Interface, Inc. (TILE) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to the Q3 2015 Interface, Inc Earnings Conference Call. My name is Leon, and I will be your operator for today. At this time, all participants are in a listen-only mode, but we will conduct a question and answer session towards the end of the conference [Operator Instructions]. As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to David Foshee, Vice President. Please go ahead.

Thank you, Operator. Good morning and welcome to Interface's Conference Call regarding third quarter 2015 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 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 An archived version of this conference call will also be available through that website. Before we begin formal remarks, please note that during today's conference call, Management's comments regarding Interface's business, which are not 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 the 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 December 28, 2014, 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 to the most comparable GAAP measures is contained in the Company's earnings release in 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. Now, I would like to turn the call over to Dan Hendrix. Please go ahead sir.

Thank you, David. Good morning, everyone. The third quarter was a continuation of the success that we have been having throughout 2015, with year-over-year improvements cost virtually all key metrics. This quarter, some of the year-over-year comparisons are even more dramatic due to the difficult quarter we experienced a year ago, but they do serve to illustrate just how far we have come and how well we have executed over the past year. In local currency, sales continue to climb at a 10% clip, with improvements across all three operating divisions Americas, Europe and Asia Pacific. We saw robust sales activity in the three largest markets, which are the U.S., the UK and Australia. We believe this growth significantly outpaced the industry in each of those markets, which means we continue to take market share. Sales in local currency also turned positive in France, our fourth largest geographic market, which is a long-awaited and very welcome relief. As we anticipated currency fluctuations continued to negatively impact our results, mostly due to the declining Euro, Australian dollar and Canadian dollar. These headwinds are expected to continue throughout most of the fourth quarter, but should begin to moderate after that as the year-over-year currency comparisons begin to equalize. Gross margins remained strong at 38.5%, which is an improvement of almost 500 basis points compared with the third quarter last year, mostly due to higher selling prices, improved product mix and lower raw material and labor costs. Even a sequential basis, we improved 10 basis points versus second quarter. Operating income was outstanding at 12.3% of sales and that is after a $2 million negative impact from currency. Along with the benefit of lower interest expense that translated in a $0.31 earnings per share. Cash flow also continue to be a bright spot as we paid down $25 million in debt and still increased our overall cash balance. Absent concerning the orders moderated during the third quarter, but on the currency-neutral basis they were essentially even with the third quarter of last year and have been slightly positive in the last three weeks of the fourth quarter. Looking ahead, I think, that we are in an excellent position to close out 2015, as our best year ever. Our sales in local currency are growing, we are taking market share in key markets, our product portfolio is excellent and we won several design awards this year. In the most recent Floor Focus survey of top architects and designers in United States, Interface was voted the number one carpet company in categories of design, quality service and performance. Once again, we remain the number one Green Leader and received number Green Kudos for networks, program and floor residential carpet tiles. Our plants are running at very high levels of efficiency, and while gross margins may take down a little bit the fourth quarter due to the seasonality of our business, it should remain at a strong level. Because this fiscal year ends on January 3rd, we do have the Christmas and New Year holidays at the end of the quarter that we expect to continue our run of the year-over-year improvement although currencies will continue exactly tolled and it has all year long. With that, I will turn it over to Patrick.

