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 July 2, 2006

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 o


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer    o
Accelerated Filer    x
Non-Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o    No x

Shares outstanding of each of the registrant's classes of common stock at August 2, 2006:

Class
 
Number of Shares
Class A Common Stock, $.10 par value per share
 
47,879,610
Class B Common Stock, $.10 par value per share
 
6,874,162







INTERFACE, INC.

INDEX
 
 
PAGE 
 
 
3
       
   
3
       
   
4
       
   
5
       
   
6
       
   
7
       
 
18
       
 
22
       
 
23
     
 
 
23
 
23
 
23
 
23
 
23
 
24
 
25







PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

INTERFACE, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(IN THOUSANDS)
 
 
 
JULY 2, 2006
 
    JANUARY 1, 2006
 
   
(UNAUDITED)
       
ASSETS
             
CURRENT ASSETS:
             
Cash and Cash Equivalents
 
$
27,347
 
$
51,312
 
Accounts Receivable, net
   
143,769
   
141,408
 
Inventories
   
142,766
   
130,209
 
Prepaid and Other Expenses
   
21,040
   
16,624
 
Deferred Income Taxes
   
4,575
   
4,540
 
Assets of Businesses Held for Sale
   
3,107
   
5,526
 
 
             
TOTAL CURRENT ASSETS
   
342,604
   
349,619
 
 
             
PROPERTY AND EQUIPMENT, less
             
accumulated depreciation
   
180,338
   
185,643
 
DEFERRED TAX ASSET
   
72,964
   
69,043
 
GOODWILL
   
176,738
   
193,705
 
OTHER ASSETS
   
41,594
   
40,980
 
 
 
$
814,238
 
$
838,990
 
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts Payable
 
$
52,525
 
$
50,312
 
Accrued Expenses
   
83,425
   
85,581
 
Liabilities of Businesses Held for Sale
   
1,855
   
4,214
 
 
             
TOTAL CURRENT LIABILITIES
   
137,805
   
140,107
 
 
             
LONG-TERM DEBT, less current maturities
   
1,573
   
--
 
SENIOR NOTES
   
292,250
   
323,000
 
SENIOR SUBORDINATED NOTES
   
135,000
   
135,000
 
DEFERRED INCOME TAXES
   
22,246
   
23,534
 
OTHER
   
40,554
   
40,864
 
 
             
TOTAL LIABILITIES
   
629,428
   
662,505
 
 
             
Minority Interest
   
4,869
   
4,409
 
 
             
Commitments and Contingencies
             
 
             
SHAREHOLDERS' EQUITY:
             
Preferred Stock
   
--
   
--
 
Common Stock
   
5,474
   
5,334
 
Additional Paid-In Capital
   
241,767
   
234,314
 
Retained Deficit
   
(12,642
)
 
(1,443
)
Foreign Currency Translation Adjustment
   
(26,876
)
 
(38,347
)
Minimum Pension Liability
   
(27,782
)
 
(27,782
)
 
             
TOTAL SHAREHOLDERS' EQUITY
   
179,941
   
172,076
 
               
 
 
$
814,238
 
$
838,990
 

See accompanying notes to consolidated condensed financial statements.

-3-



INTERFACE, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)

(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)

   
THREE
MONTHS
ENDED
 
SIX
MONTHS
ENDED
 
                   
 
 
 
JULY 2,
2006 
 
JULY 3,
2005 
 
JULY 2,
2006 
 
JULY 3,
2005 
 
NET SALES
 
$
258,678
 
$
246,545
 
$
509,312
 
$
481,260
 
Cost of Sales
   
177,511
   
169,317
   
349,163
   
332,893
 
 
                         
GROSS PROFIT ON SALES
   
81,167
   
77,228
   
160,149
   
148,367
 
Selling, General and Administrative Expenses
   
58,381
   
56,005
   
116,683
   
109,974
 
Impairment of Goodwill
   
--
   
--
   
20,712
   
--
 
Restructuring Charge
   
--
   
--
   
3,260
   
--
 
Loss on Disposal - European Fabrics
   
1,723
   
--
   
1,723
   
--
 
 
                         
OPERATING INCOME
   
21,063
   
21,223
   
17,771
   
38,393
 
Interest Expense
   
10,936
   
11,506
   
22,168
   
23,084
 
Other Expense
   
453
   
268
   
981
   
868
 
 
                         
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAX EXPENSE
   
9,674
   
9,449
   
(5,378
)
 
14,441
 
Income Tax Expense
   
3,768
   
5,509
   
5,798
   
7,578
 
 
   
   
             
Income (Loss) from Continuing Operations
   
5,906
   
3,940
   
(11,176
)
 
6,863
 
Loss from Discontinued Operations, Net of Tax
   
(21
)
 
(9,763
)
 
(27
)
 
(14,525
)
Loss on Disposal of Discontinued Operations, Net of Tax
   
--
   
(1,598
)
 
--
   
(1,935
)
NET INCOME (LOSS)
 
$
5,885
 
$
(7,421
)
$
(11,203
)
$
(9,597
)
 
