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Edited Transcript of TILE earnings conference call or presentation 26-Jul-19 1:00pm GMT

Q2 2019 Interface Inc Earnings Call

ATLANTA Aug 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Interface Inc earnings conference call or presentation Friday, July 26, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bruce A. Hausmann

Interface, Inc. - VP & CFO

* Christine Needles

Interface, Inc. - Global Head of Corporate Communications

* 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

* John Allen Baugh

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* 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 - Research Analyst

* Samuel John Darkatsh

Raymond James & Associates, Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning. My name is Natalie, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Q2 2019 Interface, Inc. Earnings Conference Call. (Operator Instructions) Thank you.

Christine Needles, Corporate Communications, you may begin your conference.

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Christine Needles, Interface, Inc. - Global Head of Corporate Communications [2]

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

During today's conference call, any management comments regarding Interface's business, which are not historical information are forward-looking statements within the meaning of the Securities Act of 1933, the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements regarding the intent, belief or current expectations of our management team, as well as the assumptions on which such statements are based. Any forward-looking statements are not guarantees of future performance, and 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 and 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 caution 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, those 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 furnished with the SEC yesterday, which explains why Interface believes presentations of these non-GAAP measures provides useful information to investors, as well as any additional material purposes for which Interface uses these non-GAAP measures, 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 recorded 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 Jay Gould, CEO.

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

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Good morning, and thank you for joining us on this call. I'm pleased to share our second quarter results and discuss our outlook for the second half of the year. We delivered a solid second quarter with net sales up 26% and organic sales up 2% versus the second quarter of last year. Thank you to the entire global Interface team for their commitment to our strategic goals and for delivering another solid quarter, keeping us on track to deliver another year of growth. We continue to execute on our value creation strategy and despite a slow growth macro environment, we entered the back half of 2019 as a stronger company. Increasing customer interest in our Carbon Neutral Floors program help drive market share gains in key markets around the world, including the United States, the U.K., Germany and India. Customers have positively responded to our move into resilient flooring, LVT and rubber. Those 2 product lines now account for approximately 25% of our revenue. And both grew at double-digit rates in local currency. In the second quarter, our Nora rubber flooring business grew 11% in local currency compared to the standalone Nora business in the same period last year. We've also made strides in our selling system transformation with the launch of our new CRM platform in the second quarter, providing a robust tool to drive sales force efficiency and much greater visibility into our sales pipeline. Our productivity initiatives remain on track as they drove a 60 basis point increase in adjusted gross margin versus the prior year, yielding a second quarter adjusted gross profit margin of 39.1%, while material costs were as expected in the quarter and remain in line with our full year expectations. We also saw pricing hold and actually increase in the number of markets around the world.

SG&A expenses were managed to the planned level of $96 million or 26.8% of net sales, despite higher than normal legal expenses related to the previously announced SEC legal matter. Together, these results delivered an adjusted diluted EPS of $0.51 for the quarter. As mentioned earlier, we are experiencing moderating growth in our carpet tiles business, consistent with the broader industry. But we are continuing to take market share. This market dynamic emboldens us to continue our strategy of expanding the lead we currently have in the carpet tile space, while broadening our product offerings in the resilient space, including LVT, which we launched in 2017 and rubber, which we acquired last year. That said, recall that our carpet tile product line has a tough comparison to prior years in the second and third quarters, where a large United States customer drove significant volume last year. With this very challenging comp, we finished the second quarter with organic orders flat versus last year. So we're anticipating Q3 organic growth to be in the range of 0% to 2% followed by organic growth in the fourth quarter of 3% to 4%.

With that, I'll turn the call over to Bruce.

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

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Thanks, Jay, and good morning to everyone. Second quarter net sales were $358 million, up 26% over the prior year, including negative currency impact of $6 million or 210 basis points year-over-year. Organic sales were up 2%, which was in line with our expectations.

Looking at revenue in more detail, legacy sales in the Americas were up 1% compared to the second quarter of last year and excluding the previously mentioned large customer order in 2018, sales in the Americas grew 5%. Legacy sales in EMEA grew 2% on local currency or down 4% in U.S. dollars due to currency headwinds driven by the euro to USD and pound sterling to USD exchange rates versus prior year.

Legacy sales in Asia Pac were up 3% in local currency compared to the second quarter of last year, both down 2% in U.S. dollars, largely due to the Australian dollar to USD exchange rate versus last year.