Thank you and good morning, everyone. I will now take a few minutes to walk through the financial highlights for the third quarter. As reported in U.S. dollars, sales for the third quarter of 2015 were up 1% to $254.7 million versus $252.1 million in the third quarter 2014. On a constant currency basis, the increases nearly 10%, a very solid improvement over the third quarter of 2014. As Dan noted and in our press release currency continues to be an issue in the quarter as it has been all year. The strong U.S. dollar led to an approximate $22 million negative sales impact for the quarter. The impact of the currency was felt throughout the income statement with gross margins been impacted by $8 million in SG&A, about $6 million leading to a decline in operating income of $2 million for translation purposes. As we experienced in the second quarter, the gross margin performance continues to drive our profitability improvement. Like Dan mention, we experienced over 500 basis points of gross margin expansion with the third quarter 2015 gross margin percentage of 38.5% versus 3311% in the third quarter of 2014. This performance is due to higher selling prices, improved product mix, lower raw material costs and increased volume in 2015. This improvement also represents the full realization of the benefits from our significant restructuring actions we took a year ago. In the Americas, we experienced a solid sales increase of 7% on a currency-neutral basis. This is driven by double-digit improvement in the corporate office market, offset by a slight decline in the overall non-corporate office market segments. However, hospitality sales continue to improve up over 20% for the quarter for the, but the other non-corporate office sales were dragged down by declines in education and government during the quarter. As Dan mentioned, floor had a nice quarter with an increase of nearly 3% driven by web-based sales. Europe continues to deliver in the third quarter with nearly 20% sales growth on the currency-neutral basis split evenly between corporate non-corporate office segments. After currency impact, sales were essentially flat in U.S. dollars. As Dan mentioned, the currency headwinds will be with us for the remainder of the year, but we should start to see it level out in the first quarter of 2016. The local currency order trend in Europe also remains robust for the first three weeks of Q4, so we remain optimistic about the prospects for the fourth quarter. The performance in Asia Pacific was a tale of two regions with Australia delivering a very nice third quarter in local currency with sales up 20% and Asia showing a decline of approximately 12% in the quarter. Due to the currency impact though, the all overall sales declined and Australia was 6% in U.S. dollars and overall 9% for the region. The improvement in Australia seen across corporate non-corporate office segments, Australia's order trend through the first three weeks of October remained very strong, so the prospects there as well in the fourth quarter remain positive. In Asia, we experienced sales decline in China and India, partly due to a public holiday in China, but Southeast Asia posted a small gain, which is a welcome sign after a weak second quarter of 2015. Our SG&A expenses increased to 26.2% of sales for the third quarter versus 25.4% in the comparable period last year. The increase was entirely due to higher incentive comp expenses as a result of improved performance in the current period. Absent these incentive costs our SG&A expenses were down as a percentage of sales, which speaks to our cost control measures including those as a result of the restructuring activities last year. We have been very careful with our spending in this area, not lose the benefits of our gross margin improvements have provided thus far. Floor also continued to improve year-over-year with sales up 3% and operating loss was trimmed by over $700,000 versus the third quarter last year. As a result of factors discussed previously, operating income in the third quarter was $31.3 million or 12.3% of sales compared with operating income of $19.6 million or 7.8% of sales in the third quarter last year, excluding the restructuring and asset impairment charge we took in third quarter last year. Including that charge in 2014, our operating income for the third quarter was $7.3 million or 2.9% of sales. Also, on the cash flow front, we had a nice quarter as we saw our cash balance increase by over $2 million while at the same time paying down $25 million on our revolver during the quarter. Our debt level net of cash now sits at just under $160 million and the credit facility continues to deliver benefits with our interest expense declining by over $4.2 million to $1.3 million in the third quarter of 2015. The refinancing continues to be highly accretive for us. During the course of the year and will continue to use the cash flow generated to reduce interest and create more savings for the balance of the year. Depreciation and amortization was $7.7 million in the third quarter compared with $6.8 million in the third quarter last year and CapEx in the third quarter $11.6 million compared with $10 million in the comparable period last year. For the full-year, we expect CapEx to be in the range of $30 million to $35 million. With that, I will open up the call for questions. Operator?

Thank you. [Operator Instructions] Your first question comes from the line of Stephen Kim from Barclays. Please go ahead.

Hey, guys. It is actually John filling in for Steve. Just first on the cost side, you guys have done a phenomenal job in expanding gross margins this year. Just looking out to '16, are there more initiatives that you guys can implement to may be expand the level of gross margins going forward? If so, what are some examples there?

Yes. We actually have an ongoing program to reduce actually 5% of our overall cost, the variable cost in the plants. We have identified a lot of key initiatives, dematerializing is one, running more efficient the plants, reducing labor invoices is another one and then there are some innovations that actually helped reduce costs as well. The program is catching stride and I think, I won't say early innings, but we are halfway through this program…

Got it. Then on the SG&A side, obviously, this year ran a little higher than we were expecting at the beginning of year because of the variable compensation coming up because of the sales results, but assuming a mid-single digit sales growth next year, where should we expect that SG&A to be around in a ballpark for '16?

