10-K 1 tile20171231_10k.htm FORM 10-K tile20171231_10k.htm
 

Table of Contents



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_______________

 

Form 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the Fiscal Year Ended December 31, 2017

 

Commission File No.: 001-33994

 

      Interface, Inc.      

(Exact name of registrant as specified in its charter)

 

Georgia

 

58-1451243

(State of incorporation)

 

(I.R.S. Employer Identification No.)

     

2859 Paces Ferry Road, Suite 2000

   

Atlanta, Georgia

 

30339

(Address of principal executive offices)

 

(zip code)

 

Registrant’s telephone number, including area code:             (770) 437-6800          

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

Title of Each Class

Name of Each Exchange on Which Registered:

Common Stock, $0.10 Par Value Per Share

Nasdaq Global Select Market

Series B Participating Cumulative Preferred Stock Purchase Rights

Nasdaq Global Select Market

 

Securities Registered Pursuant to Section 12(g) of the Act:               None             

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ☑ NO ☐

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ☐ NO ☑

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES ☑ NO ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES ☑ NO ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☑

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Securities Exchange Act of 1934. (Check one)

 

Large accelerated filer ☑

Accelerated filer ☐

Non-accelerated filer ☐

Smaller reporting company ☐ 

Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ☐ NO ☑

 

Aggregate market value of the voting and non-voting stock held by non-affiliates of the registrant as of June 30, 2017: $1,215,708,813 (61,868,133 shares valued at the closing sale price of $19.65 on June 30, 2017). See Item 12.

 

Number of shares outstanding of each of the registrant’s classes of Common Stock, as of February 18, 2018:

 

Class

Number of Shares

Common Stock, $0.10 par value per share

59,337,559

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2018 Annual Meeting of Shareholders are incorporated by reference into Part III.



 

 

TABLE OF CONTENTS

 

PART I

3

ITEM 1. BUSINESS

3

ITEM 1A. RISK FACTORS

13

ITEM 1B. UNRESOLVED STAFF COMMENTS

16

ITEM 2. PROPERTIES

16

ITEM 3. LEGAL PROCEEDINGS

17

ITEM 4. MINE SAFETY DISCLOSURES

17

PART II

17

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

17

ITEM 6. SELECTED FINANCIAL DATA

20

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

21

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

32

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

34

CONSOLIDATED STATEMENTS OF OPERATIONS

34

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

35

CONSOLIDATED BALANCE SHEETS

36

CONSOLIDATED STATEMENTS OF CASH FLOWS

37

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

38

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

70

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

71

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

72

ITEM 9A. CONTROLS AND PROCEDURES

72

ITEM 9B. OTHER INFORMATION

72

PART III

72

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

72

ITEM 11. EXECUTIVE COMPENSATION

73

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

73

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

73

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

73

PART IV

73

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

73

ITEM 16. FORM 10-K SUMMARY

76

SIGNATURES

79

EXHIBIT INDEX

80

 

 

 

PART I

 

ITEM 1. BUSINESS

 

Introduction and General

 

References in this Annual Report on Form 10-K to “Interface,” “the Company,” “we,” “our,” “ours” and “us” refer to Interface, Inc. and its subsidiaries or any of them, unless the context requires otherwise.

 

We are a worldwide leader in design, production and sales of modular carpet, also known as carpet tile. For the past several years, modular carpet sales growth in the floorcovering industry has outpaced the growth of the overall industry, as architects, designers and end users increasingly recognized the unique and superior attributes of modular carpet, including its dynamic design capabilities, greater economic value (which includes lower costs as a result of reduced waste in both installation and replacement), and installation ease and speed.

 

As a global company with a reputation for high quality, reliability and premium positioning, we market modular carpet in over 110 countries under the established brand names Interface® and FLOR®. Our principal geographic markets are the Americas, Europe and Asia-Pacific, where the percentages of our total net sales were approximately 59%, 25% and 16%, respectively, for fiscal year 2017.

 

Capitalizing on our leadership in modular carpet for the corporate office market segment, we are executing a market diversification strategy to increase our presence and market share for modular carpet in non-corporate office market segments, such as government, education, healthcare, hospitality and retail space. Our diversification strategy also targets the U.S. residential market segment for carpet. As a result of our efforts, our mix of corporate office versus non-corporate office modular carpet sales in the Americas was 44% and 56%, respectively, for 2017. Company-wide, our mix of corporate office versus non-corporate office sales was 59% and 41%, respectively, in 2017. We believe the appeal and utilization of modular carpet is growing in non-corporate office market segments, and we are using our considerable skills and experience with designing, producing and marketing modular products that make us the market leader in the corporate office segment to support and facilitate our penetration into these segments around the world.

 

In 2017, we globally launched a line of luxury vinyl tile (“LVT”) products, which represents our first introduction into a category of products that we call “modular resilient flooring”. Our LVT products accounted for more than half of our sales growth in 2017 compared with the prior year.

 

Our Strengths

 

Our principal competitive strengths include:

 

Market Leader in Attractive Modular Carpet Segment. We are the world’s leading manufacturer of carpet tile. Modular carpet has become more prevalent across all commercial interiors markets as designers, architects and end users have become more familiar with its unique attributes. We continue to drive this trend with our product innovations and designs discussed below. According to the annual Floor Focus interiors industry survey of the top 250 designers in the United States, carpet tile was ranked as the number one “hot product” for each of the years 2002 through 2012, and was ranked number two for each of the years 2013 through 2017. We believe that we are well positioned to lead and capitalize upon the continued shift to modular carpet, both domestically and around the world.

 

Established Brands and Reputation for Quality, Reliability and Leadership.  Our products are known in the industry for their high quality, reliability and premium positioning in the marketplace, and our established brand names are leaders in the industry. The 2017 Floor Focus survey ranked Interface second in “Best Overall Business Experience” among carpet companies, and it ranked our Interface brand first or second in the survey categories of service, quality, design, performance and value. In the North American residential market segment, our FLOR brand is known for its high style carpet design squares that consumers assemble to create custom rugs, runners or wall-to-wall designs in the home. On the international front, Interface is a well-recognized brand name in carpet tiles for commercial and institutional use. More generally, we believe that as the appeal and utilization of modular carpet continues to expand into market segments such as government, healthcare, education, hospitality, retail and residential space, our reputation as the pioneer of modular carpet — as well as our established brands and leading market position for modular carpet in the corporate office segment — will enhance our competitive advantage in marketing to the customers in these new markets.

 

Innovative Product Design and Development Capabilities.  Our product design and development capabilities have long given us a significant competitive advantage, and we believe they continue to do so as modular carpet’s appeal and utilization expand across virtually every market segment and around the globe. One of our recent design innovations is the introduction of long and narrow rectangular carpet tiles in the shape of planks, and even more narrow versions known as Skinny Planks. The use of planks and Skinny Planks increases the design versatility of our carpet tile, as these products can create aesthetics (such as a herringbone pattern) that are different from, or enhance, that of our traditional square carpet tiles.

