Interface, Inc. — Q2 2015 Form 10-Q
Business context and period: The filing covers the quarter and six months ended July 5, 2015. Interface reports three geographic operating segments—Americas, Europe and Asia-Pacific—as one reporting segment. The quarter comprised 13 weeks; the first half comprised 27 weeks, versus 26 weeks in the first half of 2014.
Financial performance
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Net sales | $263.6 million | $260.6 million | $500.5 million | $479.6 million |
| Gross profit | $101.3 million | $90.4 million | $186.7 million | $165.1 million |
| Operating income | $33.2 million | $24.3 million | $54.6 million | $36.4 million |
| Net income | $21.7 million | $13.1 million | $34.0 million | $17.1 million |
| Diluted EPS | $0.33 | $0.20 | $0.51 | $0.26 |
| Gross margin | 38.4% | 34.7% | 37.3% | 34.4% |
| Operating margin | 12.6% | 9.3% | 10.9% | 7.6% |
Cash flow and liquidity: First-half operating cash flow was $50.9 million, compared with $0.8 million in 2014. Capital expenditures were $12.1 million; operating cash flow less capital expenditures was $38.7 million. Cash increased to $71.8 million from $54.9 million at December 28, 2014. Working capital included a $27.2 million inventory increase, partly offset by $15.2 million from lower receivables.
Debt: At July 5, 2015, debt totaled approximately $259.1 million: $200.0 million of term loans and $59.1 million of revolving borrowings. The weighted-average borrowing rate was 1.9%; the facility matures in October 2019. The company reported $187.8 million of additional facility borrowing capacity and $19.0 million available under other subsidiary credit lines. It was in compliance with facility covenants and expected to remain compliant for the foreseeable future.
Material changes and management commentary
- Sales increased 1.2% in Q2 and 4.4% in the first half, despite reported U.S.-dollar sales being reduced by foreign exchange effects of approximately $24.1 million and $43.3 million, respectively. Management also estimated currency reduced operating income by $3.4 million in Q2 and $5.5 million in the first half.
- In Q2, Americas sales rose 7%; reported sales declined 7% in Europe and 6% in Asia-Pacific. Management said local-currency sales increased approximately 16% in Europe and 4% in Asia-Pacific. Corporate office demand was a key contributor; performance across non-office markets varied, including strength in hospitality and education and weakness in several other segments.
- Gross margin improved as cost of sales fell to 61.6% of sales in Q2 from 65.3%. Management attributed the improvement to 5–7% lower global raw-material costs, higher production and fixed-cost absorption, manufacturing efficiencies, stabilization in Asia-Pacific operations, and savings from the 2014 restructuring plan.
- Q2 SG&A rose 3.0% year over year, primarily because of higher share-based compensation and incentive compensation; first-half SG&A increased 2.6%. First-half restricted-stock compensation expense was $9.1 million, versus $2.7 million a year earlier.
- Interest expense declined to $1.8 million in Q2 and $3.7 million in the first half, from $5.4 million and $10.9 million, respectively, following the 2014 refinancing of 7.625% senior notes with lower-rate syndicated-facility borrowings.
- First-half cash uses included $10.5 million for share repurchases and $5.3 million for dividends. The company repurchased 500,000 shares during the first half under its annual program.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management’s forward-looking statements identify commercial-interiors industry economic conditions and the risk factors in the 2014 Form 10-K as uncertainties; the company disclaimed an obligation to update forward-looking statements.
- Currency movements remain material: the U.S. dollar’s strengthening reduced reported sales and operating income, and the first-half foreign-currency translation adjustment was a $20.2 million loss. Management’s sensitivity analysis estimated that a 10% exchange-rate move could change the fair value of financial instruments by a decrease of $10.1 million or an increase of $8.3 million; it cautioned that this does not represent actual net exposure.
- The company had accrued approximately $27.2 million for unrecognized tax benefits; its deferred tax asset reflected a $21.9 million reduction for these benefits.
- The 2014 restructuring plan targeted a 100-employee reduction and included a $12.4 million charge in Q3 2014. At July 5, 2015, $1.1 million of workforce-reduction costs remained; no restructuring charge for the plan was reported in the current-period results presented.
- Interface reported ordinary-course legal proceedings, none required to be disclosed, and no material second-quarter changes to its previously disclosed risk factors. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether sales growth and margin gains persist after separating foreign-exchange effects, the extra first-half week, and lower input costs.
- Whether demand trends by geography and end market—particularly corporate office, hospitality, education, retail and healthcare—continue as management described.
- How share-based compensation and incentive costs affect future SG&A and earnings.
- Debt repayment, variable-rate exposure, available borrowing capacity, and ongoing compliance with credit-facility covenants.
- The timing and potential cash impact of unrecognized tax benefits and remaining restructuring costs.