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 3, 1999 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 11, 1999: Class Number of Shares ----- ---------------- Class A Common Stock, $.10 par value per share 46,133,361 Class B Common Stock, $.10 par value per share 6,497,413 1 INTERFACE, INC. INDEX PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements 3 Balance Sheets - October 3, 1999 and January 3, 1999 3 Statements of Income - Three Months and Nine Months Ended 4 October 3, 1999 and October 4, 1998 Statements of Comprehensive Income - Three Months and 4 Nine Months Ended October 3, 1999 and October 4, 1998 Statements of Cash Flows - Nine Months 5 Ended October 3, 1999 and October 4, 1998 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 15 PART II. OTHER INFORMATION Item 1. Legal Proceedings 16 Item 2. Changes in Securities and Use of Proceeds 16 Item 3. Defaults Upon Senior Securities 17 Item 4. Submission of Matters to a Vote of Security Holders 17 Item 5. Other Information 17 Item 6. Exhibits and Reports on Form 8-K 17 2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS INTERFACE, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS (UNAUDITED) (IN THOUSANDS) OCTOBER 3, JANUARY 3, ASSETS 1999 1999 - ----- ---- ---- CURRENT ASSETS: Cash and Cash Equivalents $ 10,936 $ 9,910 Accounts Receivable 214,211 194,803 Inventories 187,605 199,338 Prepaid Expenses 32,306 26,607 Deferred Tax Asset 7,630 7,866 ----------- ----------- TOTAL CURRENT ASSETS 452,688 438,524 PROPERTY AND EQUIPMENT, less accumulated depreciation 241,538 245,312 EXCESS OF COST OVER NET ASSETS ACQUIRED 285,959 302,969 OTHER ASSETS 72,019 50,059 ----------- ----------- $ 1,052,204 $ 1,036,864 =========== =========== LIABILITIES AND COMMON SHAREHOLDERS' EQUITY - ------------------------------------------- CURRENT LIABILITIES: Notes Payable $ 16,575 $ 26,855 Accounts Payable 73,855 80,154 Accrued Expenses 105,645 115,317 Current Maturities of Long-Term Debt 2,762 2,786 ----------- ----------- TOTAL CURRENT LIABILITIES 198,837 225,112 LONG-TERM DEBT, less current maturities 151,722 112,651 SENIOR NOTES 150,000 150,000 SENIOR SUBORDINATED NOTES 125,000 125,000 DEFERRED INCOME TAXES 22,082 23,482 ----------- ----------- TOTAL LIABILITIES 647,641 636,245 ----------- ----------- Minority Interest 1,920 1,795 Common Stock 5,967 5,983 Additional Paid-In Capital 222,475 231,959 Retained Earnings 229,339 219,230 Accumulated Other Comprehensive Income - Foreign Currency Translation (30,993) (31,668) Minimum Pension Liability Adjustment (6,399) (6,399) Treasury Stock, 7,200,000, Class A Shares, at Cost (17,746) (20,281) ----------- ----------- $ 1,052,204 $ 1,036,864 =========== =========== See accompanying notes to consolidated condensed financial statements. 3 INTERFACE, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF INCOME (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) THREE MONTHS ENDED NINE MONTHS ENDED ----------------------------- ---------------------------- OCTOBER 3, OCTOBER 4, OCTOBER 3, OCTOBER 4, 1999 1998 1999 1998 ---- ---- ---- ---- NET SALES $ 304,246 $ 328,264 $ 917,564 $ 964,080 Cost of Sales 209,906 215,005 630,956 637,414 --------- --------- --------- --------- GROSS PROFIT ON SALES 94,340 113,259 286,608 326,666 Selling, General and Administrative Expenses 75,643 80,685 227,741 238,885 --------- --------- --------- --------- OPERATING INCOME 18,697 32,574 58,867 87,781 Other (Expense) Income - Net (9,998) (10,136) (30,684) (29,626) --------- --------- --------- --------- INCOME BEFORE TAXES ON INCOME 8,699 22,438 28,183 58,155 Taxes on Income 3,440 8,078 10,989 21,848 --------- --------- --------- --------- NET INCOME $ 5,259 $ 14,360 $ 17,194 $ 36,307 ========= ========= ========= ========= Basic Earnings Per Share $ .10 $ .27 $ .33 $ .70 ========= ========= ========= ========= DILUTED EARNINGS PER SHARE $ .10 $ .27 $ .33 $ .69 ========= ========= ========= ========= Average Shares Outstanding -- Basic 52,829 52,462 52,906 51,773 --------- --------- --------- --------- Average Shares Outstanding -- Diluted 52,829 54,105 52,906 52,916 --------- --------- --------- --------- See accompanying notes to consolidated condensed financial statements. INTERFACE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) (IN THOUSANDS) THREE MONTHS ENDED NINE MONTHS ENDED ----------------------- ----------------------- OCTOBER 3, OCTOBER 4, OCTOBER 3, OCTOBER 4, 1999 1998 1999 1998 ---- ---- ---- ---- Net Income $ 5,259 $14,360 $17,194 $36,307 Other Comprehensive Income, Foreign Currency Translation Adjustment 6,663 16,140 675 12,398 ------- ------- ------- ------- Comprehensive Income $11,922 $30,500 $17,869 $48,705 ======= ======= ======= ======= See accompanying notes to consolidated condensed financial statements. 