Interface, Inc. (TILE) Q1 2012 Earnings Report, Transcript and Summary

Good day ladies and gentlemen, and welcome to the Q1 2012 Interface, Inc. Earnings Conference Call. My name is Gary and I’ll be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. [Operator Instructions] I will now hand the call over to Matt Steinberg [indiscernible].

Thank you, operator. Good afternoon and welcome to Interface’s conference call regarding first quarter 2010 results. Joining us from the company are Dan Hendrix, Chairman and Chief Executive Officer; and Patrick Lynch, Senior Vice President and Chief Financial Officer. Dan will review the highlights from the quarter as well as Interface’s business outlook. Patrick will then review the company’s key performance metrics and financial results. We will then open the call for Q&A. A copy of the earnings release can be downloaded off the Investor Relations section of Interface’s website. An archive version of this conference call will also be available through that website. Before we begin the formal remarks, please note that during today’s conference call, management’s comments regarding Interface’s business, which are non historical information, are forward-looking statements. Forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from any such statements including risks and uncertainties associated with the economic conditions in the commercial interiors industry as well as risks and uncertainties discussed under the heading Risk Factors in Item 1A of the company’s Annual Report on Form 10-K for the fiscal year ended January 1, 2012, which has been filed with the Securities and Exchange Commission. We direct all listeners to that document. Any such forward-looking statements are made pursuant to the Private Securities Litigation Reform Act of 1995. The company assumes no responsibility to update or revise forward-looking statements made during this call and cautions listeners not to place undue reliance on any such forward-looking statements. Management’s remarks during this call refer to certain non-GAAP measures, a reconciliation of these non-GAAP measures for the most comparable GAAP measures are contained in the company’s results released and Form 8-K filed with the SEC yesterday. These documents can be found on the Investor Relations portion of the company’s website www.interfaceglobal.com. Lastly, please note that this call is being recorded and broadcasted for Interface. It contains copyrighted material and may not be rerecorded or rebroadcast without Interface’s expressed permission. Your participation on the call confirms your consent to the company’s taping and broadcasting of it. With these formalities out of the way, I’d like to turn the call over to Dan Hendrix. Please go ahead, sir?

