Interface Inc (TILE) 2013 Q4 法說會逐字稿

Good day, ladies and gentlemen and welcome to the fourth quarter 2013 Interface, Incorporated earnings conference call. My name is [Jeanette] I will be your operator for today. At this time, all participants are in a listen only mode. (Operator Instructions). As a reminder this conference is being recorded for replay purposes. I would now like to turn the conference over to Mr. David Foshee, Vice President. Please proceed.

Thank you, Operator. Good morning and welcome to Interface's conference call regarding fourth quarter 2013 results. Joining us from the Company are Dan Hendrix, Chairman and Chief Executive Officer, and Patrick Lynch, Senior Vice President and Chief Financial Officer. Dan will review highlights from the quarter as well as Interface's business outlook. Patrick will then review the Company's key performance metrics and financial results.

We will then open the call for Q & A. A copy of the earnings release can be downloaded off the investors relation session of Interface's website. An archived version of this conference call will also be available through that website. Before we begin formal remarks, please note that during today's conference call, management's comments regarding Interface's business, which are not historical information are forward-looking statements.

Forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from any such statements, including risks and uncertainties associated with the economic conditions in the commercial interiors industry, as well as the risks and uncertainties discussed under the heading risk factors in item 1A of the Company's annual report on Form 10-K for the fiscal year ended December 30, 2012, which has been filed with the Securities and Exchange Commission. We direct all listeners to that document.

Any such forward-looking statements are made pursuant to the Private Securities Litigation Reform Act of 1995. The Company assumes no responsibility to update or revise forward-looking statements made during this call, and cautions listeners not to place undue reliance on any such forward-looking statements. Management's remarks during this call refer to certain non-GAAP measures.

The reconciliation of these non GAAP measures to the most comparable GAAP measures is contained in the Company's results in Form 8-K filed with the SEC yesterday. These documents can found on the investor relations portion of the Company's website www.interfaceglobal.com. Lastly, please note that this call is being recorded and broadcast for Interface.

It contains copyrighted material and may not be rerecorded or rebroadcasted without Interface's express permission. Your participation on the call confirms your consent to the Company's taping and broadcasting of it. Now, I would like to turn the call over to Dan Hendrix. Please go ahead, sir.

Good morning, everyone. The top line in the fourth quarter came in just ahead of last year, which is about what we expected at the time of our last conference call. The biggest news of the quarter was the progression in Europe, where sales pulled even year-over-year in local currency, and were up 4% as reported in U.S. dollars.

It's been eight quarters since we last reported a year over year sales increase in Europe, so this is welcome news, and is a continuation of the improving trends we have seen over the last few quarters. The Americas business continues with it's steady growth, generally in line with the broader economy, and we believe we are outperforming the commercial carpet industry in the U.S. The corporate office market was the biggest growth in dollars while the residential business had the highest percentage gain year over year, followed by the hospitality segment.

The residential growth was mostly driven by FLOR stores. We also had a nice increase in FLOR sales on the web. We now have a total of 21 FLOR stores open with the same stores sales up 44%during the fourth quarter. The aggregate on stand alone basis the stores were break even in the fourth quarter and turned a small profit for the year. Our Asia Pacific business continued to feel the effects with last year's fire in Australia, as well as a softer macro economic conditions and currency impacts with sales down 13% year-over-year.

Patrick will speak more about the currency impact in a little bit. The good news is that we closed out our insurance claim related to the fire, which resulted in a gain, and we started up our new plant outside of Sydney in the first week of January. I'm very pleased with the expansion of our gross margin during the fourth quarter, which is up 240 basis points year over yearand 40 basis points sequentially versus the third quarter.

This improvement is a reflection of the progress in our lien manufacturing initiatives as well as streamlining our supply chain in Asia Pacific throughout the year. On this note, I should point out that we do expect some negative margin impact in our Asia Pacific business during the first part of 2014 as we ramp up our new plan in Australia and rebalance production among the three plants in the region. We expect margins to normalize by the third quarter.

