Interface Inc (TILE) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Second Quarter 2011 Interface, Incorporated Earnings Conference Call. (Operator instructions).

As a reminder, this conference is being recorded for replay purposes.

I will now turn the presentation over to your host for today's call, to Matt Steinberg from FD. You may proceed.

Thank you, Operator. Good morning and welcome to Interface's conference call regarding second quarter 2011 results. Joining us from the company are Dan Hendrix, President and Chief Executive Officer, and Patrick Lynch, Senior Vice President and Chief Financial Officer.

Dan will review highlights from the quarter as well as Interface's business outlook. Patrick will then review the company's key performance metrics and financial results. We will then open the call for Q and A.

If you have not yet received a copy of the results release, which was issued after the close of the market yesterday, please call Financial Dynamics at 212-850-5600, or you can get a copy off the Investor Relations section of Interface's website. An archived version of this conference call will also be available through that website.

Before we begin the formal remarks, please note that during today's conference call, management's comments regarding Interface's business which are not historical information are forward-looking statements. Forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from any such statements, including risks and uncertainties associated with the economic conditions (of) the commercial interiors industry, as well as risks and uncertainties discussed under the heading Risk Factors in item 1A of the Company's Annual Report on Form 10K for the fiscal year ended January 2, 2011, 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 responsibility to update or revise forward-looking statements made during this call and cautions listeners not to place undue reliance on any such forward-looking statements.

Management's remarks during this call refer to certain non-GAAP measures. A reconciliation of these non-GAPP measures to the most comparable GAAP measures are contained in the company's results release and Form 8K filed with the SEC yesterday.

These documents 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 and may not be rerecorded or rebroadcast without Interface's express permission. Your participation on this call confirms your consent to the Company's taping and broadcasting of it.

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

Thank you and good morning to everyone. I'd like to start out by giving you a quick overview of our second quarter.

I'm pleased with our results for the second quarter, which reflected an increase in demand for our products across each of our key markets and segments.

Our second quarter also had demonstrated traction we're beginning to see from our investment initiatives in sales, marketing, our retail business, and expanding manufacturing capacity to prepare for the growth opportunities as the secular shift to carpet tile continues to accelerate.

Demand that we'd characterize as steady last quarter is becoming more robust, translating into a 67% increase in earnings per share compared against a strong performance a year ago.

Highlights include -- in Europe, we had double-digit sales growth in local currency for the second quarter in a row. This region continues to benefit from improved demand levels driven by the recovery of the corporate office market, as well as encouraging growth in the emerging markets, such as Eastern Europe.

Strong growth in the America's modular business, with sales up double digits, driven by the corporate office market and increasing demand in the education, government, and healthcare sectors. Asia Pacific saw double-digit growth, as well, due not only to strong demands but also the continued growth opportunity this region represents for modular carpet.

A large part of Asia's continent is a new market for modular carpet overall and we're investing in educating the market on the benefits of carpet tile.

Our new plan in China is critical to our development of this region and it is progressing largely on plan. While the plant generated a loss in the quarter, we achieved a break-even run rate in the month of June. Demand trends in China are strong. In the facility, we are ramping up from one shift a day to two shifts in August. Emerging markets continue to be a bright spot, also delivering double-digit sales growth.

Now, the details our businesses. The U.S. modular business saw its seventh straight quarter of year-over-year sales improvement, driven not just by strong performance in the corporate office segment but also in non-office segments, particularly education, government, and healthcare. With healthy demand trends, we believe we are positioned to take advantage of the continued recovery in this region.

And we had a great NeoCon Trade Show with a number of new product launches, and that, coupled with the investments I mentioned, and operation, sales, and marketing initiatives, we should drive further growth.

I'm happy to say the biggest news at Bentley Prince Street is it turned the corner and generated a small profit in the second quarter. Sales increased by more than 13% year over year as demand for our high-end carpet tile products continued to improve. Carpet tile now represents 40% of its total sales this year and is growing. Another bright spot for Bentley is the broadloom sales were also up 5% year over year.

