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Executives

Bob Joy – Investor Relations

Daniel Hendrix – Chief Executive Officer

Patrick Lynch - Senior Vice President, Chief Financial Officer

Analysts

Keith Hughes - Robertson Humphrey

Matt McCall - BB&T Capital Markets

John Baugh - Stifel Nicolaus

Carl Reichardt - Wachovia Securities

Eric Prouty - Canaccord

Sam Darkatsh - Raymond James

Jeff Kobylarz - Stone Harbor Investment

Interface Inc (IFSIA) Q4 2007 Earnings Call February 21, 2008 10:00 AM ET

Operator

Good day ladies and gentlemen and welcome to the fourth quarter 2007 Interface earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Bob Joy. Please proceed.

Bob Joy

Thank you, operator. Good morning and welcome everyone to Interface’s conference call regarding fourth quarter and full year 2007 results. Joining us from the company are Dan Hendrix, President and Chief Executive Officer and Patrick Lynch, Senior Vice President and Chief Financial Officer.

Dan will review highlights from the quarter as well as Interfaces business outlook. Patrick will then review the company’s key performance metrics and the financial results. We will then have time for any questions.

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 An archived version of this conference call will also be available through that website.

Before we began 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 1-A 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 on any such forward-looking statements.

Lastly, please note that this call is being recorded and broadcast 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 confirms your 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.

Dan Hendrix

Thank you, Bob and good morning to everyone. As you saw in our earnings release the fourth quarter was the best performing quarter in Interface’s history and it capped off the best performing year in our history from continuing operations. Overall our performance in the fourth quarter was at record levels for operating income, operating margin, income from continuing operations, net income and earnings per share.

We reported strong revenue growth for the fourth quarter and the full year as we continued to take market share. Within the modular carpet business segment, fourth quarter sales increased 18% year over year. This growth was very broad based across each of our key geographic regions the Americas, Europe and Asia Pacific.

I believe we had four primary factors driving sales growth in our modular business. First, the market has continued its secular shift towards carpet tile which partially accounts for the sustained growth we have seen in our corporate office market.

Second, our market segmentation strategy continues to make good head way with the institutional and hospitality markets making the most significant percentage gains in the fourth quarter.

Third, sales in the emerging geographic market such as India, China, the Middle East, Eastern Europe and Latin America continue to expand significantly.

Fourth, I believe our sustainability strategy is helping us win business everyday. As a result of this sales growth as well as the operating leverage we created in the business, operating income and operating margins expanded significantly.

In our floor residential carpet tile business, sales and orders continue to climb compared with the fourth quarter last year. I am very encouraged by its Internet and catalogue business which is up 35% year over year.

Bentley Prince Street was down compared with the fourth quarter last year which is a disappointment but we did complete the installation and start up of our carpet tile backing line and we expect to see improved results in the first quarter of 2008.

We continue to see robust order growth in the fourth quarter with consolidated orders increasing 17%, supported by our record results in the fourth quarter we decided to increase our dividend to $0.03 per share for the quarter.

Despite the uncertain economic forecast and the anticipated pressure on the corporate office market this year, there are many opportunities for Interface to grow. We are still in the early stages and leading the markets secular shift from broadloom to carpet tile. Including Bentley Prince Street sales of carpet tile, modular carpet now represents about 90% of our sale and we are in uniquely positioned to benefit from this trend and lead this trend.

Market segmentation continues to gain momentum as modular carpet is making the leap from becoming a niche product to actually leading the product category. Non-corporate office sets now represent a more significant portion of our sales. With our global manufacturing capabilities on four continents we are in a prime position to capitalize on the explosive growth in the emerging geographic markets.

Because our international sales now comprise 50% of our revenues, we are much less exposed to the down cycles in the US office market. Our backlog was up nicely versus year end 2006 and our pipeline of new orders continues to be solid, up 11% for the first six weeks of this year.

In short, we are off to a good start in 2008 and we are looking forward to another strong year for Interface. Now I will turn it over to Patrick for more details.

