Interface Inc (TILE) 2006 Q3 法說會逐字稿

Good morning. My name is Courtney, and I will be your conference operator today. At this time, I would like to welcome everyone to the Interface Incorporation's third-quarter 2006 earnings 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 session. (OPERATOR INSTRUCTIONS). Thank you.

I would now like to turn the call over to Mr. Eric Boyriven of Financial Dynamics. Mr. Boyriven, you may now begin your conference.

Thank you, operator. Good morning and welcome to Interface's conference call regarding third-quarter 2006 results. 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 received a copy of press release, which was issued yesterday after the close of the market, please call Financial Dynamics and 212-850-5600, or you can get a copy off the Investor Relations section of Interface's Web site. An archived version of this conference call will also be available through the Web site.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 actual results to differ materially from any such statements, including risks and uncertainties associated with the economic conditions and the commercial interiors industry, as well as risks and uncertainties discussed under the heading "Risk Factors" in Item 1-A 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 such 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 made during this call and cautions listeners not to place undue reliance on any such forward-looking statements.

Management's remarks during this call refer to certain non-GAAP measures. A reconciliation of these non-GAAP measures to the most directly comparable GAAP measures are contained in the Company's results release and Form 8-K filed with the SEC yesterday, each of which can be found on the Investor Relations portion of the Company's Web site, www.InterfaceInc.com.

Lastly, please note that this call is being recorded for Interface and 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'd like to turn the call over to Dan Hendrix. Please go ahead, sir.

Thank you, Eric, and good morning to everyone.

The third quarter was an acceleration of the solid growth that we've been experiencing all year-long and in fact for the last three years. We saw strong performance or significant improvement in each of our businesses, which is a real testament to the quality of our products, the demand we are seeing in the marketplace, and the hard work of our employees.

One thing in particular I'd like to highlight is the outstanding order activity we had in the quarter. Third-quarter orders increased 20% over the levels we saw a year ago, reaching $287 million, their highest point in six years despite a number of business divestitures. This order number demonstrates the increasing demand we've been seeing in the marketplace and should set up for a nice fourth quarter.

We continue to take share and expand our leadership position in the modular carpet market on a global basis. Modular carpet continues to make inroads as the floor covering of choice across most market segments, and this fact is reflected in the continued growth and strength in our modular business.

It's also reflected in the annual Floor Focus magazine survey of the top 250 design firms in the United States, which just came out last week. For the eighth year in a row, carpet tile was named the number one hot product, meaning that designers are specifying more of that product. I'm happy to say, for the third year in a row, Interface was ranked number one in best overall business experience. This just gives you a little bit of flavor for our core customers in our industry and what they are saying about Interface and about carpet tile in general.

Geographically, our modular business performed well across all regions, particularly well in the United States and Europe, with the growth coming from non-office segments, as well as from ongoing recovery of what we are seeing in the corporate office market.

At the same time, we continue to diversify our customer base through our market segmentation strategy and saw a particular strength within the hospitality and healthcare market segments during the quarter. The prospects of our modular business continue to look bright with orders up 25% in the third quarter compared to year ago.

Things are also looking very bright at Bentley Prince Street. As you know, we've been committed to improving the performance of this business, and we've seen the success of our actions throughout the last two years. The third quarter was no exception, as the improving corporate office market and our segmentation initiatives helped drive another quarter of strong, solid growth. Sales at Bentley Prince Street were up nearly 16% from a year-ago levels, while the actions we've taken to reduce costs, help drive operating income improvement as well, operating margins doubled to 6% from just under 3% a year ago. We believe this positive trend will continue.

Fabrics was a bit of a disappointment for us during the quarter, although it is on the road to recovery. Improving this business has been a primary focus of the management team this entire year. If you will recall, last quarter, I mentioned that we had some unanticipated interruptions in yarn supply and some manufacturing inefficiencies surrounding the consolidation of production at our Elkin, North Carolina facility. The yarn issues have been largely addressed, and we saw a welcomed improvement in operations at Elkin over the course of the quarter. Overall sales within the U.S. fabric business were up 6% versus a year ago.

I think it's very important to note that we saw steady growth in sales and improved operations within the fabric business on a monthly basis as we progressed throughout the quarter. With this trend, I believe the fabric business will achieve breakeven or better results in the fourth quarter.