                         
 
                         
Earnings (Loss) Per Share - Basic
                         
Continuing Operations
 
$
0.11
 
$
0.08
 
$
(0.21
)
$
0.13
 
Discontinued Operations
   
--
   
(0.19
)
 
--
   
(0.28
)
Loss on Disposal of Discontinued Operations
   
--
   
(0.03
)
 
--
   
(0.04
)
 
                         
Earnings (Loss) Per Share - Basic
 
$
0.11
 
$
(0.14
)
$
(0.21
)
$
(0.19
)
 
                         
Earnings (Loss) Per Share - Diluted
                         
Continuing Operations
 
$
0.11
 
$
0.08
 
$
(0.21
)
$
0.13
 
Discontinued Operations
   
--
   
(0.19
)
 
--
   
(0.28
)
Loss on Disposal of Discontinued Operations
   
--
   
(0.03
)
 
--
   
(0.03
)
                           
Earnings (Loss) Per Share - Diluted
 
$
0.11
 
$
(0.14
)
$
(0.21
)
$
(0.18
)
                           
Common Shares Outstanding - Basic
   
53,375
   
51,398
   
52,995
   
51,362
 
Common Shares Outstanding - Diluted
   
54,996
   
52,481
   
52,995
   
52,622
 

See accompanying notes to consolidated condensed financial statements.

-4-



INTERFACE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)

(IN THOUSANDS)

 
 
 
 
THREE
MONTHS
ENDED
 
SIX
MONTHS
ENDED
 
           
 
 
 
JULY 2,
2006
 
JULY 3,
2005
 
JULY 2,
2006
 
JULY 3,
2005
 
                   
Net Income (Loss)
 
$
5,885
 
$
(7,421
)
$
(11,203
)
$
(9,597
)
Other Comprehensive Income (Loss), Foreign Currency Translation Adjustment
   
9,694
   
(13,089
)
 
11,471
   
(22,169
)
Comprehensive Income (Loss)
 
$
15,579
 
$
(20,510
)
$
268
 
$
(31,766
)

See accompanying notes to consolidated condensed financial statements.

-5-


INTERFACE, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)

(IN THOUSANDS)
 
 
   
SIX MONTHS ENDED
 
   
JULY 2,
2006
 
JULY 3,
2005
 
OPERATING ACTIVITIES:
             
Net loss
 
$
(11,203
)
$
(9,597
)
Impairment of fixed assets, related to discontinued operations
   
--
   
3,466
 
Loss from discontinued operations
   
27
   
11,059
 
Loss on disposal of discontinued operations
   
--
   
1,935
 
Income (loss) from continuing operations
   
(11,176
)
 
6,863
 
Adjustments to reconcile income (loss) to cash provided by (used in) operating activities:
             
Impairment of Goodwill
   
20,712
   
--
 
Restructuring Charge
   
2,708
   
--
 
Depreciation and amortization
   
15,931
   
16,194
 
Deferred income taxes and other
   
(5,650
)
 
(10,740
)
Working capital changes:
             
Accounts receivable
   
(9,579
)
 
(12,063
)
Inventories
   
(21,925
)
 
(15,476
)
Prepaid expenses
   
(4,412
)
 
(6,231
)
Accounts payable and accrued expenses
   
3,524
   
16,136
 
 
             
Cash used in continuing operations
   
(9,867
)
 
(5,317
)
Cash provided by discontinued operations
   
--
   
7,859
 
 
             
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES:
   
(9,867
)
 
2,542
 
 
             
INVESTING ACTIVITIES:
             
Capital expenditures
   
(16,083
)
 
(5,832
)
Cash proceeds from sale of discontinued operations
   
--
   
551
 
Cash proceeds from sale of European Fabrics
   
28,837
   
--
 
Investment in intellectual property
   
--
   
(2,700
)
Other
   
(3,916
)
 
(3,022
)
 
             
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES:
   
8,838
   
(11,003
)
 
             
FINANCING ACTIVITIES:
             
Net borrowing of long-term debt
   
1,573
   
9,825
 
Repurchase of senior subordinated notes
   
(30,750
)
 
--
 
Debt issuance cost
   
(679
)
 
--
 
Proceeds from issuance of common stock
   
5,650
   
722
 
 
             
CASH PROVIDED BY (USED IN) BY FINANCING ACTIVITIES:
   
(24,206
)
 
10,547
 
 
             
Net cash provided by (used in ) operating, investing and financing activities
   
(25,235
)
 
2,086
 
Effect of exchange rate changes on cash
   
1,270
   
(1,809
)
 
             
CASH AND CASH EQUIVALENTS:
             
Net change during the period
   
(23,965
)
 
277
 
Balance at beginning of period
   
51,312
   
22,164
 
 
             
Balance at end of period
 
$
27,347
 
$
22,441
 


See accompanying notes to consolidated condensed financial statements.

-6-


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 Company's year-end financial statements and notes thereto contained in its Annual Report on Form 10-K for the fiscal year ended January 1, 2006, as filed with the Commission.

