Interface Inc Q3 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the Q3 2020 Interface Earnings Conference call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question and answer session. To ask a question during the session, you'll need to press one on your telephone. If you require any further assistance, please press Star zero. 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 Interfaces Conference Call regarding third quarter 2020 results hosted by Dan Hendrix, chairman and CEO, and Bruce Hausmann, vice president and CFO. During today's conference call, any management comments regarding interfaces 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 statement, including risks and uncertainties associated with the ongoing COVID-19 pandemic and those described in our FCC 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 FCC today. Lastly, this call's being recorded and broadcasted for Interface. It contains copyrighted material and may not be re-recorded 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. We'll continue to invest in 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 percent in the third quarter versus last year. I'm encouraged by some early bright spots in the business. Third quarter orders increased 11 percent sequentially compared to the second quarter, potentially signaling stabilization. We saw modest sequential improvement across all product categories. We're beginning to see modestly improving trends in Europe. In particular, we're having a standout year in our 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 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 percent in the third quarter, despite a 31 percent decline in carpet tile production. This reflects the strong capabilities of our supply chain and operation teams and the flexibility of our 70 percent 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 dollars 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, Provençal made up nearly 100 percent of our revenue. Today, it is only two thirds of our sales. We've quickly grown our Albizzi business since launching in 2017 and our rubber business in 2018. We believe rubber and Albizzi have doubled Interface's total addressable market from about four billion to approaching nine billion. There is an opportunity for additional reach in the 10 billion dollar commercial soft surface market for the ongoing conversion problem of carpet tiles to further strengthen our competitive position. We also continue to expand our market presence in 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 of our business. This diversification helps us to adapt during times of economic and market volatility. In the current environment, we are capitalizing on opportunities in hospitality, where hotels are renovating and remodeling with limited capacity, and we see the same trends in health care and education, especially K through 12. In addition, the direct-to-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 percent of our commercial business. We expect to gain 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 patterns and shading to guide traffic direction, zoning, and other visual cues. Ultimately, companies still view office space as a necessity for culture and innovation. They say culture beats strategy. Every time we anticipate demand to pick up in the coming quarters, we believe there will be a comeback in the office market in the second half of 2021. According to a recent Ginzler study, 44 percent of employees prefer to be back in the office full-time, while 44 percent 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 products and increasing selling focus from our sales force. Our objective is to take our fair share of this two billion dollar 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, and that's where we rolled out our first carbon negative carpet tile, measured Cradle to Cradle. Today, we launched this new product as part of our latest global collection called Embodied Beauty, along with our new nano vinyl, bio-based seaQuest bio, and sequence biotech backings. These new backings are our first non-EPS product offerings in the United States, expanding our market opportunity with a growing customer base that prefers a PVC option. The styles from Embodied Beauty are currently available in the United States, and you may 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 this is a big step toward our commitment for Interface to be a 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 percent compared to the prior year, with orders down 25 percent in the Americas, 16 percent in EMEA, and 15 percent in Asia Pacific. However, orders increased 11 percent over the second quarter, potentially signaling stabilization in demand. Sales in the third quarter 2020 were 279 million, down 20 percent compared to the prior year period, but up seven percent sequentially compared to Q2. Declines in carpet were somewhat moderated by lesser declines in equity and rubber. Sales in the Americas were down 29 percent, with declines across all product categories, and sales were down 17 percent in local currency and down 12 percent in U.S. dollars. Again, with declines across all product categories. Sales in Asia-Pacific were down 10 percent in local currency and down 8 percent in U.S. dollars. Declines in carpet were offset by solid performance in both LVT and rubber and 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. The third quarter adjusted gross profit margin was 37.2 percent. While this was down 270 basis points from the prior year period, it was still a very healthy outcome when carpet production was down 31 percent year-over-year. This is a testament to our strong supply chain, strong plant operators, and our ability to flex our plants and cost structure with changes in demand. SG&A expenses were 88 million in the third quarter or 31.6 percent of net sales, while adjusted SG&A expenses were 75 million or 27.1 percent of net sales in the third quarter 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 eight million in severance charges related to payments for our voluntary and involuntary separation program, and we've benefited from approximately 3.5 million from 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. 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 for ten cents per diluted share, and adjusted net income was 17 million or 28 cents per diluted share. 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 8 million or 7 percent year-over-year, driven by a decline in carpet. Notably, finished goods inventory decreased 25 percent year over year. Managing our working capital metrics continues to be a top priority. We ended the quarter with 104 million in 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 2.9 times 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 for 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. 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've 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, the 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're seeing in our end markets. We believe that a broad 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 challenging 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'm 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. Now, I'll open it up for questions.

At this time, we'd like to take any questions you may have. To ask a question, please press star and the number one on your telephone keypad. Our first question comes from Kathryn Thompson with Thompson Research Group. Your line is open.

Hey, good morning. It's actually Brian on for Kathryn. Thank you for taking my questions. I wanted to start with the outlook for Q4 and kind of help bridge the gap between the two statements of Q3. Orders were up 11 percent sequentially, but Q4 is on track, similar to Q3. I guess I thought if orders are up a little bit more, then maybe Q4 would be a little bit more. But it sounds like it should be down to a similar scene in Q3. So I guess how do we bridge the gap between those two?