Going forward, I think we are in an excellent position to build upon our success to date. We remain the leader in the modular marketplace as we continue to drive acceptance of modular carpet. We will build on this position by taking advantages of opportunities in the traditional markets for our products and expanding our presence in new ones.

Bentley Prince Street has continued its remarkable turnaround and the actions we've taken in our fabric business have begun to take hold as we work to improve the performance of that operation, and I believe we are well on our way there. There's been a lot of hard work in that business, and I believe we will see the results of that hard work.

(indiscernible) all of the markets we continue to serve show increasing demand, as evidenced by our excellent order activity. As a result, we expect to see continued growth and profitability enhancement across our businesses as we move into the fourth quarter and beyond.

With that, I will turn it over to Patrick for him to give you some details on the quarter.

Thanks and good morning, everyone. I will now walk you through some of the financial highlights from the quarter.

Excluding the results from the recently divested European fabrics business, net sales increased 18.4% to 270.6 million from 228.5 million in the third quarter of 2005, representing our 14th consecutive quarter over year-over-year improvements in sales. Currency changes positively impacted sales by approximately 3 million and operating income by approximately 300,000 during the quarter.

Gross profit margin for the third quarter of 2006 was 31.5%, up from 31.4% in the third quarter of last year. While we saw higher raw material pricing and some disruptions in our yarn supply during the quarter, the higher sales levels and focus on cost controls resulted in improved profitability.

SG&A expense in the third quarter of 2006 was 60.3 million versus 56 million a year ago. The increase is due to the higher sales level seen in the quarter, as well as additional investments and reorganization costs to support our sales and marketing initiatives. As a percentage of net sales, SG&A expense declined to 22.3% from 23% a year ago. The leverage built into our model was clearly evident in the improvement in operating income on an 18.4% increase in sales, excluding the European fabrics business.

Operating income increased 27.6% in the 2006 third quarter to 25 million from 19.6 million in the third quarter of last year. As a percentage of sales, our operating margin improved to 9.2% from 8.6%.

2006 third-quarter interest expense was 10.5 million versus 11.4 million last year, reflecting a combination of less debt during the period and improved pricing on borrowings under our revolving credit facility.

For the third quarter of 2006, we reported net income of 9.1 or $0.17 per diluted share, an increase of 78% over net income of 5.1 million or $0.10 per diluted share in the year-ago period.

Depreciation and amortization in the third quarter of 2006 totaled 7 million versus 7.1 million a year ago.

Capital expenditures in the third quarter of 2006 were 7.1 million versus 6.8 million in the 2005 third quarter. Our CapEx during the quarter included investments to increase modular carpet production capacity, within our North American and Asian operations, to address the steadily increasing demand we see in those markets. Overall, we had negative cash flow for 2006 third quarter of 10.7 million, largely as a result of the increases in working capital. As we did last year, we expect to see significantly positive cash flow in the 2006 fourth quarter. However, at the same time, we continue to invest in the future of our business.

Now, I will review some key balance sheet data. At the end of the 2006 third quarter, we had 28.9 million in cash. We had additional borrowing capacity under a revolving credit facility; it was 80.1 million. Our average DSOs during the third quarter were 50.9 days versus 53.3 days in the third quarter of '05. Our inventory turns were 5.1 versus 4.8 last year. Along with the capital expenditures I discussed previously, our other primary use cash in the quarter was 7.7 million for bond repurchases.

Now, I will review some of the details from our individual business units. Our modular business continued to post strong year-over-year growth. In the third quarter of 2006, total modular sales grew 22.6% to 193.6 million from 158 million a year earlier. Operating income rose 34.6% to 24.3 million, or 12.6% of sales, from 18.1 million or 11.4% of the sales in the third quarter of last year, as profitability expanded off a higher sales base. Our North American and Asia-Pacific modular businesses continue to perform well, but the biggest driver of our modular business has been the improving trends in our European modular division.

At Bentley Prince Street, sales rose 15.6% to 37.1 million from 32.1 million in the third quarter of last year, continuing the improving performance we've seen in this business over the course of 2006. At the same time, operating income nearly tripled to 2.2 million from 800,000 in the third quarter of last year, as operating margins expanded to 6% from 2.6% last year.

Our U.S. fabrics business had sales of 36.4 million in the third quarter of 2006, up from 34.5 million in the year-ago period. For the third quarter, the fabric segment recorded an operating loss of 500,000, compared with an operating income of 1 million in the third quarter of last year when the results from the European fabrics business are backed out.

