Interface Inc (TILE) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the investors conference call. My name is Chanelle, and I will be your coordinator for today. At this time all participants are in listen only mode. We will be facilitating a question and answer session towards the end of the conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's conference, Mr. Bob Joyce from FD. Please proceed.

Thank you, operator. Good morning, and welcome to Interface's conference call regarding third-quarter 2008 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, and Patrick will then review the company's key performance metrics and financial results. We will then have time for any questions that you may have.

If you have not yet received a copy of the results release we issued yesterday after the close of the 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 An archived version of this conference call will also be available through that website.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 commercials interiors industry, as well as 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 this call and cautions listeners not to place undue reliance in any such forward-looking statements.

Lastly, please note that this call is being recorded and broadcast for Interface and contains copyrighted material. Not be re-recorded or rebroadcast without Interface's express permission. Your participation on this call confirms your consent to the company's taping and broadcasting of it. So with these formalities out of the way I would like to turn the call over to Dan Hendrix. Please go ahead, Dan.

Thank you Bob and good morning to everyone. Overall our third-quarter results reflected the prevailing market conditions. Not surprisingly, the macroenvironment has impacted almost every market including the market for modular carpet. Despite this, we were able to create opportunities in wholesales even versus strong third-quarter comparison last year. Our modular carpet business benefited from the continued secular shift toward carpet tile as well as diversification across market segments and geographies. The effects of the global slowdown in the corporate office market particularly in Western Europe and the United States were offset by continued solid demand for modular carpet in non-office segments such as government, education, healthcare and retail as well as growth in the emerging geographic markets such as Eastern Europe, Latin America and the Middle East.

During the quarter modular sales in both the non-office segments and emerging markets were up double-digit percentages, which offset declines in the more mature office markets. We also continued to invest in the implementation of our market diversification strategy in Europe, which has been a key driver for our success in the US market. While these investments have affected our profitability in the near term, we believe we are well positioned in Europe to achieve a first mover advantage in the non-office European marketplace, which is experiencing significant growth on a much smaller base in the United States.

We also saw strong growth in Asia Pacific due to its relatively good economic climate although it is beginning to feel the ripple effects from anxieties in other parts of the world. Bentley Prince Street had a modest decline in sales. However, modular sales within the business continued to grow in the third quarter and reaffirmed the broader shift we are seeing in carpet tile. We made progress in addressing the operational issues related to the ramp up of its carpet tile backing operations. Also as we mentioned last quarter we have been focused on right sizing the Bentley Prince Street business.

During the third quarter we reduced headcount and took out costs which will help us make the business more profitable at the existing sales levels. And we expect to start seeing the benefits of these efforts in the fourth quarter. Over the past several years Interface has been building its business for long-term growth and to withstand economic downturns. Our work to date should help mitigate the effects of the current economic environment yet still allow us to make investments necessary to grow our business. We are confident in our business for several reasons.

There is a clear secular shift to carpet tile. Interface is the largest manufacturer and the most recognized brand in modular carpet, with global manufacturing capabilities which puts us in a unique position to benefit from this opportunity. Our market diversification strategy has opened opportunities for Interface in non-office markets including government, education, healthcare and hospitality. It is in these markets we are seeing the strongest growth rates as spending in these areas is not as cyclical as it is in the office and retail markets. Carpet tile penetration is currently very low, and their cycles and drivers are different from those seen in the traditional corporate office market.

We are also benefiting from our geographic diversification. Today approximately 50% of our sales come from outside the United States. This reduces our exposure to any one region and opens up opportunities for future growth. We also have established a solid financial foundation to support our future growth by strengthening our balance sheet by generating cash and reducing debt. Now we are well-positioned to financially manage through an economic down cycle while still having the capacity to invest as necessary to achieve our objectives for the business.

And lastly, we are the global leader in sustainability which goes a long way in the market and is helping us win business every day. We believe we are well positioned for this business environment and our primary objectives are to protect the profitability of our business and generate cash to further reduce debt with an eye toward long-term growth. At the same time we will continue to effectively manage costs to align them with our sales levels and create the opportunities necessary to drive revenue and profit. With that, I will turn it over to Patrick.

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 third quarter of 2008 were $278.4 million compared with sales of $279.5 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 third quarter of 2008 and all other periods presented now reflect fabrics division as discontinued operations.

