Interface Inc (TILE) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2007 Interface earnings conference call. My name is Francis, and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will conduct a question and answer towards the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes.

I would like to now turn the presentation over to your host for today's call, Bob Joyce. Please proceed.

Thank you, operator. Good morning, and welcome to Interface's conference call regarding fourth quarter and full year 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 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 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 at www.interfaceinc.com. An archived version of this conference call will also be available through that website.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 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 the call, and cautions listeners not to place undue reliance on any such forward-looking statements. Lastly, please note this is call being recorded and broadcast for Interface. It contains copyrighted material. It may not be rerecorded or rebroadcast without Interface's express permission. Your participation on the call confirms your consent to the company's taping and broadcasting of it.

With these formalities out of of the way, I would like turn the call over to Dan Hendrix. Please go ahead, sir.

Thank you, Bob, and good morning to everyone.

As you saw in our earnings release, the fourth quarter was the best-performing quarter in Interface's history, and it capped off the best-performing year in our history from continuing operations. Overall, our performance in the fourth quarter was at record levels for operating income, operating margin, income from continuing operations, net income and earnings per share. We reported strong revenue growth for the fourth quarter and the full year, as we continued to take market share. Within the modular carpet business segment, fourth quarter sales increased 18% year-over-year. This growth was very broad based across each of our the key geographic regions, the Americas, Europe and Asia Pacific.

I believe we had four primary factors driving sales growth in our modular business. First, the market has continued its secular shift toward carpet tile, which partially accounts for the sustained growth we see in our corporate office market. Second, our market segmentation strategy continues to make good headway, with the institutional [hot] tile markets making the most significant percentage gains in the fourth quarter. Third, sales in the emerging geographic markets such as India, China, the Middle East, Eastern Europe and Latin America continue to expand significantly. Fourth, I believe our sustainability strategy is helping us win business every day.

As a result of this sales growth, as well as the operating leverage we've created in the business, operating income and operating margins expanded significantly. In our four residential carpet tile business, sales and orders continued to climb compared with the fourth quarter last year. I am very encouraged by its internet and catalog business, which was up 35% year-over-year. Bentley Prince Street was down compared with the fourth quarter last year, which is a disappointment, but we did complete the installation and start-up of our carpet tile [backing line], and we are expecting to see improved results in the first quarter of 2008. We continue to see robust order growth in the fourth quarter, with consolidated orders increasing 17%. Supported by our record results in the fourth quarter, we decided to increase our dividend to $0.03 per share for the quarter.

Despite the uncertain economic forecast and the anticipated pressure on the corporate office market this year, there are many opportunities for Interface to grow. We are still in the early stages and leading the market sector shift from broadloom to carpet tile. Including Bentley Prince Street sales of carpet tile, modular carpet now represents about 90% of our sales and we are uniquely positioned to benefit from this trend and lead this trend. Market segmentation continues to gain momentum as modular carpet is making the leap from becoming a niche product to actually leading the product category. Noncorporate office [sectors] now represent a more significant portion of our sales.

With our global manufacturing capabilities on four continents, we are in a prime position to capitalize on the explosive growth in the emerging geographic markets. Because our international sales now comprise 50% of our revenues, we are much less exposed to the down cycles in the U.S. office market. Our backlog was up nicely very year-end 2006, and our top line of new orders continues to be solid, up 11% for the first 6 weeks of this year. In short, we are off to a good start in 2008, and we are looking forward to another strong year for Interface.

Now I will turn it over to Patrick for more details.

Thank you and good morning, everyone.

I will now take a few minutes and outline some of the financial highlights from the quarter. Sales for the fourth quarter of 2007 were $293.3 million, an increase of 13.2% compared with $259.1 million in the fourth quarter a year ago. As previously announced, the company sold its Fabrics Division in July 2007, and therefore the financial statements for the fourth quarter of 2007 and all other periods presented now reflect the Fabrics Division as discontinued operations.

Gross profit margin in the fourth quarter of 2007 was 35.5%, compared to 33.8% in the fourth quarter of last year. SG&A expense in the fourth quarter of 2007 was $64.7 million or 22.1% of revenue, versus $57.7 million or 22.3% of revenue a year ago. Operating income in the fourth quarter was $39.4 million, compared with operating income of $29.9 million in the fourth quarter of 2006. As a percentage of sales, operating income increased 11.5 - from 11.5% in the fourth quarter of last year to 13.4%, which is a record operating margin for the company. Interest expense for the fourth quarter of 2007 was $7.2 million versus $9.5 million last year. In the 2007 fourth quarter, income from continuing operations was a record $20.3 million or $0.33 per diluted share, compared with income from continuing operations of $12.4 million or $0.21 per diluted share in the fourth quarter of 2006. Net income for the fourth quarter of 2007 was also $20.3 million or $0.33 per diluted share, versus net income of $12.1 million or $0.21 per diluted share in the fourth quarter of 2006. Depreciation and amortization in the fourth quarter was $5.4 million versus $6 million a year ago. Capital expenditures in the fourth quarter of 2007 were $13 million versus $8.8 million in the 2006 fourth quarter.