While still an operating loss position, I think it's important to point out that, on a sequential basis, the results for this business have improved over the 3 million operating loss, 1.7 of which was a loss on disposal in the 2006 second quarter. While we recognize there is much room for continued improvement, there's clear evidence that the actions we've taken to right-size and to control costs have begun to take hold, and we're pleased with our progress to date.

With that, we will open the call up for questions.

Operator?

I apologize. (OPERATOR INSTRUCTIONS). John Baugh, Stifel Nicolaus.

Congratulations. A couple or three things--you touched on European modular getting a lot better, but you said I think it was led by U.S. and Asia. Can you just put a little more color on what's going on in Europe with modular and relate that to shipments as well as orders?

Yes. I would say that the European modular business, the office market is actually improving there. We are also executing on segmentation, so you have the same situation where you've got growth on the non-office and growth in the office piece. We're taking share there as well. I mean, I think the office market, if you looked at it, or the overall market was up low or high single digit and we were higher than that.

Okay.

With the sales increases, we have a situation where you will expand margins.

So I'm assuming the rate of sales growth in Europe still trails the rate of growth in the U.S. and Asia, but is it closing the gap?

Yes, it is closing the gap. It's not too far behind on orders and shipments.

Then could you just comment on--I think I heard you reference raw materials, but as you at the sales volume for the quarter, it was 270 million. The last couple of quarters, you were in the 250 to 258. Your gross margin was more or less identical. It's already 1.5. I'm just curious as to the factors that kept gross margins from expanding? And if it was raw materials, what the outlook for the fourth quarter and beyond is?

I would say part of it was raw materials and that we had a price increase, that we had obviously the backlog to push us through and so forth. We've also had some manufacturing issues at the Elkin plant, and we've also had some manufacturing inefficiencies in the fact that we have been running Thailand and Australia 24/7. So we've ramped up those businesses and as you ramp up to meet capacity, can you have to catch up with the curve and we've seen a little bit of manufacturing effeciencies there.

You've mentioned that Elkin is going to get better or already is better. What about the Asian plant?

Yes. I think Thailand, we've got that settled down where we are going to finish our expansion there in December. We actually will double the footprint of that facility in December, and we are back on a more normal operating schedule there.

Do you see any raw material relief looking ahead, Dan?

Well, yes. I don't see the pressure on raw materials, and in fact, when you have the situation that we have today, there's a lot of deals to be cut out there and so forth. I think that, from a raw material standpoint, it will not be a negative and it could get better.

Nice. Then lastly, your accelerated growth here that you're seeing, does that alter your--that's a high-class problem but does it alter your free cash flow generation for the year that you thought you'd do (multiple speakers)?

Yes, we are going to have to ramp up to meet a 25% increase in modular business. You're going to have some working capital requirements on that. As you noticed in the call, our actual our days and turns actually are improving, but just for the normal growth, you will see some working capital increases in there. I will say we're spending a little bit more on CapEx. We are thinking 25 million but we might be between 25 and 30. So yes, I think we will be positive, but I think the cash flow number that people have in their models of 25 will be probably somewhere between 10 and 20.

Keith Hughes, SunTrust.

Thank you. I had a couple of questions. First, the operator was (indiscernible) get my name right so I missed the answer to the gross margin question, The flat or modestly up year-over-year, Dan, you said raw materials was one driver. What were the other ones?

We had some inefficiency obviously in Elkin that we worked through. That's been a continued bugaboo for us and I think we will see a much better improved situation there in the fourth quarter. We are also running 24/7 in our Thailand plant and also our Australian plant. When you do that, you know you have certain inefficiencies that get created with that operating schedule. What I told John is that we actually are increasing the capacity in Thailand significantly, and that will be done in December, and we will be back to a more normal operating schedule there. We will still have the same issues in Australia, but we are ramping up capacity there as well.

If we look within just the tile segment, you've ran about 12.5% operating margin for several quarters now. To get any higher than that, will the--Thailand/Australia operations--is that the key, or is that a further pick-up in Europe?

I think it's a combination of both.

If we look at the tile business in terms of office and non-office, were the growth rates dramatically different in the third quarter?

Actually, in the U.S., surprisingly they were the same. We are still at a 50-50 mix, office to non-office in the U.S., which is pretty amazing to me. I would have anticipated, as the office market increased, that we would see that shift a little bit, but we have not.

