Interface Inc (TILE) 2020 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Q3 2020 Interface, Inc. Earnings Conference Call. (Operator Instructions) I would now like to hand the conference over to your speaker today, Christine Needles. Thank you. Please go ahead.

Good morning and welcome to Interface's conference call regarding third quarter 2020 Results posted by Dan Hendrix, Chairman and CEO; and Bruce Hausmann, Vice President and CFO. During today's conference call, any management comments regarding Interface's business, which are not historical information, are forward-looking statements within the meaning of federal securities laws.

Forward-looking statements include statements regarding the intent, belief or current expectations of our management team as well as the assumptions on which such statements are based. Any forward-looking statements are not guarantees of future performance and 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 ongoing COVID-19 pandemic and those described in our SEC filings.

The company assumes no responsibility to update forward-looking statements. Management's remarks during this call also refer to certain non-GAAP measures. Reconciliations of the non-GAAP measures to the most comparable GAAP measures and explanations for their use are contained in the company's earnings release and Form 8-K furnished with the SEC today.

Lastly, this call is being recorded and broadcasted for Interface. It remains 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.

After our prepared remarks, we will open the call for questions. Now, I'd like to turn the call over to Dan Hendrix, Chairman and CEO.

Good morning, and thank you for joining us today. Before we discuss financial results for the quarter, let me first talk about the status of our business and what we're seeing in the marketplace. Thank you to our Interface team for your hard work this quarter as we continue to manage through the COVID-19 pandemic and the ongoing impact on our business. We remain focused on managing the things that we can control while continuing to invest in the initiatives, specifically our product innovation pipeline and selling system that will set us up for long-term success. I'm very proud of the team for providing best-in-class service levels while ensuring the safety of our people.

Our net sales were down 20% in the third quarter versus last year. I'm encouraged by some early bright spots in the business. Third quarter orders increased 11% sequentially compared to the second quarter potentially signaling stabilization. We saw modest sequential improvement across all product categories. We're beginning to see modest improving trends in Europe.

In particular, we're having a standout year in our Nora Rubber business in Germany. And our business in China has returned to growth. Australia seems to have a better handle on COVID-19 than most of the world. And more people are returning to the office in Asia Pacific where work from the home is less common. This is a positive signal for us with half our revenues outside the United States.

We maintain healthy adjusted gross margins of 37% in the third quarter despite a 31% decline in carpet tile production. This reflects the strong capabilities of our supply chain and operation teams and the flexibility of our 70% variable manufacturing cost structure. We remain committed to rightsizing the business to maintain our profitability when necessary. We have taken actions to realize $80 million of annual run rate cost reductions in response to the pandemic and anticipate full year 2020 adjusted SG&A expense of approximately $310 million.

Overall, we have made progress expanding our product lines. In 2016, carpet tile made up nearly 100% of our revenue. Today, it is only 2/3 of our sales. We've quickly grown our LVT business since launching in 2017, and we acquired our rubber business in 2018. We believe rubber and LVT have doubled Interface's total addressable market from about $4 billion to approximately $9 billion. And there's an opportunity for additional reach in the $10 billion commercial soft (inaudible) market with the ongoing conversion of Broadloom to carpet tile.

To further strengthen our competitive position, we also continue to expand our market presence in end markets beyond the corporate office. This includes health care, education, life sciences, hospitality, retail, consumer and multifamily where we compete on design, innovation, service, price, and sustainability.

In the past few years, these efforts have resulted in major shifts in our revenue composition. The commercial office market, which used to represent the majority of our revenue is now less than half our business. This diversification helps us to adapt during times of economic and market volatility.

In the current environment, we are capitalized on opportunities in hospitality, where hotels are renovating and remodeling while at limited capacity. And we see the same trends in health care and education, especially K-12. In addition, the direct consumer e-commerce platform of our core business is having an exceptionally strong year, growing double digits.

With COVID-19, we're seeing a change in design needs in schools and offices. Renovations and remodels compared to new construction make up about 80% of our commercial business, and we expect to get traction accommodating redesigns that address social distancing measures as large companies and businesses begin to reopen.

Our products can help to address these challenges with design elements like pattern and shading to guide traffic direction, zoning, and other visual cues. Ultimately, companies still view office space as a necessity for culture and innovation as they say culture beats strategy every time.

We anticipate demand to pick up in the coming quarters, and we believe there will be a recovering office market in the second half of 2021. According to our recent Gensler study, 44% of employees prefer to be back in the office full time, while 44% prefer a hybrid office home arrangement. This bodes well for the comeback of the office market.

