Interface, Inc. — Q2 2014 Form 10-Q
Business context and period: Interface reports as a single segment, with operations in the Americas, Europe and Asia-Pacific. The filing covers the quarter and six months ended June 29, 2014; comparative periods ended June 30, 2013. Amounts below are in millions except per-share data.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $260.6 | $243.5 | $479.6 | $453.9 |
| Gross profit | $90.4 | $86.2 | $165.1 | $157.5 |
| Gross margin | 34.7% | 35.4% | 34.4% | 34.7% |
| Operating income | $24.3 | $21.8 | $36.4 | $35.8 |
| Operating margin | 9.3% | 9.0% | 7.6% | 7.9% |
| Net income | $13.1 | $11.0 | $17.1 | $18.0 |
| Diluted EPS | $0.20 | $0.17 | $0.26 | $0.27 |
Q2 sales rose 7.0% year over year and six-month sales rose 5.7%. For the quarter, sales increased in all regions: Americas 4%, Europe 15% in U.S. dollars (9% local currency), and Asia-Pacific 5%. Six-month sales were up in the Americas and Europe but down 7% in Asia-Pacific.
Six-month operating cash flow was $0.8, versus cash used of $9.0 in the prior-year period. Capital expenditures were $22.0, resulting in cash used in investing activities of $23.7. Cash declined $22.9 from year-end to $50.0. At June 29, current assets were $406.6 and current liabilities $135.5.
At quarter-end, senior notes were $247.5 and revolving-facility borrowings were $31.5; total debt was approximately $279.0. The notes bear 7.625% interest and mature in 2018. Revolver borrowings had a weighted-average rate of approximately 4.5%; $165.2 of additional borrowing capacity remained, after $3.3 of letters of credit. Management reported compliance with facility covenants and expected continued compliance.
Material changes and management commentary
- Q2 net income increased to $13.1 from $11.0, while six-month net income declined to $17.1 from $18.0. The first half of 2013 included a $1.9 tax benefit from resolving a tax dispute.
- Q2 gross margin fell 0.7 percentage points year over year, reflecting manufacturing costs, new-product and market expansion mix, and initially lower selling prices. Management said margin improved sequentially as the Minto, Australia plant ramp progressed and lean manufacturing initiatives continued.
- Management expected further gross-margin expansion through the balance of 2014 and further SG&A reductions as a percentage of sales in the second half. No numerical earnings or sales guidance was provided.
- Q2 SG&A was 25.3% of sales versus 26.5% a year earlier, attributed to spending controls and sales growth. Six-month SG&A was 26.8% of sales in both years.
- Australia’s replacement manufacturing facility in Minto began operating in January 2014 after the 2012 Picton facility fire. Management said the transition weighed on first-half Asia-Pacific sales, which began recovering in Q2.
- Inventory increased to $172.5 from $149.6 at year-end and receivables to $149.9 from $131.9. Management identified higher inventory and receivables as significant first-half cash uses.
- The 2014 income-tax provision was $8.5 for six months, compared with $5.4 in 2013, which included the tax-resolution benefit. Accrued unrecognized tax benefits were $26.8 at quarter-end.
- The company implemented a tax-presentation accounting standard that reduced both long-term deferred tax assets and long-term other liabilities by approximately $21.8; the filing describes this as a presentation change. The company did not expect the newly issued revenue-recognition standard to have a material financial impact.
Risks, contingencies, and controls
Management cited economic conditions in the commercial interiors industry and the risk factors in the 2013 Form 10-K as relevant uncertainties. The filing reported no material second-quarter changes to risk factors; ordinary-course legal proceedings were not required to be disclosed. Foreign-exchange sensitivity analysis estimated changes in fair value of financial instruments of negative $10.3 or positive $8.4 under a 10% currency-rate move; management cautioned that this excludes offsetting changes in net foreign investments. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported.
Investor facts to verify
- Whether anticipated gross-margin improvement and second-half SG&A leverage materialize, given Q2 and first-half gross-margin pressure.
- Whether Asia-Pacific sales recover following the Minto plant start-up, and whether manufacturing ramp costs and disruptions abate.
- Whether rising inventory and receivables convert to cash; first-half operating cash flow was modest despite positive net income.
- Revolver utilization, covenant compliance, and refinancing or repayment needs for the 7.625% notes due 2018.
- Developments in the $26.8 of accrued unrecognized tax benefits and any further tax or accounting-standard effects.