form10-q.htm



SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

þ
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For Quarterly Period Ended September 28, 2008

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 þ    No o

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

Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o
Smaller reporting company 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 þ

Shares outstanding of each of the registrant’s classes of common stock at October 31, 2008:

Class
 
Number of Shares
 
Class A Common Stock, $.10 par value per share
    56,374,393  
Class B Common Stock, $.10 par value per share
    6,720,051  



 
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INTERFACE, INC.

INDEX
   
PAGE
PART I.
FINANCIAL INFORMATION
 
 
Item 1.
Financial Statements
3
   
Consolidated Condensed Balance Sheets – September 28, 2008 and
December 30, 2007
 
3
   
Consolidated Condensed Statements of Operations – Three Months and Nine Months
Ended September 28, 2008 and September 30, 2007
 
4
   
Consolidated Statements of Comprehensive Income (Loss) – Three Months and Nine Months
Ended September 28, 2008 and September 30, 2007
 
5
   
Consolidated Condensed Statements of Cash Flows – Nine Months Ended September 28, 2008
and September 30, 2007
 
6
   
Notes to Consolidated Condensed Financial Statements
 
7
 
Item 2.
 
Management’s Discussion and Analysis of Financial Condition
and Results of Operations
 
20
 
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
25
 
Item 4.
Controls and Procedures
25
     
PART II.
OTHER INFORMATION
 
 
Item 1.
Legal Proceedings
26
 
Item 1A.
Risk Factors
26
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
26
 
Item 3.
Defaults Upon Senior Securities
26
 
Item 4.
Submission of Matters to a Vote of Security Holders
26
 
Item 5.
Other Information
26
 
Item 6.
Exhibits
26



 
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

INTERFACE, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
 (IN THOUSANDS)
   
SEPTEMBER 28, 2008
   
DECEMBER 30, 2007
 
   
(UNAUDITED)
       
ASSETS
           
CURRENT ASSETS:
           
Cash and Cash Equivalents
  $ 85,521     $ 82,375  
Accounts Receivable, net
    165,350       178,625  
Inventories
    145,494       125,789  
Prepaid and Other Expenses
    20,462       18,985  
Deferred Income Taxes
    5,304       5,863  
Assets of Business Held for Sale
    3,180       4,792  
TOTAL CURRENT ASSETS
    425,311       416,429  
                 
PROPERTY AND EQUIPMENT, less accumulated depreciation   
    166,891       161,874  
DEFERRED TAX ASSET
    57,928       60,942  
GOODWILL
    143,153       142,471  
OTHER ASSETS
    50,662       53,516  
TOTAL ASSETS
  $ 843,945     $ 835,232  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
CURRENT LIABILITIES:
               
Accounts Payable
  $ 60,501     $ 57,243  
Accrued Expenses
    97,366       120,388  
Current Portion of Long-Term Debt
    --       --  
Liabilities of Business Held for Sale
    27       220  
TOTAL CURRENT LIABILITIES
    157,894       177,851  
                 
LONG-TERM DEBT, less current maturities
    --       --  
SENIOR NOTES
    175,000       175,000  
SENIOR SUBORDINATED NOTES
    135,000       135,000  
DEFERRED INCOME TAXES
    7,389       7,413  
OTHER
    37,791       38,852  
TOTAL LIABILITIES
    513,074       534,116  
                 
Minority Interest
    7,732       6,974  
                 
Commitments and Contingencies
               
                 
SHAREHOLDERS’ EQUITY:
               
Preferred Stock
    --       --  
Common Stock
    6,306       6,184  
Additional Paid-In Capital
    338,960       332,650  
Retained Earnings (Deficit)
    15,579       (15,159 )
Accumulated Other Comprehensive Income – Foreign Currency Translation Adjustment
    (7,338 )     1,270  
Accumulated Other Comprehensive Income – Pension Liability
    (30,368 )     (30,803 )
TOTAL SHAREHOLDERS' EQUITY
    323,139       294,142  
    $ 843,945     $ 835,232  

See accompanying notes to consolidated condensed financial statements.

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

(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)

   
THREE MONTHS ENDED
   
NINE MONTHS ENDED
 
                         
   
SEPT. 28, 2008
   
SEPT. 30, 2007
   
SEPT. 28, 2008
   
SEPT. 30, 2007
 
                         
NET SALES
  $ 278,423     $ 279,471     $ 835,164     $ 787,925  
Cost of Sales
    183,506        181,542       540,688         514,543  
                                 
GROSS PROFIT ON SALES
    94,917       97,929       294,476       273,382  
Selling, General and Administrative Expenses
    63,895       63,179       199,047       181,558  
Loss on Disposition – Specialty Products
    --       --       --       1,873  
OPERATING INCOME
    31,022       34,750       95,429       89,951  
                                 
Interest Expense
    8,173       8,643       24,109       26,924  
Other Expense
    804       1,281       1,415        2,316  
                                 
