

We are pleased with the strong growth in order rates we have seen over the course of the second quarter. And we are optimistic that we can continue to generate revenue growth throughout the year and improve profitability across all our business lines through execution of our strategy coupled with improving market trends. We feel very, very good about where Interface is positioned today. In my 22 years I have never seen a better upside for this company. And with that I'll turn it over to Patrick for some more details on the quarter.

Thank you Dan and good morning everyone. As in previous calls the results that I'm about to review with the exception of net loss, exclude the owned resource dealer businesses. As we've previously announced, the Company made the decision to exit this business, which is therefore being treated as discontinued operations in accordance with accounting standards. For the second quarter of 2005 sales increased 14% to $246.5 million versus $216.2 million in the second quarter of 2004 representing the ninth straight quarter of year-over-year improvement in sales.

The positive impact of currency changes on sales in the 2005 second quarter was approximately $2.6 million. Second quarter 2005 gross profit margin was 31.3% compared with 30.9% in the year ago period. The improvement in gross margin was due to a combination of raw material prices stabilizing and increased sales levels. SG&A expenses in the second quarter were $56 million or 22.7% of sales compared with $51 million or 23.6% of sales in the same quarter last year.

The year-over-year increase in absolute terms was due primarily to higher costs related to the growth in overall sales and increased marketing efforts. However, our cost savings programs enabled us to reduce SG&A as a percentage of overall sales. Operating income during the second quarter of 2005 jumped to $21.2 million or 8.6% of sales versus $15.9 million or 7.3% of sales in the second quarter of last year. Interest expense was essentially flat at $11.5 million in the second quarter of 2005 versus $11.6 million in the second quarter of last year.

As described in our press release, we repatriated $10.5 million of earnings from foreign subsidiaries during the second quarter of 2005 to take advantage of the tax relief provided in the American Job Creation Act of 2004. Consequently the company recorded a tax charge of $1.6 million or $0.03 per share in the second quarter related to the repatriation. Including the repatriation tax charge, income from continuing operations in the second quarter of 2005 was $3.9 million or $0.08 per diluted share.

Please remember that we are reporting the results of operations for our owned resource dealer businesses as discontinued as required by accounting standards. Included in those results are an after tax operating loss of $9.8 million and a loss on disposal of $1.6 million after tax related to the sale of certain assets in the resource dealer businesses. As Dan mentioned, we have completed the divestiture of our resource dealer businesses as planned. As we said on past calls, our aligned distribution channel is still an important part of our sales 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 discontinued operations, we reported a net loss in 2005 in the second quarter of $7.4 million or $0.14 per diluted share compared with a net loss of $0.2 million or $0.00 per share in the second quarter of 2004. Depreciation and amortization in the second quarter of '05 was $8.1 million compared to $8.5 million in the second quarter of last year. Second quarter 2005 capital expenditures were $2.4 million versus $3.3 in the year ago period.

Now a few key balance sheet data items. At the end of 2005-second quarter we had $22.4 million in cash, $71.4 million of additional borrowing capacity under our revolving credit facility. Our average DSO during the quarter was 55.6 days, which is less than the 59.6 days we recorded in the second quarter of '04. Our inventory turns were 4.5 times compared with 3.9 times in the second quarter of '04.

Now a couple of details from our individual business units. As Dan mentioned second quarter of 2005 continued to see strong activity within our worldwide modular businesses. Sales in this segment rose 20% to $163.7 million for the quarter from $136.9 million a year ago. As in past quarters this is largely the result of ongoing successes in our market segmentation strategy and the gradually improving conditions in the U.S. corporate office market.

This increase in sales led to improved operating profits from the segment, which totaled $21.4 million or 13.1% of its sales versus $14.4 million or 10.5% of its sales last year. Bentley Prince Street sales were relatively flat in the second quarter at $29.4 million versus $29.3 million in the year ago period. However, this business generated an operating profit of $0.5 million versus an operating loss of $0.6 million in the second quarter of 2004.

Sales in our fabrics business increased 5.6% to $49.5 million versus sales of $46.9 million a year ago. During the quarter we reduced inventories in this business by $5 million, which impacted its profitability causing an essentially breakeven performance versus an operating profit of $2 million in the second quarter of last year. We expect to see the performance of the fabrics business improve as we progress through the year. With that, we'll now open the call up to questions.

[OPERATOR INSTRUCTIONS]. Your first question comes from Sam Darkatsh with Raymond James.

Good morning Dan. Good morning Patrick.

Good morning.

Very nice quarter. String a few more of these together and we'll really start having some fun.

What a difference two years will make, Sam.

