Good morning. My name is Heidi and I will be your conference operator today. At this time I would like to welcome everyone to the Q1 2019 Interface 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.

Christine Needles with corporate communications you may begin your conference. .

Thank you so much, Heidi. Good morning, and welcome to Interface's conference call regarding first quarter 2019 results, hosted by Jay Gould, President and CEO; and Bruce Hausmann, Vice President and CFO.

During today's conference call, all management remarks 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 and our expectations regarding our acquisition of Nora Systems, 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 30, 2018, 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 to place undue reliance on any such forward-looking statements. Management's remarks during this call also refer to certain non-GAAP measures.

The directly comparable GAAP measures as well as a reconciliation of the 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, each of which can be accessed in the Investor Relations section of the company's website, www.interface.com.

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. Before we begin, I would like to draw your attention to the fact that in addition to filing our normal SEC 8-K with our earnings release, we concurrently filed another Form 8-K announcing an inquiry by the SEC into our historical quarterly EPS calculations and rounding practices during the period of 2014 to 2017.

We also announced that our chief accounting officer has gone on paid administrative leave after it was learned that in 2018 in the process of collecting materials from 2015, '16 and '17 for production to the SEC, that he added certain after-the-fact notes to those materials that were then produced to the SEC.

The company believes at this time, however, that the after-the-fact inclusions of these notes had no impact on the EPS calculations that are subject of the above described investigation. Again, this SEC inquiry relates to 2014 to 2017.

Since this is an ongoing matter, we can't provide any further information or answers to questions at this time other than what's in the 8-K filing. But I will say the company has been cooperating and continues to cooperate fully with the SEC.

So with that, now I'm pleased to share with you our first quarter results and discuss the progress that we're making on our value creation strategy and agenda. We delivered a very solid first quarter that was in line with our expectations. Sales were up 24% versus the prior year, with organic sales of 2%.

I'd like to say thank you to the global Interface team for starting this year with very solid results and keeping us on track to accomplish our full year commitments. As we discussed at our last earnings call, in the first quarter we held a Global Sales Summit with 3 main objectives.

Firstly, to fully integrate the Nora sales team into the Interface family and to accelerate our cross-selling processes and capture revenue synergies this year. Secondly, we wanted to advance our selling system transformation to ensure our 2019 route to market strategies are fully seated.

And lastly, we wanted to engage every front-line seller on our sustainability mission Climate TakeBack, which is activated through our Carbon Neutral Floors program. And I'm really excited today that we're already delivering meaningful results across all 3 of these objectives.

Nora sales grew 9% in local currency versus the first quarter of last year when Nora was a standalone company. Secondly, sales productivity is up, which will be further enhanced as we launch our new CRM platform in the second quarter of this year to provide even stronger tools and greater visibility into our sales pipeline.

And importantly, we have seen a very positive response in the marketplace to carbon neutral floors, allowing us to take share in carpet tile in key markets and also to help us drive growth in our LVT.

Now in addition to this, our team will be introducing a very highly integrated and inspiring local collection of carpet tile and LVT products at NeoCon this June, which as you know is our largest commercial flooring event of the year.

From a manufacturing standpoint our productivity initiatives continued to deliver margin expansion and remain on track to deliver our full year objectives. Input cost inflation including raw materials came in just as anticipated and remain in line with our full year expectations.

The first quarter adjusted gross margin of 39.4% was up 50 basis points versus the gross margin in the prior period of last year. SG&A expenses were also on plan at $99 million, which equated to 33.3% of sales. Again these results delivered a solid first quarter with adjusted EPS of $0.14, putting us on track to deliver our full year objectives.

Organic orders at the end of Q1 were up 2%. And we anticipate second quarter organic growth rate to be in the 2% to 3% range. Importantly, Nora orders were up 12% at the end of the quarter, again reflecting strong sales productivity and cross-selling results as we're activating initiatives to capture revenue synergies.

With that, I'd like to turn the call over to Bruce for a deeper dive into the first quarter results. So Bruce, please go ahead..

