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 1, 2023, under Part II, Item 7 of that Form 10-K. Our discussions here focus on our results during the quarter ended April 2, 2023, or as of, April 2, 2023, and the comparable periods of 2022, 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 three-month periods ended April 2, 2023 and April 3, 2022 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 the 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 1, 2023. 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. 28 Table of Contents Overview During the quarter ended April 2, 2023, we had consolidated net sales of $295.8 million, up 2.7% compared to $288.0 million in the first quarter last year. Higher sales were primarily in the education, corporate office, public buildings and residential market segments. Consolidated operating income was $9.5 million for the first quarter of 2023, compared to $27.4 million in the first quarter last year. Continuing inflationary pressures on raw materials and lower manufacturing fixed cost absorption on lower manufacturing volumes adversely impacted our gross profit margin in the current year period coupled with higher selling, general and administrative costs. Consolidated net loss for the quarter ended April 2, 2023 was $0.7 million or $0.01 per share, compared to consolidated net income of $13.3 million or $0.22 per share in the first quarter last year. Cybersecurity Event As previously disclosed in our current report on Form 8-K filed with the SEC on November 23, 2022, we discovered a cybersecurity attack, perpetrated by unauthorized third parties, affecting our IT systems on November 20, 2022 (the “Cyber Event”). Promptly, out of an abundance of caution, we shut down certain systems including shipping, inventory management and production systems and engaged forensic experts to evaluate the extent of the Cyber Event and its impact to our operations. We took steps to supplement existing security monitoring, including scanning and protective measures, and notified law enforcement. We substantially resumed our operations within two weeks following the occurrence of the Cyber Event. In the first quarter of 2023, we incurred approximately $0.4 million of additional expenses related to the ongoing investigation of the Cyber Event. These costs were primarily included in selling, general and administrative expenses in the consolidated condensed statement of operations. We have cyber risk insurance and anticipate that a portion of our costs and expenses related to the Cyber Event will ultimately be recovered by insurance. We expect to incur ongoing costs for enhanced data security against unauthorized access to, or manipulation of, our systems and data. Impact of Macroeconomic Trends The continued disruption in economic markets due to high inflation, increases in interest rates, supply chain issues, and the continuing impact of COVID-19 in China all pose challenges which may adversely affect our future performance. These impacts have increased our costs and adversely affected our gross profit margin. To mitigate these impacts, we 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. During the first quarter of 2023, EAAA sales were also adversely impacted by slower economic recovery and decreased customer demand in parts of Asia, resulting in approximately 30% lower net sales in Asia during the current quarter compared to the same period last year. 29 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 periods ended April 2, 2023 and April 3, 2022: Three Months Ended April 2, 2023 April 3, 2022 Net sales 100.0 % 100.0 % Cost of sales 67.6 62.9 Gross profit 32.4 37.1 Selling, general and administrative expenses 29.2 27.3 Restructuring, asset impairment and other charges 0.0 0.3 Operating income 3.2 9.5 Interest/Other expense, net 3.4 2.4 Income (loss) before income tax expense (0.2) 7.1 Income tax expense 0.1 2.5 Net income (loss) (0.3) % 4.6 % Consolidated Net Sales Below is information regarding our consolidated net sales, and analysis of those results, for the three-month periods ended April 2, 2023, and April 3, 2022: Three Months Ended Percentage Change April 2, 2023 April 3, 2022 (in thousands) Consolidated net sales $ 295,792 $ 288,002 2.7 % For the quarter ended April 2, 2023, consolidated net sales increased $7.8 million (2.7%) versus the comparable period in 2022, primarily due to higher prices (approximately 6%). Currency fluctuations had a negative impact on consolidated net sales of approximately $7.2 million (2.5%) for the first quarter of 2023, due primarily to the weakening of the Euro, Australian dollar and British Pound sterling against the U.S. dollar. On a market segment basis, the sales increase was primarily in the education, corporate office, public buildings and residential living market segments as a result of higher government spending on school renovation projects and corporate reinvestment. Consolidated Cost and Expenses The following table presents our consolidated cost of sales and selling, general and administrative expenses for the three-month periods ended April 2, 2023, and April 3, 2022: Three Months Ended Percentage Change April 2, 2023 April 3, 2022 (in thousands) Cost of sales $ 199,919 $ 181,203 10.3 % Selling, general and administrative expenses 86,254 78,492 9.9 % Consolidated Cost of Sales For the quarter ended April 2, 2023, consolidated cost of sales increased $18.7 million (10.3%) compared to the first quarter of 2022, primarily due to continuing inflationary pressures on raw material costs. Currency translation had a positive impact on consolidated cost of sales in the first quarter of 2023 and partially reduced our costs by approximately $5.1 million (3.0%) compared to the same period last year. As a percentage of net sales, our cost of sales increased to 67.6% for the first quarter of 2023 versus 62.9% for the first quarter of 2022. 