Interface Inc (TILE) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2015 Interface Inc. Earnings Conference Call. My name is Lee Ann, and I will be your operator for today. At this time, all participants are in a listen-only mode, but we will conduct a question-and-answer session towards the end of the conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to David Foshee, Vice President. Please go ahead.

Thank you, Operator. Good morning and welcome to Interface's conference call regarding third quarter 2015 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 Investor Relations section 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 An archived version of this conference call will also be available through that website.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 discuss under the heading "Risk Factors" in item 1A of the Company's annual report on Form 10-K for the fiscal year ended December 28, 2014, 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. A reconciliation of these non-GAAP measures to the most comparable GAAP measures is contained in the Company's earnings release in Form 8-K filed with the SEC yesterday. These documents can be found on the Investor Relations portion of the Company's website, www.interfaceglobal.com.

Lastly, please note that this call is being recorded and broadcasted for Interface. It contains copyrighted material and may not be re-recorded or re-broadcasted without Interface's express permission. Your participation on the call confirms your consent to the Company's taping and broadcasting of it.

Now I'd like to turn the call over to Dan Hendrix. Please go ahead, sir.

Thank you, David. Good morning, everyone. The third quarter was a continuation of the success that we've been having throughout 2015 with year-over-year improvements across virtually all key metrics.

This quarter, some of the year-over-year comparisons are even more dramatic due to the difficult quarter we experienced a year ago, but they do serve to illustrate just how far we've come and how well we've executed over the past year. And local currency sales continued to climb at a 10% clip with improvements across all three operating divisions -- Americas, Europe, and Asia Pacific.

We saw robust sales activity in our three largest markets, which are the US, the UK, and Australia. We believe this growth significantly outpaces the industry in each of those markets, which means we're continuing to take market share.

(inaudible) local currency also turned positive in France, our fourth largest geographic market, which is a long-awaited and very welcome relief. As we anticipated, currency fluctuations continue to negatively impact our results mostly due to the declining euro, Australian dollar, and the Canadian dollar. These headwinds are expected to continue throughout most of the fourth quarter but should begin to moderate after that as the year-over-year currency comparisons begin to equalize.

Gross margins remain strong at 38.5%, which is an improvement of almost 500 basis points compared with the third quarter last year mostly due to higher selling prices, improved product mix, and lower raw material and labor costs. Even on a sequential basis, we improved 10 basis points versus second quarter.

Operating income was outstanding at 12.3% of sales, and that's after a $2 million negative impact from currency. Along with the benefit of lower interest expense, that translated into $0.31 earnings per share.

Cash flow also continued to be a bright spot as we paid down $25 million in debt and still increased our overall cash balance.

I had some concern that orders moderated during the third quarter, but on a currency-neutral basis, they were essentially even with the third quarter of last year and have been slightly positive in the last three weeks of the fourth quarter.

Looking ahead, I think we're in an excellent position to close out 2015 as our best year ever. Our sales and local currency are growing. We're taking market share in key markets. Our product portfolio is excellent, and we won several design awards this year.

In the most recent FLOR-focused survey of top architects and designers in the United States, Interface was voted the number-one carpet company in categories of design, quality, service, and performance and once again we were named the number-one green leader and received number-one green kudos for networks, program, and FLOR residential carpet tiles.

Our plants are running at very high levels of efficiency, and while gross margins may tick down a little bit in the fourth quarter due to the seasonality of our business, it should remain at a strong level.

Because this fiscal year ends on January 3rd, we do have the Christmas and New Year holidays at the end of the quarter, nevertheless we expect to continue our run of the year-over-year improvement, although currencies will continue exactly told, and it has all year long.

With that, I'll turn it over to Patrick.

Thank you and good morning, everyone. I'll now take a few minutes to walk through the financial highlights for the third quarter.

As reported in US dollars, sales for the third quarter of 2015 were up 1% at $254.7 million versus $252.1 million in the third quarter of 2014. On a constant currency basis, the increase was nearly 10%, a very solid improvement over the third quarter of 2014.