Thanks, Jay, and good morning to everyone. First quarter net sales were $298 million, up 24% over the prior year period, and organic sales were in line with our expectations, up 2% over the prior year period. That $298 million top line includes a negative currency impact of $8 million or 330 basis points year-over-year.

If we break down our revenue into more detail, LVT growth drove organic growth, while carpet tile was relatively flat year-over-year. You might recall our carpet tile product line is lapping a very strong comparison from Q1 of last year when we started delivering on a large customer order.

Nora contributed $60 million of sales in the quarter, up 9% in local currency versus Nora's first quarter last year. And Americas' organic sales were up 3% compared to the first quarter last year. And in EMEA, organic sales grew 2% in local currency, however, they were down 5% in U.S.

dollars due to currency headwinds mostly driven by euro to USD and pounds sterling to USD exchange rates versus prior year. Asia-Pacific organic sales were down 4% compared to the first quarter last year as we lapped very strong double-digit organic growth in China and India in the prior year period.

And in our global market segments, growth was driven by healthcare and education in the first quarter. Our first quarter gross margin was 38.8%, which included $2 million of Nora purchase accounting amortization. Adjusted gross margin was 39.4%, which was a 50 basis point improvement over gross margin in the prior year period.

We are very pleased with the progress of our productivity initiative and we remain on track to achieve our targets for the year. SG&A expenses were in line with expectations at $99 million in Q1, or 33.3% of sales. And first quarter operating income was $16 million compared to $23 million in a prior year period.

Adjusted operating income in Q1 of 2019 was $18 million compared to $23 million last year. And in Q1, we recorded net income of $7 million or $0.12 per diluted share compared to net income of $15 million or $0.25 per diluted share in Q1 of last year. Adjusted net income in Q1 of 2019 was $8 million or $0.14 per diluted share.

And adjusted EBITDA was $31 million in Q1 of 2019. Now if we move over to the balance sheet and cash flows, our balance sheet and liquidity are very strong as we ended the quarter with $254 million of borrowing capacity under our revolving credit facility.

We also ended the quarter with $67 million of cash on hand and $642 million of gross debt, meaning net debt, which is simply gross debt minus cash on hand, was $575 million at the end of the quarter.

And on a pro forma basis, our trailing 12-month adjustment EBITDA is approximately $202 million as laid out in the reconciliation tables of our earnings press release. Now doing the math on these numbers, our net debt to pro forma adjusted EBITDA ratio is approximately 2.8.

This is simply the $575 million of net debt divided by the $202 million of pro forma adjusted EBITDA over the trailing 12 months. These of course are all non-GAAP measures. And as a reminder, please refer to the reconciliation tables in our press release to reconcile GAAP to non-GAAP measures.

Interest expense was $7 million in the first quarter compared with $2 million in Q1 of last year. And the increase in interest expense, of course, was due to financing the Nora acquisition which occurred in the third quarter of 2018. Depreciation and amortization was $11 million in Q1 compared to $9 million last year.

And capital expenditures were in line with expectations at $20 million in the first quarter this year compared to $7 million last year as we invest in the business and deploy the capital necessary to deliver on our productivity initiatives. Now I'd like to hand it back to Jay to provide an update on our 2019 outlook..

Thank you, Bruce. As we continue to execute our value creation strategy, we are targeting to achieve the following results in 2019. Total net sales growth including Nora, of 14% to 16%. That includes a 200 basis point impact from currency headwinds. We will achieve organic sales growth from carpet and LVT of 2% to 4%.

We will deliver adjusted gross profit margin of 40% to 40.5%. And we will have adjusted SG&A expenses of 28% to 28.5% as a percentage of sales. Full year company interest and other expenses of $29 million to $30 million, and the full year effective tax rate to be approximately 28%.

Our diluted share count is anticipated to be approximately 60 million shares.