On the retail side, we're also encouraged by the continued solid performance of FLOR. Our FLOR stores continued to perform well ahead of plan during the quarter. The second quarter, same store sales in Chicago were up over 50% compared with the same period a year ago. And in Chicago, New York and Santa Monica stores, each were profitable during the quarter.

We had a terrific FLOR store opening in Atlanta a few weeks ago and we continue to expand our footprint. Last week, our fifth store opened in Dallas, soon to be followed by stores in Houston and Brooklyn later this summer. To date, these stores have been excellent vehicles to drive the awareness of our FLOR brand and have worked well to drive sales growth in conjunction with our catalogue and online presence.

So, overall, we see great opportunities for our business going forward. The steady momentum we've seen building in the corporate office market has momentum and appears sustainable, as evidenced by order growth of over 12% to nearly 290 million in the quarter. America's modular looks like it will hit record sales levels during the year, and we are encouraged by what we're seeing in the European market as orders in the quarter point to signs of continued recovery in that market. In Asia Pacific, with the ramp-up of the China plant, we'll solidify our position as the global market leader in the carpet tile business.

Going forward, we've investing our global presence on a number of fronts. We see the continued rebound in the mature office markets around the world. We continue to see opportunities for growth in the education, healthcare, and hospitality sectors in the United States. We remain committed to rolling out our additional FLOR stores. We are committed to building out our capabilities in the non-office commercial markets in Europe, and we will continue to invest and enhance our leadership position in the emerging markets.

The opportunities for these investments is now and we believe that making them will benefit us significantly and increase our profitability over the longer term.

With that I'll turn it over to Patrick for more details.

Thank you, and good morning everyone. I'll take a few minutes to talk on the financial highlights for the second quarter.

Sales for the second quarter of 2011 increased 18.1% to $267.6 million from $226.6 million in the second quarter of 2010. As Dan mentioned, our sales performance is driven by the continued rebound in the corporate office market, particularly in Europe and North America, growth in our non-office commercial segments, led by the education and healthcare sectors, and increasing demand in the emerging markets.

Gross profit remained steady at 35.4% compared with the second quarter of 2010. Our higher sales volumes were offset by double-digit increase in raw material costs and startup costs related to our China facility, which had a loss in the quarter but exited June at a break-even run rate. We continue to see upward pressure on raw material costs and expect to announce another price increase later this year.

SG&A expense in the second quarter of 2011 increased to $68.6 million from $58.7 million last year. The increase was attributable in part to increased sales commissions due to higher sales volumes, investments we've made in our non-office segmentation strategy, global sales and marketing efforts, and investments in our FLOR consumer strategy in the U.S. Currency impacted accounted for about $3.5 million of the increase in SG&A.

As a percentage of sales, SG&A decreased slightly to 25.6% compared with 25.9% a year ago. On prior calls we've mentioned our focus on reducing SG&A margins. While we will continue to make the investments we see necessary to build our global presence, this goal remains a priority going forward.

Operating income in the second quarter of 2011 improved by 21.8% to $26.1 million, or 9.8% of sales, compared with operating income of $21.5 million, or 9.5% of sales, from our year-ago results.

Interest expense in the second quarter was $6.8 million compared with $8.1 million in the second quarter of 2010. This reduction reflects the refinancing of most of our senior and senior subordinated notes during the fourth quarter 2010.

Net income attributable to Interface for 2011 second quarter was $12.8 million, or $0.20 per share, compared with $7.6 million, or $0.12 per share, in the year-ago period.

Depreciation and amortization was $8.6 million in the second quarter compared with $6.8 million in the second quarter 2010. Capital expenditures for the second quarter of 2011 were $8.5 million compared with $8.5 million in 2010. For the full year of 2011, we continue to expect expenditures to be around $35 million to $40 million.

Now we'll take a few minutes to review some of the details of our individual business segments.

Our modular carpet segment continued its strong performance in the 2011 second quarter.

Sales were $240.6 million, up 18.7% from the year-ago period, reflecting growth across all regions.

Operating income for the modular carpet segment in 2011 rose 5.9%, or $1.5 million, to $26.9 million, up from $25.4 million a year ago as a percentage of sales operating income for the segment was 11.2% compared with 12.5% last year. The decreased margins were the result of our strategic investment program as well as the operating loss from our China facility during the quarter.

