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Edited Transcript of TILE earnings conference call or presentation 26-Apr-18 1:00pm GMT

Thomson Reuters StreetEvents

Q1 2018 Interface Inc Earnings Call

ATLANTA Apr 27, 2018 (Thomson StreetEvents) -- Edited Transcript of Interface Inc earnings conference call or presentation Thursday, April 26, 2018 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bruce Hausmann

Interface, Inc. - VP & CFO

* Christine Needles

* Jay D. Gould

Interface, Inc. - President, CEO & Director

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Conference Call Participants

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* David Sutherland MacGregor

Longbow Research LLC - CEO and Senior Analyst

* Kathryn Ingram Thompson

Thompson Research Group, LLC - Founding Partner, CEO and Director of Research

* Keith Brian Hughes

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Matthew Schon McCall

Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst

* Michael Robert Wood

Nomura Securities Co. Ltd., Research Division - Senior Equity Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Q1 2018 Interface Earning's Conference Call. (Operator Instructions) .

As a reminder, this conference call is being recorded. I would now like to turn the conference over to Christine Needles, Global Corporate Communications. Ma'am, you may begin.

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Christine Needles, [2]

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Thank you, Ashley. Good morning, and welcome to Interface's conference call regarding first 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 to place undue reliance on any such forward-looking statements.

Management's remarks during this call refer to certain non-GAAP measures. A reconciliation of these non-GAAP measures to the most comparable GAAP measures is contained in the company's earnings release and Form 8-K filed with the SEC yesterday.

Lastly, this call is being recorded and broadcasted for Interface. It contains copyrighted material and may not be rerecorded or rebroadcasted without Interface's 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.

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Jay D. Gould, Interface, Inc. - President, CEO & Director [3]

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Good morning. Well once again, I'd like to begin by thanking our Interface teams around the world for delivering a very solid first quarter, consistent with our expectations. We remain focused on our priorities and are working together globally to ensure that our value creation strategy is working in the marketplace. So let's jump right into our first quarter results. We delivered solid performance down the P&L with first quarter GAAP net sales growth of 8.8% year-over-year. Our LVT business continues to gain traction with our customers, driving growth alongside our core carpet tile business. If you remember, it was this time last year that we had just launched our first LVT line in the Americas, with launches in Europe and APAC throughout 2017. Now with the full year of selling and our largest market behind us, we're seeing promising growth in our resilient business, with additional designs and innovation on the horizon for the back half of 2018. We're also delighted with the growth we see in our core carpet tile business and the way that our customers are using carpet tile and LVT, together, as a modular system to design beautiful floors and positive spaces across the segments that we serve. Organic sales which adjust for the impact of foreign currency fluctuations and also for the exit of our FLOR store -- specialty retail stores was up a solid 6.6% year-over-year.

Turning to orders, our first quarter organic orders were up 12% year-over-year. Our first quarter revenue in order trends were consistent with the pace that we anticipated, as expected orders were influenced by a large strategic customer and a deal that we negotiated late last year. We're now starting to see our order book translate to the P&L. This will help revenue growth in quarters 2 and 3. For the second quarter we're targeting net sales growth in the range of 9% to 11%. As anticipated, our first quarter gross margin of 38.9% was down slightly year-over-year, due to higher input prices as well as the exiting of the FLOR specialty retail. As planned, we held our SG&A expenses flat as a percentage of sales over the prior year. With dollars up versus last year as we made the planned investments in our growth-related strategies, the pace of SG&A spend is in line with our anticipated annual run rate. The outcome of all this was solid EPS growth. We delivered EPS of $0.25, compared to last year's Q1 GAAP EPS of $0.13, that's a 19% increase versus a -- that's a 19% increase.

Regarding our capital allocation, we continue to execute against our previously announced $100 million share repurchase program. In the first quarter, we completed an additional $14.5 million of stock repurchases. Now, I'd like to turn the call over to Bruce for a full review of the financial details of the first quarter. Bruce, the call is yours.