Patrick Lynch

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

Gross profit margin in the fourth quarter of 2007 was 35.5% compared with 33.8% in the fourth quarter of last year. SG&A expense in the fourth quarter of 2007 was $64.7 million or 22.1% revenue versus $57.7 million or 22.3% of revenue a year ago.

Operating income in the fourth quarter was $39.4 million compared with operating income of $29.9 million in the fourth quarter of 2006. As a percentage of sales, operating income increased from 11.5% in the fourth quarter of last year to 13.4% which is a record operating margin for the company.

Interest expense for the fourth quarter of 2007 was $7.2 million versus $9.5 million last year. In the 2007 fourth quarter, income from continuing operations was a record $20.3 million or $0.33 per diluted share compared with income from continuing operations of $12.4 million or $0.21 per diluted share in the fourth quarter of 2006.

Net income for the fourth quarter of 2007 was also $20.3 million or $0.33 per diluted share versus net income of $12.1 million or $0.21 per diluted share in the fourth quarter of 2006.

Depreciation and amortization in the fourth quarter was $5.4 million versus $6 million a year ago. Capital expenditures in the fourth quarter of 2007 were $13 million versus $8.8 million in the 2006 fourth quarter.

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

Now I will take a minute and review some of the details of our individual business segments. We continued to see strong year-over-year growth in our modular segment. In the fourth quarter of 2007 total segment sales grew 18.1% to $257 million from $217.7 million in the same quarter last year.

As Dan outlined, performance in this segment was strong across geographic locations. Operating income for the segment increased 35% to $40.1 million or 15.6% of sales from $29.6 million or 13.6% of sales in the fourth quarter of last year, primarily driven by our higher revenue levels.

At Bentley Prince Street, sales were down 4% to $36.3 million from $37.8 million in the fourth quarter of last year. Operating income was $1.4 million compared to $1.5 million in the fourth quarter 2006.

Now we will open up the call for questions.

Question-and-Answer Session

Operator

Your first question comes from the line of Keith Hughes - Robertson Humphrey. Please proceed.

Keith Hughes - Robertson Humphrey

Patrick what are you going to spend on CapEx in 2008?

Dan Hendrix

Probably $50 million, Keith.

Keith Hughes - Robertson Humphrey

Is that going to be capacity expansion in certain geographies?

Patrick Lynch

Exactly right, principally targeted in the Asia Pacific region.

Keith Hughes - Robertson Humphrey

How much was Asia up in 2007?

Dan Hendrix

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

Keith Hughes - Robertson Humphrey

Dan, you had mentioned you are 50% international right now; how much of that is Asia and how much is Europe at this point?

Dan Hendrix

10% is Asia and 40% is Europe.

Keith Hughes - Robertson Humphrey

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

Dan Hendrix

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

Keith Hughes - Robertson Humphrey

Would that be for the domestic Chinese market?

Dan Hendrix

Yes.

Keith Hughes - Robertson Humphrey

Acquisitions, is that anything you would consider at this point?

Dan Hendrix

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

Operator

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

Matt McCall - BB&T Capital Markets

Just following up on that last question. Are debt levels at a comfortable level for you or are you going to continue to move that lower?

Dan Hendrix

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

Matt McCall - BB&T Capital Markets

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

Dan Hendrix

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

Matt McCall - BB&T Capital Markets

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

Dan Hendrix

Still our stated strategy for the last I don’t four, five years that we have a 20% incremental target and that’s what we pay bonuses around and that’s what we budget around. It’s nice when you hit the kind of sales levels we hit in the fourth quarter you are going to see a lot of margin expansion.

Matt McCall - BB&T Capital Markets

Okay and then I think last quarter you talked a lot about some of the cost pressures that you I think you mentioned in your prepared marks that some of the issues subsided may be mid-quarter at Bentley Prince Street. Any items that you can highlight?

Dan Hendrix

I think two things really helped us. We were running 24/7 in our Thailand plant, we had add capacity there in the second half and we were able to keep the benefits of the added capacity to operate efficiently and we had some problems in Australia with ramping up and adding new technology there and we saw the benefits of that in the fourth quarter as well. At Bentley Prince Street we will see that hopefully this quarter and I keep saying that, but its coming.

