Interface Inc (TILE) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2010 Interface earnings conference call. At this time, all participants are in listen-only mode. Later we will facilitate a question-and-answer session. (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 call, Miss Jessica Greenberger, of FD.

Thank you, operator. Good afternoon, and welcome to Interface's conference call regarding third quarter 2010 results. Joining us from the company be 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 open the call for Q&A. If you have not received a copy yet of the release, which was issued after the close of the market today, please call Financial Dynamics at 212-850-5600, or you can get a copy off of the Investor Relations section of Interface's website. An archive 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 said statements, including risks and uncertainties associated with the economic conditions in the commercial interiors industry, as well as risks and uncertainties discussed under the heading "Risk Factors" in item 1-A of the Company's annual report on form 10-K, for the fiscal year ended January 3, 2010, which has been 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 responsibilities to update or revise forward-looking statements made during this call, and cautions listeners not to place undo reliance on any such forward-looking statements. Management's remarks during this call may refer to certain non-GAAP measures. A reconciliation of these non-GAAP measures to the most comparable GAAP measures are contained in the Company's results release in form A-K filed with the SEC today, each of which can be found on the Investor Relations portion of the Company's website, www.interfaceglobal.com.

Lastly, please note that this call is being recorded and broadcasted for Interface. It contains copyrighted material. It may not be re-recorded or re-broadcast without Interface's express permission. Your participation on the call confirm yours consent to the company's taping and broadcasting of it. With these formalities out of the way, I would like to turn the call over to Dan Hendrix. Please go ahead, Sir.

Thank you. And good afternoon to everyone. We're very pleased with our third quarter results. We turned in another strong performance as momentum continues in our business as we once again saw significant year-over-year increases in overall sales, margins, and earnings. We continue to benefit from the ongoing sector shift toward carpet tile and growing our market share. Our sales increase in the third quarter was largely due to two factors. First, from the continuing release of pent-up demands from the corporate office market globally, with a focus on office refurbishment; and second, from the emerging markets, particularly in India and China.

The investments we made in our end market diversification strategy also continued to positively impact our sales as non-office segments such as hospitality, education, and government grew nicely compared with last year. This revenue growth drove gross margin expansion both year-over-year and sequentially. The combination of increased sales, enhanced manufacturing efficiencies, and cost reduction initiatives led to a 48% increase in operating income, on a 16% increase in revenues year-over-year.

Looking regionally, our Asian/Pacific division once again delivered excellent results, and Australia, which is now our second largest market, continued to be a key driver in the region. The sales environment in emerging markets was increasingly robust, particularly in India, China, and Brazil, with demand for our products coming from the investments being made by both local and multinational companies. I'm really pleased with our progress in China. Over the past several years, we've invested in building our sales presence there with carpet source from our plant in Thailand. After establishing a sufficient sales presence, we made a decision to develop our infrastructure with a new plant, which is scheduled to be fully operational in about a month. With a new plant we'll serve the greater China area while our plant in Thailand will continue to serve Southeast Asia, India, and the Middle East. As those regions continue to grow, we're very optimistic about our opportunities.

It's worth noting that other emerging markets such as the remainder of Latin America, Africa, and Eastern Europe also delivered solid results during the quarter. Our America's modular business had nice performance, making its fourth straight quarter of year-over-year improvement. The corporate office segment lead the game, while non-office segments also performed well, particularly hospitality, education, and government.

To (inaudible) a bit further, our core US modular business had its best sales quarter ever. In Europe, we're continuing to see some very welcomed improvement, as both sales and profitability increased significantly year-over-year. We're benefiting from rebound in corporate office market in most all of Europe. In Germany, which is the second largest carpet market in Europe, we're starting to see the sector shift to carpet tile that we're experiencing in the US and other parts are of the world. Across Europe, we've been increasing our marketing efforts to capitalize on strength of demand in the non-office segments. At Bentley Prince Street, while the demand for high-end broadloom remains somewhat challenging, we started to see some positive results from the actions we've taken to adjust product mix, reduce inventories, control costs, and increase efficiencies. At the same time this business is benefiting from the general improvement in the market, a lift in demand from the higher end financial service customers in particular.