At Bentley Prince Street, demand continued to improve, and this segment generated sales of $27.1 million in the 2011 second quarter, up 13.4% from $23.9 million in the second quarter of 2010.

Operating income at Bentley Prince Street saw a positive swing of over $1 million to operating income of $96,000 from an operating loss of $1.1 million in the prior period.

Turning to the balance sheet, we exited the quarter with $27.3 million in cash compared with $69.2 million at end of the fourth quarter 2010.

Inventories were $170.5 million at the end of second quarter compared with $136.8 million at the end of fourth quarter 2010. The increase in inventory was the primary reason for the decrease in cash as we purchased additional materials in anticipation of cost increases and to maintain service levels for our customers. We expect inventory levels to come down in the second half of 2011, as is typically the case.

Our average DSOs during the second quarter were 52.2 days compared with 52 days in the year-ago period, and the inventory turns in the quarter were 4.2 times compared with 4.9 times last year. Overall we were pleased with our results for the second quarter of 2011. The quarter reflected strong financial performance, excellent operational execution, and continued growth of our market position. As we end our seasonally strongest quarters, we remain focused on executing our strategic initiatives as we continue to leverage the global opportunities we see in the marketplace and further enhance our position as the global leader in the carpet tile market.

Now I'll turn the call back over to our operator for your questions.

Thank you. (Operator instructions)

Our first question is from the line of [Kathryn Thompson] from Thompson Research Group. You may proceed.

Hi. Thanks for taking my questions today. We know from your last call that April got off to a strong start in terms of sales. Could you clarify how sales trended throughout the quarter and what type of relative sales momentum are you seeing in July?

Well, if you looked at the quarter April, May and June, it billed the way it normally bills for us. Remember the education season is in that second quarter. July is 10% ahead of April in orders, so that that trend continues for us as well. And seasonally, third quarter's our best order quarter, and the fourth quarter's our best shipment quarter. So we're encouraged by the second half of this year.

How was July relative to last year?

July -- well, we had our best July last year by a lot, and so I would say that July is flat with last year's July but well ahead of April.

Okay. Could you break out on a percentage basis the driver for higher SG&A in the quarter? In other words, how much of the increase was attributable to sales versus new initiatives like store openings and China?

Yes, of the kind of -- are you looking at it on a year-over-year basis or on a sequential basis?

Year over year, but you can look at it sequentially.

Yes, year over year, we had currency of about $3.5 million. There was about $1.2 million additional spend in the consumer business. There was about $3 million additional spend in America's modular, combination of both selling and marketing costs, higher commission rates on the increased sales, and about $1.5 million related to Europe, the additional segmentation initiative, selling cost there, and then Asia Pacific was an additional about $2 million, and China was probably $1 million of that.

Thinking about it how -- in thinking how we should model going forward, how much was permanent and how much goes away, and how should we think about SG&A as a percentage of sales in the back half of the year?

Well, I think that the percentage of sales SG&A should -- we should push that down closer to the 24% when you look at the next six months, with the fourth quarter being the lowest of those two quarters. We are making investments, but we also realize that we need to control SG&A costs, so we're challenging every G&A cost that we have in the company today.

So just to clarify, so second half '11, you're looking at closer to 24%?

Trending, yes, the fourth quarter should be closer to 24% and we should be under 25% in the third quarter.

Okay, okay. Last quarter, we were expecting a sequential decline in inventory, but we saw a little bit of an increase this quarter. Could you clarify -- I know you had some comments in your prepared commentary, but could you clarify a little bit more about the inventory, why it's sequentially higher, and what to expect for the rest of the year other than (inaudible - multiple speakers)?

Well, we've had a -- one of our yarn suppliers has had some pretty tough times, and so we've had to bill raw materials and inventories to meet five-week lead times, particularly in our U.S. business, and I think they finally have their act together, and we expect the lead times from our yarn suppliers to decline, and with that, we would reduce inventories in line with that. So if Patrick said we expect inventories to decline the second half, my expectation is that we would almost get back to where we were last year by the end of the fourth quarter.