You can name that tune in two notes. The fabrics inventory drawdowns. Patrick, you mentioned you took inventories down $5 million. What was the impact on under absorption due to that $5 million?

It was about $1.2 million in the quarter, Sam.

And you mentioned that you had higher marketing costs. Do you have a sense of what those higher marketing costs might have been on a sequential basis more versus Q1? Because I know you had some higher marketing costs in Q1 as well.

About $2 million, Sam, we increased it.

Okay. So those two items combined were a headwind of, if my math's right, maybe $0.04 or so in the quarter if you assume that there were no positive benefits to the marketing expenses?

Yes. We're actually increasing our marketing in the segmentation strategies. We're actually increasing our marketing costs within our broadloom business as well. And we're also increasing salespeople. So you're getting a -- we're going to get some benefit from that as well.

Got you.

We probably wouldn't spend the money.

Clearly. Sequentially from the first quarter it looks like a variable margin -- contribution margin was about 34% on the operating line on the incremental sales. What do you see in terms of ballpark leverage on the operating line on incremental sales over the next few quarters?

Historically we've had this model between 25 and 30. I don't think we're going to change that model today. But we are investing in the future.

Okay. And so that was what I was getting at. Were there going to be some step function costs that you see in the next couple of quarters that might revise that leverage or do you think that leverage, that historical leverage would hold true?

I hope it will hold true.

Okay. Last question before I let others ask. Quarters were up nicely overall. Sequentially they were flat. There may be some seasonal things, I'm thinking, in that sequential number. But would that potentially imply lower sequential sales growth than the 5% sequential sales growth we saw Q2 over Q1, the fact that orders were kind of flattish sequentially or am I reading too much into that?

You're reading too much into it. We're a made to order house. And the business activity hopefully will improve. And we will get our fair share of it. And the market conditions are pretty healthy right now.

So as the quarter progressed business continued to improve?

I hope so. That's our --

As does the Q2, as Q2 progressed business improved?

We -- yes actually it did improve a little bit from the -- April to June.

Yes, okay. Thank you sir.

Your next question comes from Keith Hughes with Robinson Humphrey.

Thanks. If you look at the -- within your carpet tile business, what was the order rate of the office versus the non-office market or revenue rate, whichever?

I would say they were 50/50, Keith. And that hadn't really happened in a while. Segmentation's been outpacing the office market growth. But the second quarter we saw a nice bump from the office market.

Okay. So you say 50/50, 50/50 revenue split?

No, as far as the incremental increase.

Okay. All right. So you're seeing, I guess, bottom line you're seeing the same strength from both those markets right now?

Actually we did in the quarter. And that's the first time that actually the office market's been ahead of the segmentation in a while.

Yes, okay. And can you remind us in tile what the breakout is between just in revenue right now, between office and non-office?

It depends on the market. If you're in the United States it's 50/50. If you're in Australia it's 50/50. If you're in Europe it's more 80/20 office to non-office. And Asia is probably 80/20 office to non-office.

80/20, okay. And I guess final question, the -- if you look at the back half of the year in broadloom and fabric, what type of operating margin if things work out your way, do you think you're going to get to in these businesses?

If we can increase sales, which we hope we can in this improving tide, the contribution margins in both the broadloom and fabrics are pretty healthy.

And the goal is still to get it to high single digits?

The whole, yes. Not this year, but yes.

Not this year, but at least be on a run rate towards that at some point.

Yes. That's next year.

Okay. All right. Thank you.

Thank you.

Your next question comes from John Baugh with Legg Mason.

Good morning. A couple of things. Can you speak to units in broadloom? I know we've had price increases. And I know you also sell some tile within Prince Street Bentley. My question really is how are -- I'm assuming units of broadloom were down year-over-year in the second quarter. And yet it sounds like your gross margins were at least flat or maybe up. I'm curious as to how you're achieving that. And then in the order picture for Prince Street broadloom -- more the picture heading into the third quarter, what that might imply for units in the third and/or fourth quarter?

I would say that you're right. Units were probably down slightly. I think I saw that number in our last business review, but not a lot, flattish to down a little bit. What we're doing is, we actually have really simplified that business. That's something that Anthony Minetti, who runs it, and John Wells have been focused on for the last two years. And we're seeing the benefit of that simplification and taking costs down.

And we saw a significant gross profit margin or variable margin improvement in that business, actually sequentially and year-over-year, which bodes well for top-line increases because a lot of that will fall to the bottom line.

So, Dan -

And order rates were actually up 9% in the second quarter, which is a welcome return to growth.

So, when you make this comment, all we need is sales to be up and we'll really leverage it would the expectation be for broadloom in the third and fourth quarters that we might actually get unit - I assume what you need is units, not revenue -

Yes, we need units. That's correct.

