Earnings Call Transcript - TILE Q3 2021

Christine Needles, Corporate Communications

Good morning and welcome to Interface’s conference call regarding third quarter 2021 results, hosted 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 most recent annual report on Form 10-K filed with the SEC. 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 broadcast for Interface. It contains copyrighted material and may not be rerecorded or rebroadcast without Interface’s expressed 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 up the call for questions. Now, I would like to turn the call over to Dan Hendrix, Chairman and CEO.

Dan Hendrix, Chairman and CEO

Thank you, Christine. Good morning and thank you for joining us. The Interface team delivered strong results this quarter and I continue to be impressed by their dedication and commitment to delivering for our customers. We saw a 12% year-over-year increase in net sales in the third quarter as customer demand continued to pick up in line with positive signs of a commercial recovery across most of our regions. We generated $29 million of cash from operating activities during the quarter and we repaid $30 million of debt to reach pre-pandemic leverage ratios. Building on the momentum we saw last quarter, orders were up 24% year-over-year, including a 34% increase in the Americas and a 12% increase in EAAA. Backlog was up 33% compared to a year ago, which is a record high for Interface, which should bode well for the fourth quarter. Despite the strong customer demand, we continue to manage through industry-wide supply chain issues. Like most of the other companies, we are facing some challenging headwinds. We have open jobs we are working to fill in our U.S. manufacturing facilities. We are experiencing raw material and freight inflation, and we are still facing disruption from COVID-19. As a result, it has been difficult to keep up with order demand in our manufacturing facilities and our gross profit margins were lower than we targeted in the quarter. To respond to this challenging operating environment, we are partially offsetting these impacts with pass-through price increases and freight surcharges. We are acting as quickly as we can, but there is a lag between raw material, freight, and labor inflation and when price increases take effect. Additionally, with the recent announcement to close our plant in Thailand by the end of 2022, we are increasing productivity and lowering manufacturing costs across our global manufacturing footprint. I am proud of our team’s efforts to control SG&A and continue to right-size the business as we work through these challenging times. Turning to our market verticals, we are seeing a significant increase in activity in the education market. K-12 schools across the U.S. are investing in infrastructure improvements with funds from the U.S. government’s 2021 pandemic relief aid program. These educational institutions also appreciate Interface’s leadership position in sustainability. Every product that goes out the door from Interface is either carbon neutral or carbon negative. The healthcare market also continues to be strong for us. We are positioned well with the right portfolio mix across rubber, LVT, and carpet tile to suit a range of needs in that market. Now, let’s talk about the office market. We saw another quarter of growth as we have customers who are renovating their offices in anticipation of their employees coming back to create more collaborative flexible workspaces. All of this activity is good for business. Change drives renovation work, and renovation work drives commercial flooring purchases. Additionally, more and more public and private companies are making their own carbon reduction and sustainability goals, which uniquely positions us to serve their needs. Our dealer strategy is also showing promise. You might recall that we launched this initiative a few quarters ago to focus more closely on new and existing dealer relationships. Our net promoter scores with this segment of our customer base are heading in the right direction, and our Open Air products continue to be incredibly popular with them. All-in, this is a win-win for our dealer partners, our end-use customers, and our company. We are very pleased with the progress we are seeing in this area of the business. And now, I’d like to share some incredible news with you about our European operations. Globally, we are very proud of our commitment so far in the climate take-back journey. During this last quarter, we transitioned our European carpet tile backing from petroleum-based bitumen to CQuest Bio. This means we stopped using petroleum-based bitumen on all of the carpet tiles we manufacture in Europe, replacing it with bio-based materials and recycled fillers. There was a celebration in our plant in Holland when the last bitumen truck pulled up and then drove away because we knew that was the last bitumen truck we would ever need. This is a win for our planet, for our customers, and it’s another important step forward on our climate take-back journey. There are so many people to thank for this milestone, and I particularly want to thank our European manufacturing team for our new manufacturing process. Additionally, Interface has become the first foreign company to receive third-party validation of our 2030 greenhouse gas reduction targets as science-based. These now validated science-based targets commit Interface to further reduce our Scope 1, 2, and 3 emissions in alignment with our goal of becoming a carbon-negative company by 2040. Interface continues to lead the pack when it comes to our commitment to sustainability. Our relentless focus on design, innovation, and sustainability continues to drive our leadership position in the industry and strengthens our foundation for future growth.