Turning to the balance sheet, at the end, at the end of the fourth quarter of 2007 we had $82.4 million in cash. At year-end we had no borrowing under our outstanding - no borrowing outstanding on our domestic revolving facility, and no borrowing outstanding under our overseas lines of credit. Average DSOs during the fourth quarter were 53 days compared to 50 days in the fourth quarter a year ago. Our inventory turns were 6 times versus 5.7 in the fourth quarter last year.

Now I will take a minute and review some of the details of our individual business segments. We continued to see strong year-over-year growth in our modular segment. In the fourth quarter 2007 total segment sales grew 18.1% to $257 million from $217.7 million in the same quarter last year. As Dan outlined, performance in this segment was strong across all geographic locations. Operating income increased for the segment increased 35% to $40.1 million or 15.6% of sales, from $29.6 million or 13.6% of sales in the fourth quarter of last year, primarily driven by our higher revenue levels. At Bentley Prince Street, sales were down 4% at $36.3 million from $37.8 million in the fourth quarter of last year. Operating income was $1.4 million compared to $1.5 million in the fourth quarter of 2006.

Now I will turn it back over to Dan with - actually we will open up the call for questions. Operator?

Thank you. (OPERATOR INSTRUCTIONS)

Your first question comes from the line of Keith Hughes with Suntrust Robinson Humphrey. Please proceed.

Thank you. Patrick, what are you going to spend in CapEx in 2008?

Probably $50 million, Keith.

Is that going to be some capacity expansion in certain geographies?

Exactly right, principally targeted in the Asia Pacific region.

How much was Asia up in 2007?

We don't give that out, Keith, for competitive reasons but it was up more than the other two markets.

Okay. Dan, you had mentioned you're 50% International right now. How much of that is Asia and how much is Europe at this point?

10% is Asia and 40% is Europe.

Okay. And I guess final question, this year it looks like it should be a pretty cash flow-rich year for you, and your debt levels seem to be at reasonable levels. Share repurchase, is that an idea? What beyond the dividend increase do you look to spend cash on?

I would say that we always have it on the table. It would be the second half of the year. We want to get the expansions done in Asia Pacific. You know, we are anticipating building a plant in China this year.

Okay. Would that be for the domestic Chinese market?

Yes.

And would - are acquisitions, is that anything you would consider at this point?

No, I think we have got tremendous headroom in the modular piece, Keith, and I don't really see anything that we need to grow our business. So right now we are not inquisitive out there.

Okay, thank you.

Your next question comes from the line of Matt McCall with BB&T Capital Markets. Please proceed.

Thank you, good morning. Following up on that last question, are debt levels at a comfortable level for you or are you going to continue to move that lower?

Yes, I think they are comfortable, Matt. I would say that our target was to get at close to $200 million and net debt we're at $230 million, so we are in that range.

Okay. And so it sounded like most of the spending on that facility is going to come in the first half. Is that the way...?

I would say we are going to get up and run. We are expanding our Asia footprint, principally in China and in Australia, and the Australian piece will be the first half and the China piece will be the second half.

Okay, got it. Great margin in modular this quarter, and I know you are a manufacturer and you have leverage but as you - help us understand the incremental margin that you expect on growth, given your spending plans.

Well, we still stay to our stated strategy for the last, I don't know, 4 or 5 years, that we have a 20% incremental target and that's what we pay bonuses around and that's what we budget around. It is nice when you have - you get the kind of sales level we hit in the fourth quarter, you are going to see a lot of margin expansion.

Okay. And then I think last quarter, you talked a lot about some of the cost pressures that hit you. I think you mentioned in the - in your prepared remarks that some the issues subsided, maybe mid-quarter, at Bentley Prince Street. Any items that you could highlight that -

We were running at, you know, 24/7 in our Thailand plant, and we had adequate capacity there and we were able to see the benefits of that capacity and the ability to operate efficiently, and we had some problems in Australia with ramping up and adding new technology there, and we saw the benefits of that in the fourth quarter as well. In Bentley Prince Street, we will see that hopefully this quarter. I know I keep saying that but it is coming.

What are the [results] of the target margin in that?

It is still 8% and we are floating around 4, 4.5.

Is it going to take - is it a top line issue to get you to 8% or is it eliminating some of these -

I think it is two things. One is, it is actually getting our backing line up and running and not have the cost of backing it on the East Coast and shipping it to the West Coast. That is one. The other is, as you move more into the modular piece away from the broadloom piece you are going to see better margins come out of the carpet tile piece. And then, obviously, you know modest top line growth would help.

