David B. Foshee - Interface, Inc. Daniel T. Hendrix - Interface, Inc. Jay D. Gould - Interface, Inc. Gregory Bauer - Interface, Inc..

John Baugh - Stifel, Nicolaus & Co., Inc. Matt McCall - Seaport Global Securities LLC Kathryn Ingram Thompson - Thompson Research Group LLC David S. MacGregor - Longbow Research LLC.

Good morning, ladies and gentlemen, and welcome to the Interface, Inc. Q4 2016 Earnings Conference Call. As a reminder to our audience, this conference may be recorded. It is now my pleasure to hand the conference over to Mr. David Foshee, Vice President. Sir, the floor is yours..

Thank you, operator. Good morning, and welcome to Interface's conference call regarding fourth quarter and full year 2016 results. Joining us from the company are Dan Hendrix, Chairman and Chief Executive Officer; Jay Gould, President and Chief Operating Officer; and Greg Bauer, Vice President and Corporate Controller.

Dan will make the opening remarks, and Jay will review highlights from the quarter as well as Interface's business outlook. Greg 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An archived version of this conference call will also be available through that website.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 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 the 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 3, 2016, 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 may 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.

These documents can be found on the Investor Relations portion of the company's website, www.interfaceglobal.com. Please note that, during this call, it's 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 Dan Hendrix..

Thank you, David. Good morning, everyone. As you saw in our announcement yesterday, this will be my last investor conference call as your company's CEO. After 16 years in this role and a total of 34 years working at the company, I've decided it's time – it's the right time for me to step back from day-to-day operations of the company.

Our board has agreed with me that Jay has done a fantastic job since he joined our company two years ago. He has embraced our culture, our mission. He has enhanced our performance and strategy, and he's brought a fresh and interject (03:10) perspective to the way he runs our business.

Jay has been properly seasoned, and he's more than ready to take over the reins for me as CEO. I'm proud of what he's accomplished so far, and I'm confident that he's going to make us even more proud with what he's going to do for us in the future. All that being said, this is not goodbye.

I'll be staying on as Chairman, serving as an advisor and a sounding board to Jay, leading our board of directors to help the company advance toward its sustainability and business goals. I can truly say it's been an honor and a privilege to serve as the company's CEO, CFO and all the other roles I've played over the last 34 years.

I've enjoyed getting to know all of you, and I really appreciate the relationships we've developed and will continue to share. We have some good fourth quarter results to discuss. We've just come off two of (03:58) the best years in the company's history, and I'm really looking forward to what we're going to accomplish over the next few years.

With that, I'll turn it over to President, COO and now CEO-elect, Jay Gould. Jay, please go ahead..

Thank you, Dan. I'd like to start by personally thanking you, Dan, for your mentorship and your partnership over the last two years. I really appreciate the confidence that you've entrusted in me and the confidence you have in my leading the company, and I'm really pleased that you're staying on as Chairman and as advisor to me.

With that, let me turn our attention to the quarterly results. I am really pleased with the fourth quarter results, especially given the sluggish environment that we've faced for most of the period. And I say most of the period because we saw a noticeable increase in order activity, following the U.S.

Presidential Election in November and that trend has continued into 2017. Our gross margin remained under pressure during the quarter due to our move to the new centralized distribution center in the Americas, which we discussed in our call last quarter.

This transition continued for most of the fourth quarter, but we did wrap it up by yearend and we expect gross margins to begin to recover as we look forward. I was also really pleased with our cost-containment efforts as we held SG&A expenses to $64 million in the quarter.

This was our lowest quarterly level for the year, and it puts us on pace to stay within our 2017 targeted run rate of $260 million to $265 million.

Excluding the restructuring and asset impairment charge, we delivered fourth quarter EPS of $0.28, pulling even with the fourth quarter of the previous year and closing out the full year of 2016 at $1.03, which is our second best earnings in the history of the company.

The momentum we picked up in the fourth quarter does give us optimism about our prospects for value creation in 2017.

As you'll recall, in our last quarterly call, I described the four activities we're focused on to yield earnings growth over the next few years and they are; firstly is to grow our core carpet tile business with improved branding, expanded sales reach and more productive innovation.