As a result, sales increased, and this business turned a profit during the quarter. Drilling down a bit more, Bentley Prince Street business is now nearly 40% carpet tile and growing, while the broadloom side of the business has continued to decline in line with the broader industry. Our forecast at Bentley Prince Street is now on continue to grow the top line, with the release of pent-up demand in the corporate office market. Our FLOR residential consumer business continues to grow, driven by web and catalog channels. We've continued to invest in our sales and marketing initiatives at FLOR to capitalize on the market opportunity we see here. Our store in FLOR store in Chicago is exceeding our expectations, and we plan to have a total of three FLOR stores open by the end of 2010.

During the quarter, orders grew 20% to our highest level in eight quarters, and our backlog increased by almost $38 million since the beginning of the year. With the secular shift towards carpet tile continuing, a corporate office market recovering quicker than expected, and a vibrant environment in the emerging markets, we feel well positioned as we approach the end of the year, and optimistic about the opportunities ahead, and we'll continue to realize the leverage in our business model as demand grows.

In the first few weeks of the fourth quarter, the momentum in sales and orders has continued. Overall, as we approach the end of the year, we feel that we're in a strong position to grow market share, capitalize on opportunities we see in the marketplace, and to continue leading the secular shift toward carpet tile. With that, I'll turn it over to Patrick to provide you with more details on our results and financial position.

Thank you, and good afternoon, everyone. I'll now take a few minutes to talk through the financial highlights from the third quarter. Sales for the third quarter of 2010 were $252.7 million, compared with sales of $218.4 million in the third quarter of 2009, an increase of 15.7%. Currency was essentially neutral year-over-year, as the weakness in the euro was offset by the strengthening of other currencies such as the Australian dollar and the Canadian dollar. As Dan mentioned, our sales performance was driven by the improved demand in the corporate office sector globally, as well as hospitality, education, and government sectors, and growing demand in the emerging markets.

Gross profit margin was 35.4% compared with 33.2% in the third quarter of 2009, reflecting the benefits of our restructuring initiatives, and increased absorption of fixed manufacturing costs due to higher sales volumes. SG&A expense in the third quarter of 2010 increased to $61.4 million from $53.5 million last year, but declined slightly as a percentage of sales to 24.3% compared with 24.5% a year ago, reflecting our ability to leverage our ongoing investments in our end market diversification strategy over increased sales. Our operating income performance also continued to demonstrate the leverage in our business model. On a 15.7% increase in sales, operating income in the third quarter of 2010 improved by 48.2% to $28 million, compared with operating income of $18.9 million in the third quarter of 2009. As a percentage of sales, 2010 third quarter operating income was 11.1%, compared with 8.7% in third quarter 2009.

Interest expense in the third quarter of 2010 was $8.4 million, compared with $9.5 million if the third quarter of 2009. As anticipated during the third quarter, we continued to realize interest expense savings of $4 million annually, as a result of our recent debt reduction initiatives. We remain focused on debt reduction in the upcoming quarters.

Net income attributable to Interface Inc. for the 2010 third quarter was $12.1 million, or $0.19 per diluted share. This compares with net income attributable to Interface Inc. of $5.5 million or $0.09 per share in the third quarter of 2009. Depreciation and amortization was $6.4 million in the third quarter, compared with $6.9 million the the third quarter last year. Capital expenditures in the third quarter were $7.1 million, compared with $2.5 million in the third quarter of 2009. For the full year 2010 we continue to expect capital expenditures to range from $25 million to $30 million.

I'll take a minute to review some of the detail of our individual business segments. The modular carpet segment continued its strong performance in the 2010 third quarter. Sales in this segment were $226.5 million, up 16.7% from $194.1 million in the third quarter of 2009. Operating income for the modular carpet segment in the 2010 third quarter was $29.5 million, or 13% of sales, compared with $20.3 million, or 10.5% of sales in the third quarter of 2009.

