Earnings Call Transcript - TILE Q2 2022

Operator, Operator

Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Interface, Inc. Second Quarter 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you. Christine Needles, Corporate Communications, you may begin your conference.

Christine Needles, Corporate Communications

Good morning, and welcome to Interface’s conference call regarding second quarter 2022 results, hosted by Laurel Hurd, CEO; and Bruce Hausmann, 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 and quarterly report on Form 10-Q 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 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. After our prepared remarks we will open up the call for questions. Now, I’d like to turn the call over to Laurel Hurd, CEO.

Laurel Hurd, CEO

Thank you, Christine, and good morning everyone. We delivered another strong quarter with sales up 18%, reflecting growth across all our core segments and regions while continuing to navigate ongoing inflationary pressure and foreign currency headwinds. I continue to be impressed with our team and in the way we’re managing through a challenging inflationary environment. Our strong execution, along with pricing and productivity gains, help to mostly offset over 1,500 basis points of input cost inflation in the quarter. We continue to see strong demand for carbon neutral and carbon negative products highlighted by a 10% increase in both orders and backlog during the quarter. Orders in the Americas were strong, growing 17% year-over-year. In EAAA, orders increased 2% on a currency-neutral basis, but their second quarter growth was negatively impacted by the Russia-Ukraine war and COVID lockdowns in China. Globally, our backlog is up 19% year-to-date, which puts us in a position of strength as we enter the back half of 2022. In the second quarter, we continued to execute on our diversification strategies, resulting in share gains in our key market segments. Corporate office was up 17%, education was up 20%, and healthcare was up 13%. Our strong results in the quarter underscore our established position as an industry leader in design and sustainability in the commercial flooring space. The team was thrilled to see an increase in participation at in-person events around the world, including Clerkenwell Design Week in London, Milan Design Week, and of course, NeoCon. We were excited about the customer response to Interface at NeoCon where our American sales and marketing teams showcased a host of new products across the full portfolio. From the range carpet tile collection to Fresco Valley LVT and patio rubber flooring, we demonstrated our integrated flooring solutions with inspiring design innovation. We continue to receive recognition for our industry-leading products and sustainability leadership. At NeoCon, we received recognition in the health and wellness category for our escapes collection and a Rising Star Award in the manufacturing category. We also earned the Metropolis Likes Award for Beaumont Reigns. On the sustainability side, we received the 2022 Judges Choice Award from Environment and Energy Leader for our carbon negative carpet tiles and backing. We achieved this through decades of research and development and because we were the first to commercially scale this type of innovation in our industry. We were once again recognized as a sustainability leader in the annual GlobeScan survey among an impressive list of companies including Unilever, Patagonia, IKEA, and more. Interface is the only company to maintain a spot on this esteemed list for 26 years running and the only flooring company to have ever been recognized. Our many successes this quarter are a testament to the power of our story, our legacy, and our continued commitment to run our business in a way that creates a climate fit for life. Overall, our second quarter results are strong, and I’m extremely proud of our global team for their tireless efforts to advance our position as an industry leader in sustainability and design. I would also like to thank our customers for the trust they place in us every day to deliver high-performing, beautiful, and innovative flooring solutions. With that, I’ll turn it over to Bruce to go through the financials.

