INTERFACE INC 10-Q

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 2, 2022, under Part II, Item 7 of that Form 10-K. Our discussions here focus on our results during the quarter and nine months ended October 2, 2022, or as of, October 2, 2022, and the comparable periods of 2021, 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. The nine-month periods ended October 2, 2022 and October 3, 2021 both include 39 weeks. The three-month periods ended October 2, 2022 and October 3, 2021 both include 13 weeks. 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 Part I, Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended January 2, 2022, as supplemented in Part II, Item 1A of the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended July 3, 2022. 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. 31 Table of Contents Executive Overview During the quarter ended October 2, 2022, we had consolidated net sales of $327.8 million, up 4.8% compared to $312.7 million in the third quarter last year, primarily due to the continued rebound in economic activity in certain countries following the impacts of COVID-19, partially offset by the negative impact of currency fluctuations. Higher sales were primarily in the corporate office, retail, public buildings and hospitality market segments. Consolidated operating income was $28.0 million for the third quarter of 2022 compared to $24.8 million in the third quarter last year, primarily due to higher sales but partially offset by the continuing impact of cost inflation in the current year period. Consolidated net income for the quarter ended October 2, 2022 was $14.1 million or $0.24 per share, compared to $11.0 million or $0.19 per share in the third quarter last year. During the first nine months of 2022, we had consolidated net sales of $962.4 million, up 11.8% compared to $860.8 million in the first nine months of last year. Higher sales were primarily in the corporate office, retail and education market segments. Consolidated operating income was $90.0 million for the first nine months of 2022 compared to $70.9 million in the same period last year, due to the continued rebound in commercial markets and higher sales. Consolidated net income for the nine months ended October 2, 2022 was $44.2 million or $0.75 per share, compared to $33.4 million or $0.57 per share in the same period last year. Impact of the COVID-19 Pandemic In March 2020, the World Health Organization declared the COVID-19 outbreak a pandemic, and the virus continues to impact areas where we operate and sell our products and services. The COVID-19 pandemic has had material adverse effects on our business, results of operations, and financial condition. The duration of the pandemic will ultimately determine the extent to which our operations are impacted. Continuing government imposed COVID-19 lockdowns and restrictions in parts of China adversely impacted sales in China by approximately 12% for the first nine months of 2022 compared with the same period last year. Ongoing global supply chain challenges and inflationary pressures resulted in higher raw material costs, higher freight costs and shipping delays during the third quarter and first nine months of 2022, which increased our operating costs and adversely impacted our gross profit margin. 32 Table of Contents Analysis of Results of Operations Consolidated Results 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, 2022 and October 3, 2021: Three Months Ended Nine Months Ended October 2, 2022 October 3, 2021 October 2, 2022 October 3, 2021 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 66.8 66.0 65.5 63.8 Gross profit 33.2 34.0 34.5 36.2 Selling, general and administrative expenses 24.7 24.9 25.0 27.5 Restructuring, asset impairment and other charges 0.0 1.2 0.2 0.4 Operating income 8.5 7.9 9.3 8.3 Interest/Other expense, net 2.4 2.8 2.4 2.8 Income before income tax expense 6.1 5.1 6.9 5.5 Income tax expense 1.9 1.7 2.3 1.5 Net income 4.2 % 3.4 % 4.6 % 4.0 % Consolidated Net Sales Below is information regarding our consolidated net sales, and analysis of those results, for the three-month and nine-month periods ended October 2, 2022, and October 3, 2021: Three Months Ended Percentage Change Nine Months Ended Percentage Change October 2, 2022 October 3, 2021 October 2, 2022 October 3, 2021 (in thousands) (in thousands) Consolidated net sales $ 327,757 $ 312,707 4.8 % $ 962,364 $ 860,752 11.8 % For the quarter ended October 2, 2022, consolidated net sales increased $15.1 million (4.8%) versus the comparable period in 2021, primarily due to higher prices and volume. Currency fluctuations had a negative impact on consolidated net sales of approximately $19.0 million (6.1%) for the third quarter of 2022, due primarily to the weakening of the Euro, British Pound sterling, Australian dollar and Chinese Renminbi against the U.S. dollar. On a market segment basis, the sales increase was primarily in the corporate office, retail, public buildings and hospitality market segments partially offset by decreases in the healthcare market segment. For the nine months ended October 2, 2022, consolidated net sales increased $101.6 million (11.8%) versus the comparable period in 2021, primarily due to higher volume and prices. Currency fluctuations had a negative impact on consolidated net sales of approximately $42.4 million (4.9%) for the first nine months of 2022, due to the weakening of the Euro, Australian dollar, British Pound sterling and Chinese Renminbi against the U.S. dollar. On a market segment basis, the sales increase was primarily in the corporate office, retail, education and residential / living market segments partially offset by decreases in the transportation market segment. 