As Dan noted, and in our press release, currency continues to be an issue in the quarter as it has been all year. The strong US dollar led to an approximate $22 million negative sales impact for the quarter. The impact of the currency was felt throughout the income statement with gross margins being impacted by $8 million and SG&A about $6 million leading to a decline in operating income of $2 million for translation purposes.

As we experienced in the second quarter, the gross margin performance continues to drive our profitability improvement. Like Dan mentioned, we experienced over 500 basis points of gross margin expansion with the third quarter 2015 gross margin percentage of 38.5% versus 33.1% in the third quarter of 2014. This performance is due to higher selling prices, improved product mix, low raw material costs, and increased volume in 2015. This improvement also represents the full realization of the benefits from our significant restructuring actions we took a year ago.

In the Americas, we experienced a solid sales increase of 7% in a currency-neutral basis. This was driven by double-digit improvement in the corporate office market offset by a slight decline in the overall non-corporate office market segments. However, hospitality sales continue to improve up over 20% for the quarter, but the other non-corporate office sales were dragged down by declines in education and government during the quarter.

As Dan mentioned, FLOR had a nice quarter with an increase of nearly 3% driven by Web-based sales. Europe continues to deliver in the third quarter with nearly 20% sales growth on a currency-neutral basis, split evenly between corporate and non-corporate office segments. After currency impact, sales were essentially flat in US dollars. As Dan mentioned, the currency headwinds will be with us for the remainder of the year, but we should start to see it level out in the first quarter of 2016.

The local currency order trend in Europe also remains robust for the first three weeks of Q4, so we remain optimistic about the prospects for the fourth quarter.

The performance in Asia Pacific was a tale of two regions with Australia delivering a very nice third quarter on local currency with sales up 20%, and Asia showing a decline of approximately 12% in the quarter. Due to the currency impact, though, the overall sales decline in Australia was 6% in US dollars and, overall, 9% for the region.

And the improvement in Australia was seen across corporate and non-corporate office segments. Australia's order trend through the first three weeks of October remains very strong, so the prospects there as well in the fourth quarter remain positive.

In Asia we experienced sales decline in China and India partly due to a public holiday in China, but Southeast Asia posted a small gain, which is a welcome sign after a weak second quarter of 2015.

Our SG&A expenses increased to 26.2% of sales for the third quarter versus 25.4% in the comparable period last year. The increase was entirely due to higher incentive comp expenses as a result of improved performance in the current period. Absent these incentive costs our SG&A expenses were down as a percentage of sales, which speaks to our cost control measures including those as a result of the restructuring activities last year.

We've been very careful with our spending in this area not to lose the benefits our gross margin improvements have provided thus far.

Floor also continued to improve year-over-year with sales up 3%, and our operating loss was trimmed by over $700,000 versus the third quarter last year. As a result of the factors discussed previously, operating income in the third quarter was $31.3 million or 12.3% of sales compared with operating income of $19.6 million, or 7.8% of sales in the third quarter last year excluding the restructuring and asset impairment charge we took in the third quarter last year. Including that charge in 2014, our operating income for the third quarter was $7.3 million, or 2.9% of sales.

Also on the cash flow front, we had a nice quarter as we saw our cash balance increase by over $2 million while, at the same time, paying down $25 million on our revolver during the quarter. Our debt level net of cash now sits at just under $160 million, and the credit facility continues to deliver benefits with our interest expense declining by over $4.2 million to $1.3 million in the third quarter of 2015. The refinancing continues to be highly accretive for us during the course of the year and we'll continue to use the cash flow generated to reduce interest and create more savings for the balance of the year.

Depreciation and amortization was $7.7 million in the third quarter compared with $6.8 million in the third quarter last year and CapEx in the third quarter, or $11.6 million compared with $10 million in the comparable period last year. For the full year, we expect CapEx to be in the range of $30 million to $35 million.

With that, I'll open up the call for questions. Operator?

(Operator Instructions) Stephen Kim, Barclay's.

Hey, guys, it's actually John filling in for Steve. Just first on the cost side -- you guys have done a phenomenal job in expanding gross margins this year. And just looking out to 2016, are there more initiatives that you guys can implement to maybe expand the level of gross margins, going forward? And, if so, what are some examples there?

