Interface, Inc. Form 10-Q 10/01/2006
 
 


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 1, 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 November 6, 2006:

Class
 
Number of Shares
 
Class A Common Stock, $.10 par value per share
   
48,092,710
 
Class B Common Stock, $.10 par value per share
   
6,739,262
 

 
 
 




INTERFACE, INC.

INDEX

 
 
 
 
PAGE 
PART I.
FINANCIAL INFORMATION
 
 
Item 1.
Financial Statements
3
   
Consolidated Condensed Balance Sheets - October 1, 2006 and
January 1, 2006
3
   
   
Consolidated Condensed Statements of Operations - Three Months and
Nine Months Ended October 1, 2006 and October 2, 2005
4
   
   
Consolidated Statements of Comprehensive Income (Loss) - Three Months
and Nine Months Ended October 1, 2006 and October 2, 2005
5
   
   
Consolidated Condensed Statements of Cash Flows - Nine Months Ended
October 1, 2006 and October 2, 2005
6
   
   
Notes to Consolidated Condensed Financial Statements
7
       
 
Item 2.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
18
   
 
Item 3.
 
Quantitative and Qualitative Disclosures about Market Risk
22
       
 
Item 4.
Controls and Procedures
23
     
PART II.
OTHER INFORMATION
 
 
Item 1.
Legal Proceedings
23
 
Item 1A.
Risk Factors
23
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
25
 
Item 3.
Defaults Upon Senior Securities
25
 
Item 4.
Submission of Matters to a Vote of Security Holders
25
 
Item 5.
Other Information
25
 
Item 6.
Exhibits
26

 





PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

INTERFACE, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(IN THOUSANDS)
 
 
 
OCTOBER 1, 2006
 
JANUARY 1, 2006
 
   
(UNAUDITED)
     
ASSETS
         
CURRENT ASSETS:
             
Cash and Cash Equivalents
 
$
28,897
 
$
51,312
 
Accounts Receivable, net
   
159,184
   
141,408
 
Inventories
   
149,775
   
130,209
 
Prepaid and Other Expenses
   
20,499
   
16,624
 
Deferred Income Taxes
   
4,474
   
4,540
 
Assets of Businesses Held for Sale
   
3,049
   
5,526
 
               
TOTAL CURRENT ASSETS
   
365,878
   
349,619
 
               
PROPERTY AND EQUIPMENT, less
             
accumulated depreciation
   
183,060
   
185,643
 
DEFERRED TAX ASSET
   
72,154
   
69,043
 
GOODWILL
   
177,502
   
193,705
 
OTHER ASSETS
   
42,869
   
40,980
 
   
$
841,463
 
$
838,990
 
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts Payable
 
$
55,119
 
$
50,312
 
Accrued Expenses
   
83,267
   
85,581
 
Liabilities of Businesses Held for Sale
   
1,679
   
4,214
 
               
TOTAL CURRENT LIABILITIES
   
140,065
   
140,107
 
               
LONG-TERM DEBT, less current maturities
   
21,541
   
--
 
SENIOR NOTES
   
284,510
   
323,000
 
SENIOR SUBORDINATED NOTES
   
135,000
   
135,000
 
DEFERRED INCOME TAXES
   
21,049
   
23,534
 
OTHER
   
40,406
   
40,864
 
               
TOTAL LIABILITIES
   
642,571
   
662,505
 
               
Minority Interest
   
5,098
   
4,409
 
               
Commitments and Contingencies
             
               
SHAREHOLDERS' EQUITY:
             
Preferred Stock
   
--
   
--
 
Common Stock
   
5,478
   
5,334
 
Additional Paid-In Capital
   
242,406
   
234,314
 
Retained Deficit
   
(3,536
)
 
(1,443
)
Foreign Currency Translation Adjustment
   
(22,772
)
 
(38,347
)
Minimum Pension Liability
   
(27,782
)
 
(27,782
)
               
TOTAL SHAREHOLDERS' EQUITY
   
193,794
   
172,076
 
               
   
