Interface, Inc. Q2 2008 Earnings Conference Call Transcript

Jul.24.08 | About: Interface Inc. (TILE)

Interface, Inc. (IFSIA) Q2 2008 Earnings Call Transcript July 24, 2008 9:00 AM ET

Executives

Bob Joy – IR

Daniel Hendrix – President and CEO

Patrick Lynch – SVP and CFO

Analysts

Keith Hughes – SunTrust

Sam Darkatsh – Raymond James

Eric Prouty – Canaccord

Nora Whitmer [ph] – Eagle Capital

Michael O’Brien – Australian Ethical

Neil McConnell – Walker Smith Capital

Matt McCall – BB&T Capital Markets

Operator

Good day ladies and gentlemen and welcome to the second quarter 2008 Interface earnings conference call. My name is Shanique and I will be your coordinator for today. (Operator instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Bob Joy from FD. Please proceed.

Bob Joy

Thank you, operator. Good morning and welcome to Interface’s conference call regarding second quarter 2008 results. Joining us from the company are Dan Hendrix, President and CEO and Patrick Lynch, Senior Vice President and Chief Financial Officer.

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

If you have not received a copy of the results release, which was issued yesterday after the close of market, please call FD at 0x01 graphic

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212-850-5600 or you can get a copy off of the Investor Relations section of Interface’s Web site. An archived version of this conference call will also be available through that Web site.

Before we begin the formal remarks, please note that during today’s conference call, management’s comments regarding Interface’s business which are not historical information are forward-looking statements. Forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from any such statements, including risks and uncertainties associated with the economic conditions in the commercial interiors industry as well as 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 SEC. We direct all listeners to that document.

Any such forward-looking statements are made pursuant to the Private Securities Litigation Reform Act of 1995. The company assumes no responsibility to update or revise forward-looking statements made during 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. Despite the challenging macro economic environment, we had a record second quarter, our best second quarter ever in terms of operating income and earnings per share.

Revenue is up 11% as we outpaced the industry and gain market share. The top line growth was driven mostly by sales in the non-office segments and emerging geographic markets.

By the market secular shift from beryllium to carpet tile and by positive currency impact, these growth drivers more than offset lower sales in Western Europe and US corporate office markets. Orders were $311 million up 3% against a very tough record level comparison of $302 million in the second quarter last year and let’s don’t overlooked that we grew income from continuing operations by 19% also versus a record second quarter comparison last year.

Our modular carpet business continued its excellent performance benefiting from the secular trend were carpet tile and our market segmentation strategy. We provide this with sales opportunity to market such as hospitality, healthcare, government and education.

Geographically, the growth was coming out of the Asia Pacific, the emerging markets and non corporate office segments in the Americas and Europe.

Conditions were particularly soft in Western Europe. We have a higher exposure to the corporate office market. Europe is an important market for Interface and we look forward to the benefits of our ongoing investments to advance our market segmentations strategy in that region.

Our Bentley Prince Street segment report a 10% decline in sales and continue to experience operational issues related to the ramp up of it’s carpet tile backing operations as well as rising raw material and energy cost which impacted it’s profitability.

However, we’re pleased with the strong order backlog going into the third quarter and the continued growth of modular sales in this business which increased 23% in the second quarter. Maybe before what we are focused on life sizing and taking cost that of the business to make it more profitable at existing sales level.

We remain confident in our strategy and believe we’re well positioned to continue to grow the business even in this tough environment for several reasons.

Our segmentation strategy provides us with opportunities in markets such as hospitality, healthcare, government and education, which have a very low penetration of carpet tile in different drivers and cycles than those seen in traditional corporate office markets. Each of the markets we are seeing are strongest percentage growth rates in today.

We continue to be in the early stages of the cyclic shift in carpet tile and Interface is the largest manufacturer of modular carpet in the world with the most recognized brands and we continue to grow our market share. We’re geographically dispersed which we expect to mitigate the effects of the difficult economic environment in the US and Western Europe.

We see significant opportunity in the horizon as we expect our ongoing investments to advance our segmentation strategy in Europe will further reduced our exposure to the corporate market in that region and open additional growth opportunities.

Sustainability is at the forefront of our industry and our leadership position is helping us win business every day. Often supporting our future growth is the strength of our balance sheet which has improved with the generating of cash from operations over time and reducing outstanding debt.

We continue to see good demand for our products as orders grew from the second from the record levels a year ago and the backlog at the end of the second quarter was up 21% versus the beginning of the year.

We will continue to take a long-term view making wise investments in market segmentation, our residential business and our global manufacturing platform.