 

 

The award-winning design firm David Oakey Designs has had a pivotal role in developing our plank and Skinny Plank products, as well as many of our other innovative product designs, and our long-standing exclusive relationship with David Oakey Designs remains vibrant and augments our internal research, development and design staff. As another example, David Oakey Designs has developed products that are manufactured using state-of-the-art tufting technology which allows us to pinpoint tufts of different colored yarns in virtually any arrangement within a carpet tile. These unique designs are best exemplified by our Urban Retreat®, Net Effect®, Human Nature® and World Woven® collections, which are sold throughout our international operations.

 

Historically, one of our best design innovations is our i2™ modular product line, which includes our popular Entropy® product for which we received a patent in 2005 on the key elements of its design. The i2 line introduced and features mergeable dye lots, and includes a number of carpet tile products that are designed to be installed randomly without reference to the orientation of neighboring tiles. The i2 line offers cost-efficient installation and maintenance, interactive flexibility, and recycled and recyclable materials. Another innovation is our TacTiles® carpet tile installation system, which uses small squares of adhesive plastic film to connect intersecting carpet tiles, thus eliminating the need for traditional carpet adhesive and resulting in a reduction in installation time and material waste.

 

Made-to-Order and Global Manufacturing Capabilities. We have a distinct competitive advantage in meeting two principal requirements of the specified products markets we primarily target — that is, providing custom samples quickly and on-time delivery of customized final products. We also can generate realistic digital samples that allow us to create a virtually unlimited number of new design concepts and distribute them instantly for customer review, while at the same time reducing sampling waste. About half of our modular carpet products worldwide are made-to-order. Our made-to-order capabilities not only enhance our marketing and sales, they significantly improve our inventory turns. Our global manufacturing capabilities in modular carpet production are an important component of this strength, and give us an advantage in serving the needs of multinational corporate customers that require products and services at various locations around the world. Our manufacturing locations across four continents enable us to compete effectively with local producers in our international markets, while giving international customers more favorable delivery times and freight costs.

 

Recognized Global Leadership in Ecological Sustainability. Our long-standing goal and commitment to be ecologically “sustainable” — that is, the point at which we are no longer a net “taker” from the earth and do no harm to the biosphere — have emerged as a competitive strength for our business and remain a strategic initiative. It includes Mission Zero®, our global branding initiative, which represents our mission to eliminate any negative impact our companies may have on the environment by the year 2020. It also includes a bold new mission called Climate Take Back™, in which we seek to lead the industry in designing and making products in ways that will maintain a climate fit for life. Our acknowledged leadership position and expertise in this area resonate deeply with many of our customers and prospects around the globe, and provide us with a differentiating advantage in competing for business among architects, designers and end users of our products, who often make purchase decisions based on “green” factors. The 2017 Floor Focus survey named our Interface business the top among “Green Leaders,” and gave us the top “Green Kudos” honors for our Net Effect collection of recycled content products.

 

Experienced and Motivated Management and Sales Force.  An important component of our competitive position is the quality of our management team and its commitment to developing and maintaining an engaged and accountable workforce. Our team is highly skilled and dedicated to guiding our overall growth and expansion into our targeted market segments, while maintaining our leadership in traditional markets and our high contribution margins. We utilize an internal marketing and predominantly commissioned sales force of more than 650 experienced personnel, stationed at over 70 locations in over 30 countries, to market our products and services in person to our customers. Our incentive compensation and our sales and marketing training programs are tailored to promote performance and facilitate leadership by our executives both in strategic areas as well as the Company as a whole.

 

Our Business Strategy and Principal Initiatives

 

Our business strategy is to continue to use our leading position in modular carpet and our product design and global made-to-order capabilities as a platform from which to drive acceptance of our modular carpet and new LVT products across several industry segments, while maintaining our leadership position for modular carpet in the corporate office market segment. These efforts generally are described in the following strategic pillars:

 

 

Grow our core carpet tile business;

 

Develop a substantial modular resilient flooring business;

 

Execute supply chain productivity;

 

Control selling, general and administrative ("SG&A") spending; and

 

Lead a world-changing sustainability movement centered around Mission Zero and Climate Take Back.

 

 

We will seek to increase revenues and profitability by capitalizing on the above strengths and pursuing the following key initiatives.

 

Penetrate Expanding Geographic Markets for Modular Products. The popularity of modular carpet continues to increase compared with other floorcovering products across most markets, internationally as well as in the United States. While maintaining our leadership in the corporate office segment, we will continue to build upon our position as the worldwide leader for modular carpet in order to promote sales in all market segments globally. A principal part of our international focus – which utilizes our global marketing capabilities and sales infrastructure – is the significant opportunities in several emerging geographic markets for modular carpet. These emerging markets, such as China, India and Eastern Europe, represent large and growing economies and opportunities for Interface to leverage its brand, experience and skills. Other expanding geographic markets, such as Germany and Italy, are established markets that are transitioning to the use of modular carpet from historically low levels of penetration. Each of these geographic markets represents a significant growth opportunity for our modular carpet business.

 

Continue to Penetrate Non-Corporate Office Market Segments. We will continue our strategic focus on product design and marketing and sales efforts for non-corporate office market segments such as government, education, healthcare, hospitality, retail and residential space. We began this initiative as part of a market diversification strategy to reduce our exposure to the economic cyclicality of the corporate office segment, and it has become a principal strategy generally for growing our business and enhancing profitability. To implement this strategy, we introduced specialized product offerings tailored to the unique demands of these segments and created targeted selling techniques dedicated to penetrating certain segments.

 

As part of this strategy, our FLOR line of products focuses on the U.S. residential carpet and rugs market segment. These products were specifically created to bring high style modular carpet and rugs to the North American residential market. Historically, we offered FLOR in three primary sales channels – catalogs, the Internet, and in our FLOR retail stores. In the fourth quarter of 2016, we adopted a restructuring plan that included the closure of FLOR’s headquarters office and most retail FLOR stores. In 2017, we completed our restructuring plan and now FLOR focuses on internet sales as well as crossover sales by our commercial sales force.

 

Develop a Substantial Modular Resilient Flooring Business. Building upon the success of our initial introduction of products into the high growth LVT market, we plan to expand our LVT product offering while also seeking to introduce new products in the modular resilient flooring category. We believe our ability to offer and sell our soft and hard surfaces in an integrated flooring design helps meet the needs of our customers by complementing and enhancing our carpet tile portfolio with true modular installation, no transition strips between surfaces, same sizes of carpet tile and LVT products, and favorable acoustic properties.

 

Continue to Minimize Expenses and Invest Strategically. We have steadily trimmed costs from our operations for several years through multiple initiatives, which have made our cost structure more efficient today and for the future. Our supply chain and other cost containment initiatives have improved our cost structure and yielded operating efficiencies. While we still seek to minimize our expenses in order to increase profitability, we will also take advantage of strategic opportunities to invest in systems, processes and personnel that can help us grow our business and increase profitability and value.