33 Table of Contents Consolidated Cost and Expenses The following table presents our consolidated cost of sales and selling, general and administrative expenses for the three-month and nine-month periods ended October 2, 2022, and October 3, 2021: Three Months Ended Percentage Change Nine Months Ended Percentage Change October 2, 2022 October 3, 2021 October 2, 2022 October 3, 2021 (in thousands) (in thousands) Consolidated cost of sales $ 218,972 $ 206,382 6.1 % $ 630,074 $ 549,397 14.7 % Consolidated selling, general and administrative expenses 80,848 77,735 4.0 % 240,711 236,867 1.6 % Consolidated Cost of Sales For the quarter ended October 2, 2022, consolidated cost of sales increased $12.6 million (6.1%) compared to the third quarter of 2021, primarily due to higher sales and continuing inflationary pressures on raw materials and freight costs. Currency translation had a positive impact on consolidated costs of sales in the third quarter of 2022 and partially reduced our costs by approximately $13.2 million (6.4%) compared to the same period last year. As a percentage of net sales, our cost of sales increased to 66.8% for the third quarter of 2022 versus 66.0% for the third quarter of 2021. For the nine months ended October 2, 2022, consolidated cost of sales increased $80.7 million (14.7%) versus the comparable period in 2021, primarily due to higher sales and the continuing impact of inflation as discussed above. Currency translation had a positive impact on consolidated cost of sales for the first nine months of 2022 and partially reduced our costs by approximately $28.8 million (5.2%) compared to the same period last year. As a percentage of net sales, our cost of sales increased to 65.5% for the first nine months of 2022 versus 63.8% for the first nine months of 2021. Consolidated Gross Profit For the quarter ended October 2, 2022, consolidated gross profit, as a percentage of net sales, was 33.2% compared with 34.0% in the same period last year. The decrease was primarily due to inflationary pressures on raw materials and freight costs as discussed above. For the nine months ended October 2, 2022, consolidated gross profit, as a percentage of net sales, was 34.5% compared with 36.2% in the same period last year. The decrease was primarily due to the continuing impact of inflation as discussed above. Consolidated Selling, General and Administrative (“SG&A”) Expenses For the quarter ended October 2, 2022, consolidated SG&A expenses increased $3.1 million (4.0%) versus the comparable period in 2021. Currency translation had a positive impact on consolidated SG&A expenses in the third quarter of 2022 of approximately $3.9 million (4.9%) compared to the same period last year. SG&A expenses for the third quarter of 2022 included higher selling expenses of approximately $2.8 million compared to the same period last year due to higher sales, higher asset impairment charges of approximately $1.2 million due to exit activities in Thailand and Russia, and higher professional fees of approximately $1.9 million as the prior year included insurance reimbursements. These increases were partially offset by lower labor costs of approximately $3.4 million due to headcount reduction initiatives in the prior year in response to the impacts of COVID-19. As a percentage of net sales, SG&A expenses decreased to 24.7% for the third quarter of 2022 versus 24.9% for the third quarter of 2021. For the nine months ended October 2, 2022, consolidated SG&A expenses increased $3.8 million (1.6%) versus the comparable period in 2021. Currency translation had a positive impact on consolidated SG&A expenses for the first nine months of 2022 of approximately $9.1 million (3.9%) compared to the same period last year. SG&A expenses included $10.4 million of higher selling expenses in the first nine months of 2022 compared to the same period last year due to higher sales, which were partially offset by lower labor costs of approximately $6.2 million due to the employee headcount reduction initiatives discussed above. As a percentage of net sales, SG&A expenses decreased to 25.0% for the first nine months of 2022 versus 27.5% for the first nine months of 2021. 