Thank you and good morning to everyone. It’s always good when I start by telling you that, when I talked about on our last call has come to tab [ph]. Namely, a robust project pipeline for the Interface commercial business began to translate into orders. The positive order trends we saw at the end of the first quarter and the first few weeks of the second quarter are very encouraging, despite a choppy beginning of the year and although things are still tough in Europe. Along with what I would call guarded optimism around market conditions, we have continued with restructuring and manufacturing improvements that are starting to take hold and enhance profitability. I’ll get to that in a minute. So let me start by giving you the big picture. We finished the quarter with orders of $249 million essentially flat versus the prior year and ahead of first quarter of sales, which translated into a $13 million increase in our backlog since year-end. Orders bound down in February, down 9%, but we experienced a strong bound in March and this is setup for an improved top line in the second quarter. From a sales perspective, we had strong comparables in the first quarter last year that we were not able to replicate in the current environment. Still sales are relatively stable in the Americas and Europe, our U.S. hospitality business was a bright spot, up 40% year-over-year on a relatively small comparison. Asia-Pacific is where we saw a substantial slide primarily in Australia where last year we had both a new construction boom and government stimulus spending in education that weren’t present this year. We made good progress on gross margin during the first quarter, up a 100 basis point sequentially versus the fourth quarter, the result of higher selling prices and better manufacturing efficiencies. Our raw material cost rose another 2% sequentially and even further elevated on a year-over-year basis, but we implemented another price increase globally in March ranging from 3% to 5% to offset the higher cost. I am very pleased with our continuing attack on SG&A expenses, which were down $6 million sequentially versus the fourth quarter. At this point, we are getting pretty down on SG&A expenses and we will continue to keep a tight control on them for the upcoming quarters while balancing against the investments we need to make in growth opportunities such as additional FLOR stores, emerging markets and segmentation. Another bright spot was cash generation, up more than $12 million in the first quarter, which is usually a heavy cash use for us as we funded bonuses, insurance premiums and build inventories. In fact, this is the only time that I can remember generating cash in the first quarter of the year. By way of comparison, we used $30 million in cash during the first quarter last year. We are excited by the continued strong performance of our FLOR consumer business with sales up 41% year-over-year. Overall, the business broke even for the first quarter compared with an operating loss in the prior year. And the FLOR retail stores were profitable this quarter on a standalone basis. We opened four new FLOR stores over the past month, stores that aren’t reflective of the first quarter numbers bringing our total stores to 11. We have not encountered any major shortcomings in the FLOR store roll out and we remain on track to have a total of 19 stores by year-end with future plans for locations in each of the top 30 markets in North America. Our first international stores are scheduled to open in Toronto and Vancouver later this year. We are very pleased with FLOR’s progress and performance and the consumer business will continue to be an integral part of our strategic investment initiative. Success in the consumer market is indicative of the factors [ph] shift to corporate founders [ph] fundamental to our growth strategy. We are also pleased with the results of Bentley Prince Street despite a relatively small operating loss on lower production volumes. [Indiscernible] in the first quarter were above the critical $25 million point, so we expect it to move out of the red in the second quarter. In Europe, we successfully completed the consultation period with our employees and the representatives regarding the shutdown of operations at our shelf facility and the closure is now underway. When fully implemented, this action will generate an additional $9 million in annual cost savings. We are currently on track to realize some of these benefits in the second quarter and we should realize the full benefits beginning later this year. Sale [ph] for the second quarter-consolidated orders are down 3%. Our strongest comparison quarter last year, orders in the U.S. and Australia are up double-digit percentage, the Europe orders are down double-digit percentage as a sovereign debt issues continue to weigh heavily there. As I mentioned earlier, we are starting to see market conditions improve in the U.S. and Australia after a difficult second half of 2011 and a tough start to 2012. We are pleased to see the restructuring actions and manufacturing improvement, enhanced profitability. We will continue to focus on improving gross margins through price increases, careful spending, further improved operations, the Shelf plant closure and increased absorption from higher production volumes. We are optimistic that the combination of our restructuring actions, investment initiatives, the secularship, the carpet tile and the general improvement in the market place will drive improvement results in the second quarter and beyond. With that, I’ll turn it over to Patrick.

