Interface, Inc.
Q1 2013 Earnings Call Transcript

Published: 25 Apr 2013

[Operator:]

Good day, ladies and gentlemen. And welcome to the Q1 2013 Interface Inc, Earnings Conference Call. My name is Matthew, and I'll be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session. (Operator instructions) As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to David Foshee Vice President, Senior Counsel and Assistant Secretary. Please proceed, Sir.

[David Foshee:]

Thank you, Matthew. Good morning and welcome to Interface’s Conference Call regarding First Quarter 2013 Results. Joining us from the company are Dan Hendrix, Chairman and Chief Executive Officer; and Patrick Lynch, Senior Vice President and Chief Financial Officer. Dan will review highlights from the quarter as well as Interface's business outlook. Patrick 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 archive version of this conference call will also be available through that website. Before we begin the 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 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, 2010, 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 are contained in the company's results 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. Lastly, please note that this call is being recorded and broadcasted for Interface. It contains copyrighted material. It may not be rerecorded or rebroadcast without Interface's express 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. Dan. Please go ahead, sir.

[Dan Hendrix:]

Good morning and thank you for joining us. I'll get straight to the quarter. You probably know that the first quarter is seasonally our slowest quarter and while that was true for some of our markets we are pleased to report that Americas division jumped out with a record number of first quarter sales. We also saw a double-digit percentage sales increase in Southeast Asia and our FLOR sales were up 24%. So there is good news coming from a majority of our global business. The bad news is that those increases were offset by weak sales in Europe due to the continued economic uncertainty there combined with an usually bad weather in the UK at the end of the quarter. Typically, we see sales increases in the UK from January to February and then from February to March. But this year March sales did not materialize as expected. That said our European division still maintain a healthy operating margin for the quarter. We also continued to be impacted by last year’s fire at our Australian plant. I'll talk more about that in a few minutes. Gross margin finished ahead of the first quarter last year but was below our target mostly due to under absorption of fixed costs associated with lower volumes. SG&A expenses were in line with our expectations but missing the topline caused the level to rise as a percentage of sales. Now let me talk a little bit about each of our regions, beginning with Americas. I gave you the highlight, a record first quarter sales. The corporate office segment which is about half of our Americas business was up an impressive 21% over the first quarter of last year substantially outperforming the market. We also experienced growth in non-office segments with increases in hospitality, government and healthcare partially offset by declines in education and retail. Geographically most of the growth was seen in the US and operating income finished ahead of prior year. From a product perspective, we are in an excellent position with four of our top ten best-selling products having been introduced in the last two years with last year’s Urban Retreat product also about to break in the top ten. This is unprecedented; it tells us that our product offering is resonating very well with the marketplace. Our business in Europe was characterized by a slow start in January followed by most countries strengthening as the quarter progressed with the exception of the UK which accounts for about 35% of our sales in Europe. One bright spot in Europe was an improving sale trend throughout the quarter in Germany finishing with a strong March. Another was sales in the European hospitality segment which grew 14% over the prior year. And markets such as Eastern Europe, Scandinavia and Middle East, Russia and India showed significant improvement and continues to represent our best opportunities for growth in that region. The first quarter sales in South East Asia tell a good story with double-digit percentage sales growth. Well performing segments here included corporate office, hospitality, education and operating income is up substantially compared with the prior period. Sales in China declined slightly year-over-year mostly due to the timing of production for major new construction projects in the region. We expect China billings to see a bounce in the second quarter and this is further evidenced by the order trends in the first three weeks of April. Finally Australia we’re still facing the headwinds from the fire with sales down 13% versus the prior year period which was pre-fire. However, we are making progress and stabilizing our supply chain and reducing lead times in Australia while operating on an import only model in advance of commissioning our rebuilt plant later this year. And we expect Australia second half of the year to be better than the first half. Shifting focus to the FLOR consumer business sales were up 24%. Mostly due to the expanded FLOR store channel. During the quarter we opened a new store in Austin, Texas bringing our total to 19 stores and overall the stores in aggregate remain profitable. Growing FLOR is our biggest investment year-over-year and we are seeing the benefit of that spend. Looking ahead America is on track for a very strong year from both the sales and operating income perspective, the macro data in the US along with the positive book-to-bill ratio remain encouraging for the rest of the year. Orders in the Americas are up 17% in the first three weeks of the second quarter outpacing the order trend we saw on the first quarter. The business climate in Europe will not be resolved quickly or easily which means we need to do a good job minimizing the impact of the depressed western European markets while pursing the opportunities to grow in pockets like Eastern Europe, Scandinavia, Germany, the Middle East, Russia and India. And particularly in segments like hospitality we are holding a tight line on costs in the region and being very judicious about where we spend based on our highest potential for growth. So we really feel good about the majority of our business primarily in the Americas and Asia; the climate in the Americas reminds me of upturns in ‘94 and 2004. And we definitely experienced that we are especially well positioned for the bounce back. The question marks that remain are what will happen with the economy in Europe particularly the UK and how quickly can we normalize our business in Australia. With that I will turn it over to Patrick.