In our Global Market segments, second quarter growth was driven by corporate office, public buildings, and healthcare. Second quarter gross profit margin was 38.8%, which included $1 million of Nora purchase accounting amortization. Adjusted gross profit margin was 39.1%, a 60 basis point improvements over gross profit margin in the prior year period. We're very pleased with the progress of our productivity initiative, their impact on our margin results, which improved sequentially throughout the quarter and they positioned us well as we entered into the back half of 2019.

SG&A expenses were $96 million in Q2, or 26.8% of sales. We incurred unusually high legal expenses in the quarter of approximately $2.7 million related to the SEC matter. Separately, on the income tax line, we had a $3 million net reduction to tax expense in the second quarter related to a [thin blockade] liability adjustment. This side then contributed to considerably low tax rate in the second quarter.

Now looking at the operating income line, second quarter operating income was $43 million compared with $34 million in the prior year period excluding order purchase accounting in Q2 of 2019, the Nora transaction-related expenses in Q2 of 2018. Adjusted operating income was $44 million in Q2 of 2019 compared to $37 million last year. In Q2, we recorded net income of $29 million or $0.50 per diluted share compared to the net income of $21 million or $0.35 per diluted share in last year.

Adjusted net income was $30 million or $0.51 per diluted share in Q2 of 2019 compared to $25 million, or $0.42 per diluted share last year. Adjusted EBITDA was $57 million in the second quarter of 2019 compared to $48 million in the same period last year, representing 20% growth in adjusted EBITDA.

Moving to the balance sheet and cash flows, our balance sheet and liquidity remains strong with $217 million of borrowing availability under our revolving credit facility at the end of the quarter.

We also reduced inventory by $13 million sequentially from Q1 2019 to Q2 2019, as we continued to improve our working capital metrics. We also ended the quarter with $84 million of cash on hand and $672 million of gross debt, net debt, which is simply gross debt minus cash on hands was there for $588 million at the end of the quarter.

And on a pro forma basis, our trailing 12-month adjusted EBITDA is approximately $200 million as laid out in the reconciliation table on our earnings press release. Our leverage ratio calculated as net debt to pro forma adjusted EBITDA was approximately $2.9 million. This result was driven by taking a $588 million of net debt divided by the $200 million of pro forma adjusted EBITDA over the trailing 12 months.

These 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 second quarter compared to $2 million in Q2 of last year. An increase in interest expense is due to a finance in Nora acquisition, which occurred in the third quarter of 2018.

Depreciation and amortization was $11 million in Q2 compared to $9 million of last year. And capital expenditures were in line with expectations at $15 million in the second quarter compared to $9 million last year as we continued to get execute on our strategic objectives, including expanding manufacturing capabilities and productivity initiatives.

In the second quarter, we also executed on the remaining $25 million of share repurchases available under our previously announced $100 million share repurchase program.

And now I'd like to hand the call back to Jay to provide us an update on our 2019 outlook.

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

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Thank you, Bruce. Our transition into a commercial flooring company is working. Resilient flooring now represents 25% of our portfolio. It's growing at double digits with accretive margins. And we also continue to take market share in carpet. So despite the slowing macro environment, we continue to expect a strong year as we execute on our strategic agenda. And we are targeting to achieve the following results in 2019: total net sales growth of 14% to 15%; organic sales growth of 2% to 3%; adjusted gross profit margin to increase 100 to 150 basis points versus the prior year, which equates to a range of 39.7% to 40.2%.

Adjusted SG&A expenses of approximately 28.5% as a percentage of net sales.

Full year company interest and other expenses are projected to be $32 million to $34 million, and the effective tax rate is anticipated to be approximately 25%. Diluted share count is anticipated to be approximately 60 million shares. So looking at the second half earnings, we anticipate the Q4 adjusted EPS to exceed the Q3 adjusted EPS by approximately $0.03 to $0.05. Capital expenditures for the full year are forecast to be $65 million to $75 million comprised of approximately $35 million of maintenance capital plus investment capital to fund growth and value-creation initiatives that will optimize and expand our manufacturing capabilities and ultimately yield greater growth and expansion.

In addition, as we've described on 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. I again want to thank the global Interface team for another very solid quarter and for keeping us on track to accomplish yet another year of growth. We are aligned on a very clear strategy and we have an inspiring mission that is helping us win in the marketplace. Thank you to our customers, our shareowners, who continue to support Interface and our climate take back vision. So with that, I'll open the call up for questions.