Bruce Hausmann, Vice President and CFO

Thank you, Dan and good morning everyone. Third quarter sales totaled $312.7 million, up 12.2% from the prior year period, with increases across all product lines. Organic growth, which excludes the impact of currency translation, was up 11.3%. Sales in the Americas were up 23.7%, driven by a release of pent-up demand in a strongly recovering commercial market. In EAAA, net sales were relatively flat as certain markets like Eastern Europe, China, Southeast Asia, and India faced new waves of COVID resulting in government lockdowns. Orders, however, were up in both regions as America saw orders up 34% year-over-year and EAAA’s orders were up 12% year-over-year. Currency fluctuations had an approximately $1.9 million of positive impact on EAAA’s third quarter net sales due to the strengthening of various foreign currencies against the U.S. dollar. Third quarter adjusted gross profit margin was 34.5%, which was a solid outcome in the face of the global supply chain crisis that our company and almost every other global company had to navigate through during the quarter. Adjusted SG&A expense for the third quarter was $77.5 million compared to $75.5 million in the same quarter last year. And as a percentage of net sales, adjusted SG&A was 24.8% this quarter compared to 27.1% in the same period last year. As you will note, we are continuing to tighten up the company’s cost structure, and we are paying particular attention to gaining greater efficiencies in our SG&A. Third quarter adjusted operating income was $30.2 million, up 7.4% compared to $28.1 million in the third quarter last year. Third quarter 2021 adjusted net income was $16.9 million or $0.29 per diluted share, and adjusted EBITDA was $42 million for the quarter. During the third quarter, in line with our prior announcement, we recorded a $3.8 million restructuring charge related to the closing of our manufacturing facility in Thailand. We expect to stop manufacturing at this facility in Q1 of 2022, and the project is expected to result in annualized savings of approximately $1.7 million, plus decreased complexity and increased efficiency of our global manufacturing footprint. Turning to our balance sheet and cash flows, the company generated $28.9 million of cash from operations in the third quarter and $64.1 million year-to-date. Liquidity at the end of the quarter was $391 million, comprised of $93 million of cash and $298 million of borrowing availability. Inventory was up $9 million or 3.7% year-over-year as we continue to be focused on managing working capital while meeting customer demand. Consistent with our focus on de-levering, we paid down $30 million of debt in the third quarter, and we paid down $49 million year-to-date. We are very pleased to be on track with our debt reduction goals. Net debt or total debt minus cash on hand was $432.1 million at the end of the third quarter. In the last 12 months of adjusted EBITDA were $153.9 million achieving a net leverage ratio of 2.8x calculated as net debt divided by adjusted EBITDA. This is a significant milestone for us as it brings that metric back to pre-pandemic levels. Third quarter 2021 interest expense was $7.7 million, including a $1.8 million non-cash charge related to our previously mentioned interest rate swaps that were discontinued in 2020, and that compares to $5.4 million in the prior year period. Capital expenditures were $5.3 million in the third quarter compared to $11.2 million in the third quarter of 2020. Looking at the fourth quarter of 2021, we expect the global economic recovery to be ongoing as more and more people receive their COVID-19 vaccinations combined with a significant level of global supply chain disruption and an inflationary environment that we believe will persist throughout the remainder of 2021 and likely into 2022. We’re continually monitoring the situation. As we look to finish 2021, we are anticipating net sales in the fourth quarter 2021 of $320 million to $330 million, adjusted gross profit percentage in the fourth quarter of 35.5% to 36.5%, adjusted SG&A expense for the full year of approximately $315 million to $319 million, interest and other expense for the full year of approximately $28 million. The adjusted effective tax rate for the full year is anticipated to be approximately 26% and capital expenditures of approximately $30 million for the full year 2021. Fully diluted share count at the end of the third quarter was 59.1 million shares.

Dan Hendrix, Chairman and CEO

Thank you, Bruce. I again want to thank the entire Interface team for a strong quarter, one that was filled with significant milestones. I hope everyone can see we continue to strengthen the company by broadening our product lines, increasing our leadership position in vertical segments like education and healthcare, leading in design and, of course, leading in sustainability. The positive momentum that we see in the business is encouraging. Despite the global supply chain issues to navigate through, which are not unique to Interface, we remain very optimistic about the future. With that, I’ll open it up for questions.

