Interface - Q2 2023

Transcript

Operator (participant)

Hello, and welcome to the Q2 2023 Interface, Inc. earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session, and if you would like to ask a question during this time, simply press star one on your telephone keypad. I will now turn the call over to Christine Needles. Please go ahead. Christine, please go ahead. My apologies for the technical difficulties. I will now turn the conference over to Christine Needles. Please go ahead.

Christine Needles (Senior Director of Global Communications and PR)

Good morning, and welcome to Interface's conference call regarding second quarter 2023 results, hosted by Laurel Hurd, 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 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. This call is being recorded and broadcasted for Interface. It contains copyrighted material and may not be re-recorded or rebroadcasted without Interface's express permission. Your participation on the call confirms your consent to the company's taping and broadcasting of it. After our prepared remarks, we will open up the call for questions. I will turn the call over to Laurel Hurd, CEO.

Laurel Hurd (CEO)

Thank you, Christine, and good morning, everyone. Once again, I want to thank the Interface team for delivering a solid quarter that was in line with our guidance and expectations and strong execution around the globe. Currency-Neutral net sales were down 5% year-over-year, as we anticipated, compared to a strong prior year comp that was up 23%. Overall, given ongoing macro challenges, we're pleased with Q2's net sales results and the steady customer demand that we saw throughout the quarter. We are executing well on our segment diversification strategy to help insulate and strengthen us even further from unpredictable market dynamics in the corporate office segment.

Education has grown to 18% of our global billings over the last 12 months. We anticipate this trend to continue as U.S. schools tap into remaining funds in the $122 billion American Rescue Plan legislation and tackle critical refurbishment and new construction projects across our primary geographies. Education is seasonally stronger in Q2. We'll provide a bit more detail on this segment. It was a bright spot for us this quarter. We saw increased activity in sales in the quarter across several of our larger markets, including the U.S., U.K., and Germany, as school administrations invested in refurbishment and maintenance projects during summer break, driving global sales in this segment up 7% year-over-year on top of 20% growth last year.

We're differentiated in education because of our reputation for high-quality flooring, overall product performance, and the breadth of our services, support, and product warranties. Especially in higher education, many customers have their own sustainability goals and seek out our low carbon footprint flooring to help achieve them. In both K-12 and higher ed, our products stand up to the wear and tear of high traffic areas and provide design aesthetic for positive learning environments for students and teachers. We effectively leverage our full product portfolio in this segment with broad use of both carpet tile and LVT, as well as nora rubber in key geographies such as Germany. Q2 is also when our biggest interior design event of the year occurs, NeoCon, where we had our second largest attendance of showroom visitors in our history, as attendance continues to rebuild to pre-COVID levels.

We've invested in enhanced digital capabilities to improve the customer experience and showcased new Interface Design Studio software that allows us to design the entire floorplate and share the carbon impact of different flooring decisions with our customers. This is a true differentiator as more and more customers need to specify lower carbon products in their projects. Of course, we are focused on driving growth with new products. At NeoCon, we launched impactful new designs, including Lost Palms and Woven Gradience carpet tile collections and Silk Complex LVT. We also previewed a new global collection launching later this year that features a modern take on designs of the past as we celebrate our fiftieth anniversary this year.

We are making meaningful progress in accelerating our new product development, a key component to our strategy, and believe these new products will help us drive market share gains in the back half. Turning to orders, we continue to see steady order demand and enter Q3 with a strong backlog. Consolidated Currency-Neutral orders in the second quarter were down 2% year-over-year on a strong prior year comp that was up 10%. Orders were down 3% in the Americas and flat in EAAA. In EMEA, orders were steady, while strong growth in Australia helped offset continued soft post-COVID recovery in Asia. We enter the back half of the year with a solid backlog that is up 13% since the beginning of the year.

We feel good about the steady demand we're seeing as customers continue to choose Interface for their flooring solutions, while remaining cautious about the dynamic market conditions around the world. Before I turn the call over to Bruce to discuss our financial results and outlook, I wanted to provide a brief update on our One Interface strategy, which is progressing as planned. As a reminder, this is a multi-year effort focused on resetting our operating model to leverage the power of our entire company to accelerate growth and improve profits. We are building strong global functions to support our world-class local selling teams, expanding margins through global supply chain management and improved productivity, and accelerating new products and designs to drive incremental growth.