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Bruce Hausmann, Interface, Inc. - VP & CFO [4]

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Thanks Jay, and good morning, everyone. As a reminder, organic sales, organic sales growth and organic order growth adjust to exclude the impact of foreign currency fluctuations and exiting FLOR specialty retail. Let's dive into first quarter 2018 results. First quarter GAAP net sales were $241 million, up 8.8% over the prior-year period. On broad-based growth and positive currency impacts, offset partially by exited -- exit of FLOR specialty retail. Organic sales were up 6.6% year-over-year and taking a closer look at our regional net sales in Q1, net sales in the Americas region grew 5%, compared to Q1 last year with solid performance across the business and continued momentum in LVT.

Growth in the U.S. business was also enhanced by continued momentum in our InterfaceSERVICES business and strong growth in Latin America. In local currency, net sales in EMEA was up 4% year-over-year, while in US dollars, EMEA's net sales were up 19% year-over-year, as we benefited from currency tailwinds. Asia Pacific net sales were up 16%, compared to Q1 last year, with both China and India having double-digit growth. In terms of our 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 particularly retail, government, and healthcare.

Q1 organic orders were up 12% year-over-year, gross margin was 38.9% for the first quarter, which reflects an anticipated decrease of 80 basis points over the prior-year period, driven by higher input costs as well as exiting FLOR specialty retail. SG&A expenses were $71 million, which was flat and on plan at 29.3% of sales. First quarter operating income margin was 9.6%, compared to 7.1% in Q1 of 2017 and excluding last year's restructuring and asset impairment charges, adjusted operating income margin was 10.4% in Q1 of last year. Our effective tax rate was down to 26%, compared to 33% in Q1 of 2017, primarily due to the U.S. Tax Cuts and Jobs Act, enacted in December 2017. We delivered net income of $15.1 million or $0.25 per diluted share, compared to Q1 of 2017 net income of $8.5 million or $0.13 per diluted share. An adjusted prior year net income, which excludes the restructuring and asset impairment charge was $13.2 million or $0.21 per diluted share.

Now moving over to the balance sheet and cash flow statement. We ended Q1 of 2018 with total cash on hand of $68 million, debt of $244 million and strong liquidity, as we had $167 million available under our revolving credit facility. Interest expense was $2.1 million for the first quarter, compared with $1.6 million in Q1 of last year. Depreciation and amortization was $11.6 million for the first quarter of 2018, compared with $8.1 million in Q1 of 2017. And capital expenditures for the first quarter were $8.9 million, compared with $7.2 million in the same period last year. And now, I'd like to turn the call back to Jay to provide an update on our fiscal year 2018 outlook.

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Jay D. Gould, Interface, Inc. - President, CEO & Director [5]

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We are continuing to focus on the execution of our strategic agenda to become the world's most valuable interior products and services company. As we close out the first quarter and move in to the second quarter, we are reaffirming our outlook for 2018. We are targeting to achieve 3% to 5% organic sales growth, gross profit margin of 39% to 39.5%, SG&A expenses that are flat as a percentage of net sales and an effective tax rate of 26% to 27%. Interest and other expenses are projected to be $2 million to $3 million higher than last year and capitals expenditures are projected to be $50 million to $60 million. Based on the historic seasonality, current forecast in prior year comparables, we continue to expect our strongest operating income growth in the second and third quarters of this year. With softer operating income growth in the first and fourth quarters. And so with that, I'll open the calls -- the call for questions. Ashley?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Kathryn Thompson of Thompson Research.

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Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO and Director of Research [2]

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For the large customer order that you discussed in the prepared commentary, is this for a onetime event or part of a larger initiative that would play out for the year and possibly beyond that?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [3]

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Well, it's certainly part of a broader strategic initiative on behalf of that customer. Although, we're seeing major resets of their stores during the second and third quarter, which will have the primary P&L impact.

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Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO and Director of Research [4]

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Okay. And -- appreciate the color on orders, so 2 things with that, follow-ups on that. First, any color on the first few weeks of this quarter, in terms of order trends? And then also, the makeup of LVT versus carpet tile for orders that -- the 12% order growth?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [5]

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Yes, Kathryn. We've seen that order strength continue here in the early weeks of the second quarter. And it's really balanced, 50-50, between carpet tile and LVT. So we're very pleased with the kind of robustness of demand right now.