We're also increasing our focus on the U.S. commercial dealer discretionary market through value-engineered product and increasing selling focus from our sales force. Our objective is to take our fair share of this $2 billion market opportunity by focusing on the dealers and offering high design products at low to mid-price points.

I'm also very excited to share an important milestone in our sustainability journey. In October, we rolled out our first carbon-negative carpet tile measured cradle to gate. We launched this new product as part of our latest global collection called Embodied Beauty, along with our new non-vinyl, bio-based CQuest Bio and CQuest Bio-X backings.

These new backings are our first non-PVC product offerings in the United States, expanding our market opportunity with the growing customer base that prefer a non-PVC options. The Embodied Beauty styles are currently available in the United States and we expect to launch them globally in 2021. We are encouraged by early demand from our customers, many of whom care about embodied carbon in their built space and have made their own commitment to be carbon-negative in the future.

We firmly believe that the demand will only increase as more companies set carbon reduction targets and is a big step toward our commitment for Interface to be carbon-negative enterprise by 2040. With that, I'd like to turn the call over to Bruce to discuss the financial results for the third quarter.

Thank you, Dan, and good morning, everyone. As we closed out the third quarter, orders were down 21% compared to the prior year, with orders down 25% in Americas, 16% in EMEA and 15% in Asia Pacific. That said, orders increased 11% over the second quarter, potentially signaling stabilization in demand. Net sales in the third quarter 2020 were $279 million, down 20% compared to the prior year period, but up 7% sequentially compared to Q2. The declines in carpet tile were somewhat moderated by lesser declines in LVT and rubber.

Sales in the Americas were down 29%, with declines across all product categories. In EMEA, sales were down 17% in local currency and down 12% in U.S. dollars, again, with declines across all product categories. And sales in Asia Pacific were down 10% in local currency, and they were down 8% in U.S. dollars. Declines in carpet tile were offset by solid performance in both LVT and rubber.

In our global market segments, we continue to see growth in living, which includes student housing, senior living and multi-residential. We also saw growth in public buildings and transportation in the quarter. Third quarter adjusted gross profit margin was 37.2%, and while this was down 270 basis points from the prior year period, it was still a very healthy outcome when carpet tile production was down 31% year-over-year. This is a testament to our strong supply chain, strong plant operators, and our ability to flex our plant and cost structure with changes in demand.

SG&A expenses were $88 million in the third quarter or 31.6% of net sales, while adjusted SG&A expenses were $75 million or 27.1% of net sales in the third quarter of 2020. The company has implemented several cost-reducing initiatives to align with reduced customer demand and anticipates full year 2020 adjusted SG&A expenses of approximately $310 million.

In the third quarter, we recorded $8 million of severance charges related to payments for our voluntary and involuntary separation program and we benefited from approximately $3.5 million in various wage support and employee retention programs around the world. We continue to realign the company's cost structure while investing in innovation to keep the company strong and agile for the medium to long term.

The third quarter operating income was $16 million compared to operating income of $44 million in the prior year period, and third quarter 2020 adjusted operating income was $28 million versus adjusted operating income of $46 million in the third quarter of last year. We recorded net income of $6 million in the third quarter of 2020 or $0.10 per diluted share and third quarter 2020 adjusted net income was $17 million or $0.28 per diluted share, and adjusted EBITDA was $37 million. Please refer to our press release for reconciliations of GAAP to non-GAAP numbers.

Turning to our balance sheet and cash flows. We generated $65 million of cash from operations and had $378 million in liquidity at the end of the quarter. We effectively controlled costs and closely managed our cash flow during this ongoing period of softened demand. Inventory was down $18 million or 7% year-over-year driven by a decline in carpet tile. Notably, finished goods inventory decreased 25% year-over-year. Managing our working capital metrics continues to be a top priority.

We ended the quarter with $104 million of cash and repaid $43 million of debt during the quarter. Net debt or gross debt minus cash on hand was $482 million in the last 12 months of adjusted EBITDA was $162 million at the end of the third quarter, resulting in a leverage ratio of 2.9x net debt to adjusted EBITDA.

Interest expense was $5 million in the third quarter compared to $7 million in the third quarter of last year, and depreciation and amortization were $12 million in the quarter versus $11 million in the third quarter of last year. Capital expenditures were $11 million in the third quarter compared to $19 million in the third quarter of last year, and we anticipate capital expenditures to be approximately $60 million for the full year 2020 and approximately $30 million for the full year 2021 as we have moderated capital spending plans this year and plan to reduce them further next year.