The order progression that we saw throughout the fourth quarter, coupled with improvements in the U.S. macroeconomic indicators and signs of stability in Europe, point to top line growth in our core carpet tile business for 2017. We think the core growth will be in the range of 3% to 4%.

Our second initiative is to optimize our flagship manufacturing and distribution assets in Troup County, Georgia. As I mentioned earlier, we completed the transition to a new distribution center, and we have substantial capital upgrades to our manufacturing plant planned for 2017.

Ultimately, our Troup County optimization project, when it's completed, will yield annualized savings of $30 million, with those full benefits flowing in 2019. Thirdly, we have now entered the modular resilient flooring market with a unique product that allows customers to integrate hard and soft flooring in a truly modular installation.

As we described in a recent press release, we rolled out (07:43) the full LVT product launch in the Americas earlier this month, and the other regions around the world will follow in the coming months. Lastly, I described our planning discipline around SG&A expenses.

Our fourth quarter spending level results put us on a run rate to achieve our annualized SG&A target, again, which is about 26% of sales or $260 million to $265 million.

With the operational cost structure we've created, along with our product innovations and upcoming plant improvements, I believe we're poised for both revenue and earnings growth in 2017. I also believe we're well on our way towards becoming the world's most valuable interior products and services company.

And with that, I'll turn it over to Greg for more discussion on the fourth quarter..

Thank you, and good morning, everyone. I'll take a few minutes now to walk through the financial highlights for the fourth quarter. Sales for the fourth quarter of 2016 were down 2.9% to $239.5 million versus $246.6 million in the fourth quarter of 2015.

On a consolidated basis, currency was not a significant factor in this decline as, on a constant currency basis, our sales declined approximately 2%. Changes in currency rates had a negligible impact on operating income for the quarter. As we saw in the third quarter, our gross margin was down compared to the corresponding period in 2015.

For the fourth quarter of 2016, our gross margin was down 220 basis points to 37.6% of sales versus a very strong 39.8% of sales in the fourth quarter of 2015. As Jay has already mentioned, the largest factor in this decline was the impact of a third-party warehouse move in our Americas group and the associated transition issues.

Costs associated with the startup and service level recovery efforts totaled approximately $2.5 million for the fourth quarter. We believe those issues are behind us now, as customer service levels are returning to expected levels and we iron out the transition concerns.

It is worth noting that Europe, despite the Brexit headwind, managed to improve its gross margin over 200 basis points for the quarter. On a consolidated basis, we did see an improvement in gross margin on a sequential basis versus the third quarter of 2016 as well.

Our sales in the Americas were down slightly with corporate office flat for the period versus the fourth quarter of 2015. In non-office segments, declines of 9% in retail and 7% in healthcare were partially offset by a 14% increase in education sales. The floor business was down approximately 6% for the quarter versus a very strong quarter in 2015.

As previously announced, we are significantly restructuring this business to exit the majority of our retail stores while maintaining an online presence as well as for redesigned (10:23) centers. We have already closed three retail stores and are keeping the remaining stores open for the balance of the first quarter.

Sales in Europe were down 9% as translated into U.S. dollars for the quarter and were impacted by both the weaker pound and euro as, on a currency neutral basis, sales were down 4% in the region for the fourth quarter of 2016 versus 2015.

As expected, due to the Brexit and associated issues, the most significant decline was in the United Kingdom, as sales declined over 25% in U.S. dollars and 18% in pounds. The rest of Europe was slightly higher in constant currencies for the quarter. And through the first seven weeks of the year, the order trend in Europe is positive overall.

Asia-Pacific sales for the quarter were flat compared to the fourth quarter of 2015, with a 10% decline in Asia offset by an 11% increase in Australia. Currency was not a significant factor in the comparison and was, in fact, a slight tailwind for the region.

Non-office segments experienced a 15% (11:15) increase for the quarter with improvements in government and hospitality. Corporate office was down 5% for the quarter in Asia Pacific.

As Jay has discussed, SG&A expense was the highlight for the quarter, as we saw those improvements in both absolute dollars as well as a percentage of sales as compared to the fourth quarter of 2015.

With SG&A at 26.6% of sales for the fourth quarter as compared to 26.8% of sales for the fourth quarter of 2015, this represents the first quarter of the year that showed an improvement as compared to the prior-year period. Our SG&A expense of $63.8 million is in line with our target run rate of $260 million to $265 million.