Fluctuations in currency positively impacted sales by approximately 3% in the third quarter of 2008 compared with the third quarter of 2007. Gross profit margin in the third quarter of 2008 was 34.1% compared with 35% in the third quarter of last year. The lower gross margin was due to under absorbed fixed overhead as a result of lower volumes, principally in our European modular business and additional fixed costs as a result of our plant expansion in our Asia-Pacific modular businesses.

SG&A expense in the third quarter of 2008 was $63.9 million or 22.9% of sales versus $63.2 million or 22.6% of sales a year ago. While SG&A levels were nearly flat year-over-year, we have continued to invest in our market diversification strategy in Europe, which should open up new sales opportunities.

Operating income in the third quarter was $31 million compared with operating income of $34.8 million in the third quarter of 2007. As a percentage of sales operating income decreased to 11.1% from 12.4% in the third quarter of last year.

Interest expense for the third quarter of 2008 was $8.2 million versus $8.6 million last year reflecting our debt reduction efforts. In the 2008 third quarter income from continuing operations were $13.6 million or $0.22 per diluted share compared with income from continuing operations of $15.2 million or $0.25 per diluted share in the third quarter of 2007.

Net income for the third quarter of 2008 was $8.4 million or $0.14 per diluted share versus net income of $8.6 million or $0.14 per diluted share in the third quarter of 2007. Included in the third quarter of 2008 was an after-tax loss from discontinued operations of $5.2 million or $0.08 per diluted share related to the US fabrics business, which was sold in 2007. Of that loss from discontinued operations $4.2 million or $0.07 per diluted share was due to a reserve placed on the deferred purchase price of that business.

As we announced at the time of the proposed transaction there was a potential for an additional $6.5 million in cash proceeds on the sale subject to the division meeting certain performance metrics over a six to 18 month period following the transaction. The remainder of the loss relates to an impairment charge for certain assets remaining from the fabrics business that are currently being held for sale.

Depreciation and amortization was $5.7 million in the third quarter of 2008 compared with $5.1 million a year ago. Capital expenditures in the third quarter were $6.6 million versus $9.6 million in the 2007 third quarter.

Turning to the balance sheet at the end of the third quarter of 2008 we had $85.5 million in cash compared to $83.6 million at the beginning of the quarter, an increase of $2 million. We had no outstanding borrowings under our domestic revolver facility and no borrowings outstanding under our overseas line of credit. Long-term debt at the end of the quarter was $310 million unchanged from December 31, 2007. Since the end of the third quarter we have repurchased $19.4 million of our 10 3/8 bonds due 2010.

Turning to our segments, in the third quarter 2008 sales in our modular carpet segment were $243 million compared with $242.9 million in the third quarter last year. Performance in this segment was especially strong in our North American modular business. Operating income for the modular segment decreased to $30.3 million or 12.5% of sales from $35.2 million or 14.5% of sales in the 2007 third quarter. The lower operating income in the segment was primarily due to the lower volume levels in our European division and additional costs for plant expansion in our Asia-Pacific division.

At Bentley Prince Street sales decreased 3.3% to $35.4 million from $36.6 million in the third quarter of last year. Operating income decreased to $0.7 million compared to $1.3 million in the third quarter of 2007. As Dan mentioned, Bentley Prince Street continued to work through operational issues associated with the ramp up of it carpet tile backing operations as well as rising raw material and energy costs. As part of our efforts to rightsize our Bentley Prince Street operations we reduced headcount and took other costs out of the segment. In addition, we raised prices to offset cost increases. In the third quarter we started to see some improvement sequentially in the segment as operating profit improved 140 basis points when compared to the second quarter of 2008, which had similar revenue levels.

We will now open the call up for questions.

(Operator Instructions) Sam Darkatsh, Raymond James.

A couple questions. First off, Dan, if things get much softer what would your inclination be in terms of paring back discretionary costs, and what costs would you look at if you are trying to conserve cash and profitability?

As I said in the call, Sam, we are going to protect the profitability. There is a lot of discretionary spend, obviously, within our P&L. I would not cut discretionary spend around the sales and marketing group, but we would look at every cost that doesn't really increase growth and take a hard look at that.

So would you expect outside of an off-the-table sort of drop, would you expect that SG&A as a percent of sales would fall? You would get some favorable leverage even in a downturn?

I would say in a downturn we would keep SG&A levels where they are percentagewise.

Okay. Give us a little bit of color as to how you see October orders looking at this point.

October orders feel a lot like they did in July, about the same rate. Interestingly enough, our US business is up 12%. Our America's business is up 12%, and our US modular business is actually up more like 15% to 20%. The weaknesses in Europe we have been highlighting that for a while; that is the biggest concern that I have. I am not very concerned about the US business at all. That is a very segmented business and we are seeing a lot of good growth come out of the nonoffice piece.

