Good morning. My name is Karina, and I will be your conference operator today. At this time, I’d like to welcome everyone to the Q3 2017 Interface, Inc. Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Ms. Christine Needles, Global Corporate Communications, you may begin your conference.

Thank you, Karina. Good morning, and welcome to Interface's conference call regarding third quarter 2017 results, hosted by Jay Gould, President and CEO; and Bruce Hausmann, Vice President and CFO. Before we begin the remarks, please note that during today's conference call management's comments regarding Interface's business, which are not historical information are forward-looking statements. Forward-looking statements 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 economic conditions in the commercial interiors industry as well as the risks and uncertainties discussed under the heading Risk Factors in Item 1A of the Company's annual report on Form 10-K for the fiscal year ended January 1, 2017, which has been filed with the Securities and Exchange Commission. We direct all listeners to that document. The Company assumes no responsibility to update or revise forward-looking statements made during the call and cautions listeners not to place undue reliance on any such forward-looking statements. Management's remarks during this call refer to certain non-GAAP measures. A reconciliation of these non-GAAP measures to the most comparable GAAP measures is contained in the Company's earnings release and form 8-K filed with the SEC yesterday. Lastly, this call is being recorded and broadcasted for Interface. It contains copyrighted material and may not be rerecorded or rebroadcasted without Interface's expressed permission. Your participation on the call confirms your consent to the Company's taping and broadcasting of it. Now, I'd like to turn the call over to Jay Gould, CEO.

Good morning. I would like to begin by thanking the Interface associates around the world for delivering another solid quarter consistent with our expectations and in line with our full-year commitments. I'm particularly pleased to see the balance of initiatives that delivered down the P&L. Strong innovation in our core carpet tile business coupled with our new LVT product line, provided strong growth in orders, and in revenue. Targeted productivity initiatives, more than offset our input cost inflation as our gross margin increased 90 basis points in the quarter. And our spending controls helped reduce SG&A as a percent of sales by more than 70 basis points in the third quarter. Now albeit against the softer Q3 of 2016, our operating income grew 20% and our earnings per share increased 28% for the quarter. Over the past year, we've been executing our value creation strategy and the most recent quarters provide evidence that our strategy is working in the marketplace. Organic order growth has climbed sequentially from 4% in Q1 to 5.7% in Q2 to 6.5% in Q3. Certainly, we've gained share in the overall carpet market, and our LVT product line has driven incremental growth. Strong productivity initiatives have enabled us to deliver at the higher end of our gross margin forecast range, 38% to 38.5% for the year. SG&A control should also deliver our forecast range of $260 million to $265 million for the year, and we’ve executed against our share repurchase initiative. These activities generated year-to-date EPS of $0.78, but if you exclude our first quarter restructuring charge, year-to-date EPS is $0.86, up 13% versus last year. And we believe that we are on track to deliver our full-year outlook as we’ve expressed on each one of our quarterly calls. Now let's look at Q3 in a…

Thanks, Jay. Good morning, everyone. As Jay noted, net sales in the third quarter were $257.4 million, up 3.7% versus Q3 of last year on broad based growth, with all regions showing improvement. Adjusting for the impact of foreign currency fluctuations and exiting FLOR specialty retail, we experienced an organic growth rate of 3.9%. We are continuing to see solid momentum in organic order growth, up 6.5% over the prior year with both core carpet tile, and the LVT business contributing relatively evenly to organic order growth, we're seeing positive reception across both pieces of the business. Sales in the Americas were up 2% in the third quarter compared to Q3 last year with growth across the region, including Canada, and our Interface services business. In local currency, sales in EMEA were up 2% year-over-year with modest improvements in several markets compared to Q3 of last year. And in U.S dollars, EMEA sales were up 6% year-over-year, as we benefited from currency tailwinds. Asia-Pacific had a strong quarter, where sales were up 12% compared to last year, with both Asia and Australia contributing double-digit growth. In terms of our global market segmentation, core office was up over the same period last year and we continue to see strong increases in non-office segments, particularly in education and government. Sales were down in our residential segment really due to the exiting of FLOR specialty retail as expected. Gross margin was 38.3% for the third quarter, which was an increase of 90 basis points over Q3 of last year. This is a result of our productivity initiatives, including the Troup County optimization project, which delivered margin expansion that was greater than the negative impact of exiting FLOR specialty retail. And for the full-year, as Jay mentioned, we continue to target gross margin in…

[Operator Instructions] Your first question is from the line of John Baugh from Stifel. Please go ahead. Your line is open.

