TILE

Business Context and Reporting Period

Company: Interface, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Three and six months ended July 4, 2010
Business Overview: Interface operates two primary reportable segments: Modular Carpet (including InterfaceFLOR, Heuga, and FLOR) and Bentley Prince Street (broadloom, modular carpet, and area rugs). The company previously sold its Fabrics Group segment, which is now reported as discontinued operations.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 7.2% in the quarter and 8.1% for the six-month period compared to the prior year. The Modular Carpet segment drove this growth with an 8.6% quarterly increase, while Bentley Prince Street declined 3.4%.
• Profitability Improvement: Net income attributable to Interface, Inc. turned from a loss of $0.5 million in the first six months of 2009 to a profit of $9.5 million in the same period of 2010. Operating income rose 47% year-over-year for the six-month period.
• Margin Expansion: Gross margin improved to 35.4% in Q2 2010 from 32.7% in Q2 2009, driven by manufacturing efficiencies and volume increases, despite higher raw material costs.
• Expense Increases: Selling, General, and Administrative (SG&A) expenses increased 12.3% in the quarter, primarily due to higher incentive compensation ($2.7M), selling expenses ($1.8M), and marketing investments ($1.7M).
• Debt Reduction: The company repurchased $39.6 million of Senior Notes in the first quarter of 2010 and redeemed $25.0 million of Senior Subordinated Notes, reducing total debt obligations.

Guidance, Outlook, and Risks

• Management Commentary: Management attributes sales growth in the Americas and Asia-Pacific to improving economic climates. Europe saw a decline in reported U.S. dollars due to currency strength, though local currency sales were relatively flat or slightly up in certain segments.
• Restructuring: A 2010 restructuring plan involving approximately 50 employees (primarily in Europe) resulted in a $3.1 million charge, with expected annual savings of $3.2 million. Actions were substantially completed in Q1 2010.
• Liquidity: As of July 4, 2010, the company held $73.2 million in cash. It has $61.2 million available under its domestic revolving credit facility and approximately $32 million under its European facility. No borrowings were outstanding under these facilities at period end.
• Risks: The filing references risks associated with economic conditions in the commercial interiors industry and foreign currency exchange rates. A strengthening U.S. dollar negatively impacted reported European sales and resulted in a $24.4 million decrease in the foreign currency translation adjustment account.
• Unusual Items: The prior year period (2009) included $5.9 million of income from litigation settlements and $6.1 million in bond retirement expenses, which are not present in the current period, making year-over-year comparisons of operating income favorable.

Investor Verification Checklist

• Debt Covenants: Verify continued compliance with covenants under the $100 million domestic revolving credit facility and the 11 3/8% Senior Secured Notes.
• Raw Material Costs: Monitor the impact of rising raw material costs (up 5-6% in Q2) on future gross margins.
• Currency Exposure: Assess the sensitivity of European operations to U.S. dollar strength, which reduced reported sales and created significant translation losses.
• Restructuring Savings: Track the realization of the anticipated $3.2 million in annual savings from the 2010 workforce reduction plan.
• Segment Performance: Investigate the continued decline in the Bentley Prince Street segment, specifically in healthcare and residential markets.