Interface Inc (TILE) 2008 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the second quarter 2008 Interface Earnings Conference call. My name is Shanique and I will be your coordinator for today. At this time, all participants are in a listen only mode. We will be facilitating a question and answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) I would now like to turn the presentation over to your host for today's call, Mr. Bob Joyce from FD. Please proceed.

Thank you, operator. Good morning and welcome to Interface's conference call regarding second quarter 2008 results. Joining us from the company are Dan Hendrix, President and CEO, 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 the financial results. We'll then have time for questions. If you have not received a copy of the results release, which was issued yesterday after the close of market, please call FD at (212)850-5600 or you can get a copy off of the Investor Relations section of Interface's website. An archived version of this conference call will also be available through that website.

Before we begin the formal remarks, please note that during today's conference call, management's comments regarding Interface's business which are not historical information are forward-looking statements. Forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from any such statements, including risks and uncertainties associated with the economic conditions in the commercial interiors industry, as well as 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 SEC. 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 the way, I would like turn the call over to Dan Hendrix. Please go ahead.

Thank you, Bob, and good morning to everyone. Despite a challenging macroeconomic environment, we had a record second quarter, our best second quarter ever in terms of operating income and earnings per share. Revenue was up 11% as we outpaced the industry and gained market share. The top line growth was driven mostly by sales in the non-office segments and emerging geographic markets. By the market's secular shift from (inaudible) to carpet and tile, and by positive currency impact. These growth drivers more than offset lower sales in Western Europe and US corporate office markets.

Orders were 311 million, up 3% against a very tough record level comparison of 302 million in the second quarter last year, and let's not overlook that we grew income from continued operations by 19%, also versus a record second comparison of last year. Our modular carpet business continued its excellent performance, benefiting from the secular trend toward carpet tile and our market segmentation strategy, which provides us with sales opportunities in markets such as hospitality, healthcare, government, and education.

Geographically the growth was coming out of the Asia-Pacific emerging markets and non-corporate office segments in the Americas and Europe. Conditions were particularly soft in Western Europe where we have a higher exposure to the corporate office market. Europe is an important market for interface and we look forward to the benefits of our ongoing investments to advance our market segmentation strategy in that region.

Our Bentley Prince Street segment reported a 10% decline in sales and continued to experience operational issues related to the ramp up of carpet tile backing operations, as well as rods and raw material, and energy costs, which impacted its profitability. However, we are pleased with the strong order backlog going into the third quarter, and the continued growth of modular sales in this business, which increased 23% in the second quarter.

Moving forward, we are focused on right sizing and taking costs out of the business to make it more profitable at existing sales level. We remain confident in our strategy and believe we're well positioned to continue to grow the business even in this tough environment for several reasons. Our segmentation strategy provides us with opportunities in markets such as hospitality, healthcare, government, and education, which have a very low penetration of carpet tile and different drivers and cycles than those scene in traditional corporate office markets.

These are the markets we are seeing are strongest percentage growth rates in today. We continue to be in the early stages of the sector shift in carpet tile, and Interface is the largest manufacturer of modular carpet in the world, with the most recognized brands. And we continue to grow our market share. We're geographically dispersed, which we expect to mitigate the effects of the difficult environment in the US and Western Europe.

We see significant opportunity on the horizon as we expect that our ongoing investments to advance our segmentation strategy in Europe will further reduce our exposure to the corporate market in that region and open additional growth opportunities. Sustainability is at the forefront of our industry and our leadership position is helping us win business every day.

Also supporting our future growth is the strength of our balanced sheet, which is improved through the generating of cash from operations over time and reducing outstanding debt. We continue to see good demand for our products as orders grew from the record levels a year ago and the backlog at the second quarter was up 21% versus the beginning of the year.

We will continue to take a long term view, making wise investments in market segmentation, our residential business, and our global manufacturing platform. Now, I'll turn it over to Patrick for more details.

Thank you, and good morning everyone. I'll now take a few minutes and outline some of the financial highlights from the quarter. Sales for the second quarter of 2008 increased 11.3% to $295 million from sales of $265 million in the year ago period. As previously announced, the company sold its fabrics division in July 2007 and therefore the financial statements for the second quarter of 2008 and all other periods presented now reflect the fabrics division as discontinued operations.

Currency changes positively impacted sales by approximately $13 million. Gross profit margin in the second quarter 2008 was 35.7% compared with 34.8% in the second quarter of last year. SG&A expense in the second quarter of 2008 was $71.9 million or 24.4% of sales versus $61.3 million or 23.1% of sales a year ago. The increase in SG&A was due in part to a $4 million currency impact and $4 million of incremental costs related to our market segmentation strategy in Europe.