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Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO and Director of Research [6]

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And then finally, inflation has been a theme for pretty much this entire earnings season, particularly, building products and materials. Could you give your thoughts on a little bit more specificity of inflation impact in the quarter? Why you think that $10 million in inflation cost for the full year is still intact? And what you're doing and what you've done to help combat inflation in your core raw materials?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [7]

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I think, that's a great question, Kathryn. And it's really how we distinguish ourselves from many of our competitors. Is it because of our use of recycled materials we are less impacted by some of the inflationary pressures than some of our competitors. So we're seeing that recycled products are not -- input cost are not increasing at the same rate as virgin. So it's our long-term strategy to get off of virgin products. So we're seeing less input cost pressure, I think, than some of our primary competitors. That said, the outlook for the year we originally said would be $8 million to $12 million, we're still feeling that's the right range. Might be on the higher end of that. We're protecting ourselves for that. With the combination of our pricing and our productivity initiatives, we still feel confident that we can offset the input cost inflation, and still achieve our 39% to 39.5% gross margin targets. However, we might be on the lower end of that. So that's how we're modeling the business right now.

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Operator [8]

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Our next question comes from Michael Wood of Nomura.

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Michael Robert Wood, Nomura Securities Co. Ltd., Research Division - Senior Equity Research Analyst [9]

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Congratulations on the orders. First question, I wanted to ask about some details on LVT. I'm curious what you're seeing in terms of the more high design offerings that you've rolled out later last year versus performance in some of the earlier designs, the more practical ones that you had at the beginning of your offering? And any trends and gross profit margins and LVT that you can update us on.

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Jay D. Gould, Interface, Inc. - President, CEO & Director [10]

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Yes, Mike. Thanks for your question. Well, if you look at our revenue, I mean, still the traditional designs, the more simplistic designs are driving the revenue because they got into the specification process early. But the market reaction to our new designs have been very encouraging. And we're starting to see a lot more sampling done at those higher design, so I think, we'll see that flow through the P&L in the second and third quarters. Margins continue to be strong in LVT. We're still in -- starting with the 4 on gross margins, so that's solid. We're still hedging a little bit as we continue to roll out globally that we're moving into some more competitive markets, but it was margin accretive of the first quarter.

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Michael Robert Wood, Nomura Securities Co. Ltd., Research Division - Senior Equity Research Analyst [11]

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Okay, that's great to hear. And any update on some of your advance manufacturing, the Troup County initiatives and ERP rollout that you're expecting to do?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [12]

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So our ERP implementation, down to the factory FLOR in the United States, is scheduled for the first quarter of next year. So we've got a whole year of kind of planning to get done there. It's on track, I feel good about it. We're actually implementing the, pretty much, the system that we did in Europe, which will ultimately, allow us to move to 1 instance instead of 3 instances of our ERP system, now that's over the next 3 to 4 years granted. The productivity initiatives down in LaGrange are right on track, we feel really good about them. We're still expecting to harvest our $10 million of productivity benefit there this year.

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Michael Robert Wood, Nomura Securities Co. Ltd., Research Division - Senior Equity Research Analyst [13]

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Okay. And finally, can I just ask about any emphasis that you're planning for your new product launches this year, in terms of how they fit into 3 year strategic initiatives? And where we might expect the direction or focus to go when you launch your new set of products this year?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [14]

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Yes, great question, and we've got a really exciting product line that we're going to launch at NeoCon. One of the things, Mike, that we've been doing over the last few years is with our product launches, we're designing across price points. So you can go from price -- what we call price category 2, which is around $16 a square foot -- a square yard, up to $30 a square yard, and we've got designs, which allow us to kind of value engineer ourselves. That's been tremendously well received in the market, and we're seeing nice growth in those lower price point categories, still at acceptable margins. So I think we've got the balance in our innovation system appropriately focused.