Earlier this year, we announced changes to our executive leadership team roles and responsibilities, and I shared that we have created a new role, Chief Supply Chain Officer, to lead efforts on supply chain optimization and help us unlock expanded gross margins. I'm pleased to share that Bill Blackerby joined us this week, filling this important role on my leadership team. Bill brings more than 25 years of experience leading and managing highly successful teams across complex international supply chain, manufacturing, and distribution operations. Bill will leverage his extensive global experience to accelerate our productivity initiatives and increase agility across our global supply chain organization. With our executive leadership now in place, I'm confident in our team's ability to better leverage the strength of our entire organization to drive improved margins and profitable growth across the business. I'm excited for the future of Interface and the opportunities that lie ahead.

With that, I'll turn it over to Bruce to go through the financials. Bruce?

Bruce Hausmann (CFO)

Thank you, Laurel. Good morning, everyone. Second quarter net sales totaled $329.6 million, a decrease of 4.9% versus last year's strong second quarter, which was up 23%. FX neutral net sales declined 4.7% year-over-year. Net sales in the Americas were down 3% year-over-year on a very strong prior year comp that was up 32%. In EAAA, net sales were down 8% on a prior year comp that was up 12%. On an FX neutral basis, EMEA was down 5%, Asia was down 31%, and Australia was up 4% year-over-year. Given the challenging year-over-year comps, we were pleased with Q2's net sales results and the steady customer demand that we saw throughout the quarter.

Second quarter adjusted gross profit margin was 33.9%, which is stronger than our guide of 33%, but a decrease of 39 basis points from the prior year period due to lower fixed cost absorption, partially offset by higher pricing and favorable product mix. For the first time in many quarters, we saw deflation in our raw material purchases as the overall rates we paid for Q2's raw material purchases decreased 2% year-over-year. That compares to 9% year-over-year inflation that we incurred in Q1's raw material purchases. As we move into the second half of 2023, we expect further year-over-year raw material deflation.

Adjusted SG&A expenses were $83.9 million, or 25.5% of net sales in the second quarter, compared to $80.4 million, or 23.2% of net sales in the second quarter of last year. The increase is primarily due to inflation. Second quarter adjusted operating income was $27.9 million, down 28% versus adjusted operating income of $38.5 million in the second quarter last year. The decrease was mostly due to lower net sales volume. Second quarter adjusted EPS was $0.25 versus $0.36 in the second quarter last year. Adjusted EBITDA was $39.8 million this year versus $49 million in the second quarter last year.

We generated $18.3 million of cash from operations in the second quarter, and liquidity was strong at quarter-end, totaling $384 million, which consisted of $93 million of cash and $291 million of revolver capacity. We repaid $25.9 million of debt in the quarter, resulting in net debt, or total debt minus cash on hand, of $382.6 million at the end of the second quarter. The last 12 months of adjusted EBITDA totaled $150.3 million, and our net leverage ratio was 2.5x, calculated as net debt divided by adjusted EBITDA. Our required principal and interest payments on all outstanding debt average approximately $10 million per quarter.

With our strong balance sheet and our strong cash generation, we plan to continue paying down debt as a top capital allocation priority. Capital expenditures were $5.6 million in the second quarter of 2023, compared to $4.3 million in 2022. As we look at our outlook, we remain cautiously optimistic about the back half of the year. We have calibrated our net sales guidance to accommodate our first half actuals and the ongoing slow post-COVID recovery in Asia, while increasing our gross profit outlook based on the improving supply chain environment. With that, we're now anticipating the following: For the third quarter of 2023, net sales of $320 million-$330 million. Adjusted gross profit margin of approximately 35.5%.

adjusted SG&A expenses of approximately $84 million, adjusted interest in other expenses of approximately $10 million, an adjusted effective tax rate of approximately 31%, and fully diluted weighted average share count of approximately 58.2 million shares. For the full fiscal year of 2023, we are also anticipating net sales of $1.285 billion-$1.310 billion, adjusted gross profit margin of 34%-34.5%, adjusted SG&A expenses of approximately $336 million, adjusted interest in other expenses of approximately $37 million, an adjusted effective tax rate of approximately 29%, and capital expenditures of approximately $32 million. As we move into the second half of the year, we remain focused on our growth strategy and our capital allocation priorities.

