SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For Quarterly Period Ended October 4, 1998 Commission File Number 0-12016 ------------------------------ INTERFACE, INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) GEORGIA 58-1451243 - ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2859 PACES FERRY ROAD, SUITE 2000, ATLANTA, GEORGIA 30339 --------------------------------------------------------- (Address of principal executive offices and zip code) (770) 437-6800 ---------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes / X / No / / Shares outstanding of each of the registrant's classes of common stock at November 9, 1998: Class Number of Shares ----- ---------------- Class A Common Stock, $.10 par value per share 46,779,052 Class B Common Stock, $.10 par value per share 5,607,761 1
INTERFACE, INC. INDEX <TABLE> <CAPTION> PAGE <S> <S> <S> <C> PART I. FINANCIAL INFORMATION Item 1. Financial Statements 3 Balance Sheets - October 4, 1998 and December 28, 1997 3 Statements of Income - Three Months and Nine Months Ended 4 October 4, 1998 and September 28, 1997 Statements of Comprehensive Income - Three Months and Nine Months 4 Ended October 4, 1998 and September 28, 1997 Statements of Cash Flows - Nine Months 5 Ended October 4, 1998 and September 28, 1997 Notes to Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and 12 Results of Operations Item 3. Quantitative and Qualitative Disclosures about Market Risk 14 PART II. OTHER INFORMATION Item 1. Legal Proceedings 14 Item 2. Changes in Securities and Use of Proceeds 15 Item 3. Defaults Upon Senior Securities 15 Item 4. Submission of Matters to a Vote of Security Holders 15 Item 5. Other Information 15 Item 6. Exhibits and Reports on Form 8-K 15 </TABLE> 2
<TABLE> <CAPTION> PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS INTERFACE, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS (UNAUDITED) (IN THOUSANDS) OCTOBER 4, DECEMBER 28, 1998 1997 ---- ---- ASSETS ------ <S> <C> <C> CURRENT ASSETS: Cash and Cash Equivalents $ 16,044 $ 10,212 Accounts Receivable 210,920 177,977 Inventories 200,992 157,630 Deferred Tax Asset 5,236 5,156 Prepaid Expenses 33,687 24,265 ---------- -------- TOTAL CURRENT ASSETS 466,879 375,240 PROPERTY AND EQUIPMENT, less accumulated depreciation 247,877 228,781 EXCESS OF COST OVER NET ASSETS ACQUIRED 302,435 278,597 OTHER ASSETS 57,946 46,945 ---------- -------- $1,075,137 $929,563 ========== ======== LIABILITIES AND COMMON SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Notes Payable $ 30,721 $ 22,264 Accounts Payable 68,776 79,279 Accrued Expenses 99,407 87,543 Current Maturities of Long-Term Debt 2,867 2,751 ---------- -------- TOTAL CURRENT LIABILITIES 201,771 191,837 LONG-TERM DEBT, less current maturities 283,562 264,499 SENIOR SUBORDINATED NOTES 125,000 125,000 DEFERRED INCOME TAXES 32,479 28,873 ---------- -------- TOTAL LIABILITIES 642,812 610,209 ---------- -------- Minority Interest 2,989 2,989 Common Stock 5,970 2,776 Additional Paid-In Capital 231,323 161,584 Retained Earnings 228,081 197,906 Accumulated Other Comprehensive Income - Foreign Currency Translation (15,757) (28,155) Treasury Stock, 7,375 Class A Shares, at Cost (20,281) (17,746) ---------- -------- $1,075,137 $929,563 ========== ======== See accompanying notes to consolidated condensed financial statements. </TABLE> 3
<TABLE> <CAPTION> INTERFACE, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF INCOME (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) THREE MONTHS ENDED NINE MONTHS ENDED ------------------ ----------------- OCTOBER 4, SEPTEMBER 28, OCTOBER 4, SEPTEMBER 28, 1998 1997 1998 1997 ---- ---- ---- ---- <S> <C> <C> <C> <C> Net Sales $ 328,264 $ 297,352 $ 964,080 $ 826,443 Cost of Sales 215,005 196,699 637,414 553,473 --------- --------- --------- --------- Gross Profit on Sales 113,259 100,653 326,666 272,970 Selling, General and Administrative Expenses 80,685 74,056 238,885 203,867 --------- --------- --------- --------- Operating Income 32,574 26,597 87,781 69,103 Other (Expense) Income - Net (10,136) (9,234) (29,626) (28,393) --------- --------- --------- --------- Income before Taxes on Income 22,438 17,363 58,155 40,710 Taxes on Income 8,078 6,852 21,848 15,886 --------- --------- --------- --------- Net Income $ 14,360 $ 10,511 $ 36,307 $ 24,824 ========= ========= ========= ========= Basic Earnings Per Share .27 .22 .70 .53 ========= ========= ========= ========= Diluted Earnings Per Share .27 .21 .69 .52 ========= ========= ========= ========= Average Shares Outstanding -- Basic 52,462 48,030 51,773 46,816 ========= ========= ========= ========= Average Shares Outstanding -- Diluted 54,105 48,940 52,916 47,726 ========= ========= ========= ========= See accompanying notes to consolidated condensed financial statements. </TABLE> <TABLE> <CAPTION> INTERFACE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) (IN THOUSANDS) THREE MONTHS ENDED NINE MONTHS ENDED ------------------ ----------------- OCTOBER 4, SEPTEMBER 28, OCTOBER 4, SEPTEMBER 28, 1998 1997 1998 1997 ---- ---- ---- ---- <S> <C> <C> <C> <C> Net Income $ 14,360 $ 10,511 $ 36,307 $ 24,824 Other Comprehensive Income, Foreign Currency Translation Adjustment 16,140 (7,458) 12,398 (22,910) -------- -------- -------- -------- Comprehensive Income $ 30,500 $ 3,053 $ 48,705 $ 1,914 ======== ======== ======== ======== See accompanying notes to consolidated condensed financial statements. </TABLE> 4