Yes. We actually have an ongoing program to reduce actually 5%, our overall cost, the variable cost in the plants. We've identified a lot of key initiatives -- dematerialization is one; running more efficient in the plants; reducing labor and waste is another one; and then there are some innovations that help reduce costs as well.

So, yes, the program is catching stride, and I think we're -- I won't say early innings, but we're halfway through this program (background noise).

Got it, got it. And then on the SG&A side, obviously, this year ran a little higher than we were expecting at the beginning of the year because of the variable compensation coming up because of the sales results. But assuming a mid single-digit sales growth next year, where should we expect that SG&A to be around, in a ballpark, for 2016?

If you look directionally what we're trying to do, we're trying to drive the gross profit margin to 40%, and we're trying to keep SG&A around the 26%, 25% range, percentage of sales.

Kathryn Thompson, Thompson.

Just one quick clarification on SG&A run rate for the second half -- in the prior quarter you were expecting around a $68 million to $70 million run rate on a quarterly basis in the second half. This quarter you came in below that, which is very good. Any color -- does that imply we should see a little bit higher on a dollars basis because of comp? How should we think about Q4 for SG&A?

I think Q4 will be largely in line with Q3, probably the $66 million to $68 million kind of range for Q4 as well.

Okay, great, helpful. And then on gross margins, you guys have been working on these initiatives for, I guess, about two years -- 18 months to two years by now and have done a nice job with expansion. This year you've had the added benefit of lower raw materials. I think that you'd said for the year, it was about a $15 million tailwind for you.

If you look at -- you deconstruct gross margins for the quarter, you've done a nice job in the past [just saying] how much in the quarter was raw materials versus the initiative -- ?

Yes, I would say of the 500 basis points about 1.5 points has been raw material. We projected about a $16 million improvement for the year.

And what about -- you've had improvement from Australia that's a good margin geography for you. How much of it was geographic mix versus some of the other, just, dematerialization and other -- ?

Well, we started a plan up last year in February, and so we really started catching our stride in the second half of last year, and it's continued to improve this year. I would say Australia has had a very negative impact related to raw material purchases because they purchase yarn in US dollars. So we've really had to raise the bar on pricing as well as in the plant to accomplish these margins that we have. I think we still have opportunities within the Australian plant to improve it as well.

Okay. And then, just finally, on the order side. If you could just give a little bit more color -- this has been incredibly choppy intra-quarter for every building product category that we have covered. If you could give a little bit of color in terms of intra-quarter orders and trans-progression. And then for the US, will you face a particularly tough comp? And maybe any other color from a comp basis, too, for orders. Thank you.

Sure, Kathryn, you're exactly right, we did. Similarly, we had a lot of choppiness throughout the quarter. On a currency-neutral basis, July was up 7% for us, then we were flat in August, and then down 7% in September getting back to about flat on a currency-neutral basis for the first three weeks of the fourth quarter.

So, yes, we experienced the same. The Americas, in particular, had very difficult comps versus last year as we had a soft patch in the early part of Q3 last year and started to ramp in September/October. Last year, October in 2014, was up over 20% over 13% Q4. So the comps are certainly getting more difficult at the Americas level here as we head into Q4.

So no change in underlying demand that you've seen, broadly speaking, throughout the US?

Well, the activity in the US market, if you talk to our salesforce, architect designers, the ABI Index, I mean, it's still pretty -- I won't call it robust, but it's a pretty healthy pipeline. It's just -- somehow there's delays in the system. I think the furniture guys are seeing the same thing. It's pretty flat. The commercial carpet market, actually, in the third quarter was flat to down, and we actually did pretty well. We're taking a lot of share in that market.

But I still think that there's a lot of activity in the US commercial market on new construction and on renovation that is out there is still good.

Mike Wood, Macquarie Security Group.

I was just wondering if you could provide some more color on the gross margin commentary. I think you said tick down in 4Q. I'm assuming that's quarter-over-quarter, and if you could just give us some color on what's driving that?