Operator, Operator

Your first question comes from Kathryn Thompson of TRG.

Brian Biros, Analyst

Hey, good morning. This is actually Brian Biros on for Kathryn. Thank you for taking my questions. I guess to start, can you touch on how volume and price trended across the two segments in the quarter?

Bruce Hausmann, Vice President and CFO

Sure, Brian. This is Bruce Hausmann. Good morning. A lot of the volume that you saw on the top line was more volume-based. We had some pricing activity. You might remember that we did some pricing activity in Q1. We did more pricing activity in Q2, and we did more pricing activity in Q3, and we will do some more for the rest of this year. Some of that activity is coming from pricing on our products as well as we’re adding some freight surcharges to offset the increased costs that we’re seeing in the freight line.

Brian Biros, Analyst

Maybe then in the EAAA segment, I guess, sales were flat. So I assume pricing was up, so that implies volume down. Any like magnitude of those two that you could share?

Bruce Hausmann, Vice President and CFO

Yes. That was mostly attributable to the new waves of COVID that we saw in Eastern Europe, China, Southeast Asia, and India. We had orders in hand, we had inventory ready to ship. The customer just couldn’t accept the product because the job site was either delayed due to COVID lockdowns or it was delayed due to the job site needing other materials that were having supply chain issues before they could bring in the flooring products. So actually, on balance, the EAAA region had a very strong quarter and all those orders will ship as soon as those job sites reopen and those COVID lockdowns ease. It was just really a timing thing between the quarters.

Brian Biros, Analyst

Got it. Has that – those lockdowns, have they continued into Q4? Or how has that trended sequentially?

Bruce Hausmann, Vice President and CFO

Yes. I mean I’m sure you’ve seen in the newspaper, Russia, for example, had increased case counts and Germany has had increased case counts. And so there are different waves. For example, in Q3, Malaysia had their borders closed entirely. We couldn’t ship any product into Malaysia. It just ebbs and flows and goes week by week. I think the good news is that we’re getting the orders, we’re getting the business. We know we’re taking share, and it’s just a matter of when the job sites can open and we can actually get the product to the customer to put down on the floor.

Brian Biros, Analyst

Got it. And then maybe thinking a little bigger picture, I guess, into next year. How would you characterize the biggest bottlenecks currently, I guess, maybe the biggest change sequentially from last quarter to this quarter and how this kind of play out into next year?

Bruce Hausmann, Vice President and CFO

Yes. I mean I think the biggest thing that’s on our mind for next year as we’re thinking about inflation and we’re thinking about price increases. We’re being very assertive with our price increases around passing the inflationary costs that we’re seeing on to our customers because we have to. We saw that in Q3. We will certainly see that in Q4, as you saw from our guide. I think we may see some of that in the first half of next year as well. I’m sure you heard the Fed talk this week about short-term inflation, that some of the stuff should normalize in 2022, but it’s a question of timing. We don’t know if that’s going to be Q1, Q2, or Q3. We’re just navigating through it. We’re making sure that things like, for example, freight surcharges are things that we can do now and that we can change later.

Dan Hendrix, Chairman and CEO

Yes. One of the biggest things that we’re fighting is labor, actually, in the United States. We are trying to hire a lot of people in our La Grange facility.

Brian Biros, Analyst

Yes, just my question is the labor situation. Do you think that gets any better at all into ‘22?

Dan Hendrix, Chairman and CEO

Yes. We’re starting to hire people. We’re trying to hire 100 people in La Grange.

Brian Biros, Analyst

Good luck. I will pass it on. Thanks.

Bruce Hausmann, Vice President and CFO

Thanks, Brian.

Keith Hughes, Analyst

Thank you. A question on the fourth quarter revenue guidance, how do you think that’s going to break out between the two regions in terms of their contribution to growth?

Bruce Hausmann, Vice President and CFO

Yes. I think it will be fairly evenly mixed, Keith. I think both regions are really well positioned to have strong growth in Q4 and frankly strong growth into the next year.

Dan Hendrix, Chairman and CEO

Yes. We have backlog record highs in both regions, actually.

Keith Hughes, Analyst

And talking about early next year, some of the raw material inflation that you and others have been talking about supply chain disruption. Do you think that’s going to continue into at least the early parts of ‘22?