Thank you and good morning everyone. I’ll take a few minutes to speak about the financial results for the first quarter. Sales for the 2012 first quarter decreased 5.2% to $232.8 million from $245.4 million in the first quarter of 2011. Our sales performance reflected a gradual improvement in the U.S. modular markets as the quarter progressed, some pockets of growth in Europe and our price increases beginning to take hold. Offset by lower sales to other parts of Europe and Asia Pacific resulting from continued general economic uncertainty and softer government and new construction spending in Australia. As Dan mentioned, we improved our gross margin by 100 basis points sequentially versus the fourth quarter. Primarily as a result of higher average sales prices and improved manufacturing efficiencies. On a year-over-year basis, gross margin declined by about 2.7 percentage points to 32.7% compared with the first quarter of 2011. This decline in gross margin was primarily the result of lower fixed cost absorption and lower production volumes as well as higher raw material cost which remained up about 5% to 6% year-over-year. The margins were also impacted by an absorption of fixed cost associated with lower manufacturing volumes at our China plant which is now running well but remain slightly below breakeven in the quarter as production volumes were affected by the impact of Chinese New Year. We also brought inventory up about $6 million in the quarter as a result of building safety stock in connection with the closure of the operations in our shelf [ph] facility. SG&A expenses in the first quarter 2012 run in line with our expectations decreasing to $59.4 million from $65.4 million last year. As a percentage of sales SG&A decreased over $110 basis points to 25.5% compared to the year ago period reflecting our efforts to reduce expenses to better reflect demand environment following our restructuring efforts in the 2011 fourth quarter. We continue to expect generate annualized SG&A expense savings of about $9 million from these efforts and another $2 million in annualized cost savings at the cost of goods sold line from the restructuring in Q4. During the quarter, we progressed with additional restructuring actions concerning the closure of the manufacturing and warehouse activities in Shelf in the U.K. as a result we incurred restructuring and asset impairment charges of $16.3 million or $0.19 per share after tax. Pre-tax annualized savings from this action are expected to be $9 million and we should begin realizing the full benefits later this year. While we’ve made excellent progress on the cost savings front, we will continue to focus on aligning our cost structure with evolving market conditions and initiate additional cost reduction actions as these opportunities arrive. Excluding the restructuring and asset impairment charges, operating income for the 2012 first quarter was $16.8 million or 7.2% of sales. Including these charges, operating income was $500,000 or 0.2% of sales in comparison with operating income and the 2011 first quarter was $21.5 million or 8.8% of sales. Interest expense in the first quarter remain flat at $6.7 million compared with the first quarter of 2011. Going forward, we expect to realize $1 million in annualized interest savings from the previously announced redemption for the final $11.5 million of our 9.5% senior subordinated note that we completed April 9 [ph]. Excluding the restructuring and asset impairment charges discussed above, net income in the 2012 first quarter was $6.3 million or $0.10 per share compared to net income in the 2011 first quarter of $9.8 million or $0.15 per share. Including all the charges, net loss was $5.9 million or $0.09 per share for the first quarter 2012. Depreciation and amortization was $7.5 million in the first quarter compared with $12.6 million in the first quarter of last year. Capital expenditures in the first quarter of 2012 were $10.4 million compared with $10.3 million in 2011. For 2012, we continue to expect expenditures to be around $30 million to $35 million. I’ll take a few minutes and review some of the details of our individual business segments. Our modular carpet segment had sales in the 2012 first quarter over $210.1 million down 4.2% from the year ago period. Sales remains flat in U.S., but were slightly lower in Europe primarily as a result of uncertain macroeconomic environment. However, we did generate better than expected results in France and Spain; and Germany remained a good market for us. Asia-Pacific declined as a result of softer market conditions, tough comparisons in Australia and choppy conditions in India. Operating income for the modular carpet segment for the 2012 first quarter was $1.1 million or 0.5% of sales down from $25.3 million or 11.5% of sales last year. Operating income for the first quarter 2012 includes the aforementioned restructuring and impairment charge of $16.3 million or 7.8% of segment sales, all of this restructuring charge was within the modular carpet segment. Bentley Prince Street generated $22.7 million and sales of $22.7 million in the 2004 first quarter, down from $26.1 million in the first quarter of 2011. They also recorded an operating loss of $600,000 in the quarter, compared with an operating loss of $200,000 in the prior year period. Turning quickly to the balance sheet, we had a strong cash generation quarter, exiting the period with $63.1 million in cash compared with $39.7 million at the end of the first quarter 2011 and $50.6 million at the end of fiscal year 2011. Inventories were $171.9 million at the end of the first quarter compared with a $166.1 million. In the fourth quarter of 2011 as anticipated from the closure of the manufacturing and warehousing activities at our Shelf facility. Our average DSOs for the first quarter were 54.7 days, compared with 54.8 days in the year-ago period and inventory turns in the quarter were 3.7 compared with 4.3 last year, partly due to the building of the safety stock [ph] at Shelf [ph]. Looking ahead, to the remainder of 2012, the demand picture is improving, but still remains cloudy overall. As evidence by order rates, we have seen improving conditions in the U.S., Australia, China while Europe remains choppy and Asia, Ex-China remains challenging. Having said that, we undertook several initiatives to improve our cost structure to better align our business with market conditions and improve our margins in the eventual recovery, enhance the profile of our balance sheet and continue to generate solid cash flow. And we’ll continue to invest in our floor retail business and other initiatives. That’s been our strategic growth goals. With that, I’ll turn the call back over to the operator for your questions.