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAX EXPENSE
    22,045       24,826       69,905       60,711  
Income Tax Expense
    8,461       9,620       26,323        23,113  
                                 
Income from Continuing Operations
    13,584       15,206       43,582       37,598  
Loss from Discontinued Operations, Net of Tax
    (5,154 )     (6,650 )     (5,154 )     (68,660 )
Loss on Disposal of Discontinued Operations, Net of Tax
    --       --       --        --  
NET INCOME (LOSS)
  $ 8,430     $ 8,556     $ 38,428     $ (31,062 )
                                 
Earnings (Loss) Per Share – Basic
                               
Continuing Operations
  $ 0.22     $ 0.25     $ 0.71     $ 0.62  
Discontinued Operations
    (0.08 )     (0.11 )     (0.08 )     (1.13 )
Loss on Disposal of Discontinued Operations
    --       --       --       --  
Earnings (Loss) Per Share – Basic
  $ 0.14     $ 0.14     $ 0.63     $ (0.51 )
                                 
Earnings (Loss) Per Share – Diluted
                               
Continuing Operations
  $ 0.22     $ 0.25     $ 0.70     $ 0.61  
Discontinued Operations
    (0.08 )     (0.11 )     (0.08 )     (1.11 )
Loss on Disposal of Discontinued Operations
    --       --       --       --  
Earnings (Loss) Per Share – Diluted
  $ 0.14     $ 0.14     $ 0.62     $ (0.50 )
                                 
Common Shares Outstanding – Basic
    61,576       60,711       61,475       60,448  
Common Shares Outstanding – Diluted
    62,070       61,860       61,988       61,590  

See accompanying notes to consolidated condensed financial statements.

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

(IN THOUSANDS)

   
THREE MONTHS ENDED
   
NINE MONTHS ENDED
 
             
   
SEPT. 28, 2008
   
SEPT. 30, 2007
   
SEPT. 28, 2008
   
SEPT. 30, 2007
 
                         
Net Income (Loss)
  $ 8,430     $ 8,556     $ 38,428     $ (31,062 )
Other Comprehensive Income (Loss), Foreign
                               
Currency Translation Adjustment and Pension Liability Adjustment
     (19,024 )     5,817       (8,173 )      12,285  
Comprehensive Income (Loss)
  $ (10,594 )   $ 14,373     $ 30,255     $ (18,777 )


See accompanying notes to consolidated condensed financial statements.

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

(IN THOUSANDS)

   
NINE MONTHS ENDED
 
   
SEPT. 28, 2008
   
SEPT. 30, 2007
 
OPERATING ACTIVITIES:
           
Net Income (Loss)
  $ 38,428     $ (31,062 )
Loss from Discontinued Operations
    5,154       68,660  
Income from Continuing Operations
    43,582       37,598  
Adjustments to Reconcile Income to Cash Provided by Operating Activities:
               
Loss on Disposition of Assets – Specialty Products
    --       1,873  
Depreciation and Amortization
    17,656       17,089  
Deferred Income Taxes and Other
    4,161       --  
Working Capital Changes:
               
Accounts Receivable
    10,286       (19,943 )
Inventories
    (21,781 )     (10,821 )
Prepaid Expenses
    (549 )     5,217  
Accounts Payable and Accrued Expenses
    (17,761 )     12,479  
                 
Cash Provided by Continuing Operations
    35,594       43,942  
Cash Used in Discontinued Operations
    --       (1,884 )
                 
CASH PROVIDED BY OPERATING ACTIVITIES:
    35,594       42,058  
                 
INVESTING ACTIVITIES:
               
Capital Expenditures
    (20,741 )     (27,523 )
Other
    (5,636 )     (8,404 )
Proceeds from Sale of Fabrics Business
    --       60,732  
Cash Provided by (Used in) Investing Activities of Continuing Operations
    (26,377 )     24,805  
Cash Used in Discontinued Operations
    --       (6,950 )
                 
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES:
    (26,377 )     17,855  
                 
FINANCING ACTIVITIES:
               
Net Borrowing of Long-Term Debt
    --       7,169  
Repurchase of Senior Notes
    --       (101,365 )
Proceeds from Issuance of Common Stock
    1,393       3,621  
Dividends Paid
    (5,669 )     (3,683 )
                 
CASH USED IN FINANCING ACTIVITIES:
    (4,276 )     (94,258 )
                 
Net Cash Provided by (Used in) Operating, Investing and
               
Financing Activities
    4,941       (34,345 )
Effect of Exchange Rate Changes on Cash
    (1,795 )     2,718  
                 
CASH AND CASH EQUIVALENTS:
               
Net Change During the Period
    3,146       (31,627 )
Balance at Beginning of Period
    82,375       109,157  
                 
Balance at End of Period
  $ 85,521     $ 77,530  


See accompanying notes to consolidated condensed financial statements.


