Interface Inc (TILE) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2017 Interface Earnings Conference Call. (Operator Instructions) I would now like to introduce your host for today's conference, Ms. Christine Needles, Global Corporate Communications. You may begin.

Thank you, Catherine. Good morning and welcome to Interface's conference call regarding second quarter 2017 results. Joining us from the company are Jay Gould, President and Chief Executive Officer; Bruce Hausman, Vice President and Chief Financial Officer; and Greg Bauer, Vice President and Corporate Controller. Jay will review highlights from the quarter as well as Interface's business outlook. Bruce 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 from 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 An archived version of this conference call will also be available through that website.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 the 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 January 1, 2017, 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 and Form 8-K filed with the SEC yesterday. These documents can be found on the Investor Relations portion of the company's website at www.interfaceglobal.com.

Lastly, please note that this call is being recorded and broadcasted for Interface. It contains copyrighted material and may not be rerecorded or rebroadcasted without Interface's expressed 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 Jay Gould. Please go ahead, Jay.

Good morning. Well, I'd like to start by thanking the Interface associates around the world. We delivered a solid Q2 and built good momentum heading into the back half. We have a clear value creation strategy. We are executing that strategy and it's beginning to work in the marketplace. Our solid Q2 provides confidence that we will deliver our full year outlook of 3% to 4% organic growth, gross margins of 38% to 38.5% and holding SG&A to $260 million to $265 million. Additionally, in Q2, we completed a $25 million share repurchase on our $100 million authorization. So looking at the details in Q2, net sales grew 1.4% on a GAAP basis. Importantly, however, organic sales were up 4%. Organic sales adjusts for foreign currency fluctuations and the exit of our FLOR specialty retail stores. Also encouraging, organic order growth was up 6%.

Order momentum for our core commercial carpet title business is promising going into the back half of the year. We also expect to see continued LVT growth as the products are now available globally, and we are on track to achieve our $20 million to $25 million in sales for 2017. And also well positioned to reach our $50 million goal for next year. In the second quarter, we delivered gross margins of 38.9%, which were down 100 basis points year-over-year, but that number was in line with our expectations due to delayed input cost inflation that didn't fully materialize in the second quarter.

Globally, we continued to manage SG&A effectively, coming in at $64.9 million or 25.8% of sales. We focused on key efficiency opportunities, while also ensuring that we invest in our growth areas like our LVT business. As planned, we were able to repurpose dollars and fund growth initiatives out of SG&A savings gained by exiting the FLOR specialty retail business.

Now it's worth pointing out that SG&A is down year-over-year by 140 basis points as a percentage of sales, and again, we're on track to deliver our targeted annual SG&A of $260 million to $265 million.

Solid sales growth, solid gross margin, coupled with SG&A management resulted in operating income of $33 million or 13.1% of sales. This is an increase of 30 basis points over last year second quarter. Now regarding our capital allocation strategy, we did complete the $25 million stock repurchase program. We also increased our quarterly dividend to $6.50.

Looking ahead to the third and fourth quarters, our full year targets -- and our full year targets, we anticipate back half organic sales growth in the 4% to 6% range and that will be offset by approximately 200 basis points of negative impact from exiting the FLOR specialty retail business. This puts us in the range to achieve our full year organic sales growth of 3% to 4%.

We do anticipate lower back half gross margin because of expected input cost production -- sorry, expected input cost inflation, lower production volumes versus a year ago and costs associated with exiting the specialty retail business. We continued to remain on target for our gross margin for the full year at 38% to 38.5%, likely finishing at the higher end of that range.

In summary, the team continues to be focused on the execution of our strategic agenda to become the world's most valuable interior products and services company. And with that, I'll turn the call over to Bruce.

Thank you, Jay, and good morning, everyone. As Jay mentioned, net sales in the second quarter were $251.7 million, up 1.4% over the prior-year period with solid gains in the Americas and Asia-Pacific. When we adjust for the impact of foreign currency fluctuations and exiting the FLOR specialty retail stores, we experienced an organic growth rate of 4%.

Organic orders also grew, and we are up 6%. This growth was evenly balanced between the core carpet tile business and the recently launched modular resilient flooring LVT business. Sales in the Americas were up 4% in the second quarter compared with the prior-year period with broad-based growth across the region, particularly in Canada and Interface services.

In local currency, sales in Europe were down 4% year-over-year and in U.S. dollars, they were down 6% year-over-year. Most markets experienced single-digit declines with the exception of Germany, and I do want to point out in the U.K. in local currency, we had strong orders in the quarter with double-digit increases over the second quarter of last year.

Asia-Pacific sales were also up compared to the prior-year period. They were up 6% in fact.