<TABLE> <CAPTION> INTERFACE, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) NINE MONTHS ENDED ----------------- OCTOBER 4, SEPTEMBER 28, 1998 1997 ---- ---- (IN THOUSANDS) <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: $28,419 $25,332 ------- ------- INVESTING ACTIVITIES: Capital expenditures (28,998) (33,963) Acquisitions of businesses (62,800) (34,647) Other (6,369) (7,601) ------- ------- (98,167) (76,211) ------- ------- FINANCING ACTIVITIES: Net borrowing (reduction) of long-term debt 14,997 50,546 Issuance/Repurchase of common stock 68,121 5,513 Dividends paid (6,134) (4,626) ------- ------- 76,984 51,433 ------- ------- Net cash provided by (used for) operating, investing and financing activities 7,236 554 Effect of exchange rate changes on cash (1,404) 300 ------- ------- CASH AND CASH EQUIVALENTS: Net increase (decrease) during the period 5,832 854 Balance at beginning of period 10,212 8,762 ------- ------- Balance at end of period $16,044 $ 9,616 ======= ======= See accompanying notes to consolidated condensed financial statements. </TABLE> 5
INTERFACE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS NOTE 1 - CONDENSED FOOTNOTES As contemplated by the Securities and Exchange Commission (the "Commission") instructions to Form 10-Q, the following footnotes have been condensed and, therefore, do not contain all disclosures required in connection with annual financial statements. Reference should be made to the notes to the Company's year-end financial statements contained in its Annual Report to Shareholders for the fiscal year ended December 28, 1997, as filed with the Commission. The financial information included in this report has been prepared by the Company, without audit, and should not be relied upon to the same extent as audited financial statements. In the opinion of management, the financial information included in this report contains all adjustments (all of which are normal and recurring) necessary for a fair presentation of the results for the interim periods. Nevertheless, the results shown for interim periods are not necessarily indicative of results to be expected for the full year. NOTE 2 - INVENTORIES Inventories are summarized as follows: <TABLE> <CAPTION> October 4, December 28, 1998 1997 ----------- ------------ <S> <C> <C> Finished Goods $125,095 $ 91,016 Work in Process 32,580 29,094 Raw Materials 43,317 37,520 -------- -------- $200,992 $157,630 ======== ======== </TABLE> NOTE 3 - BUSINESS ACQUISITIONS AND DIVESTITURES During the first three quarters of 1998, the Company acquired four floorcovering contractors (Carpet Workshop, Inc., based in Florida; Kustom Carpet Services, Inc., based in Washington, D.C.; Corporate Floorworks, Inc., based in Indiana; and J. Graham Carpet Co., Inc., based in New York), three carpet maintenance companies (Castle Carpet Care, Inc., based in the State of Washington; G&H Services, Inc., based in Connecticut, and Oldtown Carpet Cleaning Services, Inc., based in North Carolina) and a floorcovering installation company (Wallum Floors, Inc., based in New Jersey). The Company also acquired Atlantic Access Flooring, Inc., a raised/access flooring manufacturer based in Maryland; and the vinyl floorcoverings business of Scan-Lock A/S, based in Denmark. As consideration, the Company paid $12.9 million and issued 113,562 shares of Common Stock valued at approximately $1.65 million. All transactions have been accounted for as purchases, and accordingly, the results of operations of the acquired companies have been included within the consolidated financial statements since their respective acquisition dates. The excess of the purchase price over the fair value of the net assets acquired was approximately $8.5 million and is being amortized over 25 years. 6
On December 30, 1997, the Company completed the acquisition of the European carpet businesses of Readicut International plc ("Readicut"), for approximately $50 million. The Company subsequently sold Readicut's Network Flooring dealer division, and it is considering the sale of certain additional assets acquired from Readicut. The retained businesses include Firth Carpets Ltd., based in Brighouse, West Yorkshire, a leading manufacturer of high quality woven and tufted carpet primarily for the contract markets; and a 40% interest in Vebe Floorcoverings BV, located in the Netherlands, a leading manufacturer of needle punch carpet. In December 1997, the Company sold certain assets related to the commercial manufacture of zinc diacrylate, a chemical compound used in the production of golf balls, for $14.1 million in cash. An immaterial gain was realized on the sale. The Company generated 1997 sales