Thank you. Good morning and congratulations on solid results. Jumping right into questions. I know, you don’t want to get into guidance next year, but Jay, maybe -- I appreciate if you could talk a little bit about some of the drivers on gross margin next year. I am particularly interested, how the price realization is matching up with what you expect input cost. I know you get a lag from your suppliers on that. And then how the Troup County initiatives may give you added boost as well. Any factors you can talk about around gross margin from a higher level going into next year would be helpful? Thank you.

Yes. John, thanks for your comments, appreciate it. We are still looking for a 50 to 100 basis point improvement in gross margins for next year. So we are looking at 39% to 39.5%. The positive drivers of that are really the Troup County initiative and strategic pricing that we have. The counterbalance that is, we do have some input cost inflation that we are expecting, about the same as what we experienced this year, somewhere around $8 million to $12 million. And the other offset is, we are still playing around LVT margins. This year they’ve been accretive to the line, but as we roll out globally, the pricing is not quite as robust as it is in the U.S. So we think that that might put some downward pressure on the gross margin line.

Okay. That’s helpful. And then you mentioned innovation in carpet tile, I am wondering precise to what you are referring to there? And then, we are aware of some low price carpet tiles, I believe with polyester face fibers getting more prominence in the market, could you discuss that and your response to that, if any, if needed? Thank you.

Yes. Well, first of all, on innovation, I'd say that this is largely design driven innovation. But we monitor, what we call our new product by [indiscernible]) index, which is the percent of our business, which is generated from products introduced over the last three years. And if you look at the most recent reading, we are up 200 basis points. So our new design innovation that we launched over the last year has been particularly well received in the market. So that’s part of what’s driving this strong order growth that we’ve received. Now, we are aware of some polyester carpet tile, it's out in the market at $8 or $9 a square yard. We don't really compete in that market, John, as you know. I mean, it has had no material impact. We believe that we gain market share in the quarter. And so, while there may be some of that activity going on at the lower end of the market, that’s not really where we compete and have not really felt that pressure.

Okay. And my last question would be, I guess on the U.K. market, which is an important market for you, any color there around Brexit and the trends you’re seeing there, plus or minus? Thank you.

Yes. I mean, we have mid single-digit growth rates in the U.K. for the quarter and, again, really for the year-to-date, so far. Orders were a little soft in the third quarter, but I think we will end up posting currency neutral revenue growth for the full-year.

Great. Thank you. Good luck.

Thank you, John.

Thank you, John. I appreciate your support.

Your next question is from the line of Kathryn Thompson from Thompson Research Group. Please go ahead. Your line is open.

Good morning, Kathryn.

Good morning. Thank you for taking my questions today. On the orders, could you give a little bit more color on how order ends? Your orders, which you outlined in your prepared commentary matches up with your sales flow through. How this impacts your Q4 and potentially 2018 sales outlook? Thank you.

Yes. First of all, order -- the order pacing through the quarter accelerated, so we had a really strong September. Secondly, there's been a buildup of our backlog on the carpet tile through the course of the year. We’ve been running at about 3% order growth on carpet tile the entire year, but that’s only translated to about 1% growth onto the P&L. So we’ve got a very solid order backlog as we go into the fourth quarter. That coupled with this acceleration of order intake during the quarter leads us to be bullish that we will deliver on that 8% to 10% revenue growth in the fourth quarter.

And just to clarify, how much did hard surface or LVT contribute to the top line versus carpet tile growth in the quarter?

In the quarter, about 3/4 of our revenue growth was driven off of LVT. So roughly, 1% from carpet tile and 3% from LVT. We think that will rebalance in the fourth quarter, so if we are looking at the 8% to 10%, I think it will be driven roughly 50-50 between carpet tile and LVT in the fourth quarter.

Yes.

Okay. And so speaking of LVT and closing the loop on that, you are still on target for that $25 million boogie for 2017?

Yes, we are.

Okay. And then finally, you outlined some initiatives that you’re going to be -- that will put you on the upper end of that SG&A range for the year and as we look into next year. Could you give us a little bit more color on the types of initiatives you’re doing, are these more sales or operational or a combination? Thank you.

Yes, thanks for asking, Kathryn. Because we are really delivering on our commitments for this year, I felt like we could go ahead and accelerate two investments in particular. One is in our global selling system, where we’re investing significantly, I mean, $3 million over a 2.5 year time period to drive some more sophistication in how we go to market. So we are deploying a sales methodology globally and so we’ve started that investment. The second piece of the investments that we’re accelerating is actually into our technology or IT areas. As you know, we went -- last year we went -- we took our ERP system down to the factory FLOR in Asia-Pacific. This year we took it down to the factory FLOR in Europe, and next year we’re taking the ERP system down to the factory FLOR in the Americas. So we’re making some investments to sure up our ability to seamlessly transition to that further deployment of our ERP system.