Capital expenditures for the full year are forecasted to be $65 million to $75 million, made up of approximately $35 million of maintenance capital plus investment capital to fund productivity initiatives that yield gross margin expansion, additional sales productivity and other attractive initiatives that are fueling our value creation strategy.

The remaining portion of the year we anticipate adjusted EPS to be spread relatively evenly in the second, third and fourth quarters. Separately and as we described in our 2018 full year results call, we have set midterm objectives to achieve 42% gross margins, 15% operating margins and 19% EBITDA margins over the next 4 to 6 years.

Again I want to thank the global Interface team for starting the year with really solid results and keeping us on track to accomplish our full year commitments. Our strategy is clear and it's working in the marketplace.

I also want to thank our customers and our share owners who continue to support Interface and our world-changing mission as we continue to execute on our Climate TakeBack vision. And so with that, I'll open it up for questions.

Heidi, could you help us with that?.

Certainly. [Operator Instructions] And your first question comes from the line of Kathryn Thompson with Thompson Research Group. Please go ahead. .

All right. Thank you for taking my questions today. Understanding any reference in your prepared commentary about a larger project that hit in Q1 from a large job last year, could you quantify what that impact was for Q1? And also remind us the potential impact going forward to Q2 and beyond. Thank you..

So for the full year it's about a 200 basis point headwind. In the first quarter it was a little bit less than 100 basis points. And we'll see the full impact of that in the second quarter, Kathryn. So it's roughly a 200 basis point headwind in the second quarter..

Perfect.

And that it really largely, that comp really is more a first half dynamic, if I remember correctly?.

Really through the first three quarters..

Okay. First three quarters. Okay. Perfect. I know that you have a little bit different dynamic in terms of how you manage rising energy costs.

But still, that said, if you could just frame for us if there's any change at all in terms of the dynamic of managing rising cost versus some of the productivity gains that you're going to have to offset some of those rising costs in 2019..

So Kathryn, the way that we manage that is through pricing of productivity initiatives are forecast to be around $20 million for the year, and we are anticipating inflation or input cost inflation of around $10 million. And what we've seen in the first quarter is completely in line with that full year outlook.

So we feel like pricing's yielding some benefit, our productivity initiatives are on track and inflation is in line with expectations..

Okay. And then just final point to just step back, looking at the forest through the trees. You referenced healthcare and education driving growth.

But to the extent that you're able to really talk about it, what are you seeing longer term, say over the next 12 to 24 months in terms of what potentially is driving demand and what you're seeing in the general marketplace? Thank you..

Well we're really seeing pretty strong growth across the segments. The choppiness really comes in geographies. So the U.K., dealing with Brexit is still choppy. But I would say in the U.S., we're seeing strong growth across all of our segments, with the exception of retail because of these headwinds that we're facing..

Thank you very much. .

Thank You Kathryn..

Your next question comes from the line of Michael Wood with Nomura..

Hi good morning. It seems like the SG&A in 1Q is lower than what you kind of guided to, pointed to when you gave that first quarter outlook. I'm curious if you can give some color on what ended up coming in better than expected with SG&A.

And is there a run rate per quarter of SG&A that you're targeting to exit this year?.

Hey, Mike. This is Bruce Hausmann. And I would attribute the Q1 SG&A number to just being good management. As you know, we're super focused on one of our 5 pillars of running the business is to optimize SG&A. We make sure that every dollar we're investing in SG&A yields a return. So I don't think it's any one specific thing.

I think it's just good management and we're trying to make sure that we are super productive with every dollar invested. And in terms of full year run rate, I would just refer you back to our press release where our full year outlook around SG&A is 28% to 28.5% of net sales.

And so you can probably back into that if you kind of took this quarter's run rate and backed into a full year number. You could probably back into pretty quickly around what the math would be for Q2, Q3 and Q4, because it doesn't bounce around that much..

Okay. On the U.K. color that you'd given in terms of the plus 2% EMEA, how does that compare with local market performance? And I assume it's gaining share. Is that share gain sustainable going forward in the U.K.

business?.