of $7.9 million and operating income of $1.1 million related to the manufacture of this chemical compound. During 1997, the Company acquired 100% of the outstanding capital stock of four floorcovering contractors: Canaan Corporation, based in Connecticut; Carpet Services of Tampa, Inc., based in Florida; Floormart, Inc., based in California; and Carpet Solutions Holdings Pty Ltd., based in Queensland, Australia. These contractors are engaged primarily in the sale and installation of commercial floorcoverings. The Company also acquired 100% of the outstanding capital stock of Facilities Resource Group, Inc., an office furniture installation company. As consideration, the Company issued 515,168 shares of Class A Common Stock valued at approximately $3.5 million and paid $11.1 million in cash. All transactions have been accounted for as purchases, and accordingly, the results of operations of the acquired companies have been included within the consolidated financial statements since their respective acquisition dates. The excess of the purchase price over the fair value of the net assets acquired was approximately $17.5 million and is being amortized over 25 years. In June 1997, the Company acquired 100% of the outstanding common stock of Camborne Holdings, Ltd., a manufacturer of interior fabrics based in West Yorkshire, U.K. for approximately $19.9 million, which was comprised of $17.1 million in cash and 255,612 shares of Class B Common Stock valued at approximately $2.8 million. The transaction was accounted for as a purchase. The results of operations of Camborne have been included within the consolidated financial statements since the acquisition date. The excess of the purchase price over the fair value of the assets was approximately $16.8 million and is being amortized over 40 years. NOTE 4 - CONCURRENT PUBLIC OFFERINGS On April 2, 1998, the Company completed concurrent public offerings of $150 million aggregate principal amount of 7.30% Senior Notes due 2008 and 3,450,000 shares of Class A Common Stock. The Company used the net proceeds of both offerings of $212.7 million to reduce amounts outstanding under its senior credit facility, and for general corporate purposes, including working capital and acquisitions. 7
NOTE 5 - STOCK SPLIT On June 15, 1998, the Company paid a two-for-one stock split, effected in the form of a 100% stock dividend, to all common shareholders of record as of June 1, 1998. In connection with the stock split, the Company issued 29,690,566 shares of Common Stock in the aggregate (including treasury shares). All earlier references to shares of the Company's Common Stock contained elsewhere in these Notes have been retroactively adjusted to reflect the stock split. NOTE 6 - STOCK REPURCHASES The Company has recently adopted a share repurchase program, pursuant to which it is authorized to repurchase up to 2,000,000 shares of Common Stock in the open market over the next two years. During the third quarter, the Company repurchased an aggregate of 175,000 shares of Common Stock under this program, at prices ranging from $12.86 to $16.78 per share. NOTE 7 - EARNINGS PER SHARE AND DIVIDENDS In March 1997, the FASB issued SFAS 128, "Earnings per Share." The new Standard simplifies the computation of earnings per share and requires presentation of two amounts, basic and diluted earnings per share. As required by the Standard, the Company has retroactively restated earnings per share data for all periods presented. Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of shares of Class A and Class B Common Stock outstanding during the period. Shares issued or reacquired during the period have been weighted for the portion of the period that they were outstanding. Basic earnings per share has been computed based upon 51,773 shares and 46,816 shares outstanding for the periods ended October 4, 1998 and September 28, 1997, respectively. Diluted earnings per share is calculated in a manner consistent with that of basic earnings per share while giving effect to all dilutive potential common shares that were outstanding during the period. Diluted earnings per share has been computed based upon 52,916 shares and 47,726 shares outstanding for the periods ended October 4, 1998 and September 28, 1997, respectively. For the purposes of computing earnings per common share and dividends per common share, the Company is treating as treasury stock (and therefore not outstanding) the shares that are owned by a wholly-owned subsidiary and the shares recently repurchased in the open market (an aggregate of 7,375,000 Class A shares recorded at cost). 8