 
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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 30, 2007, 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 30, 2007, 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 $67.2 million, after working capital and certain other adjustments. Of this $67.2 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 18 months following the sale.  During the third quarter of 2008, the Company determined that the receipt of this deferred amount is less than probable and therefore incurred an after-tax charge of $4.2 million related to a full reserve against the deferred amount.  As described below in Notes 9 and 10, the Company incurred impairment charges of approximately $61.9 million during the first nine months of 2007 (none of which was incurred in the third quarter of 2007) to reduce the carrying value of the business segment to fair value as represented by the purchase price.  In the second and third quarters of 2007, the Company incurred approximately $12.4 million of direct costs to sell the business segment ($8.8 million of which was incurred in the third quarter of 2007).  The major classes of assets and liabilities related to the business segment at disposition were accounts receivable of $15.2 million, inventory of $32.7 million, property, plant and equipment of $36.5 million, and accounts payable and accruals of $11.4 million.  In the third quarter of 2008, the Company recorded a charge of $0.9 million, after tax, to reduce the carrying value of certain assets remaining from the segment that are held for sale to their realizable values.

Prior periods have been restated to include the results of operations and related disposal costs, gains and losses for this business segment as discontinued operations.  In addition, assets and liabilities of this business segment have been reported in assets and liabilities held for sale for all reported periods.

NOTE 3 – INVENTORIES

Inventories are summarized as follows:

   
September 28, 2008
   
December 30, 2007
 
   
(In thousands)
 
Finished Goods
  $ 87,100     $ 77,036  
Work in Process
    22,820       17,347  
Raw Materials
    35,574       31,406  
    $ 145,494     $ 125,789  


 
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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 September 28, 2008, and September 30, 2007, outstanding options to purchase 220,000 and 30,000 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 nine months ended September 28, 2008 and September 30, 2007, outstanding options to purchase 195,000 and 50,000 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)
 
September 28, 2008
  $ 8,430       61,576     $ 0.14  
Effect of Dilution:
                       
Options and Restricted Stock
    --       494       --  
                         
Diluted
  $ 8,430       62,070     $ 0.14  
                         
September 30, 2007
  $ 8,556       60,711     $ 0.14  
Effect of Dilution:
                       
Options and Restricted Stock
    --       1,149       --  
                         
Diluted
  $ 8,556       61,860     $ 0.14  
       
For the Nine-Month
Period Ended
 
Net Income (Loss)
   
Average Shares
Outstanding
   
Earnings (Loss)
Per Share
 
   
(In Thousands Except Per Share Amounts)
 
September 28, 2008
  $ 38,428       61,475     $ 0.63  
Effect of Dilution:
                       
Options and Restricted Stock
    --       513       (0.01 )
                         
Diluted
  $ 38,428       61,988     $ 0.62  
                         
September 30, 2007
  $ (31,062 )     60,448     $ (0.51 )
Effect of Dilution:
                       
Options and Restricted Stock
    --       1,142       0.01  
                         
Diluted
  $ (31,062 )     61,590     $ (0.50 )

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 11 for further information).  In June of 2007, the Company entered into an agreement to sell its former Fabrics Group business segment, and the sale was completed in the third quarter of 2007 (see Note 2 for further information).  Accordingly, the Company has included the operations of the former Fabrics Group business segment in discontinued operations. 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 30, 2007, 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 September 28, 2008
                       
Net Sales
  $ 242,986     $ 35,437       --     $ 278,423  
Depreciation and Amortization
    3,917       622       --       4,539  
Operating Income
    30,297       725       --       31,022  
                                 
Three Months Ended September 30, 2007
                               
Net Sales
  $ 242,889     $ 36,582       --     $ 279,471  
Depreciation and Amortization
    3,546       473       --       4,019  
Operating Income
    35,187       1,259       --       36,446  

   
Modular
Carpet
   
Bentley
Prince Street
   
Specialty
Products
   
Total
 
   
(In thousands)
 
Nine Months Ended September 28, 2008
                       
Net Sales
  $ 728,372     $ 106,792       --     $ 835,164  
Depreciation and Amortization
    11,277       1,762       --       13,039  
Operating Income
    96,530       2,514       --       99,044  
                                 
Nine Months Ended September 30, 2007
                               
Net Sales
  $ 673,666     $ 112,067     $ 2,192     $ 787,925  
Depreciation and Amortization
    10,725       1,406       12       12,143  
Operating Income (Loss)
    93,568       4,226       (1,733 )     96,061  

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
 
   
Sept. 28, 2008
   
Sept. 30, 2007
   
Sept. 28, 2008
   
Sept. 30, 2007
 
   
(In thousands)
   
(In thousands)
 
DEPRECIATION AND AMORTIZATION
                       
Total segment depreciation and amortization
  $ 4,539     $ 4,019     $ 13,039     $ 12,143  
Corporate depreciation and amortization
    1,134       1,110       4,617       4,946  
Reported depreciation and amortization
  $ 5,673     $ 5,129     $ 17,656     $ 17,089  
                                 
