Interface, Inc.
Q4 2016 Earnings Call Transcript

Published: 23 Feb 2017

[Operator:]

Good morning, ladies and gentlemen, and welcome to the Interface, Inc. Q4 2016 Earnings Conference Call. As a reminder to our audience, this conference may be recorded. It is now my pleasure to hand the conference over to Mr. David Foshee, Vice President. Sir, the floor is yours.

[David B. Foshee:]

Thank you, operator. Good morning, and welcome to Interface's conference call regarding fourth quarter and full year 2016 results. Joining us from the company are Dan Hendrix, Chairman and Chief Executive Officer; Jay Gould, President and Chief Operating Officer; and Greg Bauer, Vice President and Corporate Controller. Dan will make the opening remarks, and Jay will review highlights from the quarter as well as Interface's business outlook. Greg will then review the company's key performance metrics and financial results. We will then open the call for Q&A. A copy of the earnings release can be downloaded off the Investor Relations section of Interface's website. An archived version of this conference call will also be available through that website. Before we begin formal remarks, please note that, during today's conference call, management's comments regarding Interface's business which are not historical information are forward-looking statements. Forward-looking statements involve a number of risks and uncertainties that could cause the actual results to differ materially from any such statements, including risks and uncertainties associated with the economic conditions in the commercial interiors industry, as well as the risks and uncertainties discussed under the heading Risk Factors in Item 1A of the company's Annual Report on Form 10-K for the fiscal year ended January 3, 2016, which has been filed with the Securities and Exchange Commission. We direct all listeners to that document. Any such forward-looking statements are made pursuant to the Private Securities Litigation Reform Act of 1995. The company assumes no responsibility to update or revise forward-looking statements made during this call and cautions listeners not to place undue reliance on any such forward-looking statements. Management's remarks during this call may refer to certain non-GAAP measures. A reconciliation of these non-GAAP measures to the most comparable GAAP measures is contained in the company's earnings release and Form 8-K filed with the SEC yesterday. These documents can be found on the Investor Relations portion of the company's website, www.interfaceglobal.com. Please note that, during this call, it's being recorded and broadcasted for Interface. It contains copyrighted material and may not be rerecorded or rebroadcasted without Interface's expressed permission. Your participation on the call confirms your consent to the company's taping and broadcasting of it. Now, I'd like to turn the call over to Dan Hendrix.

[Daniel T. Hendrix:]

Thank you, David. Good morning, everyone. As you saw in our announcement yesterday, this will be my last investor conference call as your company's CEO. After 16 years in this role and a total of 34 years working at the company, I've decided it's time – it's the right time for me to step back from day-to-day operations of the company. Our board has agreed with me that Jay has done a fantastic job since he joined our company two years ago. He has embraced our culture, our mission. He has enhanced our performance and strategy, and he's brought a fresh and interject (03

[Jay D. Gould:]

Thank you, Dan. I'd like to start by personally thanking you, Dan, for your mentorship and your partnership over the last two years. I really appreciate the confidence that you've entrusted in me and the confidence you have in my leading the company, and I'm really pleased that you're staying on as Chairman and as advisor to me. With that, let me turn our attention to the quarterly results. I am really pleased with the fourth quarter results, especially given the sluggish environment that we've faced for most of the period. And I say most of the period because we saw a noticeable increase in order activity, following the U.S. Presidential Election in November and that trend has continued into 2017. Our gross margin remained under pressure during the quarter due to our move to the new centralized distribution center in the Americas, which we discussed in our call last quarter. This transition continued for most of the fourth quarter, but we did wrap it up by yearend and we expect gross margins to begin to recover as we look forward. I was also really pleased with our cost-containment efforts as we held SG&A expenses to $64 million in the quarter. This was our lowest quarterly level for the year, and it puts us on pace to stay within our 2017 targeted run rate of $260 million to $265 million. Excluding the restructuring and asset impairment charge, we delivered fourth quarter EPS of $0.28, pulling even with the fourth quarter of the previous year and closing out the full year of 2016 at $1.03, which is our second best earnings in the history of the company. The momentum we picked up in the fourth quarter does give us optimism about our prospects for value creation in 2017. As you'll recall, in our last quarterly call, I described the four activities we're focused on to yield earnings growth over the next few years and they are; firstly is to grow our core carpet tile business with improved branding, expanded sales reach and more productive innovation. The order progression that we saw throughout the fourth quarter, coupled with improvements in the U.S. macroeconomic indicators and signs of stability in Europe, point to top line growth in our core carpet tile business for 2017. We think the core growth will be in the range of 3% to 4%. Our second initiative is to optimize our flagship manufacturing and distribution assets in Troup County, Georgia. As I mentioned earlier, we completed the transition to a new distribution center, and we have substantial capital upgrades to our manufacturing plant planned for 2017. Ultimately, our Troup County optimization project, when it's completed, will yield annualized savings of $30 million, with those full benefits flowing in 2019. Thirdly, we have now entered the modular resilient flooring market with a unique product that allows customers to integrate hard and soft flooring in a truly modular installation. As we described in a recent press release, we rolled out (07