Our expansion of gross margin was partially offset by increased SG and A expenses as we enhanced our sales and marketing initiatives at FLOR and higher incentive based compensation. We believe that these increased expenses will continue to yield sales growth in efficiency benefits but we are also keeping a close watch on SG and A in the early months of 2014 to keep them in check relative to our top line.

I feel like we are on a solid footing as we begin 2014 with my main concern being the early year softness we've seen in the Asia Pacific business. Order activity in the U.S. and Europe has been good but Australia has been soft in the first six weeks, and China also had a slow start due to the early Chinese new year holiday. Even in the U.S. we have had some setbacks from bad weather, in the mid west and east coast. As you know the first quarter is typically is our seasonally lightest quarter.

That being said, we still feel good about our prospects for the year. Leading indicators in the U.S. are moving in the right direction and project activity within the (inaudible) community has been firming up nicely. While we expect the pace of the economic recovery in the U.S. to remain gradual but modest during the year, we believe that we have upside to take share, and out perform the rest of the industry.

Like most retailers, stores have been effected by weather during the first six weeks of the year, with stores in warm weather cities doing much better compared to stores in cold weather cities. We remain focused on balancing sales growth and achieving profitability at the [FLOR] during the year. The outlook for Europe has brightened over the past six months with consistent evidence that its economic downturn is subsiding, with France being the exception, as it trails the rest of the region.

We see very good order activity in the U.K., Germany, and Holland, and we expect this trend to continue throughout the year. In Australia, the overall market is soft in the early going butI do think we are poised to regain market share, as delivery times and service levels significantly improve with the ramp up of the new plant. The prospects for the rest of Asia are mixed bag, with our success to be determined by our ability to improve service levels, regain market share, rebalance production among our facilities,penetrate non office segments and lead in design and sustainability. We also need to see how the civil unrest in Thailand plays out.

As earlier said, we will keep a close watch on SG and A. We'll be looking to grow our current SG and A level as the year progresses. But I also will not hesitate to stringently tighten up these expenses if our top line doesn't grow as expected. I will now turn it over to Patrick for some financial highlights.

Thank you and good morning, everyone. I will now take a few minutes to walk through the financial highlights for the fourth quarter. Sales for the fourth quarter of 2013 were up slightly to $251.7 million, compared with $249.6 million in the fourth quarter of 2012. On a consolidated basis there was not a significant currency impact for the quarter.

We are very much encouraged by the continued expansion of gross margin in 2013. We saw an improvement of gross margin of 240 basis points to 36.5% versus 34.1%in the fourth quarter of 2012. And a sequential improvement for 40 bases points verses the third quarter of 2013. We attribute this to continued implementation of our lien manufacturing initiatives worldwide and streamlining of our supply chain in the Asia Pacific region.

Our raw material prices were effectively flat in the fourth quarter of 2013 versus the same period in 2012. While we are anticipating gross margin headwinds with the realignment of our manufacturing activities in the Asia Pacific region in the first quarter, we are excited about the impact of the newly commissioned facility we'll have in our operations as we continue throughout 2014. In the Americas we saw sales increase approximately 3%, largely due to the strength of the corporate office market and residential market segments.

We stand at 21 FLOR stores now and we continue to see healthy sales growth in that business. The remainder of our market segments in the Americas remained relatively flat year over year, with the exception of a decline in the education segment. As Dan mentioned we are optimistic about the prospects in Europe over the results of the fourth quarter. Sales were essentially flat in local currency and up 4% in U.S. Dollars. We saw the majority of the increase in Europe in our corporate office segment, and we also experienced gross margin in operating increase verses the fourth quarter of 2012.

Turning to the Asia Pacific region, we experienced decline in sales of approximately 13%, due largely to Australia, which experienced a U.S. Dollars decline of 18%. Currency was a significant factor as the sales declined in Australia was only 7%. We also experienced smaller declines across southeast Asia and China, the decline in Asia Pacific was primarily within the corporate office segment, which provides the majority of its net sales. We did some strong sales performance, however, in the retail and government market segments.

Despite the top line decline, we still generated respectable profits in the region and believe there's plenty of organic growth and share gains to be realized. As previously discussed we recently commissioned our new plant in Australia, and once the manufacturing picture has been rebalanced we look forward to strong contributions from this new facility. On the topic of Australia, we are pleased to have settled our insurance claim related to the fire.