[Patrick Lynch:]

Thank you and good morning everyone. I will now take a few minutes to walk through the financial results for the first quarter. As a reminder, given the sale of Bentley Prince Street in 2012 results for Bentley Prince Street for the 2012 first quarter and all prior periods have been classified as discontinued operations. Sales for the first quarter of 2013 were essentially even with that of the first quarter 2012 and on a consolidated basis there was not a significant currency impact for the first quarter. Despite the lower than expected sales, we've managed to improve our gross profit margin versus the first quarter of 2012 by 30 basis points. As Dan mentioned we expect margin expansion to continue during 2013. We saw a record first quarter sales in our US modular business primarily driven by our corporate office, hospitality, government and healthcare markets partially offset by declines in retail and education market. As previously mentioned Europe continues to be a challenge experienced a 10% sales decline in local currency and down 9% as reported in US dollars. With the exception of hospitality this decline was across nearly all market segments. As Dan mentioned there is no there is no quick phase in this region but there are areas of promise in Europe particularly with regards in emerging markets and segmentation opportunities. Our Asia Pacific division saw sales decline 8% during the quarter mostly due to the effects of the Australian fire. There were however positive areas in South East Asia where we saw double digit percentage sales growth. And Australia was able to maintain a respectable profit margin despite its lower sales level. We expect to see solid top line growth in the Asia region particularly in China going forward. For the first quarter on a consolidated Asia’s gross margin increased to 33.9% compared with 33.6% in the first quarter. The year-over-year increase in gross margin, the result of higher fixed cost absorption or a higher production volume in the Americas that was partially offset by lower margins on our European operations due to lower production associated with lower sales volume in the region. Raw materials were effectively flat in the first quarter of 2013 versus the same period in 2012. In the first quarter 2013 SG&A increased to 57.3 million from 53.9 million last year. As a percentage of sales SG&A increased to 150 basis points to 27.2% compared with 25.7% a year ago. The increase in SG&A is due to a continued rollout of the FLOR stores accounting for 1.7 million in the increase as well as increase sales team additions in the Americas are counting for 1.3 million in increase. While SG&A in terms of absolute dollars was in line with our expectation we were not able to generate at a quick top line growth in the quarter to support the additional spending levels. Because the majority of the increase in SG&A relates to our fastest growing segments, we feel these investments find long term gains. Operating income in the first quarter of 2013 was 14 million or 6.7% of sales compared with operating income of 16.6 million or a 7.9% of sales in the first quarter of 2012 excluding restructuring and asset impairment charges of 16.3 million including all those charges operating income was the first quarter 2012, it was 300,000. Interest expense was 6.2 million in the quarter versus 6.5 million versus last year. Depreciation and amortization was 66.7 million of the first quarter 2013 compared with 7.5 million in the first quarter of last year. CapEx in the first quarter was 14.9 million compared with 10.4 million in the comparable period in 2012. For the full year we would expect our CapEx to be in the range of 40 million to 45 million. Quickly to the balance sheet, we exited the quarter with 65 million in cash compared with 63 million at the end of the first quarter last year and 90.5 million at the end of 2012. Inventories are a 157.5 million at the end of the first quarter compared with the 144.7 at the end of the first quarter of 2012 and 141.2 million as of the end of 2012. DSOs during the first quarter of 53.7 days compared with 54.7 days in the year ago period and inventory returns were flat at 3.7 times first quarter this year and first quarter last year. With that I will open the call up for questions. Operator.

