Interface Inc (TILE) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Interface Second Quarter 2007 Earnings Conference Call. My name is Jaquilla, and I will be your coordinator for today. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to Mr.Bob Joyce of FD. Please proceed, sir.

Thank you, Operator. Good morning, and welcome to Interface's conference call regarding second quarter 2007 results.

Joining us from the Company are Dan Hendrix, President and Chief Executive Officer, and Patrick Lynch, Senior 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 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 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 An archived version of this conference call will also be available through that website.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 the risks and uncertainties discussed under the heading Risk Factors in Item 1A of the Company's most recent annual report on Form 10K, filed with the Securities and Exchange Commission. We will direct all listeners to that document.

Any such forward-looking statements are made pursue 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.

Lastly, please note that this call is being recorded for Interface. It contains copyrighted material, may not be rerecorded or rebroadcast without Interface's express permission. Your participation on this call confirms your consent to the Company's taping of it.

With those formal remarks out of the way, I'd like to turn the call over to Dan Hendrix. Please go ahead, sir.

Thank you Bob, and good morning, everyone. The great start of 2007 continued into the second quarter, which was an outstanding quarter for Interface, and is one in which we reached significant milestones.

During the quarter we reported strong performance across our core businesses, and continued to build market share. This is evident in orders during the quarter which were up 28% to 304 million, the highest order level ever for our continuing operations.

Importantly, during the quarter we announced the sale of our fabric division, which we recently completed, enabling Interface to focus on its core growing businesses, while improving our balance sheet. After the sale, our company is now almost 90% modular carpet.

Our performance for the second quarter was driven by our modular business, with the second quarter sales increasing 21% and orders up 30%. Modular carpet sales increased across each of our primary geographic regions, the Americas, Europe, Asia Pacific, leading us to record revenues in this business.

Our segmentation strategy is performing well, although the office segment growth slightly outpaced the non-office segment of the second quarter, further stabling the office market's rebounding strength.

Within our non-office commercial segments, the hospitality and institutional markets made the most significant gain in the second quarter. The increased sales in our modular business drove its profitability, with operating income up 34% from the same period last year.

Our four residential carpet offices made good progress in the second quarter, with both sales and orders up substantially. Our partnership with Target is on track, and our Rug-in-a-Box product is now being rolled out in approximately 1,500 Target stores around the country. In addition, our Martha Stewart Collection of Flor Carpet Tiles has been launched, and our product rollout is ongoing.

We are very pleased with the improved performance of our Bentley Prince Street business. During the quarter its revenues grew 6% to 8%, operating income for Bentley Prince Street increased 18% for the second quarter. As we resolve our isolated manufacturing inefficiencies from earlier this year, we expect further growth and profitability improvements in this business throughout 2007.

We are pleased to have completed the transaction to sell our fabrics division. The divesture makes good strategic and financial sense for Interface. We are now a more focused organization, concentrating on opportunities within our modular business and Bentley Prince Street businesses, which have delivered strong performances throughout the years. Financially, the transaction is in line with our goal of further strengthening our balance sheet and reducing our outstanding debt.

We have received approximately $61 million in cash proceeds from the sale at this point, and we have the opportunity to receive up to $6.5 million pursuant to an earn-out arrangement over the next year and a half.

We feel that we found a great home for our fabrics business, and I would like to thank the employees of our fabric division for their dedication and hard work they've delivered over the years.

Looking forward, we remain very optimistic about our marketplace and our future performance. We are positioned to benefit from the ongoing secular shift toward modular carpet, a product category where we are the clear global leader.

In addition, our segmentation strategy continues to drive growth into non-office commercial segments. The office segment is recovering globally, and we are well positioned for growth in that market as well.

With orders increasing 28% during the quarter, we are growing faster than the overall market. Although we don't know how long we will sustain this growth rate, our markets currently are very strong, and we are well positioned to benefit from our market opportunities.

Business has remained robust in the initial weeks of the third quarter, and we are very excited about the prospects as we move into the second half of this year.

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

Thank you, and good morning, everyone. I'll now take a few minutes and outline some of the financial highlights from the quarter.

Sales from continuing operations for the second quarter of 2007 increased 18.7% to $265 million, from sales of $223.2 million in the year-ago period. As previously announced, the Company sold its fabrics division, and therefore the financial statements for the second quarter of 2007, and all other periods presented, now reflect the fabrics division as discontinued operations. Discontinued operations also include the results of the Company's former European fabrics business, which was sold in the second quarter of 2006.