OPERATING INCOME
                               
Total segment operating income
  $ 31,022     $ 36,446     $ 99,044     $ 96,061  
Corporate expenses and other reconciling amounts
    --       (1,696 )     (3,615 )     (6,110 )
Reported operating income
  $ 31,022     $ 34,750     $ 95,429     $ 89,951  

 
- 9 -

 
                      



   
September 28, 2008
   
December 30, 2007
 
ASSETS
 
(In thousands)
 
Total segment assets
  $ 705,906     $ 670,515  
Discontinued operations
    3,180       4,792  
Corporate assets and eliminations
    134,859       159,925  
Reported total assets
  $ 843,945     $ 835,232  


NOTE 6 – LONG-TERM DEBT

On January 1, 2008, the Company amended its domestic revolving credit agreement (the “Facility”).  The amendment (the “First Amendment”) extended the stated maturity date of the Facility to December 31, 2012.  In addition, the applicable interest rates for LIBOR-based loans were reduced.  Interest on those loans is now charged at varying rates computed by applying a margin ranging from 1.00% to 2.00% (reduced from the range of 1.25% to 2.25%) over the applicable LIBOR rate, depending on the Company’s average excess borrowing availability during the most recently completed fiscal quarter.  The Company also is no longer required to deliver monthly financial statements to the lenders.  In light of our recent borrowing levels and in an effort to reduce unused line fees, the Company reduced the maximum aggregate amount of loans and letters of credit available to the Company at any one time from $125 million to $100 million (subject to a borrowing base, as existed prior to the First Amendment), with an option to increase that maximum aggregate amount to $150 million (the same option level that existed prior to the First Amendment) upon the satisfaction of certain conditions.  The lender group was reduced from 5 lenders to 4 lenders, and the lending commitments were reallocated among the remaining lenders.  In connection with the reduction in the number of lenders and the reallocation of lending commitments, the threshold of “Required Lenders” for purposes of certain amendments and consents under the Facility was increased from more than 50% of the aggregate amount of the lending commitments to more than 66⅔% of the aggregate amount of the lending commitments.

The Company is presently in compliance with all covenants under the Facility and anticipates that it will remain in compliance with the covenants for the foreseeable future.

As of September 28, 2008, there were zero borrowings and $9.9 million in letters of credit outstanding under the Facility.  As of September 28, 2008, the Company could have incurred $65.6 million of additional borrowings under the Facility.

Interface Europe B.V. (the Company’s modular carpet subsidiary based in the Netherlands) and certain of its subsidiaries maintain a Credit Agreement with ABN AMRO Bank N.V. Under this Credit Agreement, ABN AMRO provides a credit facility for borrowings and bank guarantees in varying aggregate amounts over time.  As of September 28, 2008, there were no borrowings outstanding under this facility, and the Company could have incurred €21.0 million (approximately $30.7 million) of additional borrowings under the facility.

Other non-U.S. subsidiaries of the Company have an aggregate of the equivalent of $16.1 million of lines of credit available.  No amounts were outstanding under these lines of credit as of September 28, 2008.

As of September 28, 2008, the estimated fair values (based on then-current market prices) of the 9.5% Senior Subordinated Notes due 2014 and the 10.375% Senior Notes due 2010 were $136.4 million and $178.3 million, respectively.

Subsequent to the end of the third quarter of 2008, the Company has repurchased approximately $19.4 million of its 10.375% Senior Notes due 2010.


 
- 10 -

 
                      



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 nine months of 2008 and 2007, the Company recognized stock option compensation costs of $0.5 million and $0.3 million, respectively.  In the third quarters of fiscal years 2008 and 2007, the Company recognized stock option compensation costs of $0.2 million and $0.1 million, respectively. The remaining unrecognized stock option compensation cost related to unvested awards at September 28, 2008, approximated $0.7 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 2008 and 2007:


 
Nine Months Ended
September 28, 2008
Nine Months Ended
September 30, 2007
Risk free interest rate
3.9%
4.73%
Expected life
3.25 years
3.25 years
Expected volatility
61%
60%
Expected dividend yield
0.57%
0.51%

The weighted average grant date fair value of stock options granted during the first nine months of fiscal year 2008 was $6.21 per share.

The following table summarizes stock options outstanding as of September 28, 2008, as well as activity during the nine months then ended:
 
   
Shares
   
Weighted Average
Exercise Price
 
Outstanding at December 30, 2007
    805,000     $ 6.22  
Granted
    145,000       14.18  
Exercised
    191,500       6.32  
Forfeited or canceled
    54,500       6.03  
Outstanding at September 28, 2008 (a)
    704,000     $ 7.86  
                 
Exercisable at September 28, 2008 (b)
    529,000     $ 5.80  

(a) At September 28, 2008, the weighted average remaining contractual life of options outstanding was 3.0 years.
(b) At September 28, 2008, the weighted average remaining contractual life of options exercisable was 2.6 years.