If you look directionally, what we are trying to do, we are trying to drive the gross profit margin to 40% and we are trying to keep SG&A around the 26% to 25% percentage of sales.

Okay. Thanks.

Thank you.

Thank you. Your next question comes from Kathryn Thompson from Thompson. Please go ahead.

Hi. Thanks for taking my questions today. Just one quick clarification on SG&A run rate for the second half. In the prior quarter you were expecting around $68 million to $70 million run rate on a quarterly basis in the second half. This quarter you came in below that, which was very good. Any color - does that imply we should see a little bit higher on a dollars basis, because of the comp? How should we think about Q4 for SG&A?

Yes. I think Q4 will be largely in line with Q3, probably the $66 million to $68 million kind of range for Q4 as well.

Okay. Great. Helpful. Then on gross margins, you guys have been working on these initiatives I guess about two years to 18 months to two years by now and have done a nice job with expansion. This year you have had the added benefit of lower raw materials. I think that you have said for the year about a $15 million tailwind for you. If you look at your deconstruct gross margins for the quarter, you have done a nice job in the past you are saying, how much in the quarter was raw materials versus the initiatives.

Yes. I would say of the 500 basis points, about a point and a half has been raw material. We projected about $16 million improvement for the year.

You have had improvement from Australian that is a good margin geography for you. How much of it was geographic mix versus some of the other just dematerialization and another…

We started the plant last year in February, so we really started catching our strides in the second half of last year and continue to improve this year. I would say Australia has had a very negative impact related to raw material purchases - as they purchase yarn in U.S. dollars, so we have really had to raise the bar on pricing as well as the plant to accomplish these margins that we have. I think we still have opportunities with them in the Australian plan and improve it as well.

Okay. Then just finally on the order side, if you could just give a little bit more color, this has been incredibly choppy intra-quarter for every building product category that we have covered. If you could give a little bit color in terms of intra-quarter orders in terms of progression, then and for the U.S., where you face a particularly tough comp, maybe any other color from comp basis too for orders? Thank you.

Sure. Kathryn. You are exactly right. Similarly we had a lot of choppiness throughout the quarter. On a currency-neutral basis, July was up 7% for us then we were flat in August and then down 7% in September. Getting back to about flat on the currency-neutral basis for the first three weeks of the fourth quarter, so yes, we experienced the same. The Americas in particular had very difficult comps versus last year as we had a soft patch in the early part of Q3 last year and started to ramp in September-October. Last year October in '14 was up over 20% over '13 Q4, so the comps are certainly getting more difficult at the Americas level here as we head into Q4.

No, change in underlying demand that you have seen broadly speaking throughout the U.S.?

I would say that activity in the U.S. market, if you talk to our sales force, architect, designers, the ABI index, I mean, it is still pretty - I won't call it robust, but it is pretty healthy pipeline. It is just somehow - there are delays in the system. I think the furniture guys are seeing the same thing. It is pretty flat the commercial private [ph] market actually in the third quarter was flat to down and we actually did pretty well. We are taking a lot of share in that market, but I still think that there's a lot of activity in the U.S. commercial market. Our new construction and our renovation - out there is still good.

Great. Thank you very much.

Thank you. Your next question comes from Mike Wood from Macquarie Securities Group. Please go ahead.

Hi. Good morning. Just wondering if you could provide some more color on the gross margin commentary, I think you said ticked down in 4Q. I assuming that next quarter-over-quarter and if you could give us some color on what is driving that.

Well, we have two holidays in there. That is part of it. Seasonality-wise, the fourth quarter is not as good as the third quarter as a rule, so you have got less throughput going through there, the disaster [ph] was seasonality business, obviously that was compared to third quarter not last year.

Great. Can you just give us an update on how much of your business I guess perhaps in the Americas is made to orders versus made to inventory at this point, how much room further you have to go there to improve gross margins?