Okay, great. Thank you so much for taking my questions.

Thank you.

Thank you.

Your next question is from the line of Sam Darkatsh from Raymond James. You may proceed.

Couple questions. First off, the pricing versus raw material arbitrage. You mentioned, Patrick, I think in your script, that it was negative in the quarter. First off, what was the quantification of that? How do you see that going as the year progresses with the price increases? And then why was it negative? I know historically you've been able to do a real good job of offsetting material inflation with price. Was there something going on in the channel or competitively that prevented at this time?

No, I would -- Sam, I would say we raised prices in line with the raw material price increases. We've just had three price increases of raw materials that have hit us, and so we keep hitting the backlog, and that's one thing that's flowing through. But we are raising prices, keeping up with the raw material price increases, but what's in our backlog tends to be negative for us that we have to push through.

So the quantification of the impact then in Q2 and then going forward in Q3, perhaps?

Yes, it was probably a $4 million or $5 million gross margin drag related to just timing of production versus raw material price increases and getting in front of that.

And does that go away in near term or is that --

I think we're going to have another price increase here in August, as well, but if you look at the raw material inputs, they're finally starting to turn down, benzine and [capolacto], so hopefully we're going to get some relief of that in the fourth quarter.

Two other questions. The FLOR initiative, ultimately, Dan, how do you see Interface going to market on the residential side? Is it just going to be the FLOR stores and online catalogue, or is there going to be other distribution besides the retailers? How do you see going to market ultimately?

I see us the way we're going to market today, which is a three-prong approach. It's the online business driven by the catalogue and then also driven by the stores.

So that -- as the current strategy is going to be is the -- asked and answered -- is going to be the forward strategy then?

Yes. I don't see it changing. I'm very pleased with what's going on with the FLOR stores. We're able to get them profitable after about four months, which to me is great. The investment in those stores is very small. It's a couple hundred thousand dollars to open a store and a commitment on a three-year lease and about three or four employees. I think we can drive in most of these markets $1.5 million per store, and it's about 1,800 square feet

What was the negative impact of the FLOR on SG&A and then the China plant under absorption, and at what point do those costs go away?

When we're looking at the FLOR business, it was about $1.2 million. We're expecting to be profitable in that business in the fourth quarter. The China plant was just under $1 million, about $700,000. And we didn't talk about it, but we also lost about $1 million in our Japanese business. That business has basically gone away.

And then last question. You continued to gain share versus what -- I guess what we can see from a U.S. commercial carpet industry growth versus what you guys are seeing in the U.S. Trends there? What are you seeing from a share aspect, things accelerating, decelerating, competitive responses?

Well, I think the competitive landscape hasn't really changed much. It's been very, very competitive for the last five years. I guess some of our competitors are talking about it more, but they have been in this market fighting for every square yard of carpet out there.

The thing that I was most pleased in is that our education business was actually up double digit, and I know that it's -- the education market was not up double digits. So we had a lot of success in the education market in the second quarter, which is great because state budgets weren't funding a lot of projects.

Thank you much, Dan.

Thank you.

Your next question is from the line of David MacGregor from Longbow Research. You may proceed.

Just to follow up on Sam's question, on the education, was your success in the K-12 or was it colleges and universities?

It was both, but higher ed, we do better than we do K-12.

Okay. I guess just with respect to the Chinese plant you're breakeven now in June, so congratulations on the progress there. Thailand's back to at or near full capacity. Does your plan for India get accelerated into 2012?

No, I don't think so. We have a lot of capacity in China that we can service the Korean market and the Japanese market to take pressure off of the Thailand business.

In India, I think we're going to look at that in 2013 as making some decisions around a plant there, but I don't really think we're going to put one [there] in 2012.

David MacGregor. Okay. And then with respect to the North American business, you talk about a positive book to bill which is still pretty encouraging, but if you could isolate office within North America, what would that book to bill look like right now, and how is that changing quarter to quarter?

Well, the office business was up the most in the America's business. It was up 20-plus percent, and so that would obviously be the most positive of the book to bill.

Right, right.

And when you look at the pipeline, the 30, 60, 90 days for the U.S. business, it is very robust actually.