The financial information included in this report has been prepared by the Company, without audit. 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. The January 1, 2006, consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States.

In 2004, the Company committed to a plan to exit its owned Re:Source dealer businesses (as well as a small Australian dealer business and a small residential fabrics business) and began to dispose of several of the dealer subsidiaries. The results of operations and related disposal costs, gains and losses for these businesses are classified as discontinued operations for all periods presented.

Additionally, certain prior period amounts have been reclassified to conform to the current period presentation.

NOTE 2 - INVENTORIES

Inventories are summarized as follows:

   
  July 2,
2006
 
January 1,
2006
 
   
(In thousands)
 
Finished Goods
 
$
82,393
 
$
71,893
 
Work in Process
   
19,399
   
16,792
 
Raw Materials
   
40,974
   
41,524
 
   
$
142,766
 
$
130,209
 

NOTE 3 - EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share is computed by dividing net income (loss) 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. Diluted earnings (loss) per share is calculated in a manner consistent with that of basic earnings (loss) per share while giving effect to all potentially dilutive common shares that were outstanding during the period. The computation of diluted earnings (loss) per share does not assume conversion or exercise of securities that would have an anti-dilutive effect on earnings (loss) per share. For the three-month period ended July 2, 2006, outstanding options to purchase 45,000 shares of common stock were not included in the computation of diluted earnings per share as the exercise prices of these options were greater than the average market price of the common shares during these periods. For the six months ended July 2, 2006, outstanding options to purchase 1,935,000 shares were not included in the computation of diluted loss per share as the Company was in a net loss from continuing operations position and thus any potential common shares were anti-dilutive. For the three-month and six-month periods ended July 3, 2005, outstanding options to purchase 905,000 and 703,000 shares of common stock, respectively, were not included in the computation of diluted loss per share as the exercise prices of these options were greater than the average market price of the common shares during these periods.

The following is a reconciliation from basic earnings (loss) per share to diluted earnings (loss) per share for the three-month and six-month periods ended July 2, 2006, and July 3, 2005, respectively.

-7-



For the Three-Month
Period Ended 
 
Net Income
(Loss) 
 
Average Shares
Outstanding
 
Earnings (Loss)
Per Share
 
   
(In Thousands Except Per Share Amounts)
 
July 2, 2006
 
$
5,885
   
53,375
 
$
0.11
 
Effect of Dilution:
                   
Options
   
--
   
1,621
   
--
 
                     
Diluted
 
$
5,885
   
54,966
 
$
0.11
 
                     
July 3, 2005
 
$
(7,421
)
 
51,398
 
$
(0.14
)
Effect of Dilution:
                   
Options
   
--
   
1,083
   
--
 
                     
Diluted
 
$
(7,421
)
 
52,481
 
$
(0.14
)

       
For the Six-Month
Period Ended                
 
Net Income
(Loss) 
 
Average Shares
Outstanding
 
Earnings (Loss)
Per Share
 
   
  (In Thousands Except Per Share Amounts)
 
July 2, 2006
 
$
(11,203
)
 
52,995
 
$
(0.21
)
Effect of Dilution:
                   
Options
   
--
   
--
   
--
 
                     
Diluted
 
$
(11,203
)
 
52,995
 
$
(0.21
)
                     
July 3, 2005
 
$
(9,597
)
 
51,362
 
$
(0.19
)
Effect of Dilution:
                   
Options
   
--
   
1,260
   
--
 
                     
Diluted
 
$
(9,597
)
 
52,622
 
$
(0.18
)

NOTE 4 - SEGMENT INFORMATION

Based on the quantitative thresholds specified in Statement of Financial Accounting Standards (“SFAS”) No. 131, “Disclosures about Segments of an Enterprise and Related Information,” the Company has determined that it has four reportable segments: (1) the Modular Carpet segment, which includes its InterfaceFLOR Commercial (formerly known as Interface), Heuga and FLOR (formerly known as InterfaceFLOR) modular carpet businesses, and also includes the Company’s Intersept antimicrobial sales and licensing program, (2) the Bentley Prince Street segment, which includes its Bentley Prince Street broadloom, modular carpet and area rug businesses, (3) the Fabrics Group segment, which includes all of its fabrics businesses, and (4) the Specialty Products segment, which includes Pandel, Inc., a producer of vinyl carpet tile backing and specialty mat and foam products. The former segment known as the Re:Source Network, which primarily encompassed the Company’s owned Re:Source dealers that provided carpet installation and maintenance services in the United States, is reported as discontinued operations in the accompanying consolidated condensed statements of operations.

The accounting policies of the operating segments are the same as those described in the Summary of Significant Accounting Policies contained in the Company’s Annual Report on Form 10-K for the fiscal year ended January 1, 2006, as filed with the Commission. Segment amounts disclosed are prior to any elimination entries made in consolidation, except in the case of Net Sales, where intercompany sales have been eliminated. 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/other expense and income taxes. Corporate expenses are primarily comprised of corporate overhead expenses. 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.