Within our Bentley Prince Street business, it is the same; it's 50-50. With the European business, we actually had (indiscernible) we saw more growth in the office than we did in the non-office.

But you are still heavily office in Europe, are you not?

Yes, we are.

All right, thank you.

Robert Manowitz, UBS.

Hi. This is Michael [Kimon] for Rob. My first question--I'm curious as to I guess, given the growth in sales for--projected for the fourth quarter, how should we think about working capital?

Working capital in the fourth quarter is generally our strongest working capital quarter, one, the absence of the $20 million in interest that gets paid in the first and the third, and then inventory levels historically come down fairly dramatically. So I'm looking for a strong source of cash from working capital in the fourth quarter.

Great. My next question is regarding bond repurchases. I'm curious as to which bonds are repurchased during the quarter, how much and also current availability on.

Sure. We've repurchased 7.7 million of the 7.3% senior notes, and we have $80 million available under the revolver at the end of the quarter.

Great, thank you.

Larry Taylor, Credit Suisse.

Good morning. I wondered. Did you guys quantify the impact of Elkin or can you give us some sense order of magnitude, what that was?

Well, if you looked at the year-over-year comparison to last year, there was a 1.5 million delta in that. We made 1 million last year and we lost 0.5 million this year. You can probably attribute most of that to Elkin.

Then, in terms of residential, can you give us a little more detail in terms of what's going on there and how much, if at all, that's expanding? Is that going to be a use of capital or are you going to continue to grow there?

We obviously will continue to grow there. I mean, it's a small base but as far as the residential goes, the activity is fantastic. We just obviously announced the Martha Stewart situation and we will come out with that product line in the first quarter. We just signed a situation with Target where we're going to actually create a rug-in-a-box in the stores and that just happened actually last week. So, we are feeling pretty good about the activity in that business, and we will have taken it from 0 to 20 million in pretty much 3.5 years and seeing growth of 35 to 40% every year, and I think that will continue.

Okay. Lastly, sort of a little bit more strategically I guess, I wonder if you could comment on what your longer-term plans are in terms of the balance sheet and some of the public debt that may be outstanding.

Well, we are going to generate cash and pay it down and continue to strengthen our balance sheet and look at paying down debt with the cash that we generate from the businesses.

Thank you very much.

Don [McDougal], Adage Capital.

Good morning, everyone. I apologize if you've addressed this already; I'm joining a little late. The SG&A was a little higher than I was expecting this quarter. Could you elaborate on anything unusual that might be going on there?

Yes. There was a situation where we were reorganizing our sales groups and we took almost a $1 million redundancy charge in the quarter.

So you wouldn't expect that $1 million to be there. So if I'm modeling (multiple speakers).

(multiple speakers) sort of a nonrecurring situation.

So I should subtract 1 million from this run-rate?

Right.

Okay. Thank you.

(OPERATOR INSTRUCTIONS). Matt McCall, BB&T Capital Markets.

Good morning. I want to jump back to the residential business. I think, in the past, you've maybe talked about it costing you, the initial investment as it ramped is actually costing you--you're losing money in that endeavor. Can you give an update on the profitability of that effort?

Yes, we are probably are going to be a run-rate of losing 0.5 million now a quarter. We were losing $1 million a quarter in that business. As the sales ramp up, we are lessening the operating loss per quarter. So yes, it's approaching what I call almost breakeven.

When do you expect it to get there?

Well, you know, Matt, that's an interesting question because we are going to get through our whole strategic planning again in December and if I think we can grow it, which I believe we can and create a $100 million business, I may just keep investing in that business. It just depends on where I think the profitability and returns are down the road. I don't see anything that says that carpet tile doesn't belong in the home. So we are going to lead into the home and it's a big opportunity, and we're going to invest in it and we're just going to play it, activity-by-activity.

You said you built it to about a $20 million business. Is that with or without some of the announcements you just spoke about, maybe Target? Do we quantify how big of an opportunity that is initially and maybe longer-term?

Well, we do want to go out and forecast Target or forecast Martha Stewart, but it's all great endorsements of carpet tile in the home.

Okay. If I make that adjustment to that redundancy charge in Q3, it looks like the sequential operating contribution margin has been running about 25, maybe 25, 26% over the last three quarters. Any reason we shouldn't expect that to continue in Q4, anything seasonally that I need to think about?