 

Use Strong Free Cash Flow Generation to Strengthen Our Balance Sheet. Our principal business has been structured to yield contribution margins that generate strong free cash flow (by which we mean cash available to apply towards servicing debt, potential stock repurchases, strategic acquisitions and the like). Our historical investments in global manufacturing capabilities, facilities and product customization techniques, which we have maintained, also contribute to our ability to generate strong levels of free cash flow. We expect to use our strong free cash flow generation capability to potentially repurchase shares and strengthen our financial position, or re-invest in our operations. We will also continue to execute programs to reduce costs further and enhance free cash flow.  In addition, our existing capacity to increase production levels without significant capital expenditures will further enhance our generation of free cash flow as demand for our products rises.

 

Sustain Leadership in Product Design and Development. As discussed above, our leadership position for product design and development is a competitive advantage and key strength. Our plank, Skinny Plank, and i2 products and TacTiles installation system have confirmed our position as an innovation leader in modular carpet. We will continue initiatives to sustain, augment and capitalize upon that strength to continue to increase our market share in targeted market segments. Our Mission Zero and Climate Take Back initiatives, which draw upon and promote our ecological sustainability commitment, are part of those initiatives and include placing our Mission Zero and Climate Take Back logos on many of our marketing and merchandising materials distributed throughout the world.

 

 

Challenges

 

In order to capitalize on our strengths and to implement successfully our business strategy and the principal initiatives discussed above, we will have to handle successfully several challenges that confront us or that affect our industry in general. As discussed in the Risk Factors in Item 1A of this Report, several factors could make it difficult for us, including:

 

 

sales of our principal products have been and may continue to be affected by adverse economic cycles in the renovation and construction of commercial and institutional buildings;

 

 

 

 

we compete with a large number of manufacturers in the highly competitive commercial floorcovering products market, and some of these competitors have greater financial resources than we do;

 

 

 

 

our success depends significantly upon the efforts, abilities and continued service of our senior management executives and our principal design consultant, and our loss of any of them could affect us adversely;

 

 

 

 

our substantial international operations are subject to various political, economic and other uncertainties that could adversely affect our business results;

 

 

 

 

large increases in the cost of petroleum-based raw materials could adversely affect us if we are unable to pass these cost increases through to our customers;

 

 

 

 

unanticipated termination or interruption of any of our arrangements with our primary third party suppliers of synthetic fiber or our sole third party supplier for LVT could have a material adverse effect on us;

 

 

 

 

we have a significant amount of indebtedness, which could have important negative consequences to us; and

     
  Some of our competitors who have greater financial resources than we do are adding manufacturing capacity into the industry throughout the world, which could increase the amount of supply in the market, adversely affect pricing in the market, and generate other competitive factors which could adversely impact our sales and profitability.

 

We believe our business model is strong enough, and our strategic initiatives are properly calibrated, for us to handle these and other challenges we will encounter in our business.

 

Seasonality

 

Historically, our first quarter has typically been our slowest quarter while our fourth quarter has typically been our best quarter, with sales generally increasing throughout the course of the fiscal year.  However, in recent years, as our sales efforts and results in the education market segment (which has a heavy buying season in the summer months) have increased and currency fluctuations have impacted us, our third quarter sales have sometimes been the highest.

 

Our Products and Services

 

Modular Carpet

 

Interface is the world’s largest manufacturer and marketer of modular carpet. Our modular carpet system, which is marketed under the established global brands Interface and FLOR, utilizes carpet tiles cut in precise, dimensionally stable squares (usually 50 cm x 50 cm) or rectangles (such as planks and Skinny Planks) to produce a floorcovering that combines the appearance and texture of traditional soft floorcovering with the advantages of a modular carpet system. Our GlasBac® technology employs a fiberglass-reinforced polymeric composite backing that provides dimensional stability and reduces the need for adhesives or fasteners. We also make carpet tiles with a backing containing post-industrial and/or post-consumer recycled materials, which we market under the GlasBacRE brand. In addition, we make carpet tile with yarn containing varying degrees of post-consumer nylon, depending on the style and color.

 

Our carpet tile has become popular for a number of reasons. Carpet tile incorporating our reinforced backing may be easily removed and replaced, permitting rearrangement of furniture without the inconvenience and expense associated with removing, replacing or repairing other soft surface flooring products, including broadloom carpeting. Because a relatively small portion of a carpet installation often receives the bulk of traffic and wear, the ability to rotate carpet tiles between high traffic and low traffic areas and to selectively replace worn tiles can significantly increase the average life and cost efficiency of the floorcovering. In addition, carpet tile facilitates access to sub-floor air delivery systems and telephone, electrical, computer and other wiring by lessening disruption of operations. It also eliminates the cumulative damage and unsightly appearance commonly associated with frequent cutting of conventional carpet as utility connections and disconnections are made. We believe that, within the overall floorcovering market, the worldwide demand for modular carpet is increasing as more customers recognize these advantages.

 

We use a number of conventional and technologically advanced methods of carpet construction to produce carpet tiles in a wide variety of colors, patterns, textures, pile heights and densities. These varieties are designed to meet both the practical and aesthetic needs of a broad spectrum of commercial interiors – particularly offices, healthcare facilities, airports, educational and other institutions, hospitality spaces, and retail facilities – and residential interiors. Our carpet tile systems permit distinctive styling and patterning that can be used to complement interior designs, to set off areas for particular purposes and to convey graphic information. While we continue to manufacture and sell a substantial portion of our carpet tile in standard styles, most of our modular carpet sales in the Americas and Asia-Pacific are custom or made-to-order products designed to meet customer specifications.

 

 

In addition to general uses of our carpet tile, we produce and sell a specially adapted version of our carpet tile for the healthcare facilities market. Our carpet tile possesses characteristics — such as the use of the Intersept® antimicrobial, static-controlling nylon yarns, and thermally pigmented, colorfast yarns — which make it suitable for use in these facilities in place of hard surface flooring. Moreover, we launched our FLOR line of products to specifically target modular carpet sales to the residential market segment. We also have created modular carpet products specifically designed for each of the education, hospitality and retail market segments.

 

We also manufacture and sell two-meter roll goods that are structure-backed and offer many of the advantages of both carpet tile and broadloom carpet. These roll goods are often used in conjunction with carpet tiles to create special design effects. Our current principal customers for these products are in the education, healthcare and government market segments.

 

Modular Resilient Flooring

 

In 2016, we began offering a category of products we call modular resilient flooring, and our first product introductions into this category were LVT products in a four-city test market in the U.S. We recognize that our customers are buying multiple flooring types to service individual projects, while also looking to partner with fewer suppliers that can offer more products and services. In the annual Floor Focus survey described above, LVT has been ranked as the number one “hot product” each of the past five years. Expanding our product portfolio to include modular resilient flooring, and specifically LVT, allows us to meet this growing demand and pursue new or incremental sales opportunities. LVT also shares many of the same attributes and benefits with carpet tile, and we were able to leverage our experience in modular carpet tile in designing a product specification to meet our aesthetic and performance standards. We also selected a reputable third party to manufacture the products to our specifications, thus allowing us to enter the product category with minimal capital commitments.

