David Foshee - VP, Senior Counsel Dan Hendrix - Chairperson, President & CEO Patrick Lynch - SVP CFO.

Stephen Kim - Barclays Josh Borstein - Longbow Research Kathryn Thompson - Thompson Research Group Mike Wood - Macquarie Research Matt McCall - BB&T Capital Markets John Baugh - Stiffel Nicolaus.

Welcome to the Quarter Two 2015 Interface, Inc Earnings Conference Call. My name is Sheila and I will be your operator for today. [Operator Instructions]. I would now like to turn the call over to Mr. David Foshee, Vice President, please proceed, sir..

Thank you, Operator. Good morning and welcome to Interface's Conference Call regarding Second Quarter 2015 results. Joining us from the company are Dan Hendrix, Chairman and Chief Executive Officer; and Patrick Lynch, Senior Vice President and Chief Financial Officer. Dan will review highlights from the quarter, as well as Interface's business outlook.

Patrick will then review the company's key performance metrics and financial results. We will then open the call for Q&A. A copy of the earnings release can be downloaded off the Investor Relations section of Interface's website. An archived version of this conference call will also be available through that website.

Before we begin the formal 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 December 28, 2014 which has been filed with the Securities and Exchange Commission.

We direct all listeners to that document. Any such forward-looking statements are made pursuant to the Private Securities Litigation Reform Act of 1995. The company assumes no responsibility to update or revise forward-looking statements made during this 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 results release in Form 8-K filed with the SEC yesterday.

These documents can be found on the Investor Relations portion of the company's website, www.interfaceglobal.com. Lastly, please note that this call is being recorded and broadcasted for Interface. It contains copyrighted material and may not be rerecorded or rebroadcast without Interface's express permission.

Your participation on the call confirms your consent to the company's taping and broadcasting of it. Now, I would like to turn the call over to Dan Hendrix. Please go ahead..

Thank you, David. Good morning everyone. As you've seen our earnings release, our second quarter was essential a further improved version of the first quarter. With many of the same strategies and dynamics driving our continued growth in both sales and profitability. When I looked over the results a handful of things jump off the page.

In local currency sales are up a healthy 10%. This outpaces the rest of the industry by a wide margin. Which indicates that we're taking significant market share in doing so in a rebounding corporate office environment. Gross margin is up 370 basis points versus the prior year. With triple digit increases coming in all three of our operating regions.

This represents many months of dedicated hard work by our associates on issues ranging from lean manufacturing to increased selling prices, power production volume, product mix management, dematerialization and lower raw material input cost.

I want to thank all of our associates for helping us realize this improvement, particularly our sales and manufacturing teams. Operating income is up 330 basis points to 12.6%. This quarter's earnings per share of $0.33 ties our all-time record set in the fourth quarter of 2007.

We had excellent results with cash management generating $12.7 million during the quarter compared with a use of $5 million in the second quarter of last year. A year over year swing of more than $25 million. As expected, currency fluctuations played a larger role in our reported results.

Making a lot of the underlying health and growth of our business. On a consolidated basis, currency negatively impacted sales by $24 million and operating income by $3.4 million. Primarily due to the declines of the euro, Australian dollar and Canadian dollar. And while orders during the second quarter reported down 1% versus the prior year.

On a currency neutral basis, they were up 7%. An all-time of $300 million versus our previous record high of $281 million in the second quarter last year. Looking geographically, we're really pleased with the way the corporate office market is rebounding in the U.S. and Europe. And we believe both regions are still in the early stages of recovery cycle.

Our core U.S. modular business was up 9% during the quarter. Europe was up 16% in the local currency. With strong results in the primary markets of the UK and Ireland. And we saw impressive growth in Germany.

In Australia, sales in local currency hit an all-time record high putting it well ahead of the year ago period where we still were ramping up the new plant. We also were pleased with the business in China. It's growing. It was profitable during the quarter. The only significant outlier was Southeast Asia with sales down 35% during the second quarter.

Business in Southeast Asia has been lumpy this year. But its second quarter orders exceeded billings by 30% which points to improving conditions. Floor also had a good quarter with sales up 4% and cut its operating loss from $1.7 million in the second quarter last year to $300,000 in the current period.

The floor stores expanded their operating margins on a stand-alone basis. We believe the second half of this year will be even better than the first half and we have good reasons for this optimism. We're taking market share in U.S., Europe and Australia.

The corporate office market is rebounding in those regions and we believe it's still in early stages of recovery. Orders in local currency are higher than billings which points to a further topline growth. We're driving gross margin expansion with ranges of initiatives that we believe are sustainable and perhaps could be even further improved.