4 INTERFACE, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) NINE MONTHS ENDED --------------------------- OCTOBER 3, OCTOBER 4, 1999 1998 ---------- ---------- (IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES: $ 11,984 $ 28,419 -------- -------- INVESTING ACTIVITIES: Capital expenditures (22,349) 28,998 Acquisitions/Divestiture of businesses 6,217 (62,800) Other (8,458) (6,369) -------- -------- (24,590) (98,167) -------- -------- FINANCING ACTIVITIES: Net borrowing (reduction) of long-term debt 30,519 14,997 Issuance/Repurchase of common stock (7,921) 68,121 Dividends paid (7,107) (6,134) -------- -------- 15,491 76,984 -------- -------- Net cash provided by (used for) operating, investing and financing activities 2,885 7,236 Effect of exchange rate changes on cash (1,859) (1,404) -------- -------- CASH AND CASH EQUIVALENTS: Net increase (decrease) during the period 1,026 5,832 Balance at beginning of period 9,910 10,212 -------- -------- Balance at end of period $ 10,936 $ 16,044 ======== ======== See accompanying notes to consolidated condensed financial statements. 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 January 3, 1999, 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: October 3, January 3, 1999 1999 Finished Goods $112,559 $123,941 Work in Process 29,568 31,908 Raw Materials 45,478 43,489 -------- -------- $187,605 $199,338 ======== ======== NOTE 3 - BUSINESS ACQUISITIONS AND DIVESTITURES During the first quarter of 1999, the Company completed the sale of Joseph, Hamilton & Seaton Ltd., a U.K.-based contract carpet distributor acquired in connection with the acquisition of the European carpet businesses of Readicut International PLC. The Company received cash consideration of approximately $11.2 million in the sale. During the first half of 1999, the Company acquired five service companies located in the U.S. As consideration in the acquisitions, the Company issued Common Stock valued at approximately $.8 million and paid $1.9 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 acquisition dates. The excess of the purchase price over the fair value of the net assets acquired was approximately $1.2 million and is being amortized over 25 years. During 1998, the Company acquired four floorcovering contractors, four carpet maintenance companies, two additional service companies, and a raised/access flooring manufacturer, all located in the U.S. The Company also purchased the vinyl floorcoverings business of Scan-Lock A/S located in Denmark, and Glenside Fabrics Limited, a manufacturer of upholstery fabrics, located in Meltham, U.K. As consideration for the acquisitions, the Company issued Common Stock valued at approximately $1.0 million, $16.9 million in cash, and $.2 million in a note receivable. 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 acquisition dates. The excess of the purchase price over the fair value of the net assets acquired was approximately $11.7 million and is being amortized over periods of 25 to 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. 6 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 adopted a share repurchase program in 1998, pursuant to which it is authorized to repurchase up to 2,000,000 shares of Common Stock in the open market or in private transactions over a two-year period. To date, the Company has repurchased and retired an aggregate of 1,075,500 shares of Common Stock under this program, at prices ranging from $8.45 to $16.78 per share. NOTE 7 - EARNINGS PER SHARE AND DIVIDENDS 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 52,906 shares and 51,773 shares outstanding for the periods ended October 3, 1999 and October 4, 1998, 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 52,906 shares and 52,916 shares outstanding for the periods ended October 3, 1999 and October 4, 1998, 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 (an aggregate of 7,200,000 Class A shares recorded at cost). The following is a reconciliation from basic earnings per share to diluted earnings per share for each of the periods presented: (In Thousands Except Per Share Amounts) Average For the Nine-Month Shares Earnings Period Ended Net Income Outstanding Per Share - --------------------------------------------------------------------------------------------------------------------------------- October 3, 1999 $ 17,194 52,906 $ .33 Effect of Dilution: Options -- -- ------------------------------------------------------- Diluted $ 17,194 52,906 $ .33 ====================================================== - ---------------------------------------------------------------------------------------------------------------------------------- October 4, 1998 $ 36,307 51,773 $ .70 Effect of Dilution: Options -- 1,143 ------------------------------------------------------ Diluted $ 36,307 52,916 $ .69 ====================================================== - ---------------------------------------------------------------------------------------------------------------------------------- 7 NOTE 8 - COMPREHENSIVE INCOME Effective the first quarter of 1998, the Company adopted FAS 130, "Comprehensive Income". This statement 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. NOTE 9 - SEGMENT INFORMATION During 1998, the Company adopted SFAS 131 which establishes standards for the way that public business enterprises report information about operating segments in their financial statements. The standard defines operating segments as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company's chief operating decision maker aggregates operating segments based on the type of products produced by the segment. Based on the quantitative thresholds specified