[Gregory Bauer:]

Thank you, and good morning, everyone. I'll take a few minutes now to walk through the financial highlights for the fourth quarter. Sales for the fourth quarter of 2016 were down 2.9% to $239.5 million versus $246.6 million in the fourth quarter of 2015. On a consolidated basis, currency was not a significant factor in this decline as, on a constant currency basis, our sales declined approximately 2%. Changes in currency rates had a negligible impact on operating income for the quarter. As we saw in the third quarter, our gross margin was down compared to the corresponding period in 2015. For the fourth quarter of 2016, our gross margin was down 220 basis points to 37.6% of sales versus a very strong 39.8% of sales in the fourth quarter of 2015. As Jay has already mentioned, the largest factor in this decline was the impact of a third-party warehouse move in our Americas group and the associated transition issues. Costs associated with the startup and service level recovery efforts totaled approximately $2.5 million for the fourth quarter. We believe those issues are behind us now, as customer service levels are returning to expected levels and we iron out the transition concerns. It is worth noting that Europe, despite the Brexit headwind, managed to improve its gross margin over 200 basis points for the quarter. On a consolidated basis, we did see an improvement in gross margin on a sequential basis versus the third quarter of 2016 as well. Our sales in the Americas were down slightly with corporate office flat for the period versus the fourth quarter of 2015. In non-office segments, declines of 9% in retail and 7% in healthcare were partially offset by a 14% increase in education sales. The floor business was down approximately 6% for the quarter versus a very strong quarter in 2015. As previously announced, we are significantly restructuring this business to exit the majority of our retail stores while maintaining an online presence as well as for redesigned (10

[Operator:]

Thank you, sir. Our first question will come from the line of John Baugh with Stifel.

[John Baugh:]

Good morning, and, Dan, congrats on a great career, and, Jay, good luck on your new role.

[Daniel T. Hendrix:]

Thank you, John.

[Jay D. Gould:]

Thanks, John.

[John Baugh:]

I wanted to, I guess, first ask a question on the Troup County move. I think you have mentioned service levels got better. Assuming service levels then were impacted, is there any way to think about how that maybe interrupted revenues in either the fourth quarter or how it could impact the first quarter?

[Jay D. Gould:]

Well, John, honestly, it's hard to say. I don't think we lost any business. We just didn't get it out the door when we should have, so we disappointed some customers along the way. I think we'll repair those customer relationships here in the first quarter. I mean, I'm thrilled with the new operation. I want to be clear about that. It's really a significant step forward for us.

[John Baugh:]

Okay. And in terms of how you measure in-stock or delivery times or whatever the metrics may be, as we sit here today, those are back to normal levels or maybe even improved, or where are we?

[Jay D. Gould:]

Actually, improved. I mean, we look at on-time and full delivery, and we're running above 95% now, which is a world-class metric.

[John Baugh:]

Okay. Super. The raw materials, update us what you're seeing there. I mean, there's been a lot of discussion about the some of the increases in some of the chemicals are perhaps temporary and not sustained, but just curious what your suppliers are telling you and what you're expecting.

[Jay D. Gould:]

We're definitely seeing headwinds in input costs. I mean, we're estimating for the full year to be between $10 million and $13 million of raw material inflation. Fortunately, we're in a good position to help offset that with our productivity initiatives. So, in our core business, we're still seeing a 50 basis point improvement in gross margins, offset, of course, by the exit out of the floor business. So, net-net, I see our margins between 38% and 38.5% for the year.