And just the last question. You talked about -- back again to one of Sam's questions on the raw material squeeze -- I'm just looking back on my notes here -- you had about $4 million to $5 million gross margin drag in second quarter. What should we expect for third quarter?

And I think the fact that we had a 35.4% gross profit margin, we would hope to hold it in a 35% range again.

Okay. I mean you had that May price increase, so does that start to get a little more traction in the third quarter?

Yes, but also, we're going to end up having an August price increase, as well.

Right, right. Great. Thanks very much.

Thank you.

Your next question is from the line of Matt McCall from BB&T Capital. You may proceed.

Good morning. Thank you. This is actually [Jack [Stenek] filling in for Matt today.

Good morning.

If I could go back to the SG&A questions that have been asked, as we look ahead, I think looking at the last transcript you had said that there's 3.5 million of incentive-based comp in Q1 that wouldn't have occurred, and so it looked like you were kind of leaning towards a sequential decline in SG&A.

I guess as we look to the rest of the year, what could potentially provide an upside surprise to SG&A as we're considering our models?

I would say we would try and hold the line on SG&A and drive it down as a percentage. I mean that's what we're trying to do. But we are going to make these investments that we're making. To me, the opportunity for this secular shift to carpet tile, we need to grab it and drive it into other markets, like hospitality. We're making a huge investment in hospitality in the United States, about $4 million this year just in that market alone. But we're going to drive it down as a percentage.

Okay. With that hospitality spend, I mean when do you think -- as that business ramps, when should we look for that to actually play a factor in your results?

I would tell you that the second quarter's better than the first quarter, and we anticipate the third quarter to be better than the second quarter, and it will ramp up as we gain traction in that business.

Okay. If I could go back (inaudible) for a second, I'm sorry. Is there any -- there won't be any costs coming out though. It will just be -- the only thing that -- the operating leverage outcome is going to be entirely different by the top line, right? You don't have any costs that you're expecting to take out over the rest of the year?

There may be some costs that we're going to take out of Japan. That's one area that we're looking at very seriously. The amount of overhead we have there doesn't really support the amount of business in Japan. And so --

What kind of -- I'm sorry. What kind of cost savings could that be?

There's $4 million or $5 million in Japan costs there.

And that business, is that the competitive landscape, or is that because of the --

No, no, no, it's just there's not any business.

Okay. As Japan recovers --

It's related to the tsunami.

But as they start to build back, do you think that business will return or --

Yes, but I think it's going to be slow.

Okay. I think that's it for me. Thanks, guys.

Thank you.

(Operator instructions). Your next question is from the line of Keith Hughes from SunTrust. You may proceed.

Thank you. Just referring to your earlier comments on the July order trends, was the third quarter of 2010, was it skewed heavily towards July in terms of orders, or how did that quarter progress?

Yes, it was. July was our best month, and it skewed from that, and August was not as good as July, and we had a five-week month in December, and that was almost in line with July.

Okay, so --

We had a lot of big things happen in July. We had some pretty big orders that hit. We had the big Bravo stocking order that hit in July. We won a major -- a large project that we won in July in the United States, and we had the J.P. Morgan big order hit. So you had a lot of things hit in July that -- last year that helped that month.

So is your expectation that that order on a year-over-year basis would turn back pretty positive here the rest of the quarter?

Yes, absolutely.

Okay.

I mean I was looking at April, and in fact, we're up double digit over April, and you take the double-digit run right on the second quarter, apply it to the third quarter, and you get to where we need to be.

And I know you don't want to give guidance, but at the end of the day, you're going up against the much more difficult comps, double-digit comps in the second half of his year. Is double-digit growth kind of what you're expecting? Would it trend down to high single? Just any sort of comments you're willing to make on that.

Well, our goal is to grow it 10% or plus, and I anticipate that there's enough business there to try and do that.

Keith Hughes. Okay. Thank you.

At this time, there are no other questions. I will now turn the call over to management for closing remarks.

Well, thank you, and we're going to -- we're excited at Interface, and I hope that we're going to have a very good third quarter and second half to this year. Thank you.

And, ladies and gentlemen, this concludes your presentation. You may now disconnect.