in SFAS 131, the Company has determined that it has two reportable segments. The two reportable segments are Floorcovering Products/Services and Interior Fabrics. The Floorcovering Products/Services segment manufactures, installs and services commercial modular and broadloom carpet, while the Interior Fabrics segment manufactures panel and upholstery fabrics. The accounting policies of the operating segments are the same as those described in Summary of Significant Accounting Policies in the notes to the Company's year-end financial statements contained in its Annual Report to Shareholders for the fiscal year ended January 3, 1999, as filed with the Commission. Segment amounts disclosed are prior to any elimination entries made in consolidation. The chief operating decision maker evaluates performance of the segments based on operating income. Costs excluded from this profit measure primarily consist of allocated corporate expenses, interest expense and income taxes. Corporate expenses are primarily comprised of corporate overhead expenses. Thus, operating income includes only the costs that are directly attributable to the operations of the individual segment. Assets not identifiable to any individual segment are corporate assets, which are primarily comprised of cash and cash equivalents, short-term investments, intangible assets and intercompany amounts, which are eliminated in consolidation. SEGMENT DISCLOSURES Summary information by segment follows: (in thousands) Floorcovering Interior For the Nine-Month Period Ended products/services fabrics Other Total - ----------------------------------------------------------------------------------------------------------------------------------- October 3, 1999 Net sales $729,625 $147,172 $40,767 $ 917,564 Depreciation and amortization 22,388 6,868 1,431 30,687 Operating income 48,254 16,845 (86) 65,013 Total assets $960,749 $210,825 $46,952 $1,218,526 - ----------------------------------------------------------------------------------------------------------------------------------- October 4, 1998 Net sales $767,678 $163,386 $33,016 $ 964,080 Depreciation and amortization 20,404 6,666 3,343 30,413 Operating income 70,336 23,343 (2,028) 91,651 Total assets $996,218 $213,800 $46,990 $1,257,008 - ----------------------------------------------------------------------------------------------------------------------------------- 8 A reconciliation of the Company's total segment operating income, depreciation and amortization and assets to the corresponding consolidated amounts follows: Nine-Month Period Ended --------------------------------------------------------- (IN THOUSANDS) October 3, 1999 October 4, 1998 DEPRECIATION AND AMORTIZATION Total segment depreciation and amortization $ 30,687 $ 30,413 Corporate depreciation and amortization 588 580 ----------- ----------- Reported depreciation and amortization $ 31,275 $ 30,993 - --------------------------------------------------------------------------------------------------------------------------- OPERATING INCOME Total segment operating income $ 65,013 $ 91,651 Corporate expenses and other reconciling amounts (6,146) (3,870) ---------- ---------- Reported operating income $ 58,867 $ 87,781 - ---------------------------------------------------------------------------------------------------------------------------- ASSETS Total segment assets $ 1,218,526 $ 1,257,008 Corporate assets and eliminations (166,322) (181,871) ------------- ------------ Reported total assets $ 1,052,204 $ 1,075,137 - ---------------------------------------------------------------------------------------------------------------------------- NOTE 10 - 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. INTERFACE, INC. AND SUBSIDIARIES NOTE 10 - SUPPLEMENTAL GUARANTOR FINANCIAL STATEMENTS STATEMENT OF INCOME FOR THE NINE MONTHS ENDED OCTOBER 3, 1999 INTERFACE, CONSOLIDATION NON- INC. AND GUARANTOR GUARANTOR (PARENT ELIMINATION CONSOLIDATED SUBSIDIARIES SUBSIDIARIES CORPORATION) ENTRIES TOTALS ------------ ------------ ------------ ------- ------ (IN THOUSANDS) Net sales $ 723,784 $ 287,986 $ -- $(94,206) $ 917,564 --------- --------- -------- -------- --------- Cost of sales 530,353 194,809 -- (94,206) 630,956 Gross profit on sales 193,431 93,177 -- -- 286,608 Selling, general and administrative 139,572 62,502 25,667 -- 227,741 --------- --------- -------- -------- --------- expenses Operating income 53,859 30,675 (25,667) -- 58,867 Other (expense) income (13,575) (3,309) (13,800) -- (30,684) --------- --------- -------- -------- --------- Income before taxes on income 40,284 27,366 (39,467) -- 28,183 and equity in income of subsidiaries Taxes on income 15,710 10,673 (15,394) -- 10,989 Equity in income of subsidiaries -- -- 41,267 (41,267) --------- --------- -------- -------- --------- Net income applicable to common shareholders $ 24,574 $ 16,693 $ 17,194 $(41,267) $ 17,194 ========= ========= ======== ======== ========= 9 BALANCE SHEET OCTOBER 3, 1999 CONSOLIDATION NON- INTERFACE, INC. AND GUARANTOR GUARANTOR (PARENT ELIMINATION CONSOLIDATED SUBSIDIARIES SUBSIDIARIES CORPORATION) ENTRIES TOTALS ------------ ------------ ------------ ------- ------ (IN THOUSANDS) ASSETS Current Assets: Cash and