I think, there is a lot of room still to improve gross margins throughout of a lot of our businesses. We have a lot of activity going on in the U.S. business to reduce costs in that facility. I guess, 35% to 40% make the inventory business today in the U.S.

Okay. Then just given that choppiness that you were just discussing in order activity and more challenging comps, should we be looking at October flat ex-currency is kind of may be where the sales could be coming in at in the fourth quarter or do comps become more challenging maybe just give a directionally what we should be looking at flat or up or down for fourth quarter that would be helpful.

Yes. I think flat to maybe slightly down in Q4, the way that it is currently progressing. You know kind of maybe in the low 260s kind of range top-line number for Q4 right now.

Okay. Thanks so much.

Thank you. Your next question comes from Keith Hughes from SunTrust. Please go ahead.

Thanks. As you referred to in the release you gained share here in the United States in the last 12 months and significant amount share given your growth versus the end of Q3, I guess number one, why if you look back on a year why was that the case? Then number two, Patrick's comments on the revenues, is that something that is going to carry into 2016?, particularly once you get past the tough comps as we end the year here?

I would say, Keith, repeat…

Taking share…

Yes. Excuse me.

Why have you taken a lot of share here in the last 12 months?

I would say that we are singly focused on carpet tile. We sell one product and we are not distracted by other products in the bag. Our product introductions the last four years have been fantastic, so I think the design that we are putting out there is really attracting a lot of projects around the architect designers and I think we have the best sales force in the industry and I think we are going out and getting the business and we have a segmentation strategy that we are trying to convert and I think that is broad [ph] our hard surface to carpet tile. I just think we have a single focus mind around carpet tile.

Historically you mentioned products, historically around products that have a more than one-year lifecycle. Is that something where you are set up to take share again in 2016?

I would say, no, they do not have a one-year lifecycle, but it is the fashion business that we are in. I think the last four product introductions and also the fact that we were really the first to go big in the planks category four years ago, has put us in a really good innovation design platform that that I think our customers like.

You had mentioned earlier the industry has not been up much all at all - little bit if you put the last three quarters together, but you clearly outpaced it, what do you think the industry view is for shipments as we head into '16 and maybe a subset to that is this kind of slowdown in orders do you hear that from everyone in the channel?

Keith, I do not know. I just think there is a lot of pent-up demand still. I will go to that, even new construction, if you look at what is going on the new commercial construction is positive for the first time in a long time, so I still believe that you maybe halfway through this ballgame on the commercial rebound, because it has not been very robust for the last four years, so I still think there is pent-up demand, but it is going to be choppy. I think that is the world we live in today.

Okay. Thank you.

Thank you. [Operator Instructions] Your next question comes from John Baugh from Stifel. Please go ahead.

Thank you. Congrats on a nice Q3. A couple of things, you mentioned the floor EBIT loss was narrowed $700,000, so what was the number for the quarter?

We lost about $1 million in the quarter, but for the full-year we are on track to have a positive year-over-year operating income improvement by over $4 million right now in the floor business.

Okay.

We do anticipate that I think in the fourth quarter that will be positive as well.

Great. Australia, that economy in general seems to be weakening. I think you commented your shipments and/or orders were strengthening. Obviously, it must be a share gain thing or there was something going on specifically in that market that has got non-res carpet demand up so much?

I would say that we are regaining our share with the service levels that we have within that facility at three weeks. I think the design that we are putting out there and it is much more of a made to order operation as well. We are also segmenting that business. The office demand is soft, but the non-office, I think we are actually converting other surfaces to carpet tile. Half of that business is non-office in Australia.

Great, so the non-office is really driving Australia?

Yes.

Okay. Last, but not least, Patrick, terrific cash flows year-to-date. Q4 is always the strong period and that is in front of us, so could you comment? I see receivables are a significant source year-to-date, maybe give some color on Q4 outlook and what is driving cash flows. Thank you.

