Interface, Inc. 2016 Form 10-K
Business context and reporting period
Interface designs, manufactures and sells modular carpet globally, primarily under the Interface and FLOR brands, with sales in more than 110 countries. It also began testing luxury vinyl tile (LVT) in the U.S. in 2016. Fiscal 2016 was the 52-week year ended January 1, 2017; fiscal 2015 had 53 weeks, which affects comparisons.
Financial performance
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net sales | $958.6 million | $1,001.9 million | Down 4.3% |
| Gross profit / margin | $368.6 million / 38.5% | $382.9 million / 38.2% | Margin up 0.3 points |
| Operating income / margin | $84.9 million / 8.9% | $113.6 million / 11.3% | Down 25.2% |
| Net income | $54.2 million | $72.4 million | Down 25.2% |
| Diluted EPS | $0.83 | $1.10 | Down 24.5% |
| Cash from operations | $93.2 million | $125.4 million | Down $32.3 million |
| Capital expenditures | $28.1 million | $27.2 million | Up $0.9 million |
Cost of sales was 61.5% of sales versus 61.8% in 2015; lower raw-material costs contributed an estimated $12 million benefit. SG&A declined in dollars but rose to 27.5% of sales from 26.9%. The filing reports no GAAP “free cash flow” figure; operating cash flow less capital expenditures was approximately $65.1 million.
At year-end, cash was $165.7 million, total debt was $270.3 million and working capital was $321.8 million. The current ratio was 3.0. Net debt was approximately $104.7 million. The syndicated facility had $2.9 million of letters of credit outstanding and $161.7 million of additional revolving capacity; it matures in October 2019. Debt is primarily variable-rate, with a 2.1% weighted-average rate. Management estimated that a 1-point rate increase would add about $2.7 million to annual interest expense.
Changes versus the prior comparable period
Sales fell in the Americas (4.2%) and Europe (8.1%), partly offset by 2% growth in Asia-Pacific. Currency movements reduced 2016 sales by approximately $10.9 million, versus a $79.5 million negative impact in 2015. In the U.K., sales declined 13% in local currency and more than 25% as reported in U.S. dollars amid Brexit-related uncertainty and sterling weakness. Lower raw-material costs and improved production utilization supported gross margin, while operating income and net income fell substantially.
Operating cash flow declined from $125.4 million to $93.2 million. Year-end cash nevertheless rose by $90.0 million, substantially reflecting $87.4 million of credit-facility borrowings. In December, a foreign subsidiary borrowed €61 million (about $63.5 million) and transferred the funds to the U.S. parent; a significant portion was expected, but not required, to be repaid in Q1 2017.
Outlook, management commentary, risks and unusual items
- Restructuring: The Q4 2016 plan includes closing FLOR’s headquarters and most retail stores, reducing about 70 FLOR positions plus other commercial carpet jobs, and writing down assets. The company recorded $19.8 million of charges in 2016 and expected another $7–9 million in Q1 2017, for total charges of approximately $27–29 million. About $17 million was expected to require future cash payments; completion was targeted for the first half of 2017. FLOR is to focus on internet and commercial-channel sales.
- Q4 result: Net income was $4.7 million, or $0.07 per diluted share, including the $19.8 million restructuring and impairment charge.
- 2017 expectations: Management estimated capital expenditures of $55–65 million and interest expense of $6–9 million. It planned a global LVT launch, beginning with the Level Set collection. No specific sales or earnings guidance was provided in the supplied filing text.
- Risks: Demand is exposed to commercial construction and renovation cycles, competition and pricing pressure, petroleum-based input costs, dependence on third-party nylon suppliers, foreign exchange and political/economic uncertainty, and substantial debt with variable rates and restrictive covenants. The facility requires a maximum consolidated net leverage ratio of 3.75:1 and minimum interest coverage of 2.25:1; the company reported compliance at year-end.
- Other matters: A $3.4 million impairment of TacTiles patent-defense costs was included in restructuring and asset impairment charges. European defined-benefit pension liability rose to $19.4 million; pension-related actuarial effects also reduced comprehensive income. No material off-balance-sheet arrangements or material litigation were reported. The auditor issued an unqualified opinion and reported effective internal control over financial reporting. Daniel Hendrix planned to step down as CEO on March 3, 2017, with President Jay Gould appointed as successor.
Important facts for investors to verify
- Whether sales and margins stabilize, especially in the U.K./Europe and the corporate-office and FLOR businesses, and how much of reported declines reflects currency and the shorter fiscal year.
- Actual 2017 restructuring charges, cash outlays, savings and completion timing, including the FLOR store exits.
- Repayment of the December 2016 borrowings, cash availability by jurisdiction, and progress toward the October 2019 facility maturity.
- Delivery and economics of the global LVT launch, including adoption, third-party manufacturing arrangements and capital needs.
- Exposure to variable interest rates, covenant headroom, foreign exchange, nylon supply and pension assumptions.