We are encouraged by the steady demand we're seeing from customers and an improving supply chain environment, which builds momentum to enhance value for our shareholders. With that, I'll turn the call back to Laurel for concluding remarks.

Laurel Hurd (CEO)

Thank you, Bruce. As we look ahead, we expect a strong second half with continued market share gains and strong cash generation. I continue to be impressed with our team's expertise and capabilities to execute our strategy as we position Interface for growth and drive value for our shareholders. We look forward to sharing our ongoing progress on our next call. Thank you.

Operator (participant)

Thank you. If you have a question, please press star one on your telephone keypad. To withdraw your question, simply press star one again. Your first question comes from the line of Kathryn Thompson of Thompson Research Group. Your line is open.

Brian Biros (Senior Analyst)

Hey, good morning, everyone. This is actually Brian Biros on for Kathryn. Thank you for taking my questions. To start, on the gross profit outlook for the full year, I believe it was lowered last quarter, and then looks like it was raised this quarter. Can you just touch further on kind of the moving pieces there? Kind of remind us what initially brought it down, and then what's changed to raise it back up again. Thank you.

Bruce Hausmann (CFO)

Hey, Brian. Good morning. This is Bruce Hausmann. Well, I'm just delighted to tell you that we're finally seeing a more stable supply chain environment and an improving supply chain environment. You know, when we entered the year, there was still a lot of uncertainty around where inflation and where raw material supply was gonna go as we entered in, you know, entered into 2023. Then as we entered into Q2, it started to stabilize some more, but you might remember that raw materials were up 9% year-over-year last quarter, or I'm sorry, in Q1. Then in Q2, we just continued to see more stabilization, and for the first time in many, many quarters, now we're seeing deflation in our raw materials, where raw materials were down 2% year-over-year.

Basically, this is just sort of updating our guide and our visibility as things continue to improve as we move through the year.

Brian Biros (Senior Analyst)

Yeah. It sounds like it's mostly the, the raw materials movement is, is the main driver. Is that right?

Bruce Hausmann (CFO)

Raw materials is a big, is a big piece of it. We're also continuing to initiate and see effects of our of our productivity initiatives. Now, to be fair, that is offset by some... by less fixed cost absorption. There are some puts and takes in the number.

Brian Biros (Senior Analyst)

Got it. Then maybe just can you also touch on if you're seeing any pricing pressure or kind of just increased competition across the business in this kind of lower growth environment here? On the one hand, it's gonna be becoming increasingly competitive out there, but you also have premium products that might be seeing better trends than the lower-end products that probably see a lot more price pressure. Just interested to hear what you guys are seeing out there.

Laurel Hurd (CEO)

Yeah, Brian, I'll take that as Laurel. I would say this, that we're pretty pleased that our pricing's holding up in the market. When we look at the US market, as an example, our... We believe we gained share in the quarter, we feel good about that, as well as year to date. As you said, our premium products continue to sell well, we're launching more and more new products, not only at the premium end, but also at a more approachable price point, we continue to capture jobs across the spectrum. We're seeing price hold up pretty well. It's competitive out there, for sure. We're not losing jobs, we're, we're pleased with the progress that we're seeing right now.

Brian Biros (Senior Analyst)

Thanks. I'll pass it along.

Operator (participant)

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

David MacGregor (President and Senior Analyst)

Yes. Good morning, everyone. Well, nice quarter, actually. I mean, given where you guys thought you'd be this quarter, the results actually turned out relatively well, so congratulations there.

Laurel Hurd (CEO)

Thanks.

David MacGregor (President and Senior Analyst)

Can you update us on One Interface? Just where are you on this? Are there major inflection points in terms of the visible results of this program that we should anticipate in the second half, or does that maybe occur more in 2024?