Turning to Bentley Prince Street. The demand for high-end broadloom, while still challenging, has improved, and progress we've made in streamlining the segment's underlying manufacturing operations, and adjusting our product mix since a year ago period has been significant. As a result, Bentley Prince Street turned a slight profit this quarter. Sales were $26.2 million in the third quarter of 2010, up 8% from $24.3 million in the third quarter of 2009, and operating income at Bentley Prince Street swung to a $45,000 profit in the third quarter of this year from a $1 million loss in the year ago period.

Quickly to the balance sheet. We exited the quarter with $80.9 million in cash, compared with $73.2 million at the end of the second quarter of 2010. Inventories were $133.8 million at the end of the third quarter 2010, compared with $119.7 million at the end of the third quarter 2009. DSO's during the quarter were two -- of 2010 were 48.6 days, compared with 51.5 days in the year-ago period, and inventory turns improved to 5.1 times versus 4.8 times in the third quarter of last year. The third quarter was another strong quarter of financial performance, with generated solid cash flow and the result of our cost control initiatives, combined with recovery and demand, we realized significant operating leverage in the business.

We're very pleased with the fact that our recent capital allocation decisions are having on our business, going forward our priorities for investment are the successful start up of our China manufacturing plant, our sales and marketing initiatives to further expand our segmentation strategy, and further debt reduction. We also remain focused on continuing to improve our profitability by leveraging our cost structure on increased sales. As a result of the prudent actions that we took during the downturn, we believe we are now in a strong financial position to execute against our strategic plans, and selectively re-invest in the opportunities we see in the marketplace. Now I'll turn the call back over to the Operator for your questions.

Thank you. (Operator instructions) And our first question will come from the line of Sam Darkatsh with Raymond James.

This is actually Josh filling in for Sam. Congratulations on a great quarter.

Thank you.

Just want to drill down a little bit more on the growth that you had in the quarter. You grew well ahead of the industry. Could you maybe break down or give us a sense of how much of that was due to carpet tile gains versus broadloom, versus what would be sort of true share gains on your part?

That's very difficult to see, to actually figure out how much is carpet tile versus broadloom and the share carpet tile is taking, because, as you know, the carpet rug doesn't report that, and information coming out of Asia/Pacific is not that granular that -- to report on that. But I'll tell you, that -- that from an industry standpoint, the commercial market in the US was up mid-single digits, and our US business was up, as you heard, 30%. So obviously we're taking share in that marketplace. How much the sector gains; we're driving that, particularly in the non-office segments there. The Asia/Pacific sector shift to carpet tile is real, and we'll leading that, as well, but to quantify it would be very difficult.

Okay. And just to get a little bit of a better sense of how sales went during the quarter. I notice that you're receivables didn't grow quite as fast as sales, and looks like book-to-bill was pretty good. Was demand a little bit choppy, or did you make an improvement in collections, or could you give me a little color on that?

I would say that the quarter was pretty consistent. We billed a lot in the last five weeks, but if you look at the trends, they were pretty consistent. 16% growth in sales, and 20% growth in orders through without the whole quarter.

Okay. That's very helpful. Congratulations again. Thank you.

Thank you.

And our next question will come from the line of David MacGregor with Longbow Research. Please proceed.

Hello Dan, hello Patrick, nice quarter.

Thank you.

Maybe if you could talk a little bit, Dan, about the mix, and if you to think -- could define I'll let define buckets, but sort of of a good-better-best collection of buckets. Just how the mix figured out. And also if you could talk about how that might be impacting your contribution margin.

If you look at the buckets, we try and make each bucket very similar contribution margins. That's how we run our business. If you lock at where the buckets are coming from, the corporate office market globally has clearly got some pent-up demand that's demand that's starting to come through. So from an actual, absolute amount of dollars, the biggest -- gains were coming out of corporate office. If you're talking about percentage gains, it's coming out of India and China in our emerging markets, which would be the second biggest bucket. And the third bucket, obviously, is the non-office segment, which is growing at double digit, but not quite as strong as 20%.