Well we believe so. Now I've said overall Europe, roughly 2% growth in local currency. That's demonstrating really strong growth in some of our markets, like what we call the [dock] region, which is Germany, Australia, Switzerland, had an absolute fabulous first quarter. We're seeing once again double-digit revenue growth.

So clearly we're taking market share in a market like that. We've also had a really strong quarter in Northern Europe and Eastern Europe. So the Benelux region is very strong. The U.K. is a bit of a challenge right now because construction has stalled there, remodeling has stalled there. So U.K. was actually down slightly in the first quarter..

Okay. And finally, that core U.S. modular carpet tile market, you said flat sales. I assume volumes, thus, are down year-over-year.

Can you just give us a sense of, and maybe even excluding the one large order, what kind of the progression was throughout the quarter? Did you see any acceleration or was it more stability or deterioration throughout the quarter?.

If you look at it from a macro perspective, it was pretty consistent. If you look at inside the markets, it's a little choppy. But that's really to be expected..

Okay. Thank you. .

Thanks Mike..

And your next question comes from the line of Keith Hughes with SunTrust. Please go ahead. .

Thank you. I just wanted to ask about some of the numbers you gave on Nora. I believe you said 9% organic sales growth in the first quarter and 12% order growth. I want to make sure that those are kind of apples-to-apples versus done on the same accounting basis on the prior year.

And then number two, talk a little more, if you could talk about what geographies, what products, things like that are driving the order growth..

So yes, those are organic. So currency neutral like-for-like the 9% and the 12%..

This is Bruce, Keith. Just to clarify, we didn't close the Nora acquisition until August of last year. So when we talked about those numbers, we're looking at Nora standalone. We're comparing the results that we saw on our P&L this year versus the results that Nora saw on its P&L last year. So it truly is an apples-to-apples looking at Nora standalone.

And yes, the 9% and 12% are apples-to-apples as well, calculated in the same manner. And to Jay's point, they're in local currency. It takes out the currency noise. Sorry to interrupt you, Jay..

No, it's good. .

And really we're seeing pretty solid growth across the board. With Nora we've got Asia-Pacific doing extraordinarily well and the top region in Nora is doing exceptionally well which is our core market in Europe. .

And how much of the business is in the U.S.

at Nora?.

About 1/3..

1/3.

And the growth rates there above, below what you're seeing in Asia and Europe?.

Slightly below, but still above what they were historically, so encouraging..

We're super encouraged, Keith, by the revenue synergies we're seeing out of Nora and the traction that we're getting there..

Okay. And we've seen just some explosive growth out of Tarkett's business, which is different than yours.

But do you have in your planning what kind of growth do you think Nora could do for like the remainder of this year based on their backlogs and order indications?.

So Keith, this is Bruce. I think as we think about that, we're trying to bake that into our full year outlook. And again I'll just refer you to our press release. So when we talk about total net sales growth including Nora of 14% to 16%, that really is what we're sort of forecasting and anticipating on the total top line.

Obviously that includes a currency headwind. And as we mentioned, we're looking at a roughly 200 basis point currency headwind based on today's currency rates. And then of course organic growth from carpet and LVT of 2% to 4%.

So you can kind of back into -- you could probably do the math pretty quickly to back into what the dollars are on Nora based on that math..

Yes. And I'm super happy with the integration team and how they're driving cross-selling activity in all the markets. I mean we took a very structured approach on how we were bringing Nora into the family. And I'm personally really encouraged by what we're seeing so far. Hopefully there's upside..

Yes hopefully there's upside. .

Thank you. .

Your next question comes from the line of Matt McCall with Seaport Global Security..

Thank you. Good morning guys. .

Good morning Matt..

So maybe continuing on that last question. Jay, you said the 2% to 4% was kind of indicative of the expectations around tile and LVT. Can you give us any more color on tile versus LVT? And I guess as a follow on to that, it's clear that Nora seems to be benefiting from the combined effort.

But what about the other direction, tile and LVT, how have they benefited or how much have they benefited from the addition of the Nora relationships?.