We have a healthy backlog compared with this time last year and the beginning of the year. And we're the industry leaders in both sustainability and innovation. With these strengths and dynamics I'm excited about our prospects for the remainder of this year. With that, I'll turn it over to Patrick..

Thank you and good morning everyone. I'll take a few minutes to walk through the financial highlights for the second quarter. As reported in U.S. dollar sales for the second quarter of 2015 were up 1.2% to $263.6 million versus $260.6 million in the second quarter of 2014.

As Dan mentioned, we're swimming against a pretty strong current in terms of currency. The impact was $24 million in the second quarter of 2015 to the topline. With currency held neutral, sales increased 10% to $287.7 million.

At the risk of being repetitive with what Dan has already said, I want to revisit the gross margin improvement that we saw in the quarter. This quarter was particularly strong. Our gross margins improved an astounding 370 basis points versus second quarter of 2014 from 34.7%. In the second quarter of last year to 38.4% in the 2015 second quarter.

While the reduction of input prices has certainly helped with the comparison, the initiatives Dan identified earlier have created what we expect to be a sustainable approach for continued gross margin improvement over the previous periods. To add some color on the sales increase, the Americas had another strong quarter.

An increase of 7% with a corporate market leading the way at a 12% increase. Also experienced smaller gains in the non-corporate markets with increases in education, hospitality and government being offset by declines in retail and healthcare segments in the quarter.

Floor also posted an increase sales of nearly 4% that substantially cut its loss from the second quarter last year. The order pipeline in the Americas broadly remains robust through the first three weeks of the third quarter. And we remain positive about the balance of the year in the Americas.

In Europe, we felt the largest impact of the currency headwinds. The sales being negatively impacted nearly $16 million leading to U.S. dollar decline in reported sales of over 6.5%. However, stripping away this historic drop in the euro shows a very different picture. Sales in the region were up nearly 16% in local currency.

Again the corporate office market led the charge here with an increase over 20%. As in the Americas the order pipeline looks promising on a local currency basis through the start of the third quarter. Europe will continue to bear the brunt of this currency headwind through the balance of the year.

Only towards the end of 2015 should we start to see currency comparisons start to level out. Continuing on with the currency theme, was also impact in Asia Pacific as the weakness in the Australian dollar led to a decline of 6.2% recorded in the region in U.S. dollars.

In local currency however, we experienced an increase of over 4% largely due to the strength of the Australian market which as Dan mentioned turned in record sales figures for the quarter. Sales in local currency in Australia were up nearly 14% as compared to the second quarter of 2014.

China and India also experienced growth during the quarter of 6% and 19% respectively. And as Dan mentioned earlier, the only soft spot in the region was Southeast Asia which declined 35%.

During the quarter as a result of higher commissions and increased incentive costs associated with the improved performance our SG&A expense increased to 25.8% of sales in the second quarter of 2015 versus 25.3% in the second quarter of last year.

However SG&A did improve as a percentage of sales on a sequential basis versus 27% the first quarter of 2015. Our selling and marketing expenses remained at or below prior year levels as we continue to keep control on SG&A spending for the balance of the year.

Due to the factors I just discussed earlier, operating income in the second quarter of 2015 was $33.2 million or 12.6% of sales compared with $24.8 million or 9.3% of sales in the second quarter of last year. [Indiscernible] currency translation had a negative impact on operating income of approximately $3.4 million.

Again in the quarter we saw the benefit of last year's debt refinancing on interest expense which was down over $3.5 million to $1.8 million as compared to five in the second quarter of last year. Depreciation and amortization was $7.8 million in the quarter versus $6.7 last year.

CapEx in the second quarter was $7.6 million versus $13 million in the comparable period. Last year for the full year, we continue to expect capital expenditures to be in the $35 to $40 million range. And as a result of an excellent operating performance we discussed previously, we had a strong quarter in terms of cash generation.

We exited the quarter with $71.8 million in cash versus $59 million at the end of the first quarter. We continue to put our cash to use in share repurchases completing another 250,000 shares in the quarter at an average of $22.41 and we also raised the dividend to $0.05 per share per quarter yesterday as well.

And we will continue to explore various opportunities to deploy our cash to continue to enhance shareholder return over the future. With that, I'll open the call for questions.

Operator?.

[Operator Instructions]. And your first question comes from the line of Stephen Kim of Barclays. Please proceed..