[Operator:]

(Operator Instructions) And your first question comes from the line of Kathryn Thompson from Thompson Research Group, please proceed.

[Kathryn Thompson:]

You, in the past, had targeted improving gross margin by about a 100 basis points year-over-year in 2013? In light of results do you still think that’s achievable and if so what would be - what would give you confidence with that?

[Dan Hendrix:]

Yes I still think it’s very achievable. Where get the (comps) [ph] on that is we mean the top line is going to grow and we are going to get absorption of our fixed cost base. Yes, I believe that we will have the 100 basis points and we sit here and the fourth quarter.

[Kathryn Thompson:]

And pulling the strings a little bit further on that based on order trends that you are seeing right now so in March and into early April could you talk a little bit about the momentum and the type and even if the order rate is from different margin profile so for instance are backlog orders from projects that are more refurb versus new or would have a different margin profile.

[Dan Hendrix:]

I would say that where the order growth is coming from is from our Americas business, we are just seeing a pretty healthy activity with A&D and as orders are coming through. And the margin profile of our American businesses is very profitable. I don’t think we can say major projects versus refurbishment, I would say the mix is still about the same. If you go to Asia which we are seeing some pretty good growth, a lot of that probably is around some new construction. But the margin profile on our Asia business is also pretty good.

[Kathryn Thompson:]

Any thoughts in terms of by region, you talked about the Americas and Asia still being strong but any specific numbers about order trends from the first three or four weeks of this quarter.

[Dan Hendrix:]

We did say that the Americas business was up 17% in the first 3 months – excuse me, 3 weeks. And we did say Asia was very strong and they are up double digit as well. So that continued in those regions. I will say that in the European business we did get a little bit of benefit in shipping because of the weather in the UK and our European business actually is not nearly as negative as it was last in March.

[Operator:]

Your next question comes from the line of David MacGregor from Longbow Research. Please proceed.

[Josh Borstein:]

This is Josh Borstein in for David MacGregor. Thanks for taking my questions. Given the fact that you have been adding some feet on the street and developing your FLOR stores, can you help us out and discuss where you think SG&A is headed either as a percentage of sales or as an absolute number here in 2Q?

[Patrick Lynch:]

You will see some sequential increase in SG&A through the balance of the year as the variable piece of SG&A rises with our intended top-line growth through the balance of the year. You will see it trending to 60 probably here shortly and then low 60s for the kind of the balance of the year. Really as a percentage of sales largely dictated on where we think the top line is going but we continue to try to drive it, so 26, or 25 kind of range is where we ideally like to be. But that’s largely predicated on where the topline is headed. In terms of FLOR store and SG&A, a lot of that is already done. The increases in SG&A should be minimal on the FLOR store for the balance of the year. We are only planning on adding two additional stores from here. In 2013, we added Austin in Q1, and have targeted Miami and Minneapolis for the balance of 2013. So you shouldn’t see a significant stair step in SG&A related to the FLOR stores in 2013.

[Dan Hendrix:]

And I would say we are not comfortable with 25% SG&A line. We think it needs to be below that level and we are going to drive the top line to drive that down or we’ll have to address our SG&A if we don’t.

[Josh Borstein:]

I appreciate the color on that. You know you talked about FLOR a little bit. Can you tell us what the same store sales were for FLOR maybe in offering EBIT margin if possible?

[Patrick Lynch:]

Sales for the seven stores that we have had it that we’ve had for longer than a year were up about 17%. You have to kind of exclude Dallas on the year-to-year basis, we are in the process of moving from one location to another. But for the seven that we've had for a full year, they were up 17% and were profitable 11% as a group in the quarter.

[Dan Hendrix:]

Ones that have been there a year, right.

[Josh Borstein:]

And then just last one for me on raw materials, you had mentioned they were flat year-over-year in the quarter. What do you see for raws looking out over the next quarter or two?

[Patrick Lynch:]

I wouldn’t say meaningful moves either way at least in the near term.

[Josh Borstein:]

And no price increases from your vendors? I know last quarter you had said, you normally have a 30-day window on that but nothing has come across as of yet.

[Patrick Lynch:]

Yes, that's correct and I’m not sure you heard us there.

[Operator:]

Your next question comes from the line of John Baugh from Stifel Nicolaus. Please proceed.