Yeah, good morning, Brian. 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'll 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. As for full year SG&A, it'll be about 310 million approximately for the full year. Of course, we have three quarters banked so far, so you can pretty much back into the Q4 number. 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 have our best estimate of where people will probably come out.

And then, I guess on the gross margins in the quarter, down 20 basis points, I think I was a little more than Q2 is down. I guess what are the drivers for that in the quarter? It seems like volume production should have been a little higher in Q3. Hopefully, we would have seen some lower input costs from the lower input costs that were in the first half of 2020 kind of flow through the income statement in the back half of the year. I guess how we think about the puts and takes for the March performance in the quarter.

Yeah, good morning, Brian. This is Bruce again. So, you know, in Q2, our production was down about 36 percent and in Q3, it was down about 31 percent. In Q4, we're anticipating a similar level. There are, as you mentioned, 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, a great supply chain organization, and a strong ability to manage costs. We're not necessarily seeing this as not an inflationary environment from an input inflation standpoint, but it's not necessarily a heavy deflationary environment either. So you kind of take in all those factors. And again, where the margin landed, we thought it was a great outcome, and we're anticipating a similar outcome for Q4. Yeah, and we continue to bring down finished goods inventory as well.

Thank you.

Your next question is from Keith Hughes with Truist Securities. Your line is open.

Thank you. Given some of the shifts in the market you talked about towards soft surface from carpet you're addressing, given the downturn, are you looking to permanently take some professional capacity out, based on the production rate you discussed earlier?

Not right now. We continue to look at capacity in Asia. We have a lot of capacity there. We want to capture the China market, and we have a plan in China that services the Chinese market, while our Thailand plant services the rest of Asia. We have an Australian plant. 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 discussed a million dollar 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. I was wondering if you were going to ask that question. We're still working through our annual operating plan process, going department by department, line by line, and grinding through all the numbers. We don't have any forward guidance on that number for this call, but we will provide that on our next call. We're going to continue managing the cost structure of the business in line with our current demand. Our SG&A is down year-over-year, and I think we're doing a good job of controlling that line and making sure that that's in alignment with our current top line.

It's fair to say the majority of it will be seen in '21.

You know, there will be some things that will happen in 2021, like for example, merit increases will come back. Bonuses will get reset based on new targets and things like that. So that's all the math that we're working through. We also had a number of furloughs and some wage support programs this year, principally in Europe, where government-sponsored programs reimburse us. We're just not sure if those will be recurring next year, as that will vary by country.

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

That's part of the 80 million, that's correct?

Yes, yes it is.

And I guess just any kind of update us on the CEO search where you stand on that.

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

Your next question is from David MacGregor with Longwood Research. Your line is open.

Yes, good morning, everyone. What a day. Good morning. Welcome back to the first question that was asked about the discrepancy between the observation on the order book and then the thought. You will look a lot like Q3. I guess the building in the 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 revisions and deferrals? Is that what's giving you some sense of encouragement when you talk about the improving order patterns? Or maybe you just elaborate a little further on that?

We're not seeing cancelations, but we are seeing delays, David, in the order book. Our order book actually has grown a little bit, and we just don't know what the fourth quarter next year is going to look like with the pandemic and the second wave. We're thinking that we've stabilized where we are, and that's down 20 percent today. Hopefully, we'll see the office market come back. But we're not just sitting on the office market. We're actually going out for 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've talked about on the last call. 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, you know, it's kind of a new business for you, isn't it? 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 go pretty sharply. Given your thoughts on maintenance capex these days, my guess is, as you build a discretionary view of the discretionary business, it's probably a bit of a burden to working capital. So could you just talk about how we should think about 2021? And I realize you have to provide 2021 guidance yet, but just conceptually, all the moving pieces directionally in the cash flow model for next year.

Well, let me see if I can answer. For capex maintenance, we're around 30 million dollars next year. We're going to hold it to that line. We're really focused on paying down debt as far as that. In the U.S. business, we're focused on the dealer business. 90 percent of our business goes through the dealer, but we specify almost all of our business and we pull it through the dealer. The dealer has discretionary business that they control. We have never focused on that discretionary piece of the market with its dealers because we've always focused on the end user and the community. We're going to pivot and focus on the dealer, showing them some love with products and technology and having our salespeople treat them like customers.

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

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

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 pricing that goes after that dealer market. Right. But it won't be inventory-related.

So it is going to be somewhat of a headwind to gross margins over just for next year.

Well, engineers will engineer the product to go out to that market. We have pretty healthy margins in there.

And finally for me, just how should I think about keeping down a little bit of debt in the quarter? And how should I think about deleveraging goals for the next 12 to 18 months?

Well, my goal is to be 1 or 2. I've always been, who is my goal? We're going to take all our available cash to pay down debt.

How quickly can you get to there, Dan?

Two years, I think. I'm looking at my CFO but two years, that's for sure.

Yeah. Our number one capital allocation policy, David, is to pay down debt first. As we mentioned, we're going to decrease CapEx materially next year, which will free up a lot of additional free cash to do that.

Okay, great. Thanks very much, guys.

As a reminder, if you'd like to ask a question, please press star for the number one on your telephone keypad. And we have no further questions. I turn the call back to the presenters for closing remarks.

Thank you for listening to our third quarter call, and I'm looking forward to talking about the fourth quarter calling in. Please, everybody be safe. Thank you.

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