Great. Thank you so much for the color. Have a great day.

Thanks, Kathryn.

Thanks, Kathryn.

Your next question is from the line of Mike Wood from Nomura Instinet. Please go ahead. Your line is open.

Hi. This is Mason on for Mike. So year-to-date, gross margins are tracking at 38.9% which is above your framework from 38% to 38.5% and suggest 4Q would have to be below 37.3% to fall within that range. Can you kind of bridge how we get there?

Yes. Thanks, Mason. You are right. So sequentially the GP margins will go down. This is really just a factor of when you think about how the business runs seasonally. In Q4, we will get less fixed cost leverage as we run the plants for a less amount of time in this quarter versus in Q3. So it's really just a -- it's just that simple of an equation.

Okay.

And last -- Q4 margins were 37.5% and it will be in that same ZIP code this year.

Yes, okay. All right. It makes sense. And then, one of your competitors recently opened up a European carpet tile plant, has anything -- has the competitive situation changed there at all?

No, we haven't felt the pressure from that. I was pleased to see that we got 2% growth in our European business for the quarter, that's -- it's actually a little bit better than we have been doing. So we are seeing a step up in the business there as well.

Okay, great. Thank you.

That was in local currency, by the way, Mason.

Okay.

Your next question is from the line of Matt McCall from Seaport Global. Please go ahead. Your line is open.

Thank you. Good morning, guys.

Good morning, Matt.

Good morning, Matt.

So, Jay, maybe go back to the John's question on the gross margin drivers. Just trying to understand that 50 to 100 basis points -- I thought it was interesting, you said $9 million productivity savings year-to-date that's net of inflation. So I assume, I think, the inflation number you had talked about was around $9 million, so $18 million of net savings. The components, again, when you talk about productivity savings and inflation, I know you talked about LVT in the pressure, but what -- I am trying to get at what part of that 50 to 100 basis points is kind of relying on top line? How much of it is just within your control through some of these moves you are going to make on the productivity side? How much inflation is expected to hurt, I don't think you quantified that number. Can you just give a little more detail?

Just to clarify, are you speaking about 2018, Matt, or you are talking about 2017?

Yes, I was talking about -- I think, Jay's comment to John's question earlier was the gross margin kind of big components from next year.

Got it. Okay.

Yes. So Yes, so -- I mean, the basic math is we are expecting to have around $22 million of gross productivity, which will be offset with $10 million to $12 million of inflation. Now, of the $22 million, about half of that’s coming from our Troup County transformation project and the other half is coming from a variety of different productivity initiatives that we drive around the world. I would say that 0% of our gross margin improvement is the result of volume increases. So we don’t need to increase our volumes to be able to deliver that 50 to 100 basis point improvement in gross margins.

Okay. Okay. But it's not saying that we don’t expect volume, it's saying that we don’t need volume.

Yes, we don’t need volume, number one. And we may not produce that because I would like to take a little whack at finished goods inventory. So we may produce flat volumes for next year and still deliver the 3% to 4% growth.

Okay, got it.

That growth is also split between carpet and LVT and as you know, the LVT is sourced. So we don’t want to bank on our couple points of volume growth to hit our gross margins.

Okay, perfect. And then to the SG&A question, you talked about the investments you’re accelerating, did you talk -- was that a reference to -- also to '18 and is that kind of forecasting some elevated SG&A? How are you thinking about SG&A relative to those two accelerated investments?

Well, I think, conservatively, we would say that SG&A as a percent of sales is going to be flat next year.

Okay.

So, we are going to drive our operating margin by 50 to 100 basis points based on our gross margin expansion.

Okay, all right. And so is that -- is the case there, that you get better volume and you can potentially drive some SG&A leverage, so volume is going to help on all fronts again, that’s assuming no volume improvement?

Well, we are going to invest behind the revenue curve on SG&A to be honest with you. I mean, we got to deliver the year, we are looking to have double-digit EPS growth for the year. So we won't put the SG&A out until we are assured that we are going to get that revenue growth.

Okay, perfect. And then, last one, Bruce, did I hear you say, CapEx is $35 million to $45 million? I don't know, if I had a number that was too high in my model, but I had something higher than that, did anything change or was my model wrong?

Yes, we brought the number down slightly. And on the Troup County optimization project, as Jay mentioned, we are completely on track from the economics of that project, from the actual construction of that project where some of that is going to shift from this year into next year, which is just -- It's just a shift of actual, when the actual checks get cut for the pieces of that project.