-8-


Segment Disclosures

Summary information by segment follows:

   
Modular
Carpet
 
Bentley
Prince Street
 
Fabrics
Group
 
Specialty
Products
 
Total
 
   
(In thousands)
 
Three Months Ended
                               
July 2, 2006
                               
Net sales
 
$
186,475
 
$
33,932
 
$
35,494
 
$
2,777
 
$
258,678
 
Depreciation and amortization
   
4,123
   
603
   
2,378
   
19
   
7,123
 
Operating income (loss)
   
23,634
   
1,704
   
(3,028
)
 
(29
)
 
22,281
 
                                 
Three Months Ended
                               
July 3, 2005
                               
Net sales
 
$
163,681
 
$
29,468
 
$
49,545
 
$
3,851
 
$
246,545
 
Depreciation and amortization
   
3,742
   
411
   
2,690
   
39
   
6,882
 
Operating income
   
21,379
   
493
   
148
   
215
   
22,235
 
                                 
Six Months Ended
                               
July 2, 2006
                               
Net sales
 
$
352,358
 
$
63,032
 
$
87,994
 
$
5,928
 
$
509,312
 
Depreciation and amortization
   
7,396
   
911
   
5,108
   
37
   
13,452
 
Operating income (loss)
   
44,309
   
2,217
   
(26,406
)
 
14
   
20,134
 
                                 
Six Months Ended
                               
July 3, 2005
                               
Net sales
 
$
317,208
 
$
57,530
 
$
98,007
 
$
8,515
 
$
481,260
 
Depreciation and amortization
   
7,047
   
807
   
5,686
   
78
   
13,618
 
Operating income
   
37,874
   
968
   
1,113
   
429
   
40,384
 

A reconciliation of the Company’s total segment operating income, depreciation and amortization, and assets to the corresponding consolidated amounts follows:
 
 
   
Three Months Ended
 
Six Months Ended
 
   
July 2, 2006
 
July 3, 2005
 
July 2, 2006
 
July 3, 2005
 
   
(In thousands)
 
(In thousands)
 
                           
DEPRECIATION AND AMORTIZATION
                         
Total segment depreciation and amortization
 
$
7,123
 
$
6,882
 
$
13,452
 
$
13,618
 
Corporate depreciation and amortization
   
571
   
1,205
   
2,479
   
2,576
 
Reported depreciation and amortization
 
$
7,694
 
$
8,087
 
$
15,931
 
$
16,194
 
 
OPERATING INCOME
                         
Total segment operating income
 
$
22,281
 
$
22,235
 
$
20,134
 
$
40,384
 
Corporate expenses and other reconciling amounts
   
(1,218
)
 
(1,012
)
 
(2,363
)
 
(1,991
)
Reported operating income
 
$
21,063
 
$
21,223
 
$
17,771
 
$
38,393
 
                           
 
   
 
July 2, 2006 
 
 
January 1, 2006
 
ASSETS
 
(In thousands)
Total segment assets
 
$
715,450
 
$
752,492
 
Discontinued operations
   
3,107
   
5,526
 
Corporate assets and eliminations
   
95,681
   
80,972
 
Reported total assets
 
$
814,238
 
$
838,990
 

Due primarily  to the sale of the European fabrics business (as described in Note 14) and the related impairment of goodwill (as described in Note 13), the total segment assets of the Fabrics Group decreased by approximately $54.4 million, from $209.5 million to $155.1 million, during the six-month period ended July 2, 2006.

-9-


Restructuring activities by segment

The table below details the restructuring activities undertaken in the first half of 2006 by segment. These charges were all incurred during the first quarter of 2006. There were no restructuring activities in the corresponding period of 2005. 

Six Months Ended
July 2, 2006
 
Modular
Carpet
 
Bentley
Prince Street
 
Fabrics
Group
 
Specialty
Products
 
Total
 
   
(In thousands)
 
Total amounts expected
to be incurred
 
$
--
 
$
--
 
$
3,260
 
$
--
 
$
3,260
 
                                 
Cumulative amounts
incurred to date
   
--
   
--
   
3,260
   
--
   
3,260
 
                                 
Total amounts incurred
in the period
   
--
   
--
   
3,260
   
--
   
3,260
 

NOTE 5 - LONG-TERM DEBT

On June 30, 2006, the Company amended and restated its revolving credit facility. Under the amendment and restatement, the maximum aggregate amount of loans and letters of credit available to the Company at any one time was increased from $100 million to $125 million, subject to a borrowing base limitation. The amended credit facility matures on June 30, 2011. The revolving credit facility includes a domestic U.S. Dollar syndicated loan and letter of credit facility up to the lesser of (1) $125 million, or (2) a borrowing base equal to the sum of specified percentages of eligible property and equipment, accounts receivable, finished goods inventory and raw materials inventory in the U.S. (the percentages and eligibility requirements for the domestic borrowing base are specified in the credit facility), less certain reserves. The previous facility included a multicurrency syndicated loan and letter of credit facility in British pounds, which has been removed from the amended facility.