 

In 2017, we launched our LVT products globally, beginning with the Level Set™ Collection which includes 41 styles of tiles with printed top layers in a variety of aesthetic looks, including natural woodgrains and stones, textured woodgrains, and patterns. These products are modular and come in sizes that match certain of our modular carpet planks and squares. They also are engineered to the same height as our modular carpet, which means better coverage of irregularities in the sub-floor, lower sound transference from floor to floor, and the ability to install our LVT and modular carpet products side by side without transition strips or layering. In addition, the Level Set Collection is constructed with the same type of backing as our carpet tiles.

 

Other Products and Services

 

We sell a proprietary antimicrobial chemical compound under the registered trademark Intersept that we incorporate in all of our modular carpet products and have licensed to another company for use in air filters. We also sell our TacTiles carpet tile installation system, along with a variety of traditional adhesives and products for carpet installation and maintenance that are manufactured by a third party. In addition, we continue to manufacture and sell our Intercell® brand raised/access flooring product in Europe. We also continue to provide “turnkey” project management services for national accounts and other large customers through our InterfaceSERVICES business.

 

Marketing and Sales

 

We have traditionally focused our carpet marketing strategy on major accounts, seeking to build lasting relationships with national and multinational end-users, and on architects, engineers, interior designers, contracting firms, and other specifiers who often make or significantly influence purchasing decisions. While most of our sales are in the corporate office segment, both new construction and renovation, we also emphasize sales in other segments, including retail space, government institutions, schools, healthcare facilities, tenant improvement space, hospitality centers, residences and home office space. Our marketing efforts are enhanced by the established and well-known brand names of our carpet products, including Interface and FLOR.

 

An important part of our marketing and sales efforts involves the preparation of custom-made samples of requested carpet designs, in conjunction with the development of innovative product designs and styles to meet the customer’s particular needs. In most cases, we can produce samples to customer specifications in less than five days, which significantly enhances our marketing and sales efforts and has increased our volume of higher margin custom or made-to-order sales. In addition, through our websites, we have made it easy to view and request samples of our products. We also use technology which allows us to provide digital, simulated samples of our products, which helps reduce raw material and energy consumption associated with our samples.

 

We primarily use our internal marketing and sales force to market our carpet products. In order to implement our global marketing efforts, we have product showrooms or design studios in the United States, Canada, Mexico, Brazil, Denmark, England, France, Germany, Spain, the Netherlands, India, Australia, Norway, United Arab Emirates, Russia, Singapore, Hong Kong, Thailand, China and elsewhere. We expect to open offices in other locations around the world as necessary to capitalize on emerging marketing opportunities.

 

 

We distribute our products through two primary channels: (1) direct sales to end users; and (2) indirect sales through independent contractors or distributors. In each case, we may also call upon architects, engineers, interior designers, contracting firms and other specifiers who often make or substantially influence purchasing decisions.

 

Manufacturing

 

We manufacture carpet at two locations in the United States and at facilities in the Netherlands, the United Kingdom, Thailand, China and Australia.

 

Having foreign manufacturing operations enables us to supply our customers with carpet from the location offering the most advantageous delivery times, duties and tariffs, exchange rates, and freight expense, and enhances our ability to develop a strong local presence in foreign markets. We believe that the ability to offer consistent products and services on a worldwide basis at attractive prices is an important competitive advantage in servicing multinational customers seeking global supply relationships. We will consider additional locations for manufacturing operations in other parts of the world as necessary to meet the demands of customers in international markets.

 

Our raw materials are generally available from multiple sources – both regionally and globally – with the exception of synthetic fiber (nylon yarn).  For yarn, we principally rely upon two major global suppliers, but we also have significant relationships with at least two other suppliers.  Although our number of principal yarn suppliers is limited, we do have the capability to manufacture carpet using face fiber produced from two separate polymer feedstocks – nylon 6 and nylon 6,6 – which provides additional flexibility with respect to yarn supply inputs, if needed.  Our global sourcing strategy, including with respect to our principal yarn suppliers and dual polymer manufacturing capability, allows us to help guard against any potential shortages of raw materials or raw material suppliers in a specific polymer supply chain.

 

We have a flexible-inputs carpet backing line, which we call “Cool Blue™”, at our modular carpet manufacturing facility in LaGrange, Georgia. Using next generation thermoplastic technology, the custom-designed backing line dramatically improves our ability to keep reclaimed and waste carpet in the production “technical loop,” and further permits us to explore other plastics and polymers as inputs. We also have technology that more cleanly separates the face fiber and backing of reclaimed and waste carpet, thus making it easier to recycle some of its components and providing a purer supply of inputs for the Cool Blue process. This technology, which is part of our ReEntry®2.0 carpet reclamation program, allows us to send some of the reclaimed face fiber back to our fiber supplier to be blended with virgin or other post-industrial materials and extruded into new fiber.

 

The environmental management systems of our floorcovering manufacturing facilities in LaGrange, Georgia, West Point, Georgia, Northern Ireland, the Netherlands, Thailand, China and Australia are certified under International Standards Organization (ISO) Standard No. 14001.

 

Our significant international operations are subject to various political, economic and other uncertainties, including risks of restrictive taxation policies, foreign exchange restrictions, changing political conditions and governmental regulations. We also receive a substantial portion of our revenues in currencies other than U.S. dollars, which makes us subject to the risks inherent in currency translations. Although our ability to manufacture and ship products from facilities in several foreign countries reduces the risks of foreign currency fluctuations we might otherwise experience, we also engage from time to time in hedging programs intended to further reduce those risks.

 

Competition

 

We compete, on a global basis, in the sale of our modular carpet products with other carpet manufacturers and manufacturers of vinyl and other types of floorcoverings, including broadloom carpet. Although the industry has experienced significant consolidation, a large number of manufacturers remain in the industry. We believe we are the largest manufacturer of modular carpet in the world. However, a number of domestic and foreign competitors manufacture modular carpet as one segment of their business, and some of these competitors have financial resources greater than ours. In addition, some of the competing carpet manufacturers have the ability to extrude at least some of their requirements for fiber used in carpet products, which decreases their dependence on third party suppliers of fiber.

 

 

We believe the principal competitive factors in our primary floorcovering markets are brand recognition, quality, design, service, broad product lines, product performance, marketing strategy and pricing. In the corporate office market segment, modular carpet competes with various floorcoverings, of which broadloom carpet is the most common. We believe the quality, service, design, better and longer average product performance, flexibility (design options, selective rotation or replacement, use in combination with our LVT or roll goods) and convenience of our modular carpet are our principal competitive advantages.