[Operator Instructions] You have the first question coming from the line of Kathryn Thompson of Thompson Research Group.

First, just want to focus on the margin. To quantify on a percentage basis or at least put some parameters around the impact of raw materials in the quarter versus lower utilization - capacity utilization on the quarter and also given higher relative raw input cost, what could we expect going forward on an annualized basis?

Yes, I would say that in the quarter probably about a 100 basis point on a year-over-year basis decline was related to the raw materials and Delta [ph], the balance was made up of the lower production volumes in Q1 versus Q1 last year. Right now, the raw material price front seems to be fairly stable. So, at this time, we don’t anticipate going out with any additional price increases at this time, but we will see how it shakes out over the next couple of quarters.

Other than the price increase you have, the 3% and 5% you have in Q2, correct?

That was in March.

In March, okay.

That’s we always stand now.

In your prepared comments, you had some numbers around sales growth by your major markets U.S., Europe, Asia, could you maybe distinguish a little bit more or at least give little more specificity around more specific sales trends in those markets. And you said Asia is down significantly and we are talking about around 10%, down 20% and you said U.S. and Europe were doing little bit better maybe little bit more specifics in those markets too?

Okay. I would - this is Dan. I would answer that from a trend standpoint of what we are seeing. The U.S. has really had a very strong 7 weeks, 8 weeks when you talk about March in the first 3 weeks and April. And so has Australia; Australia is doing very well and Australia as you know represents 10% of our business. When Patrick mentioned Asia, he was really talking about South East Asia that had a - we had a slow start in South East Asia, I will say that the South East Asia has been picking up lately. For some reason in January, I am not sure what Chinese New Year did to us but the China business and South East Asia [ph] business had a very slow start. Europe is where we - is where I have concerns as far as what’s going on with the sovereign debt issues. Europe has been soft really since January and Europe is one thing we got our eye on, but the other [ph] market seem to be - the activity is really good and we are starting to see some pick up there.

Can you remind us what percentage of sales Europe is?

30.

Europe?

Yes, about 30, right.

Our next question comes from the line of Mike Wood from Macquarie Capital.

Can you pin point also, in terms of what you felt the change was in the orders trends that happened in mid February.

I think the - if you remember going back to the call, we talked about that the activity was really good, but corporations just weren’t letting go of the orders. I think that’s still the case in Europe, there is a pretty good activity project pipeline that we’re not seeing corporations actually place the orders today. In the United States and in Australia particularly, I would say the Americas business in Australia that activity is pretty robust and we are starting to see the orders come through. And I think that’s consistent with what the industry is seeing, particularly the furniture [indiscernible]. Businesses is pretty good in that market.

Got it. And next quarter you have tough comparisons and your orders sighted [ph] one of your toughest comps. Could you help us with some direction in terms of given a positive trend that you’ve seen whether or not we can actually have a positive order growth next quarter?

I hate to give you a forecast on that, we don’t typically do that. I would just say that the activity feels a lot better than it did in February when we were on this call and I anticipate an improving second quarter over first quarter.

Okay, thanks. And just finally, can you give us some color on the dual class share structure, which collapsed and you’ve talked about that in your 8-K filing in early March, what actually triggered that?

We have the passing of Ray Anderson and if the B stock gets below 10%, then all the B converts to A and we have one class of stock. And so you had and it was the pretty fair margin anywhere there’s 300,000 shares that would trigger that, going into this year. And so we had 300,000 shares that got converted from B to A would trigger that.

Next question comes from the line of David MacGregor of Longbow Research.

Can you talk about your backlog and how is the mix that change quarter-over-quarter different from what you were booking say a quarter ago?

I mean our backlog built by $13 million in the Q1, so we are starting to get kind of positive kind of book-to-bill ratio, and which is nice to see here in Q1. The bulk of that strength really is coming out of the Americans group currently.

Americas. Is that mostly corporate?