The decline in SG&A expenses is due to lower administrative, selling and marketing costs, as well as lower incentive compensation costs for the quarter.

As we have previously communicated, we intend to use the SG&A savings from our restructuring plans to reinvest in our strategic priorities to grow both the core carpet tile business and our new modular resistant (sic) [resilient] (12:06) flooring product lines.

As previously announced, we incurred a restructuring and asset impairment charge of $19.8 million in the fourth quarter, which included workforce reductions of our floor team members and a number of other employees in the commercial business in the Americas and Europe, as well as write-downs of certain under-utilized and impaired assets.

These actions are well underway, and we expect to begin realizing the savings from these actions in the first quarter of 2017 with full realization in the second half of the year.

Despite the lower sales and step-back in gross margin, thanks to the SG&A performance, we exited the fourth quarter of 2016 with operating income, excluding the aforementioned restructuring and asset impairment charges, of $26.2 million or 10.9% of sales compared to $27.6 million or 11.2% of sales for the comparable period in 2015.

Including the restructuring and asset impairment charges, our operating income for the fourth quarter of 2016 was $6.4 million or 2.7% of sales. I want to say a quick word on cash. As you can see from our release, we finished the quarter with cash of $165.7 (13:08) million, an increase of $52 million during the quarter.

This increase was a result of borrowings, from which one of our (13:14) subsidiaries drew €61 million under our syndicated credit facility. The funds were distributed to the U.S. to fund current and projected cash needs, including capital expenditures associated with our Troup County optimization project and anticipated share repurchases.

A significant portion of these borrowings are expected to be repaid in the first quarter of 2017. Absent this increase in borrowings, our cash declined by about $11 million for the quarter, of which $8 million was due to the repurchase of 515,000 shares of our common stock under our established repurchase plan.

As described in our earnings release, our debt net of cash on hand was $104.7 million as of the end of 2016. This is compared to debt net of cash on hand of $137.8 million as of the end of 2015. Our interest expense was $1.4 million for both the fourth quarters of 2016 and 2015.

Depreciation and amortization was $8.2 million in the fourth quarter of 2016 compared to $7.6 million in the fourth quarter of 2015. Capital expenditures for the quarter were $7.2 million compared with $3.5 million in the comparable period of 2015.

For the full year of 2016, our capital expenditures were $28.1 million compared to $27.2 million in 2015. With that, I'll open the call up for questions. Operator..

Thank you, sir. Our first question will come from the line of John Baugh with Stifel..

Good morning, and, Dan, congrats on a great career, and, Jay, good luck on your new role..

Thank you, John..

Thanks, John..

I wanted to, I guess, first ask a question on the Troup County move. I think you have mentioned service levels got better.

Assuming service levels then were impacted, is there any way to think about how that maybe interrupted revenues in either the fourth quarter or how it could impact the first quarter?.

Well, John, honestly, it's hard to say. I don't think we lost any business. We just didn't get it out the door when we should have, so we disappointed some customers along the way. I think we'll repair those customer relationships here in the first quarter. I mean, I'm thrilled with the new operation. I want to be clear about that.

It's really a significant step forward for us..

Okay.

And in terms of how you measure in-stock or delivery times or whatever the metrics may be, as we sit here today, those are back to normal levels or maybe even improved, or where are we?.

Actually, improved. I mean, we look at on-time and full delivery, and we're running above 95% now, which is a world-class metric..

Okay. Super. The raw materials, update us what you're seeing there. I mean, there's been a lot of discussion about the some of the increases in some of the chemicals are perhaps temporary and not sustained, but just curious what your suppliers are telling you and what you're expecting..

We're definitely seeing headwinds in input costs. I mean, we're estimating for the full year to be between $10 million and $13 million of raw material inflation. Fortunately, we're in a good position to help offset that with our productivity initiatives.

So, in our core business, we're still seeing a 50 basis point improvement in gross margins, offset, of course, by the exit out of the floor business. So, net-net, I see our margins between 38% and 38.5% for the year..

Okay. And I wanted to follow up on the definition of core business. So, I think you mentioned something about the revenues or orders this year.

Just define for us, is that simply taking out floor, or is that U.S.-only? (17:24) consolidated, et cetera?.