34 Table of Contents Restructuring Activities On September 8, 2021, the Company committed to a restructuring plan that continues to focus on efforts to improve efficiencies and decrease costs across its worldwide operations, including the closure of the Company’s manufacturing facility in Thailand at the end of the first quarter of 2022. During the first nine months of 2022, we recognized restructuring charges of approximately $1.6 million under this plan primarily related to the impairment of property, plant and equipment at the Thailand facility. In conjunction with the closure of its Thailand facility, the Company recorded a write-down of inventory of $2.5 million in the first nine months of 2022 within cost of sales in the consolidated condensed statements of operations. See Note 15 entitled “Restructuring and Other Charges” of Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information. Segment Operating Results AMS Segment – Net Sales and Adjusted Operating Income (“AOI”) The following table presents AMS segment net sales and AOI for the three-month and nine-month periods ended October 2, 2022, and October 3, 2021: Three Months Ended Percentage Change Nine Months Ended Percentage Change October 2, 2022 October 3, 2021 October 2, 2022 October 3, 2021 (in thousands) (in thousands) AMS segment net sales $ 194,449 $ 176,770 10.0 % $ 557,768 $ 460,402 21.1 % AMS segment AOI (1) 24,975 21,595 15.7 % 74,502 54,606 36.4 % (1) Includes allocation of corporate SG&A expenses. Excludes non-recurring items related to restructuring, asset impairment, severance and other costs. See Note 11 entitled “Segment Information” of Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information. During the third quarter of 2022, net sales in AMS increased 10.0% versus the comparable period in 2021, primarily due to higher prices and volume. The sales increase was primarily in the retail, public buildings and corporate office market segments partially offset by decreases in the healthcare and consumer residential market segments. During the first nine months of 2022, net sales in AMS increased 21.1% versus the comparable period in 2021, primarily due to higher sales volume and prices. The sales increase was primarily in the corporate office, education, retail, public buildings and residential / living market segments. AOI in AMS increased 15.7% during the third quarter of 2022 compared to the prior year period, primarily due to higher sales. AMS SG&A expenses as a percentage of net sales in the third quarter of 2022 decreased approximately 0.5% compared to the third quarter of 2021, which contributed to the increase in AOI for the current quarter. AOI in AMS increased 36.4% during the first nine months of 2022 compared to the prior year period, primarily due to higher sales. AMS SG&A expenses as a percentage of net sales decreased approximately 1.4% for the first nine months of 2022 compared to last year, which contributed to the increase in AOI for the current year period. 35 Table of Contents EAAA Segment – Net Sales and AOI The following table presents EAAA segment net sales and AOI for the three-month and nine-month periods ended October 2, 2022, and October 3, 2021: Three Months Ended Percentage Change Nine Months Ended Percentage Change October 2, 2022 October 3, 2021 October 2, 2022 October 3, 2021 (in thousands) (in thousands) EAAA segment net sales $ 133,308 $ 135,937 (1.9) % $ 404,596 $ 400,350 1.1 % EAAA segment AOI (1) 6,273 8,586 (26.9) % 25,908 26,557 (2.4) % (1) Includes allocation of corporate SG&A expenses. Excludes non-recurring items related to purchase accounting amortization, Thailand plant closure inventory write-down, and restructuring, asset impairment, severance and other costs. See Note 11 entitled “Segment Information” of Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information. During the third quarter of 2022, net sales in EAAA decreased 1.9% versus the comparable period in 2021. Higher selling prices and volume were offset by the impact of negative currency fluctuations of approximately $18.5 million (13.6%) for the third quarter of 2022 compared to the same period last year due to the weakening of the Euro, British Pound sterling, Australian dollar and Chinese Renminbi against the U.S. dollar. Continuing government-imposed COVID-19 lockdowns and restrictions in parts of China during the third quarter of 2022 adversely impacted EAAA sales for the current quarter. Higher EAAA sales in the corporate office and hospitality market segments were offset by decreases in the healthcare, public buildings and transportation market segments. During the first nine months of 2022, net sales in EAAA increased 1.1% versus the comparable period in 2021. Higher sales volume and prices were mostly offset by the impact of negative currency fluctuations of approximately $41.4 million (10.3%) for the first nine months of 2022 compared to the same period last year due to the weakening of the Euro, Australian dollar, British Pound sterling and Chinese Renminbi against the U.S. dollar. Government-imposed COVID-19 lockdowns and restrictions in parts of China adversely impacted EAAA sales for the first nine months of 2022. The EAAA sales increase was primarily in the corporate