Interest on borrowings and letters of credit under the revolving credit facility is charged at varying rates computed by applying a margin (ranging from 0.0-2.25%) over a baseline rate (such as the prime interest rate or LIBOR), depending on the type of borrowing and our average excess borrowing availability during the most recently completed fiscal quarter. In addition, the Company pays an unused line fee on the facility ranging from 0.25-0.375%, depending on our average excess borrowing availability during the most recently completed fiscal quarter. The revolving credit facility is secured by substantially all of the assets of Interface, Inc. and its domestic subsidiaries (subject to exceptions for certain immaterial subsidiaries), including all of the stock of its domestic subsidiaries and up to 65% of the stock of its first-tier material foreign subsidiaries. Those collateral documents provide that, if an event of default occurs under the revolving credit facility, the lenders’ collateral agent may, upon the request of the specified percentage of lenders, exercise remedies with respect to the collateral that include foreclosing mortgages on the Company’s real estate assets, taking possession of or selling its personal property assets, collecting its accounts receivable, or exercising proxies to take control of the pledged stock of its domestic and first-tier material foreign subsidiaries.

Under the amended facility our negative covenants have been relaxed in several respects, including with respect to the repayment of our other indebtedness and the payment of dividends and limiting their application to Interface, Inc. and its domestic subsidiaries. Additionally, the financial covenants have been amended to delete the senior secured debt coverage ratio and to modify the terms of the sole remaining financial covenant, a fixed charge coverage test. The Company is currently in compliance under the revolving credit facility and anticipates that it will remain in compliance with the covenants.

As of July 2, 2006, $1.6 million in borrowings at a weighted-average interest rate of approximately 8.25% and $11.4 million in letters of credit were outstanding under the revolving credit facility. As of July 2, 2006, the Company could have incurred $91.8 million of additional borrowings under its revolving credit facility.

As of July 2, 2006, the estimated fair values (based on then-current market prices) of the 9.5% Senior Subordinated Notes due 2014, the 10.375% Senior Notes due 2010 and the 7.3% Senior Notes due 2008 were $139.0 million, $190.3 million and $117.8 million, respectively.

-10-


NOTE 6 - STOCK-BASED COMPENSATION

 Stock Option Awards

In the first quarter of fiscal 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payments,” which revises SFAS 123, “Accounting for Stock-Based Compensation.” This standard requires that the Company measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. That cost will be recognized over the period in which the employee is required to provide the services - the requisite service period (usually the vesting period) - in exchange for the award. The grant date fair value for options and similar instruments will be estimated using option pricing models. Under SFAS 123R, the Company is required to select a valuation technique or option pricing model that meets the criteria as stated in the standard, which includes a binomial model and the Black-Scholes model. At the present time, the Company is continuing to use the Black-Scholes model. SFAS 123R requires that the Company estimate forfeitures for stock options and reduce compensation expense accordingly. The Company has reduced its 2006 expense by the assumed forfeiture rate and will evaluate experience against this forfeiture rate going forward.
 
 If compensation costs for the Company’s stock options had been determined based on the fair value at the grant dates for awards made prior to the implementation of SFAS 123R, under those plans and consistent with SFAS No. 123R, the Company’s net income and net income per share would have been adjusted to the pro forma amounts indicated below:

   
Three Months Ended
 
Six Months Ended
 
   
July 2, 2006
 
July 3, 2005
 
July 2, 2006
 
July 3, 2005
 
   
(In thousands, except per share amounts)
 
(In thousands, except per share amounts)
 
Net income (loss) as reported
 
$
5,885
 
$
(7,421
)
$
(11,203
)
$
(9,597
)
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects
   
(80
)
 
(119
)
 
(190
)
 
(272
)
Add: Recognized stock-based compensation
   
80
   
--
   
190
   
--
 
 
Pro forma net income (loss)
 
$
5,885
 
$
(7,540
)
$
(11,203
)
$
(9,869
)
                           
Basic earnings (loss) per share as reported
 
$
0.11
 
$
(0.14
)
$
(0.21
)
$
(0.19
)
Basic pro forma earnings (loss) per share
 
$
0.11
 
$
(0.15
)
$
(0.21
)
$
(0.19
)
Diluted earnings (loss) per share as reported
 
$
0.11
 
$
(0.14
)
$
(0.21
)
$
(0.18
)
Diluted pro forma earnings (loss) per share
 
$
0.11
 
$
(0.14
)
$
(0.21
)
$
(0.19
)
 
The Company recognized stock compensation costs of $0.1 million and zero in the second quarters of 2006 and 2005, respectively, and $0.2 million and zero, respectively, in the first six months of 2006 and 2005, respectively. The remaining unrecognized compensation cost related to unvested awards at July 2, 2006, approximated $0.5 million, and the weighted average period of time over which this cost will be recognized is approximately two years.
 
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants issued in the first six months of fiscal 2006 and 2005:

   
Six Months Ended
July 2, 2006
Six Months Ended
July 3, 2005
Risk free interest rate
  
4.57%
4.08%
Expected life
  
3.17 Years
2.0 Years
Expected volatility
  
60%
60%
Expected dividend yield
  
0%
0%
  
The weighted average grant date fair value of stock options granted during the first half of fiscal 2006 was $4.42.