Yes, I had two questions basically. The first relates to the SG&A control which was impressive in the quarter. I guess one of the things our sense is that the strength in the U.S. comes at a somewhat higher variable comp. It carries with it a little bit of higher variable comp.

And so I just wanted to understand if you continue to see the strong sales growth that you've been achieving recently, where do we think for the year and kind of the run rate on SG&A should be?.

Yes, I think the SG&A run rate should continue around this range, $68 maybe boost up a little bit to $70 million over the balance of the quarter. But I think we've had some expenses certainly on the incentive side that were a bit front-end loaded here in 2015.

So I feel better about the second half of the year and the ability to stay around the $68 to $70 million range for the balance of the year [indiscernible]..

And then the second question relates to your CapEx. I think we talked about CapEx maybe increasing a little bit as you go forward. I was wondering if you could be a little bit more specific about what kinds of investments will be funded with anticipated increasing CapEx like specifically what sorts of things you're looking to do..

Well, in particular I think the target of the near-term focus on capital expenditures will be targeted towards our Americas business. I think our capacity and our manufacturing footprint in the other regions of the world are sufficient. Our Americas business probably represents the near term, the highest need.

With the continued strength in the business and trying to get in front of that. In terms of what in particular, I think it's still to be determined exactly what shape that CapEx will take in terms of perhaps additional manufacturing capacity, footprint or additional warehousing space. We're still in the process of evaluating that.

But in terms of likelihood of CapEx expenditure we'll be focused around the Americas and we'll have a better picture come October in terms of what exactly the particulars there will be..

Your next question comes from the line of Josh Borstein, Longbow Research. Please proceed..

Just a few questions. First, Dan, on gross margins you said the gross margin rate was sustainable.

Just to make sure, were you referring to the 38.4% you put up in 2Q?.

Yes..

Okay and what gives you I guess the confidence in that sustainability? It sounds like even your respective input costs which are lower, you guys have done something that gives you the confidence to sustain that gross margin rate..

Well, I think we've got a lot of things going our way. We've got some really good mix management going on around the product line. We have raised prices on certain products that we felt like the margins weren't right on. On the innovation side we're doing a lot of manufacturing to reduce costs that we've outlined.

And we've got a very good lean manufacturing situation going. We also compared last year, we ramped up the Australia plant this year. It's actually running very well..

Okay and just thinking back to last quarter you thought 36% was sustainable. And I personally thought that was impressive in and of itself.

Just what's changed over just the past three months that you've seen such an outperformance here?.

We're doing very well in our manufacturing footprint and we're actually maintaining our selling prices..

All right and just a question for me on the top line. You'd mentioned in the press release you see headroom for additional sales growth in the second half of the year.

By that do you mean you just expect to see year-over-year growth in the second half of this year versus second half of last year?.

Yes, that as well as I think historically our second half of the year is seasonably better than the first half of the year. So from a seasonality standpoint, we should have a better second half..

And just thinking about 3Q here given the currency, how should we think about the topline either on a sequential or a year-over-year basis, if you can help us out a little bit?.

Well, I mean I think it will be kind of a similar trajectory heading into the second half of the year. I think the momentum that we carried from 1Q into 2Q continues here in the early part of Q3. So I think the momentum from here will be consistent. Probably in the 265, 270'ish range for next quarter where things sit right now..

The next question comes from the line of Kathryn Thompson of TRG, please proceed..

Going back to gross margins. Are you able to qualify and rough bucket what drove margins, how much did lower raw materials, volumes and also favorable geographic mix? And really when I focus on the favorable geographic I'm thinking more of a Australia market which is your best margin market.

So of those three broad buckets, what did they contribute to the overall margin improvement? And then I guess what would obviously be the manufacturing and efficiencies that you talked about..

Well, as far as the raw material input cost we've actually given that number out. But it's about a $15 million benefit through the year, this year. Which translates to about 1.5%. If you looked at the selling mix and price. I think that's up around 2% or 3%, 2 point something percent.

And then the manufacturing input costs we're using less raw materials in the mix. And that contributes to the rest of it..

How much?.

And drill down in each one of the markets, we really don't give that data out..

Okay, so you wouldn't be able to say for instance how much Australia contributed to overall earnings prior to the fire versus what it is today? Because one of the--.

To get your head around it, the biggest improvement is actually in our U.S. business. The margin enhancement in the U.S. business was significant. So we finally got a lot of traction on the initiatives that we've been working on for the last year and a half. Australia improvement was big, but it wasn't the biggest contributor.

It was U.S., then Europe and then Australia actually..