Any chatter with respect to fiber costs coming off as of yet with oil prices where they are on the demand side?

Not yet.

Would you anticipate with (multiple speakers) caprolactam coming off would you anticipate something (multiple speakers)

Anticipating the oil and supply demand issues and we will have a lot of leverage with our yarn suppliers.

Two more quickies, and then I will defer to others. With the bonds trading underneath par are you active in the market in terms of buying those bonds back or what are your thoughts there Patrick?

We are, and we have repurchased 19.4 million since the end of the quarter.

And any thoughts on the Chinese capacity that you were looking to add in --?

We will continue to look at that. We've got our business license. We've got our land identified. And a lot of those expenditures will occur actually in 2010.

So we should look at CapEx next year as being closer to depreciation, perhaps?

Depreciation and amortization, correct.

Okay, thank you.

Keith Hughes, SunTrust.

On the CapEx number, why are all the expenditures coming in 2010, Dan? I thought that was coming a little faster.

We are taking a little longer to get the buildings specified and go through the whole process in China.

And if you look at your order patterns in nonoffice or any of the pieces of nonoffice, have they shown any deceleration whether it is hospitality, education, healthcare, things like that?

Not yet. The nonoffice, particularly US, is very strong.

Okay.

We have not seen that. Where we play, the $13-$25 space in the specified market, I think we are doing very well in that part of the market.

And finally in Bentley Prince Street -- where are you in terms of the process of getting carpet tile capacity in, and how much of the unit sales is now carpet tile?

Well, the carpet tile line is in, and we went in a very conservative manner. The speeds of the line were slower than what we originally designed it to do. We added some of the excess weight to the back just from a belt and suspenders perspective on a quality perspective. And we did that initially and we are ramping up to faster speeds and reducing some of the material on the back. So we are a good way towards where we had designed the product. We are probably 75%, 80% there in terms of being finalized.

The modular piece, Keith, we will end the year about 30% modular and 70% (inaudible)

30% modular, okay. Thank you.

(Operator Instructions) John Baugh, Stifel Nicolaus.

Patrick, currency, can you tell us year to date now what --.

I know it was about $10 million in the quarter. I don't have the year-to-date figure off the top of my head. I have to come back to you on what the year to date impact is.

Do you have a guess on EBITDA impact year-to-date, and with the euro now weakening dramatically, any guidance going into '09 in terms -- obviously revenue is going to go the other way. I am wondering what EBITDA does.

I would say order of magnitude year-to-date was probably $2 million or so year-to-date.

Of benefit?

The pieces, the currency impact, the benefit that we've gotten on a year-over-year basis.

It is a straight translation, John.

Okay.

There is not any leverage that you get out of the currency going either way.

So if we saw a similar move to the negative next year, a similar move --.

$2 million to $3 million again.

Okay. Where do you stand today on a run rate basis in the United States and then maybe in Europe in office versus nonoffice mix?

It is 52% corporate, 48% noncorporate.

In the US?

In the US. On a global basis, hang on, it is 58% corporate, 42% noncorporate.

So let me make sure I got that right. The US, the office or corporate is 52% of the mix sort of on a run rate right now; and everywhere else in the world it is 58%?

Globally 58%, corporate, 42%; in the US, let me check that -- sorry, 44% corporate, 56% noncorporate in the US -- excuse me.

And globally.

It is 58% global corporate office and in the US it is 44% office.

Okay, US is 44%. Okay, and there has been so much concern about the financial markets here and for that matter in Europe. Any way to sort of put that in a box, Dan, in terms of your customer exposure both here and in Europe? And if we were going to make assumptions of those markets, the financial piece is off 30% or 40%, any kind of feel for that?

We are actually trying to dig into that. We did a quick look at that, and I think we were exposed in our office market globally about 20%, 22% to the financial part.

That is a global number?

Right.

Okay, and just to, as we look out to next year obviously we've got to make our own net income assumptions. If we saw revenues decline, I would assume you generate a source from working capital, or would that be wrong? And help me with inventories; how they track Q4 and into next year.

I think inventories in Q4 will probably be down. We've got a target of $9 million to $10 million. Part of the reason we have an inventory build is our allocated inventory to orders. We are seeing a lot of delays in the order book where they actually don't want the product until the project is ready to be installed, and that is a global thing. That is happening all over the world and that is one reason we've had this inventory build that hasn't been released to the backlog.