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Operator [15]

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Our next question comes from Keith Hughes of SunTrust.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [16]

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Just wanted to dig into your comments on double-digit growth in office. Is -- how does that compare to what you saw in the second half of last year? And what would you attribute the strength to?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [17]

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Really, since the summertime of last year, we've seen companies releasing their capital budgets, particularly in the U.S. And so it's really this broad brush approach to renovation, I think, that's driving that, Keith. And I don't want to just say only in the U.S., and we had 9% order growth, almost 10% order growth in Europe in the first quarter. So we're starting to see renovation budgets in Europe also being released. The difference between this year and last year is, people are releasing their capital budgets earlier in the year.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [18]

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Okay. Second question, how much did raw material inflation hurt you in the first quarter in dollars?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [19]

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Let's -- about between $2 million and $2.5 million.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [20]

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Okay, so if you're going to get the high end of the range with -- what we expect to see something in that range for every quarter for the reminder this year? That how are you're...

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Jay D. Gould, Interface, Inc. - President, CEO & Director [21]

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I think -- yes, I think roughly Mike -- Keith that's about right.

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Bruce Hausmann, Interface, Inc. - VP & CFO [22]

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And Keith, remember for inflation, we're sort of thinking $8 million to $12 million for the year. Certainly, there's a lot of the ways out there around inflation, so that's why Jay mentioned earlier, if you were to ask what our crystal ball says now, we're a little -- we're sort of, I'm thinking, it may be in the higher end of that range for the total year.

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Jay D. Gould, Interface, Inc. - President, CEO & Director [23]

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For the input cost.

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Bruce Hausmann, Interface, Inc. - VP & CFO [24]

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Exactly. Which is why when we say 39% to 39.5% GP, our best estimate is probably on the softer -- on the lower end of that range.

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Jay D. Gould, Interface, Inc. - President, CEO & Director [25]

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We will be in that range in the second quarter. And we have pretty good visibility as we enter our quarter. So I'm expecting 30 to 50 basis point improvement year-over-year for the second quarter.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [26]

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So that would imply, not only for the second but for the back half of the year you should see some pretty meaningful improvement year-over-year. Does that come from pricing? Or what's going to drive it?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [27]

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It's really a combination of productivity and pricing. We feel really good about our productivity funnel. We're always a little cautious on pricing to see if it's going to hit. So we use pricing constantly as a dial and we're reading what's going on in the market, and adjusting how we quote bid and how we quote jobs.

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Operator [28]

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And our next question comes from Matthew McCall of Seaport Global.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [29]

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So, maybe, first on the inflation front. I think you addressed kind of the oil derivatives. What about -- there's a lot of concern out there about transportation, can you address your risk there? And you said you're trending toward the high end of that range, is that just because of what's going on with -- is it any specific inputs? Is it nylon? Is it PVC? Is it all of the above?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [30]

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Well, first of all we're not as highly influenced on transportation issues as some of our competitors, because we use transportation as just a pass on to our customers. So we -- those costs get directly pass through the P&L. We're -- I mean -- we're being more cautious on input cost inflation, primarily because we've seen oil tick up to $75. So we're not seeing it hit yet, but we're being a little cautious for the back half.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [31]

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Okay, okay. Okay. So maybe jump over to SG&A. Just wondering about the seasonal pattern you expect there. Q1 was a little higher than we had expected. You reiterated your Q1 -- or your full year outlook. Is there anything we should know about the seasonal pattern given what you saw in Q4 or what you did in Q1?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [32]

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Well, we're saying roughly 27% of gross of net sales, so roughly $280 million for the year. We are making investments in our growth initiatives earlier in the year. One of the things I saw on the first quarter, we actually did spend a little bit more SG&A than I anticipated. Because we filled jobs more quickly. I talked about we were in the process of doubling the amount of frontline sales managers we had in the U.S. And we got those jobs filled more quickly than I anticipated. That's a good thing actually. It demonstrates that Interface is still an attractive people -- place for people to work. And so I'm actually encouraged with the early results of our sales transformation plan. We've had no regrettable losses, and the initiatives seem to be, based on the order intake, the initiatives seem to be yielding the kind of results that we were expecting.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [33]