-11-


The following table summarizes stock options outstanding as of July 2, 2006, as well as activity during the six month period then ended:
 
   
Shares 
 
Weighted Average
Exercise Price
 
Outstanding at January 1, 2006
   
2,925,000
 
$
5.81
 
Granted
   
90,000
   
10.49
 
Exercised
   
1,050,000
   
5.65
 
Forfeited or canceled
   
30,000
   
3.52
 
Outstanding at July 2, 2006 (a)
   
1,935,000
 
$
6.14
 
               
Exercisable at July 2, 2006 (b)
   
1,542,000
 
$
6.27
 
 

(a)
At July 2, 2006, the weighted-average remaining contractual life of options outstanding was 4.1 years.
(b)
At July 2, 2006, the weighted-average remaining contractual life of options exercisable was 3.7 years.

At July 2, 2006, the aggregate intrinsic values of options outstanding and options exercisable were $10.7 million and $8.4 million, respectively (the intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option).
  
Cash proceeds and intrinsic value related to total stock options exercised during the first six months of fiscal years 2006 and 2005 are provided in the following table:
 
   
Six Months Ended
 
   
July 2, 2006
 
 July 3, 2005
 
   
(In thousands)
 
Proceeds from stock options exercised
 
$
5,936
 
$
722
 
Intrinsic value of stock options exercised
 
$
6,780
 
$
385
 

Restricted Stock Awards

During the six months ended July 2, 2006, and July 3, 2005, the Company granted restricted stock awards for 394,000 and 386,000 shares, respectively, of Class B common stock. These awards (or a portion thereof) vest with respect to each recipient over a three to five year period from the date of grant, provided the individual remains in the employment or service of the Company as of the vesting date. Additionally, these shares (or a portion thereof) could vest earlier upon the attainment of certain performance criteria, in the event of a change in control of the Company, or upon involuntary termination without cause.

Compensation expense related to the vesting of restricted stock was $2.2 million and $0.8 million for the six months ended July 2, 2006, and July 3, 2005, respectively. SFAS 123R requires that the Company estimate forfeitures for restricted stock and reduce compensation expense accordingly. The Company has reduced its 2006 expense by the assumed forfeiture rate and will evaluate experience against this forfeiture rate going forward.

The following table summarizes restricted stock activity as of July 2, 2006, and during the six-month period then ended:

   
Shares
 
Weighted Average
Grant Date
Fair Value
 
Outstanding at January 1, 2006
   
1,471,000
 
$
7.68
 
Granted
   
394,000
   
8.64
 
Vested
   
515,000
   
7.49
 
Forfeited or canceled
   
--
   
--
 
Outstanding at July 2, 2006
   
1,350,000
 
$
8.02
 

As of July 2, 2006, the unrecognized total compensation cost related to unvested restricted stock was $5.9 million. That cost is expected to be recognized by the end of 2010.

As stated above, SFAS 123R requires the Company to estimate forfeitures in calculating the expense relating to stock-based compensation, as opposed to only recognizing these forfeitures and the corresponding reduction in expense as they occur. In prior years, the Company did not estimate the forfeitures of its restricted stock as the expense was recorded. In accordance with the standard, the Company is required to record a cumulative effect of the change in accounting principle to reduce previously recognized compensation for awards not expected to vest (i.e. forfeited or canceled awards). Upon adoption of SFAS 123R, the Company adjusted for this cumulative effect and recognized a reduction in stock-based compensation, which was recorded within the selling, general and administrative expense on the Company’s consolidated condensed statement of operations. The adjustment was not recorded as a cumulative effect adjustment, net of tax, because the amount was not material to the consolidated condensed statement of operations.

-12-



NOTE 7 - EMPLOYEE BENEFIT PLANS

The following tables provide the components of net periodic benefit cost for the three-month and six-month periods ended July 2, 2006, and July 3, 2005, respectively:

   
Three Months Ended
 
Six Months Ended
 
Defined Benefit Retirement Plan (Europe)
 
July 2, 2006
 
July 3, 2005
 
July 2, 2006
 
July 3, 2005
 
   
(In thousands)
 
(In thousands)
 
Service cost
 
$
458
 
$
654
 
$
904
 
$
1,317
 
Interest cost
   
2,418
   
2,597
   
4,772
   
5,226
 
Expected return on assets
   
(2,721
)
 
(2,693
)
 
(5,372
)
 
(5,420
)
Amortization of prior service costs
   
--
   
6
   
--
   
12
 
Recognized net actuarial (gains)/losses
   
482
   
639
   
951
   
1,285
 
Amortization of transition obligation
   
13
   
44
   
26
   
89
 
Net periodic benefit cost
 
$
650
 
$
1,247
 
$
1,281
 
$
2,509
 

 
   
Three Months Ended
 
Six Months Ended
 
Salary Continuation Plan (SCP)
 
July 2, 2006
 
July 3, 2005
 
July 2, 2006
 
July 3, 2005
 
   
(In thousands)
 