Natalie, could you do that for us, please?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Michael Wood of Nomura Instinet.

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Michael Robert Wood, Nomura Securities Co. Ltd., Research Division - Research Analyst [2]

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The third quarter to fourth quarter ramp, you mentioned the organic growth numbers that you're expecting in the second half. Is there anything else that's contributing like SG&A timing or productivity timing?

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

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Well, on the top line, I mean, first of all, I'd say, we have lower comps, easier comps in the fourth quarter than we have in the third quarter. So that is the driver of it. Secondly, we've got continued pushing of resilient flooring and we're expecting even greater growth of the LVT business in the fourth quarter.

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Michael Robert Wood, Nomura Securities Co. Ltd., Research Division - Research Analyst [4]

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Great. You mentioned the longer-term margin goals that you have. Can you just give us some of the next major milestones. When you work towards those? Are there going to be any disruptions or bumps in the road that we should be aware of? And can you remind us how much of the savings maybe you've achieved so far?

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

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Well, there's a lot. Let me unpack that a little bit. First of all, our gross margins from 2014 to 2019 will have expanded 600 basis points. A key piece of that is that our U.S. asset transformation that we've been working on for 3 years, that project will be complete by the end of the year and we will have harvested the $30 million that we anticipated with that project. We do have additional productivity plans over the next 3 years to help us on that margin to 42% gross margins and 15% operating margins. We're going to talk about that in detail at the end of the third quarter as we present our kind of go-forward plan for '20 and beyond. But I will say that the productivity pipeline is fairly robust, which leads to our confidence level in achieving those margin targets.

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Michael Robert Wood, Nomura Securities Co. Ltd., Research Division - Research Analyst [6]

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Great. Finally, can I just ask what the reduction of 30 basis points in gross profits, your guidance, what contributed to that? In your outlook?

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Bruce A. Hausmann, Interface, Inc. - VP & CFO [7]

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Yes. It's -- we're still anticipating the productivity initiatives that we expected as we started the year. So $20 million of gross productivity offset by roughly $10 million of inflation to yield, $10 million of net productivity, which is at 100 to 150 basis points improvement in gross margins that we're expecting. The 20 basis point miss versus our going-in assumption is largely coming from some reduction in manufacturing volume in Europe and some mixed issues related to some Nora volume, particularly in China, where we took a very large order at a government facility, but it came at significantly reduced margins. So a little bit of mix, a little bit of fixed cost leverage out of Europe.

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Operator [8]

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And our next question comes from the line of Kathryn Thompson of Thompson Research Group.

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Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO and Director of Research [9]

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(inaudible) today. On the Resilient segment, could you give more granularity on the LVT and rubber separately sales and order growth in the U.S. versus the European market? And also just clarify today where we are in terms of the geographic break out of the sales in U.S. versus Europe and other markets for the broad resilient category?

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

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Well, the Nora business is a very globally based business, but about a third of that business is in the United States. And we had really strong growth in the first half of the year in United States on rubber. We also had great growth in Germany, and what we call the dark region, which are the German speaking countries of Germany, Australia and Switzerland, really strong first half performance there. A little bit weaker across the rest of Europe. We also saw very strong growth in China, albeit with reduced margins in the first half of the year.

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Bruce A. Hausmann, Interface, Inc. - VP & CFO [11]

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Just to wrap the numbers around that Kathryn. This is Bruce. Roughly 55% of our revenues are in America's, roughly 30% in EMEA and about 15% in Asia -- Asia Pac.

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Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO and Director of Research [12]

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For specifically resilient category?

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Bruce A. Hausmann, Interface, Inc. - VP & CFO [13]

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That's in total. I'm giving you the total numbers. We actually don't -- we don't really break out by product category where the -- with various mixes.