Yes, we were hoping to have shovels in the ground in July and we will have them in the ground in the fourth quarter, but it was just a little bit delayed. Again, we validated the economics, we pulled in the $10 million that we expected to get out this year, but the capital spending is just -- had been delayed relative to expectations.

Okay. So does that point to kind of a $50 plus million spend next year?

Probably. Yes, that sounds right.

All right. Thank you, guys.

[Operator Instructions] Your next question is from the line of David MacGregor from Longbow. Please go ahead. Your line is open.

Yes. Good morning, everyone. Nice quarter, Jay. I guess, I wanted to tap in on this discussion around SG&A, and you make the observation in your prepared remarks and in the press release that there is largely a repurposing of SG&A going on here and references made to the FLOR business, of course. I guess, I want to just get you to talk a little bit about the extent to what you feel this repurposing opportunity allows you to keep the SG&A and sort of that, these levels are flat to revenue as you go forward, and how much more revenue growth opportunity do you have off this SG&A spend before we can see any inflection in SG&A?

Well, as you know, our longer-term strategy, David, is to bring that percentage down.

Okay.

So I would like to be able to run it at a 30 to 50 basis point improvement in SG&A. But we are also in this transformation phase of the company as we attempt to really globalize and get a, I would say, professionalize the company. So we are looking at a flat SG&A as a percent of sales for next year, so we can make these couple of investments, I think are critical. But longer term, I still want to bring that number down to under 26% of sales, that is the intention.

And you also have to remember the credit that, target SG&A run rate was -- the run rate was $275 million entering into this year. So when we are bringing it from to $260 million to $265 million this year, it actually is a net reduction to SG&A, in addition to the repurposing that's happened, David, as we’ve launched the new LVT business. So, it's been a big success for the company. It's been a muscle, that I think the company has learned and is learning -- continuing to learn how to flex is to move the SG&A around, so that we can continue advancing and accelerating the business and leveraging the business. So -- and if we can keep it flat as a percentage of sales, next year, and continue to accelerate growth as we’ve sort of planned, we consider that a win and we consider that there will be some nice drop through on the bottom line, and nice EPS growth.

Maybe just ask the question in a different way then. Out of that $265 million, how much of that is structural, and just -- kind of out reached to you and what portion of that $265 million might be available for repurposing?

I mean, it's -- that’s kind of a hard question. I would say, it's all available for restructuring to be honest with you. I mean, we are constantly looking at how do we -- where do we best spend our SG&A. So I think, when we were at that $275 million run rate, we took about on an annualized basis about $12 million out of SG&A for the FLOR stores. Then we took another $10 million, as we went into this year, to repurpose it towards LVT activity. So -- and that’s all pretty much played out as planned. One of the challenges that we have, David, in running the company is, I’ve added about $10 million of expense at the corporate center to help build functional capabilities, like product management, HR, and so we are taking that $10 million that we’ve invested at the center and taking it out of our regions. So we are constantly looking at that total $265 million budget and say, how do we reshape that to make sure we are competitive for the future.

Okay, great. Just a couple of follow-ups, if I could. You talked about the acceleration in September orders, can you drill into that a little for us and just let us know, kind of, what was driving that?

Well, honestly, what I think is happening is, as we -- as the years progressed and corporate earnings have been relatively strong, people are releasing their capital budgets. They want to get them spent before the end of the year. And, I think more than anything, that’s what’s helped -- that’s why we believe our backlog will be able to release that backlog and orders continued to be strong. I mean, as we are here in the first few weeks of the fourth quarter, orders remain really strong year-over-year.

Any specific verticals into driving that, Jay?

Well, corporate office is one that’s been very solid. Education has been very strong this year. I think state coffers have been refunded. So I mean, it's really across the board, our biggest weakness right now is in retail, not a surprise, I guess there and also residential is weak.

Okay. And last question, just -- to what extent do you see growing domestic capacity and LVT becoming a sort of a competitive issue for your Asian source of products?

Sorry, I missed the first part of that, David.

Well, just you got increasing domestic capacity in LVT, and I am just wondering to what extent you are seeing competitive issue for your Asian source product, and can you just talk about that dynamic a little bit?

Yes. Our pricing in the U.S. is really held up. I think we had the sweet spot on pricing, it has not been an issue for us at all. I think a lot of that capacity that came on board in the U.S. is directed towards residential, big box.

Right.

So, again, I think, we got the product in the pricing right on LVT at least so far.

Great. Congratulations on all the projects. Thanks.

Thanks, David. I appreciate it.

Thanks, David.

There are no further questions on the phone at this time. I will now turn the call back over to Mr. Jay Gould. Well, thank you very much. We had a very solid quarter, we are looking forward to delivering the year and we appreciate your support. We will talk to you next quarter. Thank you.