Our sales performance in the second quarter represents our 17th consecutive quarter-over-quarter improvement in sales. Currency changes positively impacted sales by approximately $5.6 million, and operating income by $800,000 during the quarter.

Gross profit margin for the second quarter of 2007 was 34.8%, compared with 33.9% in the second quarter of last year. SG&A expense in the second quarter of 2007 was $61.3 million or 23.2% of revenue, versus $51.6 million or 23.1% of revenue a year ago.

The two largest portions of this increase were a currency conversion impact of approximately $2 million, and accelerated restricted stock vesting in incentive payments amounting to approximately $1.5 million as a result of the recent stock price appreciation.

The Company reported operating income for the 2007 second quarter of $30.9 million, compared with operating income of $24.1 million in the same period of 2006. Interest expense for the second quarter of 2007 was $9.2 million, versus $10.9 million last year, reflecting our actions to reduce debt.

In the 2007 second quarter, income from continuing operations was $13.3 million, or $0.22 per share, compared with income from continuing operations of $8.5 million or $0.15 per share in the second quarter of 2006. Including the results of discontinued operations, we reported net income of $1 million or $0.02 per share in the 2007 second quarter, compared with net income of $5.9 million or $0.11 per share in the 2006 second quarter.

Depreciation and amortization in the second quarter of 2007 was $5.6 million versus $5.3 million a year ago, capital expenditures in the second quarter of 2007 were $7.1 million versus $7.4 million in the 2006 second quarter.

Overall, we had positive cash from operating and investing activities of $21.4 million in the second quarter of 2007, compared with $43.9 million in the second quarter of 2006, which included proceeds from the sale of our European fabrics business last year.

Turning to the balance sheet at the end of the second quarter, we had $89.3 million in cash. Our balance sheet will benefit from the proceeds of the sale of our fabrics business through further debt reduction. At the end of the second quarter, our additional borrowing capacity under our primary revolving credit facility was $62.7 million, our average DSOs in the second quarter were 50 days, and our inventory's terms were $5.4 million, which were in line and consistent with second quarter last year.

Now I'll review some of the details of our individual business units. Our modular business continued to show strong year-over-year growth. In the second quarter of 2007, total sales from our modular business grew 20.9 percent to $225.5 million from $186.5 million in the same quarter last year. The modular business continued to perform well in all geographic locations, but most significantly in the Americas and in Europe. Operating income increased 33.9% to $31.6 million or 14% of sales, from $23.6 million or 12.3% of sales in the second quarter of last year, primarily driven by our higher revenue levels.

At Bentley Prince Street sales grew 16.5% to $39.5 million, from $33.9 million in the second quarter of last year. Operating income increased $17.6 million to $2 million, or 5.1% of sales in the second quarter of 2007, from $1.7 million or 5% of sales reported in the second quarter of the prior year.

As Dan noted earlier, we resolved the previously experienced isolated manufacturing inefficiencies from earlier in the year, and we continue to expect further growth and profitability improvements from this business in the second half of the year.

With that said, we'll now open the call up for questions. Thank you.

(OPERATOR INSTRUCTIONS) And your first question comes from the line of Keith Hughes, with SunTrust. Please proceed.

We had talked on the last call about raw material costs, and there was some pressure in residential. Did you see the same in commercial and where does it stand going into the third quarter.

We actually raised prices, Keith. We saw-- one of our suppliers actually went up in raw material prices, and we raised prices as well, and we really don't expect anything on the horizon today.

Was that in the second or in the third quarter?

Actually, it would have hit the third quarter. Got announced-- actually got announced in the-- in June, and went effective late in the quarter, second.

Okay. And in Europe, it-- where does profitability of carpet tiles in Europe versus the United States in kind of general levels?

They're almost comparable now.

Okay, that's a pretty dramatic improvement for Europe, isn't it?

Yes, it is.

Okay, thank you.

And your next question comes from the line of Stephen Kim with Citigroup. Please proceed.

Good morning, this is [Mark Montanen] on the line for Stephen. It appears that modular margins are pretty much the best they've been in the last several years. I'm wondering if this is due to anything in particular, or just mainly improved economies of scale?

I would say it's the sales growth. We're getting the flow-through in that business.