 

We believe we have competitive advantages in several other areas as well.  First, having both an internal design staff as well as our relationship with David Oakey Designs allows us to introduce numerous innovative and attractive carpet tile and LVT products to our customers.  Additionally, we believe that our global carpet tile manufacturing capabilities are an important competitive advantage in serving the needs of multinational corporate customers. We believe that the incorporation of the Intersept antimicrobial chemical agent into the backing of some modular carpet products enhances our ability to compete successfully across all of our market segments generally, and specifically with resilient tile in the healthcare market.

 

In addition, we believe that our environmental sustainability goals and commitment to eliminate our negative impact on the environment by 2020 is a brand-enhancing, competitive strength as well as a strategic initiative. Our customers are concerned about the environmental and broader ecological implications of their operations and the products they use in them. Our leadership, knowledge and expertise in the area, especially in the “green building” movement and related environmental certification programs, resonate deeply with many of our customers and prospects around the globe. Our modular carpet products historically have had inherent installation and maintenance advantages that translated into greater efficiency and waste reduction. We are using raw materials and production technologies, such as our Cool Blue backing line and our ReEntry 2.0 reclaimed carpet separation process, that directly reduce the adverse impact of those operations on the environment and limit our dependence on petrochemicals.

 

Product Design, Research and Development

 

We maintain an active research, development and design staff of approximately 80 people and also draw on the research and development efforts of our suppliers, particularly in the areas of fibers, yarns and modular carpet backing materials. Our research and development costs were $14.0 million, $14.3 million, and $14.5 million in 2017, 2016, and 2015, respectively.

 

Our research and development team provides technical support and advanced materials research and development for us. The team assisted in the development of our post-consumer recycled content, polyvinyl chloride, or PVC, extruded sheet process that has been incorporated into our GlasBacRE modular carpet backing. Our post-consumer recycled content PVC extruded sheet exemplifies our commitment to “closing-the-loop” in recycling. More recently, this team developed our TacTiles carpet tile installation system, which uses small squares of adhesive plastic film to connect intersecting carpet tiles. The team also helped implement our Cool Blue flexible inputs backing line and our ReEntry 2.0 reclaimed carpet separation technology and post-consumer recycling technology for nylon face fibers. With a goal of supporting sustainable product designs in floorcoverings applications, we continue to evaluate bio-based and renewable polymers for use in our products. Our research and development team also supports the dissemination, consultancies and technical communication of our global sustainability endeavors. This team also provides all biochemical and technical support to Intersept antimicrobial chemical product initiatives.

 

Innovation and increased customization in product design and styling are the principal focus of our product development efforts, and this focus has led to several design breakthroughs such as our plank and Skinny Plank products, as well as our i2 product line. Our carpet design and development team is recognized as an industry leader in carpet design and product engineering for the commercial and institutional markets.

 

David Oakey Designs provides carpet design and consulting services to us pursuant to a consulting agreement, and this firm augments our internal research, development and design staff. David Oakey Designs’ services under the agreement include creating commercial carpet designs for use by our modular carpet businesses throughout the world, and overseeing product development, design and coloration functions for our modular carpet business in North America. The agreement can be terminated by either party upon six months prior written notice to the other party. David Oakey Designs also contributed to our ability to efficiently produce many products from a single yarn system. Our mass customization production approach evolved, in major part, from this concept and increases the number and variety of product designs, which in turn enables us to offer products with competitive margins.

 

Environmental Initiatives

 

In the latter part of 1994, we commenced a sustainability strategy within our business that we now call Mission Zero, aimed at reducing waste, environmental footprint and costs. Mission Zero, which includes our QUEST waste reduction initiative, is directed towards the elimination of energy and raw materials waste in our businesses, and, on a broader and more long-term scale, the practical reclamation — and ultimate restoration — of shared environmental resources. The initiative involves a commitment by us:

 

We have engaged some of the world’s leading authorities on global ecology as environmental advisors. The list of advisors includes: Paul Hawken, author of The Ecology of Commerce: A Declaration of Sustainability and The Next Economy, and co-author of Natural Capitalism: Creating the Next Industrial Revolution; Amory Lovins, energy consultant and co-founder of the Rocky Mountain Institute; Bill Browning, fellow and former director of the Rocky Mountain Institute’s Green Development Services; Janine M. Benyus, author of Biomimicry; and Bob Fox, renowned architect.

 

 

As more customers in our target markets share our view that sustainability is an important factor in making purchasing and design decisions, and not just good deeds, our acknowledged leadership position should strengthen our brands and provide a differentiated advantage in competing for business. To further raise awareness of our goal of becoming sustainable, we launched our Mission Zero global branding initiative, which represents our mission to eliminate any negative impact our companies may have on the environment by the year 2020. In 2016, we launched the Climate Take Back initiative, in which we seek to lead industry in designing and making products in ways that will maintain a climate fit for life. Our Mission Zero and Climate Take Back logos appear on many of our marketing and merchandising materials distributed throughout the world.

 

A high point in our pursuit of sustainability has been our creation with the Zoological Society of London of a program called Net-Works® in which we’ve worked with communities in the Philippines to collect discarded fishing nets that are damaging a large coral reef, and divert them to our yarn supplier where they are recycled into new carpet fiber. Net-Works provides a source of income for members of these communities in the Philippines, while also cleaning up the beaches and waters where they live and work. Our Net Effect Collection of carpet tile products, among others, contains yarn that is partly made from the recycled fishing nets collected through the Net-Works program. Through 2017, this program has collected more than 142 tons of discarded fishing nets. Net-Works is a big step in redesigning our supply chain from a linear take-make-waste process toward a closed loop system, and it advances our ultimate goal of becoming a restorative enterprise.

 

Backlog

 

Our backlog of unshipped orders was approximately $122.9 million at February 11, 2018, compared with approximately $107.8 million at February 12, 2017. Historically, backlog is subject to significant fluctuations due to the timing of orders for individual large projects and currency fluctuations. All of the backlog orders at February 11, 2018 are expected to be shipped during the succeeding six to nine months.

 

Patents and Trademarks

 

We own numerous patents in the United States and abroad on floorcovering products and on manufacturing processes. The duration of United States patents is between 14 and 20 years from the date of filing of a patent application or issuance of the patent; the duration of patents issued in other countries varies from country to country. We maintain an active patent and trade secret program in order to protect our proprietary technology, know-how and trade secrets. Although we consider our patents to be very valuable assets, we consider our know-how and technology even more important to our current business than patents, and, accordingly, believe that expiration of existing patents or non-issuance of patents under pending applications would not have a material adverse effect on our operations.

 

We also own many trademarks in the United States and abroad. In addition to the United States, the primary jurisdictions in which we have registered our trademarks are the European Union, Canada, Australia, New Zealand, Japan, and various countries in Central America, South America and Asia. Some of our more prominent registered trademarks include: Interface, FLOR, Intersept, GlasBac, Mission Zero, and Net-Works. Trademark registrations in the United States are valid for a period of 10 years and are renewable for additional 10-year periods as long as the mark remains in actual use. The duration of trademarks registered in other jurisdictions varies.