Bruce Hausmann, CFO

Thank you, Laurel, and good morning everyone. Second quarter net sales increased 17.6% to 347 million. Organic sales growth, which excludes the impact of currency translation, was 22.8%. Net sales in the Americas were up 32%, driven by continued strength in the commercial market. At EAAA, net sales were up 1.2%, and on a currency-neutral basis, net sales were up 12.1%. Second quarter adjusted gross profit margin was 34.3%, a decrease of 315 basis points from the prior year period as we continued to see higher freight, labor, and raw material costs, partially offset by higher pricing to our customers. While we’re not satisfied with gross margins at this level over the long haul, we are proud of the team in mostly offsetting over 1,500 basis points of inflationary pressure that we saw in Q2. We also anticipate continued inflationary pressure in the back half of 2022, which we will continue to work to offset with pricing and productivity. For the past two years, we have focused on building earnings power by making structural changes to our SG&A, and we are seeing the fruits of these efforts in the P&L. Adjusted SG&A expense for the second quarter was 80.4 million or 23.2% of net sales, compared to 79.4 million or 26.9% of net sales in the same period last year. Second quarter adjusted operating income was 38.5 million, up 24% versus adjusted operating income of 31.1 million in the second quarter last year. This is a great result on strong net sales growth, excellent work by our sales team, and our supply chain operators to mostly offset inflation that has been at a 40-year high, along with continued vigilance focused on SG&A management. Fully diluted earnings per share were $.28, up 7.7% versus $0.26 in the second quarter last year. Adjusted fully diluted earnings per share were $0.36, up 20% versus $0.30 in Q2 last year. Second quarters adjusted EBITDA increased 13.4% to 49 million in the second quarter of 2022. Turning to our balance sheet and cash flows, the company used 12.7 million of cash from operations in the first half of 2022. As a reminder, our customers' seasonality is to use cash in the first half of the year and generate cash in the back half. Liquidity at the end of the quarter remains strong at 345 million, comprised of 92 million of cash and 253 million of borrowing capacity on our revolving credit. Inventory was 318 million, up 23% year-over-year primarily due to raw material inflation. Our balance sheet remained strong. Net debt to total debt minus cash on hand was 453.7 million at the end of the second quarter, and our net leverage ratio was 2.4 times calculated as net debt divided by adjusted EBITDA. We continue to have confidence in our strong balance sheet and our capital structure. Capital expenditures were 4.3 million in the second quarter of 2022, compared to 6.9 million in the second quarter last year. In May, we announced a new $100 million share repurchase authorization. During the second quarter, we repurchased approximately $5.6 million of Interface common stock. Turning to our outlook, there continues to be significant macroeconomic and geopolitical uncertainty in the global economy. Persistent inflation and rising interest rates present challenges to the business, while FX-related headwinds negatively affect the foreign currency-denominated net sales we generate outside of the U.S. when we translate those sales into U.S. dollars. At the same time, these challenges are being partially offset by strong execution by our sales and manufacturing teams, and continued demand in the commercial market, including office, education, and healthcare, where we have a leadership position and a strong backlog as we move into the back half of the year. As we sorted through these factors and think about what to expect in the back half, we are anticipating the following: For the third quarter of 2022, net sales of 325 million to 345 million. Note, we are anticipating FX to decrease our year-over-year third quarter net sales growth rate by approximately 5%. Adjusted gross profit margin of approximately 33.5% on persistent inflation. Adjusted SG&A expenses of approximately 83 million, adjusted interest and other expenses of approximately 9 million, and an adjusted effective tax rate of approximately 28%, with a fully diluted weighted average share count at the end of the third quarter of approximately 59.1 million shares. For the full fiscal year 2022, we are anticipating net sales of 1.3 billion to 1.325 billion adjusted gross profit margin of approximately 34.5% to 35%. Adjusted SG&A expenses of approximately 326 million, adjusted interest and other expenses of approximately 32 million, an adjusted effective tax rate of approximately 28%, and fully diluted weighted average share counts at the end of the year of approximately 59.2 million shares and capital expenditures of approximately 30 million. While we’re continuing to see solid growth in the business, our second half net sales comparison will not look as strong as the first half of 2022, as we left the very strong net sales results achieved in the second half of last year. We will also continue to manage inflationary headwinds by engaging in ongoing selling price increases and executing productivity initiatives in our manufacturing facilities. By leveraging our strong financial foundation and our brand, we are confident our expertise will allow us to continue to capitalize on growth opportunities and execute our value creation strategy. And with that, I’d like to turn the call back to Laurel for concluding remarks.

