TILE

Business Context and Reporting Period

Company: Interface, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Business Overview: Interface is the worldwide leader in the design, production, and sales of modular carpet, holding approximately 35% of the global specified carpet tile market. The company also manufactures broadloom carpet, interior fabrics, and specialty products. Its strategy focuses on penetrating non-corporate office segments (healthcare, hospitality, education, retail) and the residential market, while maintaining leadership in the corporate office segment. The company is known for its "Mission Zero" ecological sustainability initiative.

Key Financial Metrics (Fiscal Year 2006)

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 9.1% to $1.076 billion, driven by an 18.2% increase in the Modular Carpet segment and a 10.1% increase in the Bentley Prince Street segment. This growth occurred despite the sale of the European fabrics business in April 2006.
• Segment Performance: The Fabrics Group segment sales declined 18.9% due to the divestiture of the European fabrics business. The Specialty Products segment declined 15.9% due to the loss of a major customer.
• Profitability: While Net Income improved significantly from $1.2 million to $10.0 million, Operating Income decreased by $9.6 million. This decline was primarily due to a $20.7 million non-cash goodwill impairment charge related to the European fabrics sale, a $1.7 million loss on disposal, and $3.3 million in restructuring charges.
• Capital Structure: The company raised approximately $78.9 million in net proceeds from a common stock offering in November 2006. It also repurchased $46.6 million of its 7.3% Senior Notes, reducing total long-term debt.
• Liquidity: Cash and cash equivalents more than doubled to $110.2 million, supported by operating cash flows, the stock offering, and the sale of the European fabrics business.

Guidance, Outlook, and Risks

Management Commentary & Outlook: Management expects further improvements in net sales as it builds upon core strengths. The company is continuing its segmentation strategy to reduce exposure to the cyclicality of the corporate office market. Backlog of unshipped orders was $123.8 million as of February 25, 2007, up from $104.6 million the prior year. The company declared its first quarterly cash dividend since 2002 ($0.02 per share) in March 2007.

Key Risks and Contingencies:

• Raw Material Costs: Significant exposure to petroleum-based raw material costs; inability to pass these costs to customers could adversely affect results.
• Debt Obligations: Substantial indebtedness ($411.4 million long-term) limits flexibility and requires significant cash flow for interest and principal payments. No long-term debt matures until April 2008.
• Goodwill Impairment: Future goodwill impairment tests could result in non-cash charges affecting earnings.
• Foreign Currency: Approximately 37% of net sales are in foreign currencies, exposing the company to exchange rate fluctuations.
• Supplier Concentration: Reliance on Invista Inc. for approximately 41% of synthetic fiber requirements.

Investor Verification Checklist

• Goodwill Impairment: Verify the $20.7 million impairment charge related to the European fabrics sale and assess the remaining goodwill balance ($180.1 million) for future risk.
• Debt Covenants: Review the revolving credit facility covenants (fixed charge coverage ratio) and the impact of the recent stock offering on compliance and liquidity.
• Raw Material Pass-Through: Confirm the company's ability to maintain gross margins given the volatility of petroleum-based input costs.
• Discontinued Operations: Ensure financial analysis excludes the Re:Source dealer businesses and European fabrics business to accurately assess continuing operations performance.
• Dividend Sustainability: Evaluate the sustainability of the newly declared dividend given the company's debt load and historical cash flow patterns.