Received the final payment of $22.3 million from our insurer in December 2013, bringing the total cash proceeds from the claim received during 2012 and 2013 to $76.7 million. The $7 million gain we recorded in the fourth quarter represents the excess cash received or the amount we have recorded as receivable with regard to this claim. In the fourth quarter of 2013 SG and A increased to $66.8 million from $63.2 million last year. As a percentage of sales SG and A increased 130 basis points to 26.6%compared with 25.3% a year ago.

These increases are due to our continued selling and marketing initiatives centered on our growth areas, namely FLOR storesand sales personnel additions. We believe these investments will continue to yield top line growth in future periods. We also saw increased incentive compensation costs compared with the prior period. We continue to keep a sharp focus on SG and A expenses and generally limit spending in areas with a significant return.

Operating income in the fourth quarter 2013 was $32 million, or 12.7% of sales. This includes a gain of $7 million on the settlement of our fire insurance. Excluding this gain, operating income was $25 million, or 10% of sales. This compares with operating income of 2012 fourth quarter of $21.9 million, or 8.8% of sales, excluding the charges of $2.3 million related to restructuring expenses. Interest expense in the fourth quarter of 2013 was $5.4 millioncompared with $5.9 million in the fourth quarter 2012.

Depreciation, amortization was $8.9 million in the fourth quarter of 2013compared with $7.6 million in the fourth quarter of 2012. Turning to the balance sheet, we exited the quarter with $72.9 million, compared with $90.5 million at the end of 2012. Inventories were $149.6 million at the end of 2013, compared with $141.2 million at the end of 2012. With that, I'll open up the call for questions. Operator?

Thank you. (Operator Instructions). Your first question comes from the line of Mike Wood with Macquarie. Please proceed.

Hi, guys. Thanks for taking my call. This is Adam in for Mike. I just had a question on the Asia rebalancing impact on gross margins. Do you still expect about a 50 basis point impact in the first half?

In the first quarter we do, yes. We still expect gross margins to be up year over year in Q1 but the Australia start up will probably have a 50 basis point drag against, really, where we will be as we start up the facility.

Okay, great. And then how many stores do you guys expect in 2014 for FLOR?

While we've identified several locations we probably have a couple that will open this year and probably similar to last year.

Okay. Great. Thanks, guys.

That will be in the back half of the year.

Your next question comes from the line of Keith Hughes with Sun Trust. Please proceed.

Thank you. Two questions. One, what did you end up doing in revenue at FLOR during the year? I believe you said you made a little bit of, I guess, a cash profit in the year. And then number two, on the orders so far in Asia being weak, is there anyway you can parse out how much the Chinese New Year, how much is just weakness in the region?

Last year, total sales for FLOR were right around $46 million for the full year. And we did have an operating loss for the full year of about $3 million for the full yearin that division.

How about a cash?

Asia, generally, it's been soft from the get gofor most of the quarter. Chinese New Year is a little bit earlier this year than last year. But still, through the first seven weeks this year versus the first seven weeks last year, the Chinese New Year has fallen in both periods. So I think it is mostly around just the general economic conditions across Asia right now.

Okay, thanks.

Your next question comes from the line of [Josh Borstein] with Longbow Research. Please proceed.

Hi. Dan, Patrick in (inaudible). I thank you for taking my questions here. You had mentioned your intention to keep SG and A in check in 2014. I'm just curious, as a percentage of sales what might that entail for the full year?

Well, our goal is, obviously, to drive it below 25%. We have an issue in Europe where it is over 30%. We need to grow into that. We have not made a decision to restructure Europe but to allow the rebound in Europe. And so we need to grow into that, and the other issue we have is FLOR. It has a very high SG and A. So we need to go into that as well.

Okay. Thank you for that. Just looking at the Asia Pacific region, as we (inaudible) the top line this year what factors should we take into consideration that might be above and beyond what we think is the industry growth rate? I am thinking specifically of capacity that might be available this year that is freed up from the Australia plant coming online.