$
841,463
 
$
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                  
 
NINE
MONTHS
               ENDED               
     
                   
 
 
 
OCTOBER 1,
       2006       
 
OCTOBER 2,
       2005       
 
OCTOBER 1,
       2006       
 
OCTOBER 2,
       2005       
 
NET SALES
 
$
270,612
 
$
243,898
 
$
779,924
 
$
725,158
 
Cost of Sales
   
185,278
   
167,357
   
534,441
   
500,250
 
                           
GROSS PROFIT ON SALES
   
85,334
   
76,541
   
245,483
   
224,908
 
Selling, General and Administrative Expenses
   
60,331
   
56,029
   
177,014
   
166,003
 
Impairment of Goodwill
   
--
   
--
   
20,712
   
--
 
Restructuring Charge
   
--
   
--
   
3,260
   
--
 
Loss on Disposal - European Fabrics
   
--
   
--
   
1,723
   
--
 
                           
OPERATING INCOME
   
25,003
   
20,512
   
42,774
   
58,905
 
Interest Expense
   
10,504
   
11,402
   
32,672
   
34,486
 
Other Expense
   
381
   
171
   
1,362
   
1,039
 
                           
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAX EXPENSE
   
14,118
   
8,939
   
8,740
   
23,380
 
Income Tax Expense
   
5,012
   
3,602
   
10,810
   
11,180
 
                       
Income (Loss) from Continuing Operations
   
9,106
   
5,337
   
(2,070
)
 
12,200
 
Loss from Discontinued Operations, Net of Tax
   
--
   
(216
)
 
(27
)
 
(14,741
)
Loss on Disposal of Discontinued Operations, Net of Tax
   
--
   
--
   
--
   
(1,935
)
NET INCOME (LOSS)
 
$
9,106
 
$
5,121
 
$
(2,097
)
$
(4,476
)
                           
                           
Earnings (Loss) Per Share - Basic
                         
Continuing Operations
 
$
0.17
 
$
0.10
 
$
(0.04
)
$
0.24
 
Discontinued Operations
   
--
   
--
   
--
   
(0.29
)
Loss on Disposal of Discontinued Operations
   
--
   
--
   
--
   
(0.04
)
                           
Earnings (Loss) Per Share - Basic
 
$
0.17
 
$
0.10
 
$
(0.04
)
$
(0.09
)
                           
Earnings (Loss) Per Share - Diluted
                         
Continuing Operations
 
$
0.17
 
$
0.10
 
$
(0.04
)
$
0.23
 
Discontinued Operations
   
--
   
--
   
--
   
(0.28
)
Loss on Disposal of Discontinued Operations
   
--
   
--
   
--
   
(0.03
)
                           
Earnings (Loss) Per Share - Diluted
 
$
0.17
 
$
0.10
 
$
(0.04
)
$
(0.08
)
                           
Common Shares Outstanding - Basic
   
53,454
   
51,648
   
53,175
   
51,457
 
Common Shares Outstanding - Diluted
   
55,070
   
53,444
   
53,175
   
52,779
 

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
 
 
 
NINE MONTHS ENDED
 
           
 
 
 
OCTOBER 1,
        2006        
 
OCTOBER 2,
       2005       
 
OCTOBER 1,
        2006        
 
OCTOBER 2,
       2005       
 
                   
Net Income (Loss)
 
$
9,106
 
$
5,121
 
$
(2,097
)
$
(4,476
)
Other Comprehensive
Income (Loss), Foreign
                         
Currency Translation Adjustment
   
4,104
   
(2,235
)
 
15,575
   
(24,404
)
Comprehensive Income (Loss)
 
$
13,210
 
$
2,886
 
$
13,478
 
$
(28,880
)

See accompanying notes to consolidated condensed financial statements.

