Interface, Inc. — Q3 2016 Form 10-Q
Business context and period: Interface reported results for the quarter ended October 2, 2016 (13 weeks) and the first nine months of fiscal 2016 (39 weeks), compared with the same 13-week quarter and 40-week nine-month period in 2015. The company reports one segment, aggregating its Americas, Europe, and Asia-Pacific operating regions. Financial statements are unaudited; management said interim adjustments were normal and recurring.
Key financial results
Amounts below are in millions, except per-share data and percentages.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $248.3 | $254.7 | $719.1 | $755.2 |
| Gross profit / margin | $92.9 / 37.4% | $98.0 / 38.5% | $278.7 / 38.8% | $284.7 / 37.7% |
| Operating income / margin | $25.7 / 10.4% | $31.3 / 12.3% | $78.6 / 10.9% | $85.9 / 11.4% |
| Net income | $15.9 | $20.1 | $49.5 | $54.2 |
| Diluted EPS | $0.25 | $0.31 | $0.76 | $0.82 |
| Operating cash flow | Not separately stated | Not separately stated | $74.2 | $92.7 |
| Capital expenditures | Not separately stated | Not separately stated | $20.9 | $23.7 |
- Quarterly comparison: Sales fell 2.5%; net income and diluted EPS each declined about 21%. Gross margin contracted 1.1 percentage points and operating margin 1.9 points.
- Nine-month comparison: Sales declined 4.8%, while net income fell 8.7%. Gross margin improved 1.1 points, but operating margin declined 0.5 points. The 2016 period had one fewer week; management noted this affects comparisons.
- Cash and liquidity: Cash was $113.7 million at October 2, up $38.0 million from January 3. Current assets were $438.3 million and current liabilities $153.9 million. The filing reports $218.4 million of additional borrowing capacity under the syndicated facility and $14.8 million available under other lines.
- Debt: Term and revolving borrowings totaled $217.6 million ($190.0 million term and $27.6 million revolving); net debt after cash was approximately $103.9 million. The facility matures in October 2019; its borrowings had a 2.2% weighted-average rate and variable-rate exposure. The company said it was covenant-compliant and expected to remain so for the foreseeable future.
Performance drivers and material changes
- Q3 regional sales declined 3.4% in the Americas and 5.7% in Europe, while Asia-Pacific grew 7.4%. Management attributed the Americas weakness largely to deferred corporate-office projects and European weakness primarily to Brexit-related uncertainty. Asia-Pacific gains included Australia, China, and India.
- For the first nine months, Americas sales fell 5.2% and Europe 8.0%; Asia-Pacific increased 2.6%. Currency reduced reported sales by $1.7 million in Q3 and $8.1 million year to date, and operating income by $0.1 million and $0.5 million, respectively.
- Q3 cost of sales as a share of sales rose to 62.6% from 61.5%, attributed to lower Americas production volume and transition costs for a centralized warehouse and distribution center. Management expected those additional costs to subside by the end of Q4 2016. Year-to-date cost of sales improved as a share of sales, helped by lower raw-material costs, higher average selling prices, and a mix shift toward higher-margin products.
- SG&A increased 0.7% in both the quarter and nine-month period; as a share of sales it rose to 27.0% from 26.2% in Q3 and to 27.8% from 26.3% year to date. Marketing investments included the rollout of modular resilient flooring products and branding initiatives.
Cash flow, capital allocation, and other items
- Nine-month cash from operations of $74.2 million was below $92.7 million in 2015. Investing used $19.8 million; financing used $18.0 million. Uses included $20.9 million of capital expenditures, $10.4 million of share repurchases, and $10.4 million of dividends.
- The company repurchased and retired 662,500 shares at a weighted-average $15.73 per share. Its amended program authorized up to $50 million of repurchases and had no specified expiration date.
- Accrued unrecognized tax benefits were approximately $28.2 million; the related deferred tax asset reflected a $14.2 million reduction for these benefits. The filing identifies ordinary-course legal proceedings but no proceedings requiring disclosure in the section.
- Foreign currency translation adjustment improved $3.8 million from year-end, primarily due to a stronger Australian dollar relative to the U.S. dollar. A hypothetical 10% currency-rate change produces modeled fair-value changes that management cautions do not represent actual exposure.
Outlook, risks, and controls
The filing provides no quantified revenue or earnings guidance. Management’s specific near-term expectation was that Americas warehouse-transition costs would ease by the end of Q4 2016. Risks discussed include commercial-interiors industry economic conditions, Brexit and other geopolitical uncertainty, foreign-exchange movements, and variable interest rates. Management reported effective disclosure controls and no material change in internal control over financial reporting; it reported no material third-quarter change to the risk factors in its 2015 Form 10-K.
Investor facts to verify
- Whether deferred corporate-office projects and the reported Americas and Europe sales weakness persist, and whether Asia-Pacific growth continues.
- Whether warehouse-transition costs subside as expected and gross and operating margins stabilize.
- Whether operating cash generation supports capital spending, dividends, and buybacks while debt remains variable-rate and covenant-compliant.
- The eventual settlement and cash implications of the $28.2 million in unrecognized tax benefits.
- How the one-week difference between the nine-month comparison periods affects interpretation of underlying sales and earnings trends.