cash equivalents $ 5,268 $ 2,632 $ 3,036 $ -- $ 10,936 Accounts receivable 159,238 81,687 (26,714) -- 214,211 Inventories 119,872 67,733 -- -- 187,605 Miscellaneous 11,586 34,893 (6,543) -- 39,936 --------- --------- --------- ----------- ----------- Total current assets 295,964 186,945 (30,221) -- 452,688 Property and equipment less accumulated depreciation 151,499 71,741 18,298 -- 241,538 Investment in subsidiaries 45,784 6,356 822,558 (874,698) -- Miscellaneous 16,058 10,064 45,897 -- 72,019 Excess of cost over net assets acquired 183,755 98,888 3,316 -- 285,959 --------- --------- --------- ----------- ----------- $ 693,060 $ 373,994 $ 859,848 $ (874,698) $ 1,052,204 ========= ========= ========= =========== =========== LIABILITIES AND COMMON SHAREHOLDERS' EQUITY Current Liabilities: Notes payable $ 5,916 $ 10,659 $ -- $ -- $ 16,575 Accounts payable 35,315 30,572 7,968 -- 73,855 Accrued expenses 71,104 41,179 (6,638) -- 105,645 Current maturities of long-term debt 1,662 1,100 -- -- 2,762 --------- --------- --------- ----------- ----------- Total current liabilities 113,997 83,510 1,330 -- 198,837 Long-term debt, less current maturities 7,083 47,258 97,381 -- 151,722 Senior notes and senior subordinated notes -- -- 275,000 -- 275,000 Deferred income taxes/other 15,007 4,718 2,357 -- 22,082 Minority interests -- 1,920 -- -- 1,920 --------- --------- --------- ----------- ----------- Total liabilities 136,087 137,406 376,068 -- 649,561 Redeemable preferred stock 57,891 -- -- (57,891) -- Common stock 94,145 102,199 5,967 (196,344) 5,967 Additional paid-in capital 191,411 12,525 224,261 (205,722) 222,475 Retained earnings 217,726 149,295 259,313 (396,995) 229,339 Foreign currency translation adjustment income (4,200) (27,431) (5,761) -- (37,392) Treasury stock, 7,200,000 Class A shares, at cost -- -- -- (17,746) (17,746) --------- --------- --------- ----------- ----------- $ 693,060 $ 373,994 $ 859,848 $ (874,698) $ 1,052,204 ========= ========= ========= =========== =========== 10 STATEMENT OF CASH FLOWS FOR THE NINE MONTHS ENDED OCTOBER 3, 1999 CONSOLIDATION NON- INTERFACE, INC. AND GUARANTOR GUARANTOR (PARENT ELIMINATION CONSOLIDATED SUBSIDIARIES SUBSIDIARIES CORPORATION) ENTRIES TOTALS ------------ ------------ ------------ ------------ ----------- (IN THOUSANDS) Net cash provided by operating activities $ 41,332 $(18,450) $(10,900) $ - $ 11,984 Cash flows from investing activities: Purchase of plant and equipment (18,378) (3,215) (756) - (22,349) Acquisitions, net of cash acquired -- -- 6,217 - 6,217 Other assets (22,572) 15,286 (1,172) - 8,458 -------- -------- -------- ------ -------- Net cash provided by (used in) investing activities (40,950) 12,071 4,289 0 (24,590) Cash flows from financing activities: Net borrowings (repayments) (1,259) 5,636 26,142 - 30,519 Proceeds from issuance/repurchase of common stock -- -- (7,921) - (7,921) Cash dividends paid -- -- (7,107) - (7,107) Net cash provided by (used in) financing activities (1,259) 5,636 11,114 - 15,491 Effect of exchange rate change on cash -- (1,859) -- - (1,859) -------- -------- -------- ------ -------- Net increase (decrease) in cash (877) (2,602) 4,503 - 1,026 Cash at beginning of year 6,145 5,234 (1,469) - 9,910 -------- -------- -------- ------ -------- Cash at end of year $ 5,268 $ 2,632 $ 3,036 $ - $ 10,936 ======== ======== ======== ====== ======== 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward Looking Statements This report contains statements which may constitute "forward-looking statements" under applicable securities laws, including statements regarding the intent, belief or current expectations of the Company and members of its management team, as well as the assumptions on which such statements are based. Any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and actual results may differ materially from those contemplated by such forward-looking statements. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements are set forth 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 January 3, 1999, and are hereby incorporated by reference. The Company undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time. 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 3, 1999, the Company had revenues and net income of $304.4 million and $5.3 million, respectively. The Company's business, as well as the commercial interiors market in general, is somewhat cyclical in nature. In recent years, the Company has benefited from a recovery in the U.S. commercial office market which began in the mid-1990's. However, many of the Company's business segments have experienced decreased demand levels over the last four quarters. As a result, the Company's results of operations, and its prospects for the balance of 1999, have been adversely affected. A significant sustained downturn in the market would materially impair the Company's revenues and earnings prospects. During the fourth quarter of 1998, the Company recorded a pre-tax restructuring charge in the amount of $25.3 million related to plant closures and consolidations of operations in Asia, Europe and the U.S., which resulted in an aggregate headcount reduction of approximately 287 salaried and hourly employees and the write-down and disposal