Yes, it is corporate drilling down the sub-segments, the strength around technology, energy in particular are 2 areas that are pretty strong and frankly, it’s compliance with services to be honest.

Sure, okay. And how would it sort of translate in terms of opening price point versus premium price point product.

I would say the average selling pricing within the backlog is higher than it was to start the year, as we’re starting to realize the price increases, but I am not sure if you - we don’t drill down between what is high end premium products we could and what is low end, we don’t, I don’t look at it that way.

Yes. I’m just trying to get a sense of the price point in that increment, it sounds like it has improved?

I - just above that you’re seeing an average price increase in that backlog, which is nice to see that we are starting to realize our price increase.

Right. And is it just the price increase, I mean excluding the price increase, would it be relatively flat or are you seeing a - I am just wondering if people are buying up market or whether people are still I think fairly cautious in terms of their purchase?

I would say, yes, both things going on there, David.

Okay.

We know - we have introduced our new [indiscernible] product line, which is the higher end premium and that’s doing very well. So I think you’ve got a mix of it. The education business starts to kick in the second quarter and you will see average prices come down with that mix, but I think we are selling premium products as well as we are selling products that are value product, both things are going on.

Okay. That’s good to hear. Last question just on the European business, I realize business conditions are weak over there and pricing has got to be very challenging, but you are probably occurring raw material cost inflationary as well. So, I just wondering you what extend you, we feel that you will succeed in pricing in the European market.

Yes, that was obviously a big challenge for us in 2011, particularly late in the year, last year was trying to push through some raw material price increases in the face of some moderating demand environment. And then actually looking at where we are in an average price increase in Europe on a year-over-year basis. They have actually done a really nice job, in globally were up about 4% on a year-over-year basis average selling price. And Europe has done a nice job here in Q1 rising prices, which is a kind of key strategy for us going into 2012.

And next question comes from the line of - is it John Baugh of Stifel Nicolaus.

I was really pleased with that cash flow number on the first quarter, I was curious as to how the year might play out whether there was some unusual things in there that may reverse or we’re just going to generate a lot more cash this year than we typically do?

You know I think we obviously with the monitoring demand environment and the business had slowed down in Q4 in the first, 6 or 7 weeks of Q1, you know, we typically generate a decent amount of cash out of working capital and did a nice job in Q1 managing inventories, you know, mostly flat with the exception of what we had to do in Europe around the plant closure. But I think for the balance for the year we will try to keep inventories relatively stable and continue to squeeze working capital where we can. So I think should be a hopefully a better than average year in terms of cash flow generation in 2012.

So can you put a number on that, Patrick, like pushing 50 or something or....?

No I would say north of 30, 35 maybe, we’ll see how it shakes out. But we are off to a good start here, at least in Q1, which is nice.

Yes, John, this is Dan. You’ve been following us since 1984 and this is the first time that I can remember first quarter we have actually generated cash.

I agree with that. Yes, you made some comments about orders and you went quickly and I think get it all and I think it started with orders and Europe were down double digits in the quarter and then you commented, could you just go through those numbers again?

What I was commenting on was, well, I will let Patrick answer that one actually. He has got ordered and selling.

Sure. I mean, I think what we were just trying to provide a little color around the first 3 weeks of April, where as in total were down 3%, but off to pretty nice start here in the Americas, up 15%, 16% and then Europe is down about 20% and Asia Pacific is roughly flat. So, it’s kind of a mixed bag, but really encouraged by what we’ve seen in the Americas over the last, 8 or 9 weeks, but kind of dark clouds currently around that demand environment in Europe.

Gotcha. And then you commented on the first quarter year-over-year raw materials hurting about a 100 bps on gross margin. What - with pricing going through in March, I’m curious how the delta if you included pricing with raw material increases in Q2 year-over-year. How that plays out in the net impact on gross margin percentage?

I mean assuming a pretty stable environment, I’m encouraged to think that we’ll get to neutral here in Q2 and not have that drag in Q2.

