Good day and thank you for standing by. Welcome to the Q3 2021 Interface, Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you need to press star one on your telephone keypad. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Christine Needles, Corporate Communications. Please go ahead.
Good morning and welcome to Interface's conference call regarding Third Quarter 2021 results hosted by Dan Hendrix, Chairman and 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 associated with the ongoing COVID-19 pandemic and those 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 on Form 8-K furnished with the SEC today. Lastly, 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. Now I'd like to turn the call over to Dan Hendrix, Chairman and CEO.
Thank you, Christine. Good morning and thank you for joining us. The Interface team delivered strong results this quarter and I continue to be impressed by their dedication and commitment to delivering for our customers. We saw a 12% year-over-year increase in net sales in the third quarter as customer demand continue to pick up in line with positive signs of a commercial recovery across most of our regions. We generated $29 million of cash from operating activities during the quarter and we repaid $30 million of debt to reach pre-pandemic leverage ratios. Building on the momentum we saw last quarter, orders were up 24% year- over- year, including a 34% increase in the Americas and a 12% increase in the EAAA.
Backlog was up 33% compared to a year ago, which is a record high for Interface, which should bode well for the fourth quarter. Despite the strong customer demand, we continue to manage through industry-wide supply chain issues. Like most of the other companies, we're facing some challenging headwinds. We have open jobs we're working to fill in our U.S. manufacturing facilities. We're experiencing raw material and freight inflation and we're still facing disruption from COVID-19. As a result, it's been difficult to keep up with order demand in our manufacturing facilities and our gross profit margins were lower than we targeted in the quarter. To respond to this challenging operating environment, we are partially offsetting these impacts with passthrough price increases and freight surcharges. We're acting as quickly as we can, but there's a lag between raw material, freight, and labor inflation and when price increases take effect.
Additionally, with the recent announcement to close our plant in Thailand by the end of 2022, we are increasing productivity and lowering manufacturing costs across our global manufacturing footprint. I'm proud of our team's efforts to control SG&A and continue to right-size the business as we work through these challenging times. Turning to our market verticals, we're seeing a significant increase in activity in education markets. K-12 schools across the U.S. are investing in infrastructure improvements with funds from the U.S. government's 2021 pandemic relief aid program. These educational institutions also appreciate Interface's leadership position in sustainability. Every flooring product that goes out the door, Interface is either carbon neutral or carbon negative. The healthcare market also continues to be strong for us.
We're positioned well with the right portfolio mix across rubber, LVT, and carpet tile to suit a range of needs in that market. Now let's talk about the office market. We saw another quarter of growth as we have customers who are renovating their office in anticipation of their employees coming back to create more collaborative, flexible workspaces. All of this activity is good for business. Change drives renovation work, and renovation work drives commercial flooring purchases. Additionally, more and more public and private companies are making their own carbon reduction and sustainability goals, which uniquely positions us to serve their needs. Our dealer strategy is also showing promise. You might recall that we launched this initiative a few quarters ago to focus more closely on new and existing dealer relationships.
Our Net Promoter Scores with this segment of our customer base are heading in the right direction and our Open Air products continue to be incredibly popular with them. All in, this is a win-win for our dealer partners, our end-use customers, and our company. We're very pleased with the progress we're seeing in this area of the business. Now I'd like to share some incredible news with you about our European operations. Globally, we are very proud of our accomplishments so far on Climate Take Back journey, and during this last quarter, we transitioned our European carpet tile backing from petroleum-based bitumen to CQuest Bio. This means we stop using petroleum-based bitumen on all of the carpet tile we manufacture in Europe, replacing it with bio-based materials and recycled fillers.
There was a celebration at our plant in Holland when the last bitumen truck pulled up and then drove away because we knew that was the last bitumen truck we would ever need. This is a win for our planet, for our customers, and it's another important step forward on our Climate Take Back journey. There are so many people to thank for this milestone and I particularly want to thank our European manufacturing team for our new manufacturing process. Additionally, Interface has become the first foreign company to receive third-party validation of our 2030 greenhouse gas reduction targets as science-based. These now validated science-based targets commit Interface to further reduce our Scope 1, 2, and 3 emissions in alignment with our goal of becoming a carbon negative company by 2040. Interface continues to lead the pack when it comes to our commitment to sustainability.
