Interface, Inc. Form 10-Q 07/01/2007
 


 
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 1, 2007

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 3, 2007:

 Class
   
Number of Shares
 
Class A Common Stock, $.10 par value per share
         
55,057,381
 
Class B Common Stock, $.10 par value per share
         
6,486,843
 


- 1 -




INTERFACE, INC.

INDEX
 
 
 
PAGE 
PART I.
FINANCIAL INFORMATION
 
 
Item 1.
Financial Statements
3
   
Consolidated Condensed Balance Sheets - July 1, 2007 and December 31, 2006
 
3
   
Consolidated Condensed Statements of Operations - Three Months and Six Months Ended July 1, 2007 and July 2, 2006
 
4
   
Consolidated Statements of Comprehensive Income (Loss) - Three Months and Six Months Ended July 1, 2007 and July 2, 2006
 
5
   
Consolidated Condensed Statements of Cash Flows - Six Months Ended July 1, 2007 and July 2, 2006
 
6
   
Notes to Consolidated Condensed Financial Statements
 
7
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
21
 
 
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
26
 
 
Item 4.
Controls and Procedures
27
     
PART II.
OTHER INFORMATION
 
 
 
Item 1.
Legal Proceedings
27
 
 
Item 1A.
Risk Factors
27
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
27
 
 
Item 3.
Defaults Upon Senior Securities
27
 
 
Item 4.
Submission of Matters to a Vote of Security Holders
27
 
 
Item 5.
Other Information
28
 
 
Item 6.
Exhibits
28



- 2 -


PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

INTERFACE, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(IN THOUSANDS)
   
JULY 1, 2007
 
DECEMBER 31, 2006
 
   
(UNAUDITED)
     
ASSETS
         
CURRENT ASSETS:
             
Cash and Cash Equivalents
 
$
89,346
 
$
109,157
 
Accounts Receivable, net
   
152,034
   
143,025
 
Inventories
   
128,446
   
112,293
 
Prepaid and Other Expenses
   
21,069
   
21,805
 
Deferred Income Taxes
   
6,940
   
6,829
 
Assets of Business Held for Sale
   
92,194
   
158,322
 
TOTAL CURRENT ASSETS
   
490,029
   
551,431
 
               
PROPERTY AND EQUIPMENT, less accumulated depreciation   
   
146,608
   
134,631
 
DEFERRED TAX ASSET
   
77,176
   
65,841
 
GOODWILL
   
137,133
   
135,610
 
OTHER ASSETS
   
48,157
   
40,827
 
TOTAL ASSETS
 
$
899,103
 
$
928,340
 
               
LIABILITIES AND SHAREHOLDERS’ EQUITY
             
CURRENT LIABILITIES:
             
Accounts Payable
 
$
55,310
 
$
49,542
 
Accrued Expenses
   
102,488
   
98,702
 
Current Portion of Long-Term Debt
   
79,235
   
--
 
Liabilities of Business Held for Sale
   
22,506
   
22,934
 
TOTAL CURRENT LIABILITIES
   
259,539
   
171,178
 
               
LONG-TERM DEBT, less current maturities
   
8,765
   
--
 
SENIOR NOTES
   
175,000
   
276,365
 
SENIOR SUBORDINATED NOTES
   
135,000
   
135,000
 
DEFERRED INCOME TAXES
   
8,196
   
2,058
 
OTHER
   
65,211
   
63,839
 
TOTAL LIABILITIES
 
$
651,711
 
$
648,440
 
               
Minority Interest
   
6,493
   
5,506
 
               
Commitments and Contingencies
             
               
SHAREHOLDERS' EQUITY:
             
Preferred Stock
   
--
   
--
 
Common Stock
   
6,146
   
6,066
 
Additional Paid-In Capital
   
329,799
   
323,132
 
Retained Earnings (Deficit)
   
(41,493
)
 
5,217
 
Accumulated Other Comprehensive Income - Foreign Currency Translation Adjustment
   
(6,654
)
 
(12,847
)
Accumulated Other Comprehensive Income - Pension Liability
   
(46,899
)
 
(47,174
)
TOTAL SHAREHOLDERS' EQUITY
   
240,899
   
274,394
 
   
$
899,103
 
$
928,340
 

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 1,
2007
 
JULY 2,
2006
 
JULY 1,
2007
 
JULY 2,
2006
 
                   
NET SALES
 
$
264,962
 
$
223,184
 
$
508,454
 
$
421,318
 
Cost of Sales
   
172,737
   
147,476
   
333,001
   
277,686
 
                           
GROSS PROFIT ON SALES
   
92,225
   
75,708
   
175,453
   
143,632
 
Selling, General and Administrative Expenses
   
61,332
   
51,617
   
118,379
   
99,455
 
Loss on Disposition - Specialty Products
   
--
   
--
   
1,873
   
--
 
OPERATING INCOME
   
30,893
   
24,091
   
55,201
   
44,177
 
                           
Interest Expense
   
9,161
   
10,936
   
18,281
   
22,168
 
Other Expense
   
612
   
445
   
1,035
   
718
 
                           
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAX EXPENSE
   
21,120
   
12,710
   
35,885
   
21,291
 
Income Tax Expense
   
7,797
   
4,234
   
13,493
   
7,386
 
                       
Income from Continuing Operations
   
13,323
   
8,476
   
22,392
   
13,905
 
Loss from Discontinued Operations, Net of Tax
   
(12,325
)
 
(868
)
 
(62,010
)
 
(23,385
)
Loss on Disposal of Discontinued Operations, Net of Tax
   
--
   
(1,723
)
 
--
   
(1,723
)
NET INCOME (LOSS)
 
$
998
 
$
5,885
 
$
(39,618
)
$
(11,203
)
                           
Earnings (Loss) Per Share - Basic
                         
Continuing Operations
 
$
0.22
 
$
0.16
 
$
0.37
 
$
0.26
 
Discontinued Operations
   
(0.20
)
 
(0.02
)
 
(1.03
)
 
(0.44
)
Loss on Disposal of Discontinued Operations
   
--
   
(0.03
)
 
--
   
(0.03
)
Earnings (Loss) Per Share - Basic
 
$
0.02
 
$
0.11
 
$
(0.66
)
$
(0.21
)
                           
