3 Things to Watch When Interface Inc. Reports

On Wednesday, modular carpet maker Interface (TILE -0.94%) is set to report third-quarter results to investors who have already braced themselves for the worst. Less than two weeks ago, the floor fell out from under the stock when the company suggested that sales and earnings could prove underwhelming in the latest period.

Here's a look at what the market expects going into the announcement.

Sources: Yahoo! Finance and management estimates.

As we look ahead, are things coming unraveled at Interface? Or could there be signs of a turnaround in the carpet market? Investors should focus on a few key items when the company reports this week.

1. Sales growth will probably be subpar

So far this year, Interface's sales have been sluggish. Positive trends in housing starts and commercial renovations have yet to bear fruit, as customers have tightened their budget for high-end carpeting.

As a result, sales are expected to be roughly flat or slightly negative for the third quarter: Interface's management recently forecasted sales in the range of $250 million to $255 million, which compares with $254.5 million during the same period of last year.

One of the reasons for stalling sales appears to be deferred order fulfillment. Customers are postponing product delivery and installation, which is expected to lead to an increase in backlog to $262 million from $255 million in the prior year. In addition, backlog is up 33% when compared with the beginning of 2013.

Management will probably elaborate on these deferred deliveries and on which regions have been the most affected. Interface has been predicting a "rebound" in the U.S. commercial office market for three straight quarters, so it would be reassuring to see evidence of this prediction taking root.

2. Management is balancing revenue and profit margins

On the surface, a couple of similarities exist between Interface's sales predicament and the story that recently unfolded at home-organization specialist The Container Store. Both companies are closely linked to growing spending on renovations, housing, and construction, yet neither of these high-end brands has performed well over the past year. And both brands have struggled to cope with an increasingly promotion- and discount-driven retail environment.

During the second quarter, Interface resorted to running its own promotional sales event to boost traffic, so it will be interesting to see whether management pulled this lever once again. If so, it failed to serve as much of a catalyst given the modest expected sales figures, and it also could have sacrificed some profit margins.

Still, giving up a little pricing power might not be the worst idea. Consistently sluggish sales mean lower throughput on the manufacturing side, and thereby more machinery downtime and increased costs. As a result, margin pressure seems to be cutting both ways right now, and Interface has to walk a fine line between reducing prices and lowering its own costs.

Fortunately, the company took measures to restructure during the quarter, an effort that is expected to yield $14 million in cost savings in fiscal 2015. As painful as it may be, Interface's steps toward reducing overhead can protect profitability even as it deals with lukewarm sales growth.

3. A buyback plan is in the works 

Beyond the operating results, expect management to shed some light on exactly when the company plans to buy back some of its stock. This is a new initiative that was the board of directors just approved earlier this month, but it is expected to commence in the fourth quarter. It allows for the repurchase of up to 500,000 shares of common stock per fiscal year, with no required minimum purchase.

Year to date, Interface's shares have lost 26% of their value relative to a 15% drop for the textile manufacturing industry. This buyback could prove to be a savvy move if Interface's shares are only temporarily depressed.

The takeaway for investors

Interface has yet to roll out the red carpet for shareholders in 2014, and it's hard to imagine that the narrative will change immediately. In the third quarter, sales are expected to moderate because of tepid consumer demand, and earnings will take a dent from restructuring and asset impairment charges.

Nevertheless, we'll learn more about the traction being made with its budding FLOR retail brand, and how Interface aims to grab market share in an estimated $11 billion consumer carpet industry. Its business is hardly unraveling, but so far it has unfolded a little more slowly than the market expected.