Dan Hendrix, Chairman and CEO

I think from a yarn standpoint, which is our biggest raw material input, I’m hoping that peaks and I’m hoping freight actually peaks as well. Container charges have gone up significantly, as you know. I’m hoping that peaks in the first quarter.

Keith Hughes, Analyst

We’ve had inflation and costs, obviously. Have you had any issues getting materials across the world, some of the main ingredients to make in carbon?

Bruce Hausmann, Vice President and CFO

Keith, we’ve been really fortunate in that regard. The short answer is no. We had no production issues due to a lack of raw materials that we needed to create our products, which is great. Just a shout out to our operators; they have really been looking ahead and making sure that they navigate through to get the draws that they need. The big bottleneck has really been labor in our U.S. manufacturing facilities where we have quite a few open jobs that we’d like to fill that would increase our capacity.

Keith Hughes, Analyst

Okay. Final question on LVT, and a lot of port congestion obviously. Did you miss sale – LVT sales in the quarter due to not being able to get it off the ship?

Dan Hendrix, Chairman and CEO

No, we had a pretty good inventory position going into it, and we have been very fortunate on our supply chain.

Bruce Hausmann, Vice President and CFO

Yes. That’s a great example where we have been striking the balance of making sure we invest in the right amount of working capital to have enough product on hand to meet customer demand.

Keith Hughes, Analyst

Okay. Thank you.

Samuel Darkatsh, Analyst

Hey Dan, Bruce. Good morning. How are you?

Dan Hendrix, Chairman and CEO

Hi Sam.

Bruce Hausmann, Vice President and CFO

Good.

Samuel Darkatsh, Analyst

A couple of questions. One, a clarification question, when – as you see your inputs and labor constraints today, when do you imagine that your price cost will turn neutral based on pricing actions that you have already announced? What’s the timing? Is it 1Q, 2Q when do you expect to get price cost neutrality?

Dan Hendrix, Chairman and CEO

My sense is Q2. We are chasing raw material input costs. I am hoping that they are peaking. If we can actually see some kind of at least flattening of raw material price increases in freight, then Q2 we should get it.

Samuel Darkatsh, Analyst

Got it. And then Bruce, can you quantify what the pricing rollover effect on sales would be for ‘22 sales over ‘21 sales, since you have been raising prices as the year progresses? What – how much growth would you get next year from that pricing rollover?

Bruce Hausmann, Vice President and CFO

As an interesting question, Sam, we are working through our AOP right now around pricing and how much of that will flow through to next year. It should be meaningful because of all the pricing activity that we are doing here in the back half. We should get some pretty good flow.

Dan Hendrix, Chairman and CEO

Yes. Sam, usually, when we have price increases like this, inflation tends to lead people to go down market, and so you don’t really see the growth in the top line because they are actually changing the mix. It’s really hard to quantify what that would be.

Samuel Darkatsh, Analyst

Do you anticipate that mix degradation occurring now, though, I would think that you have a somewhat or at least more inelastic demand backdrop or activity backdrop than normal?

Dan Hendrix, Chairman and CEO

Yes. We introduced Open Air, which is the dealer product program that’s at a lower price but same margin. We are seeing a lot of growth in that. It’s really hard to figure out what kind of price increase will impact sales next year due to that.

Samuel Darkatsh, Analyst

Got it. My last question, and thanks for bearing with me. So, the SG&A cut in 3Q and 4Q versus your original expectations. Can you be a bit more specific in terms of where that came from? How much of that was discretionary versus maybe structural and what a realistic SG&A footprint looks like next year based on mid-single digit growth?

Bruce Hausmann, Vice President and CFO

Yes. Sam, we are just continuing to take a hard look at the cost structure of the company globally. We have been doing a lot of work around spans and layers, looking at the number of direct reports that each manager or director has and also looking at where work is done, whether it’s done locally or regionally or in corporate. We are trying to mix right so that we meet customer demands while also being the most efficient globally and leveraging our SG&A. We are really proud of the management team that we have done great work and great strides at bringing our SG&A as a percentage of revenue down. It continues to be a real focus for us. Regarding the guide for next year, when we release our Q4 earnings, we will be able to provide more guidance around all of our metrics, quite frankly, some revenue growth, our GP, our SG&A run rates, and our tax rates. But for now, you can think about a lot of the reductions we are making are permanent.