Well it's encouraging. If you take a market like Germany, it's working extraordinarily well. The leader of the dock region of Nora and the leader of the dock region of Interface are working really collaboratively to drive that. We see upside in our ability to sell carpet and LVT into the healthcare segment.

And we'll be introducing products later this year that will help accelerate that. And I'll tell you, Matt, the LVT business is going exceptionally well. Of our 2% growth in the first quarter, the majority of that was driven by LVT..

And this is Bruce, Matt. Just as a courtesy heads up, part of that was driven by, you might remember last year we had an incredibly strong quarter in Q1 of last year in tile. And so it was just it was a very, very strong comp..

So we continue to see growth in both product lines, in tile and LVT..

Okay. Thank you. So back to SG&A again. I just want to make sure I understand kind of the goal here. The goal, just doing the math is a 27% SG&A as a percent of sales over the next 4 to 6 years. You were 27.3% last year. If I strip out the $8 million from the sales summit, it looks like you'd be around 27.7% this year.

Maybe relative to those two numbers, what causes it to take 4 to 6 years to get there? Or will you get there sooner and maybe it takes a little longer to get the gross margin where you want it to get to, to get to the 15% and the 19%?.

No. Matt, what you have to realize is last year's number didn't include a full year of Nora. And Nora spends more than the legacy Interface on SG&A. So this is the first year they're getting kind of a full year impact of Nora in our SG&A.

So I think it's fair for you to say, okay, the starting point is 28% to 28.5% less $8 million, as the starting point..

So about 27.7%. And then in the past I think you've given us some bogies, annual targets.

What's the leverage target year-on-year as we move forward? And what kind of top line or volume do you need to see to reach that target?.

Hey, Matt. This is Bruce. We really don't give guidance out into 2020 and 2021. We do mention here that we have a 4- to 6-year algorithm that we're driving toward, and that's the 42% gross margin, the 15% operating margin and the 19% EBITDA margin.

But in terms of like providing sort of more granular information about 2020 or 2021, we're just not there yet..

Yes and what I would add to that Bruce completely that is that the key operative number there is getting the 15% _ markings. So we're going to balance how we spend SG&A and how we achieve our gross margin objectives. They hit that 15% ROI.

So we're super focused on that right now and that what Bruce calls the margin _ is just the combination of great productivity management and solid SG&A optimization. .

Okay. Perfect. Thank you guys. .

Thank you Matt..

Your next question comes from the line of David MacGregor with Longbow Research. Please go ahead. .

Good morning everyone. .

Morning David..

Can you just take apart the 50 basis points of advance in the gross margins, adjusted gross margins? Just help us understand some of the puts and takes there. I mean you had talked in passing, Jay, about being pleased with the productivity. But I'm guessing there was more going on there as well.

And maybe to what extent do you think you're starting to benefit from the lower fourth quarter oil prices and some of that coming through? But if you could just give us some of the puts and takes around that, it'd be helpful. Thanks..

Well one of the things is we're seeing some pricing read through in the market. So that helped in the first quarter. We're getting 100 bps of pricing opportunity reading through. We've also seen as LVT continues to grow that that's margin accretive. So that helps the gross margin. Raw material pricing is really flat.

So we're fine with input cost inflation here in the first quarter. We'll see our productivity roll out more in the next 3 quarters, a little bit less of an impact in the first quarter..

Okay.

And then just the 100 basis points of price, can you just give us a little bit of a greater feel of where you're picking that up?.

Well it's really in the Americas and in Europe. They have both -- we took pricing in both markets late last year, in October of last year, and so we're seeing that read through now..

Okay.

And then the RMI, the raw materials inflation being flat, when do you start to benefit from some of that pullback in the petrochemical markets in the fourth quarter? Does that come through in terms of any of your feedstock prices here anytime soon?.

Well oil prices are back up..

Okay.

So how does the gross margin progress into 2Q? Can you talk a little bit about what your expectations are there?.