Laurel Hurd, CEO

Thank you, Bruce. And thank you to everyone who contributed to our results for the second quarter of 2022. Just over 100 days into my role and even after this relatively short time with the company, I’m very confident we will continue to grow and gain market share with our outstanding design expertise, innovation, and our focus on sustainability. Let me share a few initial observations based on what I’ve learned in the first few months with Interface. To understand our global supply chain and manufacturing capabilities, I did a deep dive into our carpet tile operations in Troup County, Georgia, and Scherpenzeel in the Netherlands. I also spent time at our Nora rubber manufacturing operations in Mannheim, Germany. Overall, I was struck by the nimbleness of our global supply chain and how well the team has been navigating the challenges that have come our way. I continue to visit each of our manufacturing sites over the coming months, including a trip to Australia in a few weeks. It’s important that I get out into the business to meet our team and see our operations in action. I’ve also spent time with our designers on the product and innovation from their latest designs across carpet, tile, LVT, and rubber. These truly work as an integrated system that allows us to deliver beautiful spaces to our customers. It’s critical for us to continue to amplify our commitment to design and innovation; it’s core to who we are and key to accelerating our growth in the marketplace. I also work closely with global leaders and their teams to gain a deeper understanding of our sustainability leadership. Our people are so proud that Interface has been the pioneer in sustainability for more than two decades, culminating in our introductions of carbon neutral and carbon negative products. Our commitment to push the boundaries of sustainability is in the bones of our business; you can feel it everywhere along with an incredible sense of pride and purpose. Finally, I spent time with our sales leaders around the world and witnessed our strong customer relationships and intense focus on designing beautiful positive spaces for them. More and more companies are encouraging their teams to return to the office, and turning to Interface with system and redesigning collaborative spaces. Helping our customers meet their carbon objectives has never been more urgent. It’s very clear to me that Interface defines best in class leadership in design, sustainability, and innovation, and there’s so much to build on for our future. Additionally, we actually see some tailwinds that will help us. First, there’s a significant amount of government spending that has been approved but not deployed into the education market where we have significant strength. We also know that employers have been working to entice their employees back into the office with beautiful spaces renovated to support increased collaboration and hybrid work, which almost always means fresh carpet and paint. We believe that a potential recession may mean a shift to more of an employer’s market, which will give them the ability to get their employees back into the office. This means more renovation, which is great for us. Overall, I’m confident that our commercial excellence and strong operational and financial discipline will enable us to continue to grow and return value to our shareholders. I’ve really enjoyed speaking with many of you and look forward to spending more time with you in the back half of 2022. With that, I’ll open it up for questions.

Operator, Operator

Your first question comes from Kathryn Thompson from Thompson Research Group. Your line is open.

Unidentified Analyst, Analyst

Hey, good morning. This is actually Brian on for Kathryn. Thank you for taking my questions. Maybe just starting on the full year guide adjustment, is that all FX impact, or is there anything else embedded in the update?

Bruce Hausmann, CFO

Brian, this is Bruce Hausmann. Good morning. The biggest impact on the change in the full year guidance is really FX. That’s the largest change as we think about how we move through the quarter. The business continues to perform very well. Commercial activity is very robust, and we’re entering the second half with a very strong backlog. So it’s really just FX as the biggest differential this quarter versus last quarter.

Unidentified Analyst, Analyst

I figured that was the case. Can you talk about monthly trends or just the exit rate from the quarter? We’ve seen other companies have accelerated momentum through the quarter, and then others saw pretty sharp drops near the end. So just curious, what you guys are seeing and how you would characterize it?

Bruce Hausmann, CFO

Hi, Brian, this is Bruce again. We had a really strong June. So we saw no deceleration in the business. If you think about how the quarter sort of moved, it was strong throughout, and we’re continuing to see strength in the business as we enter into Q3.

Unidentified Analyst, Analyst

Encouraging signs. I think, last one for me right now, just, I guess seeing any impact from higher inflation and higher interest rates on projects in the market, if anything’s being delayed, scaled down or kind of people choosing different products. Any impact there you guys are hearing?

Bruce Hausmann, CFO

Hi Brian, it’s Bruce again. We have not seen any slowdown from interest rates rising, nor have we seen the commercial activity slow. The one thing that has changed now versus say six months ago is that, as you might remember, we were listening to the Fed about inflation being temporary, and we have not seen inflationary pressures wane. We’ve seen inflationary pressure continue into the back half here. So we’re still dealing with that. The good news is that with our premium brand, we’re able to get a lot of price, and our customers are accepting our price increases. But as we move into the back half, we’re continuing to fight inflationary headwinds, and that’s built into our guidance.

Operator, Operator

Your next question comes from the line of David MacGregor from Longbow Research. Your line is open.

David MacGregor, Analyst

Yes. Good morning, everyone. I wonder if you can talk about the negative price cost. Bruce, just responding to the last question, you were talking about premium brands and your ability to raise prices. What gives us some sense of timing in terms of when does price-cost flip positive for you? Is it early ‘23, or just how do we think of it? I know the fourth quarter gross margin in the guide continues to look like where we are now, so I’m assuming here that maybe it’s not in the next couple of quarters. But can you speak to that, please?