of certain assets. The restructuring charge is comprised of $13.0 million of cash expenditures for severance benefits and relocation costs (of which $4.5 million remained unpaid at October 3, 1999 and is included in accrued expenses) and $12.3 million of non-cash charges, primarily for the write-down of impaired assets. Results of Operations For the three month and nine month periods ended October 3, 1999, the Company's net sales decreased $23.8 million (7.3%) and $46.5 million (4.8%), respectively, compared with the same periods in 1998. The decreases were primarily attributable to (i) a decline in sales of broadloom carpet in the U.S. by the Company's Bentley Mills subsidiary, due to soft market conditions and a shift to an owned and aligned distribution channel which served to reduce the number of dealers selling Bentley Mills products, (ii) a decline in sales of broadloom carpet in Europe, particularly in the United Kingdom, due to the divestiture of Joseph, Hamilton & Seaton, Ltd. and Firth's loss of sales personnel due to integration with the modular carpet sales force, and (iii) decreased sales volume in the Company's interior fabrics operations resulting from continued soft market conditions. The decrease was offset somewhat by increased sales volume (i) in the Company's Asia-Pacific division, which continues to show signs of recovery from the recent economic downturn in that region, and (ii) in the Company's architectural products division, driven in part by the 1998 acquisition of Atlantic Access Flooring and its line of steel panel products. Although sales in the Company's U.S. floorcovering operations were essentially flat, there was a shift in the relative mix of sales, with increased service revenues offsetting lower product sales. Cost of sales, as a percentage of net sales, increased to 69.0% and 68.8%, respectively, for three month and nine month periods ended October 3, 1999, compared to 65.5% and 66.1%, respectively, for the same periods in 1998. The increase was primarily attributable to (i) the failure to fully absorb overhead expenses, as a result of the decline in sales, and (ii) the shift in the relative mix of sales towards service revenues, which historically have had lower gross profit margins than product sales. Selling, general and administrative expenses, as a percentage of net sales, increased to 24.9% in the third quarter of 1999, compared to 24.6% in the same period in 1998, primarily as a result of the decline in sales, increased consulting and development 12 expenses associated with the Year 2000 initiative, and costs associated with the integration of the Re:Source Americas network, the consolidation of certain of the Company's operations in the Americas through a "shared services" approach, and the departure of the Company's former chief operating officer. However, the SG&A cost-to-sales ratio of 24.8% for the nine-month period ended October 3, 1999 was consistent with the same period in 1998. For the three month and nine month periods ended October 3, 1999, other expenses were consistent with the same periods in 1998. However, due primarily to higher overall levels of bank debt, other expenses increased $1 million compared to the same nine month period in 1999. As a result of the aforementioned factors, the Company's net income decreased 63.4% to $5.3 million and 52.6% to $17.2 million, respectively, for the three month and nine month periods ended October 3, 1999, compared to the same periods last year. Liquidity and Capital Resources The Company's primary source of cash during the nine months ended October 3, 1999 was $30.5 million from long-term financing. The primary uses of cash during the nine months ended October 3, 1999 were (i) $22.3 million for additions to property and equipment in the Company's manufacturing facilities, (ii) $10 million for European minimum pension obligations, and (iii) $8.5 million for repurchases of common stock. 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. In 1998, the Company adopted a share repurchase program, pursuant to which it is authorized to repurchase up to 2,000,000 shares of Class A Common Stock in the open market or in private transactions over a two-year period. In 1999 to date, the Company has repurchased and retired 893,000 shares of Class A Common Stock at an average price of $9.00 per share. Since the adoption of the program, the Company has repurchased an aggregate of 1,075,500 shares under this program. 