Okay. Thank you. The other question I had for you, just was with respect to Bravo, and if you could give us an update on how that is going?

It's going well. We had our first stocking order, and we've had restocking in two of the 13 regions. We have optimistic about what's happening within the Bravo network, and I think we're going to have a lot of success in Main Street through that.

Okay. Last question was just on China, and, as you prepare to ramp that plant. Wonder if you could just talk about what's the greatest risk in your Chinese business plan as of today, and if you could just give us a sense of what some of the competitive issues you're going to have to deal with there might be, that would be helpful.

First of all, I don't want to give out a lot of competitive data.

Yes, just more qualitative assessment of --

I would say that there's not a lot of lot of risk to China becoming a major carpet tile market. I think in China they have adopted carpet tile as the floor covering, particularly in the office market. We need to see a refurbishment market in China, not just a new construction market.

So I it would say that if you talk about short term risk, it's that new construction -- that you see that being a little choppy, but there is going to be a refurbish market that comes behind that. We have to be different in China. There's a lot of Chinese manufacturers that are local today, and we have to lead with design. We have to lead with custom capabilities and a make-to-order model, which is what we run our whole business globally by. We've got a great brand in China, and we just have to execute for the market's -- in our opinion it's going to be there.

Are you going to have many competitors that have that low-velocity made-to-order manufacturing model?

No, most of that is not a made-to-order model with -- that has custom capabilities. Most of it is the real low end when you talk about the local Chinese manufacturers. We do have two people that have plants in China, [Milliken], which they do somewhat have a make-to-order model from a print standpoint, and you've got Candace that's there with a plant as well.

All right. Thanks a lot, guys. Again, great quarter.

Thank you.

And our next question will come from Keith Hughes with Suntrust.

Could you give us a little more detail on how orders broke down by geography in the quarter?

Wow. I'm not sure I want to give all that data out. I would say that the European, from the local currency standpoint, was 20% in Europe -- 22%. If you look at the US business, it was approaching between 15% and 20%, and then Asia was 24%.

Pretty uniform across, and I think from your previous question, you were saying among the end user markets, corporate office was the strongest. Is that the case both in US and --

Not a percentage basis, emerging markets was the strongest, but has a lower base that you're comparing it to. So from an absolute standpoint, the corporate office was the pig effort contributor.

Corporate office, okay. And as you ramp up in here in Asia, could you give us a reminder of how much business you're doing in Asia right now as percentage of the whole tile pie.

Asia Pacific will be about 15% of the pie, and that doesn't include India. If you throw India in there you're probably talking closer to 17%, 18%.

And final question, was currency a hit in the quarter, Patrick?

Oh, it was neutral, Keith. We had some drag from the Euro, but benefited from the Australian dollar and a little bit from the Canadian dollar, so it was overall neutral.

Are you seeing any kind of potential raw material inflation in the near term.

No.

All right. Thank you.

Seems rather stable.

And our next question will come from the line of Matt McCall with BB&T Capital Markets. Please proceed.

Thanks, good afternoon, guys.

Hello, Matt.

I want to follow up on that last one. No price -- or no cost concerns, the last quarter or so you take bite some supply chain issues, Dan, and I had a note in my model that there were some expectations that would remain in this 35.5% range on the gross margin front because of that. Was that the reason you didn't see much gross margin expansion sequentially?

I would say that -- no, I don't think that the supply has to do with the cost side of it. I think we're fixing the supply part of the yarn, we're ramping up and getting supply of yarn. It's still somewhat of an inhibitor, but it's getting better. We've got cost associated with China that are in the numbers that -- the plant has not started up yet, but we've got hundred people in China absorbing the start-up cost. That's part of it. But, no, I would say we're -- we haven't seen any raw material price increases, we raised prices when we saw that. And it's a little bit of supply chain issue with one of our suppliers, but it's getting a lot better.

Did you say you did --

35.5 to 36 is where you're going to sight unless we continue to see top line growth double digit, and then it will go up.

