INTERFACE INC - Quarter Report: 2016 October (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For Quarterly Period Ended October 2, 2016

Commission File Number 001-33994

INTERFACE, INC.

(Exact name of registrant as specified in its charter)

2859 PACES FERRY ROAD, SUITE 2000, ATLANTA, GEORGIA 30339

(Address of principal executive offices and zip code)

(770) 437-6800

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑    No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☑ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). 

Yes ☐     No ☑

Shares outstanding of each of the registrant’s classes of common stock at November 4, 2016:

INTERFACE, INC.

INDEX

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

INTERFACE, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(IN THOUSANDS)

See accompanying notes to consolidated condensed financial statements.

INTERFACE, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(UNAUDITED)

(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)

See accompanying notes to consolidated condensed financial statements.

INTERFACE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

(IN THOUSANDS)

See accompanying notes to consolidated condensed financial statements.

INTERFACE, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(IN THOUSANDS)

See accompanying notes to consolidated condensed financial statements.

INTERFACE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Our discussions below in this Item 2 are based upon the more detailed discussions about our business, operations and financial condition included in our Annual Report on Form 10-K for the fiscal year ended January 3, 2016, under Item 7 of that Form 10-K. Our discussions here focus on our results during the quarter and nine months ended, or as of, October 2, 2016, and the comparable periods of 2015 for comparison purposes, and, to the extent applicable, any material changes from the information discussed in that Form 10-K or other important intervening developments or information since that time. These discussions should be read in conjunction with that Form 10-K for more detailed and background information.

Forward-Looking Statements

This report contains statements which may constitute “forward-looking statements” within the meaning of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended by the Private Securities Litigation Reform Act of 1995. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements include risks and uncertainties associated with economic conditions in the commercial interiors industry, as well as the risks and uncertainties discussed under the heading “Risk Factors” included in Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended January 3, 2016, which discussion is hereby incorporated by reference. The Company undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time.

General

During the quarter ended October 2, 2016, we had net sales of $248.3 million, compared with net sales of $254.7 million in the third quarter last year. During the first nine months of fiscal year 2016, we had net sales of $719.1 million, compared with net sales of $755.2 million in the first nine months of last year. Fluctuations in currency exchange rates had negative impacts on our sales and operating income in the 2016 reported periods, compared with the prior year periods. The following table presents the amounts (in U.S. dollars) by which the exchange rates for converting foreign currencies into U.S. dollars have negatively affected our net sales and operating income for the three months and nine months ended October 2, 2016. The impacts of changes in foreign currency presented in the tables are calculated based on applying the prior year period's average foreign currency exchange rates to the current year period.

During the third quarter of 2016, we had net income of $15.9 million, or $0.25 per share. During the third quarter of 2015, we had net income of $20.1 million, or $0.31 per share. During the nine months ended October 2, 2016, we had net income of $49.4 million, or $0.76 per share. During the nine months ended October 4, 2015, we had net income of $54.2 million, or $0.82 per share.

The first nine months of 2016 were comprised of 39 weeks, while the first nine months of 2015 were comprised of 40 weeks. (The additional week was in the first quarter of 2015.) This is a factor in certain of the comparisons discussed in this Item 2.

Results of Operations

The following table presents, as a percentage of net sales, certain items included in our Consolidated Condensed Statements of Operations for the three-month and nine-month periods ended October 2, 2016, and October 4, 2015, respectively:

Net Sales

Below we provide information regarding net sales, and analyze those results, for the three-month and nine-month periods ended October 2, 2016, and October 4, 2015, respectively.