Yes. That's a good question, John. When I talk about core, I'm really talking about our global carpet tile business. So, taking floor out of that. So, the revenue walk – outlook for the year is kind of walk like this. I mean, we're going to have a negative, roughly, 140 basis points because of the floor store exits.

We think the core carpet tile business is going to grow in the 300 basis point range and that LVT is going to add between 200 basis points and 250 basis points. So, you walk that down, and we're looking at roughly 350 basis points of growth for the year..

Okay. And my last question is around the UK. Could you perhaps walk us through the progression of that business in the fourth quarter and what you're seeing in the first quarter? I think you said orders in Europe are up year-to-date for seven weeks, and I assume that includes the UK. But love a little color on the UK and Europe, in general..

Yes, well what I would say – let me start with 2017 and then we're going to walk back to the fourth quarter. On a currency neutral basis, orders in Europe were up about 4% year-to-date, so through the first seven weeks. On a pure euro basis, we're actually down 2%, and that's the impact of the British pound. So, in local currency, our business is up.

But as it's translated to either the euro or the dollar, it's actually down..

Okay.

In the fourth quarter, were there any trends there in the UK stabilizing, and what have you seen year-to-date in the UK?.

Yes. So, again, in British pounds, we've seen a growth in the UK year-to-date. So, in the first seven weeks, we're up about 5% in British pounds. So, that's actually really encouraging news, and that trend did start in December. So, post U.S. elections – and I know we're talking about the UK. But post U.S.

elections, we really saw a rebound in our business globally..

Great. Thanks for that color, and good luck..

Thanks, John..

Thank you. Our next question will come from the line of Matt McCall with Seaport Global Securities. Please proceed..

Thanks. Good morning, guys..

Good morning, Matt..

Congrats, Jay, on the new role, and, Dan, good luck on the next phase, in your next venture. I've enjoyed the last decade. So, maybe a follow-up on that last question from John. You said, Jay, that the – you saw in inflection in order patterns.

Can you put any numbers behind that, how the quarter progressed and what you're seeing, kind of, year-to-date overall by geography, whatever you want to share?.

Yes. So, October was down double-digits, November was basically flat and December was up about 8%. So, that all combined for a slight decline. But the optimism, as we head into the year – and so, the first seven weeks, we're seeing about plus 5% globally. That's currency neutral. It's about 4%, if you let currency flow through there..

Okay.

And what about North America, specifically?.

Yes, it follows that trend..

Very similar? Okay. So, you quantified the distribution moves. I think you said $200 – or $2.5 million – maybe that was you, Greg.

So, all of that is going to be gone in Q1, or are there some residual effects that will impact the margin as we start the year?.

So, if you look back over the third and fourth quarter, we spent about an incremental $5.5 million. I think we'll recapture at least $4 million of that in this year and maybe more. So, we're operating at a slightly higher target than what we had set out. But I think, over the next three to four months, we'll figure out how to run it at target levels.

What was critical, Matt, is that we get the service levels where we needed them. So, we've put a little bit of labor at it. (22:00) But the operation is running really well. We're really pleased with it..

Okay. And then, let's see, one more. So, you talked about the LVT launch, and that – so, the U.S. launch occurred you said earlier this month, so February. So, all of this is going to hit 2017. Can you quantify the impact on SG&A? SG&A looks good at (22:28) $260 million, $265 million.

So, how much of that – how much incremental spend associated with LVT, both in the U.S.

and globally, is included in that number?.

Well, we reallocated about $10 million of SG&A cuts into growth initiatives, including the LVT. So, I mean, roughly $5 million to $6 million is what we're putting into the LVT launch..

Okay.

And any thoughts on where that other $5 million went?.

Well, it went to refuel incentives, which we didn't pay out at full payment last year..

Got it. Okay. Thank you, guys..

Thank you. Our next question will come from the line of Kathryn Thompson with Thompson Research GP. Please proceed..

Hi. Thanks for taking my questions today. Dan, best of luck. I know you'll be enjoying some of your Florida State Football. And, Jay, best of luck in your new role. I wanted to follow up on LVT.

I wanted to get additional thoughts on the mechanics behind the LVT rollout, what's the initial reaction been to the market and additional color just in terms of balancing the dynamic of rising raw materials and margin profile for that product relative to carpet tile, given the raw material dynamics. Thank you very much..