Well, there's definitely -- we have service levels that have gone from ten to 12 weeks back down to three to four weeks so we do have the capacity to take orders in that region. But we have to go out and regain share in Australia. That's the biggest challenge that we have and I think Australia, generally, has a pretty weak economy going on today. But I expect the other parts of Asia to growthroughout the year. If you look back I would expect that China and Asia will grow. And the biggest question I have is Australia and regaining share there in the economic conditions in that region.

Will you have additional capacity outside Australia now that the capacity utilization rates they measured are coming down in some of the plants that were formally servicing Australia?

Yes. If you looked at Thailand, we, obviously, were servicing most of Australia's business from Thailand. We run it seven days 24/7. We are now running that plant five days. So we have excess capacity in Thailand and we also excess capacity in China.

Okay. And just from a modeling perspective, what should we be modeling for interest expense for the full year in 2014?

Probably around $21 million, $22 million for the full year.

Okay, great. And if I can just sneak one more in. I'm just curious what you've seen lately in terms of modular carpet formats. Has the proportion of square versus rectangular versus plank formats changed at all recently? And what might that say about trends that you're currently seeing?

Well, I would say that one of the greatest growth areas that we see related to the [shades] is in the skinny planks. That's increasing significantly, particularly in the U.S. So I think the plank format will grow for usas a platform that we think really changes the look of the square, the carpet tile. So I think the plank category is going to be a significant category for us going forward.

Are those going into any particular [red] markets or is it pretty varied?

Is it pretty varied. Hospitality. It plays really well in hospitality.

Okay. And is there any margin difference profile between the formats?

No. Planks -- we're actually charging a little bit more for planks to keep the same margin profile.

Okay. Great. I appreciate it and good luck.

Thank you.

Thank you.

Your next question comes from the line of Stephen Kim with Barclays. Please proceed.

Thanks very much. Guys, I wanted to ask you a little bit about the orders. It looks like in the first three month -- three quarters of last year orders were generally flattish, it was up very slightly, and then in the fourth quarter looks like they are up pretty nicely. I think you have 10%.

Just curious as to if you could comment a little bit about that,particularly if there's anything unusual, in that number that may make the increase look more promising than maybe you feel about it.

Well, yes, you are right. We did have year-over-year were flat through the first three quarters and the fourth quarter was up 10%,largely driven by our European business, which was up 15%. The U.S. business and the Americas business was up 11%. Still, headwinds in Asia Pacific started in Q4. But the comps in the fourth quarter last year was $230 million, which was probably the pretty weak quarter last year so the comp looks a little better this year, in Q4, versus last year.

And if we were to look at that, the order increase, can you give us a sense for how it trended by month? And also can you talk about whether or not there was any impact or benefit from the Australian plant sort of getting back up and running?

Yes. None of that really impacted the [overall] trend. The Australia facility didn't -- wasn't commissioned until early part of January here in 2014. But the trend through the quarter, October was up 12%, November was up 6%and then December was up 14%. A little choppy there in Q4.

Yes. Okay. Well, that's helpful. If we can talk a little bit about the gross margin, which exceeded our expectations. I was curious if you could talk a little bit about what you thought some of the puts and takes were on the gross margin side. You mentioned the lean initiatives and the productivity initiatives, which you've been working on.

But I wanted to see if you could break that out for us a little bit in terms of what the components were. And also on the gross margin you talked about being weaker in one -- in the first quarter, particularly, and I think first half of next year. If you could be a little more specific about what you think that could be.

Yes. It's difficult to parse out the gross margin impact of what lean, in particular, versus just our continued process improvement in gross margin expansion in the fourth quarter, in particular. It was just a continuation of the general efforts that we have had ongoing now for probably the better part of the last two years.

The only highlight that I might identify, really, in Q4 was some lift that we have been expecting across our European division,which has our highest incremental contribution margins. And with some decent top line numbers we start to see a decent amount of lift ofgross margin expansion in that particular division.

So couple that top line improvement coupled with the lean initiatives that we have had ongoing, really, led to most of the gross margin improvement. As it relates to Q1 and the head winds, yes, rebalancing that facility probably, as we've identified, is about a 50 basis point drag versus where we think we ought to be when it gets up to normalized production levels.

