Good morning. My name is Denise, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Q2 2018 Interface, Inc. Earnings Conference Call. Thank you. Christine Needles, Global Corporate Communications, you may begin your conference.

Thank you so much, Denise, and good morning, and welcome to Interface's conference call regarding second quarter 2018 results hosted by Jay Gould, President and CEO; and Bruce Hausmann, Vice President and CFO. 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 December 31, 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 this call and cautions listeners not 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 express 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, and thank you for joining our second quarter results call. It's an exciting time at Interface. We delivered another solid quarter of operating results with strong top line performance. We also announced our intent to acquire nora systems, a global leader in performance flooring and the worldwide share leader in the rubber flooring category. I again want to thank the entire global Interface team for their continued focus on results as we all concentrate on execution to deliver our value-creation strategy. I'm proud to work alongside such a talented team and appreciate all the team members around the globe for the hard work that was done to deliver another solid quarter. I also look forward to working with the entire team as we enter the second half of 2018 and look forward to our continued focus to create value for all of our stakeholders, including our shareowners, our employees, our customers, and of course, the environment. Let me talk through some of the highlights of the second quarter. Once again, we delivered solid performance down the P&L with second quarter GAAP net sales growth of 12.7% year-over-year and organic sales growth of 10.6%. We continue to see these increases across our portfolio with core carpet tile and LVT contributing equally to our sales growth in the quarter. Turning to order momentum, our organic orders, which adjust for the impact of foreign currency fluctuations, were up 9.7% year-over-year. Overall, these strong revenue and order trends are on pace with our expectations. As you may recall, during our quarter one earnings release, we anticipated that in the second quarter, net sales would grow in the 9% to 11% range. So, we were pleased to see the second quarter actual results in-line with those expectations. There are a number of key…

Good morning. Thanks, Jay. Good morning to everyone. And as a reminder, organic sales, organic sales growth and organic order growth adjust to exclude the impact of foreign currency fluctuations and the impact in Q1 last year, as we fully exited floor specialty retail. In addition, adjusted operating income, adjusted net income and adjusted EPS adjust to exclude last year's Q1 charge related to exiting floor specialty retail and transaction costs related to the nora acquisition. Let's take a closer look at second quarter 2018 results. Second quarter GAAP net sales were $284 million, up 12.7% over the prior-year period; and organic sales were up 10.6% year-over-year. Breaking our revenue down into more detail. Net sales in the Americas grew 13.8% compared to Q2 last year with broad-based growth throughout the region. And in local currency, EMEA's net sales grew 5.6% year-over-year. In U.S. dollars, EMEA's net sales were up 13.9% year-over-year as we benefited from currency tailwinds. And in Asia-Pacific, net sales were up 2.8% compared to Q2 last year with continued momentum in China. Taking a look at global market segmentation. Core office saw double-digit growth over the same period last year, and we continued to see increases in our non-office segments including retail, healthcare, hospitality and education. Q2's organic growth were up 9.7% year-over-year with carpet tile and LVT contributing relatively equally. Orders – or, I'm sorry, Q2's gross margin was 38.5%, reflecting a 40 basis point year-over-year decrease as a result of delayed productivity initiatives due to increased sales volume and a change in this quarter's revenue mix that was more heavily weighted toward our InterfaceServices business. And SG&A expenses were $75 million or 26.6% of net sales, which included $3 million of transaction costs related to the nora acquisition. Now, excluding these transaction costs, SG&A…