Earnings (Loss) Per Share - Diluted
                         
Continuing Operations
 
$
0.22
 
$
0.15
 
$
0.36
 
$
0.25
 
Discontinued Operations
   
(0.20
)
 
(0.01
)
 
(1.00
)
 
(0.43
)
Loss on Disposal of Discontinued Operations
   
--
   
(0.03
)
 
--
   
(0.03
)
Earnings (Loss) Per Share - Diluted
 
$
0.02
 
$
0.11
 
$
(0.64
)
$
(0.21
)
                           
Common Shares Outstanding - Basic
   
60,322
   
53,375
   
60,210
   
52,995
 
Common Shares Outstanding - Diluted
   
61,571
   
54,996
   
61,435
   
54,548
 

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 1, 2007
 
JULY 2, 2006
 
JULY 1, 2007
 
JULY 2, 2006
 
                   
Net Income (Loss)
 
$
998
 
$
5,885
 
$
(39,618
)
$
(11,203
)
Other Comprehensive Income, Foreign
                         
Currency Translation Adjustment and Pension Liability Adjustment
   
2,795
   
9,694
   
6,468
   
11,471
 
Comprehensive Income (Loss)
 
$
3,793
 
$
15,579
 
$
(33,150
)
$
268
 


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 1, 2007
 
JULY 2, 2006
 
OPERATING ACTIVITIES:
         
Net loss
 
$
(39,618
)
$
(11,203
)
Loss from discontinued operations
   
62,010
   
25,108
 
Income from continuing operations
   
22,392
   
13,905
 
Adjustments to reconcile income (loss) to cash used in operating activities:
             
Loss on disposition of assets - Specialty Products
   
1,873
   
--
 
Depreciation and amortization
   
11,960
   
10,822
 
Deferred income taxes and other
   
(1,839
)
 
(5,708
)
Working capital changes:
             
Accounts receivable
   
(7,949
)
 
(8,893
)
Inventories
   
(16,115
)
 
(18,501
)
Prepaid expenses
   
1,740
   
(3,068
)
Accounts payable and accrued expenses
   
8,305
   
5,073
 
               
Cash provided by (used in) continuing operations
   
20,367
   
(6,370
)
Cash provided by (used in) discontinued operations
   
3,188
   
(492
)
               
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES:
   
23,555
   
(6,862
)
               
INVESTING ACTIVITIES:
             
Capital expenditures
   
(17,947
)
 
(14,267
)
Other
   
(7,163
)
 
(3,973
)
Cash used in investing activities of continuing operations
   
(25,110
)
 
(18,240
)
Cash provided by (used in) discontinued operations
   
(6,015
)
 
27,028
 
               
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES:
   
(31,125
)
 
8,788
 
               
FINANCING ACTIVITIES:
             
Net borrowing of long-term debt
   
8,743
   
1,573
 
Repurchase of senior notes
   
(22,400
)
 
(30,750
)
Proceeds from issuance of common stock
   
2,773
   
5,650
 
Dividends paid
   
(2,450
)
 
--
 
Debt issuance costs
   
--
   
(679
)
               
CASH USED IN FINANCING ACTIVITIES:
   
(13,334
)
 
(24,206
)
               
Net cash used in operating, investing and
             
financing activities
   
(20,904
)
 
(22,280
)
Effect of exchange rate changes on cash
   
1,093
   
1,230
 
               
CASH AND CASH EQUIVALENTS:
             
Net change during the period
   
(19,811
)
 
(21,050
)
Balance at beginning of period
   
109,157
   
47,275
 
               
Balance at end of period
 
$
89,346
 
$
26,225
 


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 December 31, 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 December 31, 2006, consolidated condensed 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. In addition, as described below in Note 2, the Company has sold its Fabrics Group business segment. 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 - SALE OF FABRICS GROUP BUSINESS SEGMENT

In the second quarter of 2007, the Company entered into an agreement to sell its Fabrics Group business segment to a third party. The sale was completed in the third quarter of 2007. The purchase price for the business segment was $70.0 million, subject to working capital and certain other adjustments. Of this $70.0 million, $6.5 million represents deferred compensation which would be remitted to the Company upon the achievement of certain performance criteria by the disposed segment over the next 18 months. At this time, the Company has determined that the receipt of this deferred amount is probable. As described below in Notes 9 and 11, the Company incurred impairment charges of approximately $61.9 million during the first six months of 2007 to reduce the carrying value of the business segment to fair value as represented by the purchase price. In the second quarter, the Company incurred approximately $3.6 million of direct costs to sell the business segment. The major classes of assets and liabilities related to the business segment at July 1, 2007, are accounts receivable of $16.7 million, inventory of $32.0 million, property, plant and equipment of $41.9 million, and accounts payable and accruals of $10.8 million.

In April 2006, subsequent to the end of the first quarter of 2006, the Company sold its European fabrics business for $28.8 million to an entity formed by the business’s management team. An impairment charge of $20.7 million was recorded in the first quarter of 2006 in connection with this sale. The major classes of assets and liabilities related to this disposal group included accounts receivable of $11.9 million, inventory of $11.4 million, property, plant and equipment of $9.5 million and accounts payable of $7.6 million. In the second quarter of 2006, the transaction resulted in a net loss on disposal of $1.7 million.

Current and prior periods have been restated to include the results of operations and related disposal costs, gains and losses for these businesses as discontinued operations. In addition, assets and liabilities of these businesses have been reported in assets and liabilities held for sale for both current and prior periods.

NOTE 3 - INVENTORIES

Inventories are summarized as follows:

   
July 1, 2007
 
December 31, 2006
 
   
(In thousands)
 
Finished Goods
 
$
73,536
 
$
66,991
 
Work in Process
   
15,632
   
13,537
 
Raw Materials
   
39,278
   
31,765
 
   
$
128,446
 
$
112,293
 



- 7 -


NOTE 4 - 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 quarters ended April 1, 2007, and April 2, 2006, outstanding options to purchase 50,000 and 45,000 shares of common stock, respectively, were not included in the computation of diluted earnings per share as their impact would be anti-dilutive. For the six months ended July 1, 2007 and July 2, 2006, outstanding options to purchase 50,000 and 80,000 shares of common stock, respectively, were not included in the computation of diluted earnings per share as their impact would be anti-dilutive.