Matt McCall - BB&T Capital Markets

Remind us of the target margin in that?

Dan Hendrix

Its still 8% and we are floating around 4% or 4.5%.

Matt McCall - BB&T Capital Markets

–What is it going to take? Is it a top line issue? Is it eliminating some of these --

Dan Hendrix

I think it is two things. I think one is actually getting our backing line up and running and not having the cost of backing it on the East Coast and shipping it to the West Coast, that’s one.

The other is as you move more into the modular piece away from the broadloom piece you are going to see better margins come out of the carpet tile piece and then obviously modest top line growth would help.

Operator

Your next question comes from the line of John Baugh - Stifel Nicolaus.

John Baugh - Stifel Nicolaus

Foreign exchange currency, what was the impact on the quarter end or a year if you have it Patrick?

Patrick Lynch

It’s about $10 million in sales and about $2 million in operating.

John Baugh - Stifel Nicolaus

Okay and correct me if I am wrong, but looking at a huge comparison Q1 on FX again, aren’t we, favorably?

Dan Hendrix

It’s in the same range.

John Baugh - Stifel Nicolaus

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

Dan Hendrix

Probably about 3%.

John Baugh - Stifel Nicolaus

That 17% I guess compares to 11% for the first six weeks, so you seen something slowing -- is that correct?Are you seeing it equally in Europe and the US and in any segments?

Dan Hendrix

I would say that the European business it was very odd, the first two weeks people stayed on holiday. The business in Europe just was not very active or very robust. It’s picked up nicely over the last four weeks. The US and Asia continued to be very good. So the weakness was really in Europe but I would say the last four weeks have been very good.

John Baugh - Stifel Nicolaus

You talked about receivables. They looked fairly high and you mentioned that DSO’s going up. Is it timing?

Dan Hendrix

We had a strong December which inflated that a little bit right there at the end of the year and a little bit of a mix shift with the international piece in Europe and in Asia Pacific were those terms are customarily longer than what we experience or have in place here in the US so –a little of that happened in the fourth quarter as well.

John Baugh - Stifel Nicolaus

So Patrick where do we end out the year in terms of free cash flow in ’07 and how should we think about it in light of Cap Ex of $50 million?

Dan Hendrix

John with the discontinued operations and the proceeds it was about $23.5 million of free cash flow for the full year.

John Baugh - Stifel Nicolaus

In ’07 okay. Then we are going to have I guess a negative spread between CapEx and DNA of close to $20 million in ’08 correct?

Dan Hendrix

That’s right.

John Baugh - Stifel Nicolaus

And we still expect to grow in ‘08 so.

Dan Hendrix

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

John Baugh - Stifel Nicolaus

How do you think about interest expense modeling going in to ‘08 please?

Dan Hendrix

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

John Baugh - Stifel Nicolaus

–A lot of noise on energy costs. Any comments on the raw material pricing spreads as we look into ‘08.

Dan Hendrix

I think it’s the same story John. We are very comfortable with our ability to raise prices and we are very comfortable with where we are positioned and we have been through a lot and it really hadn’t impact us and I don’t think it will impact us this year.

John Baugh - Stifel Nicolaus

Could you comment or would you care to comment on what your average price for square yard did last year?

Dan Hendrix

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

Operator

Your next question comes from the line of Carl Reichardt - Wachovia Securities.

Carl Reichardt - Wachovia Securities

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

Patrick Lynch

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

Carl Reichardt - Wachovia Securities

But that’s total modular Patrick?

Patrick Lynch

Total modular, there is probably $3 million or $4 million of that $50 million dedicated for the Bentley Prince Street business in ‘08.

Dan Hendrix

We are probably doubling the capacity of our Asia Pacific business with this CapEx expenditures.