For the quarter ended October 2, 2016, net sales decreased $6.3 million (2.5%) versus the comparable period in 2015. As noted above, on a consolidated basis, currency fluctuations did not have a significant impact on the comparison, as weakness in the British Pound was offset by a recovery in the Australian Dollar and the Euro. On a geographic basis, we experienced sales declines in the Americas (down 3.4%) and Europe (5.7%), while sales in our Asia-Pacific region increased 7.4%. In the Americas, the decrease in sales was almost entirely attributable to a decline in the corporate office market (down 10%), and was a result of customer deferrals of projects in this segment. This decrease was offset partially by a 1% increase in non-office segments, with increases in the hospitality (up 19%) and healthcare (up 13%) market segments negated by a decrease in the government segment (down 16%). Our direct-to-consumer FLOR business experienced a 1% sales increase for the third quarter versus the comparable period in 2015. In Europe, the economic and political uncertainty surrounding the Brexit referendum was the primary driver of the sales decline, as the decrease was most severe in the United Kingdom and was partially offset by increases in Central and Southern Europe, with Germany leading the way in growth. On a segment basis, the European sales decline was most significant in the corporate office market with a 3% decline; however, with the exception of the hospitality market segment (up 33%), all other market segments were down for the quarter with education (down 20%) being the most significant. The sales increases in Asia-Pacific were primarily experienced in Australia (up 10%), China (up 21%) and India (up 5%), offset by a decline of 13% in Southeast Asia, Japan and Korea. On a segment basis, the increase in Asia-Pacific sales for the quarter was due to a 11% increase in the corporate office segment, offset by a decline of 4% in non-office segments.

For the nine months ended October 2, 2016, net sales decreased 36.1 million (4.8%) versus the comparable period in 2015. Fluctuations in currency had a small impact on the comparison; if currency rates had remained consistent from the first nine months of 2015, the decease would have been approximately $8.1 million less. On a geographic basis, we experienced sales declines in the Americas (down 5.2%) and Europe (down 8%), partially offset by an increase of 2.6% in our Asia-Pacific business. In the Americas, the sales decline was most significant in the first six months of the year, when sales were down 6% year over year. The decline on a year-to-date basis was due to lower sales in the corporate office market (down 6%). Other than the hospitality (up 15%) and healthcare (up 9%) market segments, all other market segments experienced a decline for the first nine months of 2016 as compared to the first nine months of 2015. In Europe, the decline was again due primarily to uncertainty leading up to and after the Brexit vote, as well as other geopolitical and other socio-economic issues. The decline in Europe was most significant in the corporate office market segment (down 8%) as well as the education market segment (down 30%). These declines were offset by smaller increases in the retail (up 12%) and hospitality (up 26%) market segments. The sales increase in Asia-Pacific was due to a strong corporate office market (up 9%) and government market segment (up over 80%). These increases were partially offset by decreases in other non-office markets in Asia-Pacific, with the retail (down 39%), education (down 16%) and hospitality (down 31%) market segments having the most significant negative impact.

Cost and Expenses

The following tables present, on a consolidated basis for our operations, our overall cost of sales and selling, general and administrative expenses for the three-month and nine-month periods ended October 2, 2016, and October 4, 2015, respectively:

For the three months ended October 2, 2016, our cost of sales decreased $1.3 million (0.8%) versus the comparable period in 2015. Fluctuations in currency exchange rates did not have a significant impact on the comparison between periods. Despite the decrease in absolute dollars, as a percentage of sales, our cost of sales increased in the third quarter of 2016 to 62.6%, versus 61.5% the third quarter of 2015. This percentage increase was attributable entirely to our Americas business unit, as both our European and Asia-Pacific regions experienced decreases in cost of sales as a percentage of sales for the third quarter of 2016 compared to the corresponding period in 2015. The reasons for the increase in cost of sales as a percentage of sales in the Americas were (1) a transition to a new centralized warehouse and distribution center in the region, which led to additional costs during the transition period, and (2) lower manufacturing volume and, as a result, less absorption of fixed costs. We expect these additional costs related to the warehouse centralization efforts to subside by the end of the fourth quarter of 2016. The decreases in cost of sales as a percentage of sales in Europe and Asia-Pacific are a direct result of better manufacturing efficiencies and lower raw material costs in these regions.