 
- 11 -

 
                      


At September 28, 2008, the aggregate intrinsic value of options outstanding and options exercisable was $2.3 million and $2.8 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 2008 and 2007 are provided in the following table:
 
   
Nine Months Ended
 
   
Sept. 28, 2008
   
Sept. 30, 2007
 
   
(In thousands)
 
Proceeds from stock options exercised
  $ 1,393     $ 3,621  
Intrinsic value of stock options exercised
  $ 1,734     $ 7,038  

Restricted Stock Awards

During the nine months ended September 28, 2008, and September 30, 2007, the Company granted restricted stock awards for 1,012,000 and 327,000 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 $4.6 million and $5.1 million for the nine months ended September 28, 2008, and September 30, 2007, 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.

The following table summarizes restricted stock awards outstanding as of September 28, 2008, and activity during the nine months then ended:

   
Shares
   
Weighted Average
Grant Date
Fair Value
 
Outstanding at December 30, 2007
    852,000     $ 9.90  
Granted
    1,012,000     $ 14.13  
Vested
    389,000     $ 10.16  
Forfeited or canceled
    --       --  
Outstanding at September 28, 2008
    1,475,000     $ 11.87  

As of September 28, 2008, the unrecognized total compensation cost related to unvested restricted stock was $12.5 million.  That cost is expected to be recognized by the end of 2012.

NOTE 8 – EMPLOYEE BENEFIT PLANS

The following tables provide the components of net periodic benefit cost for the three-month and nine-month periods ended September 28, 2008, and September 30, 2007, respectively:

   
Three Months Ended 
   
Nine Months Ended
 
Defined Benefit Retirement Plan (Europe)
 
Sept. 28, 2008
   
Sept. 30, 2007
   
Sept. 28, 2008
   
Sept. 30, 2007
 
   
(In thousands)
   
(In thousands)
 
Service cost
  $ 687     $ 724     $ 2,080     $ 2,154  
Interest cost
    3,287       3,102       9,925       9,220  
Expected return on assets
    (3,830 )     (3,290 )     (11,569 )     (9,779 )
Amortization of prior service costs
    --       --       --       --  
Recognized net actuarial (gains)/losses
    359       702       1,087       2,087  
Amortization of transition obligation
    --       29       --       86  
Net periodic benefit cost
  $ 503     $ 1,267     $ 1,523     $ 3,768  

 
- 12 -

 
                      



   
Three Months Ended 
   
Nine Months Ended
 
Salary Continuation Plan (SCP)
 
Sept. 28, 2008
   
Sept. 30, 2007
   
Sept. 28, 2008
   
Sept. 30, 2007
 
   
(In thousands)
   
(In thousands)
 
Service cost
  $ 67     $ 66     $ 201     $ 197  
Interest cost
    237       224       712       672  
Amortization of transition obligation
    55       55       164       164  
Amortization of prior service cost
    12       12       36       36  
Amortization of loss
    74       72       221       215  
Net periodic benefit cost
  $ 445     $ 429     $ 1,334     $ 1,284  


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 nine 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 discussed in Note 2, in the third quarter of 2008, the Company incurred an after-tax charge of $4.2 million related to a reserve placed on the receipt of the contingent additional purchase price from the sale of its Fabrics Group business segment.  Also in the third quarter of 2008, the Company recorded a charge of $0.9 million, after tax, to reduce the carrying value of certain assets remaining from the segment that are held for sale to their realizable values.

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 at that time, are reported as discontinued operations.

Summary operating results for the above-described discontinued operations are as follows:

   
Three Months Ended
   
Nine Months Ended
 
   
Sept. 28, 2008
   
Sept. 30, 2007
   
Sept. 28, 2008
   
Sept. 30, 2007
 
   
(In thousands)
   
(In thousands)
 
Net sales
    --     $ 10,271       --     $ 82,003  
Loss on operations before taxes on income
    (7,856 )     (10,230 )     (7,856 )     (79,610 )
Tax benefit
    2,702       3,580       2,702       10,950  
Loss on operations, net of tax
    (5,154 )     (6,650 )     (5,154 )     (68,660 )

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

 
  September 28, 2008
   
December 30, 2007
 
   
(In thousands)
 
Current assets
  $ 24     $ 79  
Property and equipment
    3,156       4,706  
Other assets
    --       7  
Current liabilities
    27       220  
Other liabilities
    --       --  


 
- 13 -

 
                      


NOTE 10 – 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 $67.2 million (after working capital and certain other adjustments).  Of this $67.2 million, $6.5 million represents deferred purchase price which would be remitted to the Company upon the achievement of certain performance criteria by the disposed segment over the 18 months following the sale.  As a result of the agreed-upon purchase price, the Company recorded an impairment of assets of approximately $13.6 million in the second quarter of 2007.  These impairment charges have been included in discontinued operations in the consolidated condensed statement of operations for the first nine months of 2007.  During the third quarter of 2008, the Company determined that the receipt of the deferred purchase price amount is less than probable and therefore incurred an after-tax charge of $4.2 million related to a full reserve against the deferred amount.  Also in the third quarter of 2008, the Company recorded a charge of $0.9 million, after tax, to reduce the carrying value of certain assets remaining from the segment that are held for sale to their realizable values.

