Interface, Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended July 2, 2023 (13 and 26 weeks, respectively); results are unaudited. Interface sells modular carpet, resilient and rubber flooring, and related products and services. Its reportable segments are Americas (AMS) and Europe, Africa, Asia and Australia (EAAA).
Financial performance
| Metric | Q2 2023 | Q2 2022 | First half 2023 | First half 2022 |
|---|---|---|---|---|
| Net sales | $329.6m | $346.6m | $625.4m | $634.6m |
| Gross profit / margin | $111.8m / 33.9% | $116.7m / 33.7% | $207.7m / 33.2% | $223.5m / 35.2% |
| Operating income / margin | $28.9m / 8.8% | $34.5m / 10.0% | $38.4m / 6.1% | $61.9m / 9.7% |
| Net income | $15.8m | $16.8m | $15.1m | $30.1m |
| Diluted EPS | $0.27 | $0.28 | $0.26 | $0.51 |
Q2 sales declined 4.9%, mainly on lower volume (about 10%), partly offset by higher prices (about 5%). First-half sales fell 1.5%, as lower volume (about 5%) was partly offset by higher prices (about 4%). Q2 gross margin edged up year over year on pricing and lower freight costs; the first-half margin contracted amid raw-material inflation and weaker fixed-cost absorption from lower production volumes. SG&A rose 5.1% in Q2 and 7.5% in the first half, increasing to 25.9% and 27.5% of sales, respectively.
Q2 net income decreased 6.1%; first-half net income fell about 49.9%. First-half operating income was also affected by higher SG&A and lower sales. Interest expense rose to $8.3m in Q2 and $16.8m for the first half, primarily due to higher rates on variable-rate term borrowings. The first-half effective tax rate was 26.7%, versus 35.0% a year earlier.
Segments
- AMS: Q2 sales decreased 2.7% to $201.3m and adjusted operating income (AOI) fell 15.3% to $24.0m. First-half sales increased 2.0% to $370.5m, while AOI declined 28.7% to $35.3m.
- EAAA: Q2 sales decreased 8.2% to $128.3m and AOI fell 62.2% to $3.8m. First-half sales declined 6.1% to $254.9m and AOI fell 60.5% to $7.8m. Management cited weaker demand and lower sales volume in Asia, alongside inflation and lower factory utilization.
Cash flow, debt and liquidity
First-half operating cash flow was $47.9m, compared with cash use of $12.7m in the prior-year period, mainly reflecting favorable working-capital movements, including collections and inventory reduction. Investing used $4.7m, including $11.3m of capital expenditures and $6.6m of proceeds from the Thailand facility sale. Financing used $49.1m, principally reflecting debt repayments. Cash declined $4.6m to $92.9m.
At July 2, 2023, principal debt totaled $481.1m: $174.1m of term loans, $7.0m of revolving borrowings and $300.0m of 5.50% senior notes due 2028. Debt net of issuance costs was $475.6m. The company had $291.4m of additional facility capacity and $1.6m of letters of credit outstanding. Facility borrowing rates were variable; the reported weighted rate on total facility borrowings was 6.43%. Management said liquidity should be sufficient for the next 12 months and expects to generate cash to meet long-term obligations. The company reported compliance with debt covenants.
Material developments, outlook and risks
- Thailand restructuring and sale: The company completed its 2021 restructuring plan after selling the closed Thailand manufacturing facility for $6.6m in Q2 and recognizing a $2.7m gain. It expects annualized savings of about $1.7m, with remaining savings expected in fiscal 2023. The gain contributed to negative restructuring and other charges in the statements.
- Cybersecurity event: A November 2022 attack disrupted certain IT, shipping, inventory and production systems; operations substantially resumed within two weeks. The investigation was substantially completed early in Q3 2023. First-half investigation costs were about $0.9m; the company expects some costs to be recovered through insurance and anticipates ongoing security spending. Potential liabilities from exposed data remain a risk.
- Q3 outlook: Management anticipated net sales could be flat but were more likely to decline versus Q3 2022. It expected lower raw-material and freight costs, continued weaker manufacturing fixed-cost absorption, and an improved gross-margin percentage, with higher SG&A primarily due to inflation. No full-year numerical guidance was provided.
- Market and operating risks: Management cited inflation, higher interest rates, the Russia/Ukraine war, supply-chain challenges, slow recovery in China and pressure in global commercial offices. These conditions may weigh on demand, costs and margins. Backlog was about $214.7m as of July 23, 2023, up from $197.4m on February 5; management attributed the increase to project and installation timing.
- Legal matters: A putative class-action settlement of $7.5m received preliminary court approval, with insurers funding the amount into escrow; final approval was scheduled for September 18, 2023. The company reversed the associated asset and liability in Q2. In the former CEO lawsuit, the court denied reconsideration of summary judgment for the company; a final trial-court judgment remained subject to possible appeal.
Important facts for investors to verify
- Whether sales and demand stabilize, particularly in Asia and corporate-office, retail and healthcare markets, and whether backlog converts to revenue.
- Whether pricing, lower input and freight costs, and manufacturing utilization improve gross margin as anticipated.
- Cash conversion and working-capital trends, including whether first-half operating cash flow benefits recur.
- Variable-rate borrowing costs, debt reduction, facility availability and continued covenant compliance.
- Insurance recoveries and any remaining financial or operational consequences of the cyber event.
- Final court approval and insurance funding status of the class-action settlement, as well as any appeal in the former CEO matter.