You know, or where do you think you're making maybe a little more progress than you thought you would? Where, on the other hand, maybe are you lagging a little bit behind? As much, as much, you know, detail as you as you can on One Interface would be a big help. Thank you.

Laurel Hurd (CEO)

Yeah, that's great. Thanks for the question, David. Look, I think we're making really good progress. I'd say we're tracking as planned. I'm pleased, as we announced, that we now have our Chief Supply Chain Officer in place, who's gonna help us a lot to continue to enhance our gross margins. I feel really good about that. Bill's a great addition to the team. He joined us on Monday. He spent his first day down in LaGrange with the team there, and really digging in. I think that will start to see having meaningful impact as he really works with the team to drive our productivity initiatives. I'm excited about that. We also, I would say, we're focused on more new products faster with more meaningful impact in the market across the globe.

The things we're tracking are speed to market and the impact of our new products. I think you're gonna continue to see that. I'd say we're just getting started there, but I feel really good about the early progress in that front. Then from a marketing perspective, our global marketing leadership team has been finalized, and the team was actually in town this week, working through both capabilities, where we're really building. We talked about our digital capabilities, which we're strengthening and pushing that around the world, while at the same time being really efficient, so we have more impact with more efficiency from our marketing initiatives.

I think we'll see really sequential improvement as we continue to balance, investing for growth in our strongest, most profitable markets, number 1 being the U.S., and we're continuing to invest there on the selling side while we really drive for efficiencies on the back end.

David MacGregor (President and Senior Analyst)

With respect to the, the question of, you know, the visibility around, you know, results.

The cadence of that visibility, you know, how should we be thinking about this? I mean, I realize you provide guidance for the balance of the year here, but just thinking about this maybe on a slightly longer-term, profile, when, when do we really see the inflection?

Laurel Hurd (CEO)

I think you'll see, I would, I would call it sequential improvement, both in gross margin progress up and SG&A leverage down. We'll see improvement as we continue to move forward. I don't expect to see a big, a big bang inflection. Again, we're being really thoughtful as we monitor our investments and push some on the selling side up in the US, while at the same time, we, we really moderate the back end of the business. I think it'll be you'd think about it as sequential progress and improvement while we're driving growth. Continuing to drive growth on the top line while we improve the margins, both, both gross profit up and SG&A down.

David MacGregor (President and Senior Analyst)

Okay, great. Thanks for that, and, and, and good luck with things there. Just within the, the, the order backlog right now, the order book, can you just talk about what you're seeing near term in terms of just shifting patterns within the US orders? You know, are you seeing growth in the low carbon, I would expect, versus maybe some negative movement elsewhere in the product mix? Can you just talk about what you're seeing there?

Laurel Hurd (CEO)

Yeah. Maybe I'll, maybe I'll step back and talk a little bit about our, our, our billings year-to-date and in the quarter, 'cause there's some really good news in there that I can unpack a little bit, and then we can shift to orders. If I look at our corporate office, right, which is obviously a big piece of our business, and we look year-to-date at that market, we're actually up in the Americas, we're up in Australia, we're flat in Europe, and we're down in Asia. We commented on, on Asia being continue to being challenged, which, as you've heard on the economic softness in China continues. That's one thing I'd say. Corporate office is pretty encouraging. We're not naive to the macro environments.

We're staying close to it, and we're cautious about that in the back half. Year to date, we feel pretty good. It's holding up well. And then if we look at, excuse me, carpet tiles, you know, our carpet tiles in the quarter, our billings were down mid-single digits globally, low single digits in the Americas. Year to date, our billings in carpet tile in the Americas are roughly flat in dollars. Again, we're pleased in some of our largest end user segments in corporate office, as well as in corporate or in carpet tile, that those categories are holding up pretty well for us. When we look at orders going forward, orders in the Americas last year were up 17%, so we had a tough comp in orders.

We've got steady demand in the Americas, and it's about where we expected it to be. I look at Asia, that's one market we've continued to struggle with, but a little color on the orders. A year or first quarter, our orders we shared were down about 50% year-over-year, and this quarter, they're down about 8.5%. We're seeing the order rate still tough, but better certainly than the trend was previously. It's just taking longer for us to convert those orders to billings, as we're continuing to see project delays in the market. That's an area that we continue to see some delays, and we're being cautious in the back half there.