- 5 -


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

(IN THOUSANDS)

   
       NINE MONTHS ENDED          
 
   
OCTOBER 1,
      2006      
 
OCTOBER 2,
      2005      
 
           
OPERATING ACTIVITIES:
             
Net loss
 
$
(2,097
)
$
(4,476
)
Impairment of fixed assets, related to discontinued operations
   
--
   
3,466
 
Loss from discontinued operations
   
27
   
11,275
 
Loss on disposal of discontinued operations
   
--
   
1,935
 
Income (loss) from continuing operations
   
(2,070
)
 
12,200
 
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
   
22,892
   
23,291
 
Deferred income taxes and other
   
(5,416
)
 
(10,791
)
Working capital changes:
             
Accounts receivable
   
(23,089
)
 
(4,280
)
Inventories
   
(27,774
)
 
(12,563
)
Prepaid expenses
   
(3,818
)
 
(7,588
)
Accounts payable and accrued expenses
   
2,478
   
2,434
 
               
Cash provided by (used in) continuing operations
   
(13,377
)
 
2,703
 
Cash provided by discontinued operations
   
--
   
10,355
 
               
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES:
   
(13,377
)
 
13,058
 
               
INVESTING ACTIVITIES:
             
Capital expenditures
   
(23,135
)
 
(12,594
)
Cash proceeds from sale of discontinued operations
   
--
   
551
 
Cash proceeds from sale of European Fabrics
   
28,837
   
--
 
Investment in intellectual property
   
--
   
(2,700
)
Other
   
(4,279
)
 
(3,148
)
               
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES:
   
1,423
   
(17,891
)
               
FINANCING ACTIVITIES:
             
Net borrowing of long-term debt
   
21,541
   
14,595
 
Repurchase of senior subordinated notes
   
(38,490
)
 
--
 
Debt issuance cost
   
(710
)
 
--
 
Proceeds from issuance of common stock
   
5,957
   
2,589
 
               
CASH PROVIDED BY (USED IN) BY FINANCING ACTIVITIES:
   
(11,702
)
 
17,184
 
               
Net cash provided by (used in) operating, investing and
             
financing activities
   
(23,656
)
 
12,351
 
Effect of exchange rate changes on cash
   
1,241
   
(2,349
)
               
CASH AND CASH EQUIVALENTS:
             
Net change during the period
   
(22,415
)
 
10,002
 
Balance at beginning of period
   
51,312
   
22,164
 
               
Balance at end of period
 
$
28,897
 
$
32,166
 

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:

     
October 1, 2006
 
January 1, 2006
 
     
(In thousands)
 
 
Finished Goods
 
$
84,461
 
$
71,893
 
 
Work in Process
   
20,195
   
16,792
 
 
Raw Materials
   
45,119
   
41,524
 
     
$
149,775
 
$
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 October 1, 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 nine months ended October 1, 2006, outstanding options to purchase 1,884,000 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 nine-month periods ended October 2, 2005, outstanding options to purchase 194,000 and 529,000 shares of common stock, respectively, were not included in the computation of diluted earnings (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 nine-month periods ended October 1, 2006, and October 2, 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)
 
October 1, 2006
 
$
9,106
   
53,454
 
$
0.17
 
Effect of Dilution:
                   
Options and Restricted Stock
   
--
   
1,616
   
--
 
                     
Diluted
 
$
9,106
   
55,070
 
$
0.17
 
                     
October 2, 2005
 
$
5,121
   
51,648
 
$
0.10
 
Effect of Dilution:
                   
Options and Restricted Stock
   
--
   
1,796
   
--
 
                     
Diluted
 
$
5,121
   
53,444
 
$
0.10
 

       
For the Nine-Month
Period Ended                
 
Net Income (Loss) 
 
Average Shares Outstanding
 
Earnings (Loss)
Per Share
 
   
(In Thousands Except Per Share Amounts)
 
October 1, 2006
 
$
(2,097
)
 
53,175
 
$
(0.04
)
Effect of Dilution:
                   
Options and Restricted Stock
   
--
   
--
   
--
 
                     
Diluted
 
$
(2,097
)
 
53,175
 
$
(0.04
)
                     
October 2, 2005
 
$
(4,476
)
 
51,457
 
$
(0.09
)
Effect of Dilution:
                   