Looking at our market segmentation globally, core office was down slightly over the same period last year, but this was offset by increases in our non-office segments, including government, retail and multifamily residential. Sales were also down in our residential segment due to the exit of FLOR specialty retail. Gross margin was 38.9% for the second quarter, which was an anticipated reduction compared to the second quarter of last year due to higher raw material input costs and the previously announced FLOR restructuring, in which the company exited the FLOR specialty retail stores. For the full year, we continued to target gross margin in the 38% to 38.5%.

As Jay mentioned, we are pleased with our efforts to manage SG&A expenses, coming in at $64.9 million or 25.8% of sales in the quarter compared to $67.3 million or 27.1% of sales last year. This improvement in both absolute dollars and as a percentage of sales is due to effective cost management as well as repurposing SG&A from the exited FLOR specialty retail stores to the core carpet and LVT business. And as you know, managing SG&A continues to be a key priority.

As mentioned in the press release, we remain focused on our full year SG&A expense target in the $260 million to $265 million range. This resulted in second quarter operating income improvement over the prior year. Second quarter operating income was $33 million or 13.1% of sales, up versus prior year of $31.8 million or 12.8% of sales last year. Net income during the second quarter of 2017 was $20.9 million or $0.33 per share, which was an increase over prior year net income of $20.7 million or $0.32 per share.

Moving over to the balance sheet, we ended the period with total cash on hand of $67 million. As Jay noted, we completed the $25 million stock repurchases in the second quarter, and we are executing on the previously announced $100 million share repurchase program. Looking ahead, we continue to be on track to execute on the remaining $75 million of repurchases over the next year.

Debt was $230 million at the end of the quarter or $164 million net of cash on hand. Interest expense was $1.7 million for the second quarter compared with $1.6 million for the second quarter last year, and depreciation and amortization was $7.4 million this quarter versus $7.4 million last year in the same quarter.

Capital expenditures for the second quarter were on plan at $6.9 million compared to $8.3 million in the comparable period last year. We do expect capital spending -- capital expenditure spending to increase in the back half of the year as we continue to invest in the business, invest in manufacturing operations and that we expect total capital expenditures to be in the $50 million to $55 million range for the total year. With that I'll open up the call for questions. Operator?

(Operator Instructions) And our first question comes from Mike Wood with Nomura.

Pleased to see the order momentum. First question, you mentioned that you didn't fully realize the higher input cost. It does look like benzene has come down significantly. Curious if you still expect the $10 million to $13 million input cost inflation or will these lower benzene prices help you more towards the end of the year or possibly 2018?

Yes, we are still anticipating inflation closer to $10 million range, so our estimates have come down the year, Mike. But because of our pricing mechanisms with our suppliers, we haven't felt it in the first half of the year as much as we will in the second half of the year.

Understood. And you guys are doing a good job staying true to the SG&A guidance. Curious if you're feeling pressures now as the growth is reemerging and how are you balancing that desire to stay in that SG&A range versus more growth opportunity for investment as that growth restarts?

Mike, I'm pleased with your observation. We just think it's discipline and we're staying disciplined to how much we reinvest in the business. We feel like we have got plenty of SG&A to deliver our strategic plan.

Okay, great. Just one final quick question on the balance sheet. Looking at it, it does look a bit under-leveraged with, maybe, just one-timed net-debt-to-EBITDA this year. You have got the CapEx in the buybacks out there. I am just curious, are you now ready to look at bolt-ons or M&A or do you want to wait for more proof that, that core business growth is here to stay?

We are not ready to venture out into the M&A conversations yet. We want to continue to deliver on this existing plan, shore-up the confidence and maybe next year we will enter into that conversation, but it is definitely not on the near-term horizon.

And our next question comes from Matt McCall with Seaport Global.

So -- let's say, I've heard some concerns about maybe some overcapacity in the LTV space. Maybe, Jay, can you address that. Is it a concern, maybe, talk about pricing trends for your business, margin trends, just are they on plan, ahead of plan, on plan? What are you seeing there? I mean, clearly the growth seems to be working, but is pricing and are margins holding up?

So Matt, before we went into the LVP -- LVT business, we were aware of the added capacity that was going to be coming on in '16, '17 and the beginning of '18. Those were previously announced. And we did study what we thought the impact would be in the commercial market. Most of that capacity is coming on for residential purposes. So what we've seen thus far is pricing on the commercial side has held. And our margins on LVT are running ahead of what we had originally modeled, which was 35%. So we are feeling pretty optimistic right now about the continued -- the ongoing the sustainable margin structure in LVT.

Okay, okay. So on the gross margin front, so 35% faster-growing part of the business, you pulled out your -- you pulled out FLOR. I know you talked about the full year view on gross margin, but maybe just giving me a little bit longer-term view on where you can see things going as you see LVT growing to a bigger piece of the pie?