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 $23.4 million. Of such amount, approximately $13.9 million is attributable to the cost of 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 $9.5 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. The Company intends to fund these costs through operating cash flows. During the quarter ended October 3, 1999, the Company expensed approximately $1.1 million in regard to modifications of both IT Systems and Non-IT Systems. To date, the Company has expensed approximately $8.7 million in the aggregate in regard to such modifications. The Company does not separately track its internal costs related to Year 2000 compliance, the majority of which are compensation expenses for employees in its information technology department. The Company has standardized its IT platforms (computers, system software and network components) and completed functional and Year 2000 testing. AS/400's, all PC servers, and PC clients are 100% migrated to standards. Voice PBX and Voice Mail platforms and all WAN and LAN assets are implemented and certified Year 2000 ready. Application software on AS/400's is migrated to the standard Year 2000-tested financial, payroll and human resource systems, and those applications are in service in the Americas. Payroll systems in Europe/Asia-Pacific are considered Year 2000 ready, and contingency plans are in place. Service provider system implementations of standard applications are complete at all sites except one, with deployment scheduled for completion at that location in November 1999. Business systems remediation, integration and testing activities are complete. Application software on PC servers principally involves Lotus Notes and related applications. Notes certification was addressed in platform testing. Testing of specific applications is complete. 13 The Company has not deferred in any material respect any of its other information technology projects to accommodate its Year 2000 compliance efforts. Remediation and testing of Non-IT equipment is complete, contingency plans are in place, and the Company anticipates no material interruption in the functioning of its equipment. The Company is continuing the process of reviewing its Year 2000 exposure to third party suppliers and customers. Surveys have been sent to critical suppliers and, in certain cases, on-site Year 2000 audits are being performed. 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 suppliers which are likely to have a material adverse effect on the Company. However, many third parties remain reluctant to provide detailed information concerning the status of their Year 2000 readiness. The Company is in the process of developing and implementing contingency plans in the event of supply problems. The principal contingencies under consideration include identifying and qualifying substitute suppliers for key materials, stockpiling certain critical supplies, and pursuing long-term supply contracts providing the Company with preferential treatment in the event of shortages. Contingency responses have been identified for all critical supply items at all owned sites except Intek, where completion is expected in November 1999. The Company believes that no single customer represents so significant a portion of its revenues that failure on the part of such a customer to plan effectively for Year 2000 would materially impact the Company's financial condition. In addition, the Company believes that the diversity of its customer base minimizes the potential financial impact of such an event. However, if broad customer buying trends are reduced due to Year 2000 issues, the Company's revenues and profitability could be adversely affected. 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 to locate and correct all relevant computer codes, and the ability of suppliers, customers and other companies on which the Company relies to modify or convert their systems to be Year 2000 compliant. This risk is particularly acute with respect to non-U.S. third parties, as it is widely reported that many non-U.S. businesses and governments are not addressing their Year 2000 issues on a timely basis. Euro Conversion A single currency called the euro was introduced in Europe on January 1, 1999. Eleven of the fifteen member countries of the European Union adopted the euro as their common legal currency as of that date. Fixed conversion rates between these participating countries' existing currencies (the "legacy currencies") and the euro were established as of that date. The legacy currencies will remain legal tender as denominations of the euro until at least January 1, 2002 (but not later than July 1, 2002). During this transition period, parties may settle transactions using either the euro or a participating country's legacy currency. The increased price transparency resulting from the use of a single currency in the eleven participating countries may affect the ability of the Company to price its products differently in various European markets. Introduction of the euro may reduce the amount of the Company's exposure to changes in exchange rates, due to the netting effect of having assets and liabilities denominated in a single currency as opposed to the various legacy currencies. Conversely, because there will be less diversity in the Company's exposure to foreign currencies, movements in the euro's value in U.S. dollars could have a more pronounced effect, whether positive or negative. As a result of the adoption of the euro, the Company's foreign exchange hedging costs could be reduced in the future. Certain of the Company's business functions have introduced euro-capability as of January 1, 1999, including, for example, systems for making and receiving certain payments, pricing and invoicing. Other business functions will be converted for the euro by the end of the transition period (December 31, 2001), but may be converted earlier where operationally efficient or cost-effective, or to meet customer needs. The Company does not expect the costs associated with these modifications to have a material adverse effect on future operations. 