 

Financial Information by Operating Segments and Geographic Areas

 

The Notes to Consolidated Financial Statements appearing in Item 8 of this Report set forth information concerning our sales and long-lived assets by geographic areas, which are also our operating segments. We have only one reporting segment.

 

Employees

 

At December 31, 2017, we employed a total of 3,092 employees worldwide. Of such employees, 1,781 were clerical, staff, sales, supervisory and management personnel and 1,311 were manufacturing personnel. We also utilized the services of 227 temporary personnel as of December 31, 2017.

 

Some of our production employees in Australia and the United Kingdom are represented by unions. In the Netherlands, a Works Council, the members of which are Interface employees, is required to be consulted by management with respect to certain matters relating to our operations in that country, such as a change in control of Interface Europe B.V. (our modular carpet subsidiary based in the Netherlands), and the approval of the Council is required for some of our actions, including changes in compensation scales or employee benefits. Our management believes that its relations with the Works Council, the unions and all of our employees are good.

 

 

Environmental Matters

 

Our operations are subject to laws and regulations relating to the generation, storage, handling, emission, transportation and discharge of materials into the environment. The costs of complying with environmental protection laws and regulations have not had a material adverse impact on our financial condition or results of operations in the past and are not expected to have a material adverse impact in the future. The environmental management systems of our floorcovering manufacturing facilities in LaGrange, Georgia, West Point, Georgia, Northern Ireland, the Netherlands, Thailand, China and Australia are certified under ISO Standard No. 14001.

 

Executive Officers of the Registrant 

 

Our executive officers, their ages as of December 31, 2017, and their principal positions with us are set forth below. Executive officers serve at the pleasure of the Board of Directors.

 

Name

Age

Principal Position(s)

Jay D. Gould

58

President and Chief Executive Officer

Robert A. Coombs

59

Senior Vice President (President - Asia-Pacific)

David B. Foshee

47

Vice President, General Counsel and Secretary

Bruce A. Hausmann

48

Vice President and Chief Financial Officer

Matthew J. Miller

49

Vice President (President - Americas)

Kathleen R. Owen

54

Vice President and Chief Human Resources Officer

J. Chadwick Scales

54

Vice President and Chief Marketing, Innovation & Design Officer

Nigel Stansfield

50

Vice President (President - Europe)

 

Mr. Gould joined us as Executive Vice President and Chief Operating Officer in January 2015, was promoted to President and Chief Operating Officer in January 2016, and was promoted to Chief Executive Officer effective March 3, 2017. From 2012 to January 2015, Mr. Gould was the Chief Executive Officer of American Standard Brands, a kitchen and bath products company. Prior to his employment with American Standard Brands, Mr. Gould held senior executive roles at Newell Rubbermaid Inc., a global marketer of consumer and commercial products, serving as President of its Home & Family business group from 2008 to 2012 and President of its Parenting Essentials business group from 2006 to 2008. He also previously held executive level positions at The Campbell Soup Company (2002-2006) and The Coca-Cola Company (1995-2002).

 

Mr. Coombs originally worked for us from 1988 to 1993 as a marketing manager for our Heuga carpet tile operations in the United Kingdom and later for all of our European floorcovering operations. In 1996, Mr. Coombs returned to us as Managing Director of our Australian operations. He was promoted in 1998 to Vice President-Sales and Marketing, Asia-Pacific, with responsibility for Australian operations and sales and marketing in Asia, which was followed by a promotion to Senior Vice President, Asia-Pacific. He was promoted to Senior Vice President, European Sales, in May 1999 and Senior Vice President, European Sales and Marketing, in April 2000. In February 2001, he was promoted to President of Interface Overseas Holdings, Inc. with responsibility for all of our floorcoverings operations in both Europe and the Asia-Pacific region, and he became a Vice President of Interface. In September 2002, Mr. Coombs relocated back to Australia, retaining responsibility for our floorcovering operations in the Asia-Pacific region while another executive assumed responsibility for floorcovering operations in Europe. Mr. Coombs was promoted to Senior Vice President of Interface in July 2008.

 

Mr. Foshee, who previously practiced with an Atlanta-based international law firm, joined us in October 1999 as Associate Counsel. He was promoted to Assistant Secretary in April 2002, Senior Counsel in April 2006, Assistant Vice President in April 2007, Vice President in July 2012, Associate General Counsel in May 2014, and Secretary and General Counsel in January 2017.

 

Mr. Hausmann joined us in April 2017 as Vice President and Chief Financial Officer.  He came to us from the food, facilities and uniform services supplier Aramark Corporation, where he served as Senior Vice President and Chief Financial Officer for Aramark’s Uniform business unit since 2009, and for Aramark’s Refreshment Services business unit since 2014.  Prior to joining Aramark, he served as Vice President and Segment Controller for the Interactive Media Group of The Walt Disney Company, which he joined in 2002.  He has also previously held finance and controller positions with several software and internet companies.

 

Mr. Miller joined us in June 2015 as Vice President and Chief Strategy Officer, and became President of our Americas business in June 2016. He came to Interface from American Standard Brands, where he was Senior Vice President of Innovation and Strategy from April 2013 to May 2015. Mr. Miller also was an independent consultant to American Standard Brands from February 2012 to April 2013. Previously, he served as Global Vice President-Finance of the Juvenile Products Segment of Newell Rubbermaid Inc. from 2008 to 2011, and as Director of Strategy and Corporate Development for Newell Rubbermaid from 2006-2008. He also has worked with a number of other global organizations, including Kraft Foods and Zyman Group.

 

 

Ms. Owen joined us in June 2015 as Vice President and Chief Human Resources Officer. Ms. Owen is responsible for the development and oversight of human resources strategies and initiatives for talent management, organization development, learning, compensation, culture and diversity for Interface associates, globally. She came to Interface from Taylor Morrison Home Corporation, a publicly traded North American real estate developer and home builder, where she served as Vice President of Human Resources from June 2005 to December 2014. Prior to that, she held several human resources positions with experience across the U.S. and Europe with companies including McKesson Technology Solutions, Check-Free Corporation and Lanier Worldwide.

 

Mr. Scales joined us in April 2016 as Vice President and Chief Innovation Officer with responsibility for the Company’s innovation strategy and platforms globally. In August 2016, he also became responsible for the Company’s marketing and design strategy, and was named Chief Marketing, Innovation and Design Officer. Prior to Interface, Mr. Scales served as Senior Vice President and General Manager for the Consumer Packaged Goods division of FOCUS Brands Inc. Prior to joining FOCUS Brands, Mr. Scales was Global Vice President of Marketing and Innovation for The Coca-Cola Company, and before that held a number of leadership positions with Unilever PLC.