Carl Reichardt - Wachovia Securities

Okay, great and then the second question which is a little broader for you Dan, thinking about the sustainability strategies you said it is helping as one of the four elements of driving the big growth in modular. I am kind of curious if you are seeing that drive units more relative to peers or pricing? And maybe it’s a combination of both

Dan Hendrix

I would say its more peers, its more market share gain. I mean the whole A&D architectural design industry obviously is focused on the environment and it’s actually not just in United States, its in Europe and its in Australia and its becoming important in China as well.

We have been at this 13 years going on 14 years and we have 100% recycled back products, we take back the products and recycle it, we now offer a post consumer yarn face weight; we are in the business, in a lot of cases, when sustainability means something and now corporate America and the corporate world is getting into the environment as well.

Ray Anderson had a great vision in 1994 about sustainability and asked the question, what about oil at $100 a barrel? Well we did.

Operator

Your next question comes from the line Eric Prouty - Canaccord.

Eric Prouty - Canaccord

A quick follow up to the previous question on the sustainability aspect. Maybe some comment on the type of activity you see out there for lead certified buildings especially in the US and even the slowing environment if you see a pick up in the number of buildings going for the lead certification.

And then just a little clarification on the previous question where do you feel like you have a higher market share in kind of a lead certified building as opposed to a non-lead certified building, thanks?

Dan Hendrix

I would say that the from the lead standpoint I mean its approaching almost 50% of the US buildings are going for lead certified that are particularly owner developed and so forth and its growing and there is no way that its going to slowdown today. I think if it’s a jump ball based on the product and sustainability means something to whoever the client is that we will win that business because of our position of sustainability.

If they are interested in take back, if they are interested in recycled content, if they are interested in a climate neutral product then all our products in United States climate neutral and we will win that argument, we won’t lose it.

Eric Prouty - Canaccord

Guys just may be to put it into context when you see 50% right now going for lead what would that have been for your business three or four years ago?

Dan Hendrix

I would say five years ago was less than ten.

Operator

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

Sam Darkatsh - Raymond James

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

Dan Hendrix

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

Sam Darkatsh - Raymond James

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

Dan Hendrix

Yeah more like 12%.

Sam Darkatsh - Raymond James

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

Dan Hendrix

We believe and I will say it again, I’ve said it for I don’t know how many years but we believe the modular shift is real and its not at all in the late stages, it’s somewhat nervous stages and were positioned to actually grow our business double-digit; that’s what I am paid on, growing it double-digit.

Sam Darkatsh - Raymond James

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

Dan Hendrix

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

Operator

(Operator Instructions) Your question comes from the line of Jeff Kobylarz with Stone Harbor Investment.

Jeff Kobylarz - Stone Harbor Investment

Good morning. In the past you have said that I believe that the mix of renovations versus new build where your demand comes from, its around 80/20 or so. That percentage, was it also the same in the fourth quarter?

Dan Hendrix

Yes it was. We didn’t really see it fall off in the office market in the fourth quarter Jeff. I know everybody is anticipating it and talking about it but we didn’t see it in the fourth quarter.

Jeff Koplag - Starn Holder Investment

As more of your business comes from overseas is that mix still 80/20? I would think there is more new build business for you.

Dan Hendrix

If you are in Europe it’s probably 90% renovation, 10% construction; if you are in Asia its probably 80% new construction, 20% renovation. There is a different view of those two markets

Jeff Koplag - Starn Holder Investment

Can you comment about how much you are increasing your sale force right now versus a year ago?

Dan Hendrix

Going through the budgets I think we had about 30 salespeople budgeted in this budget. I think last year we actually increased it probably more like 40. We are still adding sales people, yes.

Jeff Koplag - Starn Holder Investment

Okay on a base roughly of what?

Dan Hendrix

Depends on how you look at sales and marketing. Let me see, I don’t know, they have moved so much, probably about 400 to 500.

Jeff Koplag - Starn Holder Investment

Bentley Prince Street, the revenues were up around 10% in the first three quarters of the year. Why the slowdown in the fourth quarter?

Dan Hendrix

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

Operator

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

Dan Hendrix

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

Operator

Thank you all for your participation in today’s conference. This concludes the presentation. You may now disconnect.

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Source: Interface Inc, Q4 2007 Earnings Call Transcript
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