We are targeting about a $9 million reduction in inventories in the fourth quarter, and typically we get $0.10 to $0.15 per sales dollar and working capital increases or declines. I expect that would flow through, as well.

And should we -- the extent whatever free cash flow you model, should we now start assuming you are going to pay off 10 3/8 interest debt assuming trades below par or is that a bad assumption?

That's a fair assumption. We will be opportunistic about repurchases. Obviously the 10 3/8 is the next maturity that needs to be addressed.

Thank you, and I think a pretty good quarter, guys. Take care.

Jeff Kobylarz, Stone Harbor.

I was just curious about a question that John asked about the 40% of the global business. I'm sorry -- 22% of your business, that's corporate, so that's finance. So is that -- does that mean out of the 58% of your global business that is corporate, that 40% of that, roughly, is the finance companies?

No, of the 58 -- I'm sorry, 22% of that would be, not 40 -- I think our corporate exposure is about 22%.

Of total sales?

Right.

Total tile sales, okay.

That's Asia, that's Europe and that's the US.

Right.

And Asia is continuing to actually expand there.

And your SG&A was just up $700,000, and you continue to invest in your diversification effort in Europe. And the investment in the second quarter was I think around $4 million, so was there a slower pace of --

No, actually if you look at the European business the volume was down 10% in local currency. And normally you would have seen the variable piece of that SG&A decline as well, but on a euro basis that SG&A investment was actually up slightly. So the variable piece decline was offset by the incremental spend on the segmentation initiative. So it was relatively equivalent to the pace that we've been spending in the second quarter; whereas in the second quarter the euros on a year-over-year basis it was flat in euro terms. The incremental piece stood out more.

And can you comment about your third-quarter US volume? Do you think you were in line with the industry trends or how would you shake out?

I still believe we took share in where we play. If you look at some of the comments from the competitors that are talking about the commercial market, they are talking about it being negative. Our suppliers that supplies most of the specified commercial market, data from them is that we are doing better than our competitors in that space. So I feel like when we play at the $13-$25 that we clearly are not losing share and I still believe we are taking share.

Okay.

The average price of the commercial corporate market is $11 a yard, and ours is $20, almost $21.

Okay, is there price competition that is going on or is it more you are winning more on design or what?

Same, we are winning on design. We've always had price competition. That is not any different.

It's not heated up any?

I would not say it is intensified.

Okay, thank you.

(Operator Instructions) Matt McCall, BB&T Capital Markets.

I think the inflation question was asked. Sounds like there might be some benefit there. You talked about in the past some internal initiatives to control costs. Can you give us an update on where some of those stand and what the expected benefit is going into '09?

We have a lot of projects, Matt, that we are tracking to about $20 million on an annualized basis and we are going after those very aggressively. I would say we actually -- the fact that you've got a sort of a slowing trend we are able to work on a lot of those versus chasing capacity. And so I anticipate, not to give you a number on it because I went by plugging into their models, but I anticipate we will get a lot of that $21 million next year.

And have you recognized any of that benefit?

Yes, sure, we recognize it going along.

In this quarter you did?

It is an ongoing process just reducing costs in the plant and, it is all about dematerializing, changing out the cheaper materials and so forth and that is an ongoing process in the plants.

Without giving numbers can you tell us about how much has been recognized thus far of that $20 million?

About $5 million to date.

Thank you.

You are persistent, Matt.

I didn't want a number. I just asked for an idea. In Bentley Prince Street I think last quarter you said we are not going to give targets anymore, we are just going to fix it, definitely made some progress in the quarter. Any thoughts on what the progression is going to look like there without trying to put any targets on it? How should we look at that business going into '09 from a profitability standpoint?

I would say we still have this target of 8% and if we can hold the top line I think we can get back to 5 to 6% next year.

On holding the top line, okay.

Where it is currently.

Is that a realistic assumption in this environment, you think?

I don't have a crystal ball, Matt. But I think we are going to -- we are segmenting that business. The dependency on the office market in Bentley Prince Street is the lowest in all our businesses now. It is more the hospitality, healthcare and so forth, education. The modular piece side I think will continue to grow. What happens in the office market piece is anybody's guess right now.

And you said it is more segmented. What is the office penetration there? What is the mix of office?

That is less than 40% now in Bentley Prince Street.

All right. And then Patrick I think you gave a little bit or Dan, update on the residential side, and I guess is there an update on the profitability outlook? I know the stance has been in the past you are going to continue to invest (multiple speakers).