Yes, I mean, we're modeling that separately, quite honestly. And we are remodeling carpet tile, and then we are going to add in what our modeling is on LVT and get the combined company output. We're still committed that -- as we exit 2019, that we'll be at 40% gross margins on the carpet tile business. Now we're going to build a -- which is going to build to $100 million LVT business. We are looking at models that say, okay what if that business is at 35% gross margins? That's obviously going to be slightly dilutive to the company total at the gross margin line, but I have said before, it's still accretive at the operating margin line. In a way to think about, so, you know, we are so focused on achieving the 40% gross margins. We set those targets because we were talking about carpet title only. So if we are operating slightly below that when you combine carpet tile and LVT, I still think it's a very healthy range for us to be in.

So is a new way to think about it, may be the operating margin target or where things want to go? I know you put some SG&A goals out there. Is it the better way to think about it just given that mix shift?

Sure, ultimately that is the way to think about it. I mean we were setting gross margin targets to allow us to hit particular operating margins, and we are still in that 14% to 15% target range. A year ago, I was talking about 13% to 15%, I think we have elevated our expectations to be 14% to 15%.

That's our long-term algorithm.

Yes, that's our long-term algorithm.

So what's the basic -- what's the main cause of the increase in -- the low in 13%, and the low in now 14%, what's helped your there?

The LVT.

And our next question comes from Keith Hughes with SunTrust.

On the closure of the FLOR stores, it looks like they'd impact revenue about $5 million in the first, like $4 million in the second. Would you expect that kind of number in the second half of the year?

Yes, quarterly it's about $4 million to $5 million impact, Keith.

And when you talk about organic growth being 3% to 4% for the year, does that include or exclude those loss of sales?

Those FLOR stores?

Yes.

Yes, it excludes that.

It excludes that, go ahead.

The way it works Keith is that organic growth excludes the FLOR specialty retail, sales that we just spoke about, so you adjust for that and you also adjust for foreign currency fluctuations.

Okay. And final question on the order growth, your organic order growth you discussed in the release. Can you talk about how that looks via geographies Europe versus North America versus Asia? And any sort of commentary on how [supply has] started in the various regions?

Yes, well the first thing I'd say is, we saw order growth build through the quarter and it's really kind of continued into July to support our 4% to 6% back half organic growth forecast or outlook. We saw better order growth in the Americas and in Asia-Pacific versus Europe.

And our next question comes from Kathryn Thompson with Thompson Research.

First on gross margins, could you parse out the difference, there is 100 basis points difference year-over-year, roughly 70 basis points should be from FLOR. Could you confirm that, that is an impact and maybe help us understand the other puts and takes as we think about that gross margin bridge?

Yes. So 100 basis points step back year-over-year, 70 basis points of that was from FLOR. The other 30 basis points were from input cost inflation, lower production volumes year-over-year. We produced 3% less volume in the quarter this year versus last year. Those were the 2 key drivers of that.

Okay and as we think about rising raw material costs, which has been big theme throughout this earnings season, how should we think about that headwind as we enter the remainder of the year, is the $10 million headwind is still on track and is it tracking in line or ahead or a little bit better than your expectations?

Well -- just let me answer that in 2 ways. I mean if you recall for the full year, so last year we delivered 38.5% gross margins. From that, we said we're going to have 70 basis points step back because of FLOR and then added to that, we're going to have 50 basis points growth in our core business, which put us back in that kind of 38.3% range, which is why we gave the range for the year. We are still executing that plan. So we fully expect to be in line with the full year on gross margin. Last year second half of the year was 37.5% gross margins, and we expect a similar pattern for the back half of this year.

Perfect, thank you. Now then moving to LVT business, you're continuing to build very nice momentum there. Could you -- I know that you said it accounted for about half of the growth for your orders, the organic growth in orders, but as you look forward into the back half of the year is to expect that momentum to improve, and also if you can get a little bit more color on how you're seeing the greatest amount of acceptance and traction of that product?

Yes, so it was about half of our order growth and it represented about 3% of our orders, which is why we still feel good about delivering the $20 million to $25 million this year and building towards delivering $50 million next year. It continues to build week on week, month on month, as a percent of our overall orders. Traction, we're getting really across the segments, I'd say, in particular, in office and in living space. So -- and Kathryn, this really builds off the trend that we're seeing globally, which is the integration of residential, commercial and hospitality and how much commercial buildings are taking influence from the residential market.

Our next question comes from David MacGregor with Longbow Research.

Jay, you were talking about orders in Europe being down compared to where you were in North America and Asia-Pacific, but I think the comment was maybe by Bruce that U.K. orders were up double digits. So I just wonder if you could talk -- open up the discussion around Europe a little bit and give us a better sense of kind of the patterns you're seeing in your order backlog within that region?