Our relentless focus on design, innovation, and sustainability continues to drive our leadership position in the industry and strengthens our foundation for future growth. With that, I'll turn it over to Bruce for the third quarter of 2021 financial recap. Bruce?
Thank you, Dan, and good morning, everyone. Third quarter sales totaled $312.7 million, up 12.2% from the prior year period with increases across all product lines. Organic growth, which excludes the impact of currency translation, was up 11.3%. Sales in the Americas were up 23.7% driven by a release of pent-up demand in a strongly recovering commercial market. In EAAA, net sales were relatively flat as certain markets like Eastern Europe, China, Southeast Asia, and India faced new waves of COVID resulting in government lockdowns. Orders, however, were up in both regions as Americas saw orders up 34% year-over-year, and EAAA's orders were up 12% year-over-year.
Currency fluctuations had an approximately $1.9 million of positive impact on EAAA's third quarter net sales due to strengthening of various foreign currencies against the U.S. dollar. Third quarter adjusted gross profit margin was 34.5%, which was a solid outcome in the face of the global supply chain crisis that our company and almost every other global company had to navigate through during the quarter. Adjusted SG&A expense for the third quarter was $77.5 million compared to $75.5 million in the same quarter last year. As a percentage of net sales, adjusted SG&A was 24.8% this quarter compared to 27.1% in the same period last year. As you'll note, we are continuing to tighten up the company's cost structure, and we're paying particular attention to gaining greater efficiencies in our SG&A.
Third quarter adjusted operating income was $30.2 million, up 7.4% compared to $28.1 million in the third quarter last year. Third quarter 2021 adjusted net income was $16.9 million, or $0.29 per diluted share, and adjusted EBITDA was $42 million for the quarter. During the third quarter, in line with our prior announcement, we recorded a $3.8 million restructuring charge related to closing of our manufacturing facility in Thailand. We expect to stop manufacturing at this facility in Q1 of 2022, and the project is expected to result in annualized savings of approximately $1.7 million, plus decreased complexity, and increased efficiency of our global manufacturing footprint.
Turning to our balance sheet and cash flows, the company generated $28.9 million of cash from operations in the third quarter and $64.1 million year- to- date. Liquidity at the end of the quarter was $391 million, comprised of $93 million of cash and $298 million of borrowing availability. Inventory was up $9 million or 3.7% year-over-year, as we continue to be focused on managing working capital while meeting customer demand. Consistent with our focus on delevering, we paid down $30 million of debt in the third quarter, and we paid down $49 million year- to- date. We are very pleased to be on track with our debt reduction goals.
Net debt or total debt minus cash on han was $432.1 million at the end of the third quarter, and the last twelve months of adjusted EBITDA were $153.9 million, achieving a net leverage ratio of 2.8x, calculated as net debt divided by adjusted EBITDA. This is a significant milestone for us as it brings that metric back to pre-pandemic levels. Third quarter 2021 interest expense was $7.7 million, including a $1.8 million non-cash charge related to our previously mentioned interest rate swaps that were discontinued in 2020 and that compares to $5.4 million in the prior year period. Capital expenditures were $5.3 million in the third quarter compared to $11.2 million in the third quarter of 2020.
Looking at the fourth quarter of 2021, we expect the global economic recovery to be ongoing as more and more people receive their COVID-19 vaccinations, combined with a significant level of global supply chain disruption, and an inflationary environment that we believe will persist throughout the remainder of 2021, and likely into 2022. We're continually monitoring the situation, and as we look to finish 2021, we are anticipating net sales in the fourth quarter 2021 of $320 million to $330 million. Adjusted gross profit percentage in the fourth quarter of 35.5% to 36.5%. Adjusted SG&A expense for the full- year of approximately $315 million to $319 million. Interest and other expense for the full- year of approximately $28 million.
The adjusted effective tax rate for the full- year is anticipated to be approximately 26%, and capital expenditures of approximately $30 million for the full- year 2021.
