Interface, Inc. — Q3 2017 Form 10-Q
Business context and period: Interface designs and sells modular flooring and related products. This unaudited report covers the quarter and nine months ended October 1, 2017, compared with the periods ended October 2, 2016. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions unless stated otherwise.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $257.4 million | $248.3 million | $730.2 million | $719.1 million |
| Gross profit / margin | $98.5 million / 38.3% | $92.9 million / 37.4% | $284.2 million / 38.9% | $278.7 million / 38.8% |
| Operating income / margin | $30.9 million / 12.0% | $25.7 million / 10.4% | $79.3 million / 10.9% | $78.6 million / 10.9% |
| Net income | $19.4 million | $15.9 million | $48.9 million | $49.5 million |
| Diluted EPS | $0.32 | $0.25 | $0.78 | $0.76 |
- Cash flow: Nine-month operating cash flow was $67.9 million, versus $78.9 million a year earlier. Capital expenditures were $22.8 million, versus $20.9 million. Cash declined $87.6 million to $78.1 million.
- Liquidity and debt: At October 1, cash was $78.1 million; facility borrowings were $173.8 million term debt and $60.8 million revolver debt, with $6.0 million of letters of credit. The company reported $183.2 million of additional facility borrowing capacity and $9.8 million available under other lines. Balance-sheet current and long-term debt totaled approximately $234.5 million.
- Capital returns: Nine-month financing cash use included $81.1 million of share repurchases, $62.1 million of debt repayments, and $11.6 million of dividends. A new $100 million repurchase authorization was adopted in Q2; approximately $50.1 million remained available at quarter-end.
Material changes and management commentary
- Q3 sales rose 3.7%; nine-month sales rose 1.5%. Currency added approximately $4.0 million to Q3 sales but reduced nine-month sales by approximately $1.0 million. Q3 sales increased in all regions; growth was strongest in Asia-Pacific, while Europe rose 2% in local currency. Nine-month Americas commercial and Asia-Pacific sales increased, while Europe declined about 1%.
- Q3 gross margin improved to 38.3% from 37.4%, with management citing improved manufacturing productivity, restructuring savings, and nonrecurring 2016 warehouse-move costs. The improvement occurred despite lower production volumes and higher raw-material prices.
- Management expects raw-material inflation and lower production volumes to increase cost of sales as a percentage of sales for the remainder of 2017. No formal earnings or revenue guidance is provided in the supplied filing text.
- Nine-month results included $7.3 million of restructuring and asset impairment charges, primarily associated with the FLOR specialty retail-store closures. The restructuring plan also involved workforce reductions and asset write-downs. Q3 sales continued to be affected by the store exits, partly offset by gains in other FLOR channels.
- Luxury vinyl tile launched in 2017; management said sales were progressing according to plan. Growth in corporate office, education, and government was partly offset by weakness in segments including retail, residential, healthcare, and hospitality, depending on the period.
- The company amended and restated its syndicated credit facility in August 2017, extending maturity to August 2022 and liberalizing restricted-payment terms. It entered a $100 million interest-rate swap to hedge a portion of term-loan interest exposure; the reported swap liability was $0.2 million. The company said it was in covenant compliance and expected to remain compliant for the foreseeable future.
Risks, contingencies, and other items
- Key exposures include commercial-interiors industry and economic conditions, foreign exchange, variable interest rates, raw-material inflation, and lower production volumes. A 10% currency-rate movement was estimated to change the fair value of financial instruments by a decrease of $9.6 million or increase of $11.7 million; management cautioned this excludes offsetting changes in net foreign investments.
- Accrued unrecognized tax benefits were approximately $28.7 million at October 1, 2017; the company increased the liability by $0.8 million during the first nine months.
- The filing reports no material change in risk factors and no legal proceedings required to be disclosed. Disclosure controls were concluded to be effective, with no material change in internal control over financial reporting reported for the quarter.
- The company was evaluating the upcoming lease accounting standard. It expected the new revenue standard to have a mostly consistent effect on revenue timing given that most product revenue is recognized on shipment or, in some cases, delivery.
Important facts for investors to verify
- Whether Q3 margin improvement can persist given management’s expectation of higher raw-material costs and lower fixed-cost absorption.
- Sales trends by region and customer segment, including the ongoing effect of FLOR store closures and the growth trajectory of LVT.
- Cash generation and working-capital needs, particularly inventory, which increased and used $22.4 million of operating cash in the first nine months.
- Debt repayment pace, covenant headroom, variable-rate exposure, and effectiveness of the interest-rate swap.
- Execution and remaining costs of the restructuring plan, as well as use of the remaining share-repurchase authorization and its effect on liquidity.