This is really more kind of a cleanup of an issue that you would had in the past with the yarn supply in previous quarters.

Given the margin performance can we assume that that issue is completely resolved now?.

Yes..

Okay and then finally if you just give a little bit more color on orders as the quarter came to a close. And looking both on a regional and end-market perspective..

Well, the momentum was choppy during the quarter. If you look at the progression in U.S. dollars, April was up 6%, May was down nearly 10% and then June bounced back to flat for the quarter. Leaving on a U.S. dollar basis orders flat.

But don't lose sight of the fact that on a local currency basis in the aggregate it was over $300 million in orders for the quarter. Which was up 7% during the quarter. So that's not insignificant there either. But it's kind of a little bit choppy order pattern in Q2..

And at least with our non-res check that we're having in the North American market, it is showing us that momentum has improved once you rolled into July. Also seen that choppiness in previous quarters.

Are you seeing a similar type trend of improvement and momentum as you had into July?.

Yes..

Yes, particularly in our U.S. business and our European business..

The next question comes from the line of Mike Wood of Macquarie Securities Group. Please proceed..

First question, I mean the volatility that it seems in Europe. You mentioned choppiness, but I think you started off the quarter with flat or down European sales and ended off very strong. Just curious how you describe that market performance.

What's leading to that extreme volatility in how you're dealing with that operationally?.

Well, I mean it's not unusual for us to have volatility in our order book. I mean that's pretty typical for us when you're dealing with project-based revenue. So the volatility is not unusual. It's something that we have dealt with. However, operationally we're prepared to manage that.

But the strength through the back half of the quarter certainly helped us schedule and plan better. In particular, in the Americas which lead to better efficiencies and margin expansion as a result. So that volatility is something that we're unfortunately accustomed to and a reality that we can deal with..

Yes. That happens to be an industry problem..

And I guess moving on, can you give some of the details in terms of the floor, maybe same-store sales performance. And what your patience is there with dealing with that business and where it is from an evolutionary perspective..

Well, we had good margin expansion within the stores. We got up to over 8% operating income in the stores on a direct basis. I think the store revenue, same-store sales were up around 8% as well. And so patience is and I think the Ford business is going to continue to do better and we're going to expand it.

And it's going to start contributing to the bottom line. I'm impatient about the results out of it, but we're actually headed the right way..

Next in queue. And your next question comes from the line of Matt McCall of BB&T Capital Markets. Please proceed..

Dan, I understand you don't give the details about gross margin by geography. But maybe talk about it from an opportunity perspective putting up 38%. Where are you kind of maybe tapped out from an opportunity perspective? Where do opportunities remain? And then maybe some of the specifics around what the drivers are.

Is 38% going to be the max or what are the drivers from here? Is it just leverage on fixed cost? Or do you have some other initiatives that aren't fully reflected in 38%?.

Well, I would say that in our NeoCon conversations we were talking about 40% is achievable. And I still think that is achievable within our framework of our business today. We still have opportunities to expand gross margins in Asia Pacific particularly in Australia and China. The U.S. business is doing very well.

We've actually expanded the margins there the most this year. But I still think there's a lot of things that we're doing to drive that. That are associated with volume as well as some initiatives to reduce cost within our manufacturing footprint..

So are any of these geographies already at 40%?.

Yes..

Okay, so when you talk about 40% being achievable is that over the next year, over the next five years? How do we think about the growth? Is it growth that's necessary? Or is it more that 38% to 40% bridge within your control?.

I would say it's both. We need some volume improvement there, but also there's a lot of things that are in our control to improve it..

And the other question I had was really on the corporate office market. You said a lot of positive things and I'm hearing a lot of positive things. But is there any area of concern at all in that market, maybe geographic variations. And I guess that's the first part of the question.

And then is it more new construction that's driving it or is it just more of that replacement demand that I know drives the majority of your business?.

Well, I would say that it's both on the drivers of it. We're seeing new construction coming through for the first time in a while. But we're also seeing a lot of renovation as people renovate their offices. They're all trying to track talent and they're all trying to make their offices where they can attract the right kind of talent.

And I think a lot of that's driving the renovation side of the business. There is a lot of pent-up demand in this. And the reason I say early stages is because typically when you have an office rebound, particularly in the United States, it goes for several years. We saw this start happening last year in September.

So we're not even a year into this recovery..

Okay and on the geographic variation side, anything that's concerning at this point? I mean it could be -- I'm asking about U.S., but anything in Europe that's concerning or is everything kind of flashing green at this point?.