That that's going to happen?

We hope. There's a - the market is healthy. We have a pretty good market out there, in the office market and in our segmentation strategy. And our goal is to grow the top line in the second half in the broadloom business.

In tile, can you give us some color around the globe, what's happening, Asia, Europe, U.S. in units and dollars? You've given us, obviously the division up almost 20%, but a little more color there would be helpful.

Well, if you go around the world, you've got - the Asia market is doing extremely well. That had another record growth quarter. Is it sustainable? Probably not. But is double-digit growth sustainable in Asia-Pacific? Yes. If you look at the United States, that was the next -- had the next biggest growth and it was up - we don't want to give the numbers out. We have competitive reasons. But it was up nicely. It had very, very significant growth, outpaced the market. We had to take and share in the United States.

And in European business, for the first time, we had double-digit growth for the first time in probably four years, which we're taking share in Europe because the market is really not going. We're just taking share there.

Would you be willing to break out, Dan, I think it was $19.5 or something for the unit in dollars. How much of that was pricing per units?

I would say - we haven't had big price increases anywhere except the United States because the Euro has helped hold raw material prices down in Europe. And in Asia we haven't had the same pressures there. So, it's probably 4 or 5% that has -- was price increases when you look at the fact that we raised prices in our broadloom and modular business in the United States.

All right. That's helpful. And the last thing is, your cash flow projection for '05. Has it changed at all in light of the fact that you seem to be growing a little bit faster? Obviously, your profitability is going up too. But what are your thoughts?

I'll let Patrick answer, let him get in here.

I think we're going to stay around the $25 million in free cash for the full year. I mean, working capital may be a little bit more of use than we had set out in the early part of the year, but the earnings should offset that.

And Patrick, there was a reference, I think you made, about a $15 million CapEx, or maybe it was Dan. What -

That's over two years. That's in our modular business. Some of that has already been spent this year thus far and deposits have been made and so forth, especially -

So, no change in the CapEx budget for '05 or in '06?

About $20 million in '05 and similar, maybe $25 million in '06.

Great, thanks. Good luck.

Your next question comes from Mike Kender (ph) with Citigroup.

Yes, just to clarify on the CapEx, the $20 and the $25 million, that's the entire business, not just modular?

That's correct.

Okay. And the only other question I had was on the ratings agencies. Your ratings were pretty stale and reflect reality three years ago. Any progress there in terms of discussions with those guys?

No, we haven't had any discussions in probably over a year now.

Okay. Any intent on the company's part to do that?

We'll probably be proactive in the second half, Mike.

Okay.

I think the rating agencies are probably keeping an eye on this and they'll react to it. They generally do.

Okay, thank you.

Your next question comes from Robert Manowitz with UBS.

Hi, good morning. Good quarter. You had indicated a ways back that you were making a push into the education market and I think that season is upon us. And I was hoping that you could add some insight on the market and your successes in this channel.

We continue to have success in the education market. That's one of the segments that we're doing very well in. We grew it again year-over-year. The season is now. It's in the second and third quarter and that's one of our areas that we think we have a lot of opportunity in. We don't give out the percentage increases due to competitive reasons, but we're having a lot of success with carpet and tile and the education market.

Okay. Nothing that you've seen so far to indicate this season's particularly strong or particular -

I actually believe the season was actually weaker than last year. We're not really hitting all the education markets, so our opportunity is there. That wasn't a market for us three years ago.

Right. Right. And then my other question is, following the success of the divestitures in Resource Americas, and I heard your comments on getting some of the underperforming, at least on a margin basis, businesses to higher levels. Do you have any thoughts of possibly looking at some of the margin dilutive businesses as possible divestiture candidates?

Well, we, obviously, don't talk about that on conference calls, but our goal is to get them profitable and get them contributing to the bottom line.

Okay, fair enough. Thank you.

Your next question comes from Jeff Kobulars (ph) with Citigroup.

Good morning. It was stated in the press release about how raw material costs have stabilized during the quarter. And I'm curious, do you see them stable, also, in the third quarter?

Right now we don't have any indication that that will change, Jeff.

Okay. And then about your patent situation. Can you quantify how many violations you see out there and what actions you're taking to protect your patents?

We actually don't want to comment on that, but we're going to protect our patents. And obviously, the entropy patent impacts the industry. I mean, it's a great product, and it's one of our fastest growing products in the history of the Company. So we're going to protect our intellectual property rights there.

Okay. All right, thank you.

Thank you.

Your next question comes from David Horn with Perennial Investors.

Hi, gentlemen. This is Chris Heinz. How are you?

Good. How are you?

Good. Nice work getting the modular market margins up.