Thanks, Bruce. So happy you're on the team. We continue to focus on execution of our strategic agenda to become the world's most valuable interior products and services company. And with the planned acquisition of nora systems, we anticipate to accelerate our value creation. In the first half of 2018, we delivered EPS growth consistent with our expectations, a 30% increase in year-to-date GAAP EPS and a 26% increase in year-to-date adjusted EPS. This growth rate puts us on track to deliver our full year commitments. Let me walk you through the building blocks of our 2018 outlook again before we wrap up our prepared remarks. Looking at the full year of 2018, Interface's existing carpet tile and LVT business is targeting to achieve a 4% to 7% organic sales growth, gross profit margin of approximately 39% and SG&A expenses that are relatively flat to 2017 as a percent of sales. Depending on the exact date of the transaction formally closing, which will determine when nora's business results start being included into Interface's business results, the nora acquisition is anticipated to have the following impacts on Interface's targeted full year 2018 results. It will increase gross profit margins by 30 to 50 basis points. It will increase SG&A expenses as a percent of net sales by 70 to 100 basis points. It will increase the company's effective tax rate to 27% to 28% and it will improve adjusted EPS by $0.03 to $0.06 in 2018. Full year post-closing company interest and other expenses are projected to be $17 million to $19 million, which includes interest expense related to funding the nora acquisition through a term loan facility. Capital expenditures for the full year post closing are expected to be $50 million to $60 million. Based on historic seasonality, current forecast and prior-year comparables, the company continues to expect its strongest operating income growth in the second and third quarters with softer growth in the first and fourth quarters. In summary, 2018 will be a very solid year with meaningful progress on our strategic agenda, sales force transformation, innovation that drives incremental growth, investments in our global supply chain that enhance productivity, continued progress in our industry-leading sustainability programs, and upgrading talent and capabilities for future growth. And our financial performance in 2018 marks another high-water spot for the company. And so, with that, I'll turn to the operator for questions.

Your first question comes from Brian Biros with Thompson Research. Your line is open.

Hey. Thank you for taking my questions, and congratulations on the good quarter results.

Thanks, Brian.

Given the slight drop in margins due to the productivity delays from the increased volume, it's a good problem to have. Can you add any color to how we think about that going into the back half of the year and if continued sales volume growth might cause any further delays? And if that poses any risk to reaching the full year 39% guidance?

Well, first of all, we feel very confident in the 39% that we've talked about. We began the year saying the range was going to be 39% to 39.5%. We've had about a $5 million delay in some of our productivity initiatives, so that's a 50 bps hit for the year. We do anticipate back-half margins being slightly stronger than front-half margins as our productivity programs will achieve the targeted number. We are not experiencing input cost inflation from raw materials that we've heard other companies talk about. I think we appropriately forecast those for the year, and all our raw materials are coming in as planned.

Thank you.

Your next question comes from Michael Wood with Nomura Instinet. Your line is open.

Hi. This is Mason Marion on for Mike. So, last night, one of your peers reported that they were experiencing issues sourcing enough LVT. Were you impacted by this shortage during the quarter, or are you seeing shortages currently?

No, we're not. We're not seeing any shortages. And the other thing I would add to that, Mason, is we are not subject to the tariff conversations. We are not sourcing out of China. We actually source out of Korea. And we made the decision because we went into the business in an asset-light way, we went heavy into working capital. So, we've got plenty of inventory to support the growth of LVT, which by the way is exceeding our expectations. LVT continues to do really well in the market.

Great. Thank you. And then, you reported another quarter of strong growth here. Is there anything you can call out that's driving this order growth? Is there perhaps another large order in there like you called out in 1Q?

No, I mean, we're doing really well with one of our retail customers in the U.S. who are remodeling a bunch of stores. But we've seen broad-based growth really across the portfolio, whether it's carpet or LVT. Plus, geographically, I think Bruce talked a little bit about the strength in the U.S., but seeing Europe come back with 6% organic growth in local currency; really, really strong. So, we're feeling the impact I think of two big things. One, our sales force transformation efforts that we started last year; and, two, our new products are really driving incremental growth.

The other thing I would add, Jay, is the segmentation was so strong this quarter. We had growth in core office, we had growth in retail, healthcare, hospitality and education. And so just from a segmentation standpoint, it was a fantastic quarter.

Yeah.

Thank you.

Your next question comes from Matt McCall with Seaport Global Securities. Your line is open.

Thank you. Good morning, guys.

Good morning, Matt.

So, maybe hit those – that $5 million again. I just want to understand it a little bit more. So, you said that – there were two things you called out. You talked about mix pressures, and you talked about productivity delays, I guess. Is that $5 million, does it encompass both of those sources of pressure?