[John Baugh:]

Could you comment on Australia, where you are with business interruption insurance and how that is going to influence, maybe the margin for the balance of the year?

[Dan Hendrix:]

Yeah, I don’t know that the insurance proceeds or how that's going to play out really will impact the income statement from continuing operations. I think any insurance recoveries that we get from this point on really will most likely flow through the loss on the Australian Fire line or gain flow through there so the continuing operations will be as it’s occurred. We have excluded and captured on the balance sheet any of the incremental or kind of one off cost, out of pocket costs that we have incurred and that's been captured on the balance sheet, so that the income statement could reflect kind of current operations as is and how they are truly operating today. We have made claims for lost profits to date and most likely when those claims are settled, we will flow to the income statement but broken out separately on a separate line item.

[John Baugh:]

In Europe I know you went through a restructuring last year with business being difficult and it's still challenging. Your other thoughts Dan around doing anything additionally at this point or do you think you can grow these pockets or regions that you talked about and work your way out that way?

[Dan Hendrix:]

I think in areas that are depressed John, that we continue to reduce costs in those areas. And where areas that we think we can grow, we are going to make some investments, but not big investments. I mean our absolute G&A costs, SG&A costs in Europe were down year-over-year if you go to the first quarter last year to this quarter. So we’ll continue to work at that. We haven’t planned any structural changes yet in the sales force or any of that. We think we are going to try and work our way through it right now.

[John Baugh:]

On FLOR, I assume your gross margin percentages are much higher and your SG&A percentages are much higher than your core business. First of all, is that assumption correct and then sort of, now it’s getting to be a little more meaningful, how does that impact, or you know, how much of the 100 basis point expectation for gross margin would just be the influence of FLOR flowing through?

[Dan Hendrix:]

I would say that it won’t, it’s made positive impact to it as we grow the top line. But the biggest influence on that is going to be the volume increases I think we are going to get out of our Americas business. If you look at what the trend is in the double-digit growth, there is a lot of flood through that happens in Americas. And so the gross margin expansion will occur throughout the year mostly in the Americas business which FLOR contributes to. It's more going to be a function of growing the top line and being very efficient in the plans and what not, follow through to operating income.

[John Baugh:]

I think you mentioned book-to-bill, I didn’t see an orders figure. Was that comment across the company or just the Americas and what was the figure? Thank you.

[Dan Hendrix:]

Sum about the company, I think was $8million or $9 million difference.

[Patrick Lynch:]

Yeah we had gross orders 222.5 million versus sales of 210 million.

[Operator:]

Your next question comes from the line of Michael Wood of Macquarie. Please go ahead.

[Michael Wood:]

Can you provide a little bit more color around the UK weather issues? Do you feel like the orders got pushed out, you had mentioned in your remarks there were some shifting resumption that occurred? That do you have form whether or not that continued in April?

[Dan Hendrix:]

If you look at the U.K., we were short in the U.K., $5 million or $6 million dollars from, and if you looked at year-over-year what we expecting we are probably short more like $8 million. And March just didn’t materialize. I'm not going to blame obviously the whole thing on weather but it did prohibit some shipments and we got the benefit of some of those shipments in the first three weeks.

[Patrick Lynch:]

UK business is actually up the first three weeks in the UK in April.

[Michael Wood:]

In Australia, can you just talk about what potential impact the fire issue might have in your market share longer term? I think you previously disclosed that’s a slide, it’s probably around 45% your market share in Australia. How quickly could you recover back to that level and where might you stand right now?

[Dan Hendrix:]

That's sort of hard to say where you stand right now. We have, obviously have lost some market share related to some smaller business that require inventory in short lead times. I do believe when the plant starts up, we’re going to have the most competitive model on Australia and that we can get back to those 45% levels. To get a hand along, what's happened in the last six months is that it's kind of hard to do that because those numbers sort of come out every year. Bur we clearly are losing some of the small orders shortly timed business that other people are servicing. I will say now that we have a pretty large inventory position in Australia and the import model as far as on time delivery is now servicing our customers. Our challenge is to go back and get those customers and start servicing them out of the inventory, which I believe we can do.

[Operator:]

Your next question comes from (inaudible).