Yes. I think we have done a good job on working capital management this year overall. I think our CapEx spend is coming in a little bit less than what we had budgeted just more from timing perspective than really any decisions that were made. I expect Q4 to continue to be our pretty solid $20 million-plus free cash flow generation quarter as well as we head into 2016, so pretty good overall cash flow generation for the full year.

Is there any thought to generate free cash flow number next year similar to that, where capital deployment goes. Thanks?

Yes. I mean, I think overall cash flow targets will be similar for 2016, with the one caveat that is perhaps a pretty significant capital expenditure program into our Americas modular business as we continue to kind of sort through kind of the various scenarios there, but perhaps setting to aside similar to a $30 million-plus to $40 million-plus CapEx plan. Not all of that will be spent in 2016, but potentially get started on that next year, so that would be perhaps over and above our traditional kind of $30 million to $35 million in CapEx. That is kind of how we see it now going into '16.

Capital deployment, I mean, you are getting strongest balance sheet I can remember in a long time.

Yes. Certainly is a long way from the seven times levered, isn't it? Yes. We are in a good position. We will refresh our share repurchase program here January 1, and continue to be opportunistic and probably focus primarily on reinvesting back in the business here in the near-term.

Thanks. Good luck.

Thank you.

Thank you. Your next question comes from Matt McCall from BB&T Capital Markets. Please go ahead.

Thanks. Good morning guys.

Hi, Matt.

Good morning.

First a couple of follow-ups from previous questions, I think you answered that your custom business is running about 35% to 40%. Dan, can you remind me - I think it used to be a little bit above that. Can you remind me what that trend has been like over the last couple of years?

Define customers. There are two kind of customers. There is one made to order and then we have a custom business that typically runs about a third of our business in the U.S. We made a strategic decision that we were going to create a made to inventory and sort of the moved the business a little bit towards that. We used to be about 80% made to order and 20% make to inventory we have moved that now to 60-40, and I think we are getting the benefits of that, because we get longer runs in the plants more efficient, but we still have all the customer capabilities and made to order capability as well. We have not changed that philosophy.

Okay. All right, and then Patrick, you talked about low 260, I think for Q4, can you talk about the FX impact that is assumed in that number? Then if we think about where FX rates are today, what would be I guess the benefit next year relative to the pressure that you faced this year?

We had a $22 million impact in Q3. I anticipate - we had at the exchange rates fell off pretty dramatically in Q4 last year, so the impact probably won't be as much in Q4 as it was in Q3, so maybe high teen's kind of impact on sales. For the full-year this year, we are going to have north of the somewhere $85 million impact on the headwinds related to foreign currency for the full-year, so that would be the benefit next year. I think we do not really get to kind of parity until mid to late Q1 on most of the major currencies on a translation basis, so this could be 70 some odd million dollars benefit next year if the currencies stay effectively where they are now.

Okay. Thank you. Then, Dan, you mentioned constructive comment about your cyclical confidence. When you look at some of the leading indicators within the business, I know Patrick, you talked about the 30-day, 60-day, 90-day pipeline the past, October roughly flat, but as you used that data to look out and 30-day, 60-day, 90 days, I think your comps get a little easy in Americas. Does the growth return as we head through the quarter into next year?

Well, I would say that you compare the pipeline to last year in October, it is a little bit higher this year than last year, but not significantly higher and we had a pretty good run in the fourth quarter and first and second quarter last year, so I am encouraged by that that, but as you know and I know, you get delays and choppiness and it is kind of hard to predict exactly which way that trend is going to go.

Okay. Then one more question, I felt that you have announced a new board member. It looks like you shared some residential construction experience. Is there anything says about plans in that market or you know is it just not all that?

No. I think she was very - we were trying to get diversity on our Board and having a sitting CEO of a Fortune 1000 Company and she met that diversity profile and sitting CEO.

Sure. Okay. Thank you.

Thank you. I would now like to turn the call over to Daniel for closing remarks.

Well, thank you for listening to our third quarter call and we look forward to talking to you on the fourth quarter call. Thank you.

Thank you. Thank you for your participation in today's conference. That does conclude your presentation. You may now disconnect and have a great day.