14 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As a result of the scope and volume of its global operations, the Company is exposed to an element of market risk from changes in interest rates and foreign currency exchange rates. The Company's results of operations and financial condition could be impacted by this risk. The Company manages its exposure to market risk through its regular operating and financial activities and, to the extent appropriate, through the use of derivative financial instruments. The Company employs derivative financial instruments as risk management tools and not for speculative or 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 counterparty credit guidelines and only enters into transactions with financial institutions with a rating of investment grade or better. As a result, the Company considers the risk of counterparty default to be minimal. INTEREST RATE MARKET RISK EXPOSURE. Changes in interest rates affect the interest paid on certain of the Company's debt. To mitigate the impact of fluctuations in interest rates, 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 maintains the fixed/variable rate mix within these parameters either by borrowing on a fixed-rate basis or entering into interest rate swap transactions. In the interest rate 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. The interest rate swap agreements generally have maturity dates ranging from fifteen to twenty-four months. At October 3, 1999, the Company had utilized interest rate swap agreements to effectively convert approximately $43.7 million of variable rate debt to fixed rate debt. The Company anticipates that for the balance of fiscal 1999 it will utilize swap agreements or other derivative financial instruments to convert comparable amounts of variable rate to fixed rate debt. FOREIGN CURRENCY EXCHANGE MARKET RISK EXPOSURE. A significant portion of the Company's operations consists of manufacturing and sales activities in foreign jurisdictions. The Company manufactures its products in the U.S., Canada, England, Northern Ireland, the Netherlands, Australia and Thailand, and sells its products in more than 100 countries. As a result, the Company's financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which the Company distributes its products. The Company's operating results are exposed to changes in exchange rates between the U.S. dollar and many other currencies, including the Dutch guilder, British pound sterling, German mark, French franc, Canadian dollar, Australian dollar, Thai baht, Japanese yen, and, since the beginning of 1999, the euro. When the U.S. dollar strengthens against a foreign currency, the value of anticipated sales in those currencies decreases, and vice-versa. Additionally, to the extent the Company's foreign operations with functional currencies other than the U.S. dollar transact business in countries other than the U.S., exchange rate changes between two foreign currencies could ultimately impact the Company. Finally, because the Company reports in U.S. dollars on a consolidated basis, foreign currency exchange fluctuations can have a translation impact on the Company's financial position. To mitigate the short-term effect of changes in currency exchange rates on the Company's sales denominated in foreign currencies, the Company regularly hedges by entering into currency swap contracts to hedge certain firm sales commitments denominated in foreign currencies. In these currency swap agreements, the Company and a counterparty financial institution exchange equal initial principal amounts of two currencies at the spot exchange rate. Over the term of the swap contract, the Company and the counterparty exchange interest payments in their swapped currencies. At maturity, the principal amount is reswapped, at the contractual exchange rate. At October 3, 1999, the contracts served to hedge firmly committed sales in Dutch guilders and Japanese yen. The contracts generally have maturity dates of fifteen to twenty-four months. At October 3, 1999, the Company had approximately $10.5 million (notional amount) of foreign currency hedge contracts outstanding. The Company expects to hedge a comparable notional amount for the balance of fiscal 1999. SENSITIVITY ANALYSIS. For purposes of specific risk analysis, the Company uses sensitivity analysis to measure the impact that market risk may have on the fair values of the Company's market sensitive instruments. To perform sensitivity analysis, the Company assesses the risk of loss in fair values associated with the impact of hypothetical changes in interest rates and foreign currency exchange rates on market sensitive instruments. The market value of instruments affected 15 by interest rate and foreign currency exchange rate risk is computed based on the present value of future cash flows as impacted by the changes in the rates attributable to the market risk being measured. The discount rates used for the present value computations were selected based on market interest and foreign currency exchange rates in effect at October 3, 1999. The market values that