Now, I will turn 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 second quarter of 2008 increased to 11.3% to $295 million from sales of $265 million in the year ago period. As previously announced, the company sold its fabrics division in July 2007 and therefore the financial statements for the second quarter of 2008 and all other periods presented now reflect fabrics division as discontinued operations. Currency changes positively impacted sales by approximately $15 million.

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

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

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

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

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

Turning to the balance sheet, at the end of the second quarter of 2008, we had $83.6 million in cash compared with $59.3 million at the beginning of the quarter, an increase of $24.3 million.

We also had no borrowings outstanding under our domestic revolving facility and no borrowings outstanding under our overseas lines of credit. Long-term debt at the end of the quarter was $310 million, unchanged from December 31, 2007.

In the second quarter of 2008, sales in our modular segment grew 15% to $259.3 million from $225.5 million in the second quarter of last year. Performance in this segment was especially strong in the Americas and Asia-Pacific.

Operating income for the modular segment increased 11.7% to $35.3 million or 13.6% of sales from $31.6 million or 14% of sales in the 2007 second quarter.

At Bentley Prince Street, sales decreased 9.6% to $35.7 million from $39.5 million in the second quarter of last year. Operating income decreased to $200,000 compared with $2 million in the second quarter of 2007.

As reported in our earnings released, Bentley Prince Street continue to work their operational issues associated with the ramp up of its carpet tile backing operations as well as rising raw material and energy cost but on a positive note, Bentley Prince Street had a strong order backlog going into the third quarter. The modular component of its business recorded a 23% increase in sales during the quarter and has raised prices to offset the increases. We will now open the call up for questions.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from the line of Keith Hughes with Sun Trust. Please proceed.

Keith Hughes – Sun Trust

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

Dan Hendrix

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

Keith Hughes – Sun Trust

Okay and the second question, we’ve had a couple of years of fantastic tile growth for yourself and for the industry. Has the competitive dynamic between yourself will all contain this change? Any major share shifts or is it pretty much the same competitive dynamic as a couple of years ago?

Dan Hendrix

It’s pretty much the same competitive dynamic. I believe that we are taking share. I don’t think the tile market is growing as much as we are. We had a great second quarter in the US kind of that you just outlined.

Keith Hughes – Sun Trust

All right. Thank you.

Dan Hendrix

Okay, thanks.

Operator

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

Sam Darkatsh – Raymond James

Good morning, Dan. Good morning Patrick.

Dan Hendrix

Sam.

Sam Darkatsh – Raymond James

I want to again to get to the order, overall orders a little bit if I could Dan. The 311 is obviously a real robust number and absolute terms. What I’m getting at is accelerating or decelerating and whether we should take anything away from the 3% number, I mean as I recall in April you are up 13% in orders and then you ended up being up three in Q2 and I was going to first ask, what July look like and secondly was there a pre-buying in that number because you are raising prices in June with a lumpy comparisons, I mean how concerned or not concern should we be that the order growth is slowing?

Dan Hendrix

Well, I would say that July started out about the same page as April. We didn’t see a fall off in July. We did have a price increase in June that you’ve probably brought in, probably 5 million to 10 million in orders. We also had a price increase last June. I don’t know if you remember we fell off the third quarter orders that as we had a price increase that brought some orders in but I think the market feels about the same as it did in April Sam.

Today that the secular shift in carpet tile is real and we had a great segmentation quarter in orders and in shipment and I suspect that will continue. The office market in Europe was down 6% and it was up 3% in the US and that’s the one thing that always concerns me is the European office market but I feel okay about order rate.

Sam Darkatsh – Raymond James

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

Dan Hendrix

I would say that we’ll get back to historical terms.

Sam Darkatsh – Raymond James

Okay. All right. Thank you, folks.

Dan Hendrix

Thanks.

Patrick Lynch

Thanks.

Operator

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

Eric Prouty – Canaccord

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

Dan Hendrix

Yes, if you look at the office market, the biggest negative impact was in France, which is in Europe, our second biggest market. The UK actually held its own when France was down, which impacted most of the European shortfall. In the US, the office market to me is okay, it’s not great. Where we are seeing the biggest opportunity for growth is in education, hospitality and healthcare in that order. Our hospitality business was up significantly smaller base but becoming more and more important to us and the education is now a major part of our business and I think we'll see continued growth in all three of those segments.

Eric Prouty – Canaccord

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

Dan Hendrix

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

Eric Prouty – Canaccord

Okay, great. Thanks a lot guys.