Operating income in the second quarter increased 8.2% to $33.4 million compared with operating income of $30.9 million in the second quarter of 2007. As a percentage of sales, operating income decreased modestly to 11.3% from 11.7% in the second quarter of last year due to the operational issues at Bentley Prince Street, and the continued investment in our segmentation strategy in Europe.

Interest expense for the second quarter 2008 was $8.1 million versus $9.2 million last year, reflecting our debt reduction efforts. In the 2008 second quarter, income from continuing operations increased 19.2% to $15.9 million, or $0.26 per diluted share, compared with income from continuing operations of $13.3 million or $0.22 per diluted share in the second quarter of 2007.

Net income for the first quarter of 2008 was also $15.9 million, or $0.26 per diluted share versus net income of $998,000, or $0.02 per diluted share in the second quarter of 2007. Included in the second quarter of 2007 was a loss from discontinued operations of $12.3 million or $0.20 per diluted share related to the fabrics business.

Depreciation and amortization was $5.5 million in the second quarter of 2008 compared with $5.6 million a year ago. Capital expenditures in the second quarter of 2008 were $8.1 million versus $7.1 million in the 2007 second quarter.

Turning to the balance sheet, at the end of the second quarter of 2008 we had $83.6 million in cash compared with $59.3 million at the beginning of the quarter, an increase of $24.3 million. We also had no borrowings outstanding under our domestic revolving facility and now borrowings outstanding under our overseas lines of credit. Long term debt at the end of the quarter was $310 million, unchanged from December 31, 2007.

In the second quarter of 2008, sales in our modular segment grew 15% to $259.3 million from $225.5 million in the second quarter last year. Performance in this segment was especially strong in the Americas and Asia-Pacific. Operating income for the modular segment increased 11.7% to $35.3 million or 13.6% of sales from $31.6 million or 14% of sales in the 2007 second quarter.

At Bentley Prince Street, sales decreased 9.6% to $35.7 million from $39.5 million in the second quarter of last year. Operating income decreased to $200,000 compared with $2 million in the second quarter of 2007. As reported in our earnings release, Bentley Prince Street continued to work through operational issues associated with the ramp up of its carpet tile backing operations, as well as rising raw material and energy costs.

But on a positive note, Bentley Prince Street had a strong order backlog going into the third quarter. The modular component of its business recorded a 23% increase in sales during the quarter and has raised prices to offset the increases.

We'll now open the call up for questions.

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

Thank you. Just wanted to ask a question on raw material real quick. What was the last price increase you implemented? Do you have any more do you anticipate coming in the third quarter and what have the input costs been doing in the last month or so?

We had a price increase in June. We had raw material price increases announced by the yarn suppliers in June as well. We don't anticipate any other price increased on the horizon today, but we're offsetting it, our raw material price increase and energy costs. We raised prices both in the Interface floor business, the modular business, and Bentley Prince Street.

And second question. We've had a couple of years of fantastic tile growth for yourself and for the industry. Has the competitive dynamic between yourself, Shaw, Mohawk, and Tandus changed? Any major share shifts, or is it pretty much the same competitive dynamic as a couple years ago?

It's pretty much the same competitive dynamic. I believe that we are taking share. I don't think the top market is growing as much as we are. We had a great second quarter in the US (inaudible) you just outlined.

Thank you.

And our next question comes from the line of Sam Darkatsh with Raymond James.

Good morning, Dan. Good morning, Patrick. Wanted to get into the overall orders if I could, Dan. The 311 is obviously a real robust number in absolute terms. What I want to get at is accelerating or decelerating and whether we should take anything away from the 3% number.

I mean, as I recall in April you were up 13% in orders and then you ended up being up 3% in Q2, and I was going to first ask, what's July look like? And secondly, was there pre-buying in that number because you were raising prices in June? Were there lumpy comparisons? I mean how concerned or not concerned should we be that the order growth is slowing?

Well, I would say that July started out about the same pace as April. We didn't see a fall off in July. We did have a price increase in June that probably bought in $5 million to $10 million in orders. We also had a price increase last June. I don't know if you remember we fell off in the third quarter, orders did, as we had a price increase that brought some orders in.

But I think the market feels about the same as it did in April, Sam. To me, the secular shift in carpet tile is real and we had a great segmentation quarter in orders and in shipments, and I suspect that will continue. The office market in Europe was down 6% and it was up 3% in the US, and that's the one thing that always concerns me is the European office market. But I feel okay about the order rate.

Last year in the third quarter, I mean normally you fill your orders the next quarter or so, roughly 100% or so and then last year was, I have a feeling it was because you had a high mix of your orders were the education end markets. Would you suspect you would revert back to that normalized fill of the orders? Or would there be some longer tailed business within your current order book?

I would say that we'll go back to historical trends.