Well look. I go back to we're going to be at 40% to 40.5% for the full year. We fully expect second quarter to start with a 4..

Yes. Yes.

And does Interface services come into play more significantly as a headwind in 2Q?.

Actually it's a slight, albeit very slight, tailwind..

So it's just a tailwind.

And then what our second quarter expectations for Nora's gross profit margins?.

They will be accretive. As we've announced, they'll be accretive to the company total..

Yes. David, this is Bruce. We actually really don't break out gross margins by product line. As we've mentioned as we've talked about Nora, we are very pleased with the margin structure of that business. And that's a margin structure that helps us..

Right. Thanks very much guys..

Thanks David..

Your next question comes from the line of John Baugh with Stifel..

Good morning and thanks for taking my question. I was wondering, and I guess this is a U.S. focus question, but you could answer it for Europe as well if there's differences. And it's carpet tile focused. And I believe you're shifting a little bit more to making the stock versus made to order. And if I'm wrong on that correct me.

But could you talk about sort of high-level trends you're seeing in carpet tile between, I don't know, high-end product versus lower-priced products, what you're doing specifically to address any changes there and where you are in this process of making more to stock versus custom? Thank you..

We are trying to maximize the use of true manufacturing facilities. And we actually have similar strategies in Europe and the U.S., where we have kind of a short run made-to-order plant and a long run plant.

We are always trying to drop orders down to the factory floor as efficiently as we can, and we continue to improve on our supply chain planning to allow us to do that. I will say that one of the things that's driving our ability to take market share is the success of our new products.

So we're currently at a -- the carpet tile business, at 38% new product vitality. So that's the percent of our revenue generated by products we've introduced over the last 3 years. And as you know, that's a remarkable number.

One of the reasons that I think that the vitality [in it] is so high is over the last few years we have been designing our collections to have good, better, best inside a collection so we can value engineer ourselves, if necessary, during the construction process. So we're seeing growth across all of our pricing categories.

But particularly in what we call category 2 and category 3 products, which are lower price, not necessarily lower margin products, which tie in with the higher-priced products. So I think that's really working in the market, John..

Okay. And then I think you mentioned about 100 basis points of price in the Americas as well as perhaps Europe.

Did I hear that right? Was there any mix involved as well up or down in carpet tile in Europe and/or Americas?.

Mix is always a hard one. I mean we don't think that there's a huge mix inside the carpet tile category. I think it's relatively flat..

Okay. And on LVT just quickly, you've mentioned I think margin accretive and it's been a successful endeavor for you guys. Do you see overall any price degradation in the LVT? Or are you, if you are, that the cost is also going down so the margin profile really isn't changed. Any granularity? Thank you..

No, our prices have really held in the marketplace. As you know, John, we have particularly focused on a specified business. And our prices are held and our margins are strong. They're accretive to the overall portfolio..

And of course you're being sourced out of South Korea, not China.

So I mean does that maybe even enhance your margin profile? Or what has the competition had to do that's coming from China versus your supply?.

Well we're certainly not subject to the tariff penalties that people pulling out of China are. But the thing that's helping our margin structure is, as we continue to ramp up, we get fixed cost leverage. So our cost structure actually is coming down slightly in 2019..

Right. Thanks for all. Thanks for answering my questions. Good luck. .

Yes, you're welcome, John. And the thing I'd say is we're super happy with the supply chain model that we selected there, to go into the category in an asset-light fashion, focus on the demand side. And then ultimately we want to build the plant up. It's a math exercise that Bruce will go through..

There are no further questions in the queue. .

Okay. Well as I said previously, a really strong start to the year. We're very excited about that. And I want to again thank the global Interface team for starting the year with very solid results, keeping us on track to accomplish our full year commitments. Our strategy is clear and it's working in the marketplace.

Again I also want to thank our customers and share owners who continue to support Interface and our world-changing mission as we continue to execute on Climate TakeBack. Thank you very much..

And this concludes today's conference call. You may now disconnect..