The following is a reconciliation from basic earnings per share to diluted earnings per share for each of the periods presented: <TABLE> <CAPTION> (In Thousands Except Per Share) Average For the Nine-Month Shares Earnings Period Ended Net Income Outstanding Per Share - ------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> October 4, 1998 $ 36,307 51,773 $ .70 Effect of Dilution: Options -- 1,143 ----------------------------------------------------- Diluted $ 36,307 52,916 $ .69 ===================================================== - ------------------------------------------------------------------------------------------------------------ September 28, 1997 $ 24,824 46,816 $ .53 Effect of Dilution: Options -- 740 Convertible Debt 120 170 ----------------------------------------------------- Diluted $ 24,944 47,726 $ .52 ===================================================== - ------------------------------------------------------------------------------------------------------------ </TABLE> NOTE 8 - COMPREHENSIVE INCOME Effective the first quarter of 1998, the Company has adopted FAS 130, "Comprehensive Income". This statement has established the standards for reporting and displaying comprehensive income and its components (revenues, expenses, gains and losses) as part of a full set of financial statements. This statement requires that all elements of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Since this statement applies only to the presentation of comprehensive income, it does not have any impact upon results of operations, financial position, or cash flows. 9
NOTE 9 - SUPPLEMENTAL GUARANTOR FINANCIAL STATEMENTS The Guarantor Subsidiaries, which consist of the Company's principal domestic subsidiaries, are guarantors of the Company's 7.3% senior notes due 2008 and its 9.5% senior subordinated notes due 2005. The Supplemental Guarantor Financial Statements are presented herein pursuant to requirements of the Commission. <TABLE> <CAPTION> INTERFACE, INC. AND SUBSIDIARIES NOTE 9 - SUPPLEMENTAL GUARANTOR FINANCIAL STATEMENTS STATEMENT OF INCOME FOR THE NINE MONTHS ENDED OCTOBER 4, 1998 INTERFACE, CONSOLIDATION NON- INC. AND GUARANTOR GUARANTOR (PARENT ELIMINATION CONSOLIDATED SUBSIDIARIES SUBSIDIARIES CORPORATION) ENTRIES TOTALS ------------ ------------ ------------ ------- ------ (IN THOUSANDS) <S> <C> <C> <C> <C> <C> Net sales $751,771 $332,532 $ - $ (120,223) $964,080 Cost of sales 530,845 226,792 - (120,223) 637,414 -------- -------- ----------- ---------- -------- Gross profit on sales 220,926 105,740 - - 326,666 Selling, general and 152,397 66,320 20,168 - 238,885 administrative expenses -------- -------- ----------- ---------- -------- Operating income 68,529 39,420 (20,168) - 87,781 Other expense (income) 12,625 5,103 11,898 - 29,626 -------- -------- ----------- ---------- -------- Income before taxes on income 55,904 34,317 (32,066) 58,155 and Equity in income of subsidiaries Taxes on income 21,523 13,212 (12,887) - 21,848 -------- -------- ----------- ---------- -------- Equity in income of subsidiaries - - 55,486 (55,486) - -------- -------- ----------- ---------- -------- Net income applicable to $ 34,381 $ 21,105 $ 36,307 $ (55,486) $ 36,307 common shareholders ======== ======== =========== ========== ======== </TABLE> 10
<TABLE> <CAPTION> BALANCE SHEET OCTOBER 4, 1998 CONSOLIDATION NON- INTERFACE, INC. AND GUARANTOR GUARANTOR (PARENT ELIMINATION CONSOLIDATED SUBSIDIARIES SUBSIDIARIES CORPORATION) ENTRIES TOTALS ------------ ------------ --------------- ------- ------ (IN THOUSANDS) <S> <C> <C> <C. <C> <C> ASSETS Current Assets: Cash and cash equivalents $ 2,963 $ 5,157 $ 7,924 $ 0 $ 16,044 Accounts receivable 141,663 93,437 (24,180) 0 210,920 Inventories 131,351 69,641 0 0 200,992 Miscellaneous 10,487 26,222 2,214 0 38,923 -------- -------- -------- ----------- ---------- Total current assets 286,464 194,457 (14,042) 0 466,879 Property and equipment less accumulated depreciation 153,236 86,350 8,291 0 247,877 Investment in subsidiaries 138,088 15,799 373,895 (527,782) 0 Miscellaneous 196,619 36,902 570,054 (745,629) 57,946 Excess of cost over net assets acquired 178,912 110,445 13,078 0 302,435 -------- -------- -------- ----------- ---------- $953,319 $443,953 $951,276 $(1,273,411) $1,075,137 ======== ======== ======== =========== ========== LIABILITIES AND COMMON SHAREHOLDERS' EQUITY Current Liabilities: Notes payable $ 13,185 $ 17,536 $ 0 $ 0 $ 30,721 Accounts payable 39,871 27,200 1,705 0 68,776 Accrued expenses 67,680 53,156 (21,429) 0 99,407 Current maturities of long- term debt 1,687 1,180 0 0 2,867 -------- -------- -------- ----------- ---------- Total current liabilities 122,423 99,072 (19,724) 0 201,771 Long-term debt, less current maturities 256,905 64,310 322,451 (360,104) 283,562 Senior subordinated notes - - 125,000 - 125,000 Deferred income taxes 15,100 8,600 8,779 0 32,479 Minority Interests 0 2,989 0 0 2,989 -------- -------- -------- ----------- ---------- Total liabilities 394,428 174,971 436,506 (360,104) 645,801 Redeemable preferred stock 57,891 0 0 (57,891) 0 Common stock 93,889 102,199 5,970 (196,088) 5,970 Additional paid-in capital 189,740 11,030 231,323 (200,770) 231,323 Retained earnings 220,126 165,398 280,834 (438,277) 228,081 Foreign currency translation adjustment (2,755) (9,645) (3,357) 0 (15,757) income Treasury stock, 7,375,000 Class A shares, at cost 0 0 0 (20,281) (20,281) -------- -------- -------- ----------- ---------- $953,319 $443,953 $951,276 $(1,273,411) $1,075,137 ======== ======== ======== =========== ========== </TABLE> 11