[John Baugh:]

Okay. And I wanted to follow up on the definition of core business. So, I think you mentioned something about the revenues or orders this year. Just define for us, is that simply taking out floor, or is that U.S.-only? (17

[Jay D. Gould:]

Yes. That's a good question, John. When I talk about core, I'm really talking about our global carpet tile business. So, taking floor out of that. So, the revenue walk – outlook for the year is kind of walk like this. I mean, we're going to have a negative, roughly, 140 basis points because of the floor store exits. We think the core carpet tile business is going to grow in the 300 basis point range and that LVT is going to add between 200 basis points and 250 basis points. So, you walk that down, and we're looking at roughly 350 basis points of growth for the year.

[John Baugh:]

Okay. And my last question is around the UK. Could you perhaps walk us through the progression of that business in the fourth quarter and what you're seeing in the first quarter? I think you said orders in Europe are up year-to-date for seven weeks, and I assume that includes the UK. But love a little color on the UK and Europe, in general.

[Jay D. Gould:]

Yes, well what I would say – let me start with 2017 and then we're going to walk back to the fourth quarter. On a currency neutral basis, orders in Europe were up about 4% year-to-date, so through the first seven weeks. On a pure euro basis, we're actually down 2%, and that's the impact of the British pound. So, in local currency, our business is up. But as it's translated to either the euro or the dollar, it's actually down.

[John Baugh:]

Okay. In the fourth quarter, were there any trends there in the UK stabilizing, and what have you seen year-to-date in the UK?

[Jay D. Gould:]

Yes. So, again, in British pounds, we've seen a growth in the UK year-to-date. So, in the first seven weeks, we're up about 5% in British pounds. So, that's actually really encouraging news, and that trend did start in December. So, post U.S. elections – and I know we're talking about the UK. But post U.S. elections, we really saw a rebound in our business globally.

[John Baugh:]

Great. Thanks for that color, and good luck.

[Jay D. Gould:]

Thanks, John.

[Operator:]

Thank you. Our next question will come from the line of Matt McCall with Seaport Global Securities. Please proceed.

[Matt McCall:]

Thanks. Good morning, guys.

[Daniel T. Hendrix:]

Good morning, Matt.

[Matt McCall:]

Congrats, Jay, on the new role, and, Dan, good luck on the next phase, in your next venture. I've enjoyed the last decade. So, maybe a follow-up on that last question from John. You said, Jay, that the – you saw in inflection in order patterns. Can you put any numbers behind that, how the quarter progressed and what you're seeing, kind of, year-to-date overall by geography, whatever you want to share?

[Jay D. Gould:]

Yes. So, October was down double-digits, November was basically flat and December was up about 8%. So, that all combined for a slight decline. But the optimism, as we head into the year – and so, the first seven weeks, we're seeing about plus 5% globally. That's currency neutral. It's about 4%, if you let currency flow through there.

[Matt McCall:]

Okay. And what about North America, specifically?

[Jay D. Gould:]

Yes, it follows that trend.

[Matt McCall:]

Very similar? Okay. So, you quantified the distribution moves. I think you said $200 – or $2.5 million – maybe that was you, Greg. So, all of that is going to be gone in Q1, or are there some residual effects that will impact the margin as we start the year?

[Jay D. Gould:]

So, if you look back over the third and fourth quarter, we spent about an incremental $5.5 million. I think we'll recapture at least $4 million of that in this year and maybe more. So, we're operating at a slightly higher target than what we had set out. But I think, over the next three to four months, we'll figure out how to run it at target levels. What was critical, Matt, is that we get the service levels where we needed them. So, we've put a little bit of labor at it. (22

[Matt McCall:]

Okay. And then, let's see, one more. So, you talked about the LVT launch, and that – so, the U.S. launch occurred you said earlier this month, so February. So, all of this is going to hit 2017. Can you quantify the impact on SG&A? SG&A looks good at (22

[Jay D. Gould:]

Well, we reallocated about $10 million of SG&A cuts into growth initiatives, including the LVT. So, I mean, roughly $5 million to $6 million is what we're putting into the LVT launch.

[Matt McCall:]

Okay. And any thoughts on where that other $5 million went?

[Jay D. Gould:]

Well, it went to refuel incentives, which we didn't pay out at full payment last year.

[Matt McCall:]

Got it. Okay. Thank you, guys.