Okay. Okay, and then the floor performance is impressive, is that being driven by the retail or is there something going on with the catalog/Internet on the core business, if you will?

It’s both. John, the catalog business was up 13% in the quarter and that’s starting to grow and I think we’re getting the benefit of stores, driving some of the business, the catalog and people can go to stores and see it and feel it and they go order it online. And then, the next biggest piece obviously is retail stores are doing well.

Good. And has there been any thought then you mentioned Toronto and Vancouver, but, I mean, what about the London and Paris’s of the world. Is there a thought to take the store concept international at this point?

Yes. I think you’ll start seeing us do that in 2013.

And next question comes from the line of Matt McCall of BB&T Capital.

So Patrick I think did I hear you right. Did you break out a $9 million projected savings from the U.K. facility. Was that the number you threw out?

That’s right, that’s the fixed overhead savings that we anticipate related to the Shelf closure.

Okay. So I think that’s outcome from...

Slightly ahead of, when we had $8 million $8.5 million [indiscernible].

Okay, okay. And then for this year you’re going to recognize how much?

We’ll probably see $3 million or $4 million this year, it’s gone very well thus far, I mean in terms of the process and in the consultation period. So we’re a little bit, ahead of where we had originally anticipated so we’ll see may be $3 million or $4 million this year.

Okay. And then I think you - in Q4 you broke out the $4 million of price cost pressure and it sounds like that number has been cut in half sequentially here in Q1. What’s the total pressure that you faced last year price versus cost in that raw material space?

I have them and I’m reaching from memory here I haven’t looked at that number in a while, but I would say it was north of 12 that we had last year in total, but I’d have to come back and confirm that.

Okay. So is the way you look that if you’re going to get the priority [ph] in Q2, that you sell $2 million this year and maybe the net savings on a year-to-year basis is 10, or is that too much?

It’s probably too much, but I have to - I’d have to scrub down and think to reflect.

Okay, okay, okay. And then so you broke out interest expense, you’ve talked about your $11 million restructuring the $34 million from U.K. price cost anything else that we should think about outside of the normal leverage that you will get from volume that’s going to help margin this year?

I think you hit it Matt. The price increases, we are going to realize that also has material increases in and I think the plants are going to run better than they have been running particularly the U.S. the last 2 quarters we are going to get the manufacturing efficiencies and you got the absorption. We’re ramping up production in the second quarter over the first quarter. So you will see the absorption there.

Okay and on that last one I think also in Q4 you talked about manufacturing inefficiencies causing you about $4 million, where does that stand - I know you talked about production volumes but where does the actual inefficiencies play out in Q2, are those back to...

I think we are going to see a much-improved manufacturing efficiencies in Q2 versus Q4.

Thank you and versus Q1?

You will see an improvement over Q1 as well.

[Operator Instructions] We have our next question from the line of Keith Hughes of SunTrust.

As you look to the second quarter, are the production rates going to pick up or slowdown from what we saw in the first?

I think it’s going to pick up Keith.

And from an inventory perspective, will that still allow you to bring the inventory down from where we are now?

Our goal is to continue to bring the inventory down during the next 3 quarters. We have to get our turns back over 4.

And Patrick, the interest expense saving, could you just repeat that number on a quarterly basis?

It’s about $250,000 per quarter, it’s a $1 million just related to the $11.5 million of the 9.5% bonds we brought in.

And final question. In Asia, I know you’ve had tough comps with Australia, are those about to end soon?

In Australia, yes. We are currently running up double-digit order trend in Australia.

How many months you’ve been doing?

No, first 3 weeks.

Yes, just for the first 3 weeks in April.

We just anniversaried that.

We have no further question at this time. So I would now like to turn the call back over to the management for any closing remarks.

Well, thank you for being on the call and thank you for being shareholders and hopefully, we will report a very good second quarter. You guys have a great year.

Thank you very much, ladies and gentlemen. This does that now concludes your conference for today. You may now disconnect. Thank you very much.