(In thousands)
 
Service cost
 
$
67
 
$
55
 
$
134
 
$
110
 
Interest cost
   
212
   
198
   
425
   
396
 
Amortization of transition obligation
   
55
   
55
   
110
   
110
 
Amortization of prior service cost
   
12
   
12
   
24
   
24
 
Amortization of (gain)/loss
   
80
   
68
   
160
   
136
 
Net periodic benefit cost
 
$
426
 
$
388
 
$
853
 
$
776
 
 

NOTE 8 - DISCONTINUED OPERATIONS

In 2004, the Company committed to a plan to exit its owned Re:Source dealer businesses, and began to dispose of several of the dealer subsidiaries. Therefore, the results of operations for the owned Re:Source dealer businesses, as well as the Company’s small Australian dealer and small residential fabrics businesses that management also decided to exit, are reported as discontinued operations.

Summary operating results for the discontinued operations are as follows:

   
Three Months Ended
 
Six Months Ended
 
 
 
July 2, 2006
 
July 3, 2005
 
July 2, 2006
 
July 3, 2005
 
   
(In thousands)
 
(In thousands)
 
Net sales
 
$
1,496
 
$
9,415
 
$
1,992
 
$
26,728
 
Loss on operations before taxes on income
   
(29
)
 
(15,000
)
 
(38
)
 
(22,826
)
Income tax benefit
   
(8
)
 
(5,237
)
 
(11
)
 
(8,301
)
Loss on operations, net of tax
   
(21
)
 
(6,765
)
 
(27
)
 
(11,059
)
Impairment loss, net of tax
   
--
   
(2,998
)
 
--
   
(3,466
)


-13-



Assets and liabilities, including reserves, related to the discontinued operations that were held for sale consist of the following:

   
July 2, 2006
 
January 1, 2006
 
   
(In thousands)
 
Current assets
 
$
1,413
 
$
2,279
 
Property and equipment
   
--
   
898
 
Other assets
   
1,694
   
2,349
 
Current liabilities
   
1,294
   
4,162
 
Other liabilities
   
561
   
52
 

NOTE 9 - SUPPLEMENTAL CASH FLOW INFORMATION

Cash payments for interest amounted to approximately $22.0 million and $21.8 million for the six-month periods ended July 2, 2006, and July 3, 2005, respectively. Income tax payments amounted to approximately $6.7 million and $3.2 million, for the six-month periods ended July 2, 2006, and July 3, 2005, respectively.

Cash flows from discontinued operations are included in operating cash flows for all periods presented as there were no material investing or financing activities related to these discontinued operations.

NOTE 10 - SUPPLEMENTAL CONDENSED CONSOLIDATING GUARANTOR FINANCIAL STATEMENTS

The Guarantor Subsidiaries, which consist of the Company's principal domestic subsidiaries, are guarantors of the Company's 10.375% senior notes due 2010, its 7.3% senior notes due 2008, and its 9.5% senior subordinated notes due 2014. These guarantees are full and unconditional. The Supplemental Guarantor Financial Statements are presented herein pursuant to requirements of the Commission.
 
 

 
-14-


INTERFACE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED JULY 2, 2006

   
GUARANTOR
SUBSIDIARIES
 
NON-
GUARANTOR
SUBSIDIARIES
 
INTERFACE, INC.
(PARENT
CORPORATION)
 
CONSOLIDATION
AND
ELIMINATION
ENTRIES
 
CONSOLIDATED
TOTALS
 
   
   
   
   
(IN THOUSANDS)
 
Net sales
 
$
177,519
 
$
109,467
 
$
--
 
$
(28,308
)
$
258,678
 
Cost of sales
   
133,908
   
71,911
   
--
   
(28,308
)
 
177,511
 
Gross profit on sales
   
43,611
   
37,556
   
--
   
--
   
81,167
 
Selling, general and administrative expenses
   
30,974
   
21,926
   
5,481
   
--
   
58,381
 
Impairment of goodwill
   
--
   
--
   
--
   
--
   
--
 
Restructuring charge
   
--
   
--
   
--
   
--
   
--
 
Loss on disposal - European Fabrics
   
--
   
1,723
   
--
   
--
   
1,723
 
Operating income (loss)
   
12,637
   
13,907
   
(5,481
)
 
--
   
21,063
 
Interest/Other expense
   
2,737
   
729
   
7,923
   
--
   
11,389
 
Income (loss) before taxes on income and equity in income of subsidiaries
   
9,900
   
13,178
   
(13,404
)
 
--
   
9,674
 
Income tax expense (benefit)
   
3,652
   
5,380
   
(5,264
)
 
--
   
3,768
 
Equity in income (loss) of subsidiaries
   
--
   
--
   
14,056
   
(14,056
)
 
--
 
Income (loss) from continuing operations
   
6,248
   
7,798
   
5,916
   
(14,056
)
 
5,906
 
Loss on discontinued operations, net of tax
   
(1
)
 
(20
)
 