Options and Restricted Stock
   
--
   
1,322
   
0.01
 
                     
Diluted
 
$
(4,476
)
 
52,779
 
$
(0.08
)

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
                               
October 1, 2006
                               
Net sales
 
$
193,640
 
$
37,098
 
$
36,391
 
$
3,483
 
$
270,612
 
Depreciation and amortization
   
3,572
   
443
   
1,987
   
33
   
6,035
 
Operating income (loss)
   
24,309
   
2,239
   
(532
)
 
87
   
26,103
 
                                 
Three Months Ended
                               
October 2, 2005
                               
Net sales
 
$
157,962
 
$
32,104
 
$
49,869
 
$
3,963
 
$
243,898
 
Depreciation and amortization
   
3,104
   
403
   
2,363
   
17
   
5,887
 
Operating income
   
18,059
   
849
   
1,916
   
188
   
21,012
 
                                 
Nine Months Ended
                               
October 1, 2006
                               
Net sales
 
$
545,998
 
$
100,130
 
$
124,385
 
$
9,411
 
$
779,924
 
Depreciation and amortization
   
10,968
   
1,354
   
7,095
   
70
   
19,487
 
Operating income (loss)
   
68,618
   
4,456
   
(26,938
)
 
101
   
46,237
 
                                 
Nine Months Ended
                               
October 2, 2005
                               
Net sales
 
$
475,170
 
$
89,634
 
$
147,876
 
$
12,478
 
$
725,158
 
Depreciation and amortization
   
10,151
   
1,210
   
8,049
   
95
   
19,505
 
Operating income
   
55,933
   
1,817
   
3,029
   
617
   
61,396
 

A reconciliation of the Company’s total segment operating income, depreciation and amortization, and assets to the corresponding consolidated amounts follows:


   
Three Months Ended
 
Nine Months Ended
 
   
October 1, 2006
 
October 2, 2005 
 
  October 1, 2006
 
October 2, 2005
 
   
(In thousands)
 
(In thousands)
 
DEPRECIATION AND AMORTIZATION
                         
Total segment depreciation and amortization
 
$
6,035
 
$
5,887
 
$
19,487
 
$
19,505
 
Corporate depreciation and amortization
   
1,210
   
1,210
   
3,405
   
3,786
 
Reported depreciation and amortization
 
$
7,245
 
$
7,097
 
$
22,892
 
$
23,291
 
 
OPERATING INCOME
                         
Total segment operating income
 
$
26,103
 
$
21,012
 
$
46,237
 
$
61,396
 
Corporate expenses and other reconciling amounts
   
(1,100
)
 
(500
)
 
(3,463
)
 
(2,491
)
Reported operating income
 
$
25,003
 
$
20,512
 
$
42,774
 
$
58,905
 
                           
  
 
 
 
 
 
 
 
October 1,  2006
   
January 1, 2006
 
ASSETS
   
(In thousands)
Total segment assets
             
$
739,090
 
$
752,492
 
Discontinued operations
               
3,049
   
5,526
 
Corporate assets and eliminations
               
99,324
   
80,972
 
Reported total assets
             
$
841,463
 
$
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 $53.4 million, from $209.5 million to $156.1 million, during the nine-month period ended October 1, 2006.

- 9 -


Restructuring activities by segment

The table below details the restructuring activities undertaken in the first nine months 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. 

Nine Months Ended
October 1, 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 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 October 1, 2006, $21.5 million in borrowings at a weighted-average interest rate of approximately 7.6% and $10.4 million in letters of credit were outstanding under the revolving credit facility. As of October 1, 2006, the Company could have incurred $76.0 million of additional borrowings under its revolving credit facility.