For the Three-Month
Period Ended                
 
Net Income
 
Average Shares
Outstanding
 
Earnings
Per Share
 
   
(In Thousands Except Per Share Amounts)
 
July 1, 2007
 
$
998
   
60,322
 
$
0.02
 
Effect of Dilution:
                   
Options & Restricted Stock
   
--
   
1,249
   
--
 
                     
Diluted
 
$
998
   
61,571
 
$
0.02
 
                     
July 2, 2006
 
$
5,885
   
53,375
 
$
0.11
 
Effect of Dilution:
                   
Options & Restricted Stock
   
--
   
1,621
   
--
 
                     
Diluted
 
$
5,885
   
54,966
 
$
0.11
 
     
For the Six-Month
Period Ended                
   
Net Income (Loss)
 
 
Average Shares
Outstanding
 
 
Earnings (Loss)
Per Share
 
 
(In Thousands Except Per Share Amounts) 
July 1, 2007
 
$
(39,618
)
 
60,210
 
$
(0.66
)
Effect of Dilution:
                   
Options & Restricted Stock
   
--
   
1,225
   
0.02
 
                     
Diluted
 
$
(39,618
)
 
61,435
 
$
(0.64
)
                     
July 2, 2006
 
$
(11,203
)
 
52,995
 
$
(0.21
)
Effect of Dilution:
                   
Options & Restricted Stock
   
--
   
1,553
   
--
 
                     
Diluted
 
$
(11,203
)
 
54,548
 
$
(0.21
)


NOTE 5 - 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 three reportable segments: (1) the Modular Carpet segment, which includes its InterfaceFLOR, Heuga and FLOR modular carpet businesses, as well as its 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, and (3) the Specialty Products segment, which includes Pandel, Inc., a producer of vinyl carpet tile backing and specialty mat and foam products. The majority of the operations of the Specialty Products segment were sold on March 7, 2007. See Note 12 for further information. In June of 2007, the Company entered into an agreement to sell its former Fabrics Group business segment, and has included the operations of this segment in discontinued operations as of July 1, 2007. The sale was completed in the third quarter of 2007. See Note 2 for further information. 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 also reported as discontinued operations in the accompanying consolidated condensed statements of operations.

- 8 -

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 December 31, 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. 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:

   
Modular Carpet
 
Bentley Prince Street
 
Specialty Products
 
Total
 
   
(In thousands)
 
Three Months Ended July 1, 2007
                         
Net sales
 
$
225,523
 
$
39,439
 
$
--
 
$
264,962
 
Depreciation and amortization
   
3,635
   
467
   
--
   
4,102
 
Operating income
   
31,619
   
2,035
   
--
   
33,654
 
                           
Three Months Ended July 2, 2006
                         
Net sales
 
$
186,475
 
$
33,932
 
$
2,777
 
$
223,184
 
Depreciation and amortization
   
4,123
   
603
   
19
   
4,745
 
Operating income (loss)
   
23,634
   
1,704
   
(29
)
 
25,039
 

   
Modular Carpet
 
Bentley Prince Street
 
Specialty Products
 
Total
 
   
(In thousands)
 
Six Months Ended July 1, 2007
                         
Net sales
 
$
430,777
 
$
75,485
 
$
2,192
 
$
508,454
 
Depreciation and amortization
   
7,179
   
933
   
12
   
8,124
 
Operating income (loss)
   
58,381
   
2,967
   
(1,733
)
 
59,615
 
                           
Six Months Ended July 2, 2006
                         
Net sales
 
$
352,358
 
$
63,032
 
$
5,928
 
$
421,318
 
Depreciation and amortization
   
7,396
   
911
   
37
   
8,344
 
Operating income
   
44,309
   
2,217
   
14
   
46,540
 

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

   
Three Months Ended
 
Six Months Ended
 
   
July 1, 2007
 
July 2, 2006
 
July 1, 2007
 
July 2, 2006
 
   
(In thousands)
 
(In thousands)
 
DEPRECIATION AND AMORTIZATION
                         
Total segment depreciation and amortization
 
$
4,102
 
$
4,745
 
$
8,124
 
$
8,344
 
Corporate depreciation and amortization
   
1,404
   
571
   
3,836
   
2,478
 
Reported depreciation and amortization
 
$
5,506
 
$
5,316
 
$
11,960
 
$
10,822
 
                           
OPERATING INCOME
                         
Total segment operating income
 
$
33,654
 
$
25,039
 
$
59,615
 
$
46,540
 
Corporate expenses and other reconciling amounts
   
(2,761
)
 
(948
)
 
(4,414
)
 
(2,363
)
Reported operating income
 
$
30,893
 
$
24,091
 
$
55,201
 
$
44,177
 

- 9 -



   
July 1, 2007
 
December 31, 2006
 
ASSETS
 
(In thousands)
 
Total segment assets
 
$
635,210
 
$
604,207
 
Discontinued operations
   
92,194
   
158,322
 
Corporate assets and eliminations
   
171,699
   
165,811
 
Reported total assets
 
$
899,103
 
$
928,340
 


NOTE 6 - LONG-TERM DEBT

On June 30, 2006, the Company amended and restated its domestic revolving credit facility. Under the amended credit facility, 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 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 amended 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 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 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 credit 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 facility and anticipates that it will remain in compliance with the covenants.

As of July 1, 2007, there were zero borrowings and $10.0 million in letters of credit outstanding under the amended facility. As of July 1, 2007, the Company could have incurred $62.7 million of additional borrowings under the facility. The available borrowing limit has been adjusted for the sale of the Fabrics Group business segment, considered probable as of the end of the second quarter 2007.