No, our model is usually built between the 20, 25, depending on what our investments are to grow the top line.

Okay, all right. Finally, you mentioned pricing; you did implement your price increase but had to work through the backlog. Can you break down pricing and volume in the quarter on the top line?

Our price increase, we increased it 3%. We probably didn't realize a whole lot of that in the whole quarter, because you had to work through the backlog. It might have been 1 point.

Okay, that's great. Thank you guys very much.

Lee Brading, Wachovia Securities. Bear with us just one second, we will see if we can't open his line for you. Mr. Brading, your line is open.

Operator?

It looks like we cannot get Mr. Brading's line. I don't know if it's muted on his end, but his line (multiple speakers).

There he is.

You wouldn't believe all the messages I just got from everybody! (LAUGHTER)

Take as much time as you need, Lee!

I really didn't have it on mute, I promise. Anyway, I had some really good questions but I've got these others instead. Are you guys--at the beginning of the call, you talked about, Dan, you did, taking share on the modular side. Now, you've had a couple of good quarters on the (indiscernible) sign on growth. Would you say you're taking share there or growing in line with the market?

Oh, there's no question we are taking share there. The market is not going in line with that business.

Any specific details on--is it--you've talked about segmentation. Is it expanding the sales force? Is it picking up any particular categories at one customer or is that a multitude of customers that you're picking up?

I think it's the execution of a strategy that we embarked on five years ago, and that was to get into all of these various segments. We did that with Bentley Prince Street as well as our Interface modular business, and we're just having success in that. And the office market rebound is coming onstream and we actually have Jack Michigan designing products for Bentley Prince Street and we've introduced a lot of great products the last 24 months through Jack. We're just back in the marketplace. I mean, Bentley Prince Street did very well on this last survey. We're back there as a brand that is doing well and we've added salespeople and all the energy that we had to turn that business around is paying dividends.

(indiscernible) mind if you look at your credit profile. In my opinion, it definitely deserves a better rating from the rating agencies. Have you guys had any discussions with them?

We've had conversations with them, and I guess they are evaluating the situation.

Okay. Then lastly, I know you don't have crystal balls, but if you did, just from the corporate market environment and we continue to see positive trends there, when do you think you would have a little more difficult comparisons (indiscernible)? How long to think corporate environment just continues (technical difficulty)?

Well, I would say that, to me, the corporate rebound is really in its second year of really strong growth. We saw that starting to happen last year, and typically you go through a four or five-year cycle here. Remember that the market was down 35%, one of the biggest declines ever in about a 24-month period, and stayed down. But I think we are in pretty early recovery of the office market. The one thing that's more interesting is the other segments are starting to spend money as well. You are seeing education come back, government come back, hospitality come back. So you've got a pretty good environment for, I think, growth. Then you've got the whole penetration of modular carpet in all of those segments going on.

Do you still look at one of the indicators as being office vacancies for?

That's one of them. I believe corporate profits to be one of the bigger ones. That's a big driver as people actually have discretionary funds and they invest in their offices and so forth. You know, if you look at corporate refurbishment, there's a pretty good growth pattern going on there as well. White-collar employment is one too.

Thanks very much, guys. Sorry for the problems.

[Jeff Cobalars], Stone Harbor.

Great quarter. I just wanted to ask, do you have any estimate for how much faster you think you grew than the market in this third quarter?

No, we don't actually--we don't speculate on that. There's no question, if you looked at the overall carpet and rug numbers for the market, we definitely outgrew that significantly. If you look at this data in Europe, we outgrew that significantly. So, we know we're taking share just based on the growth dynamics.

You did say that the education business was good this past quarter. Can you comment (multiple speakers) about that?

Well (multiple speakers) you're out of the buying season in education in the third quarter, but for the year, yes, very good. Hospitality actually is starting to kick in and healthcare is starting to kick in a little bit and we get contraction there--a small base, but good growth.

Okay, terrific. Thanks very much.

At this time, I would like to turn the call back over to management for closing remarks.

Thank you for listening in on the call. As you can tell, we are very excited about what's going on at Interface and we are having a lot of fun and we hope to report some very good earnings next quarter. Have a great week. Thanks.

This does conclude today's Interface Incorporation's third-quarter 2006 earnings conference call. At this time, all parties may now disconnect.