Thank you.

Here are a couple of clarifying questions. First, on the EBIT margins, how high can they go on the modular business in particular?

Well, our stated goal is to get them to 14, 15% in the next two to three years.

And have they achieved that historically?

Yes, they have, back in '98.

Okay. Are we back to '98 levels?

Right.

Okay. And the other businesses, do you have a stated goal?

Yes, the goal is 8% in the broadloom business and 8% in the fabric business. And the fabric business was at 12% actually in 2000, and the broadloom business has been around the 8% until the last downturn.

And this is a goal by when for all of these businesses?

It's the three-year goal, which we're in the third year - I mean, we're in the first year of that three-year goal.

Okay. So, that's a '08 kind of objective?

No, it's an '07 objective. What we've always stated is, we want to see our way to the 8% in '06 in those two businesses.

Okay. On the cash flow projection, I still struggle with this. You're projecting $25 million in free cash flow for the year. That's 32, roughly, of DNA, 20 of CapEx and then 10 to 15 of disposition. That doesn't leave anything for net income. So what am I missing?

You need to extrapolate that yourself. I think there's an upside to our cash flow.

That's fine, thank you. And then, my last question, of course, has to do with the debt. It's all good to be so levered when margins are rising, but as we know in this business historically, they can also contract as cycles contract and the debt's not very much fun on the way down. What actions are in place to --

We review that situation every quarter, what our options are.

Are stocks up 53% since the last earnings call, 90 days ago? Does it make sense to issue some equity and use the proceeds to pay off some debt?

We are - we review our options every quarter and I think we're, hopefully, at the beginning of an increase in our stock. We'll review that every quarter.

Good. Thank you.

[OPERATOR INSTRUCTIONS] Your next question comes from Eva Yoon (ph) with Independent United Capital.

Yes, hi. Actually it's Cheryl Van Winkle. A couple of questions. The first one is, with the bottlenecking that you're planning in modular, how much will you be increasing your modular capacity?

Well, with this first round we will probably increase it about 50% in the United States and we'll double it in Asia.

Oh, wow. That's wonderful. Now when you say the first round -

In other words, the bottlenecks that we're breaking are in tufting machines and so forth. Understand bottlenecks, when you break a bottleneck it's not - it's all incremental. It's not like you're building a whole new plant. You're putting a new tufting machine in, several new tufting machines or backing line or so forth. So, it's an incremental breaking the bottleneck.

Okay. And when you say first round, does that imply something about a second round?

Well we -- hopefully we're going to continue to grow our business and we'll have to expand capacity. But we're trying to get ahead of the curve on the order trend right now.

Okay, great. And that's that $15 million over two years that you mentioned to do that. That's great. I also had a couple of numbers questions. I missed what your CapEx was for this quarter.

$2.4 million.

$2.4, okay. And how much did you get on divestitures this quarter?

It was a net $2 million positive.

$2 million positive. So, that's net of - you mean net of the taxes or -

Net of the losses and the realization of working capital that generated $2 million in the quarter.

Okay. And what was the amount you had outstanding on the revolver?

Just under $10 million, $9.9, $9.8.

$9.9, okay. And then I just wanted to ask you, when we look at orders, how good an indication are they of what's going on in the business? I mean, is that - I mean, I don't know if orders are something you get sort of in all your areas or -

Orders give you a good trend, but the backlog really is only like eight or nine weeks of our forecasted run rate to date, so it has to be in the order trends that you fill out the quarter. But it's an indicator.

Okay. So, then, for example, last quarter when orders were up 9% but then your actual sales were up about 20% in modular. That's because everything was particularly strong in June?

May and June, yes.

Right. Okay. So, they're up 17%. Now, so if things stay the way they are right now that's probably -

You also had some anomalies last year because you had price increases that sort of bumped up the order rates, particularly in the first half of the year. So you have to - there's a - don't get trapped into the last year on the order rates.

Okay. So, people were trying to order ahead of the price increases.

Put their orders in ahead of the price increases.

And have you - okay, and now, do you have further price increases?

We aren't anticipating any at this point.

So, you expect nothing between, say, now and the end of the year.

To date nobody has really indicated that they're going to raise prices, to date.

So when was the last price increase that was put in?

We had it in, I think, June, right?

No, March.

Oh, okay.

It went into effect early April.

Right.

Okay. It was early April. Okay, great. Thank you very much.

Thank you.

[OPERATOR INSTRUCTIONS] There are no further questions at this time. Gentlemen, do you have any closing remarks?

Thank you for hanging in there with us and I hope we'll have a great quarter the next time. Thank you.

Thank you for participating in today's conference call. You may now disconnect.