Yeah, it does, Matt. On the labor front, I'll say two things. I mean, we've had to add more people in the plants to produce this amount of volume, and we've run every Sunday for the last four months, which is a labor rate issue. So, the mix issue is related to our Services business. Although we make a similar margin on selling carpet, we make a much lower margin on labor because it's not our own labor. We use sourced labor, so we don't mark it up as much. So, the gross margin on that piece of business is lower.

So, of the $5 million – go ahead, Bruce. Sorry.

Yeah. I just want to clarify. As you know, we're on a journey to capture $30 million of cost productivity. We captured $10 million last year. We're going to – we're still going to capture that $10 million of this year. It's just a little bit of a pause, and then we're going to capture $10 million next year. So, this is just a short-term pause, and we continue to be on track across the company on our journey.

Yeah, yeah. We'll exit 2019 exactly where we expected to be.

Yeah.

And then, when you talked about the cost savings initiatives and the manufacturing changes at South Georgia, can you talk about the steps along the way? What – I understand the cost savings, and that's helpful. But what's occurring? And then, beyond the cost savings, how much of that is going to help eliminate the productivity issues and the need for temporary labor and working Sundays, things like that? I'm just trying to understand, as we hit these thresholds, what actually occurs at the facilities.

Well we are building extensions onto an existing manufacturing location. So, the first step, Matt, was 18 months ago we put in a proof-of-concept tufting operation to prove that we could run this long-run facility. Then, over the course of last year, we were in the process of then installing more tufting machines. So, we now have seven tufting machines. We'll ultimately have 12 to 14 tufting machines. But we had to build an extension onto the building. So, that's in process right now. That will be fully complete by the end of this year. So, we'll add the other five to seven tufting machines. Then, we have to build another 100,000 square-foot extension onto the facility, which is already planned but we haven't started construction on that. We'll complete that at the end of 2019. So, then, that facility will be fully built out and we'll be delivering on the $30 million of savings that we promised. We actually have another initiative that starts in 2020 and will go through 2020 and 2021, which will bring additional productivity benefits, so beyond the $30 million. So, we still have a lot of room left in that productivity funnel.

Okay. And then – thanks. That's very helpful, Jay. Thank you. But the – I guess the rolling (00:23:55) question will be, give me an update on the CapEx plans associated with this, how they're going to layer in over the next few years. Including, are there any additional – is there any additional spending tied to that 2020 to 2021 plan?

Well, I mean, I just – so we're going to spend $50 million to $60 million this year, which includes nora, by the way. So, we're slightly delayed a little bit inside our build-out in LaGrange. But we're fine. We'll probably spend a similar amount next year, $50 million to $60 million, as we tackle that 100,000 square-foot addition. We'll give some guidance for next year probably as we get into the fourth quarter because we need to get through nora, to be honest with you. They have relatively modest capital spending. But we just want to make sure. We need to dive into their planning.

Okay. And I'm sorry, one more question for me. Jay, you talked about the strength in office, and, Bruce, you talked about the segmentation benefits in the quarter. But can you just talk about your overall cyclical viewpoint, Jay, as we've come through some of these policy changes in Washington? We've seen some of the macro indicators we watch kind of show some improvement. What's – have you seen any changes? Obviously, the top line is working pretty well. But have you seen any changes? And then, how has it changed your outlook as we move out into 2019 just from a pure cyclical perspective?

Well, look, I think a lot of the conversation coming out of Washington is purely negotiation tactics. If tariffs are enacted, we've got our assets deployed globally. So, we're fine. We're forecasting no penalty if the tariffs do get enacted. I think yesterday we made progress with Europe. So, it's feeling still pretty robust. I mean, we're going to see global GDP announced I think later this week. But we're feeling the positive impact of global economic growth. And even in our European business, I mean, being up 6%, Matt, in the quarter, I mean, that's pretty solid growth for us.

Okay. Perfect. Thank you, Jay.

Your next question comes from David MacGregor with Longbow Research. Your line is open.