Dan Hendrix, Chairman and CEO

Yes. One of the things that we are really focused on, Sam, is getting it to 26%.

Samuel Darkatsh, Analyst

So, the $80 million run rate do you think is a workable number over the near to intermediate term?

Bruce Hausmann, Vice President and CFO

Yes. We are focused more on SG&A as a percentage of revenue. So, between the next 15 months to, call it, 18 months, we are focused on getting it down to 26% over time.

Dan Hendrix, Chairman and CEO

Or lower.

Samuel Darkatsh, Analyst

Thank you. Thank you, both.

David MacGregor, Analyst

Yes. Good morning everyone. I wonder if I could just start off by asking you to remind us on your fiber costs, your yarn costs. What percentage is recycled versus virgin fiber? I know you have got a very high percentage of recycled fiber, but could you just remind us on the proportions?

Dan Hendrix, Chairman and CEO

Yes, it’s about half, David.

David MacGregor, Analyst

Okay. And what’s happening with recycled fiber costs?

Dan Hendrix, Chairman and CEO

That is going up less than virgin for sure; a lot less.

David MacGregor, Analyst

Yes. So, is that fairly – would it be fair to characterize it as relatively stable or inflation maybe just not hit it yet?

Dan Hendrix, Chairman and CEO

Well, inflation in yarn actually is labor and freight as well and now energy if you are manufacturing in Europe. So, the input costs were pretty stable, but the process costs are not.

David MacGregor, Analyst

Okay. Maybe just a couple of the sort of qualitative points you made in your prepared remarks. You talked about the European CQuest Bio product. Congratulations on that. I know that’s a big milestone in the industry. How differentiated are you on that? Are you unique in that sense, or are there any of your competitors that have also left the bitumen behind and moved on to a bio-backed product?

Dan Hendrix, Chairman and CEO

We are very unique in that. I would say that Tarkett has a bio-based product as well in Europe. That’s one of our biggest competitors there, but we are very unique in that.

Bruce Hausmann, Vice President and CFO

One of the unique things is that every product that goes out the door now is a bio-based product. So, the bitumen has gone away entirely on every carpet tile that goes out the door in our manufacturing plant, which is a huge accomplishment.

Dan Hendrix, Chairman and CEO

And Tarkett is not at that place.

David MacGregor, Analyst

Right. Is the market – in your spec writing, is the market really specifying that product now? Are they leaning pretty hard into that, or do you think you are just out in front and it will have future benefit?

Dan Hendrix, Chairman and CEO

It’s starting to show up in specs, particularly in the United States.

David MacGregor, Analyst

Congratulations on that progress. With regard to the dealer market initiative here in the United States, can you just you talked about the fact that you are seeing strength in K-12, in healthcare. But I have always thought that the dealer market has been maybe more of an office market, but maybe you could just help us understand just what the growth drivers are behind your share growth there. Are you adding a number of dealers? Is there sort of in the distribution line that’s helping this?

Dan Hendrix, Chairman and CEO

Yes. It’s pretty simple, David. We are focused on the dealer. We are acting like they are a customer now and not like they are an enemy. We are having a lot of success in that market. And the dealers are very segmented, by the way.

David MacGregor, Analyst

In what sense?

Dan Hendrix, Chairman and CEO

They focus on healthcare, education, and the office market.

David MacGregor, Analyst

Right. So, is it still largely on office market at this point?

Dan Hendrix, Chairman and CEO

That’s half our business.

David MacGregor, Analyst

Within the dealer channel?

Dan Hendrix, Chairman and CEO

No, it’s segmented. Dealers – everybody has installed product and dealers installed it.

David MacGregor, Analyst

Okay. Maybe I can follow-up with you offline on that. And then just – you talked about earlier on about the demand recovery you are seeing commercial market recovery occurring. I guess how much of the growth in the backlog numbers or in the order growth numbers you cited here would be related to the dealer market versus your spec business?

Dan Hendrix, Chairman and CEO

That’s really hard to quantify that because 80% of our business goes through the dealer market. We know we are focused on the dealer, and we are winning discretionary business out of the dealer. But to quantify it would be very difficult.

David MacGregor, Analyst

Okay. Alright. Gentlemen, thanks very much.

Dan Hendrix, Chairman and CEO

Thank you for listening to our call. And I’m just going to say, Go Braves. Talk to you next quarter.

Operator, Operator

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