Interface, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; comparisons are to the periods ended October 1, 2017. Amounts are in millions of dollars except per-share data. Interface manufactures and sells flooring products, principally carpet tile and resilient flooring. It completed its acquisition of Germany-based nora on August 7, 2018.
Financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $318.3 | $257.4 | $842.5 | $730.2 |
| Gross profit | $99.9 | $98.5 | $302.7 | $284.2 |
| Gross margin | 31.4% | 38.3% | 35.9% | 38.9% |
| Operating income | $15.8 | $31.3 | $72.5 | $80.6 |
| Net income | $8.2 | $19.4 | $43.9 | $48.9 |
| Diluted EPS | $0.14 | $0.32 | $0.74 | $0.78 |
- Cash flow: Nine-month operating cash flow was $58.7 million, versus $67.9 million. Capital expenditures were $28.9 million. Investing cash outflow was $429.0 million, including $400.7 million paid for nora. Financing cash inflow was $392.7 million, primarily reflecting $479.8 million of borrowings.
- Liquidity and debt: Cash was $107.3 million at September 30, 2018. Facility borrowings included $625.2 million of term loans and $32.1 million of revolver debt; letters of credit were $3.6 million. The company reported $264.3 million of additional facility borrowing capacity and $9.6 million under other credit lines. Total balance-sheet debt was $648.9 million, including current and long-term debt.
- Balance sheet: Total assets were $1,343.0 million and shareholders’ equity was $353.0 million. Inventories rose to $278.8 million from $177.9 million at year-end 2017.
Material changes and drivers
- Sales rose 23.7% in Q3 and 15.4% for the first nine months. Q3 included $41.2 million of nora revenue; sales also benefited from carpet tile and LVT growth. Currency reduced Q3 sales by about $2.9 million but increased nine-month sales by about $12.1 million.
- Q3 gross margin fell to 31.4% from 38.3%; nine-month margin declined to 35.9% from 38.9%. Management cited acquisition-related purchase-accounting charges, delayed productivity initiatives amid higher volumes, and a mix shift toward InterfaceServices, which typically has lower gross margins. Q3 cost of sales included $17.8 million of acquired inventory step-up amortization and $2.4 million of acquired-intangible amortization.
- Q3 operating income fell to $15.8 million and net income to $8.2 million. Nine-month net income also declined despite higher sales. Higher interest expense reflected acquisition-related borrowing; reported 2018 results also included $8.2 million of pretax acquisition-related costs for the nine months and $1.4 million of Q3 loss on termination of a currency option. The tax-rate reduction under the 2017 Tax Act partly benefited earnings.
- nora generated $41.2 million in revenue and a $12.5 million net loss from acquisition through September 30. The purchase price was $447.2 million, including acquired cash; provisional goodwill was $183.3 million. The company said the acquisition supports growth in resilient flooring and healthcare, life sciences, and education markets.
Outlook, risks, and other matters
- The filing provides no quantified earnings or revenue guidance. Management said it anticipates continued compliance with credit-facility covenants for the foreseeable future.
- Variable-rate debt creates interest-rate exposure: management estimated a 1% rate increase or decrease would change annual interest expense by approximately $6.5 million at current debt levels. The company also disclosed foreign-exchange exposure and uses currency forwards and an interest-rate swap to hedge specified cash flows.
- Management cited commercial-interiors economic conditions and previously disclosed risk factors. Routine legal proceedings were reported, with none requiring disclosure in the filing. The acquisition purchase accounting remained provisional; warranty/indemnity coverage and seller claims are subject to limitations.
- The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It was evaluating the effect of the upcoming lease-accounting standard, which it expected to add assets and liabilities for operating leases.
Investor verification priorities
- Track whether nora’s operating performance improves from its initial reported net loss and how much of future sales growth is organic versus acquisition-related.
- Assess whether gross margins recover as acquired inventory step-up costs end and productivity initiatives take effect; monitor lower-margin service mix.
- Review debt repayment, interest-rate exposure, covenant headroom, and the effect of variable borrowing costs on earnings and cash flow.
- Monitor inventory and other working-capital needs, which consumed cash during the first nine months, alongside acquisition integration and capital spending.
- Follow completion of nora purchase-price accounting, goodwill and intangible-asset valuations, and remaining acquisition-related costs and contingencies.