However, we still think that gross margin on a consolidated basis should be up on a year over year basis as a groupbut just not up to the level we will be at once we get up to full production levels.

Okay. That's helpful. Thanks very much. And then one last question, if I can, about the SG and A. I think in the past you talked about, in generalized terms, we should be thinking about SG and A on a 10% incremental basis.

Was curious if you could talk a little bit about that. Did we hear that right? Is that where you think the long term SG and A profile is? And maybe talk about anything that may have influenced recent results there.

I'm not sure what the 10% -- I'm not sure how that translates.

Yes. Maybe we misheard it but our sense was is that, in general, long term, if we think about growth in top line that we could generally expect the SG and A to grow on a 10% kind of rate incrementally. Maybe we misheard that but if we did --

Our -- my overall objective is to drive the SG and A closer to the 23% with the growth. We got to that -- those levels in 2008 when we saw the growth. If we can get the double digit growth rate we expect when we see the rebound in Europe and the U.S., then we will drive SG and A down.

Okay that's very helpful.

There's a lot of leverage in the SG and A line for growth, particularly in Europe.

Alright. Thanks very much, guys.

Thank you.

Your next question comes from the line of Kathryn Thompson with Thompson. Please proceed.

Hi. Thanks for taking my questions today. Two part question. First, it's focusing on the Americas, in particular your U.S. results, which just really don't [have] the feedback from the industry that we have received throughout the quarter.

I was going to see if you could give a little bit more clarity on what trends were intra quarter in the U.S. andwhat are you seeing early into 2014. In particular, I know that weather can be an impact for manufacturing but it shouldn't necessarily be a [meaningful] impact for orders, at least for some of the checks that we've done. So, basically, more clarity on your U.S. business in the quarter?

Can you clarify what piece of it doesn't reconcile with your check?

It's just the volume trends. Yes, the volume trends are a little lighterthan what we would have expected.

Okay. Yes. Well, we did identify, in the last conference call, that we did have some softness in our order pattern in August, September time frame, which led to the softness in our Q4business in the Americasfrom a top line perspective. If you want to drill down into the order pattern, in particular, in Q4October was up 6% in orders,November was up 15% in ordersand then December was up right at 10%.

So for the full quarter they were up 11% in the order pattern. But we weren't terribly surprised by the top line performance of the Americas business due to what we had flagged earlier on the softness in the orders in August and September.

And, Kathryn, if you look at the commercial market overall in the fourth quarter, it was pretty flatfrom an industry standpoint. So I'm not sure, in your channel checks, where that is coming from.

Yes. It's really more on the [flooring] side, and that's helpful. How are -- how has weather impacted your order trends -- ?

Well, we have lost ten selling days in the high weather in the east coast as in the mid westwith our sales force. We've actually had our plant shut down in LaGrange for five days. So we've had a negative impact related to selling as well as production.

But despite that, the first seven weeks, the Americas business is up 6% through the first seven weeks in orders. So it hasn't fallen off all together. It's hanging around mid single digits order pattern.

Okay. That's helpful. And then, finally, if you could discuss just how you are managing around rising energy costs and just clarifying what percentage of the costs (inaudible) is related energy both when you think about your raw materials and the energy that you use to run the plants.

Sure. Our energy consumption, from a manufacturing perspective, is not significant. We've done a lot over the last ten or 15 years to lessen our dependence on our energy, our input costs and have found alternatives. So from a manufacturing perspective our total cost of sales of energy is probably less than 10%. What is the exposure is the embedded energy related to our nylon, our raw material inputs.

To date, we haven't seen any price increases. I'm aware of one that's been done, I believe, on the Nylon 6 in other parts of the industry. It hasn't impacted us currently. But, again, we haven't had a price increase now in almost two years in raw materials.

So we've done a good job over the past ten or 15 years managing around our energy consumption from a manufacturing perspective, and we are cognizant of where some of the inputs into our raw material costs are trending. But at this time, we don't have a raw material price increase coming through.

Okay. And just a final question. Do you hedge your energy?

We do not.

Okay. Great. Thank you so much.

Thank you.

Your next question comes from the line of Sam Darkatsh with Raymond James. Please proceed.