Fully diluted share count at the end of the third quarter was 59.1 million shares. With that, I'd like to hand it back to Dan for concluding remarks.
Thank you, Bruce. I, again, want to thank the entire Interface team for a strong, strong quarter, and one that was filled with significant milestones. As I hope everyone can see, we continue to strengthen the company by broadening our product lines, increasing our leadership position in vertical segments like education and healthcare, leading in design and, of course, leading in sustainability. The positive momentum that we see in the business is encouraging, and despite the global supply chain issues to navigate through, which are not unique to Interface, we remain very optimistic about the future. With that, I'll open it up for questions. Operator?
At this time, if you would like to ask a question, please press star then the number one on your telephone keypad. Again, to ask a question, press star one on your telephone keypad. Your first question comes from Kathryn Thompson of TRG.
Hey, good morning. This is actually Brian Biros on for Kathryn TRG. Thank you for taking my questions. T o start, can you touch on how volume and price trended across the two segments in the quarter?
Sure, Brian, this is Bruce Hausmann. Good morning. A lot of the volume that you saw on the top line was more volume-based. We had some pricing activity. Y ou might remember that we did some pricing activity in Q1. We did more pricing activity in Q2, and we did more pricing activity in Q3, and we'll do some more the rest of this year. Some of that's coming on pricing on our products as well as we're adding some freight surcharges to offset the increased costs that we're seeing in the freight line.
Maybe then in the EAAA segment , you know, sales are flat, so I assume pricing was up, so that implies volume down. Any magnitude of those two that you could share?
Yeah, you know, the orders were up 12% in EAAA. The reason why the billings were flat was mostly attributable to the new waves of COVID that we saw in Eastern Europe, China, Southeast Asia, and India. What we saw in EAAA in particular was we had orders in hand, we had inventory ready to ship, and the customer just couldn't accept the product because the job site was either delayed due to a COVID lockdown or it was delayed due to the job site needing other materials that had supply chain issues that they needed to bring in first before they could bring in the flooring products.
Actually, on balance, the EAAA region had a very strong quarter, and all those orders will ship as soon as those job sites reopen up and those COVID lockdowns, you know, ease. It's just really a timing thing between the quarters.
Got it. Has that, those lockdowns, have they continued into Q4, or how has that trended sequentially?
Yeah, I mean, I'm sure you've seen in the newspaper, Russia, for example, has had increased case counts, and Germany has had increased case counts. There's just, you know, different ways. For example, in Q3, Malaysia had their borders closed entirely. We couldn't ship any product into Malaysia. It just ebbs and flows, and it goes week by week. I think the good news is that we're getting the orders, we're getting the business, we know we're taking share, and it's just a matter of, you know, when the job sites can open, and we can actually get the product to the customer to put down on the floor.
Got it. Maybe thinking a little bigger picture into next year, just how would you characterize the biggest bottlenecks currently, maybe the biggest change sequentially from last quarter to this quarter and how those kind of play out into next year?
Yeah. I mean, I think the biggest thing that's on our mind for next year is, you know, we're thinking about inflation, and we're thinking about price increases. We're being very assertive with our price increases around passing the inflationary costs that we're seeing on to our customers because we have to. We saw that in Q3. We'll certainly see that in Q4, as you saw from our guide. I think that we may see some of that in the first half of next year as well. I'm sure you heard the Fed talk this week about, you know, short-term inflation, and that some of the stuff should normalize in 2022, but it's the question of timing. W e don't know if that's going to be Q1, Q2, or Q3.
We're just navigating through it. We're making sure that things like, for example, freight surcharges are things that we can do now and that we can change later. If the freight costs ease into next year.
Yeah. One of the biggest things that we're fighting is labor, actually, in the United States. We're trying to hire a lot of people in our LaGrange facility.
Yeah.
And that's not new .
My question was kind of more.
That's not new to us.
F or labor, do you think that gets any better at all into 2022 or just more of the same?
Yeah, we're starting to hire people. We're trying to hire 100 people in LaGrange.
All right. Good luck. I'll pass it along. Thanks.