As of October 1, 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 $139.7 million, $192.5 million and $111.1 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 No. 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 No. 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 No. 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 No. 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
 
Nine Months Ended
 
   
October 1, 2006
 
October 2, 2005
 
October 1, 2006
 
October 2, 2005
 
   
(In thousands, except per share amounts)
 
(In thousands, except per share amounts)
 
Net income (loss) as reported
 
$
9,106
 
$
5,121
 
$
(2,097
)
$
(4,476
)
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects
   
(77
)
 
(157
)
 
(267
)
 
(436
)
Add: Recognized stock-based compensation
   
77
   
--
   
267
   
--
 
                           
Pro forma net income (loss)
 
$
9,106
 
$
4,964
 
$
(2,097
)
$
(4,912
)
                           
Basic earnings (loss) per share as reported
 
$
0.17
 
$
0.10
 
$
(0.04
)
$
(0.09
)
Basic pro forma earnings (loss) per share
 
$
0.17
 
$
0.10
 
$
(0.04
)
$
(0.10
)
Diluted earnings (loss) per share as reported
 
$
0.17
 
$
0.10
 
$
(0.04
)
$
(0.08
)
Diluted pro forma earnings (loss) per share
 
$
0.17
 
$
0.10
 
$
(0.04
)
$
(0.09
)
 
The Company recognized stock compensation costs of $0.1 million and zero in the third quarters of 2006 and 2005, respectively, and $0.3 million and zero, respectively, in the first nine months of 2006 and 2005, respectively. The remaining unrecognized compensation cost related to unvested awards at October 1, 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 nine months of fiscal years 2006 and 2005:

   
Nine Months Ended
October 1, 2006
 
Nine Months Ended
October 2, 2005
Risk free interest rate
  
4.57%
 
4.22%
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 nine months of fiscal year 2006 was $4.42 per share.


- 11 -



The following table summarizes stock options outstanding as of October 1, 2006, as well as activity during the nine-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
   
1,095,000
   
5.70
 
Forfeited or canceled
   
36,000
   
3.56
 
Outstanding at October 1, 2006 (a)
   
1,884,000
 
$
6.13
 
               
Exercisable at October 1, 2006 (b)
   
1,526,000
 
$
6.26
 

(a) At October 1, 2006, the weighted-average remaining contractual life of options outstanding was 4.0 years.
(b) At October 1, 2006, the weighted-average remaining contractual life of options exercisable was 3.6 years.

At October 1, 2006, the aggregate intrinsic values of options outstanding and options exercisable were $12.7 million and $9.9 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 nine months of fiscal years 2006 and 2005 are provided in the following table:
 
   
              Nine Months Ended          
 
   
October 1, 2006 
 
 October 2, 2005
 
   
      (In thousands)
 
Proceeds from stock options exercised
 
$
6,244
 
$
2,557
 
Intrinsic value of stock options exercised
 
$
7,033
 
$
1,893
 

Restricted Stock Awards

During the nine months ended October 1, 2006, and October 2, 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 $2.5 million and $1.3 million for the nine months ended October 1, 2006, and October 2, 2005, respectively. SFAS No. 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 October 1, 2006, and during the nine-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
   
545,000
   
7.60
 
Forfeited or canceled
   
9,000
   
7.76
 
Outstanding at October 1, 2006
   
1,311,000
 
$
8.00
 

As of October 1, 2006, the unrecognized total compensation cost related to unvested restricted stock was $5.4 million. That cost is expected to be recognized by the end of 2010.


- 12 -



As stated above, SFAS No. 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 No. 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.

NOTE 7 - EMPLOYEE BENEFIT PLANS

The following tables provide the components of net periodic benefit cost for the three-month and nine-month periods ended October 1, 2006, and October 2, 2005, respectively:
 

   
   Three Months Ended    
 
    Nine Months Ended     
 
Defined Benefit Retirement Plan (Europe)
 
October 1, 2006
 
October 2, 2005
 
October 1, 2006
 
October 2, 2005
 
 
(In thousands) 
(In thousands)
Service cost
 
$
464
 
$
644
 
$
1,368
 
$
1,961
 
Interest cost
   
2,448
   
2,556
   
7,220
   
7,782
 
Expected return on assets
   
(2,755
)
 
(2,650
)
 
(8,127
)
 