Well, the market reaction to LVT has been tremendous. I mean, the energy level from our selling organizations around the world have just been incredible, Kathryn, honestly. And the thing that most excites the customers is, first of all, the full integration between the hard and soft with no transition scripts (24:19) required.

Secondly, the modularity of the product that it goes down with our TacTiles. (24:23) And thirdly, one other piece of feedback I've gotten just recently is, because we designed the product at the exact same size as our carpet tile, the designers have really reacted to that very positively. So, we did launch the product in February into the U.S.

selling organization, actually across North America so that includes Canada and Mexico. And then, we will begin late in the first quarter to roll that out in the UK, Spain, France, China and Australia. So, we've had sales meetings in each one of those markets to introduce the product to the selling organization, and we'll start to sell in late March.

Regarding the margin structure of the business, I've talked to you previously that we modeled this business at 35% gross margins and accretive operating margins at about 20%. We're running north of that right now, and the market reaction to our pricing has been very positive.

So, right now, as we fold it into the (25:37) P&L, it's margin accretive even at the gross margin line. We'll see how that goes. I mean, we're protecting ourselves. I think the modeling is still safe at 35%, and we haven't experienced any cost increases from our Asian supplier as of yet.

So, I'm feeling really bullish about the margin structure of the LVT business..

Okay. That's helpful. As far as I know, you have a couple of moving parts with some of the operational changes that you really have been working over the past several years with the entire Interface team. But also, in particular, over the past two quarters, it sounds like you're mostly there in terms of completion.

But as you walk through the year and, more importantly, as you look over the next two to three to four years, where do you see Interface's business strategically? Where would you like it to be by the end of 2017 in terms of mix and margin, looking at those gross margins and SG&A? And then, over the next – a little bit more longer term, two to three years, where would you like that to be?.

Well, let me start with the latter, and I'll go to the former. I mean, you know that our margin goals as a company is to get to 40% gross margins and 14% to 15% operating margins, and I think we're well on track to get there. We're not going to get there this year, but I certainly expect getting there over the next two years.

This year, our margins – I'm expecting gross margins in the 38% to 38.5% range and SG&A at about 26%. So, we are looking for a step-up in our operating margin to roughly 12% to 12.5%..

Perfect. Thanks very much for taking my questions today, and good luck to both you and Dan..

You didn't mention my Harvard football team, by the way..

Sorry about that. The last time I checked, Dan's team did a little bit better. So....

You're right..

Best of luck..

Thanks, Kathryn..

Thank you. Our next question will come from the line of Dan (sic) [Dave] (28:04) MacGregor with Longbow Research. Please proceed..

Yes. Good morning, everyone.

To what extent is the order growth tied to the LVT launch? Or is the order growth you referenced excluding LVT?.

Yes, it doesn't include LVT yet. So, that's all core carpet tile growth..

Okay. Thanks for that clarification. Just a couple of other things quickly. You talked about the LVT launch, and thanks for going through the detail on that.

How should we think about the upfront costs of the launch and to what extent could that change some of the numbers that you referenced as being, kind of, your base line expectations?.

Well, the biggest single cost in the launch is frankly sampling, which will grow with sales. So, it's not a front-loaded event, Dan (sic) [Dave] (28:55)..

Okay. Thirdly, the Troup County manufacturing optimization project, I think it was expected to generate about $7 million of the total of $30 million in savings for 2017.

Is this still a good number we can use?.

Yes..

Okay. Terrific. Thanks very much. And, Dan, thanks for everything over the years. Appreciate all the help. Good luck, Jay..

Okay. Thank you..

Thank you. There are no further questions in queue. So, now, I'd like to hand the call back over to Jay Gould, President, for closing comments or remarks.

Sir?.

Well, thank you for your continued support. I know this is an emotional time, seeing Dan kind of step into a new role. I just want to reinforce he's not leaving us. He's staying on as Chairman and a real advisor to me. And, Dan, you've built an amazing company. I'm so happy to help you create value with it as we look forward.

And I think 2017 is going to be a great year..

And so do I..

So, thanks, everyone. Appreciate it..

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program, and you may all disconnect. Everybody, have a wonderful day..