office and hospitality market segments partially offset by decreases in the public buildings, transportation and education market segments. AOI in EAAA decreased 26.9% during the third quarter of 2022 versus the comparable period in 2021 primarily due to lower sales and the continuing impact of inflationary pressures on raw materials, freight and labor costs. Currency fluctuations had a negative impact on AOI of approximately $2.1 million (15.2%) for the third quarter of 2022 compared to the third quarter of 2021. AOI in EAAA decreased 2.4% during the first nine months of 2022 versus the comparable period in 2021 primarily due to higher cost inflation as discussed above and the negative impact of currency fluctuations of approximately $5.1 million (11.6%). EAAA SG&A expenses as a percentage of net sales in the first nine months of 2022 decreased approximately 2.7% compared to last year, which partially offset the negative impacts on AOI discussed above. 36 Table of Contents Financial Condition, Liquidity and Capital Resources General At October 2, 2022, the Company had $79.4 million in cash. At that date, the Company had $201.6 million in term loan borrowings, $26.0 million in revolving loan borrowings, and $1.6 million in letters of credit outstanding under our Facility, and we had $300.0 million of Senior Notes outstanding. As of October 2, 2022, we had additional borrowing capacity of $272.4 million under the Facility and $2.0 million of borrowing capacity under another line of credit in place at a non-U.S. subsidiary. We anticipate that our liquidity is sufficient to meet our obligations for the next 12 months, and we expect to generate sufficient cash to meet our long-term obligations. On October 14, 2022, the Facility was amended to, among other changes, extend the maturity date to October 2027. See Note 16 entitled “Subsequent Events” of Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information. The Senior Notes are unsecured and are guaranteed, jointly and severally, by each of the Company’s material domestic subsidiaries, all of which also guarantee the obligations of the Company under its existing Facility. The Company’s foreign subsidiaries and certain non-material domestic subsidiaries are considered non-guarantors. Net sales for the non-guarantor subsidiaries were approximately $147 million and $443 million for the three-month and nine-month periods ended October 2, 2022, respectively, and net sales for the non-guarantor subsidiaries were approximately $148 million and $432 million for the three-month and nine-month periods ended October 3, 2021, respectively. Total indebtedness of the non-guarantor subsidiaries was approximately $45 million as of both October 2, 2022 and January 2, 2022. Balance Sheet Inventories, net, were $319.1 million at October 2, 2022 compared to $265.1 million at January 2, 2022. The increase of $54.0 million was primarily due to higher raw material costs and freight costs due to continuing inflationary pressures and inventory build driven by higher customer demand and global supply chain disruption. Analysis of Cash Flows The following table presents a summary of cash flows for the nine-month periods ended October 2, 2022 and October 3, 2021, respectively: Nine Months Ended October 2, 2022 October 3, 2021 (in thousands) Net cash provided by (used in): Operating activities $ 14,883 $ 64,056 Investing activities (13,314) (17,406) Financing activities (10,456) (53,079) Effect of exchange rate changes on cash (8,916) (3,815) Net change in cash and cash equivalents (17,803) (10,244) Cash and cash equivalents at beginning of period 97,252 103,053 Cash and cash equivalents at end of period $ 79,449 $ 92,809 Cash provided by operating activities was $14.9 million for the nine months ended October 2, 2022, which represents a decrease of $49.2 million from the prior year period. The difference was primarily due to a greater use of cash for working capital during the first nine months of 2022. Specifically, higher inventories as a result of increased customer demand, higher raw material costs and input costs contributed to the greater use of cash for working capital compared to last year. Accrued bonus payments during the first quarter of 2022 also contributed to the increased use of cash for the first nine months of 2022. Cash used in investing activities was $13.3 million for the nine months ended October 2, 2022, which represents a decrease of $4.1 million from the prior year period. The decrease from the comparable period was primarily due to a decrease in capital expenditures due to reduced capital investment. 