(8,070
)
Amortization of prior service costs
   
--
   
6
   
--
   
18
 
Recognized net actuarial (gains)/losses
   
488
   
628
   
1,439
   
1,913
 
Amortization of transition obligation
   
13
   
43
   
39
   
132
 
Net periodic benefit cost
 
$
658
 
$
1,227
 
$
1,939
 
$
3,736
 

   
             Three Months Ended               
 
         Nine Months Ended           
 
Salary Continuation Plan (SCP)
 
 October 1, 2006
 
October 2, 2005
 
October 1, 2006
 
October 2, 2005
 
   
(In thousands)
 
(In thousands)
 
Service cost
 
$
67
 
$
55
 
$
200
 
$
165
 
Interest cost
   
212
   
198
   
637
   
594
 
Amortization of transition obligation
   
55
   
55
   
165
   
165
 
Amortization of prior service cost
   
12
   
12
   
36
   
36
 
Amortization of (gain)/loss
   
80
   
68
   
240
   
204
 
Net periodic benefit cost
 
$
426
 
$
388
 
$
1,278
 
$
1,164
 

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         
 
       Nine Months Ended        
 
   
   October 1, 2006
 
   October 2, 2005
 
October 1, 2006
 
October 2, 2005
 
   
(In thousands)
 
(In thousands)
 
Net sales
 
$
804
 
$
3,238
 
$
2,796
 
$
29,966
 
Loss on operations before taxes on income
   
--
   
(334
)
 
(38
)
 
(23,160
)
Income tax benefit
   
--
   
(118
)
 
11
   
(11,885
)
Loss on operations, net of tax
   
--
   
(216
)
 
(27
)
 
(11,275
)
Impairment loss, net of tax
   
--
   
--
   
--
   
(3,466
)


- 13 -



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

   
   October 1, 2006
 
January 1, 2006
 
   
(In thousands)         
 
Current assets
 
$
1,355
 
$
2,279
 
Property and equipment
   
--
   
898
 
Other assets
   
1,694
   
2,349
 
Current liabilities
   
1,168
   
4,162
 
Other liabilities
   
511
   
52
 

NOTE 9 - SUPPLEMENTAL CASH FLOW INFORMATION

Cash payments for interest amounted to approximately $41.7 million and $43.1 million for the nine-month periods ended October 1, 2006, and October 2, 2005, respectively. Income tax payments amounted to approximately $13.8 million and $9.3 million, for the nine-month periods ended October 1, 2006, and October 2, 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 OCTOBER 1, 2006

   
GUARANTOR
SUBSIDIARIES
 
NON-
GUARANTOR
SUBSIDIARIES
 
INTERFACE, INC.
(PARENT
CORPORATION)
 
CONSOLIDATION
AND
ELIMINATION ENTRIES
 
 
CONSOLIDATED TOTALS
 
   
   
   
   
(IN THOUSANDS)
 
Net sales
 
$
191,311
 
$
113,666
 
$
--
 
$
(34,365
)
$
270,612
 
Cost of sales
   
145,397
   
74,246
   
--
   
(34,365
)
 
185,278
 
Gross profit on sales
   
45,914
   
39,420
   
--
   
--
   
85,334
 
Selling, general and administrative
                               
expenses
   
31,219
   
23,624
   
5,488
   
--
   
60,331
 
Impairment of goodwill
   
--
   
--
   
--
   
--
   
--
 
Restructuring charge
   
--
   
--
   
--
   
--
   
--
 
Loss on disposal - European Fabrics
   
--
   
--
   
--
   
--
   
--
 
Operating income (loss)
   
14,695
   
15,796
   
(5,488
)
 
--
   
25,003
 
Interest/Other expense
   
1,920
   
2,126
   
6,839
   
--
   
10,885
 
Income (loss) before taxes on income
                               
and equity in income of subsidiaries
   
12,775
   
13,670
   
(12,327
)
 
--
   
14,118
 
Income tax expense (benefit)
   
5,305
   
3,328
   
(3,621
)
 
--
   
5,012
 
Equity in income (loss) of subsidiaries
   
--
   
--
   
17,812
   
(17,812
)
 
--
 
Income (loss) from
                               
continuing operations
   
7,470
   
10,342
   
9,106
   
(17,812
)
 