Yes, well the 2 areas of real strength are the U.K. and Germany. And when Bruce quoted the double-digit growth in orders, that's accurate, but that is in local currency, it's in British pounds. If you translate that back into euros, we're up just a little bit. So we are still dealing with the currency issues in the U.K. But the fundamental business again, if you look at it on a constant-currency basis, is very encouraging in the U.K. Also Germany, very high single-digit growth in orders. So we are seeing the continuation of the trend from broadloom to carpet title in Germany. We are seeing weaknesses in other markets quite honestly. So Southern Europe is a little weak for us and Benelux area is a little weak right now.

Okay, my recollection is that you guys had ramped up pretty significantly in terms of your sales presence in the U.K. market, specifically London and at one point, it was sort of a slogan within the company, 'let's take London'. And I'm wondering if that level of investment on year-over-year basis is now leveling out as you wait to get paid for that prior level of investment or whether you continue to build there.

Well, I think we're starting to see the return on that investment by the order growth that we're getting in -- again, in local currency in the U.K. So yes, I feel actually very optimistic about the investments that we made to own London.

Are you still growing the London team, though, or you have leveled that out?

No, no. That's plateaued off now. So SG&A is flat. When we went through our, kind of, restructuring late last year. We did not touch that team. We felt bullish about the opportunities there.

Okay. And then just second question. Is there is any kind of update you can give us on kind of the whole initiative of trying to venture up with the large retailer on FLOR and see where that goes? Is there anything there we should be thinking about going forward?

No. Unfortunately, I'd still model no value creation out of the FLOR business right now. Honestly, I'm encouraged by the work that we're doing on the Internet, but we don't currently have a retailer lined up yet.

(Operator Instructions) And our next question comes from John Baugh with Stifel.

Good to see the orders are up. I was wondering if you could comment on the next stage of the manufacturing plants over the 3-year plan. Where you are? What the next phase is? And then maybe talk about influence on gross margin the next phase may have as we look to '18 versus '17?

Yes, well we're about half way through a 5-year transformation of that -- those manufacturing assets in Southern Georgia. This year, we should capture about $10 million of the $30 million 3-year plan. So we have another $20 million to harvest, which we think will come pretty uniformly over the next 2 years. We are moving into a heavy capital investment phase. Over the next year, we are getting ready to break ground on an expansion. But the proof-of-concept of how we're going to run the plants have been fully done. So we have right now 6 tufters running in our long-run plant, shortly to be 7. Ultimately, we'll have 12 tufters in that long-run plant. And the economics of that are very encouraging, John. So I am just -- honestly, I'm thrilled with the results that the team down there is driving.

Great. And then this is a North American question. Could you comment on carpet title only, I guess, not that LVT is big yet. But was there a channel mix drag on margin with office being weak and some of the other categories strong? Was there any change within the mix, high-priced to low-priced through your line? Just trying to get any color, is there's any movement on gross margins relates to North American carpet tile?

We had a really strong quarter in North American margins, honestly, John. And I love the balance the team is finding between pricing and volume, so I just think that they've hit that dial turn exactly right in the second and third quarter.

Great. And then are you seeing, someone earlier asked a question about the European investment in the sales. As I recall, you also made some investments in the North American sales force that of course initially dragged. Is that starting to pay benefits and are your sales personnel numbers in North America still growing or kind of where you want it where in you'll get more leverage because of the increases you took in the prior period?

I mean, we are getting a return on the investments that we made there. We feel good, I mean, based on the order growth here that we're seeing as we head into the back half of the year. But I think we are done making investments in the sales organization? No. Generally we're outgunned in the major metropolitan markets by our primary competitors, so as you look out over the next few years, while staying within our SG&A targets, we're going to invest more in salespeople.

And we have a follow-up from David MacGregor with Longbow Research.

Jay, I just wanted to ask about NeoCon this year and kind of what your takeaways were and what are you are hearing in terms of customer preferences and how those are evolving and, I guess, I'd be interested in the kind of year-over-year comparisons and your observations?

Well, the traffic was up 7% year-over-year, so NeoCon was high energy this year. We got great feedback from our design. We had 2 major global launches that we previewed at NeoCon, one from our internal design team and one from David Oakey Studios. And I thought it was a really strong showing for us. The other thing that really took our customers -- held our customers' interest pretty high was our LVT, and so we previewed some LVT product that we're going to be launching in the back half of this year. So I think our first round of LVT was a little utilitarian, meaning we covered all the bases, but the next round is really led by design and how it integrates with our carpet. So while LVT is very prevalent amongst all the competitors, I think the customers really appreciated our approach to the integration of carpet and LVT design. So I'm pretty psyched actually as we go into the back half of the year, as we start selling those new products.

And I'm showing no further questions at this time. I'd like to turn the call back to Mr. Jay Gould for any closing remarks.

Okay, well, first of all, thanks for your continued support, really encouraged as we go into the back of the year that we're going to execute on our commitments. And I look forward to our next quarter call. Thanks very much.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.