NOTE 11 – SALE OF PANDEL, INC.

In the first quarter of 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 first quarter of 2007, Pandel had net sales of $2.2 million.  Prior to the sale, certain of Pandel’s production assets were conveyed to another subsidiary of the Company.

NOTE 12 – SUPPLEMENTAL CASH FLOW INFORMATION

Cash payments for interest amounted to $32.3 million and $38.2 million for the nine months ended September 28, 2008, and September 30, 2007, respectively.  Income tax payments amounted to $19.3 million and $11.9 million for the nine months ended September 28, 2008, and September 30, 2007, respectively.

NOTE 13 – RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment to ARB No. 51.”  SFAS No. 160 establishes standards of accounting and reporting of noncontrolling interests in subsidiaries, currently known as minority interests, in consolidated financial statements, provides guidance on accounting for changes in the parent’s ownership interest in a subsidiary and establishes standards of accounting of the deconsolidation of a subsidiary due to the loss of control.  SFAS No. 160 requires an entity to present minority interest as a component of equity.  Additionally, SFAS No. 160 requires an entity to present net income and consolidated comprehensive income attributable to the parent and the minority interest separately on the face of the consolidated financial statements.  This standard is effective for fiscal years beginning after December 15, 2008.  The Company is currently assessing the effect, if any, that the adoption of this pronouncement will have on its consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations.”  SFAS No. 141R requires the acquiring entity to recognize and measure at an acquisition date fair value all identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree.  The statement requires an entity to recognize and measure the goodwill acquired in a business combination or a gain from a bargain purchase.  SFAS No. 141R requires disclosures about the nature and financial effect of the business combination and also changes the accounting for certain income tax assets recorded in purchase accounting.  This standard is effective for fiscal years beginning after December 15, 2008.  The Company currently does not believe that the adoption of this pronouncement will have any effect on its consolidated financial statements.

 
- 14 -

 
                      



In February 2007, the 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 adoption of this pronouncement did not have any impact on the Company’s consolidated financial statements.

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.  For financial assets subject to fair value measurements, SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.  In November 2007, the FASB granted a deferral for the application of SFAS No. 157 with regard to non-financial assets until fiscal years beginning after November 15, 2008.  The adoption of the pronouncement for financial assets did not have a material impact on the Company’s consolidated financial statements.  The Company is currently assessing the effect, if any, that the adoption of this pronouncement with regard to non-financial assets 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.  The Company adopted this standard on December 31, 2007, the first day of the 2008 fiscal year.  The Company provides an endorsement split-dollar policy to one individual.  In accordance with the standard, the Company recorded the present value of the expected future policy premiums for this insurance policy, an amount of approximately $2.0 million, as an adjustment to retained earnings.


NOTE 14 – 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 three and nine months ended September 28, 2008.  As of September 28, 2008, the Company had approximately $7.9 million accrued for unrecognized tax benefits.


NOTE 15 – 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 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.


 
- 15 -

 
                      



INTERFACE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 28, 2008


   
GUARANTOR SUBSIDIARIES
   
NON-GUARANTOR SUBSIDIARIES
   
INTERFACE, INC.
(PARENT CORPORATION)
   
CONSOLIDATION AND ELIMINATION ENTRIES
   
CONSOLIDATED TOTALS
 
   
(IN THOUSANDS)
 
Net sales
  $ 178,179     $ 129,669     $ --     $ (29,425 )   $ 278,423  
Cost of sales
    133,639       79,292       --       (29,425 )     183,506  
Gross profit on sales
    44,540       50,377       --       --       94,917  
Selling, general and  administrative expenses
     28,307        30,031        5,557        --        63,895  
Operating income (loss)
    16,233       20,346       (5,557 )     --       31,022  
Interest/Other expense
    (6,121 )      2,879       12,219       --        8,977  
Income (loss) before taxes on income and equity in income of subsidiaries
    22,354       17,467       (17,776 )     --       22,045  
Income tax (benefit) expense
    8,302       5,801       (5,642 )     --       8,461  
Equity in income (loss) of subsidiaries
    --        --       20,564        (20,564 )       --  
Income (loss) from continuing operations
    14,052       11,666       8,430       (20,564 )     13,584  
Loss on discontinued operations, net of tax
    (5,154 )     --       --        --        (5,154 )
Net income (loss)
  $ 8,898     $ 11,666     $ 8,430     $ (20,564 )   $ 8,430  