Okay, and did you say you did raise prices, or you would raise prices?

No, we would raise prices if we had a raw material price increase.

Got it. And you mentioned the costs in China, have you quantified what that pressure was in the quarter?

About $700,000 in Q3.

Q3 -- And then what was that -- do you remember, Patrick, what that was in Q2?

About $500,000 to $600,000. Stepped up little bit.

All right. And then on the residential side, any update on the profitability there, Dan?

We're still investing in it. We're going to continue to do that. I'll tell you, I'm very encouraged by that business. We're going to start investing in some TV advertising and so forth locally, which is not that expensive. The FLOR -- the three-prong approach of the web, the catalog, and the FLOR store. I think is very exciting for us, to really drive this -- the FLOR consumer business, and stay tuned. We're going to have some success there.

Okay. And then finally, the Germany comment you made, and I think my memory is failing me here, you were talking about some success, consecular shift there. I thought I remember Germany being more of a mature market from a tile perspective. Am I --

The penetration in jury Germany is like 7% tile in the commercial market, and it's largest European commercial market, and we're going to drive the modular shift there as well.

Okay. So maybe it's the lack of penetration.

It's a huge opportunity for us to really drive the business in Europe and have growth.

Okay. Okay. Thank you all.

Thank you.

And our next question will come from the line of John Baugh with Stifel Nicklaus. Please proceed.

Good afternoon. Just a couple of quick ones. When you get this Chinese plant up and running, how much volume are you going to be able to drop in there? What will that be relative to your capacity, and then what do you think the best guess is when you break even there?

I think we'll break even by the end of the Second Quarter of running this plant, because we've already got the business there. We're going to take to it out of Thailand and put it into China, and we'll be running about 25% of the capacity. Actually 20% of that capacity, when we start up. So we have a lot of head room to grow to capacity there.

So you can break even running at a quarter of the capacity?

Break even running the shift, yes.

Wow. Okay. And then I guess I'm trying to understand better the US office. I know it's coming out of the doldrums. I assume it's almost all remodeling because there's just nothing being built that I know of, or will be for the next few years. You've given us some color, I think you mentioned financial firms and high-tech firms. Just curious in a general sense what you're seeing.

Is this all share gain? Tile versus broadloom? Or are you seeing absolute growth in the remodel market, or are you just aligned with the right customers? Any color there? Thank you.

Well, I think we're aligned with the right customers obviously. I do I think there is some pent-up demand in the corporate office market that's been there for a while. We talk about recovery typically being six to seven years, and we got interrupted by the financial crisis, and a lot of people didn't get to it, and you only saw a it was two and a half year recovery. So there's a lot of pent-up demand that's starting to come through, our broadloom business is improving as well. The commercial market was up about almost 8%. So I don't think it's all tile gains, but I think that's part of it, and we're in line with the right offering and the right customers, and we're benefiting from that, as well.

And last, I guess the education season is more or less in the books. How did that pan out for you, Dan?

Education business was up globally, and into the US, and it -- we had a tail-end of it, which at which thought might happen in September was sort of a late rush, as people got funding for projects before the schools open. And now we have an opportunity in obviously December when they -- when they shut down for the holidays, to get some business there, as well. But I'm pretty pleased with education, and I think the secular shift in education to tile is real, and we're going to benefit from that, also.

Patrick, any interest expense guidance for '11?

No, it should stay right about here, 8.4.

Okay. Great. Thanks. Good luck.

Thank you.

Thanks.

And our next question will come from the line of Glen Wortman with Sidoti and Company. Please proceed.

Good evening, everyone. Just thinking about the pent-up demand factor that's really helping orders and sales. As you work through some of that pent-up demand, how should we think about to top line growth. For example, in corporate office heading to 2011, do you expect that to decelerate?