Good morning, everyone. Jay, if I could just start on LVT and you kind of set this question up a little bit earlier in responding to the sourcing question. But the two things that have really sort of distinguished your LVT business to me is, number one, you're not really sourcing. You've got a contract manufacturing arrangement, if I understand that correctly, which has maybe some nuanced differences but it's a more reliable supply channel. And then, secondly, as you pointed out, it's Korea rather than China. So I guess the question here is as these tariffs start to unfold, and whether they actually ultimately come to pass or whether this is just a bunch of saber-rattling I guess remains to be seen, but let's assume for a moment it does come to become some kind of a meaningful impediment for foreign flow into the U.S. market, how much of a competitive advantage is that expected to provide to you? And have you sized that at all?

Let me first validate a couple of your assumptions, and then I'll talk about the tariffs. Absolutely this is contract manufactured, not sourced. We design the product and then went to look for a world-class manufacturer to make it for us. We chose a company in Korea. It's actually owned by a Japanese company, so we have redundant manufacturing capabilities in two different countries in Asia. We – when we launched the business, we said we'd do $50 million in the second year, and we are well on track to actually beat that. Are there upsides? Potentially. We haven't really factored that into our outlook because I don't know how to factor it in. But all I can say is the business continues to gain momentum around the world.

Yeah. If you were to pick up an extra 10% market share or 5% market share, can you quantify what that increment would represent in terms of revenue?

That's massive. But I'd like to say – so the carpet tile business globally commercial is $4.4 billion, growing at a couple percent. Our metrics would say the commercial LVT business is $2.7 billion category, growing at 10-plus percent.

Yes.

So, we are just skimming the market right now with our $50 million business.

Right.

We have plenty of room to grow. If we picked up 5 share points, it would be huge.

Okay. I got that. Just a couple other questions. You've got some competitors right now that are bringing on carpet tile capacity in both the U.S. and Western Europe. Could you just talk about the degree of overlap with your offering and how you're responding to that?

Well, despite the threat that the sky is falling, we haven't felt any of that. As you know, those – the majority of that expanded capacity is in a piece of the industry where we don't really compete, which is $10 a square yard carpet tile. And our average selling price is north of $20. So in the dealer market, in the low-end of the market, I think Engineered Floors is going to make progress. I mean, I think Bob Shaw is a really smart guy. But we haven't seen any impact on our business at all. And as the numbers would show, David, we are taking market share.

Yeah, that would appear to be the case. InterfaceServices, is this kind of a one quarter event, or should we anticipate this continuing through the second half?

We are also anticipating a really strong third quarter overall and with Services. I think we'll have 8% to 10% revenue growth in the third quarter – organic revenue growth in the third quarter.

Great. Thanks, and congrats on the progress.

Yeah. Thanks, David.

Your next question comes from Judy Merrick with SunTrust. Your line is open.

Judy in for Keith. Just to clarify a couple items. You talked about the double-digit growth in the core office. Was that in the Americas or was that global or kind of all across your geographies?

Yeah. Judy, it was all across. We had a really strong progress in office in all three of our regions.

And it was kind of consistent through the quarter, would you say?

It was, it was. It was a good, smooth quarter.

Okay. Great. And also, in the first quarter, you mentioned a large customer order hitting sales in 2Q and 3Q. Is that still your expectation? And also, can you remind me, is that mostly LVT or carpet tile or kind of a mix for that large customer?

Yeah. It was the large retail customer that are remodeling a bunch of stores here in the U.S., and it primarily is impacting Q2 and Q3. Sorry, what was the other part of the question?

And is it carpet tile or a mix (00:31:30)?

It's – and it's mostly carpet.

Got you. Okay. Great. Thank you so much.

You're welcome, Judy.

Thanks, Judy.

And there are no further questions queued up at this time. I'll turn the call back over to Jay Gould.

Thanks, Denise. Thanks, everyone, for participating. We feel really good about the quarter. The year is shaping up exactly as we thought it would; really pleased with the execution across the company, and look forward to the next quarter call. Thanks for participating.

This concludes today's conference call. You may now disconnect.