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Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO and Director of Research [14]

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Okay. As it was to be more important category that would be something that would be helpful going forward just in terms of -- because if you're having double-digit growth in that category versus flat for carpet tile, it helps to build the bridge for the growth story. So the second question really has more to do on what you're seeing more specifically in Europe and China. I understand, and obviously, not surprising to see softening trends in the European market, but if you could give a little bit more color on where in Europe you're seeing a little bit better or a little bit weaker markets? And also, clarify a little bit more some of the challenges you're seeing in China just as the U.S. company operating in China right now?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [15]

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Yes. I would say on a core legacy business, we're still seeing strong growth in the dark region and a slowdown pretty much across the board. The U.K., it's very soft. South Europe has been soft so far this year, although orders looked interesting. So it's a pretty broad slowdown of the market across Europe. China has been very difficult on the legacy business. I think that there is some anti-American sentiment going on. And then overall slowdown of the China economy. You can literally feel it when you go there, Kathryn. So keeping an eye on that business. I would say that revenue and orders have been weak coming out of China. The offset to that for us is India where we're having another fabulous year in India, and many of our global accounts continue to put new offices in India. So very pleased with the performance there.

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Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO and Director of Research [16]

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Okay. And final, just a follow-up question on Nora. As you're continuing to roll it out, I understand you're getting some good synergies on the top line. What end markets are you seeing particular strength? And are there any new markets that really hadn't been fully penetrated? Are there any new markets that are -- geographic markets that are seeing particular strength?

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

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We're seeing great growth in healthcare and some growth in education on the Nora piece of the business. So very encouraged with that. We still have an opportunity, I think, to better address rubber in the office market, where it's used in code base and in stair treads. So there is an opportunity for us to do a better job there. And I think we'll accelerate our growth into back half of the year if that crops up.

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Operator [18]

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And our next question comes from the line of Keith Hughes of SunTrust.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [19]

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Just want a question on SG&A. You'd take that out to the 28.5%, could you talk about the contributions to get those numbers up?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [20]

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Well, yes. I mean we're still in the range where we talked about at the start of the year, 28%, 28.5%. We do have some added legal expense, it will be a full year expense. I think $2.7 million of that float into the second quarter. So that will -- that's going to have a full year impact. We are trying to pull back on SG&A to keep it as percent of sales as our top line soften a little bit. We're making some reductions in our total SG&A dollars.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [21]

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Okay. And the accounting investigate, I think you announced last quarter, is there any update on that?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [22]

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No. We don't have an update. I mean it's going to the government space. So we're responding to request and just trying to get through the process.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [23]

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And final question. I don't know if it's just me. I am having a hard time hearing you, could you just read off again the geographic growth excluding currency and local currency?

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

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Yes. I got that, Keith. Can you hear me okay?

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [25]

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Yes, barely. If you could just read it one more time.

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Bruce A. Hausmann, Interface, Inc. - VP & CFO [26]

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Okay. Hopefully, you can hear me now. So Americas was up 1% compared to second quarter of last year. And excluding the large customer order that we mentioned, that we had in 2018, sales in Americas grew 5%. Now legacy sales in EMEA grew 2% in local currency, but were down 4% in U.S. dollars due to currency headwinds that were driven by the euro to USD and pound to USD exchange rates versus last year. And legacy sales in Asia Pacific were up 3% in local currency compared to the second quarter of last year, but were down 2% in U.S. dollars. Again, more currency headwinds really driven by Australian dollar to USD exchange rate versus last year.

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Operator [27]

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And our next question comes from the line of Matt McCall of Seaport Global Securities.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [28]

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So you gave the adjusted Americas growth of 5% ex the 1 large order, I think that, that also impacts Q3. So when I look at that, Q3 growth of 0.2 -- or 0% to 2%, what is the growth excluding that large order or the impact of that large order last year?

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Bruce A. Hausmann, Interface, Inc. - VP & CFO [29]

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Matthew, this is Bruce. There will be a similar impact in Q3 as we had in Q2.

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

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Yes.

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

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Okay. And so, I guess same question when I think about the full year. So you got about 4 points of impact in Q2, 4 points of impact in Q3, does that imply that there is maybe -- is that -- what is that? 2 points for the full year, so that 2% to 3% organic growth kind of on an adjusted basis for that large order would,maybe be more than like 4% to 5%, 5% to 6% or something like that?

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Bruce A. Hausmann, Interface, Inc. - VP & CFO [32]

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Yes. I've said it a lot. It's about 250 basis points for the year globally, Matt. So yes. I mean you could add 200 to 250 basis points to your organic growth rate to get it out on a normalized basis.

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

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And so that kind of leads to the next question, Jay, the long-term view for carpet tile, is the mid-single digit the right number? Or is GDP growth the right number? And then how important are some of the new product moves? And I'm talking carpet tile specifically and some of the manufacturing moves in helping you offset some of the maybe the secular pressures that you're facing there?