 
- 16 -

 
                      



CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 28, 2008

   
GUARANTOR
SUBSIDIARIES
   
NON-
GUARANTOR
SUBSIDIARIES
   
INTERFACE, INC.
(PARENT
CORPORATION)
   
CONSOLIDATION
AND
ELIMINATION
ENTRIES
   
CONSOLIDATED
TOTALS
 
 
(IN THOUSANDS)
 
Net sales
  $ 482,177     $ 436,522     $ --     $ (83,535 )   $ 835,164  
Cost of sales
    351,540       272,683       --       (83,535 )     540,688  
Gross profit on sales
    130,637       163,839       --       --       294,476  
Selling, general and administrative expenses
    83,640       93,804       21,603       --       199,047  
Loss on disposal – Specialty Products
    --       --       --       --       --  
Operating income (loss)
    46,997       70,035       (21,603 )     --       95,429  
Interest/Other expense
    (3,356 )     9,284       19,596       --       25,524  
Income (loss) before taxes on income and equity in income of subsidiaries
  50,353       60,751       (41,199 )     --       69,905  
Income tax (benefit) expense
    19,082       19,511       (12,270 )     --       26,323  
Equity in income (loss) of subsidiaries
    --       --       67,357       (67,357 )     --  
Income (loss) from continuing operations
    31,271       41,240       38,428       (67,357 )     43,582  
Income (loss) on discontinued operations, net of tax
     (5,154 )      --        --        --        (5,154 )
Net income (loss)
  $ 26,117     $ 41,240     $ 38,428     $ (67,357 )   $ 38,428  


 
- 17 -

 
                      


CONDENSED CONSOLIDATING BALANCE SHEET

SEPTEMBER 28, 2008

   
GUARANTOR SUBSIDIARIES
   
NON-GUARANTOR SUBSIDIARIES
   
INTERFACE, INC.
(PARENT CORPORATION)
   
CONSOLIDATION AND ELIMINATION ENTRIES
   
CONSOLIDATED TOTALS
 
   
(IN THOUSANDS)
 
ASSETS
                             
Current Assets:
                             
Cash and cash equivalents
  $ --     $ 56,009     $ 29,512     $ --     $ 85,521  
Accounts receivable
    71,699       93,651       --       --       165,350  
Inventories
    77,114       68,380       --       --       145,494  
Prepaids and deferred income taxes
    5,948       12,091       7,727       --       25,766  
Assets of business held for sale
    30        3,150       --       --        3,180  
Total current assets
    154,791       233,281       37,239       --       425,311  
Property and equipment less accumulated depreciation
    80,088       81,400       5,403       --       166,891  
Investment in subsidiaries
    267,393       160,624       107,298       (535,315 )     --  
Goodwill
    68,167       74,986       --       --       143,153  
Other assets
     7,748       12,879       87,963       --       108,590  
    $ 578,187     $ 563,170     $ 237,903     $ (535,315 )   $ 843,945  
                                         
LIABILITIES AND SHAREHOLDERS’ EQUITY
                                       
Current Liabilities:
  $ 65,609     $ 92,069     $ 216     $ --     $ 157,894  
Long-term debt, less current maturities
    --       --       --       --       --  
Senior notes and senior subordinated notes
    --       --       310,000       --       310,000  
Deferred income taxes
    1,614       11,323       (5,548 )     --       7,389  
Other
    2,980       7,987       26,824       --       37,791  
Total liabilities
    70,203       111,379       331,492       --       513,074  
                                         
Minority interests
    --       7,732       --       --       7,732  
                                         
Redeemable preferred stock
    57,891       --       --       (57,891 )     --  
Common stock
    94,145       102,199       6,306       (196,344 )     6,306  
Additional paid-in capital
    191,411       12,525       338,960       (203,936 )     338,960  
Retained earnings (deficit)
    165,497       357,064       (429,838 )     (77,144 )     15,579  
Foreign currency translation adjustment
    (960 )     (138 )     (6,240 )     --       (7,338 )
Pension liability
    --       (27,591 )     (2,777 )      --         (30,368 )
    $ 578,187     $ 563,170     $ 237,903     $ (535,315 )   $ 843,945  
                                         


 
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CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS
ENDED SEPTEMBER 28, 2008

   
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
  $ 20,235     $ 47,053     $ (31,694 )   $ --     $ 35,594  
Cash flows from investing activities:
                                       
Capital expenditures
    (9,678 )     (10,883 )     (180 )     --       (20,741 )
Investing cash flow from discontinued operations
    --       --       --       --       --  
Other
     (1,359 )       (69 )     (4,208 )     --       (5,636 )
Net cash used for  investing activities
    (11,037 )     (10,952 )     (4,388 )     --       (26,377 )
Cash flows from financing activities:
                                       