<TABLE> <CAPTION> STATEMENT OF CASH FLOWS FOR THE NINE MONTHS ENDED OCTOBER 4, 1998 INTERFACE, CONSOLIDATION NON- INC. AND GUARANTOR GUARANTOR (PARENT ELIMINATION CONSOLIDATED SUBSIDIARIES SUBSIDIARIES CORPORATION) ENTRIES TOTALS ------------ ------------ ------------ ------- ------ (IN THOUSANDS) <S> <C> <C> <C> <C> <C> Net cash provided by operating activities $ 7,004 $23,378 $(1,963) $ 0 $28,419 Cash flows from operating activities: Cash flows from investing activities: Purchase of plant and equipment (15,393) (11,886) (1,719) 0 (28,998) Acquisitions, net of cash acquired 0 0 (62,800) 0 (62,800) Other assets 0 0 (6,369) 0 (6,369) ------- ------- ------- ------- ------- Net cash provided by (used in) investing activities (15,393) (11,886) (70,888) 0 (98,167) Cash flows from financing activities: Net borrowings (repayments) 6,991 (11,433) 19,439 0 14,997 Proceeds from issuance of common stock 0 0 68,121 0 68,121 Cash dividends paid 0 0 (6,134) 0 (6,134) ------- ------- ------- ------- ------- Net cash provided by (used in) financing activities 6,991 (11,433) 81,426 0 76,984 ------- ------- ------- ------- ------- Effect of exchange rate change on cash 0 (1,404) 0 0 (1,404) ------- ------- ------- ------- ------- Net increase (decrease) in cash (1,398) (1,345) 8,575 0 5,832 Cash at beginning of year 4,361 6,502 (651) 0 10,212 ------- ------- ------- ------- ------- Cash at end of year $ 2,963 $ 5,157 $ 7,924 $ 0 $16,044 ======= ======= ======= ======= ======= </TABLE> 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General The Company's revenues are derived from sales of commercial floorcovering products (primarily modular and broadloom carpet) and related services, interior fabrics and specialty products. During the quarter ended October 4, 1998, the Company had revenues and net income of $328.3 million and $14.4 million, respectively. The Company's business, as well as the commercial interiors market in general, is somewhat cyclical in nature. The Company's strong financial performance in recent years is attributable in part to increased U.S. demand for its products, resulting from a recovery in the U.S. commercial office market which began in the mid-1990's. Although orders for certain of the Company's products have recently begun to slow, overall demand for the Company's products in the U.S. continues to be solid. However, a downturn in the market could lessen the overall demand for commercial interiors products and could impair the Company's growth. The Company's growth could also be impacted by international developments. Specifically, countries in the Asia-Pacific region have recently experienced weaknesses in their currency, banking and equity markets. These weaknesses have adversely affected demand for the Company's products. However, sales in the Asia-Pacific region represented only 4% of the Company's sales during the quarter ended October 4, 1998. Management is considering whether to rationalize and restructure operations in certain countries where the Company has underperformed management's expectations or where consolidation opportunities exist. Results of Operations For the three month and nine month periods ended October 4, 1998, the Company's net sales increased $30.9 million (10.4%) and $137.6 million (16.7%), respectively, compared with the same periods in 1997. These increases were primarily attributable to increased sales volume (i) of products and related services in the Company's U.S. floorcovering operations, due to increased demand for and increased market share of its modular carpet products, as well as additional sales generated by the Re:Source Americas network, (ii) of floorcovering products in Europe as a result of the acquisition of Firth Carpets early in the first quarter of 1998, and (iii) in the Company's interior fabrics operations due to increased demand for the Company's lighter weight, higher margin fabric products. These increases were offset somewhat by decreased sales volume (i) in the Company's Asia-Pacific division due to the economic turmoil in Asia, (ii) in the Company's architectural products division, and (iii) of modular carpet products in the United Kingdom. Cost of sales, as a percentage of sales, decreased to 65.5% and 66.1%, respectively, for the three month and nine month periods ended October 4, 1998, when compared to 66.2% and 67.0% for the same periods in 1997. The decrease was attributable to (i) increased profitability in the Company's Interface Americas Workplace Solutions unit (comprised of the Re:Source Americas network and the Company's other service businesses), (ii) economies of scale associated with increased sales volume in the Company's floorcovering and interior fabrics operations, (iii) decreased manufacturing costs in the Company's floorcovering and interior fabrics operations through the Company's QUEST waste reduction initiative, and (iv) a favorable product mix. 13