[Unidentified Analyst:]

I have a bigger picture question about operating margins. And as a shareholder I'm a little bit frustrated with the margins with this company. And for a dominant producer like you guys in all these great innovative products, is there a way to kind of get to a mid-teens operating margins with like a two to three year time horizon?

[Dan Hendrix:]

Yes. I think if you got a recovery particularly in the U.S., which we’re talking a lot about that but the operating margins in our U.S. business, which is about half typically are in, if you go back to ‘06 to ‘07 , even in ‘08 are in that change area that you are talking about ‘13, ‘14. The biggest margin pressure area that we are fighting is in Europe as far as what's going to happen there. We are typically around the good times we're in the same area that you are talking about but now as we've said had sales to press where we are, we are sitting around 7% in that market today, and that's about 28% of our business. So our challenge to get back to that is what happens in Europe. The profile of our company, if we get back to being one, then we’ll be back to those levels that you are talking about.

[Unidentified Analyst:]

In terms of the lead manufacturing initiatives and things of that sort that would be implemented in the US, is that an ongoing process is that nearing completion, sort of what’s the time horizon on that?

[Dan Hendrix:]

I would say that the lean manufacturing is a journey. And I think we are well underway in part of my optimism we are going to get to 100 basis points that Kathryn asked about. That is the fact that lean is taking hold in the operations taking hold in the operations in the grains and we expect to see some benefits there particularly in the second half of the year.

[Operator:]

Your next question comes from Sean Wondrack from Deutsche Bank. Please proceed.

[Sean Wondrack:]

My first question has to do with your comments on Asia-Pacific and China. Can you dig in a little bit to the Chinese situation you said that sales were down slightly but EBIT was up substantially despite the lower sales. What's driving that?

[Dan Hendrix:]

I would say that couple of things are driving it. One is that we are getting the benefit of some production that we are servicing in Australia. So we are getting the benefit of some flow through in that business also been raising our prices in China, in that marketplace going to higher margins, average commodities part of that business. To me, in China, there is a lot of new construction that’s on the horizon in the next three years that we have visibility into. And right now our China business is really tight in new construction. Our challenge is going to be how we get into service market, because in China, there is really not market because (inaudible) less than 10 years old. But we did believe there will be a refurbishing market as well. And in China, our domestic business, you see it very dependent on multinationals and domestic. How can (inaudible) about China being a big capital market in the next ten years and where they are to play in that market.

[Sean Wondrack:]

If you look at your individual regions, could you tell us what capacity utilization is in like the Americas versus Europe versus Asia-Pacific; where are you at capacity wise?

[Dan Hendrix:]

If you look at the US business, we have got new capacity coming on stream.

[Patrick Lynch:]

85% capacity, yes. But we are going to 75% level but were the biggest investments of the 75% probably running in at about 60% capacity in Europe. China, we are running around 60%, 70% capacity in China, and in Thailand we are running at a 100% capacity. They still run 24x7. I will be alleviated when we open our plant in Australia in the fourth quarter. So you‘ll get back to a lot more normalized capacity in the Asia-Pacific region.

[Sean Wondrack:]

I would imagine for every five points you are saying the Americas, that's going to drive a lot of profitability in the EBIT line as you continue to push capacity higher. I think I’m cutting out, thank you.

[Operator:]

Next question comes from Judy Merrick with SunTrust. Please proceed.

[Judy Merrick:]

I’d like to clarify, in Europe, I think you said the category that showed across as a hospitality, and is that across Europe or just mostly in the eastern Europe and is that where you think striving for improvement?

[Patrick Lynch:]

Across Europe, we are making investments around the global hospitality, the brand is called Interface Hospitality and have had a lot of success in the Americas business and we are taking that globally. And so we are in the early stages of the global hospitality push that we are seeing benefits of that.

[Judy Merrick:]

Were there any other categories in Eastern Europe are using the stabilization (inaudible) or mostly just in that category?

[Dan Hendrix:]

I would say that if you go to the non-western markets, we are okay. It just happens when you represent 25% of Europe.

[David Foshee:]

Thank you for your questions ladies and gentlemen. I would now like to hand over the call to Dan Hendrix for the closing remarks.

[Dan Hendrix:]

Thank you for listening in on the call. If you didn’t get it I’m fairly bullish about the second half of the year, and thank you for listening. Operator Thank you ladies and gentlemen. This concludes your presentation. You may now disconnect. Have a good day.