Net borrowings
    --       --       --       --       --  
Other
    (10,392 )     (13,296 )     23,688       --       --  
Proceeds from issuance of  common stock
    --       --       1,393       --       1,393  
Dividends paid
    --        --       (5,669 )     --       (5,669 )
Net cash provided by (used for) financing activities
    (10,392 )     (13,296 )     19,412       --       (4,276 )
Effect of exchange rate change on cash
    --        (1,795 )     --       --       (1,795 )
Net increase (decrease) in cash
    (1,194 )     21,010       (16,670 )     --       3,146  
Cash at beginning of period
    1,194       34,998       46,183       --       82,375  
Cash at end of period
  $ --     $ 56,008     $ 29,513     $ --     $ 85,521  


 
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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 30, 2007, under Item 7 of that Form 10-K.  Our discussions here focus on our results during the quarter ended, or as of, September 28, 2008, and the comparable period of 2007 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 30, 2007, 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, 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.  Under the terms of the purchase agreement, we are eligible to receive up to $6.5 million of additional purchase price pursuant to an earn-out agreement focused on the performance of the business segment, as owned and operated by the purchaser, during the 18-month period following the closing.  In the third quarter of 2008, we determined that the receipt of this additional purchase price is less than probable and therefore incurred an after-tax charge of $4.2 million related to a full reserve against the deferred amount.  Also in the third quarter of 2008, we recorded a charge of $0.9 million, after tax, to reduce the carrying value of certain assets remaining from the segment that are held for sale to their realizable values.  As discussed in the Notes to Consolidated Condensed Financial Statements in Item 1 of Part 1, in the first nine months of 2007, we recorded charges for impairment of goodwill of $44.5 million (none of which was incurred in the third quarter of 2007) and impairment of other assets of $17.4 million (none of which was incurred in the third quarter of 2007) related to the Fabrics Group business segment.

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 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 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.

 
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Our discontinued operations had no net sales in the three-month and nine-month periods ended September 28, 2008.  Loss from operations of these businesses, net of tax, was $5.2 million in each of the three-month and nine-month periods ended September 28, 2008.  Included in this loss from discontinued operations are after-tax charges of $4.2 million and $0.9 million related to a reserve placed on the additional contingent purchase price from the sales of the Fabrics Group business segment and the impairment of certain assets remaining from the segment, respectively, as discussed above.  Our discontinued operations had net sales of $35.9 million and $71.7 million in the three-month and nine-month periods ended September 30, 2007, respectively (these results are included in our statements of operations as part of the “Loss from Discontinued Operations, Net of Tax”). Loss from operations of these businesses, inclusive of goodwill and other asset impairments as well as costs to sell the businesses, net of tax, was $6.7 million and $68.7 million in the three-month and nine-month periods ended September 30, 2007, respectively.

General

During the quarter ended September 28, 2008, we had net sales of $278.4 million, compared with net sales of $279.5 million in the third quarter last year.  Fluctuations in currency exchange rates positively impacted 2008 third quarter sales by 3% (approximately $7.7 million), compared with the prior year period.  During the first nine months of fiscal 2008, we had net sales of $835.2 million, compared with net sales of $787.9 million in the first nine months of last year.  Fluctuations in currency exchange rates positively impacted sales in the first nine months of 2008 by 3% (approximately $26.7 million), compared with the prior year period.

Including the losses from discontinued operations discussed above, we had net income of $8.4 million, or $0.14 per diluted share, during the third quarter of 2008, compared with net income of $8.6 million or $0.14 per diluted share, during the third quarter last year.

For the first nine months of 2008, including the impact of the loss from discontinued operations, we had net income of $38.4 million, or $0.62 per diluted share.  In the first quarter of 2007, 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 and other costs related to the sale of the Fabrics Group business segment and the loss on disposal of Pandel, Inc. led to our net loss of $31.1 million, or $0.50 per diluted share, during the first nine months of 2007.

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 nine-month periods ended September 28, 2008, and September 30, 2007, respectively:

   
Three Months Ended
   
Nine Months Ended
 
   
Sept. 28, 2008
   
Sept. 30, 2007
   
Sept. 28, 2008
   
Sept. 30, 2007
 
                         
Net sales
    100.0 %     100.0 %     100.0 %     100.0 %
Cost of sales
    65.9       65.0       64.7       65.3  
Gross profit on sales
    34.1       35.0       35.3       34.7  
Selling, general and administrative expenses
    22.9       22.6       23.8       23.0  
Loss on disposal of Specialty Products
    --       --       --       0.2  
Operating income
    11.1       12.4       11.4       11.4  
Interest/Other expense
    3.2       3.6       3.1       3.7  
Income from continuing operations before tax expense
    7.9       8.9       8.4       7.7  
Income tax expense
    3.0       3.4       3.2       2.9  
Income from continuing operations
    4.9       5.4