Okay. Thank you all.

Thank you.

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

Good morning, thank you. Foreign currency, what was the impact in the quarter end/or year, if you have it, Patrick?

For the quarter, John, it is $10 million in sales and about $2 million in operating income.

Okay. And correct me if I am wrong, but we are going to have a huge comparison in Q1 on FX again, aren't we, favorably?

It is in the same range.

About 10 basis points.

Yeah, 10 or 11.

Okay. When you talk about the orders being up, I guess it was 17%, I assume there is some FX in that as well, correct?

Probably about 3%, John.

Okay. And that 17% I guess compares to 11% for the first 6 weeks. So you have seen something of a slowing, is that correct, number one? And number two, where are you seeing equally in Europe and U.S. and - in any segments?

And I would say in the European business, it was very odd. The first 2 weeks, it's like people stayed on holiday. The business in Europe just was not very active or very robust. It has picked up nicely the last 4 weeks. But U.S. and Asia continue to be very good. So the weakness was really in Europe, but I will say the last four weeks have been very good.

Okay. And free cash flow, talk about receivables first. They look fairly high and you mentioned the DSOs going up. Is there timing, is there areas -

Yes, you know, a strong December, which kind of inflated that a little bit, you know right there at the end of the year, so - and a little bit of a mix shift with the International piece in Europe and Asia Pacific, where those terms are customarily longer than what we experience or have in place here in the U.S., so a little bit of that happened in the fourth quarter as well.

So Patrick, where did we end out the year in terms of free cash flow in '07, and how should we think about it in the light of CapEx of $50 million, and we're still going to -

[Down] to discontinued operations and the proceeds, it was about $23.5 million of free cash flow for the full year.

In '07.

In '07.

Okay. Then we are going to have a negative spread between CapEx and D&A of what, close to $20 million in '08, correct?

That's right.

We still expect to grow in '08, so -

About $0.10 to $0.15 per sales dollar will get tied up in working capital.

Okay, so that's helpful. Then help me think about interest expense modeling going into '08, please.

We still have about $310 million in total debt. The blended interest rate on that is near 10%. So you have got a base of $31 million or so of interest expense. And we earn a little bit on the cash we have, 2 to 3%, so you are in the 28 to 30 range for the full year, assuming no further debt reduction or bond repurchases.

Okay. Super. The last one. A lot of noise on energy costs. Any comments on, you know, the raw material pricing spread as we look into '08?

I think it is the same story, John. We are very comfortable with our ability to raise price and we are very comfortable with our position and we have been through a lot and it really hadn't impacted us and I don't think it will impact us this year.

Did you comment, or would you care to comment, on what your average price per square yard did last year?

We don't comment on that. It was actually up a little bit.

Okay. Thank you very much.

Your next question comes from the line of Carl Reichardt with Wachovia Securities. Please proceed.

Good morning, guys. A couple of questions just on the capacity expansion for next year. Patrick, do you have a rough idea of what the total percentage capacity expansion would be as you look at it? And then, is that going to do anything to margins in terms of timing next year to get the capacity ramp that we need to think about when modeling the '08 quarters?

Yes, we will probably see a slight drag in Asia Pacific in the second half of the year, when the Chinese - the dollars are getting spent towards the Chinese facility. I would say overall we are probably adding, between Asia Pacific and America, probably another 15-plus to 20% overall capacity, broadly, with the $50 million in CapEx if you take all the pieces.

That is total modular, Patrick, not just -

Total modular, yeah, I mean it's very - you know, there is probably 3 or $4 million of that $50 million dedicated for the Bentley Prince Street business.

Yes, Carl, we are probably doubling the capacity of our Asia Pacific business with these CapEx expenditures.

Great. The second question is a little broader for you, Dan. I've been thinking about the sustainability strategy. You said it was helping to - as one of the four elements of driving the big growth in modular. I'm kind of curious if you're seeing that drive units more relative to peers or pricing? And maybe it is a combination of both?

I would say it is more peers. It is more market share gains. I mean the whole A&D, architecture and design industry, obviously is focused on the environment, and it is actually not just the United States, it is in Europe and it is in Australia, and it's becoming important in China as well. And we have been at this 13 years, going on 14 years, and we have 100% recycled back products, we take back the products and recycle it. We now offer a post-consumer yarn [face-weight]. You know, we're just - we are winning the business in a lot of the cases when sustainability means something. And Corporate America and corporate World is getting in tune with the environment, as well. So it's just - you know, Ray Anderson had a great vision in 1994 about sustainability, and asked the question, "What about oil at $100 a barrel, what will we do?"

I appreciate that. Thanks a lot, guys.