[Operator:]

Thank you. Our next question will come from the line of Kathryn Thompson with Thompson Research GP. Please proceed.

[Kathryn Ingram Thompson:]

Hi. Thanks for taking my questions today. Dan, best of luck. I know you'll be enjoying some of your Florida State Football. And, Jay, best of luck in your new role. I wanted to follow up on LVT. I wanted to get additional thoughts on the mechanics behind the LVT rollout, what's the initial reaction been to the market and additional color just in terms of balancing the dynamic of rising raw materials and margin profile for that product relative to carpet tile, given the raw material dynamics. Thank you very much.

[Jay D. Gould:]

Well, the market reaction to LVT has been tremendous. I mean, the energy level from our selling organizations around the world have just been incredible, Kathryn, honestly. And the thing that most excites the customers is, first of all, the full integration between the hard and soft with no transition scripts (24

[Kathryn Ingram Thompson:]

Okay. That's helpful. As far as I know, you have a couple of moving parts with some of the operational changes that you really have been working over the past several years with the entire Interface team. But also, in particular, over the past two quarters, it sounds like you're mostly there in terms of completion. But as you walk through the year and, more importantly, as you look over the next two to three to four years, where do you see Interface's business strategically? Where would you like it to be by the end of 2017 in terms of mix and margin, looking at those gross margins and SG&A? And then, over the next – a little bit more longer term, two to three years, where would you like that to be?

[Jay D. Gould:]

Well, let me start with the latter, and I'll go to the former. I mean, you know that our margin goals as a company is to get to 40% gross margins and 14% to 15% operating margins, and I think we're well on track to get there. We're not going to get there this year, but I certainly expect getting there over the next two years. This year, our margins – I'm expecting gross margins in the 38% to 38.5% range and SG&A at about 26%. So, we are looking for a step-up in our operating margin to roughly 12% to 12.5%.

[Kathryn Ingram Thompson:]

Perfect. Thanks very much for taking my questions today, and good luck to both you and Dan.

[Jay D. Gould:]

You didn't mention my Harvard football team, by the way.

[Kathryn Ingram Thompson:]

Sorry about that. The last time I checked, Dan's team did a little bit better. So...

[Daniel T. Hendrix:]

You're right.

[Kathryn Ingram Thompson:]

Best of luck.

[Jay D. Gould:]

Thanks, Kathryn.

[Operator:]

Thank you. Our next question will come from the line of Dan (sic) [Dave] (28

[David S. MacGregor:]

Yes. Good morning, everyone. To what extent is the order growth tied to the LVT launch? Or is the order growth you referenced excluding LVT?

[Jay D. Gould:]

Yes, it doesn't include LVT yet. So, that's all core carpet tile growth.

[David S. MacGregor:]

Okay. Thanks for that clarification. Just a couple of other things quickly. You talked about the LVT launch, and thanks for going through the detail on that. How should we think about the upfront costs of the launch and to what extent could that change some of the numbers that you referenced as being, kind of, your base line expectations?

[Jay D. Gould:]

Well, the biggest single cost in the launch is frankly sampling, which will grow with sales. So, it's not a front-loaded event, Dan (sic) [Dave] (28

[David S. MacGregor:]

Okay. Thirdly, the Troup County manufacturing optimization project, I think it was expected to generate about $7 million of the total of $30 million in savings for 2017. Is this still a good number we can use?

[Jay D. Gould:]

Yes.

[David S. MacGregor:]

Okay. Terrific. Thanks very much. And, Dan, thanks for everything over the years. Appreciate all the help. Good luck, Jay.

[Jay D. Gould:]

Okay. Thank you.

[Operator:]

Thank you. There are no further questions in queue. So, now, I'd like to hand the call back over to Jay Gould, President, for closing comments or remarks. Sir?

[Jay D. Gould:]

Well, thank you for your continued support. I know this is an emotional time, seeing Dan kind of step into a new role. I just want to reinforce he's not leaving us. He's staying on as Chairman and a real advisor to me. And, Dan, you've built an amazing company. I'm so happy to help you create value with it as we look forward. And I think 2017 is going to be a great year.

[Daniel T. Hendrix:]

And so do I.

[Jay D. Gould:]

So, thanks, everyone. Appreciate it.

[Operator:]

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program, and you may all disconnect. Everybody, have a wonderful day.