Interface, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 30, 2014; comparative period ended March 31, 2013. Financial statements are unaudited. Interface operates in the Americas, Europe and Asia-Pacific and reports as one segment.
Financial performance
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Net sales | $219.0 million | $210.4 million |
| Gross profit / margin | $74.7 million / 34.1% | $71.3 million / 33.9% |
| Operating income / margin | $12.0 million / 5.5% | $14.0 million / 6.7% |
| Net income | $4.0 million | $7.0 million |
| Diluted EPS | $0.06 | $0.11 |
| Cash used in operating activities | $2.6 million | $9.0 million |
| Capital expenditures | $9.1 million | $14.9 million |
Sales rose 4.1%. Gross margin improved 0.2 percentage points, while operating margin fell 1.2 points and net income declined 42%. SG&A increased 9.4% to $62.7 million, or 28.6% of sales versus 27.2%. Interest expense declined to $5.5 million from $6.2 million. Income tax expense was $2.5 million versus $0.4 million; the prior-year quarter included a $2.0 million tax benefit from tax pricing agreements.
Cash, liquidity and debt
Cash was $62.5 million at March 30, 2014, down $10.4 million during the quarter. Working capital was $263.9 million, based on current assets of $394.6 million and current liabilities of $130.8 million. Operating cash outflow reflected a $20.0 million increase in inventory, partly offset by an $8.1 million reduction in receivables. Cash dividends paid were $2.0 million.
Debt comprised $247.5 million of 7.625% Senior Notes due 2018 and $30.9 million drawn under the revolving credit facility. The facility had $169.1 million of additional borrowing capacity and $4.2 million in letters of credit outstanding; other non-U.S. credit lines provided a further $8.4 million of availability. The company reported compliance with facility covenants and expected to remain compliant for the foreseeable future.
Material changes and management commentary
- Americas sales increased 5% and Europe increased 15% in U.S. dollars (11% in local currency); Asia-Pacific sales declined 17%. Growth in Americas non-office segments and broad European gains were partly offset by lower Asia-Pacific demand.
- Severe U.S. winter weather caused five lost production days and weighed on consumer spending. Asia-Pacific results also reflected softer demand, Chinese New Year seasonality, currency effects, and the transition to local Australian production.
- The replacement Australian facility in Minto began operating in January 2014 after the 2012 fire disrupted the Picton facility. Start-up inefficiencies weighed on Asia-Pacific gross margin; management expected that margin to normalize later in 2014 as the plant ramped up.
- Management attributed improved cost-of-sales percentage to lean manufacturing and production efficiencies, partly offset by higher raw-material and labor costs. Higher selling, administrative and marketing spending included targeted sales-team additions, marketing investment, FLOR store costs, and higher stock compensation expense.
Outlook, risks and unusual items
The filing provides no quantified full-year guidance. Management cautioned that interim results are not necessarily indicative of full-year results. Forward-looking statements are subject to commercial-interiors industry and other risks described in the company’s 2013 Form 10-K. The company reported no material changes to risk factors, no legal proceedings requiring disclosure, and no material changes in internal control; management concluded disclosure controls were effective.
A new accounting standard for unrecognized tax benefits reduced both long-term deferred tax assets and long-term other liabilities by approximately $21.8 million, including a corresponding adjustment to the prior-year balance sheet. Accrued unrecognized tax benefits were approximately $27.5 million. A 10% currency-rate movement against the U.S. dollar was estimated to change the fair value of financial instruments by a decrease of $9.7 million or an increase of $8.0 million; management noted this sensitivity excludes offsets from net foreign investments.
Investor verification points
- Assess whether revenue growth and Europe/Americas gains can offset continued Asia-Pacific weakness and the Australian plant’s ramp-up costs.
- Track SG&A growth, operating-margin compression and the persistence of higher stock-based compensation expense.
- Monitor inventory levels and operating cash conversion, given the quarter’s inventory-driven cash outflow and lower cash balance.
- Review debt, revolver utilization, covenant headroom and the company’s ability to fund capital needs and dividends.
- Examine tax expense and uncertain-tax-position exposure, including the prior-year $2.0 million tax benefit and the $27.5 million accrued liability.