Dan Hendrix

Thank you.

Operator

And our next question comes from the line of David Glenn [ph] with Eagle Capital. Please proceed.

Nora Whitmer – Eagle Capital

Hi this is Nora Whitmer [ph]. The $4 million incremental cost for the market segmentation strategy in Europe, I was wondering if you could flesh out exactly what that is? Is it feet on the street or what’s –

Dan Hendrix

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

Nora Whitmer – Eagle Capital

And then, that’s incremental from a year ago. What does that look like versus last quarter, the first quarter?

Dan Hendrix

It is about $1.5 million to $2 million on a sequential basis.

Nora Whitmer – Eagle Capital

It’s up by $1.5 million to $2 million?

Dan Hendrix

Yes, on a sequential basis.

Nora Whitmer – Eagle Capital

Okay, right. So you are building that out and would expect to see something permanent in the future?

Dan Hendrix

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

Nora Whitmer – Eagle Capital

Terrific, thank you.

Dan Hendrix

Thanks.

Operator

(Operation instructions) And our next question comes from the line of Michael O’Brien with Australian Ethical .Please proceed.

Michael O’Brien – Australian Ethical

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

Dan Hendrix

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

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

Patrick Lynch

We could get a deal done today if we wanted to. The markets out there, we don’t really like the price, it would be cheaper than the 10 3/8, but we think that market will improve where we can get a better deal done and we can generate cash as well.

Michael O’Brien – Australian Ethical

Would you incur penalties for pre-paying early?

Dan Hendrix

Yes. There will be a premium to repurchase the bonds both issuances today. Yes.

Michael O’Brien – Australian Ethical

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

Dan Hendrix

Yes, we have. The office market in the United States represents about 20% of our business overall and the office market in Europe represents about 20% of our business. I’m not sure if that helps you or not, the Western office markets. So, about 40% of our businesses is tied with the US and Western office markets.

Michael O’Brien –Australian Ethical

Can you sort of give me more color as to what may have been, like, did you lose 5% or --?

Dan Hendrix

In Europe, the office market was down 6%. In the US, it was up 3%.

Michael O’Brien –Australian Ethical

Okay.

Dan Hendrix

I said that in our earlier –

Michael O’Brien –Australian Ethical

Sorry, I wasn’t sure if you were referring to US sales or the industry, sorry.

Dan Hendrix

I am sorry. The industry – the carpet rug industry had put out a total commercial number and I would say that based on the volume out there, it was down about 3%.

Michael O’Brien –Australian Ethical

Great. Thanks very much.

Operator

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

Eric Prouty – Canaccord

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

Dan Hendrix

Nothing material changed. It's a matter of timing and all of the projects that we have outlined and have committed to are still in place. Timings on some few things perhaps are getting pushed out for regulatory and other negotiated items, but we will probably be in the $40 million this year and comparable in '09. And then, some of that will carry over into 2010, but nothing has changed from our map, just the where and what particular calendar year it will fall.

Eric Prouty – Canaccord

Okay. Fair enough. Thanks guys.

Patrick Lynch

When we get down with this capital plan, we will have a plant in China, we will have a plant in Southeast Asia, we will have double the footprint in Australia and we will have a lot of capacity that we can actually grow the business with. But, we will pretty much take our global footprint and put it where we want it to be.

Operator

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

Neil McConnell – Walker Smith Capital

Hi, guys. Good morning.

Dan Hendrix

Good morning.

Neil McConnell – Walker Smith Capital

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

Dan Hendrix

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

Neil McConnell – Walker Smith Capital

Okay. In everything, I think you just mentioned that it is mostly on track for the capacity additions over there?

Dan Hendrix

Yes, right. We are working diligently to continue that project forward.

Neil McConnell – Walker Smith Capital

Great. Thanks.

Operator

(Operator instructions) We do have a follow-up from the line of David Glenn with Eagle Capital. Please proceed.

Nora Whitmer – Eagle Capital

Hi, it’s Nora again. I forgot to ask about consumer and what you are seeing there and also wanted to let you know -- you have actually bought some tiles yesterday.

Dan Hendrix

How do you like it?

Nora Whitmer – Eagle Capital

Yes, well, we are putting them in on Saturday. And then – but they look good in the store.

Dan Hendrix

Yes.

Nora Whitmer – Eagle Capital

And also, you called out some production issues at Bentley Prince Street and I don't know if you could quantify them or give us sort of a range. And then also, just what is happening otherwise production-wise at other plants around the world, Australia, that type of thing.

Dan Hendrix

See if I can get all those to my head.