Thank you, folks.

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

Great. Thanks a lot guys. You did mention some of the office data. Maybe just a little more detail, if there was any major shift during the quarter in the office, non-office mix of your traditional business, and then maybe you could point out where there was strength between office, institutional, healthcare, and hospitality.

Yes, if you look at the office market, the biggest negative impact was in France, which is in Europe our second biggest market. The UK actually held its own and France was down, which impacted most of the European short fall. In the US, the office market to me, it's okay. It's not great. Where we're seeing the biggest opportunity for growth is in education, hospitality, and healthcare in that order.

Our hospitality business was up significantly, a smaller base, but becoming more and more important to us, and education is now a major part of our business. And I think we'll see continued growth in all three of those segments.

Great, and then any sort of insight you can give us into, say, new build versus a replacement type business? Any insight into that?

Well, our business historically is 90% refurbishment and 10% new construction, and those dynamics really hadn't changed that much.

Okay, great. Thanks a lot, guys.

And our next question comes from the line of David Lund with Eagle Capital. Please proceed.

Hi, this is Meryl Witmer. The $4 million incremental cost for the market segmentation strategy in Europe, I was wondering if you could flesh out exactly what that is. Is it feet on the street, or -- ?

It's a revenue growth team which was comprised of a number of individuals. It's product development. It's marketing catalog spend, a combination of all of those.

And then that's incremental from a year ago. What does that look like versus last quarter?

It's about 1.5 million to 2 million on a sequential basis.

It's up by 1.5 million to 2 million?

Yes, on a sequential basis.

Right, so you're building that out and would expect to see something from it in the future.

Yes, we made a conscious decision that the real opportunity for growth is in segmentation in Europe and we went through this in the United States four years ago, and we've been building it out slower in Europe. And we decided that we needed to accelerate that. One reason is our competition in Europe really isn't doing anything. They're pretty much in survival mode and we just think it's an opportunity to take share and change the dynamics of that marketplace.

Terrific. Thank you.

(OPERATOR INSTRUCTIONS) And our next question comes from the line of Michael O'Brien with Australian Ethical. Please proceed.

Hi, guys. Congratulations on a great quarter. Just a couple of quick questions. One was, just want to clarify your view on refinancing the current debt program, whether that's something you consider doing or not.

It's certainly something that we're considering. I'm staying very close to the situation, monitoring the credit markets pretty closely. Obviously the credit markets here in the United States certainly is a challenging environment. There are deals getting done most oftentimes by people that have to deals and want to deals.

So we're continuing to evaluate a number of options here in the US and we'll hopefully give the credit markets a little bit of time to play themselves out and be opportunistic about the options that we have in front of us. But yes, refinancing is something that's on the forefront of my thinking right now.

We could get a deal done today if we wanted to. The market's out there. We don't really like the price. It would be cheaper than the 10 and three-eighths, but we think the market will improve where we can get a better deal done.

And we're going to continue to generate cash as well.

Would you incur penalties for prepaying early?

Yes, there would be a premium to repurchase the bonds, both issuances today, yes.

And just in terms of the sales and the soft office market, have you actually quantified approximately the lost sales you might have had from the downturn in the US and Europe?

No, the office market in the United States represents about 20% of our business overall, and the office market in Europe represents about 20% of our business. I'm not sure if that helps you or not, the Western office markets. So about 40% of our business is tied to the US and Western office markets.

And can you sort of give any more color as to what may have been, like did you lose, say, 5%?

In Europe, the office market was down 6%. In the US, it was up 3%. I said that earlier.

Sorry, I wasn't sure if you were referring to yourselves or the industry.

I'm sorry. The industry, there's the carpet and rug industry puts out a total commercial number and I would say that based on the volume out there, it was down about 3%.

Great. Thanks very much.

And our next question comes as a follow up from the line of Eric Prouty with Canaccord. Please proceed.

One quick follow up. Any change to your CapEx plans that you talked about the end of last year, and could you just reiterate what they are?

Nothing material changed. It's just a matter of timing. I mean all of the projects that we've outlined and have committed to are still in place. Timing on a few things perhaps are getting pushed out for regulatory and other negotiated items, but we'll probably be in the $40 million this year and comparable in '09. And then some of that will carry over into 2010.

But nothing has changed from our map just in which particular calendar year it will fall.

Fair enough. Thanks, guys.

When we get done with this capital plan, we will have a plan in China. We'll have a plan in Southeast Asia. We'll have developed a footprint in Australia and we'll have a lot of capacity that we can actually grow the business with. It will pretty much take our global footprint, put it where we want it to be.

And our next question comes from the line of Neil McConnell with Walker Smith Capital. Please proceed.

Hi, guys. Good morning. Just wanted to see if you could give us some color on the Asian region, what percent of business it is now, and what the growth rate looks like.

