Business context and reporting period
Interface, Inc. manufactures and markets commercial flooring, including carpet tile and modular resilient flooring. This unaudited Form 10-Q covers the three and six months ended July 1, 2018; comparisons are with the periods ended July 2, 2017. Amounts below are in U.S. dollars, generally millions unless noted.
On August 7, 2018, after quarter-end, Interface completed its acquisition of Germany-based nora, a resilient flooring manufacturer. Nora’s results are included only from the acquisition date forward.
Financial results and position
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $283.6 | $251.7 | $524.2 | $472.8 |
| Gross profit | $109.1 | $97.9 | $202.7 | $185.7 |
| Gross margin | 38.5% | 38.9% | 38.7% | 39.3% |
| Operating income | $33.7 | $33.5 | $56.7 | $49.3 |
| Net income | $20.6 | $20.9 | $35.7 | $29.5 |
| Diluted EPS | $0.35 | $0.33 | $0.60 | $0.46 |
- Sales increased 12.7% in Q2 and 10.9% in the first half. Currency contributed approximately $5.3 million and $15.1 million, respectively. First-half sales by geography were Americas 59.4%, Europe 25.3%, and Asia-Pacific 15.3%.
- Q2 operating margin was 11.9%, versus 13.3%; first-half operating margin was 10.8%, versus 10.4%. Gross margins declined in both comparisons.
- First-half cash provided by operations was $5.0 million, down from $21.9 million. Working-capital uses included $16.4 million from receivables, $24.3 million from inventories, and $18.0 million from prepaid and other current assets. Capital expenditures were $16.4 million.
- Cash was $67.0 million at July 1, down from $87.0 million at year-end 2017. Debt was approximately $243.5 million, comprising $162.5 million of term loans and $81.0 million of revolver borrowings; $5.7 million of letters of credit was outstanding. The company reported $163.3 million of additional facility borrowing capacity and $9.8 million available on other lines.
- Total assets were $824.6 million and shareholders’ equity was $340.6 million at July 1. The company repurchased 615,000 shares for $14.5 million and paid $7.7 million in dividends in the first half.
Material changes versus prior comparable periods
- Q2 net income edged down despite higher sales; diluted EPS increased from $0.33 to $0.35, aided by lower average shares outstanding. First-half net income rose about 21% and diluted EPS rose from $0.46 to $0.60.
- Cost of sales grew faster than sales in Q2. Management attributed margin pressure to delayed productivity initiatives amid higher volumes and a sales mix weighted more toward InterfaceServices, which typically has lower gross margins. SG&A also rose, including higher incentive compensation, selling costs, and nora transaction costs.
- First-half 2017 included $7.3 million of restructuring and asset impairment charges; there were no such charges in the first half of 2018. The prior-year restructuring related primarily to FLOR retail store closures.
- Interest expense increased to $4.4 million in the first half from $3.3 million, reflecting higher average borrowing rates. The effective tax rate fell to 27% from 33%, primarily reflecting the lower U.S. statutory rate under the Tax Act, partly offset by base-broadening provisions.
Outlook, commentary, risks and unusual items
- The filing provides no specific financial guidance or quantified outlook. Management said it expected to remain in compliance with credit-facility covenants for the foreseeable future.
- The nora acquisition had an enterprise value of €385 million (approximately $447 million); after acquired cash, the net purchase price was approximately €344 million (approximately $400 million). The acquisition was funded in connection with an amended and restated credit facility. Purchase accounting valuations and pro forma information were incomplete at filing.
- Q2 included $5.8 million of pretax nora-related transaction costs: approximately $3.0 million in SG&A and a $2.8 million mark-to-market expense on a currency option. The option had a €315 million notional value and was terminated when the acquisition closed.
- Management identified integration, synergy realization, employee or customer attrition, disruption, higher integration costs, and increased indebtedness as risks of the acquisition. Other cited exposures include commercial interiors industry conditions, variable interest rates, foreign currency movements, and uncertainty in finalizing Tax Act accounting. Accrued unrecognized tax benefits were approximately $28.9 million at quarter-end.
- The company adopted the new revenue standard on January 1, 2018, with no significant adoption impact. Nearly 97% of revenue came from flooring materials; most product revenue is recognized upon shipment or, in some cases, delivery.
Important facts for investors to verify
- Post-close nora purchase accounting, acquired liabilities, financing terms and leverage, and realized synergies relative to integration costs.
- Whether sales growth persists excluding currency effects, by geography and product, and whether gross-margin pressure and productivity delays improve.
- Cash conversion and working-capital trends, particularly inventory, receivables and prepaid assets, alongside capital spending and shareholder returns.
- Interest-rate and foreign-exchange exposure, covenant headroom after the acquisition, and final outcomes for provisional Tax Act estimates and unrecognized tax positions.