On March 9, 2007, Interface Europe B.V. (the Company’s modular carpet subsidiary based in the Netherlands) and certain of its subsidiaries entered into a Credit Agreement with ABN AMRO Bank N.V. Under the Credit Agreement, ABN AMRO provides a credit facility for borrowings and bank guarantees in varying aggregate amounts over time as follows:

- 10 -


 
                 Time Period                   
 
Maximum Amount 
in Euros      
 
 
 
 
(in millions)
 
 
January 1, 2007 - April 30, 2007
 
20
 
 
May 1, 2007 - September 30, 2007
 
26
 
 
October 1, 2007 - April 30, 2008
 
15
 
 
May 1, 2008 - September 30, 2008
 
21
 
 
October 1, 2008 - April 30, 2009
 
10
 
 
May 1, 2009 - September 30, 2009
 
16
 
 
From October 1, 2009
 
5
 

Interest on borrowings under this European facility is charged at varying rates computed by applying a margin of 1% over ABN AMRO’s Euro base rate (consisting of the leading refinancing rate as determined from time to time by the European Central Bank plus a debit interest surcharge), which base rate is subject to a minimum of 3.5% per annum. Fees on bank guarantees and documentary letters of credit are charged at a rate of 1% per annum or part thereof on the maximum amount and for the maximum duration of each guarantee or documentary letter of credit issued. An unused line fee of 0.5% per annum is payable with respect to any undrawn portion of the facility. The facility is secured by liens on certain real, personal and intangible property of the Company’s principal European subsidiaries. The facility also includes various financial covenants (which require the borrowers to maintain a minimum interest coverage ratio, total debt/EBITDA ratio, and tangible net worth/total assets) and affirmative and negative covenants, and other provisions that restrict the borrowers’ ability to take certain actions. As of July 1, 2007, there were approximately €6.7 million (approximately $8.8 million) in borrowings outstanding under this facility, at an approximate rate of interest of 5.75%.

As of July 1, 2007, 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 $145.5 million, $188.1 million and $86.7 million, respectively.


NOTE 7 - STOCK-BASED COMPENSATION 
 
 Stock Option Awards

In the first quarter of fiscal 2006, the Company adopted 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. The Company has elected to use the Black-Scholes model. The adoption of SFAS No. 123R, applying the “modified prospective method,” as elected by the Company, requires the Company to value stock options prior to its adoption of SFAS No. 123R under the fair value method and expense these amounts over the remaining vesting period of the stock options. SFAS No. 123R requires that the Company estimate forfeitures for stock options and reduce compensation expense accordingly. The Company has reduced its stock compensation expense by the assumed forfeiture rate and will evaluate experience against this forfeiture rate going forward.

During the first six months of 2007 and 2006, the Company recognized stock option compensation costs of $0.2 million in each period. In each of the second quarters of fiscal years 2007 and 2006, the Company recognized stock option compensation costs of $0.1 million. The remaining unrecognized compensation cost related to unvested awards at July 1, 2007, approximated $0.4 million, and the weighted average period of time over which this cost will be recognized is approximately two years.
 

- 11 -


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 years 2007 and 2006:

   
Six Months Ended
 July 1, 2007
 
Six Months Ended
 July 2, 2006
 
Risk free interest rate
   
4.73
%
 
4.57
%
Expected life
   
3.25 years
   
3.11 years
 
Expected volatility
   
60
%
 
60
%
Expected dividend yield
   
0.51
%
 
0
%

The weighted average grant date fair value of stock options granted during the first six months of fiscal 2007 was $6.99 per share.

The following table summarizes stock options outstanding as of July 1, 2007, as well as activity during the six months then ended:
  
   
    Shares    
 
Weighted Average
Exercise Price
 
Outstanding at December 31, 2006
   
1,759,000
 
$
6.07
 
Granted
   
30,000
   
15.66
 
Exercised
   
518,000
   
6.35
 
Forfeited or canceled
   
19,000
   
10.44
 
Outstanding at July 1, 2007 (a)
   
1,252,000
 
$
6.20
 
               
Exercisable at July 1, 2007 (b)
   
1,064,000
 
$
5.73
 

(a) At July 1, 2007, the weighted-average remaining contractual life of options outstanding was 3.3 years.
(b) At July 1, 2007, the weighted-average remaining contractual life of options exercisable was 3.1 years.

At July 1, 2007, the aggregate intrinsic value of options outstanding and options exercisable was $15.2 million and $13.4 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 2007 and 2006 are provided in the following table:
 
   
              Six Months Ended         
 
   
July 1, 2007
 
 July 2, 2006
 
   
(In thousands)
 
Proceeds from stock options exercised
 
$
2,773
 
$
5,650
 
Intrinsic value of stock options exercised
 
$
5,772
 
$
6,780
 

Restricted Stock Awards

During the six months ended July 1, 2007, and July 2, 2006, the Company granted restricted stock awards for 277,000 and 394,000 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 restricted stock grants was $3.6 million and $1.6 million for the six months ended July 1, 2007, and July 2, 2006, respectively. SFAS No. 123R requires that the Company estimate forfeitures for restricted stock and reduce compensation expense accordingly. The Company has reduced its expense by the assumed forfeiture rate and will evaluate experience against this forfeiture rate going forward.


- 12 -


The following table summarizes restricted stock activity as of July 1, 2007, and during the six months then ended:

   
      Shares      
 
Weighted Average
Grant Date
        Fair Value        
 
Outstanding at December 31, 2006
   
1,311,000
 
$
8.00
 
Granted
   
277,000
 
$
15.00
 
Vested
   
620,000
 
$
8.59
 
Forfeited or canceled
   
1,500
   
8.64
 
Outstanding at July 1, 2007
   
966,500
 
$
9.56
 

As of July 1, 2007, 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 2011.

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 in the first quarter of 2006, 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 8 - EMPLOYEE BENEFIT PLANS

The following tables provide the components of net periodic benefit cost for the three-month and six-month periods ended July 1, 2007, and July 2, 2006, respectively:


   
           Three Months Ended        
 
           Six Months Ended                
 
Defined Benefit Retirement Plan (Europe)
 
July 1, 2007
 
July 2, 2006
 
July 1, 2007
 
July 2, 2006
 
   
(In thousands)
 
(In thousands)
 
Service cost
 
$
718
 
$
458
 
$
1,430
 
$
904
 
Interest cost
   
3,073
   
2,418
   
6,118
   
4,772
 
Expected return on assets
   
(3,259
)
 
(2,721
)
 
(6,489
)
 
(5,372
)
Amortization of prior service costs
   
--
   
--
   
--
   
--
 
Recognized net actuarial (gains)/losses
   
695
   
482
   
1,385
   
951
 
Amortization of transition obligation
   
29
   
13
   
57
   
26
 
Net periodic benefit cost
 
$
1,256
 
$
650
 
$
2,501
 
$
1,281
 

   
           Three Months Ended        
 
            Six Months Ended               
 
Salary Continuation Plan (SCP)
 