While we are seeing indications of stabilization in our end markets, a high level of uncertainty created by the global pandemic still remains. As a result, Interface is not providing fiscal year 2020 guidance. That said, based on everything we know today, we anticipate Q4 2020 will be similar to Q3 2020 in terms of the year-over-year revenue decline and gross profit margins.

And now I'll turn the call back to Dan for concluding remarks.

Thank you, Bruce. We are encouraged by some of the recent data points and trends we are seeing in our end markets, and we believe that a broadened portfolio, coupled with a more focused segmentation strategy will bolster our share growth. We're committed to innovation and have a strong pipeline of exciting new products for 2021. We will continue to right-size the organization to meet demand and focus on strong liquidity and cash flow generation.

Most notably, Interface will continue to be successful, resilient and agile during these changing times as we always have been. Thank you to the entire Interface team around the world for your resilience and dedication to our company and our customers. Your health and safety remain our top priority, and we truly value your hard work and commitment.

I am proud of the way our company is navigating this challenging year with COVID-19. Thank you also to our customers and shareholders for your continued support. We remain focused on keeping our business strong and well positioned for long-term success. With that, I'll open it up for questions. Operator?

(Operator Instructions) Our first question comes from Kathryn Thompson with Thompson Research Group.

This is actually Brian on for Kathryn. I wanted to start on the outlook for Q4 and kind of see if you can bridge the gap between the 2 statements of Q3 orders were up 11% sequentially, but Q4 is tracked similar to Q3. And I guess I would have thought if orders were up a little bit more than maybe Q4 would be up a little bit more, but it sounds like should be down to a similar extent in Q3? I guess, how do we bridge the gap between those two?

It's Bruce Hausmann. So the way we're thinking about Q4, based on everything we know today is that if you think about year-over-year top line growth, it will be really similar to what we saw in Q3. And if you think about gross profit margins, we're thinking that they'll be very similar to what we saw in Q3. And if we think about full year SG&A, it will be about $310 million approximately for the full year. And of course, we have 3 quarters banked so far. So you can pretty much back into the Q4 number.

And so the good news is that we're seeing stabilization in the business. The good news is that orders sequentially are up. But based on all the puts and takes of the numbers, that's kind of how we -- our best estimate where Q4 will probably come out.

And then, I guess, on the gross margins in the quarter, down 270 basis points. I think that was a little more than Q2 was down. I guess, what are the drivers for that in the quarter? And it seems like volume production should have been a little higher in Q3, hopefully, would have seen some lower input costs from the lower input costs that were in the first half of 2020 kind of flowing through the income statement in the back half of the year. I guess, how do we think about the puts and takes for the margin performance in the quarter?

This is Bruce Hausmann again. So in Q2, our production was down about 36%. And in Q3, it was down about 31%. In Q4, we're anticipating a similar level. There are -- as you mentioned, there are a lot of puts and takes in that. We felt really good about where the gross margins landed for the quarter based on great operators in our plants, great supply chain organization, and a strong ability to manage costs.

We're not necessarily seeing -- this is not an inflationary environment from an inflation standpoint, but it's not necessarily a heavy deflationary environment either. So you kind of bake in all those factors. And again, where the GP landed, we thought it was a great outcome, and we're anticipating a similar outcome for Q4.

Yes. And we continue to bring down finished goods inventory as well.

Yes, that's a really good point. I don't know if you heard that point, but finished goods inventory was down 25%, which is -- so we continue to be very focused on our working capital.

Our next question is from Keith Hughes with Truist Securities.

Given some of the shifts in the market you had talked about towards soft surface, the carpet you were addressing, and given the downturn with -- in Carpet Town now, are you looking to permanently take some carbon tile capacity out given these production rates you discussed earlier?

Not right now, we're not. We continue to look at capacity in Asia. We have a lot of capacity there, and we're going to -- we want to capture the China market, and we have a plan in China that services the Chinese market. And our Thailand plant services the rest of Asia, and we have an Australian plant. So we're not looking to take it out today, but we'll continue to look at it and flex it as demand ebbs and flows.

Okay. And you had discussed $80 million run rate of cost savings. Can you talk about how much of that will be realized in '20 and how much in '21?

Keith, this is Bruce Hausmann. I was wondering if you were going to ask that question. We're still working through our AOP or our annual operating plan process. And we're going department by department, line-by-line and grinding through all the numbers. And so we don't have any forward guidance on that number for this call, but we will provide that on our next call. And -- but I would just say that we're going to continue managing the cost structure of the business in line with our current demand.