It still represents about 10% of the business and the growth rates we're seeing are north of 20%.

Okay, and everything I think you just mentioned, but is mostly on track for the capacity additions over there?

Yes, we're working diligently to continue that project forward.

Great, thanks.

(OPERATOR INSTRUCTIONS) We do have a follow up from the line of David Lund with Eagle Capital. Please proceed.

Hi, it's Meryl again. I forgot to ask about consumer and what you're seeing there, and I also wanted to let you know I actually bought some tiles yesterday.

How do you like it?

Well, we're putting them in on Saturday, and then -- but they looked good in the store. Also, you called out some production issues at Bentley Prince Street and I didn't know if you could quantify them or give us sort of a range. And then also just what's happening otherwise, production wise at other plants around the world, Australia, that type of thing.

See if I can get all those in my head. The one on the online businesses, I'm pleased with that. We've hired a new consumer marketing person that really, I think, is going to add a lot more expertise to us on how to do the catalog and online business. So I'm pleased with that. The carpet tile belongs in the home and we're going to do it. We're going to invest in it and that's going to become a more significant part of our business.

The Martha Stewart line has done very well. As far as the production at Bentley Prince Street, it probably costs us about $1 million as we ramp up that tile line, and we're really going slow at it. We're putting more raw materials on the back to make sure we don't have problems with the product on the floor, and faulty claims, and so forth, and running at slower speeds.

It never goes as well as you think it's going to go, but I think we're on top of it, and we'll see continued improvement there. And what was the third one? Oh, Australia --

Australia, or anywhere else.

From a production standpoint, I think we ran very well in our European plants, in our Americas plant, in our Thailand plant. Australia, we're continuing to renovate that and it probably cost us about $500,000 in efficiencies as we continue to work through the whole renovation of that plant.

Great, thank you.

(OPERATOR INSTRUCTIONS) And our next question does come from the line of Matt McCall with BB&T Capital Markets. Please proceed.

Thank you. Good morning everybody. Sorry, I had some technical difficulties so if you've answered some of this, I'm really going to follow up on the last question. Dan, I think you said Bentley cost you about $1.25 million.

That's just the production side of it.

Okay, maybe that'll be the answer to this question, but if I look at that, your operating margin would probably still have been down year over year. It sounds like some of the production issues that Australia, or just help me understand what were the push and the takes that would draw. I know there were some incremental SG&A spending, FX, maybe some things like that, but just help me walk through what would have pressured margins outside of Bentley Prince Street.

Well, as far as Bentley Prince Street, you've got a sales comparison decline as well. So you've got to look at the incremental margins on the $3 million plus sale shortfall compared to last year, a 10% decline. The biggest thing is the investment in the European marketing. I mean I was very pleased with the gross profit line, even with the difficulties at Bentley Prince Street.

We're hitting around 36%, so it was really the investment in the whole marketing and sales infrastructure. We also invested in Asia as well. So to me we made the investments to grow the top line and are taking a little bit longer term view.

And forgive me if you said this already, but as we look at the rest of the year, are we going to see similar investment levels on the SG&A line from a dollar standpoint? How should we look at the balance of the year?

Matt, I would think that unless it's currency impacted that the level we have in the second quarter, we will not go above that level in my mind. We're going to look at a lot of cost reduction initiatives as well, particularly at Bentley Prince Street. So I think you're at that level today.

So no higher?

Unless it's currency related.

And then how should we look at the Bentley profitability with all those puts and takes? It sounds like you're going to take some actions there. How should we look at that for the balance of the year?

I'm not making any more promises. I'm just going to go fix it.

I hear you. Okay, thank you, guys.

And our next question comes as a follow up from the line of Michael O'Brien with Australian Ethical. Please proceed.

Just be interested in our take on how you view sales growth over the next couple of years given the expansion plans in Asia and also the initiatives in Europe. Can you give some sort of rough guidance?

We don't really give those kind of guidance. I think we can grow the segmentation strategy double digit and I think emerging markets can grow double digits, and I don't have a crystal ball about what's going to happen in the office markets in Western Europe and the US. But I do know that we will outperform the industry.

Can you talk about the theoretical capacity of the business based on the expansion plans?

Yes, when we get the China plant built and we get the Australian plant, double the footprint of that plant, we'll be running the capacity in Asia, we'll probably be about 60% in Asia. And the footprint will be there to take it further than that from a capacity standpoint. From the US standpoint, we're probably running about 75% of capacity. We'll incrementally add capacity there. We've got plenty of capacity in Europe and Bentley Prince Street to reach those double digit growths we talked about.

Okay, thank you.

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

Well, thank you everyone and I hope to report a great quarter in the third quarter.

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