Bruce Hausmann, CFO

Yes. Good morning, David. We’re getting closer. If you think about pricing getting at parity with inflation, we’re getting a lot closer on that front. We continue to activate pricing in the marketplace, and we plan to continue activating more pricing in the back half as inflation persists. Unfortunately, the inflation that we were hoping would wane in the back half has not happened. We are continuing to chase it. But we’re getting good results. It’s a combination of price increases on our core products as well as freight surcharges. I think in the back half, we’re going to see a lot of what we saw in the first half regarding inflation and the differential of pricing versus inflation to parity. As we move into next year, the Fed is taking a lot of action to try to rein inflation in, and it’s one of our top three concerns that we’re keeping a close eye on, because we’re looking for that to crest and then start waning, which obviously will make a big difference.

David MacGregor, Analyst

And then secondly, just the EAAA orders up 1.7% on a currency-neutral basis. Can you speak to how incoming daily orders were tracking at the end of the quarter specifically with respect to the EAAA and how that might be looking in July? Any signs of improvement? What are you assuming for growth for this segment in your full year guidance?

Bruce Hausmann, CFO

Yes. Thanks, David. Again, it’s Bruce. The softness that we saw in EAAA in the order rate of 2% was really related to China. It was those extraordinary COVID-related lockdowns that we saw in Q2; for example, you might recall, Shanghai was locked down with over 25 million people. We believe that business did not go away; it was just deferred. But it certainly affected the order rate. We’re anticipating a strong back half for EAAA. Construction activity remains robust. The orders exceeded billings in the quarter. The only challenge we are dealing with is delays on the job sites, which can delay the installation of our products. That’s been ongoing, but commercial activity is strong in Europe and Asia. As we enter the back half, we have a strong backlog. We’re very optimistic about our EAAA region.

David MacGregor, Analyst

Good. I’ll pass it along. Thanks very much, Bruce.

Operator, Operator

Your next question comes from a line of Keith Hughes from Truist Securities. Your line is open.

Keith Hughes, Analyst

Question on gross margin. I heard you saying earlier, the implied guidance does have gross margin released in the second half pretty low. Are you assuming or factoring in more price increases? Are those coming in, and what would the impact be, particularly in the fourth quarter?

Bruce Hausmann, CFO

Hi Keith, this is Bruce. We are factoring in additional price increases. We’re also factoring in persistent inflation. We don’t see, by the way, you’re probably wondering what does this mean for the long haul? We don’t see any reason why we can’t get back to the pre-COVID levels, we’re just sort of working through this inflation at a 40-year high. We’re working through what happens when you buy raw materials at a very high price, and then it goes into the work process, becomes finished goods, and eventually flushes through to the P&L. So you’re seeing that cycle. What we have not seen is inflation go down. So we’re continuing to price to our customers and continuing to work through that inflationary environment from raw materials to finished goods to revenue.

Keith Hughes, Analyst

And so are you assuming you have more input in relation to what we’re saying today?

Bruce Hausmann, CFO

Yes, we’re assuming that. We assume there will be similar year-over-year rate increases to what we saw in the first half.

Keith Hughes, Analyst

And just building back on the order rates. You talked about China being a problem in the quarter for obvious reasons. In the second half of the year, what’s the outlook for Europe? Or is there weakening there given all the situation in Europe?

Bruce Hausmann, CFO

The way that we think about the numbers specifically for Europe is high single digits plus some in local currency. We should see mid-single digits. So on the P&L, it will be mid single digits plus probably about a 5% haircut due to the FX we’re experiencing. As you know, the Euro and the U.S. dollar are around parity, and when we translate those, you have Euro-based sales in U.S. dollars, which results in about a 5% haircut. We’re anticipating a good strong quarter in Europe, again because commercial activity is robust. What we’re dealing with is obviously the FX related headwinds.

Operator, Operator

And there are no further questions at this time. I’ll turn the call back over to Laurel Hurd for some final closing comments.

Laurel Hurd, CEO

Great. Thanks, everyone. I just want to close by thanking all of our Interface associates around the world for their continued efforts. Thank you to our customers for their ongoing support, as well as all of you, and I look forward to working with you going forward.

Operator, Operator

This concludes today’s conference call. Thank you for your participation. You may now disconnect.