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Okay. All right. Okay, so the large order you referenced, is there a situation where you could have some gross margin pressure there? Not only because it's a large order, maybe comes with better pricing to the customer, but also because you -- I know you've got that 90-day lock for your alls, but sounds like this is going to stretch out a little long, do you have the accelerators in that contract? How does it work? Is there any risk to gross margins where I'm getting at?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [34]

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Well, there is some gross margin pressure with that big job, yes. It's dilutive to the overall average, however, there's no input cost inflation risk on that because we've already acquired all the raw material we require to make it, so we -- there's going to be no risk factor associated with that.

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Operator [35]

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And our next question comes from David MacGregor of Longbow Research.

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Jay D. Gould, Interface, Inc. - President, CEO & Director [36]

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I may sound boring on these calls because I'm just reiterating what we thought the year was going to look like. But I guess, that's a good thing.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [37]

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Yes, sounds like it. Can you just unbundle the 6.6% organic growth between LVT and carpet tile?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [38]

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Yes, so the -- on the revenue side it was about 80-20 LVT the carpet tile. Now, I did say earlier in the call that orders were 50-50. So we definitely saw a dramatic increase in the order activity in the later part of the first quarter.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [39]

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Okay. Just thinking about kind of win rates, I mean, the investment thesis going into the LVT business in the first place was -- it was going to increase your ability to close on the business you were pitching, because you had this sort of extra surface you could provide into jobs that were incorporating both surfaces. Can you just talk about your win rate experience now that you're a few quarters into the LVT business? And how's that helped kind of the average -- through the average ticket or the price of the average revenue per job, I guess, is what I'm driving at?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [40]

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Yes, well our win rate...

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [41]

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Or your win rate of jobs I guess.

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Jay D. Gould, Interface, Inc. - President, CEO & Director [42]

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Yes, our win rate has increased. I think, that's a really good insight from you. And I'd say that because our market share, we're gaining market share. All of our indications are that in our key markets we've gained market share. I hate to sound trite, but getting into this we really felt like it's like selling fries with a hamburger. It's a nice add-on sale and what we saw in about half the jobs that we compete on, include hard surfaces as well as soft surface. And so by offering a hard surface, we were able to meet the expectation of having one supplier that could provide both. And so that hypothesis has really proven out to be true, David.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [43]

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Last question for me is just with regards to given all the raw material inflation that seems to be on people's minds, the pricing power in America versus pricing power in Europe and Asia PAC. Could you just talk about how you perceive that and how we should think about that going forward?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [44]

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Well there's no question, we do have pricing power, and we do sell at a premium to the market. We're constantly monitoring that price gap versus competitors. We've seen growth across all of our category pricing, but particularly categories 2 and 3 are the -- that are growing nicely. Year up, we probably have a little bit less pricing power than we have in the U.S. However, the businesses is, again, growing cross all the price points there. And with 9% -- one of the real exciting parts about the first quarter is seeing 9% or 10% order growth in Europe. It's been a long time since we've seen that kind of robust environment there. So we're encouraged for Europe as we look at the full year.

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Operator [45]

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(Operator Instructions) We do have a question from the line of Kathryn Thompson of Thompson Research.

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Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO and Director of Research [46]

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Just a quick follow-up question on the productivity gains and inflation. So roughly $10 million in inflation for the year, are you planning to realize $10 million or $20 million in terms of productivity gains in fiscal 2018?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [47]

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Well, the combination of pricing and productivity, we're anticipating to yield about $20 million.

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Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO and Director of Research [48]

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Okay. So it's pricing and productivity?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [49]

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Yes, yes.

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Operator [50]

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And I'm showing no further questions at this time. I'd like to turn the call back to Jay for closing remarks.

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Jay D. Gould, Interface, Inc. - President, CEO & Director [51]

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Well, thank you again for your support in the first quarter. We look forward to having a conversation during the course of the year. Thanks again.

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Operator [52]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.