Okay. And then with respect to the Rug-in-a-Box, I know that you said earlier it will be rolled out in about 1,500 or so Target stores. Are these products already fully saturated in those stores, or is there--

They're actually going to be in the stores September 2, that's the--

September 2, and is there any timeline with the rollout of those, or is it going on to all 1,500 at the same time?

It's going on pretty much in all 1,500 of them. I'm sure it's not going to happen the same day, but it's anticipated it rolls out 1,500 in September.

Okay, great. Thank you very much.

Your next question comes from the line of John Baugh with Stifel Nicolaus. Please proceed.

Thank you. Could you provide some color on Asia and Europe in terms of carpet tile shipments, carpet tile orders and you sort of touched on profitability, but that as well.

Yeah, we don't comment on that, John, but I would say that it was-- all the businesses, all the regions were over 20% Asia Pacific, Europe and Americas.

And we had 30% overall, but they were all pretty much around that number.

What are you doing, again, in Asia, in terms of manufacturing?

We have a plant in Thailand servicing Asia, we also have a plant in Australia servicing that part of the region.

Is there something on the books for China?

Not today. We'll eventually manufacture in China, yes.

Okay. And then [I know you don't want to talk about it] but the residential business, any feel for run rate of revenues, and I'm not so worried about breaking even, I'm just-- because I'm sure you could break even if you stop some investment there--

The U.S. residential business, I think, will approach $30 million this year in revenues.

And where--

And that's from a dead standing still start three years ago.

And where is-- is that on your website, is that going to be Target, is that going to be Lowes, where's kind of the key--

I would say that the online web business is going to be over half of that business, and then you have the Target, you have the Lowes, and you have the Martha Stewart rollout, which is actually a web business as well. And then you have a lot of boutique places that were in--

Okay. And then lastly, on the sort of cash debt pay down, Patrick, maybe you could describe this-- how that unfolds over the next 12 months, what you do.

Yeah, John, we're taking into consideration all of our options right now, looking at the markets. The market conditions certainly have gotten very choppy in the last four to five weeks. But right now we're going to continue to target the 7.3% notes as we have historically, we'll continue to watch pricing and try to optimally and judiciously use our cash to delever.

Those come due next year, right?

April 2008, that's correct.

And would it be your anticipation that you'll-- between now and then, what do you think will happen with those?

Well, we're looking at all kinds of options right now. I still need to do a little bit more analysis, but we'll certainly be targeting those over the next eight months for sure.

And the $61 million came in in July, so that's not reflected on the balance sheet, correct?

Correct.

Thank you.

And your next question comes from the line of Sam Darkatsh for Raymond James. Please proceed.

Good morning Dan, good morning Patrick.

Good morning.

First off, fabulous results. A few questions here. Dan, any sense of what the industry growth in carpet tile was in the quarter? I know it's not reported broadly, but any sense of that, as to perhaps how much share you gained?

It was very difficult to tell that because nobody really breaks it out when they report, but I know that we are probably growing at least twice the market.

Patrick Lynch: With the office furniture guys talking about a fair amount of deceleration in the States, and you're saying that you're not seeing that at all, that the mix of corporate versus non-corporate commercial is still pretty much static. Do you suspect that-- based on what you see, do you suspect that your corporate end markets are ultimately going to decelerate, or not, or is this--

You know, it's-- we're actually going after every floor that there is globally now, that's the market that we play in, and the U.S. office market is probably between 20% and 25% of our overall business. When you look at that marketplace, I would say that it's pretty robust on the refurbishment side, and I think that will continue, that's got a lot of legs to it.

Remember that we're, in good days, we're only 25% new construction. Now I-- when I talk to our people, we believe that there's a lot of strength left in the office market, particularly refurbishment, for the next several years. But we're not linked to that office market the way we used to be, and we have this whole move to modular carpet that gives us a lot of headroom growth.

But we're not seeing a decel in the office market in the States today.

And I suspect that you suspect that as the secular adoption continues in the non-office side, that that should perhaps offset, if not more than offset any deceleration that you might see?

That's our strategy. It's been that way for a while.

Two more questions. I'm guessing that order growth exceeded sales growth in every geography, is that correct?

That's correct.

And last question, with respect to your inventories, it looks like, if my math is right, your inventories were roughly-- grew roughly the same as sales on a year-on-year basis, if you adjust for the disposition of fabrics. Is that correct, Patrick?

That's right.

I would think that with modular being a big part of your mix now, an even bigger part of your mix, since that's largely a make-to-order model, wouldn't your turns improve, or is there a seasonal thing where your turns improve later in the year?