30 Table of Contents Consolidated Gross Profit For the quarter ended April 2, 2023, consolidated gross profit, as a percentage of net sales, was 32.4% compared with 37.1% in the same period last year. The decrease was primarily due to continuing inflationary pressures on raw material costs and lower manufacturing fixed cost absorption on lower manufacturing volumes as discussed above. Consolidated Selling, General and Administrative (“SG&A”) Expenses For the quarter ended April 2, 2023, consolidated selling, general and administrative expenses increased $7.8 million (9.9%) versus the comparable period in 2022. Currency translation had a positive impact on consolidated SG&A expenses in the first quarter of 2023 and partially reduced our costs by approximately $1.3 million (1.5%) compared to the same period last year. SG&A expenses were higher for the first quarter of 2023 primarily due to higher selling expenses of approximately $3.7 million due to higher sales, higher severance costs of approximately $2.3 million driven by employee headcount reduction and cost saving initiatives, Cyber Event costs of approximately $0.5 million and the continuing impact of inflation. As a percentage of net sales, SG&A expenses increased to 29.2% for the first quarter of 2023 versus 27.3% for the first quarter of 2022. Restructuring Activities On September 8, 2021, the Company committed to a new restructuring plan that continued to focus on efforts to improve efficiencies and decrease costs across its worldwide operations, involving the closure of the Company’s manufacturing facility in Thailand at the end of the first quarter of 2022. In the first quarter of 2023, we recognized restructuring charges of approximately $0.1 million under this plan primarily related to the transfer of equipment from the Thailand facility to other manufacturing locations. See Note 15 entitled “Restructuring and Other Charges” and Note 16 entitled “Assets Held For Sale” of Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information. Interest Expense During the quarter ended April 2, 2023, interest expense was $8.5 million, an increase of $1.7 million from the comparable period in 2022, primarily due to higher interest rates on outstanding term loan borrowings under the Facility. 31 Table of Contents 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 periods ended April 2, 2023, and April 3, 2022: Three Months Ended Percentage Change April 2, 2023 April 3, 2022 (in thousands) AMS segment net sales $ 169,241 $ 156,509 8.1 % AMS segment AOI (1) 11,269 21,138 (46.7) % (1) Includes allocation of corporate SG&A expenses. Excludes Cyber Event costs, property casualty loss, 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 first quarter of 2023, net sales in AMS increased 8.1% versus the comparable period in 2022 primarily due to higher sales prices and volume. The AMS sales increase was primarily in the corporate office, education and residential living market segments. AOI in AMS decreased 46.7% during the first quarter of 2023 compared to the prior year period primarily due to higher raw material costs as a result of continuing inflationary pressures. Unfavorable fixed cost absorption in the current period also negatively impacted AOI. AMS SG&A expenses as a percentage of net sales in the first quarter of 2023 increased 1.0% due to higher selling expenses and inflation, which also contributed to the decrease in AOI for the current quarter. As a percentage of net sales, AOI decreased to 6.7% during the first quarter of 2023 compared to 13.5% in the same period last year. EAAA Segment – Net Sales and AOI The following table presents EAAA segment net sales and AOI for the three-month periods ended April 2, 2023, and April 3, 2022: Three Months Ended Percentage Change April 2, 2023 April 3, 2022 (in thousands) EAAA segment net sales $ 126,551 $ 131,493 (3.8) % EAAA segment AOI (1) 3,929 9,504 (58.7) % (1) Includes allocation of corporate SG&A expenses. Excludes purchase accounting amortization, Cyber Event costs, 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 first quarter of 2023, net sales in EAAA decreased 3.8% versus the comparable period in 2022, as higher sales prices were offset by the negative impacts of currency fluctuations and lower sales volume in Asia. Currency fluctuations had a negative impact on EAAA sales of approximately $6.3 million (4.8%) for the first quarter 2023 compared to the same period last year due to the weakening of the Euro, Australian dollar and British Pound sterling against the U.S. dollar. During the first quarter of 2023, EAAA sales were also adversely impacted by slower economic recovery and decreased customer demand in parts of Asia. On a market segment basis, the EAAA sales decrease was most significant in the corporate office, healthcare and retail market segments, partially offset by increases in the public buildings and education market segments. AOI in EAAA decreased 58.7% during the first quarter of 2023 versus the comparable period in 