Thanks.
Thank you, Brian.
Your next question comes from the line of Keith Hughes of Truist.
Thank you. Question on the fourth quarter revenue guidance, h ow do you think that's going to break out between the two regions in terms of their contribution to growth?
Yeah. I think it'll be fairly evenly mixed, Keith. I think both regions are really well positioned to have strong growth in Q4, and frankly, strong growth into next year.
Yeah, we have backlogs at record highs in both regions, actually.
It's true.
Talking about early next year, some of the raw material inflation that you and many others have been talking about, supply chain disruption. Do you think that's going to continue into the, at least the early parts of 2022?
Y arn is our biggest raw material input. I'm hoping that peaks. I'm hoping freight actually peaks as well. C ontainer charges have gone up significantly, as you know. I'm hoping that peaks in the first quarter.
We've had inflation and cost, obviously, h ave you had any issues getting materials across the world, some of the, you know, main ingredients to making carpet?
Keith, you know, we've been really fortunate in that regard. The short answer is no. We've had no production issues due to not having the raw materials that we needed to create our products, which is great. It's a shout-out to our operators. They've really been looking ahead and making sure that they navigate through to get the materials that they need. The big bottleneck, and we mentioned this to Brian on the earlier questions, has really been labor in our U.S. manufacturing facilities where we have quite a few open jobs that we'd like to fill that would increase our capacity.
Okay, final question on LVT, y ou know, a lot of port congestion, obviously. Did you miss sales, hit any LVT sales in the quarter, due to not being able to get it off the ship?
No, we had a pretty good inventory position going into it and we have been very fortunate on our supply chain.
Yeah. That's a great example where we've been striking the balance of making sure we invest in the right amount of working capital to make sure that, you know, we have enough product on hand to meet customer demand.
Okay, thank you.
Cool.
Your next question comes from Samuel Darkatsh of Raymond James.
Hey, Dan, Bruce. Good morning. How are you?
Hey, Sam. Good.
A couple questions, o ne, a clarification question. As you see your inputs and labor constraints today, when do you imagine that your price cost will turn neutral based on the pricing actions that you've already announced and what have you? What's the timing? Is it 1Q, 2Q? When do you expect to get price cost neutrality?
My sense is Q2. We're chasing raw material input costs, and I'm hoping that they're peaking, as I just said. In Q2, if we can actually see some kind of at least flattening of raw material price increases and freight, then Q2, we should get it.
Got it. Then, Bruce, can you quantify what the pricing rollover effect on sales would be for 2022 sales over 2021 sales? Since you've been raising prices as the year progresses, obviously, there's going to be a favorable rollover. How much growth would you get next year from that pricing rollover?
That's an interesting question, Sam. W e're working through our AOP right now around pricing and how much of that will flow through to next year. It should be meaningful, you know, because of all the pricing activity that we're doing here in the back half. We should get some pretty good flow.
Yeah, Sam, usually when we have price increases like this, inflationary, people actually tend to go down market on that. You don't really see the growth in the top line because they're actually changing the mix. That's really hard to quantify what that would be.
Do you anticipate that mix degradation occurring now, though? I would think that you have a somewhat, or at least more inelastic demand backdrop, or at least activity backdrop than normal, no, o r maybe I'm wrong?
Yeah, well, you know, we introduced Open Air, which is the dealer product program that's at a lower price. Same margin, but lower price, and we're seeing a lot of growth in that. It's really hard to figure out what kind of price increase will impact sales next year due to that.
Got it. My last question is and thanks for bearing with me. The SG&A cut in 3Q and 4Q versus your original expectations, can you be a bit more specific in terms of where that came from? How much of that was discretionary versus maybe structural? What a realistic SG&A footprint looks like next year based, if we assume kind of mid-single-digit growth?
Yeah. Sam, you know, we're just continuing to take a hard look at the cost structure of the company globally. We've been doing a lot of work around spans and layers, looking at the, for example, the number of direct reports that each manager or director has to her or him, and also looking at where work is done, whether it's done locally or regionally or, you know, in corporate. We're trying to make sure that we get the mix right so that we meet customer demands while also being the most efficient that we can be globally and leveraging our SG&A. This is an area that I just want to emphasize.