      July 1, 2007
 
July 2, 2006
 
July 1, 2007
 
July 2, 2006
 
   
(In thousands)
 
(In thousands)
 
Service cost
 
$
66
 
$
67
 
$
132
 
$
134
 
Interest cost
   
224
   
212
   
448
   
425
 
Amortization of transition obligation
   
55
   
55
   
110
   
110
 
Amortization of prior service cost
   
12
   
12
   
24
   
24
 
Amortization of (gain)/loss
   
72
   
80
   
144
   
160
 
Net periodic benefit cost
 
$
429
 
$
426
 
$
858
 
$
853
 





- 13 -


NOTE 9 - DISCONTINUED OPERATIONS

As discussed above in Note 2, in the second quarter of 2007, the Company committed to a plan to exit its Fabrics Group business segment, and in the third quarter of 2007, the Company completed the sale. Therefore, the results for the Fabrics Group business segment have been reported as discontinued operations. In connection with this action, the Company also recorded write-downs for the impairment of assets and goodwill of $17.4 million and $44.5 million, respectively, in the first six months of 2007. In connection with the sale, the Company recorded the aforementioned impairments to reduce the carrying value of the business segment to its fair value as of July 1, 2007. In the second quarter of 2007, the Company recorded approximately $3.8 million of direct costs to sell the business segment which had been incurred through the end of the quarter. At this time, the Company also expects to incur approximately $6.0 million of additional costs in connection with the sale of the business segment. These costs are expected to be incurred before the end of 2007.

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 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 above-described discontinued operations are as follows:

   
     Three Months Ended    
 
       Six Months Ended              
 
   
July 1, 2007
 
July 2, 2006
 
July 1, 2007
 
July 2, 2006
 
   
(In thousands)
 
(In thousands)
 
Net sales
 
$
35,906
 
$
35,494
 
$
71,732
 
$
87,994
 
Loss on operations before taxes on income
   
(18,962
)
 
(3,986
)
 
(69,380
)
 
(26,547
)
Tax benefit
   
6,637
   
1,395
   
7,370
   
1,439
 
Loss on operations, net of tax
   
(12,325
)
 
(2,591
)
 
(62,010
)
 
(25,108
)

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

   
July 1, 2007
 
December 31, 2006
 
   
(In thousands)
 
Current assets
 
$
49,146
 
$
54,156
 
Property and equipment
   
41,938
   
54,094
 
Other assets
   
1,110
   
50,072
 
Current liabilities
   
14,962
   
11,181
 
Other liabilities
   
7,544
   
11,753
 

NOTE 10 - RESTRUCTURING

During the first quarter of 2006, the Company recorded a pre-tax restructuring charge of $3.3 million. The charge reflected: (i) the consolidation and closure of a fabrics manufacturing facility in East Douglas, Massachusetts; (ii) workforce reduction at this facility; and (iii) a reduction in carrying value of another fabrics facility and other assets. These activities were expected to reduce excess capacity in the Company’s dyeing and finishing operations and improve overall manufacturing efficiency.

A summary of the restructuring activities is presented below:

     
    TOTAL    
 
     
(In thousands)
 
 
Facilities consolidation
 
$
1,000
 
 
Workforce reduction
   
300
 
 
Other impaired assets
   
1,960
 
     
$
3,260
 

Of the total restructuring charge, approximately $0.3 million related to expenditures for severance benefits and other similar costs, and $3.0 million related to non-cash charges, primarily for the write-down of carrying value and disposal of certain assets. As of July 1, 2007, there are no significant cash payments or other activities remaining under the plan, as the plan was substantially completed by the end of 2006.

- 14 -

Because the restructuring charge is related to the Fabrics Group business segment, it has been included in discontinued operations in the consolidated condensed statement of operations for the first six months of 2006.


NOTE 11 - IMPAIRMENT OF GOODWILL AND OTHER ASSETS

In the first quarter of 2007, the Company recorded charges for impairment of goodwill of $44.5 million and impairment of other intangible assets of $3.8 million related to its Fabrics Group business segment. The Company was exploring possible strategic options with respect to its fabrics business, and its analyses indicated that the carrying value of the assets of the fabrics business exceeded their fair value. When such an indication is present, the Company measures potential goodwill and other asset impairments based on an allocation of the estimated fair value of the reporting unit to its underlying assets and liabilities. An impairment loss is recognized to the extent that the reporting unit’s recorded goodwill exceeds the implied fair value of goodwill. In addition to the impairment of goodwill, the Company determined that the other intangible assets of the business unit were impaired as well. As discussed above in Note 2, in the second quarter of 2007, the Company entered into an agreement to sell its fabrics business unit for approximately $70.0 million. As a result of this agreed-upon purchase price, the Company recorded an impairment of assets of approximately $13.6 million in the second quarter of 2007. This impairment was determined based upon the fair value of the business unit as compared to the fair value represented by the purchase price. Given the nature of the Company’s assets and liabilities, the impairment charge was a reduction of carrying value of property, plant and equipment, as it was determined that all other assets were carried at a value approximating fair value. These impairment charges have been included in discontinued operations in the consolidated condensed statement of operations for the first six months of 2007.

During the first quarter of 2006, in connection with the sale of its European fabrics business (described in more detail above in Note 2), the Company recorded a charge of $20.7 million for the impairment of goodwill related to its fabrics reporting unit and those European operations. This charge was based on a review of the Company’s carrying value of goodwill at its fabrics facilities as compared to the potential fair value as represented by the proposed sale price. This impairment charge has been included in discontinued operations in the consolidated condensed statement of operations for the first six months of 2006.


NOTE 12 - SALE OF PANDEL, INC.
 