 

Mr. Stansfield was the Operations Manager for Firth Carpets (our former European broadloom operations) at the time it was acquired by us in 1997. For two years following that acquisition, Mr. Stansfield served as Manufacturing Systems Manager, part of a global project team that designed and implemented MRP manufacturing software systems at seven of our manufacturing plants. In 1999, he returned to Firth Carpets as Operations Director. In 2002, he became a member of our European research and development team focusing on our sustainability initiatives, and in 2004, he became Product and Innovations Director for all of our European Operations. In 2010, he joined our European management team as Senior Vice President of Product, Design and Innovation, before being named Vice President and Chief Innovations Officer for the Company in March 2012. In December 2016, he became President of our business serving Europe, the Middle East and Africa.   

 

Available Information

 

We make available free of charge on or through our Internet website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our Internet address is http://www.interface.com. The SEC maintains a website that contains annual, quarterly and current reports, proxy statements and other information that issuers (including the Company) file electronically with the SEC. The SEC’s website is http://www.sec.gov.

 

Interface, Inc. was incorporated in 1973 as a Georgia corporation.

 

Forward-Looking Statements

 

This report on Form 10-K contains “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. Words such as “believes,” “anticipates,” “plans,” “expects” and similar expressions are intended to identify forward-looking statements. 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 those contemplated by such forward-looking statements. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements include risks and uncertainties associated with economic conditions in the commercial interiors industry as well as the risks and uncertainties discussed below in Item 1A, “Risk Factors”.

 

 

ITEM 1A. RISK FACTORS 

 

You should carefully consider the following factors, in addition to the other information included in this Annual Report on Form 10-K and the other documents incorporated herein by reference, before deciding whether to purchase or sell our common stock. Any or all of the following risk factors could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Sales of our principal products have been and may continue to be affected by adverse economic cycles in the renovation and construction of commercial and institutional buildings.

 

Sales of our principal products are related to the renovation and construction of commercial and institutional buildings. This activity is cyclical and has been affected by the strength of a country’s or region’s general economy, prevailing interest rates and other factors that lead to cost control measures by businesses and other users of commercial or institutional space. The effects of cyclicality upon the corporate office segment tend to be more pronounced than the effects upon the institutional segment. Historically, we have generated more sales in the corporate office segment than in any other market. The effects of cyclicality upon the new construction segment of the market also tend to be more pronounced than the effects upon the renovation segment. These effects may recur and could be more pronounced if global economic conditions do not improve or are weakened.

 

We compete with a large number of manufacturers in the highly competitive floorcovering products market, and some of these competitors have greater financial resources than we do.  We may face challenges competing on price, making investments in our business or on product design.

 

The floorcovering industry is highly competitive. Globally, we compete for sales of floorcovering products with other carpet manufacturers and manufacturers of other types of floorcovering. Although the industry has experienced significant consolidation, a large number of manufacturers remain in the industry.  Moreover, some of our competitors are adding manufacturing capacity into the industry throughout the globe which could increase the amount of supply in the market.  Increased capacity at our competitors could result in pricing pressure on our products (including products, like LVT, which may currently carry attractive margins) and less demand for our products, thus adversely affecting both revenues and profitability.

 

Some of our competitors, including a number of large diversified domestic and foreign companies who manufacture modular carpet as one segment of their business, have greater financial resources than we do.  Competing effectively may require us to make additional investments in our product development efforts, manufacturing facilities, distribution network and sales and marketing activities. 

 

In addition, we often compete on design preferences.  Our customers’ design preferences may evolve or change before we adapt quickly enough to those changes or before we recognize those changes have happened in the marketplace. If this occurs, it could negatively affect our sales as our customers choose other product offerings.

 

Our success depends significantly upon the efforts, abilities and continued service of our senior management executives, our principal design consultant and other key personnel (including sales personnel), and our loss of any of them could affect us adversely.

 

We believe that our success depends to a significant extent upon the efforts and abilities of our senior management executives. In addition, we rely significantly on the leadership that David Oakey of David Oakey Designs provides to our internal design staff. Specifically, David Oakey Designs provides product design/production engineering services to us under an exclusive consulting contract that contains non-competition covenants. Our agreement with David Oakey Designs can be terminated by either party upon six months prior written notice to the other party. Our business also depends on the recruitment and retention of other key personnel, including strong sales leaders.

 

We may lose the services of key personnel for a variety of reasons, including if our compensation programs become uncompetitive in the relevant markets for our employees and service providers, or if the Company undergoes significant disruptive change (including not only economic downturns, but potentially changes management believes are positive in the long term). The loss of key personnel with a great deal of knowledge, training and experience in the carpet industry – particularly in the areas of sales, marketing, operations, product design and management – could have an adverse impact on our business. We may not be able to easily replace such personnel, particularly if the underlying reasons for the loss make the Company relatively unattractive as an employer.

 

We are implementing a multi-year transformation of our sales organization, including the implementation of standardized processes in which our sales force goes to market, interacts with customers, works with the architect and design community and, in general, operates day-to-day.  We are also implementing technology tools that the sales force will be required to use as part of their day-to-day jobs, and new management positions to actively manage and coach the sales force.  All of these changes are disruptive, which may create challenges for our sales force to adapt, particularly for long tenured employees, which comprise a large portion of our sales force.  There are no guarantees that these efforts will increase sales or improve profitability of the business, or that they will not instead adversely disrupt the business, decrease sales, and decrease overall profitability.

 

Our substantial international operations are subject to various political, economic and other uncertainties that could adversely affect our business results, including by restrictive taxation or other government regulation and by foreign currency fluctuations.

 

We have substantial international operations. In 2017, approximately half of our net sales and a significant portion of our production were outside the United States, primarily in Europe and Asia-Pacific. Our corporate strategy includes the expansion and growth of our international business on a worldwide basis. As a result, our operations are subject to various political, economic and other uncertainties, including risks of restrictive taxation policies, changing political conditions and governmental regulations. This includes, for example, the uncertainty surrounding the implementation and effect of the United Kingdom’s June 2016 referendum in which voters approved the United Kingdom’s exit from the European Union, including changes to the legal and regulatory framework that apply to the United Kingdom and its relationship with the European Union. We also make a substantial portion of our net sales in currencies other than U.S. dollars (approximately half of 2017 net sales), which subjects us to the risks inherent in currency translations. The scope and volume of our global operations make it impossible to eliminate completely all foreign currency translation risks as an influence on our financial results. In addition, political unrest, terrorist acts, military conflict and disease outbreaks have increased the risks of doing business abroad generally.

 

 

Concerns regarding European sovereign debt and market perceptions about the instability of the euro, the potential re-introduction of individual currencies within the Eurozone, the potential dissolution of the euro entirely, or the U.K. exiting the European Union, could adversely affect our business, results of operations or financial condition.