9,106
 
Loss on discontinued operations,
net of tax
   
--
   
--
   
--
   
--
   
--
 
Loss on disposal of discontinued
operations, net of tax
   
--
   
--
   
--
   
--
   
--
 
Net income (loss)
 
$
7,470
 
$
10,342
 
$
9,106
 
$
(17,812
)
$
9,106
 



CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED OCTOBER 1, 2006

   
GUARANTOR
SUBSIDIARIES
 
NON-
GUARANTOR
SUBSIDIARIES
 
INTERFACE, INC.
(PARENT
CORPORATION)
 
CONSOLIDATION
AND
ELIMINATION ENTRIES
 
CONSOLIDATED TOTALS
 
   
   
   
   
(IN THOUSANDS)
 
Net sales
 
$
531,366
 
$
339,903
 
$
--
 
$
(91,345
)
$
779,924
 
Cost of sales
   
401,053
   
224,733
   
--
   
(91,345
)
 
534,441
 
Gross profit on sales
   
130,313
   
115,170
   
--
   
--
   
245,483
 
Selling, general and administrative
                               
expenses
   
91,287
   
68,455
   
17,272
   
--
   
177,014
 
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)
   
35,766
   
24,280
   
(17,272
)
 
--
   
42,774
 
Interest/Other expense
   
7,638
   
3,946
   
22,450
   
--
   
34,034
 
Income (loss) before taxes on income
                               
and equity in income of subsidiaries
   
28,128
   
20,334
   
(39,722
)
 
--
   
8,740
 
Income tax expense (benefit)
   
11,020
   
13,216
   
(13,426
)
 
--
   
10,810
 
Equity in income (loss) of subsidiaries
   
--
   
--
   
24,199
   
(24,199
)
 
--
 
Income (loss) from
                               
continuing operations
   
17,108
   
7,118
   
(2,097
)
 
(24,199
)
 
(2,070
)
Income (loss) on discontinued operations,
net of tax
   
2
   
(29
)
 
--
   
--
   
(27
)
Loss on disposal of discontinued
operations, net of tax
   
--
   
--
   
--
   
--
   
--
 
Net income (loss)
 
$
17,110
 
$
7,089
 
$
(2,097
)
$
(24,199
)
$
(2,097
)


- 15 -


CONDENSED CONSOLIDATING BALANCE SHEET
OCTOBER 1, 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
 
$
--
 
$
23,417
 
$
5,480
 
$
--
 
$
28,897
 
Accounts receivable
   
82,402
   
71,699
   
5,083
   
--
   
159,184
 
Inventories
   
99,710
   
50,065
   
--
   
--
   
149,775
 
Prepaids and deferred income taxes
   
8,945
   
8,163
   
7,865
   
--
   
24,973
 
Assets of businesses held for sale
   
2,532
   
517
   
--
   
--
   
3,049
 
Total current assets
   
193,589
   
153,861
   
18,428
   
--
   
365,878
 
Property and equipment
                               
less accumulated depreciation
   
112,350
   
65,504
   
5,206
   
--
   
183,060
 
Investment in subsidiaries
   
200,010
   
128,620
   
141,319
   
(469,949
)
 
--
 
Goodwill
   
108,075
   
69,427
   
--
   
--
   
177,502
 
Other assets
   
13,178
   
26,648
   
75,197
   
--
   
115,023
 
   
$
627,202
 
$
444,060
 
$
240,150
 
$
(469,949
)
$
841,463
 
LIABILITIES AND
                               
SHAREHOLDERS' EQUITY
                               
Current Liabilities
 
$
60,358
 
$
67,155
 
$
12,552
 
$
--
 
$
140,065
 
Long-term debt, less current maturities
   
--
   
--
   
21,541
   
--
   
21,541
 
Senior notes and senior subordinated notes
   
--
   
--
   
419,510
   
--
   
419,510
 
Deferred income taxes
   
14,899
   
7,366
   
(1,216
)
 
--
   
21,049
 
Other
   
</