On March 7, 2007, the Company sold its subsidiary Pandel, Inc. for $1.4 million to an entity formed by the general manager of Pandel. The operations of Pandel represent the Company’s Specialty Products segment. Pandel primarily produces vinyl carpet tile backing and specialty mat and foam products. As a result of this sale, the Company recorded a loss on disposition of $1.9 million in the first quarter of 2007. The total assets of this business were $3.3 million, comprised primarily of inventory and accounts receivable. Total liabilities related to this business were $0.4 million. In the second quarter of 2006, Pandel had net sales of $2.8 million. In the first six months of 2007 and 2006, Pandel had net sales of $2.2 million and $5.9 million, respectively. Prior to the sale, certain of Pandel’s production assets were conveyed to another subsidiary of the Company, where they will continue to be used in its carpet tile backing process.


NOTE 13 - SUPPLEMENTAL CASH FLOW INFORMATION

Cash payments for interest amounted to $19.2 million and $22.0 million for the six months ended July 1, 2007, and July 2, 2006, respectively. Income tax payments amounted to $8.3 million and $6.7 million for the six months ended July 1, 2007, and July 2, 2006, respectively.


NOTE 14 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115.” This standard permits an entity to choose to measure certain financial assets and liabilities at fair value. SFAS No. 159 also revises provisions of SFAS No. 115 that apply to available-for-sale and trading securities. This statement is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the effect, if any, that the adoption of this pronouncement will have on its consolidated financial statements.


- 15 -


In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the effect, if any, that the adoption of this pronouncement will have on its consolidated financial statements.

In September 2006, the Emerging Issues Task Force (“EITF”) of the FASB reached consensus on EITF Issue No. 06-04, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements” (“EITF 06-04”). The scope of EITF 06-04 is limited to the recognition of a liability and related compensation costs for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to postretirement periods. EITF 06-04 is effective for fiscal years beginning after December 15, 2007, and the Company is currently evaluating the effect of this standard on its consolidated financial statements.

In June 2006, the EITF reached a consensus on Issue No. 06-03, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)” (“EITF 06-03”). EITF 06-03 concludes that (a) the scope of this issue includes any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer, and (b) the presentation of taxes within the scope on either a gross or a net basis is an accounting policy decision that should be disclosed under Opinion 22. Furthermore, EITF 06-03 states that for taxes reported on a gross basis, a company should disclose the amounts of those taxes in interim and annual financial statements for each period for which an income statement is presented. The consensus, which requires only disclosure changes, is effective for periods beginning after December 15, 2006. As the Company has historically recognized such taxes on a net basis, the adoption of this standard did not have a material effect on its results of operations or financial position.


NOTE 15 - INCOME TAXES

In July 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes.” In summary, FIN 48 requires that all tax positions subject to SFAS No. 109, “Accounting for Income Taxes,” be analyzed using a two-step approach. The first step requires an entity to determine if a tax position is more-likely-than-not to be sustained upon examination. In the second step, the tax benefit is measured as the largest amount of benefit, determined on a cumulative probability basis, that is more-likely-than-not to be realized upon ultimate settlement. FIN 48 was effective as of January 1, 2007, with any adjustment in a company’s tax provision being accounted for as a cumulative effect of accounting change in beginning equity. On January 1, 2007, the Company adopted the provisions of FIN 48. As required by FIN 48, the cumulative effect of applying the provisions of the Interpretation have been reported as an adjustment to the Company’s retained earnings balance as of January 1, 2007. The Company recognized a $4.6 million increase in its liability for unrecognized tax benefits with a corresponding decrease to the fiscal year 2007 opening balance of retained earnings.

There have been no material changes to the Company’s unrecognized tax benefits during the six months ended July 1, 2007.
 

NOTE 16 - 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.

- 16 -



INTERFACE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED JULY 1, 2007


   
GUARANTOR SUBSIDIARIES
 
NON-GUARANTOR SUBSIDIARIES
 
INTERFACE, INC.
(PARENT CORPORATION)
 
CONSOLIDATION AND ELIMINATION ENTRIES
 
CONSOLIDATED TOTALS
 
   
(IN THOUSANDS)
 
Net sales
 
$
168,050
 
$
131,650
 
$
--
 
$
(34,738
)
$
264,962
 
Cost of sales
   
122,547
   
84,928
   
--
   
(34,738
)
 
172,737
 
Gross profit on sales
   
45,503
   
46,722
   
--
   
--
   
92,225
 
Selling, general and administrative expenses
   
27,261
   
24,696
   
9,375
   
--
   
61,332
 
Operating income (loss)
   
18,242
   
22,026
   
(9,375
)
 
--
   
30,893
 
Interest/Other expense
   
2,146
   
2,035
   
5,592
   
--
   
9,773
 
Income (loss) before taxes on income and equity in income of subsidiaries
   
16,096
   
19,991
   
(14,967
)
 
--
   
21,120
 
Income tax (benefit) expense
   
12,337
   
5,296
   
(9,836
)
 
--
   
7,797
 
Equity in income (loss) of subsidiaries
   
--
   
--
   
6,129
   
(6,129
)
 
--
 
Income (loss) from continuing operations
   
3,759
   
14,695
   
998
   
(6,129
)
 
13,323
 
Loss on discontinued operations, net of tax
   
(12,325
)
 
--
   
--
   
--
   
(12,325
)
Net income (loss)
 
$
(8,566
)
$
14,695
 
$
998
 
$
(6,129
)
$
998
 



- 17 -



CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JULY 1, 2007

   
GUARANTOR
SUBSIDIARIES
 
NON-
GUARANTOR
SUBSIDIARIES
 
INTERFACE, INC.
(PARENT
CORPORATION)
 
CONSOLIDATION
AND
ELIMINATION
ENTRIES
 
CONSOLIDATED
TOTALS
 
   
(IN THOUSANDS)
 
Net sales
 
$
317,133
 
$
254,818
 
$
--
 
$
(63,497
)
$
508,454
 
Cost of sales
   
230,809
   
165,689
   
--
   
(63,497
)
 
333,001
 
Gross profit on sales
   
86,324
   
89,129
   
--
   
--
   
175,453
 
Selling, general and administrative
                               
expenses
   
47,373
   
53,791
   
17,215
   
--
   
118,379
 
Loss on disposal - Specialty Products
   
1,873
   
--
   
--
   
--
   
1,873
 
Operating income (loss)
   
37,078
   
35,338
   
(17,215
)
 
--
   
55,201
 
Interest/Other expense
   
3,340
   
3,086
   
12,890
   
--
   
19,316
 
Income (loss) before taxes on income
                               
and equity in income of subsidiaries
   
33,738
   
32,252
   
(30,105
)
 