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

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Yes, I don't know if it's secular pressures. I certainly think it's a couple of year pressure point as resilient flooring is making a bigger dent, particularly in the office market. I do see that moving back and we'll get back to the kind of GDP growth on carpet tile because it's a superior flooring surface in commercial, in general, but in particular, for the office market because of its acoustic benefits. So I see that -- I see the category growth rates coming back over time. And we would anticipate 3% to 4% growth of carpet tile, both from the category as well as continued market share gains. We do believe -- I mean our new part of vitality for the portfolio is at 38% right now. So our new products are definitely capturing demand in the market. As you know, the customers are responding to that. Additionally, and as we move into the next year, we'll have a broader portfolio in carpet tile including some non-PVC backing, which has been a gap in our portfolio, really forever. So I think, Carpet Neutral Floors, and as we move into being even more aggressive around carbon conversation, coupled with design innovation, we'll have a portfolio that should allow us to take market share.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [35]

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Okay, that's helpful. And then one last question on the SG&A, maybe following up on, I think, it was Keith that asked. Last quarter when you gave guidance on SG&A, how much legal was in that projected range? How much legal related to the SEC issue specifically was in that guidance last quarter?

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

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It was modest, to be perfectly honest with you. I mean we didn't expect spending at the levels that we did in the second quarter. And frankly, we don't think those levels will continue that high. So it was a bit of a surprise in the second quarter, how much we had to invest there.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [37]

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So what does -- so where -- can you quantify, where you thought it was going to be? Now where you think it's going to be? And then what I'm trying to get at is what you've actually pulled out? You said you've pulled some SG&A back. I'm trying to figure out exactly how much you've pulled back? And then I guess the bigger question is, what are you pulling back?

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

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Well, I mean with pullbacks (inaudible) $5 million to $10 million of SG&A if we ever got to accommodate for whatever this legal expense is going to be. I mean we honestly don't know. We've got to just go through the process with the government, Matt. And that's -- and what are we pulling back, I mean, we've pulled back some incentives, these were not going to deliver on our expectations for the year. And we'll trim the tabs everywhere. We're trimming the tabs a little bit on -- in Europe right now because it's soft.

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Operator [39]

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And our next question comes from the line of Sam Darkatsh of Raymond James.

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Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [40]

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2 or 3 questions. The Nora growth that you called out, the 11% on a like-for-like basis, that's obviously terrific and higher than when you originally bought Nora, I think you were targeting kind of the mid-single plus. I know you've mentioned a large order in China, but I also know that you've made a number of synergistic moves to sell Nora more holistically. When you look now at the next 2, 3 years or so, what sort of steady-state growth rate might we expect now from Nora, best you can tell?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [41]

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I think in those, look 4% to 5% range is much more likely. I -- look, I'm thrilled with the 11%. The Nora team -- the Nora sales team has done an absolutely fabulous job in kind of coming into the Interface family. I don't think the long-term prospects are double-digit growth though.

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Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [42]

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So how sustainable over the next, I don't know, 2, 3, 4 quarters or so might this high single, low double-digit rate last?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [43]

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I think for a while. I think with the expanded geographic reach that we have with Interface will help. And I also think kind of getting deeper in some of our core markets will help. We are -- the Interface selling systems is deeper in things like office, where I think we can take market share there.

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Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [44]

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Next question, capital allocation. It appears as though you've finished your share repo, at least, your current authorization. Your valuation is still modest, although, I think you are at roughly 3x debt-to-EBITDA. So talk about priorities going forward, repo versus debt pay down, where is the imperative at this point and why?

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Bruce A. Hausmann, Interface, Inc. - VP & CFO [45]

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Yes. Sam, this is Bruce. Really the key priorities kind of go in this order. First is investing in the business. The investments that we're making in the business are showing up as productivity on the P&L. So we want to continue that momentum. That's just driving the margin expansion you're seeing today. And that's what gets us to the 42% as well. The second is paying down debt and deleveraging, which we're also focused on. And then I think you're also aware, we also have a competitive dividend as well that we pay.

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Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [46]

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So okay. You did not include share repurchase in that. So what's the optimal capital structure now, as you see it, is it roughly 2 turns from the 3 today?

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Bruce A. Hausmann, Interface, Inc. - VP & CFO [47]

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Yes, I think that that's what we're targeting toward as we continue to deleverage.