I would expect if history plays out, and this is not historical times. It is historical times in predicting what history says, I'm not sure, but I know there's a lot of pent-up demand. Usually when you see the pent-up demand coming through that last five, six, seven years like I mentioned. I think we're on the very early stages of that pent-up demand coming through. You get the question is that bubble or not? I know if it is a bubble, then a lot of options won't actually be dealt with a again. And corporations have a lot o f cash on their balance sheet, and as you see every week, earnings from corporations are pretty good. So I think they're starting to decide to spend money on their offices, and we're benefiting from that. That's happening around the world, not just in the United States. But I expect the pent-up demand will last more than, you know, six months. I suspect it will be longer than that.

Okay. Just on SG&A front, how should we think about SG&A costs over the next several quarters?

We're going to invest in the growth. We had orders of 20%. I mentioned $61 million was a target. We might move to $62 million, $63 million, but we're going to invest as long as we see growth opportunity around the world. I'm going to invest in the consumer business. We're going to invest in emerging markets, but you can expect to it be driven down from hopefully the 24%. We'll get into the 23%s, but it won't go much lower than that.

Okay. And then finally on residential. Do you have an estimate where you think sales will shake out in 2010 and maybe some goals for 2011?

Well, my goal is as I mentioned more than once is to have a $100 million business in five years and that's still my goal. We haven't had a breakout sales yet with this business. We're just now starting to invest in it. We cut the budget in 2009 to get profitable in half. We're going up maybe 10% of that business this year, but that's not a breakout sales rate. But I suspect in 2011 we'll have a breakout sales.

All right. Thank you very much.

Thank you.

And our next question will come from the line of Carl Reichardt with Wells Fargo securities. Please proceed.

Hello, guys. I'm sorry guys if I missed this before, is in Bentley Prince Street, do you have the mix split between carpet tile and broadloom?

40% carpet tile, and 60% is broadloom.

Okay, thank you. And then Dan, can you talk in terms of Chinese usage now of carpet tile. What's your guess as to the percentage of internally consumed product that's manufactured there compared to imported?

I do not have that. That would be -- That's a data point I don't have. I would say if you're talking about class one space, there's been a new law in China that requires a class one rating as well. And so nylon yarn, I've got to use a nylon yarn today to get a class one rating, and so that part of the business is probably -- is probably over 50% tile, class one space. That's -- that's just a pure guess.

Okay. Thanks so much.

An answer doesn't exist for the question you're asking.

All right. Thanks.

And our next question will come from the line of Eric Glover with Canaccord. Please proceed.

Hello, good afternoon. I was wondering if you could talk about the improvement at Bentley Prince Street in terms of profitability, whether you think you have really turned the corner with this business now, and when can we expect possibly to see some fairly significant operating income out of the business?

I would say that we've always said that if we could get it over $25 million, we could turn profitable in this business, and I'm happy to say that that happened. You know, our goal is to continue to grow this business. We're going to grow the tile part of it faster than the broadloom piece of it. It's got some pretty good contribution margins. If we can grow the top line to $30 million, you'll see some more significant contributions from that. To give you a data on that, I know what contribution levels, I just don't want to tell you, sorry.

Okay --

But it's significant. That business used to be a $150 million business, and it got down to about a $90 million business. If you get back to $130 million, it will return it's cost to capital.

Okay. Just a follow on one of the previous questions. Where do you think the overall market is in terms of carpet tile adoption? Just maybe touch on some of the specific geographies, like US , Europe, and

That's a big question around the world. I would say that the adoption in the US in the office market, we think it's a little over 50%. In the non-office commercial, we think it's approaching 20%, 25%. If you go to Europe, it's in our presentation. We actually have the by almost market what we think the penetration is, but the UK is closer to 50%, Germany is 8%. In Asia, the data doesn't really exist to figure out what the carpet tile penetration is. In Australia, we think the carpet tile penetration might be approaching 50%.

Okay. Thank you.

Thank you.

Ladies and gentlemen, this concludes the question-and-answer portion of today's call. I will now turn the call back over to management for any closing remarks.

Well, thank you for listening in. I hope to report a great Fourth Quarter, and you guys have a great finish to your earnings as well. Thanks.

Thank you for your participation in today's conference. This conclude this presentation. You may now disconnect. Good day, everyone.