Yeah. The second half of the year is typically where we generate the most cash, we typically build inventories through the first half of the year, and those inventory levels come down over the second half. So I would expect that to happen again this year as well.

Yeah, you have to think about Europe being a pretty big piece of our business, and we have shutdowns in Europe for the holiday season, so we build inventory in Europe particularly in the second quarter that comes down in the third.

So Patrick, generally speaking, how much cash-- do you expect to have inventories be a source of cash, or how should we look at inventory--

Well, working capital, generally speaking, is about $0.10 to $0.15 per sales dollar. I expect working capital to still be a use of cash for the full year, continuing at the growth rates that we're at, but the inventory levels and turns should improve over the second half of the year, like they have historically.

Excellent. Thank you very much, gentlemen.

Thank you, Sam.

And your next question comes from the line of Matt McCall for BB&T. Please proceed.

Thank you, good morning.

Hey Matt.

It sounded like-- I wanted to jump into the mix for each one of the segments. I think one of the last questions was that the mixes remained-- or comments was that the mixes remained stagnant in the U.S. Can you give us the mix, office versus non-office, in the U.S. versus Europe versus China?

We don't actually break that out. China's all office, Matt, and Europe is more office than it is non-office, and the U.S. is about 50-50.

About 50-50. Now, I guess the question's more regarding the segmentation strategy, what's the plan or what's been the benefit to this point of any segmentation strategy, I guess only in Europe, given that China's all office.

Well Asia Pacific's not all office, but China's all office.

Actually just Asia Pacific, I apologize.

I mean Australia, which is part of Asia Pacific, is about 50-50 office and non-office. But I will tell you that the growth is coming out of education, hospitality, retail, all the segments were actually taking-- were actually growing in Europe and in North America in those segments.

That mix, is there anything-- I think the office non-office mix moved to 50-50 over really, over the past three years in the U.S., and Europe, is it going-- is it on the same type of trajectory, are we going to be 50-50 in the next three or four years there?

That's the plan. It'll be a little tougher to get to it, because it's a little bit more mix when you're talking about the various countries. But we are having a lot of success in healthcare, a lot of success in hospitality in Europe in retail space.

Okay. And when you were talking about the residential, I think you specifically said U.S. residential. Is there a residential effort outside the U.S.?

We actually have one in Europe as well, it's approaching $18 million as well.

Same type of scenario there, investing for growth?

Yes.

And you--

We're losing about a little over $1 million trying to fuel the growth in those businesses, and we'll end up the year with a $45 million to $50 million residential business.

And the million is for Europe and the U.S. total.

That's combined, right.

And do I remember correctly that last quarter there was some-- maybe some plant expansion or some inefficiencies related to the Australian facility, is that right?

That's still ongoing. We're expanding that facility, we're running it 24-7, seven days a week. And when you do that, you have inefficiencies, there's no way around it.

And I think you quantified them last quarter, is that right? What kind of hit did you-- just from inefficiencies overall?

I would say that the margin hit was probably about the same as it was last quarter in Australia.

Okay.

That's something that you live with when you're running 24-7.

Okay.

We hope to have that expansion done the second half of this year.

Okay, and then I know in the past you've spoken about your margin outlooks and your growth outlooks for the two segments. Any update there, any comments?

I would say that we obviously believe that we can grow the top line double-digit and get the 20% flow-through in those businesses, and that's our goal, and that's been our long-term goal and I don't see that changing.

We're actually beating that today, and we've beat it for the last three or four years.

Yeah, okay. Great job, thank you guys.

Thank you.

(OPERATOR INSTRUCTIONS) And your next question comes from the line of Robert Jordan with Morgan Stanley. Please Proceed.

Hi, good morning. I wondered if you could, since sales have grown so much, if you could tell us at last quarter's sales rate how you stand on capacity in modular in the different regions around the world.

We're in pretty good shape, except Australia. We continue to expand capacity in the United States, so we're expanding the capacity there and we'll have some more capacity online in the second half of the year. If you look at Europe, we're-- we've got a lot of capacity in Europe, we've got a lot of capacity in Thailand today. We have a lot of capacity in our Bentley Prince Street businesses. So the two bottlenecks that we've been dealing with are the United States operation on modular and Australia. But there's still pretty good headroom from a capacity standpoint around the world.