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Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [48]

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Got it. And then my last question, I apologize for jumping on the horse with the legal cost again but do they continue? Or do you anticipate them continuing as long as the SEC process continues? Or is it just kind of an initial upfront legal cost and then it kind of win those away until there is a decision one way or the other?

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Bruce A. Hausmann, Interface, Inc. - VP & CFO [49]

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So Sam, I mean, the honest answer is that you never know. It's almost impossible to give you a definitive answer. But if you are to say, what's our best guesstimate. We had a -- we had a little bit of a hump to get out. We had a little bit of expense that we had to incur this quarter, but we don't. And our best estimate is that's not an ongoing run rate so.

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Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [50]

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So something half of that rate might be something we should bake in at least until there is resolution?

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Bruce A. Hausmann, Interface, Inc. - VP & CFO [51]

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That's not what I'm saying. I'm not just saying half or a quarter. I'm just saying, I wouldn't -- I think that, that was unusually high. And I would be disappointed if it was -- if it continued at that rate. So it's not something that we're anticipating. But with these kinds of matters, you have to just spend the money that you need to spend.

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Operator [52]

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And our next question comes from the line of David Macguire (sic)[MacGregor] of Longbow Research.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [53]

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Jay, congratulations on a good quarter. What percentage of your project wins now include LVT and Nora? And how does that compare with say, a year ago?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [54]

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Well, I mean the -- all I can really tell you is the percent of orders that include both. And it's roughly 40% and it continues to grow.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [55]

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Where would that have been a year ago?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [56]

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I would say, 20% or less. I mean it's really working. This idea about selling an integrated flooring design has really helped. And the fact that our products are interchangeable, they're of the same size, has really helped the design community. And as odd as that sounds, I'm not aware of any of our competitors that do the same thing.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [57]

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That's remarkable, 40% versus 20%. What -- the jobs you aren't winning, is it due to price or breadth of offering, or just talk about the ones that getaway?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [58]

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Well, we don't compete in the low-price point categories, as you know. So I'm going to take those off the table. The ones we don't lose, from a design perspective, it's -- unfortunately, there's a belief in the market that there needs to be some democracy amongst players, and what we're trying to do is win our rightful market share, which I tell our salespeople is a 100%. That's what I believe is there are rightful market share is 100% and the deals we lose is because we don't have enough time to spend with our customers.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [59]

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So people are just spreading the business around?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [60]

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Yes.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [61]

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Okay. On Nora, I guess we're about the anniversary the acquisition, it's obviously been a very successful acquisition. What's the expected first year accretion?

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Bruce A. Hausmann, Interface, Inc. - VP & CFO [62]

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From a GPS perspective?

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [63]

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Sure, that works.

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Bruce A. Hausmann, Interface, Inc. - VP & CFO [64]

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Yes, we -- so we don't really breakout the legacy business from the Nora page on the contribution, David.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [65]

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Well at the time that you acquired the company, you thought you could do $0.15 to $0.20 in the first year. So I guess what -- how did we measure against that initial expectations?

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Bruce A. Hausmann, Interface, Inc. - VP & CFO [66]

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So what we do provide is a bit of -- we provide revenue accretion every quarter, which is what we're trying to do. It's also accretive to the GP line and accretive to the OI line. We don't necessarily breakout the components of that, as if they are 2 different businesses. So frankly, the 2 businesses are being integrated so well together that over time, it becomes difficult. They become an integrated one instead of 2 separate companies.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [67]

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Sure. But you're communicating your accretion expectations at the time of the purchase. It seems fair to be able to circle back around with you a year later and just see how you held up against that initial expectation. I'm just trying to guess that sort of -- if you can't quantify it, are you ahead of where you thought you'd be or are you behind or are you in line, just how does that stack up?

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Bruce A. Hausmann, Interface, Inc. - VP & CFO [68]

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Yes. No, I think that as you mentioned, the acquisition has been a great acquisition and is very, very much on track. And it's -- where -- and you can see from the growth rate and from the synergies that we're getting out of it, we're very pleased.