2022, primarily due to higher raw material costs as a result of continuing inflationary pressures and lower manufacturing fixed cost absorption on lower manufacturing production volumes. Currency fluctuations had a negative impact on AOI of approximately $0.7 million (4.4%) for the first quarter of 2023 compared to the first quarter last year. EAAA SG&A expenses as a percentage of net sales in the first quarter of 2023 decreased approximately 0.6% compared to the first quarter of 2022, which partially offset the decrease in AOI for the first quarter of 2023. As a percentage of net sales, AOI decreased to 3.1% during the first quarter of 2023 compared to 7.2% in the same period last year. 32 Table of Contents Financial Condition, Liquidity and Capital Resources General At April 2, 2023, the Company had $101.3 million in cash. At that date, the Company had $197.6 million in term loan borrowings, $9.4 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 April 2, 2023, we had additional borrowing capacity of $289.0 million under the Facility. 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. 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 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 $141 million and $144 million for the three-month periods ended April 2, 2023 and April 3, 2022, respectively. Total indebtedness of the non-guarantor subsidiaries was approximately $41 million and $43 million as of April 2, 2023 and January 1, 2023, respectively. Balance Sheet Accounts receivable, net, were $147.8 million at April 2, 2023, compared to $182.8 million at January 1, 2023. The decrease of $35.0 million was primarily due to customer collections in the first quarter of 2023, including the impact of delays in customer billings from the Cyber Event, in which the due dates for those delayed billings were pushed from the fourth quarter of 2022 to the first quarter of 2023. Inventories, net, were $312.7 million at April 2, 2023, compared to $306.3 million at January 1, 2023. The increase of $6.4 million was primarily due to higher raw material costs due to continuing inflationary pressures. Analysis of Cash Flows The following table presents a summary of cash flows for the three-month periods ended April 2, 2023 and April 3, 2022, respectively: Three Months Ended April 2, 2023 April 3, 2022 (in thousands) Net cash provided by (used in): Operating activities $ 29,584 $ (17,696) Investing activities (5,712) (4,781) Financing activities (21,035) 2,894 Effect of exchange rate changes on cash 872 (1,581) Net change in cash and cash equivalents 3,709 (21,164) Cash and cash equivalents at beginning of period 97,564 97,252 Cash and cash equivalents at end of period $ 101,273 $ 76,088 Cash provided by operating activities was $29.6 million for the three months ended April 2, 2023, compared with $17.7 million of cash used in operating activities in the prior year comparable period. The increase was primarily due to a greater source of cash from working capital during the first three months of 2023. Specifically, customer collections in the first three months of 2023 contributed to a decrease in accounts receivable, primarily attributable to delays in customer billings from the Cyber Event, in which the due dates for those delayed billings were pushed from the fourth quarter of 2022 to the first quarter of 2023. The prior year comparable period included a greater use of cash for working capital attributable to an increase in inventories compared with the three months ended April 2, 2023. Cash used in investing activities was $5.7 million for the three months ended April 2, 2023, which represents an increase of $0.9 million from the prior year comparable period. The increase from the comparable period was primarily due to an increase in capital expenditures due to higher capital investment. 33 Table of Contents Cash used in financing activities was $21.0 million for the three months ended April 2, 2023, compared with $2.9 million of cash provided by financing activities in the prior year comparable period. The increased use of cash was primarily due to higher repayments of revolving loan borrowings in 2023 as a result of cash generated from operating activities as described above. Outlook We anticipate revenue growth in the second quarter of fiscal year 2023 compared with the first quarter of 2023. We are also anticipating continued impacts to our global supply chain and manufacturing operations — particularly significant cost increases in our raw materials globally and continued lower manufacturing fixed cost absorption versus the comparable prior year period. The impacts may also potentially include shipping delays, and other disruption. These impacts to our supply chain and manufacturing operations may increase our costs and continue to 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. 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 raw material availability and cost, and demand for our products. Backlog As of April 23, 2023, the consolidated backlog of unshipped orders was approximately $208.9 million. As disclosed in our Annual Report on Form 10-K for the fiscal year ended January 1, 2023, backlog was approximately $197.4 million as of February 5, 2023. Disruptions in supply and distribution chains and the impact of government imposed COVID-19 lockdowns in China have resulted in delays of construction projects and flooring installations in many regions worldwide. 34 Table of Contents