Well, we have two holidays in there, that's part of it. Seasonality-wise the fourth quarter is not as good as the third quarter as a rule, so you've got less throughput going through there. It just has to do with seasonality of the business. Obviously, it was compared to third quarter not last year.

Great. Can you just give us an update on how much of your business, I guess, perhaps in the Americas is made to order versus made to inventory at this point -- how much room further you have to go there to improve gross margins?

Well, I think there's a lot of room, still, to improve gross margins throughout a lot of our businesses. We have a lot of activity going on in the US business to reduce costs in that facility. I guess 35% to 40% is part of our -- make the inventory business today in the US.

Okay. And then just given that choppiness that you were just discussing in the order activity and the more challenging comps. Should we be looking at October flat, ex currency, is kind of maybe where the sales could be coming in at in the fourth quarter? Or do comps become more challenging, maybe, just directionally so we should be looking at flat or up or down for fourth quarter? That would be helpful.

Yes, I think flat to maybe slightly down in Q4 the way that it's currently progressing. Kind of maybe in the low 260s kind of range, top line number for Q4 right now.

Keith Hughes, SunTrust.

As you refer to in the release, you gained share here in the United States in the last 12 months, and it's a significant amount of share given your growth versus the industry. I guess, number one, why -- as you look back on the year, why was that the case? And then, number two, regardless of Patrick's comments on the revenue, is that something that's going to carry into 2016 particularly once you get past the tough comps as we end the year here?

I would say --

-- taking share.

Oh, yes, excuse me.

-- taking a lot of share here in the last 12 months, I guess.

I would say that we're singly focused on carpet tile. We sell one product, and we're not distracted by other products in the bag. Our product introductions the last four years have been fantastic, so I think the design that we're putting out there is really attracting a lot of projects around with the architect's designers. And I think we have the best salesforce in the industry, and I think we're going out and getting the business, and we have a segmentation strategy that we're trying to convert anything that's broadloom or hard surface to carpet tile. I just think we have a single focus mind around carpet tile.

Historically, you mentioned products. Historically, around products they have a more than one-year lifecycle. Is that something where you're set up to take share again in 2016?

I would say, no, they don't have a one-year lifecycle, but it is a fashion business that we're in, and I think the last four product introductions and also the fact that we were really the first to go big in the planks category four years ago has put us in a really good innovation design platform that I think our customers like.

You had mentioned earlier the industry has not been up much at all -- well, a little bit if you put those last three quarters together that you clearly outpace it. What do you think the industry view is for shipments as we head into 2016 and maybe a subset to that, is this kind of slowdown in orders, did you hear that from everyone in the channel?

Keith, I don't know. I just think there's a lot of pentup demand still. I will go to that. I even do construction. If you look at what's going on in the new commercial construction is positive for the first time in a long time. So I still believe that you're maybe halfway through this ballgame on the commercial rebound, because it hasn't been very robust for the last four years. So I still think there's pentup demand, but it's going to be choppy. I think that's the world we live in today.

(Operator Instructions) John Baugh, Stifel.

Thank you and congrats on a nice Q3. A couple of things -- you mentioned the floor EBIT loss was narrowed 700. So what was the number for the quarter?

They lost about $1 million in the quarter. But for the full year, we're on track to have a positive year-over-year operating income improvement by over $4 million right now in the floor business.

We do anticipate, I think, in the fourth quarter that we'll be positive as well.

Great. Australia -- that economy, in general, seems to be weakening. I think you commented your shipments and/or orders were strengthening. Obviously, it must be a share gain thing or is there something going on specifically in that market that's got non-res carpet demand up so much?

I would say that we are regaining our share back with the service levels that we have within that facility at three weeks. I think the design that we're putting out there, and it's much more of a make-to-order operation as well. And we're also segmenting that business. The office demand is soft, but the non-office, I think we're actually converting other surfaces to carpet tile. Half that business is non-office in Australia.

Great. So the non-office is really driving Australia.

Yes.

Okay, and last but not least, Patrick, terrific cash flows year-to-date and Q4 is always the strong period, and that's in front of us. So could you comment -- and I see receivables are a significant source year-to-date. Maybe give us some color on Q4 outlook and what's driving cash flows, thank you.