The Company's interior fabrics business also experienced decreased manufacturing costs as a result of continued efficiencies generated from the new, state-of-the-art yarn manufacturing facility in Guilford, Maine. Selling, general and administrative expenses, as a percentage of net sales, decreased to 24.6% in the quarter ended October 4, 1998 compared to 24.9% in the same period in 1997, primarily as a result of improved cost containment measures worldwide in the third quarter. However, the SG&A cost-to-sales ratio increased to 24.8% in the nine- month period ended October 4, 1998 compared to 24.7% in the same period in 1997. The increase was attributable primarily to (i) the continued development of the Re:Source Americas network infrastructure and (ii) consulting and development expenses associated with the Year 2000 initiative. For the three month and nine month periods ended October 4, 1998, other expense increased $0.9 million and $1.2 million, respectively, compared to the same periods in 1997, due primarily to higher overall levels of bank debt incurred as a result of the Company's acquisitions. As a result of the aforementioned factors, the Company's net income increased 36.6% to $14.4 million and 46.3% to $36.3 million, respectively, for the three month and nine month periods ended October 4, 1998, compared to the same periods in 1997. Liquidity and Capital Resources The Company's primary sources of cash during the nine months ended October 4, 1998 were (i) $68.1 from the issuance (net of repurchases) of Common Stock, (ii) $28.4 from operating activities, and (iii) $15.0 from long-term financing. The primary uses of cash during the nine months ended October 4, 1998 were (i) $62.8 million associated with acquisitions, and (ii) $29.0 million for additions to property and equipment in the Company's manufacturing facilities. Management believes that cash provided by operations and long-term loan commitments will provide adequate funds for current commitments and other requirements in the foreseeable future. The Company has recently adopted a share repurchase program, pursuant to which it is authorized to repurchase up to 2,000,000 shares of Common Stock in the open market over the next two years. During the third quarter, the Company repurchased an aggregate of 175,000 shares of Common Stock under this program, at prices ranging from $12.86 to $16.78 per share. Year 2000 As is the case with other companies using computers in their operations, the Company is faced with the task of addressing the Year 2000 issue. The Year 2000 issue arises from the widespread use of computer programs that rely on two-digit codes to perform computations or decision-making functions. The Company has done a comprehensive review of its computer programs to identify the systems that would be affected by the Year 2000 issue. The Company has retained IBM Corporation to assist in its Year 2000 conversion process. The Company categorizes its systems into one of two categories: those that are linked to the Company's AS-400 computer network ("IT Systems"), and those that are not ("Non-IT Systems"). The Company currently estimates the total cost of modifying its IT Systems to be Year 2000 ready to be approximately $19 million. Of such amount, approximately $10 million is attributable to the cost of 14
new hardware and software which will be required in connection with the global consolidation of the Company's management and financial accounting systems. This new equipment and upgraded technology will have a definable value lasting beyond the Year 2000. In these instances, where Year 2000 compliance is ancillary, the Company intends to capitalize and depreciate such costs. The remaining $9 million (based on current estimates) will be expensed as incurred. With respect to Non-IT Systems, the Company currently estimates the total cost of the modifications necessary to be Year 2000 ready to be approximately $2 million, although it could be more. During the quarter ended October 4, 1998, the Company expensed approximately $2.5 million in regards to modifications of both IT Systems and Non-IT Systems. To date, the Company has expensed approximately $5.5 million in the aggregate in regards to such modifications. The Company currently anticipates that the modifications to both its IT Systems and its Non-IT Systems will be completed by the end of the second quarter of 1999, although it could be later. The balance of 1999 will then be available for testing the modifications, as well as for training employees in the use of new hardware and software. The Company is still in the process of reviewing its Year 2000 exposure to third party customers, distributors and suppliers. The Company's most reasonably likely worst case Year 2000 scenario is that a key supplier's systems will malfunction and, as a result, the Company will suffer a period of business interruption during which it is unable to meet related obligations to its customers. The Company is currently unaware of any Year 2000 problems faced by any third party customers, distributors or suppliers which are likely to have a material adverse