--
   
--
   
(21
)
Loss on disposal of discontinued operations, net of tax
   
--
   
--
   
--
   
--
   
--
 
Net income (loss)
 
$
6,247
 
$
7,778
 
$
5,916
 
$
(14,056
)
$
5,885
 



CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JULY 2, 2006

   
GUARANTOR
SUBSIDIARIES
 
NON-
GUARANTOR
SUBSIDIARIES
 
INTERFACE, INC.
(PARENT
CORPORATION)
 
CONSOLIDATION
AND
ELIMINATION
ENTRIES
 
CONSOLIDATED
TOTALS
 
   
   
   
   
(IN THOUSANDS)
 
Net sales
 
$
340,055
 
$
226,237
 
$
--
 
$
(56,980
)
$
509,312
 
Cost of sales
   
255,656
   
150,487
   
--
   
(56,980
)
 
349,163
 
Gross profit on sales
   
84,399
   
75,750
   
--
   
--
   
160,149
 
Selling, general and administrative expenses
   
60,068
   
44,831
   
11,784
   
--
   
116,683
 
Impairment of goodwill
   
--
   
20,712
   
--
   
--
   
20,712
 
Restructuring charge
   
3,260
   
--
   
--
   
--
   
3,260
 
Loss on disposal - European Fabrics
   
--
   
1,723
   
--
   
--
   
1,723
 
Operating income (loss)
   
21,071
   
8,484
   
(11,784
)
 
--
   
17,771
 
Interest/Other expense
   
5,718
   
1,820
   
15,611
   
--
   
23,149
 
Income (loss) before taxes on income and equity in income of subsidiaries
   
15,353
   
6,664
   
(27,395
)
 
--
   
(5,378
)
Income tax expense (benefit)
   
5,715
   
9,888
   
(9,805
)
 
--
   
5,798
 
Equity in income (loss) of subsidiaries
   
--
   
--
   
6,387
   
(6,387
)
 
--
 
Income (loss) from continuing operations
   
9,638
   
(3,224
)
 
(11,203
)
 
(6,387
)
 
(11,176
)
Income (loss) on discontinued operations, net of tax
   
2
   
(29
)
 
--
   
--
   
(27
)
Loss on disposal of discontinued operations, net of tax
   
--
   
--
   
--
   
--
   
--
 
Net income (loss)
 
$
9,640
 
$
(3,253
)
$
(11,203
)
$
(6,387
)
$
(11,203
)


-15-


CONDENSED CONSOLIDATING BALANCE SHEET
JULY 2, 2006
   
GUARANTOR
SUBSIDIARIES
 
NON-
GUARANTOR
SUBSIDIARIES
 
INTERFACE, INC.
(PARENT
CORPORATION)
 
CONSOLIDATION
AND
ELIMINATION
ENTRIES
 
CONSOLIDATED
TOTALS
 
   
 
 
 
 
   
(IN THOUSANDS)
 
ASSETS
                               
Current Assets:
                               
Cash and cash equivalents
 
$
1,092
 
$
24,011
 
$
2,244
 
$
--
 
$
27,347
 
Accounts receivable
   
74,160
   
65,741
   
3,868
   
--
   
143,769
 
Inventories
   
95,811
   
46,955
   
--
   
--
   
142,766
 
Prepaids and deferred income taxes
   
10,121
   
7,982
   
7,512
   
--
   
25,615
 
Assets of businesses held for sale
   
1,916
   
1,191
   
--
   
--
   
3,107
 
Total current assets
   
183,100
   
145,880
   
13,624
   
--
   
342,604
 
Property and equipment less accumulated depreciation
   
112,030
   
63,267
   
5,041
   
--
   
180,338
 
Investment in subsidiaries
   
202,045
   
120,493
   
129,599
   
(452,137
)
 
--
 
Goodwill
   
108,075
   
68,663
   
--
   
--
   
176,738
 
Other assets
   
13,101
   
26,176
   
75,281
   
--
   
114,558
 
 
 
$
618,351
 
$
424,479
 
$
223,545
 
$
(452,137
)
$
814,238
 
LIABILITIES AND
                               
SHAREHOLDERS' EQUITY
                               
Current Liabilities
 
$
59,009
 
$
61,007
 
$
17,789
 
$
--
 
$
137,805
 
Long-term debt, less current maturities
   
--
   
--
   
1,573
   
--
   
1,573
 
Senior notes and senior subordinated notes
   
--
   
--
   
427,250
   
--
   
427,250
 
Deferred income taxes
   
14,899
   
8,563
   
(1,216
)
 
--
   
22,246
 
Other
   
10,354
   
27,784
   
2,416
   
--
   
40,554
 
Total liabilities
   
84,262
   
97,354
   
447,812
   
--
   
629,428
 
 
                               
Minority interests
   
--
   
4,869
   
--
   
--
   
4,869
 
 
                               
Redeemable preferred stock
   
57,891
   
--
   
--
   
(57,891
)
 
--
 
Common stock
   
94,145
   
102,199
   
5,474
   
(196,344
)
 
5,474
 
Additional paid-in capital
   
191,411
   
12,525