We are really proud as a management team that we've done great work, and great strides at bringing our SG&A as a percentage of revenue down, and it continues to be a real focus for us. Regarding the guide for next year, you know, when we release our Q4 earnings, we'll be able to provide more guidance around, you know, all of our metrics, quite frankly, some revenue growth, our GP, and our SG&A run rates and our tax rates. For now, I think that you can sort of think about a lot of the reductions that we're making are permanent reductions to the cost structure that flow through.
Yeah, one of the things so that we're really focused on, Sam, is getting it to 26%.
The $80 million run rate you think is a workable number over the near to intermediate term?
Yeah. We're focused more so on SG&A as a percentage of revenue so between the next 15 to call it 18 months, we're focused on getting it down to 26% over time.
Or lower.
Yeah.
Thank you. Thank you both.
Your next question comes from David MacGregor of Longbow Research.
Yeah. Good morning, everyone. I wonder if I could just start off by asking you to remind us on your fiber costs, your yarn costs. What percentage is recycled versus virgin fiber? I know you've got a very high percentage of recycled fiber but could you just remind us on the proportions?
Yeah. It's about half, David.
Okay. What's happening with recycled fiber costs?
That is going up less than virgin, for sure. A lot less.
Is it?
Yeah.
Would it be fair to characterize it as relatively stable or
No.
Inflation maybe just not hit it yet?
Well, inflation in yarn actually is labor and freight as well, and now energy, if you're manufacturing in Europe. The input costs were pretty stable but the process costs are not.
Okay. Maybe just a couple of the sort of qualitative points you made on your prepared remarks. You talked about the European CQuest Bio product. Congratulations on that. I know that's a big milestone in the industry. How differentiated are you on that? Are you unique in that sense or are there any of your competitors that have also left the bitumen behind and moved on to a bio-backed product?
We're very unique in that. I would say that Tarkett has a bio-based product as well in Europe. That's one of our biggest competitors there, but we're very unique in that.
One of the unique things is that every product that goes out the door now is a bio-based product. The bitumen has gone away entirely on every carpet tile that goes out the door in our manufacturing plant, which is a huge accomplishment.
Tarkett's not at that place.
Correct.
Right. Is the market in your spec writing, is the market really spec-ing that product now? Are they leaning pretty hard into that, or is this something where you think you're just out in front and it'll have future benefit?
Oh, it's starting to show up in specs.
Yeah.
Particularly in the United States.
Good. Well, congratulations on that progress. With regard to the dealer market initiative here in the United States, can you just. You talked about the fact that you're seeing strength in K-12 and healthcare, but I've always thought of that dealer market as being maybe more of an office market. Maybe you could just help us understand just what the growth drivers are behind your share growth there. Are you adding number of dealers? Is there sort of a growth i n the distribution pipeline that's helping this? ?
Yes. Yes. Yes, they are. It's pretty simple, David. We're focused on the dealer. We're acting like they're a customer now and not like they're an enemy. We're having a lot of success in that market. The dealers are very segmented, by the way.
In what sense?
No. They focus on healthcare, education, and the office market.
Right. Right. Is it still largely an office market at this point?
That's half our business.
Within the dealer channel?
No, it's segmented. Dealers, everybody has to install product, and dealers install it.
Okay. Maybe I can follow up with you offline on that.
Okay.
Then, just you talked about earlier on about the demand recovery. You're seeing commercial market recovery occurring. H ow much of the growth in the backlog numbers or in the order growth numbers you cited here would be related to the dealer market versus your spec business?
That's really hard to actually quantify that because 80% of our business goes through the dealer market. We just know we're focused on the dealer and we're winning discretionary business out of the dealer. To quantify it would be very difficult.
Okay. All right, gentlemen. Thank you very much.
Thanks.
At this time, there are no further questions. I will now turn the conference over to Dan Hendrix for closing remarks.
Well, thank you for listening to our call, and I'm just going to say it, go Braves. Talk to you next quarter.
This concludes today's conference call. You may now disconnect.