I would say we are going to change that posture. We are going to break even with it next year, and we are going to do that by focusing on what, we are having the success on the web and catalog business.

Web and catalog; and is that the case so that web and catalog I guess that would be -- is that focused mostly domestically, or are you --

The European piece, as well. We've got a EUR20 million residential business in Europe, as well. And same thing there. We are going to focus on the web and catalog piece of it and drive it to breakeven.

Patrick, remind me of what that is going to -- what kind of hit that's going to be this year or give me the hit through Q3.

It will be $8 million for the year if you add those two businesses together.

Okay. Thank you, guys.

Eric Glover, Canaccord Adams.

I was just wondering if you could remind me what percentage of your sales are coming from Asia at this point, and what's the growth rate you are seeing there?

10% is coming from Asia, and we were up 20% plus in the third quarter.

Okay. Thanks a lot.

[Joe Salerno], Goodnow Investments.

I may have missed this, but Patrick, Europe segmentation, is that costing you guys about $4 million a quarter, one, and two.

Correct.

Could you guys flesh out what is behind it and when you might expect that to play out in sales, are you expecting to see some gain this year, next year?

Yes, we are already seeing some of the gains in segmentation today. I guess the answer to your first question is yes, it is about EUR2.5 million or so a quarter. We are starting to see the benefits; the segmentation piece is actually obviously offsetting the corporate declines in Europe. And we will continue to see that spend continue through the balance of the year and perhaps even into early next year around segmentation. It is a key initiative for us organizationally, we need to reorient and balance that mix in Europe comparable to what we've done in the US. So yes, we will continue that on.

That is about a EUR50 million business today, the non-office piece in Europe. And it has been growing between 15% and 20% the last two years. We need to accelerate that growth.

Okay, so if these efforts are resulting in sales, then probably at some point it is really a breakeven effort. If you are spending to get sales, are you there yet would you say or no?

Yes, we are, obviously.

So this is just incremental?

Right. I mean, it is offsetting what is going on in the western office markets there. The UK and France particularly.

All right. And secondly, when you guys look at the refurbishment market, which I think you guys say is maybe 80% or 90% of your orders; what drives that? Just taking a step back, is it more the tenant, or is it the building like if a lease is up it is -- a bone the building throws to the tenants?

I think it's both. I think it is both depending on the tenant. If it is tenant improvement space and the building is being churned and there is obviously incentives to refurbish the building from that standpoint. But typically if you've got -- let's say Fortune 1000 companies that have longer leases or they own their buildings it is the refurbishment cycles; they refurbish usually every eight to nine years. In this kind of cycle they typically push it out 12, 13 years.

Would you say the US and Europe is similar like that, the dynamics?

Yes.

Lastly, when you look at Europe being materially softer than the US, does it have anything -- what is your assessment as to why? Is it just the commercial market there is just gotten softer earlier, or are there other dynamics going on?

I would say there is a lot more discretionary spend that goes through dealers in the European market, particularly in the UK and in France, and that has dried up there.

Okay, thank you.

(Operator Instructions) Chris Arndt, Select Equity.

I was wondering if you could comment on your gross margin for fourth quarter and the first quarter particularly in light of the fact that you might be slowing production given that the inventory levels are high. What extent is that going to negatively impact the gross margin?

I think you -- I mean we typically don't provide guidance around it, but I would say that broadly speaking you are going to see gross margin in a very comparable level to where you are in the third quarter. I think we've made a few adjustments, taken out a couple shifts, one in California and one in Europe. So we have rightsized our manufacturing operations around this in the third quarter, so you probably won't see as big a depression. It will probably be in the, broadly speaking in similar levels where we are in the third in broad strokes.

Okay, and just to follow up on the comment that customers are pushing out their -- what are in fact actually are they doing? They are just taking longer to complete a building or complete a project?

Sometimes the contractors would take the product early and they would take discounts on the products, as well. I think they are being stretched from a credit standpoint. So they want the product shipped almost the day it gets installed on a project, so a project gets pushed out, they are pushing out delivery dates with us, as well. Some projects are getting delayed. As you can imagine.

Okay. That's helpful. Thanks.

That concludes the Q&A session. I would now like to turn the call back over to management.

Thank you, and nobody is more disappointed about the third quarter than me. And I believe we are positioned to do very well in this environment. We have been building this business for a downturn if it happened with the segmentation strategy in the emerging markets. And the carpet tile secular shift is real, and I think we are positioned to grow this company long-term. Thank you.

That concludes the presentation. Thank you for your participation. You may now disconnect. Have an excellent day.