Nora Whitmer – Eagle Capital

The consumer and then plants.

Dan Hendrix

The one on the online businesses, I am pleased with that. We have hired a new consumer marketing person that really I think is going to add a lot more expertise to us on how to do the catalog and online business. So, I'm pleased with that. The carpet tile belongs in the home and we are going to do it. We are going to invest in it and that is going to become a more significant part of our business. The (inaudible) lines have done very well.

As far as the production at Bentley Prince Street, it will probably cost us about $1 million if we ramp up the tile line and we are really going slow. We are putting more raw materials on the back to make sure we don’t have problems with the product on the floor and quality plant and so forth and running it at slower speed. It never goes as well as you think it is going to go but I think we are on top of it and we will see continued improvement there.

Nora Whitmer – Eagle Capital

Okay.

Dan Hendrix

What was the third one? Oh, Australia.

Nora Whitmer – Eagle Capital

Australia or anywhere else assuming that is from our production cost.

Dan Hendrix

From our production standpoint, I think we ran very well in our European plants and America’s plant and our Thailand plant. Australia, we are continuing to renovate that and it probably cost us about $500,000 and in inefficiency as we continue to work through the whole renovation of that plant.

Nora Whitmer – Eagle Capital

Okay, great. Thank you.

Dan Hendrix

Thank you.

Operator

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

Matt McCall – BB&T Capital Markets

Thank you. Good morning everybody.

Dan Hendrix

Good morning.

Matt McCall – BB&T Capital Markets

Sorry, I have some technical difficulty. So if you’re interested– I really got a follow-up with my last question. Dan, I think you said that it costs you about a million and a quarter –

Dan Hendrix

That is the production side of it.

Matt McCall – BB&T Capital Markets

Okay, maybe that will be my next question but to follow up with that, your operating margin were probably still have been down year over year. Some of the production issues with Australia or you can just help me understand what were the person it takes that would draw another some incremental SG&A spending, FX, maybe some things like that but just help me walk through what would were the pressure margin outside of the Bentley Prince Street.

Dan Hendrix

As far as Bentley Prince Street, you got a sales comparison decline as well. You got to look at back on our margins on the 3 plus million sales work fall compared to the last year, a 10% decline.

Matt McCall – BB&T Capital Markets

The biggest thing is the investment in the European marketing. I mean, I was very pleased with the gross profit line, even with the difficulty at Bentley Prince Street.

Dan Hendrix

You know we’re hitting around out 36%. So it is really the investment in the whole marketing sales infrastructure. We also invested in Asia as well. So, to me we made the investments to go to the top line and had undertaken a little bit longer term view.

Matt McCall – BB&T Capital Markets

And as we are looking now and forgive me if you’ve said this already but as we move to the rest of the year– Are we going to see similar investment levels on the SG&A on from a dollar standpoint, how we should we look at the balance of the year?

Dan Hendrix

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

Matt McCall – BB&T Capital Markets

So I think you’re at that level today. Shall we say no higher but not –

Dan Hendrix

Unless it’s currency related.

Matt McCall – BB&T Capital Markets

Got you. Okay, and then, how should we look at the Bentley profitability with all these presentations, like you are going to take some actions there? How should we look at that for the balance of the year?

Dan Hendrix

I’m not making anymore promises. I’m just going to go to fix it.

Matt McCall – BB&T Capital Markets

Okay. Okay, thank you again.

Operator

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

Michael O’Brien – Australian Ethical

I need to see how you’ve take on how you view sales with the credit over the next couple of years given the expansion plans in Asia and also the initiatives in Europe. Can you get us in for the rough guidance?

Dan Hendrix

We don’t really give this kind of guidance.

I think we can grow the segmentation strategy, double digit. And I think the emerging markets can grow double digits and I don’t have a crystal ball about what’s going to happen in the office markets in Western Europe and the US.

But I do know that we will outperform the industry.

Michael O’Brien – Australian Ethical

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

Dan Hendrix

We will get the China plant build and we’ll get the Australian plant – double the footprint of that plan. We’ll be running the capacity in Asia. It will probably be about 60% in Asia and in the footprint will be there to take it further than that from the capacity standpoint. From the US standpoint, we’ll probably run about 75% of capacity and we’ll incrementally act to pass you there. We got plenty of capacity in Europe and Bentley Prince Street–to erase those double digit gross we talked about.

Michael O’Brien – Australian Ethical

Okay, thank you.

Dan Hendrix

Thank you.

Operator

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

Dan Hendrix

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

Operator

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

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