And where do you think the U.S. stands or is the U.S. at--

We're running it five and a half days three days a week-- I mean five and a half days a week, three shifts, with only one bottleneck that we're really dealing with today.

Okay, is that the yarn-setting?

That's actually the latex line.

The latex line.

That should be solved in the second half of the year.

Okay. And so on a related question, can you talk about now sort of 2008, 2009, how that effects your CapEx plans and in what sort of activities and equipment you're going to be putting your CapEx in the next couple of years.

I would say that we're still going to be in that $25 million to $30 million, we've moved that up a little bit. But I think $25 million to $30 million, based on the growth rates that we're experiencing today.

And is that aside from the-- the China's what, like $8 million?

That would be more-- that would probably be more like $12 million to $15 million.

China's $12 million to $15 million.

If we bought the building or leased the building depends on that number.

And so the balance of the $12 million to $15 million, mostly in the U.S. or all in the U.S.?

I would say mostly in the U.S., yes, mostly in the U.S.

Okay, thank you very much.

Thank you.

And your next question comes as a follow-up question from the line of John Baugh with Stifel Nicolaus. Please proceed.

Thank you. AUSP, Dan, I mean, I guess office actually outperformed the others, the others were a little lower, but I was wondering what you're seeing in terms of your average unit selling price.

It's just-- it was very consistent. We haven't really seen much decline there around the world. The education is a little less pricey, but it's also, from a margin standpoint, it's similar. But from an average selling price, not really much difference in--

Is education K-12, or is it other stuff. And then you mentioned institutional, what do you call institutional?

Government and education.

Education can be college university.

Oh yeah it is, it's not all K-12 by any stretch.

Okay.

It's both K-12 and higher ed. You know, there's big budgets in the higher ed.

Got it. Thank you

Thank you.

And your next question comes from the line of Jessica Tom with Goldman Sachs. Please proceed.

Hi, good morning. It doesn't sound like you're seeing a flow-down yet in your end margins, but when things do slow down, where would you like to be from a debt-to-EBITDA, or debt-to-cap perspective?

I would say that we're probably going to generate another $35 million in the second half of this year, and we'll use it to pay down debt. And when we end up paying down that debt, we're going to be under 1.5 EBITDA to funded debt, net debt.

Right.

And we're obviously comfortable with that level.

Given where the share price is currently, does it make any sense to raise equity to maybe accelerate the debt reduction and take out some of the [10 and three-eights]?

No, it does not.

Okay, thanks.

Thank you.

(OPERATOR INSTRUCTIONS) And your next question comes from the line of Jeff Kobylarzfrom Stone Harbor Investment.

Guys, I'm curious what percentage of the floors that are being either built or refurbished out there today, what percentage are getting modular, would you say, today, and compare that to what the percentage was, say, two years ago.

In the office market we have some data points, Jeff, and we think in the U.S. office market that it's probably 50% to 60% of the floors today are going modular carpet.

And that's share gain, we might have been 45% three years ago?

I think it will actually go up to 75% of the floors before it hits equilibrium. The other end markets, education, retail space, it has a very low penetration rate.

Okay, thank you.

Thank you.

And your final question comes as a follow-up question from the line of Robert Jordan for Morgan Stanley. Please proceed.

Hi. As you get more into education, retail and healthcare, is it any way changing the kind of distribution pattern and who you need to deal with, or is it still all specified coming straight from the factory?

It's still specified, but you have different, in some cases, installers and the product dealers, as we call them. In some cases you have different architects and designers. Particularly in education, it's a little bit different distribution model. But our sales force obviously calls on those segments today. We don't change that approach. You get more targeted in those markets with specialized sales people, but you don't really change how you go to market.

At the margin, it maybe doesn't seem like a big deal because you-- you're really doing so well at everything, but which competitive moves from some of the other major players are you at least keeping your eye on, even if it's not going to diminish the growth rate? And obviously you're still growing fast.

We have very good competitors around the world, and we're out there, obviously, trying to penetrate all these markets with our product offering. Our made-to-order model, particularly in the United States helps us because we have specific products for every end market that we introduce. But we have good competition from Shaw, Mohawk, Anderson, they remain good competitors. And we're just going to introduce products and penetrate these markets.

Okay. Good luck with everything, thanks gentlemen.

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

Well, thank you for being shareholders, and I hope to report a great third quarter. Thanks.

Thank you for your attendance in today's presentation. This concludes the conference, you may now disconnect. Good day.