--
   
35,885
 
Income tax (benefit) expense
   
17,085
   
10,330
   
(13,922
)
 
--
   
13,493
 
Equity in income (loss) of subsidiaries
   
--
   
--
   
(23,435
)
 
23,435
   
--
 
Income (loss) from
                               
continuing operations
   
16,653
   
21,922
   
(39,618
)
 
23,435
   
22,392
 
Income (loss) on discontinued operations, net of tax
   
(62,010
)
 
--
   
--
   
--
   
(62,010
)
Net income (loss)
 
$
(45,357
)
$
21,922
 
$
(39,618
)
$
23,435
 
$
(39,618
)


- 18 -


CONDENSED CONSOLIDATING BALANCE SHEET

JULY 1, 2007

   
GUARANTOR SUBSIDIARIES
 
NON-GUARANTOR SUBSIDIARIES
 
INTERFACE, INC.
(PARENT CORPORATION)
 
CONSOLIDATION AND ELIMINATION ENTRIES
 
CONSOLIDATED TOTALS
 
   
(IN THOUSANDS)
 
ASSETS
                     
Current Assets:
                               
Cash and cash equivalents
 
$
350
 
$
25,132
 
$
63,864
 
$
--
 
$
89,346
 
Accounts receivable
   
67,627
   
80,960
   
3,447
   
--
   
152,034
 
Inventories
   
64,907
   
63,539
   
--
   
--
   
128,446
 
Prepaids and deferred income taxes
   
8,279
   
11,345
   
8,385
   
--
   
28,009
 
Assets of business held for sale
   
91,003
   
1,191
   
--
   
--
   
92,194
 
Total current assets
   
232,166
   
182,167
   
75,696
   
--
   
490,029
 
Property and equipment less accumulated depreciation
   
67,530
   
73,401
   
5,677
   
--
   
146,608
 
Investment in subsidiaries
   
196,375
   
148,058
   
74,107
   
(418,540
)
 
--
 
Goodwill
   
68,168
   
68,965
   
--
   
--
   
137,133
 
Other assets
   
10,999
   
24,378
   
89,956
   
--
   
125,333
 
   
$
575,238
 
$
496,969
 
$
245,436
 
$
(418,540
)
$
899,103
 
                                 
LIABILITIES AND SHAREHOLDERS' EQUITY
                               
Current Liabilities
 
$
79,675
 
$
89,569
 
$
90,295
 
$
--
 
$
259,539
 
Long-term debt, less current maturities
   
8,765
   
--
   
--
   
--
   
8,765
 
Senior notes and senior subordinated notes
   
--
   
--
   
310,000
   
--
   
310,000
 
Deferred income taxes
   
6,683
   
6,395
   
(4,882
)
 
--
   
8,196
 
Other
   
4,065
   
44,358
   
16,788
   
--
   
65,211
 
Total liabilities
   
99,188
   
140,322
   
412,201
   
--
   
651,711
 
                                 
Minority interests
   
1,624
   
4,869
   
--
   
--
   
6,493
 
                                 
Redeemable preferred stock
   
57,891
   
--
   
--
   
(57,891
)
 
--
 
Common stock
   
94,145
   
102,199
   
6,146
   
(196,344
)
 
6,146
 
Additional paid-in capital
   
191,411
   
12,525
   
329,799
   
(203,936
)
 
329,799
 
Retained earnings (deficit)
   
132,138
   
280,657
   
(493,919
)
 
39,631
   
(41,493
)
Foreign currency translation adjustment
   
(1,159
)
 
(191
)
 
(5,304
)
 
--
   
(6,654
)
Pension liability
   
--
   
(43,412
)
 
(3,487
)
 
--
   
(46,899
)
   
$
575,238
 
$
496,969
 
$
245,436
 
$
(418,540
)
$
899,103
 
                                 


- 19 -


CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS
ENDED JULY 1, 2007

   
GUARANTOR SUBSIDIARIES
 
NON-GUARANTOR SUBSIDIARIES
 
INTERFACE, INC.
(PARENT CORPORATION)
 
CONSOLIDATION AND ELIMINATION ENTRIES
 
CONSOLIDATED TOTALS
 
   
(IN THOUSANDS)
 
Net cash provided by (used for) operating activities
 
$
50,905
 
$
(13,490
)
$
(13,860
)
$
--
 
$
23,555
 
Cash flows from investing activities:
                               
Purchase of plant and equipment
   
(13,092
)
 
(4,345
)
 
(510
)
 
--
   
(17,947
)
Investing cash flow from discontinued operations
   
(6,015
)
 
--
   
--
   
--
   
(6,015
)
Other
   
241
   
--
   
(7,404
)
 
--
   
(7,163
)
Net cash used for investing activities
   
(18,866
)
 
(4,345
)
 
(7,914
)
 
--
   
(31,125
)
Cash flows from financing activities:
                               
Net borrowings
   
--
   
8,743
   
--
   
--
   
8,743
 
Repurchase of senior notes
   
--
   
--
   
(22,400
)
 
--
   
(22,400
)
Proceeds from issuance of common stock
   
--
   
--
   
2,773
   
--
   
2,773
 
Dividends paid
   
--
   
--
   
(2,450
)
 
--
   
(2,450
)
Net cash provided by (used for) financing activities
   
--
   
8,743
   
(22,077
)
 
--
   
(13,334
)
Effect of exchange rate change on cash
   
--
   
1,093
   
--
   
--
   
1,093
 
Net increase (decrease) in cash
   
32,039
   
(7,999
)
 
(43,851
)
 
--
   
(19,811
)
Cash at beginning of period
   
5,338
   
33,131
   
70,688
   
--
   
109,157
 
Cash at end of period
 
$
37,377
 
$
25,132
 
$
26,837
 
$
--
 
$
89,346
 


- 20 -


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Our discussions below in this Item 2 are based upon the more detailed discussions about our business, operations and financial condition included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006, under Item 7 of that Form 10-K. Our discussions here focus on our results during the quarter ended, or as of, July 1, 2007, and the comparable period of 2006 for comparison purposes, and, to the extent applicable, any material changes from the information discussed in that Form 10-K or other important intervening developments or information since that time. These discussions should be read in conjunction with that Form 10-K for more detailed and background information.