Your next question comes from the line of Eric Prouty with Canaccord. Please proceed.

Great, thanks a lot guys. A quick follow-up to the previous question on the sustainability aspect. Maybe some comment on the type of activity you see out there for lead-certified buildings, especially in the U.S. and even in the slowing environment, if you see a pick up in the number of buildings going for the lead certification? And then just a little clarification on the previous question where - do you feel like you have a higher market share in kind of a lead-certified building as opposed to a non-lead certified building?

Yeah, I would say from the lead standpoint, it is approaching almost 50% of the U.S. buildings are going for lead certified, that are particularly owner-developed and so forth, and it is growing. There is no way it is going to slow down today. I think if it is a jump ball, based on the product and if sustainability means something on the - to the - whoever the client is, that we will win that business because of our position on sustainability. If they are more - if they are interested in take back, if they are interested in recycled content, if they are a interested in a climate-neutral product, all our products in the United States are climate neutral, and we will win the argument more than we'll lose it.

Maybe to put it into context, when you say 50% right now going for lead, what would that have been for your business 3 or 4 years ago?

I would say 5 years ago, it was less than 10.

Great, thank you.

Your next question comes from the line of Sam Darkatsh with Raymond James. Please proceed.

Good morning, gentlemen, how are you? Most of my questions have been asked and answered. Dan, are you seeing anything either in your order book or reading the tea leaves in your end markets that gives you any concern or pause that you won't hit double-digit sales growth this year?

I think the one thing that we have to overcome, Sam, is the subprime in the financial institutions, particularly in the United States. They are obviously cutting discretionary spending, particularly in New York and Boston and so forth, and that's a concern that - you know, we have to overcome that by growing the non-office, non-financial institution piece. One thing that is going to help mitigate that, and I said it in my comments, is the fact that carpet tile is going to take a share of the office market. By the way, we did not have a great office market in 2007, from a commercial standpoint, in the United States.

As it stands right now, based on the share gains and acceptance that tile is seeing both in absolute terms and outside of the corporate end markets, that that kind of slow down in the financial institutions, which I think represents like what, like 10% of your business?

More like 12%.

12% of your business, that - as you look at it right now, that shouldn't inhibit double-digit top line growth for you?

We believe, and I will say it again, I have said it for I don't know how many years, but we believe the modular shift is real and it is not at all in the late stages, it is somewhat in the early stages and we are positioned to actually grow our business double-digits. That's what I am paid on, growing at double-digits.

The other question I would have, you mentioned that European orders growth basically matched European sales growth. I note your penetration in Germany is real low. Are you seeing increased adoption there yet, or is it still kind of a nascent acceptance in that country, with such a large potential market?

I would say that we are actually making a lot of inroads in Germany. Our biggest percentage increase in Europe last - came out of Germany - it's a small base, penetration of carpet tile in the largest commercial market in Europe., it is at 5% to 6%. There is a lot more acceptance of the A&D architects our there of modular carpet. We've got - I don't if you remember, we changed our whole management team out in Germany about 12 months ago, and I expect a lot of great things out of Germany in the next 5 years.

Thank you much.

Thank you.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Jeff Kobylarz with Stone Harbor Investments. Please proceed.

Good morning. In the past, you've said that - I believe, that the mix of renovations versus new build, where your demand comes from, it's around 80/20 or so, and is that percentage - did it - was it also the same in the fourth quarter?

Yes, it was.

We didn't really see it fall off in the office market in the fourth quarter, Jeff. I know everyone is anticipating it and talking about it, but we didn't see it in the fourth quarter. So it's still about 80/20.

Okay. And as you move more of your business, as more of your business comes from overseas, is that mix still 80/20 or is it - I would think there is new build if -

If you are in Europe, it's probably 90% renovation and 10% new construction. And if you are in Asia, it is probably 80% new construction and 20% renovation. But there is a different view of those two markets.

All right. Can you comment about how much you are increasing your sales force over - right now versus a year ago, say?

We have - going through the budgets, I think we had about 30 sales people budgeted this - in this budget. I think last year we actually increased it probably more like 40.

Okay.

But we are still adding sales people, yes.

On a base roughly of what?

Depends on how you look - on sales and marketing. Let me see, they move so much. Probably about 400 to 500.

All right. And then Bentley Prince Street, the revenues were up around 10% in the first three quarters of the year. Why the slow down in the fourth quarter?

I think modular carpet is taking share and Bentley Prince Street has a large part of its business still in broadloom and we need to accelerate the carpet tile part. I think it is under a little bit of pressure.

Thanks very much.

Thanks.

At this time there are no other questions. I would like to turn it back over to management for closing remarks.

Thank you, everybody, for listening to the call and thank you for being shareholders, and I hope to report a great year in '08. Thanks.

Thank you all for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.