effect on the Company. However, many third parties are reluctant to provide detailed information concerning the status of their Year 2000 readiness, particularly if they have not completed their analysis of their systems. There can be no guarantee that the foregoing cost estimates or deadlines will be achieved and actual results could differ from those anticipated. Specific factors that might cause differences include, but are not limited to, the ability of suppliers, customers and other companies on which the Company's systems rely to modify or convert their systems to be Year 2000 ready, the ability to locate and correct all relevant computer codes and similar uncertainties. The Company is in the process of developing contingency plans for such scenarios, including identifying substitute suppliers for key materials. Derivative Financial Instruments The Company employs the use of derivative financial instruments for the purpose of reducing its exposure to adverse fluctuations in interest and foreign currency exchange rates. While these hedging instruments are subject to fluctuations in value, such fluctuations are generally offset by the fluctuations in value of the underlying exposures being hedged. The Company does not hold or issue derivative financial instruments for trading purposes. The Company monitors the use of derivative financial instruments through the use of objective measurable systems, well-defined market and credit risk limits, and timely reports to senior management according to prescribed guidelines. The Company has established strict counter party credit guidelines and only enters into transactions with financial institutions of investment grade or better. As a result, the Company considers the risk of counter party default to be minimal. 15
Management of the Company has developed and implemented a policy to maintain the percentage of fixed and variable rate debt within certain parameters. The Company enters into interest rate swap agreements, which maintain the fixed/variable mix within these defined parameters. In these swaps, the Company agrees to exchange, at specified intervals, the difference between fixed and variable interest amounts calculated by reference to an agreed-upon notional principal linked to LIBOR (London Interbank Offered Rate). At October 4, 1998, the Company had utilized interest rate swap agreements to effectively convert approximately $45 million of variable rate debt to fixed rate debt. The weighted average rate on these borrowings was 6.9% at October 4, 1998. The interest rate swap agreements have maturity dates ranging from five to 24 months. The purpose of the Company's foreign currency hedging activities is to reduce the risk that the eventual local currency inflows resulting from sales to foreign customers will be adversely affected by changes in exchange rates. The Company enters into forward exchange and currency swap contracts to hedge certain firm sales commitments denominated in foreign currencies. At October 4, 1998, the Company had approximately $14.5 million (notional amount) of foreign currency hedge contracts outstanding. The contracts served to hedge firmly committed Dutch guilder, German mark, Japanese yen, French franc, British pound sterling, and other foreign currency revenues. The contracts generally have maturity dates of six to nine months. The Company, as of October 4, 1998, recognized a $12.4 million decrease in its foreign currency translation adjustment account compared to December 27, 1998, because of the strengthening of certain currencies against the U.S. dollar. The decrease was associated primarily with the Company's investments in certain foreign subsidiaries located in Continental Europe. The translation adjustment to shareholders' equity was converted by the guidelines of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 52. Forward-Looking Statements THIS FORM 10-Q CONTAINS STATEMENTS WHICH MAY CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE SECURITIES ACT OF 1933 AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED BY THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. ANY SUCH FORWARD- LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE CONTEMPLATED BY SUCH FORWARD-LOOKING STATEMENTS, INCLUDING THE RISKS AND UNCERTAINTIES DISCUSSED IN THE SAFE HARBOR COMPLIANCE STATEMENT FOR FORWARD-LOOKING STATEMENTS INCLUDED AS EXHIBIT 99.1 TO THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 28, 1997, WHICH DISCUSSION IS INCORPORATED HEREIN BY THIS REFERENCE. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. 16
PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In February 1998, the Company sent two "cease and desist" letters to Collins & Aikman Floorcoverings, Inc. ("CAF"), demanding that CAF cease manufacturing certain carpet products which the Company believes infringe upon certain of its copyrighted product designs. The Company and CAF subsequently began settlement negotiations in an attempt to resolve the Company's claims. On July 28, 1998, CAF filed a complaint (the "Complaint") against the Company and certain other parties in the U.S. District Court for the Northern District of Georgia, Atlanta Division. In the Complaint, CAF alleges that the Company has infringed upon certain of CAF's copyrighted product designs. The Complaint also contains a claim against the Company for tortious interference with contractual rights relating to a consulting agreement between CAF and David Oakey, a former consultant of CAF and current consultant of the Company. CAF is seeking damages and injunctive relief in connection with the foregoing claims. On September 28, 1998, the Company filed its Answer and Counterclaims to the Complaint, which includes certain counterclaims against CAF for copyright infringement. The Company continues to believe that CAF's claims are unfounded and that the Company has meritorious defenses to such claims. Moreover, the Company intends to aggressively assert its claims against CAF. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS RECENT SALES OF UNREGISTERED SECURITIES During the fiscal quarter ended October 4, 1998, the Company issued an aggregate of 113,562 shares of its Common Stock that were not registered under the Securities Act of 1933 (the "Securities Act"). The shares, in combination with cash, were issued as consideration in the acquisitions of Kustom Carpet Services, Inc. and Oldtown Carpet Cleaning Service, Inc., to two individuals. The market price on the dates of issuance ranged from $12.00 per share to $12.25 per share. The issuance of the foregoing shares is exempt from registration under the Securities Act pursuant to Section 4(2) of the Securities Act, or Regulation D promulgated thereunder, as transactions by an issuer not involving a public offering. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5. OTHER INFORMATION None 17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed with this report: <TABLE> <CAPTION> EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------- ---------------------- <C> <S> 3.1 Restated Articles of Incorporation (included as Exhibit 3.1 to the Company's quarterly report on Form 10-Q for the quarter ended July 5, 1998, previously filed with the Commission and incorporated herein by reference). 3.2 Bylaws, as amended (included as Exhibit 3.2 to the Company's quarterly report on Form 10-Q for the quarter ended April 1, 1990, previously filed with the Commission and incorporated herein by reference). 4.1 See Exhibits 3.1 and 3.2 for provisions in the Company's Articles of Incorporation and Bylaws defining the rights of holders of Common Stock of the Company. 4.2 Rights Agreement between the Company and Wachovia Bank, N.A., dated as of March 4, 1998, with an effective date of March 16, 1998 (included as Exhibit 10.1A to the Company's registration statement on Form 8-A/A dated March 12, 1998, previously filed with the Commission and incorporated herein by reference). 4.3 Indenture governing the Company's 9.5% Senior Subordinated Notes due 2005, dated as of November 15, 1995, among the Company, certain U.S. subsidiaries of the Company, as Guarantors, and First Union National Bank of Georgia, as Trustee (included as Exhibit 4.1 to the Company's registration statement on Form S-4, File No. 33-65201, previously filed with the Commission and incorporated herein by reference); and Supplement No. 1 to Indenture, dated as of December 27, 1996 (included as Exhibit 4.2(b) to the Company's Annual Report on Form 10-K for the year ended December 29, 1996, previously filed with the Commission and incorporated herein by reference). 4.4 Form of Indenture governing the Company's 7.3% senior notes due 2008, among the Company, certain U.S. subsidiaries of the Company, as Guarantors, and First Union National Bank, as trustee (included as Exhibit 4.1 to the Company's registration statement on Form S-3/A, File No. 333-46611, previously filed with the Commission and incorporated herein by reference). 10.1 Split Dollar Insurance Agreement, dated effective as of February 21, 1997, among the Company and Charles R. Eitel. 10.2 Split Dollar Insurance Agreement, dated effective as of February 21, 1997, among the Company and Daniel T. Hendrix. 10.3 Split Dollar Insurance Agreement, dated effective as of February 21, 1997, among the Company and Gordon D. Whitener. 27.1 Financial Data Schedule (for SEC use only). (b) No reports on Form 8-K were filed during the quarter ended October 4, 1998. 18
SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. INTERFACE, INC. Date: November 16, 1998 By: /s/ Daniel T. Hendrix Daniel T. Hendrix Senior Vice President (Principal Financial Officer)
EXHIBIT INDEX Exhibit Number Description of Exhibit 10.1 Split Dollar Insurance Agreement, dated effective as of February 21, 1997, among the Company and Charles R. Eitel. 10.2 Split Dollar Insurance Agreement, dated effective as of February 21, 1997, among the Company and Daniel T. Hendrix. 10.3 Split Dollar Insurance Agreement, dated effective as of February 21, 1997, among the Company and Gordon D. Whitener. 27.1 Financial Data Schedule. </TABLE>