And I'm sure you've noticed our SG&A is way down year-over-year. And I think that we're doing a good job at controlling that line and making sure that that's in alignment with our current top line.

Is it fair to say the majority of it will be seen in '21?

There will be some things that will happen in '21, like, for example, merit increases will come back, for example, bonuses, all sort of get reset based on new targets and things like that. So that's all the math that we're working through.

And the furloughs.

And the furloughs that come back. We had a number of furloughs. We also had some wage support programs this year, principally in Europe, where there are government-sponsored programs that we get reimbursed. And we're just not sure if those will be recurring next year because that's country by country, government by government that has to approve those.

But we have taken out some permanent structural costs as well, we have.

Okay. That's part of the $80 million, I assume, correct?

Yes, it is.

And I guess, just any kind of update for us on the CEO search, where you stand on that process?

We're looking at doing that next year. It's sort of a tough time to do a CEO search in this pandemic. So we're looking to kick it off next year.

Our next question is from David MacGregor with Longbow Research.

Just want to go back to the first question that was asked about the discrepancy between the observation on the order book and then the -- the thought that 4Q will look a lot like 3Q. I guess the building in orders is happening a little further out in the order book. Is it? And I guess the question I wanted to ask on this point is, are you seeing any slowdown in the number of push-outs and provisions and deferrals? Is that's what you're giving you some of encouragement when you talk about the improving order patterns? Or maybe you could just elaborate a little further on that.

Well, we're not seeing cancellations, but we are seeing delays, David, in the order book. And actually, our order book actually, I think, has grown a little bit. And so we just don't know what the fourth quarter and next year is going to look like with the pandemic and even the second wave of the pandemic.

So we're thinking that we've stabilized where we are, and it's down 20% today. And hopefully, we'll see the office market come back. But we're not just sitting on the office market, we're actually going after a lot of other opportunities and trying to go after the health care market with our other business. Trying to go after this dealer business that we talked about on the last call, David. So we're trying to take share out there as well.

Okay. And then I wanted to come back and ask you about the dealer discretionary business because that's kind of a new business for you, I think, isn't it? And I'm just trying to understand how we should think about that with regard to the cash flow for 2021. Clearly, your CapEx is going to be down pretty sharply. It'd be interesting to know what your thoughts are in terms of maintenance CapEx these days, but my guess is, as you build out a dealer discretionary business, there's probably a bit of a burden to working capital. So could you just talk about how we should think about '21? And I realize you haven't provided '21 guidance yet, but just conceptually how you think about the moving pieces directionally and the cash flow model for next year.

Well, let me step back and answer it. For the CapEx maintenance, we're around $30 million next year in CapEx, and we're going to hold it to that line. We're really focused on paying down debt. As far as it's the U.S. business we're focused on, on the dealer business. 90% of our business goes through the dealer, but we specify almost all of our business and we hold the spec and we pull it through the dealer.

But the dealer has discretionary businesses they also control, and we've really never focused on that discretionary piece of the market with those dealers because we've always focused on the end user and the A&D community. So we're going to pivot and really focus on the dealer and show them some love with products and with technology, and with our salespeople actually calling them and treating them like a customer.

So how should we think about that in terms of just the inventory build required?

There's not an inventory build on that at all.

Yes, David, this is Bruce. We don't anticipate any sort of meaningful increase to working capital to go and capture that piece of the market.

There is going to be some new product development around the mid- to low-end pricing that goes after that vivo market, right? It won't be inventory related.

So it is going to be somewhat of it -- to the extent you're successful this is going to be a little bit of a headwind to gross margins, I would guess, for next year.

We will engineer the product to go after that market where we have pretty healthy margins in there.

Okay. And then finally for me, just how should I think about -- like to see paying down a little bit of debt quarter, but how should we think about deleveraging goals for the next 12 to 18 months?

My goal is to be under 2. Always been under 2 is my goal. And we're going to take all our available cash to pay down debt.

How quickly can you get to there, Dan?

2 years? I think -- I'm looking at my CFO, but 2 years, to 3 years, for sure.

Our #1 capital allocation policy, David, is to pay down debt first. And as we mentioned, we're going to decrease CapEx materially next year, which will free up a lot of additional free cash in order to do that.

(Operator Instructions) And we have no further questions. I will turn the call back to presenters for closing remarks.

Well, thank you for listening to our third quarter call, and I'm looking forward to talking about the fourth quarter call. And please, everybody, be safe. Thank you.

This concludes today's conference call. You may now disconnect.