For the nine months ended October 2, 2016, our cost of sales decreased $30.1 million (6.4%) versus the corresponding period in 2015. Fluctuations in currency exchange rates did not have a significant impact on the comparison between periods. The first nine months of 2016 showed improvement as a percentage of sales due to lower raw materials costs, higher average selling prices and a mix shift towards higher margin accretive products, such as skinny planks. These decreases to cost of sales were partially offset, however, by the factors discussed above in the Americas for the third quarter of 2016 with regard to additional costs associated with our transition to centralized warehouse and distribution center and lower absorption of fixed costs on lower production volume. In total, as a percentage of sales, our cost of sales declined to 61.2% for the nine-month period ended October 2, 2016, versus 62.3% for the corresponding period in 2015. As discussed above, we expect the additional warehouse centralization costs in the Americas to subside by the end of the fourth quarter of 2016.

For the three months ended October 2, 2016, our selling, general and administrative expenses increased $0.5 million (0.7%) versus the comparable period in 2015. Fluctuations in currency exchange rates did not have a significant impact on the comparison between periods. The increase in selling, general and administrative expenses was due entirely to higher marketing expense for the third quarter of 2016 of approximately $1.0 million. These additional expenses were primarily related to the rollout of our modular resilient flooring (luxury vinyl tile) products, which are hard surface flooring products that complement our modular carpet products, as well as additional marketing expenses related to our core modular carpet offerings. These increases were offset by lower selling costs of approximately $0.5 million due to lower sales activity for the quarter. Due to the slight overall increase in expenses discussed above, as well as lower sales levels, as a percentage of sales our selling, general and administrative expenses increased to 27.0% for the three months ended October 2, 2016, compared to 26.2% for the three months ended October 4, 2015. Our selling, general and administrative expenses did have a small sequential decline as a percentage of sales from the second quarter of 2016, when they were 27.1% of sales.

For the nine months ended October 4, 2016, our selling, general and administrative expenses increased $1.4 million (0.7%) versus the comparable period in 2015. Fluctuations in currency exchange rates did not have a significant impact on the comparison between periods. The largest driver of this increase was higher marketing expenses of $5.4 million due to strategic marketing initiatives including our modular resilient flooring projects as well as global marketing and branding initiatives. Selling expenses also increased by approximately $0.9 million for the first nine months of 2016 as compared to the prior year period due to personnel additions in the Americas, primarily in the first six months of 2016. These increases were offset by approximately $5.0 million of lower administrative costs, primarily as a result of lower levels of share-based payments and incentives as performance targets are not expected to be met to the same level in 2016 as in 2015. Due to the above factors and the decline in sales, as a percentage of sales our selling, general and administrative expenses increased to 27.8% for the first nine months of 2016, versus 26.3% for same period in 2015.

Interest Expense

For the three-month period ended October 2, 2016, our interest expense increased $0.3 million to $1.7 million, from $1.3 million in the third quarter of 2015. This increase was due to a slightly higher weighted average borrowing rate for the 2016 period versus that of the 2015 period. For the nine-month period ended October 2, 2016, our interest expense decreased $0.2 million to $4.8 million, from $5.0 million in the comparable period last year. The decrease was due to lower average daily outstanding borrowings under our Syndicated Credit Facility, primarily during the first six months of 2016 as compared to the corresponding period of 2015.

Liquidity and Capital Resources

General

At October 2, 2016, we had $113.7 million in cash. At that date, we had outstanding $190.0 million of term loan borrowings, $27.6 million of revolving loan borrowings and $4.0 million in letters of credit under our Syndicated Credit Facility. As of October 2, 2016, we could have incurred $218.4 million of additional borrowings under our Syndicated Credit Facility. In addition, we could have incurred an additional $14.8 million of borrowings under our other lines of credit in place at other non-U.S. subsidiaries.