Yes, I think we've done a good job on working capital management this year, overall. I think our CapEx spend is coming in a little bit less than what we had budgeted, just more from a timing perspective than, really, any decisions that were made.

I expect Q4 to continue to be pretty solid, $20 million-plus free cash flow generation quarter, as well, as we head into 2016. So pretty good overall cash flow generation for the full year.

Then is there any thought to, if you generate a free cash flow number next year similar to that, where capital deployment goes? Thanks.

Yes, I mean, I think, overall, cash flow targets will be similar for 2016 with the one caveat of perhaps a pretty significant capital expenditure program into our Americas modular business as we continue to kind of sort through, kind of, the various scenarios there. But perhaps setting to aside, somewhere to a $30 million-plus to $40 million-plus CapEx plan, not all of that will be spent in 2016 but potentially get started on that next year. So that would be, perhaps, over and above our traditional, kind of, $30 million to $35 million in CapEx. That's kind of how we see it now going into 2016.

And capital deployment, I mean, you're getting the strongest balance sheet I can remember in a long time.

Yes, it certainly is a long way from the 7 times levered, isn't it? Yes, we're in a good position. We'll refresh our share repurchase program here January 1 and continue to be opportunistic and probably focus primarily on reinvesting back in the business here in the near term.

Matt McCall, BB&T Capital Markets.

So, first, a couple of follow-ups from previous questions. I think you answered that your custom business is running about 35% to 40%. Dan, can you remind me -- I think it used to be a little bit above that. Can you remind me what that trend's been like over the last couple of years?

Yes, well, define custom. There's two kind of customs. There's on make-to-order and then we have a custom business that typically runs about a third of our business in the US.

We made a strategic decision that we were going to create a make-to-inventory and sort of move the business a little bit towards that. We used to be about 80% make-to-order and 20% make-to-inventory. We've moved that now to 60%-40%. I think we're getting the benefits of that because we get longer runs, and the plant's more efficient. But we still have all the custom capabilities and make-to-order capabilities as well. We haven't change that philosophy.

Okay, all right. And then, Patrick, you talked about low 260s, I think, for Q4. Can you talk about the FX impact that's assumed in that number? And then if we think about where FX rates are today, what would be the, I guess, the benefit next year relative to the pressure that you faced this year?

Well, we had a $22 million impact in Q3. I anticipate -- we had the exchange rates fell off pretty dramatically in Q4 last year, so the impact probably won't be as much in Q4 as it was in Q3. So maybe high teens kind of impact on sales.

For the full year this year we're going to have north of somewhere -- $85 million impact on headwinds related to foreign currency for the full year. So that would be the benefit next year. I think we don't really get to kind of parity until mid to late Q1 on most of the major currencies on a translation basis. So -- it could be some-odd $70 million benefit next year if the currencies stay effectively where they are now.

Okay, thank you. Then, Dan, you made some constructive comments about your cyclical confidence. When you look at some of the leading indicators within the business, I know, Patrick, you talked about the 30, 60, 90-day pipeline in the past. October roughly flat, but as you used that data to look out 30, 60, 90 days, does -- I think your comps get a little easier in the Americas. Does the growth return as we head through the quarter into next year?

Well, I would say that if you compared the pipeline to last year in October, it's a little bit higher this year than last year but not significantly higher. And we had a pretty good run in the first half of the -- well, fourth quarter and the first and second quarter last year, so I'm encouraged by that.

But as you know and I know, you get delays and choppiness, and it's kind of hard to predict exactly which way that trend is going to go.

Okay, and then one more question. I saw that you announced a new Board member. It looked like she has some residential construction experience. Is there anything that that says about plans in that market, or is it just none at all?

No, no. I think she was a very -- we were trying to get diversity on our Board and having the sitting CEO of a Fortune 1000 company, and she met that diversity profile and sitting CEO.

Thank you. I would now like to turn the call over to Daniel for closing remarks.

Well, thank you for listening to our third quarter call and we look forward to talking to you on the fourth quarter call. Thank you.

Thank you, and thank you for your participation in today's conference. That does conclude your presentation. You may now disconnect and have a great day.