Good morning, Dan, good morning, Patrick. How are you?

Hi, Sam.

Hi, Sam.

Most of my questions have been asked and answered. My math, back of the envelope, Patrick, it looks like incremental margins this year should be somewhere around 20% or so, and, I'm guessing, in the out years it should be something similar. Am I far off on that?

No, that's generally where we try to internally build our businesses around.

Okay. Thank you. And then the inventory levels looked a little high. Is that accurate? Where is it? And I know a lot of us understand that you have, largely, a made to order model. So how do you look at that inventory with a made to order model?

Sure. Inventory in Q4 was a little high. We tried to bring down production levels consistent with the demand levels and came up a little bit short in Q4. Anticipate normalizing production levels headed into 2014. And for the full year it should be a relatively small use of cash, if any, on the inventory level for the full year.

So bringing production down a little bit in Q1 and then normalizing in Q2, and then going forward?

Well, production levels will be up on a year-over-year basis in production and will be up, sequentially, Q1 versus Q4, which is generally pretty soft. So when we -- we ramp through the first half of the year and then bring it down in the back half of the year. But I would imagine, based on the demand level, that our production levels will be higher in Q1 2014 verses Q1 2013. But for the full year our inventories will, hopefully, be flat if not just up slightly, a slight use of cash for the full year.

Very good. Very helpful. Thank you, much.

Thank you.

Thank you.

Your next question comes from the line of Philip Volpicelli with Deutsche Bank. Please proceed.

Good morning. I just wanted to look at the composition of your balance sheet. I believe in November that the [eleven and three eighths]notes were mature. Did you retire those?

Yes.

And then, obviously, you took out --Okay. And that's why you have the [revolver borrows] of that $26.3 million at the end of the year?

Yes. There was a final stub of about $8 million that we addressed earlier in, I think, 2013. But then we also did a repayment on our [seven and five eighths]senior notes, taking advantage of some call protection that we had, and redeemed that. And, effectively, moved that, the $25 million of borrowing, under our global credit facility,saving about 300 basis points,350 basis points. And then getting some local borrowings and local jurisdictions for a tax efficiency.

Yes. Great. And so what is the availability, as of the end of the year, on the revolving credit facility?

It's somewhere in the $150 million, $175 million range.

Okay. As you expanded it.

That's right.

And then is the plan -- the remainder of the [seven and five eighths] are callable at the end of 2014. Is the plan to call those and then refinance them with the accordion feature on the revolver?

That's certainly a possibility. We are looking at all options right now. But that is certainly one of the scenarios. We haven't made our final decision on that yet.

Okay. Last one for me. CapEx in the fourth quarter, [are there] CapEx expectations for 2014?

Yes, CapEx in Q4 was high. It was a little over $40 million but that was $26 million of that related to the manufacturing facility that we purchased in Australia. And I would say CapEx for 2014 will be in the $40 million to $45 million range.

Great. Thank you very much.

Thank you.

(Operator Instructions). Your next question is a follow up from the line of Josh Borstein with Longbow Research. Please proceed.

Hi. You had mentioned in the non corporate [UF] office was generally flat. Did that include hospitality as well?

Yes. The hospitality business was actually up. We are getting hurt on the government side of that business.

Okay. On the GSA side. Because I know you had been making end roads. Is it more of a matter of just lapping difficult comps or was there something else going on in the quarter?

I'm not aware of any particular difficult comps in the quarter, no.

Okay. And then just the last one. You had talked about expanding production in the U.S. Is that still the plan? And what kind of capital might that require?

Sure. We're always looking at opportunities to expand. Right now, plans have not been finalized on that but when and if we decide to do that it could be an incremental $25 million or $30 million in CapEx. Only a small portion of that is currently contemplated in the 2014 CapEx requirements in the $40 million to $45 million that I just referenced.

Okay.

But we have not authorized a full scale increase in manufacturing capacity in our Americas business yet.

Okay, great. Thank you.

Thank you.

And at this time we have no further questions. I would now like to turn the call back over to Mr. Dan Hendrix for any closing remarks.

Thank you for listening to our conference call, and I will speak to you next quarter.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.