result from these computations are compared with the market values of these financial instruments at October 3, 1999. The differences in this comparison are the hypothetical gains or losses associated with each type of risk. As of October 3, 1999, based on a hypothetical immediate 150 basis point increase in interest rates, with all other variables held constant, the market value of the Company's fixed rate long-term debt would be impacted by a net decrease of $15.7 million. Conversely, a 150 basis point decrease in interest rates would result in a net increase in the market value of the Company's fixed rate long-term debt of $25.9 million. At January 3, 1999, a 150 basis point movement would have resulted in the same changes. As of October 3, 1999, a 10% movement in the levels of foreign currency exchange rates against the U.S. dollar, with all other variables held constant, would result in a decrease in the fair value of the Company's financial instruments of $1.3 million or an increase in the fair value of the Company's financial instruments of $1.1 million. At January 3, 1999, a 10% movement would have resulted in the same changes. As the impact of offsetting changes in the fair market value of the Company's net foreign investments is not included in the sensitivity model, these results are not indicative of the Company's actual exposure to foreign currency exchange risk. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On July 28, 1998, Collins & Aikman Floorcoverings, Inc. ("CAF") -- in the wake of receiving "cease and desist" letters from the Company demanding that CAF cease manufacturing certain carpet products that the Company believed infringe upon certain of its copyrighted product designs -- filed a lawsuit against the Company asserting that certain of the Company's products, primarily its Caribbean(TM) design product line, infringed on certain of CAF's alleged copyrighted product designs. The lawsuit, which is pending in the United States District Court for the Northern District of Georgia, Atlanta Division, Civil Action No. 1:98-CV-2069, seeks injunctive relief and unspecified monetary damages. The lawsuit also asserts other claims against the Company and certain other parties, including for alleged tortious interference by the Company with CAF's contractual relationship with the Roman Oakey Designs firm. On September 28, 1998, the Company filed its answer denying all the claims asserted by CAF, and also asserting counterclaims against CAF for copyright infringement. The Company believes the claims asserted by CAF are unfounded and subject to meritorious defenses, and it is defending vigorously all the claims. At the present time, discovery has been limited by Court order to matters relating to CAF's motion for preliminary injunction, and both the Company and CAF have filed motions for summary judgment. As a result of Court-ordered mediation not leading to a resolution of the disputes between the parties, the Company expects the Court will soon set a schedule for arguments and a hearing on the pending motions. The Company's insurors have denied coverage under the Company's insurance policies, which annually would otherwise provide up to $100 million of coverage. On June 8, 1999, the Company filed suit against the insurors to challenge that denial. That lawsuit is pending in the United States District Court for the Northern District of Georgia, Atlanta Division, Civil Action No. 1:99-CV-1485, and is in the early stages of its proceedings. Both the CAF infringement lawsuit and the Company's insurance coverage lawsuit involve complex legal and factual issues, and while the Company believes strongly in the merits of its legal positions, it is impossible to predict with accuracy the outcome of either such litigation matter at this stage. The Company intends to continue its aggressive pursuit of its positions in both actions. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not applicable. 16 ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable ITEM 5. OTHER INFORMATION John R. Wells was promoted to the position of President of the Company's Americas floorcovering operations on November 8, 1999. Gordon D. Whitener, former President of the Americas floorcovering operations, was offered another position within the Company, but he declined and has departed the Company. Mr. Whitener has also resigned as a director of the Company. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed with this report: EXHIBIT NUMBER DESCRIPTION OF EXHIBIT 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 October 4, 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 Executive Bonus Plan (included as Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended July 3, 1999, previously filed with the Commission and incorporated herein by reference). 27.1 Financial Data Schedule (for SEC use only). (b) No reports on Form 8-K were filed during the quarter ended October 3, 1999. 17 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, 1999 By: /s/ Daniel T. Hendrix ----------------------- Daniel T. Hendrix Senior Vice President - Finance, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) 18 EXHIBIT INDEX Exhibit NUMBER DESCRIPTION OF EXHIBIT 27.1 Financial Data Schedule. 19