37 Table of Contents Cash used in financing activities was $10.5 million for the nine months ended October 2, 2022, which represents a decrease of $42.6 million from the prior year period. The year-over-year difference was primarily due to higher revolving loan borrowings in 2022 as a source of cash to fund operating activities as described above, partially offset by a use of cash for repurchases of the Company’s common stock pursuant to a new share repurchase program adopted in the second quarter of 2022. Share Repurchases In the second quarter of 2022, the Company adopted a new share repurchase program in which the Company is authorized to repurchase up to $100 million of its outstanding shares of common stock. The program has no specific expiration date. During the nine months ended October 2, 2022, the Company repurchased 1,126,176 shares of common stock at a weighted average price of $12.83 per share pursuant to this program. Purchase Obligations In March of 2022, we entered into a purchase obligations commitment to procure fiberglass raw materials through the end of 2026 for approximately $22.5 million. We expect that approximately $4.5 million will be purchased within the next 12 months. Critical Accounting Policies and Estimates Goodwill In accordance with applicable accounting standards, the Company tests goodwill for impairment annually in the fourth quarter and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. During fiscal year 2022, the Company has experienced significant cost inflation, volatility in the Company stock price and a negative geopolitical climate in Europe. The Company considered these factors and determined they did not indicate that the fair value of the EMEA reporting unit was less than its carrying value as of October 2, 2022. If the uncertainty caused by these events continues, they may warrant the need to write down the value of goodwill associated with our EMEA reporting unit if a future test indicates that its fair value is less than its carrying value. The fair value of the EMEA reporting unit exceeded its carrying value by approximately 20% at the most recent goodwill test date performed in the fourth quarter of 2021. The goodwill allocated to the EMEA reporting unit as of October 2, 2022 was $29.4 million. The amount of any potential future goodwill impairment charge is uncertain as the impairment test involves a significant amount of risk, uncertainty and judgment. 38 Table of Contents Forward-Looking Statement on Impact of COVID-19 While we are aggressively managing our response to the COVID-19 pandemic, its impacts on our full fiscal year 2022 results and beyond are uncertain. We believe the most significant elements of uncertainty are (1) the intensity and duration of the impact on construction, renovation, and remodeling; (2) corporate, government, and consumer spending levels and sentiment; (3) the ability of our sales channels, supply chain, manufacturing, and distribution partners to continue operating through disruptions; and (4) the severity of global supply chain disruptions and their effects on inflation, labor shortages, raw material shortages, and other factors that disrupt our supply chain and manufacturing facilities. Any or all of these factors could negatively impact our financial position, results of operations, cash flows, and outlook. As the impact of the COVID-19 pandemic continues to affect companies with global operations, specifically as it relates to the global supply chain, we anticipate that, at a minimum, our business and results in the final quarter of 2022 will continue to be affected, and the timeline and pace of recovery is uncertain. We anticipate a sequential revenue increase in the fourth quarter of fiscal year 2022 compared with the third quarter of 2022. We are also anticipating continued impacts to our global supply chain and manufacturing operations. These impacts are expected to include significant cost increases in our raw materials globally and continued labor shortages and cost increases. The impacts may also potentially include raw material shortages, higher freight costs, shipping delays, and other disruptions. These impacts to our supply chain and manufacturing will increase our costs and adversely affect our gross margins, they may inhibit our ability to manufacture and ship product timely, and at times they may inhibit our ability to meet customer demands and expectations. We also plan to continue evaluating our cost structure and global manufacturing footprint to identify and activate opportunities to decrease costs and optimize our global cost structure. Cash flows from operations, cash and cash equivalents, and other sources of liquidity are expected to be available and sufficient to meet foreseeable cash requirements. However, the Company’s cash flows from operations can be affected by numerous factors including the uncertainty of COVID-19 and its impact on global operations, raw material availability and cost, and demand for our products. Backlog As of October 23, 2022, the consolidated backlog of unshipped orders was approximately $236.2 million. As disclosed in our Annual Report on Form 10-K for the fiscal year ended January 2, 2022, backlog was approximately $215.6 million as of February 6, 2022. Disruptions in global supply and distribution chains and government imposed lockdowns due to the impact of COVID-19 have resulted in delays of construction projects and flooring installations in many regions worldwide. 39 Table of Contents