It is also important for you to consider that borrowings under our Syndicated Credit Facility comprise essentially all of our indebtedness, and that these borrowings are based on variable interest rates (as described above) that expose the Company to the risk that short-term interest rates may increase. For information regarding the current variable interest rates of these borrowings and the potential impact on our interest expense from hypothetical increases in short term interest rates, please see Note 4 in Part I, Item 1 of this report and the discussion under the heading “Interest Rate Risk” in Item 7A of our Annual Report on Form 10-K for the year ended January 3, 2016.

Analysis of Cash Flows

We exited the quarter ended October 2, 2016 with $113.7 million in cash, an increase of $38.0 million during the first nine months of the year. The increase in cash was due to cash flow from operating activities of $74.2 million in the first nine months of 2016. The factors driving the increase in cash from operating activities were (1) $49.5 million of net income for the year-to-date period, and (2) $1.5 million due to a decrease in accounts receivable. The increase in cash from operating activities was partially offset by a use of $6.1 million for a reduction in accounts payable and accruals. We also borrowed $20.3 million under our Syndicated Credit Facility during the nine months ended October 2, 2016, but repaid $17.5 million of borrowings during this time, for a net cash increase of $2.8 million from this borrowing activity. Our other primary uses of cash during the first nine months of 2016 were (1) $20.9 million of capital expenditures, (2) $10.4 million used to repurchase and retire 662,500 shares of our outstanding common stock, and (3) $10.4 million for the payment of dividends.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our discussion below in this Item 3 is based upon the more detailed discussions of our market risk and related matters included in our Annual Report on Form 10-K for the fiscal year ended January 3, 2016 under Item 7A of that Form 10-K. Our discussion here focuses on the period ended October 2, 2016, and any material changes from (or other important intervening developments since the time of) the information discussed in that Form 10-K. This discussion should be read in conjunction with that Form 10-K for more detailed and background information.

At October 2, 2016, we recognized a $3.8 million increase in our foreign currency translation adjustment account compared to January 3, 2016, primarily because of the weakening of the U.S. dollar against certain foreign currencies, particularly the Australian dollar.

Sensitivity Analysis. For purposes of specific risk analysis, we use sensitivity analysis to measure the impact that market risk may have on the fair values of our market sensitive instruments.

To perform sensitivity analysis, we assess the risk of loss in fair values associated with the impact of hypothetical changes in interest rates and foreign currency exchange rates on market sensitive instruments.

Because the debt outstanding under our Syndicated Credit Facility has variable interest rates based on an underlying prime lending rate or LIBOR rate, we do not believe changes in interest rates would have any significant impact on the fair value of that debt instrument. Changes in the underlying prime lending rate or LIBOR rate would, however, impact the amount of our interest expense. For a discussion of these hypothetical impacts on our interest expense, please see the discussion in Item 7A of our Annual Report on Form 10-K for the year ended January 3, 2016.

As of October 2, 2016, a 10% decrease or increase in the levels of foreign currency exchange rates against the U.S. dollar, with all other variables held constant, would result in a decrease in the fair value of our financial instruments of $13.1 million or an increase in the fair value of our financial instruments of $16.0 million, respectively. As the impact of offsetting changes in the fair market value of our net foreign investments is not included in the sensitivity model, these results are not indicative of our actual exposure to foreign currency exchange risk.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was performed under the supervision and with the participation of our management, including our Chairman and Chief Executive Officer and our Senior Vice President and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Act”), pursuant to Rule 13a-14(c) under the Act. Based on that evaluation, our Chairman and Chief Executive Officer and our Senior Vice President and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report.

There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are subject to various legal proceedings in the ordinary course of business, none of which is required to be disclosed under this Item 1.

ITEM 1A. RISK FACTORS

There are no material changes in risk factors in the third quarter of 2016. For a discussion of risk factors, see Part I, Item 1A, “Risk Factors,” in our Annual Report on Form 10-K for the fiscal year ended January 3, 2016.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

The following exhibits are filed with this report:

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

EXHIBITS INCLUDED HEREWTIH

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