Forward-Looking Statements

This report contains statements which may constitute "forward-looking statements" within the meaning of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended by the Private Securities Litigation Reform Act of 1995. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements include risks and uncertainties associated with economic conditions in the commercial interiors industry as well as the risks and uncertainties discussed under the heading “Risk Factors” included in Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006, which discussion is 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.

Sale of Fabrics Group Business Segment

In July 2007, subsequent to the end of the second quarter of 2007, we completed the sale of our Fabrics Group business segment to a third party pursuant to an agreement we entered into in the second quarter of 2007. Following working capital and other adjustments provided for in the agreement, we received $60.7 million in cash at the closing of the transaction. We may receive up to $6.5 million of additional purchase price under the agreement pursuant to an earn-out arrangement focused on the performance of that business segment, as owned and operated by the purchaser, during the 18-month period following the closing. As discussed in the Notes to Consolidated Condensed Financial Statements in Item 1 of Part 1, in the first quarter of 2007, we recorded charges for impairment of goodwill of $44.5 million and impairment of other intangible assets of $3.8 million related to the Fabrics Group segment. In addition, as a result of the agreed-upon purchase price for the segment, we recorded an additional impairment of assets of approximately $13.6 million in the second quarter of 2007.

Previously, in April 2006, we sold our European component of the fabrics business (Camborne Holdings Limited) for $28.8 million to an entity formed by the business’s management team. In connection with the sale, we recorded a pre-tax non-cash charge of $20.7 million for the impairment of goodwill in the first quarter of 2006 and a loss on disposal of $1.7 million in the second quarter of last year. For the first six months of 2006, the European fabrics business generated revenue of $17.3 million and operating loss (after the $20.7 million impairment of goodwill charge) of $19.6 million.

As described below, the results of operations of the former Fabrics Group business segment, including the European component as well as the related impairment charges and loss on disposal discussed above, are included as part of our discontinued operations.

Discontinued Operations

As described above, in the second quarter of 2007, we entered into an agreement to sell our Fabrics Group business segment to a third party, and we completed the sale in the third quarter of 2007. In addition, in 2004, we decided to exit our owned Re:Source dealer businesses, which were part of a broader network comprised of both owned and aligned dealers that sell and install floorcovering products, and began to dispose of several of our dealer subsidiaries. We now have sold or terminated all ongoing operations of our dealer businesses, and in some cases we are completing their wind-down through subcontracting arrangements.

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we have reported the results of operations for the Re:Source dealer businesses (as well as the results of operations of a small Australian dealer business and a small residential fabrics business that we also decided to exit at that time), and the results of operations for the former Fabrics Group business segment (including the European component which was sold in April 2006), for all periods reflected herein, as “discontinued operations.” Consequently, our discussion of revenues or sales and other results of operations (except for net income or loss amounts), including percentages derived from or based on such amounts, excludes these discontinued operations unless we indicate otherwise.

- 21 -



Our discontinued operations had net sales of $35.9 million and $35.5 million in the three-month periods ended July 1, 2007, and July 2, 2006, respectively, and had net sales of $71.7 million and $88.0 million in the six months ended July 1, 2007, and July 2, 2006, respectively (these results are included in our statements of operations as part of the “Loss from Discontinued Operations, Net of Taxes”). Loss from operations of these businesses, net of tax, was $12.3 million and $2.6 million in the three-month periods ended July 1, 2007 and July 2, 2006, respectively, and $62.0 million and $25.1 million in the six months ended July 1, 2007, and July 2, 2006, respectively.

Restructuring Charge

We recorded a pre-tax restructuring charge of $3.3 million in the first quarter of 2006. The charge reflected: (1) the closure of our fabrics manufacturing facility in East Douglas, Massachusetts, and consolidation of those operations into our facility in Elkin, North Carolina; (2) workforce reduction at the East Douglas, Massachusetts facility; and (3) a reduction in carrying value of another fabrics facility and other assets. The restructuring charge was comprised of $0.3 million of cash expenditures for severance benefits and other similar costs, and $3.0 million of non-cash charges, primarily for the write-down of carrying value and disposal of assets. Because this restructuring charge related to the Fabrics Group business segment, it is now included as part of our discontinued operations.

General

During the quarter ended July 1, 2007, we had net sales of $265.0 million, compared with net sales of $223.2 million in the second quarter last year. Fluctuations in currency exchange rates positively impacted 2007 second quarter sales by 2% (approximately $6 million), compared with the prior year period. During the first six months of fiscal 2007, we had net sales of $508.5 million, compared with net sales of $421.3 million in the first six months of last year. Fluctuations in currency exchange rates positively impacted sales in the first six months of 2007 by 3% (approximately $13 million), compared with the prior year period.

During the second quarter of 2007, after the impairment charge described above, we had net income of $1.0 million, or $0.02 per diluted share, compared with net income of $5.9 million, or $0.11 per diluted share, in the second quarter last year. The 2006 second quarter results included a loss on disposal of discontinued operations (net of tax) of $1.7 million, or $0.03 per diluted share.

In the first quarter of this year, we sold our Pandel, Inc. business for $1.4 million and recorded a loss of $1.9 million on this sale. (Pandel comprised the Company’s Specialty Products segment.) The impairment of assets related to the sale of the Fabrics Group business segment and the loss on disposal of Pandel, Inc. led to our net loss of $39.6 million, or $0.64 per diluted share, during the first six months of 2007. The goodwill impairment and restructuring charges described above led to our net loss of $11.2 million, or $0.21 per share, during the first six months of 2006.

- 22 -



Results of Operations

The following table presents, as a percentage of net sales, certain items included in our Consolidated Condensed Statements of Operations for the three-month and six-month periods ended July 1, 2007, and July 2, 2006, respectively:

   
Three Months Ended
 
Six Months Ended
 
 
 
July 1, 2007
 
July 2, 2006
 
July 1, 2007
 
July 2, 2006
 
                   
Net sales
   
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
Cost of sales
   
65.2
   
66.1
   
65.5
   
65.9
 
Gross profit on sales
   
34.8
   
33.9
   
34.5
   
34.1
 
Selling, general and administrative expenses
   
23.2