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Jay D. Gould, Interface, Inc. - President, CEO & Director [69]

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Yes. I think that's fair. We'll circle back at the end of the -- so at the end of the third quarter when we do results and talk more about that, we'll have a full year under our belt. And I would say, David, is what's working and what are some of the challenges. Top line is working. The integration of the selling organizations in the cross site, I feel like that's working really well in the United States and Germany. What's been a challenge quite frankly are the margins, we -- they were dilutive in the first quarter, we talked about that, to our gross margins. And we're continuing to get our arms around the manufacturing environment in (inaudible). We're participating in a whole new category. We're learning to work with the new works council in Germany. And that's been a little bit slower than I would have liked, but it's coming around. So at the operating income line, it has been positive. We haven't gone through the stage of going through any kind of account reduction yet, which is going to be an opportunity to better find synergies as we get our systems in place. So we're going live with our order-to-cash integration starting in the fourth quarter of this year, and it'll be a couple of quarter rollout as we take that global, which will give us an opportunity to better harmonize these systems. So I think fundamentally, it's working. It's been -- it's added to our bottom line. And that's been good at a time when frankly carpet tile has been a little bit soft.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [70]

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Great, great. Now that's helpful. I appreciate the candor, Jay. Just last question for me, there's been new industry capacity brought into carpet tile on U.S. and Europe. Can you just talk about how that additional industry capacity may be influencing you competitively?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [71]

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We haven't seen it at all, David. Once again, I would say, even with our -- from my expectation, our second quarter gross margin was about 100 bps miss. I wanted it to be at 40% and we delivered 39.1%. None of that was coming out of the U.S. We actually hit our target in the Americas. So the added capacity in the Americas has had no impact on our margin structure. Europe is soft, and I don't think it's because of the Mohawk added capacity in Europe, our numbers are a little bit soft in Europe because the top line is soft in Europe. We actually produced a lot less volume because we took inventory down in Europe. So we had some fixed cost leverage challenges in our manufacturing environment in Europe. It's not really from competitive pricing. Hopefully, that helps.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [72]

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It does help. Are you expecting those production curtailments to continue into the third quarter in Europe?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [73]

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Yes.

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Operator [74]

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And our last question comes from the line of John Baugh of Stifel.

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John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [75]

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Just had a quick question on carpet tile in the U.S. I'm just curious, Jay, what are you seeing in terms of mix? It strikes me as though the low end of tiles where most of the growth is and, of course, you operated the high-end. Are you -- where are you with the strategy to make more to stock versus custom order? What are you seeing in terms of orders in carpet tile in terms of high versus low price points and just general mix commentary around the U.S. tile business?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [76]

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You know, it's ironic. We're selling a lot of $15, $16 carpet, but we're also selling a lot of $35-plus carpet. We have a booming business in the commercial of selling carpet tile as area rugs, and a lot of that is the floor branded product, which, again, sells at $35-plus a square yard. So there is a -- one of the things we did a few years ago, John, if you might remember is in our design approach, in every new design, we have a good, better, best approach. And so we can kind of value engineer ourselves as we get into the purchase journey. So we're seeing growth at the low end and the high end of our portfolio.

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John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [77]

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Okay. And then just back to Nora really quickly. If you exclude the China order, which is obviously not U.S., I'm trying to get a sense of whether in the early innings of owning this, you're seeing benefit to Nora from Interface and integrated sales. And you mentioned that commercials is a big opportunity, of course, you were strong in that area. So it doesn't sound like that's occurred yet. But I'm just curious whether you're seeing any wins in the U.S. that you would chalk up to Nora being part of Interface?

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Jay D. Gould, Interface, Inc. - President, CEO & Director [78]

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Well, yes. I mean the answer is yes. Both in the U.S. and Germany, which are really our 2 markets with scale. It's still early days but the sharing of lease, the sharing of opportunities, bringing 1 sales person into another account is working. And I mean there is countless numbers of individuals deals that I can reel off that have worked.

And John, by the way, it will get better when we all get on the same CRM platform. So in May, we took the Interface people live at our new salesforce.com platform. The Nora people will go live in the fourth quarter and having one integrated system, so we can look at all the deal activity, will actually help accelerate that.

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Operator [79]

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And there are no further questions at this time. I will now turn it over to Jay for closing remarks.

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Jay D. Gould, Interface, Inc. - President, CEO & Director [80]

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Thank you, Natalie. Well, once again, thanks to the Interface team around the world for another very solid quarter. I'm excited that we continue to take market share. I'm thrilled with the progress and the transformation of the company into a flooring company. And for everyone on the call, I appreciate your continued interest and investment in Interface. Thank you. Talk to you next quarter.

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Operator [81]

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This concludes today's conference call. You may now disconnect. Have a great day.