Well, I would say we're making it green in some markets by taking share. But I would say that there's not really any areas of concerns that are significant. I mean if you look at Texas and what's going on with the oil industry, that's actually down, but other markets in the United States are actually growing.

Northeast is finally starting to grow in the Boston area..

Your next question comes from the line of John Baugh of Stiffel. Please proceed..

Just a couple of things.

One on gross margin, is there any influence on the FX on that percentage number, Patrick?.

There is. I don't have that off the top off my head, John. I have to come back to you with that..

That's fine. And you had such a great free cash flow year to date. And you typically free cash flowed heavy I believe in the fourth quarter. So kind of curious as to how that number may be shaping up for the year..

Yes, you know cash flow generally you're right. Seasonally we generate the most cash in the back half of the year. I think right now we're targeting probably after CapEx and so forth, pre-dividends and share repurchases nearly $40 million of free cash flow for the full year before those other items..

John, as far as the FX on the gross margins, it's a negative impact actually, because we have raw materials that we buy in Australia that are U.S. dollar based..

That's what I was thinking..

It's not positive. It's actually negative..

Yes, when you get that number that'd be great. And then on the raw material side we've seen another dip down here in energy prices recently.

It's fickle I know, but how would you describe your input cost trends over the last I don't know month, two or any kind of an outlook to the extent you have insight looking forward?.

I would say that in the second half of the year you're going to have a little bit of headwinds in the raw material input cost. They've sort of ticked up the things that we follow around benzine and capital lockdown of propylene. But it's not significant, but it has turned up a little bit..

Okay. And finally, everybody focused, rightly so, on the gross margin performance. And you mentioned holding price and I think mix. And I've seen, Dan, it somewhat ties to the incentives you've put in place for the sales force.

Or is there something else going on? Is that the confidence level of the sustainability that clearly your customers are listening to your sales people? Your sales people are being incented.

And there's no reason to think any of that will change?.

Yes, I would say that you're talking about driving things to, what we call, the ecosystem and sending them to drive to that. Yes, that's continuing. We're also having great product introductions where we're actually able to command better pricing on it. So I think our last three product introductions have been really good.

NeoCon was one of the best product introductions I think we've ever had. And so a lot of it is around new products as well..

The next question comes from the line of Josh Borstein of Longbow Research. Please proceed..

On the reselling prices that you had mentioned, can you talk about in what geographies or what verticals those price increases took place?.

Well, broadly we raise prices in the United States. And we also have been raising prices in Europe as well. So those are two markets that we've been able to hold our price and raise them..

And could you talk a little bit about the competitive landscape particularly in the U.S..

Have your competitors been any more or less aggressive lately?.

I would say we have great competitors in the United States and they're always aggressive with trying to get the business. I don't think the competitive landscape has changed that much over the last three or four years actually..

Okay. And just with respect to the share gains that you had mentioned.

What's behind the share gains? Where are they specifically? Are you beating the competition on price, on innovation, on service or something else?.

I would say all of the above. I think our new product introductions have been really good and I'll go back to that. And we have the best sales force I think in the industry. And so we're taking share particularly in Europe and the U.S.

and Australia and I think it's around our sales force and our product and some of the innovation things that we're doing..

Okay and last, Dan, you'd talked about raw material prices ticking up in the second half of the year. I think you also called out $15 million in savings. I think last quarter you guys talked about $12 million in savings.

Have you realized some additional savings since last quarter?.

A little bit, but our increased volumes is in the back half of the year are being offset by some of these price increases that we're seeing. So we've leveled out at about a $15 million annualized benefit now..

Okay, got it.

And in terms of the currency headwinds, still anticipating around $10 million I think on the EBIT line?.

Yes, for the full year. Yes, about $80 million on the topline and 10 plus from the EBIT line for the full year..

And your next question comes from the line of Keith Hughes of Sun Trust. Please proceed..

This actually Judy in for Keith. Just a follow up on a previous question on the share gains strength there.

How would you say that is relative to the underlying demand in the markets? Has it been a lot stronger or just kind of running in conjunction with the growth and the rebound and particularly the corporate office markets?.

Well, I think if you looked at the data that we look at, particularly in the United States the office. Not the office market but the commercial market is up maybe 3%. We were up 9% of the U.S. market, so that's an indication of the share gains there. If you look at Europe, we're up 16% in Europe and that's clearly share gains. It's not the market..

[Operator Instructions]. We have no more questions coming through at this time..

Thank you for listening to our conference call. And we'll talk to you next quarter..

Ladies and gentleman, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day..