David MacGregor (President and Senior Analyst)

Yeah. Well, good progress. Last question for me, Bruce, you, you, you talked about raw materials up 9% in the first quarter, then down 2% in the second quarter. Is, is there any way you can help us with the modeling of the second half, how we should be thinking about the cadence into 3Q and 4Q?

Bruce Hausmann (CFO)

Yeah. Around raw materials specifically, David? Is that what you're asking about?

David MacGregor (President and Senior Analyst)

Yes. Yes.

Bruce Hausmann (CFO)

Yeah. You know, the way that we're thinking about it, obviously there's a lot of moving pieces. We think that raw materials will be down mid-single digits in Q3 year-over-year, and similar kind of zone in Q4. You know, we think that that will help us in the back half, and obviously, that helps us as we move into 2024.

David MacGregor (President and Senior Analyst)

Okay. Thanks, everyone.

Laurel Hurd (CEO)

Thanks, David.

Operator (participant)

Our next question comes from the line of Keith Hughes of Truist. Your line is open.

Keith Hughes (Managing Director and Senior Equity Analyst)

Thank you. How much were units down in the second quarter?

Bruce Hausmann (CFO)

Keith, units were down roughly 10% in the second quarter, year-over-year.

Keith Hughes (Managing Director and Senior Equity Analyst)

Okay.

Bruce Hausmann (CFO)

Of course, pricing was up roughly 5%, and that's what got us to what you see on the P&L, the negative 5% growth.

Keith Hughes (Managing Director and Senior Equity Analyst)

Right. Your guidance for the second half implies revenue growth, low single-digit revenue growth for the, for the half. What kind of units, what are you expecting units in that number?

Bruce Hausmann (CFO)

... Yeah, we're anticipating mid-single digits being down from a volume perspective in the back half, and then pricing will be up, and then that leaves us, you know, if you look at sort of the midpoint of our guide, it'll leave us, you know, roughly flattish in the back half.

Keith Hughes (Managing Director and Senior Equity Analyst)

Right. I guess my question is, we look by geography, how, what, what, who have been the leaders in that number, who have been the laggards in again, specific unit?

Bruce Hausmann (CFO)

Around price volume? Yeah, Americas-

Keith Hughes (Managing Director and Senior Equity Analyst)

Yeah.

Bruce Hausmann (CFO)

has been actually has been stronger around units. For example, if you look at Americas, our volume was down 7% only, versus in the rest of the world, it was down roughly 15%. Where we're seeing the volume decline has been more, has been more prominent outside the US, while Americas has been stronger.

Keith Hughes (Managing Director and Senior Equity Analyst)

Okay. I assume you're gonna start lapping some price increases from last year. Oh, let me ask it this way: When, when do you think you'll lap your last move in price in response to the raw material inflation?

Bruce Hausmann (CFO)

You know, it, it kind of... it feathers in, is the answer, because we did pricing throughout the year last year, and so we are getting the wraparound effect of that for sure in the first half of this year, and we'll get some of that in the back half. You know, Keith, we, as we look at all of our various markets, you know, where we need to continue taking price, we'll continue taking price, and there are, there, there will, there will be opportunities to do some of that in certain markets in the back half.

Keith Hughes (Managing Director and Senior Equity Analyst)

Okay. Okay, great. Thank you very much.

Bruce Hausmann (CFO)

Cool.

Laurel Hurd (CEO)

Thanks, Keith.

Operator (participant)

There are no further questions at this time. I will turn the call to Laurel Hurd.

Laurel Hurd (CEO)

Great, thank you, and thanks for the questions and your engagement this morning. Before we end the call, I wanted to thank the entire Interface team for their continued dedication and effort. I also wanted to congratulate the team for being recognized as one of TIME 100 most influential companies for our carbon-neutral and carbon-negative carpet tiles. It's another example of the strength of our sustainability leadership, driving differentiation in the market. That was exciting news, and with that, I just want to thank you all for listening, and have a great day.

Operator (participant)

This concludes today's conference call. Thank you for joining. You may now disconnect your lines.