 

Following the European sovereign debt crisis that began in 2011, concerns still persist regarding the debt burden of certain countries using the euro as their currency (the “Eurozone”) and their ability to meet future financial obligations, the overall stability of the euro and the suitability of the euro as a single currency given the diverse economic and political circumstances in individual Eurozone countries. Despite remedial efforts undertaken by the European Commission and others, these concerns have caused instability in the euro and could lead to the re-introduction of individual currencies in one or more Eurozone countries, or, in more extreme circumstances, the possible dissolution of the euro currency entirely. Should the euro dissolve entirely, the legal and contractual consequences for holders of euro-denominated obligations would be determined by laws in effect at such time. These potential developments, or market perceptions concerning these and related issues, could adversely affect the value of our euro-denominated assets and obligations or increase the risks of foreign currency fluctuations or cause the failure of hedging programs intended to reduce those risks. In addition, concerns over these effects on financial institutions in Europe and globally could have an adverse impact on the capital markets generally, and more specifically on our ability and the ability of our customers, suppliers and lenders to finance our and their respective businesses, to access liquidity at acceptable financing costs, if at all, on the availability of supplies and materials, and on the demand for our products.

 

In addition, the results of a June 2016 referendum vote in the U.K. were in favor of the U.K. exiting the European Union (the “Brexit Vote”).  On March 29, 2017, the U.K. notified the European Union of its intention to withdraw pursuant to Article 50 of the Lisbon Treaty. The terms of the withdrawal are subject to a negotiation period that could last at least two years from the withdrawal notification date.  The uncertainty leading up to and following the Brexit Vote has had a negative impact on our business and demand for our products in Europe, and particularly in the U.K.  In addition, the Brexit Vote has had a detrimental effect, and could have further detrimental effects, on the value of either or both of the euro and the British Pound Sterling, which could negatively impact our business (principally from the translation of sales and earnings in those foreign currencies into our reporting currency of U.S. dollars).  Such a development could have other unpredictable adverse effects, including a material adverse effect on demand for office space and our carpet products in the U.K. and in Europe if a U.K. exit leads to economic difficulties in Europe.

 

Large increases in the cost of petroleum-based raw materials could adversely affect us if we are unable to pass these cost increases through to our customers.

 

Petroleum-based products comprise the predominant portion of the cost of raw materials that we use in manufacturing. While we attempt to match cost increases with corresponding price increases, continued volatility in the cost of petroleum-based raw materials could adversely affect our financial results if we are unable to pass through such price increases to our customers.

 

Unanticipated termination or interruption of any of our arrangements with our primary third party suppliers of synthetic fiber or our sole third party supplier for luxury vinyl tile (“LVT”) could have a material adverse effect on us.

 

We depend on a small number of third party suppliers of synthetic fiber and a single supplier for our LVT products. The unanticipated termination or interruption of any of our supply arrangements with our current suppliers of synthetic fiber (nylon) or sole supplier of LVT, including failure by any third party supplier to meet our product specifications, could have a material adverse effect on us because we do not have the capability to manufacture our own fiber for use in our carpet products or our own LVT. Our suppliers may not be able to meet our demand for a variety of reasons, including our inability to forecast our future needs accurately or a shortfall in production by the supplier for reasons unrelated to us, such as work stoppages, acts of war, terrorism, fire, earthquake, energy shortages, flooding or other natural disasters. If any of our supply arrangements with our primary suppliers of synthetic fiber or our sole supplier of LVT is terminated or interrupted, we likely would incur increased manufacturing costs and experience delays in our manufacturing process (thus resulting in decreased sales and profitability) associated with shifting more of our synthetic fiber purchasing to another synthetic fiber supplier or developing new supply chain sources for LVT. A prolonged inability on our part to source synthetic fiber included in our products or LVT on a cost-effective basis could adversely impact our ability to deliver products on a timely basis, which could harm our sales and customer relationships.

 

We have a significant amount of indebtedness, which could have important negative consequences to us.

 

Our significant indebtedness could have important negative consequences to us, including:

 

 

making it more difficult for us to satisfy our obligations with respect to such indebtedness;

 

 

increasing our vulnerability to adverse general economic and industry conditions;

 

 

limiting our ability to obtain additional financing to fund capital expenditures, acquisitions or other growth initiatives, and other general corporate requirements;

 

 

requiring us to dedicate a substantial portion of our cash flow from operations to interest and principal payments on our indebtedness, thereby reducing the availability of our cash flow to fund capital expenditures, acquisitions or other growth initiatives, and other general corporate requirements;

 

 

limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

 

 

placing us at a competitive disadvantage compared to our less leveraged competitors; and

 

 

limiting our ability to refinance our existing indebtedness as it matures.

 

 

As a consequence of our level of indebtedness, a substantial portion of our cash flow from operations must be dedicated to debt service requirements. In addition, borrowings under our Syndicated Credit Facility have variable interest rates, and therefore our interest expenses will increase if the underlying market rates (upon which the variable interest rates are based) increase. The terms of our Syndicated Credit Facility also limit our ability and the ability of our subsidiaries to, among other things, incur additional indebtedness, pay dividends or make certain other restricted payments or investments in certain situations, consummate certain asset sales, enter into certain transactions with affiliates, create liens, merge or consolidate with any other person, or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of our assets. They also require us to comply with certain other reporting, affirmative and negative covenants and meet certain financial tests. If we fail to satisfy these tests or comply with these covenants, a default may occur, in which case the lenders could accelerate the debt as well as any other debt to which cross-acceleration or cross-default provisions apply. Our Syndicated Credit Facility matures in August 2022. We cannot assure you that we would be able to renegotiate, refinance or otherwise obtain the necessary funds to satisfy these obligations.

 

It is important for you to consider that we have a significant amount of indebtedness. We cannot assure you that we will be able to renegotiate or refinance any of our debt on commercially reasonable terms, or at all. If we are unable to refinance our debt or obtain new financing, we would have to consider other options, such as selling assets to meet our debt service obligations and other liquidity needs, or using cash, if available, that would have been used for other business purposes.

 

The market price of our common stock has been volatile and the value of your investment may decline.

 

The market price of our common stock has been volatile in the past and may continue to be volatile going forward. Such volatility may cause precipitous drops in the price of our common stock on the Nasdaq Global Select Market and may cause your investment in our common stock to lose significant value. As a general matter, market price volatility has had a significant effect on the market values of securities issued by many companies for reasons unrelated to their operating performance. We thus cannot predict the market price for our common stock going forward.

 

Our earnings in a future period could be adversely affected by non-cash adjustments to goodwill, if a future test of goodwill assets indicates a material impairment of those assets.

 

As prescribed by accounting standards governing goodwill and other intangible assets, we undertake an annual review of the goodwill asset balance reflected in our financial statements. Our review is conducted during the fourth quarter of the year, unless there has been a triggering event prescribed by applicable accounting rules that warrants an earlier interim testing for possible goodwill impairment. In the past, we have had non-cash adjustments for goodwill impairment as a result of such testings ($61.2 million in 2008 and $44.5 million in 2007). A future goodwill impairment test may result in a future non-cash adjustment, which could adversely affect our earnings for any such future period.

 

Changes to our facilities could disrupt our operations.

 

From time to time, we make improvements to our physical facilities, or move operations to new ones.  Large scale changes or moves could disrupt our normal operations, leading to possible loss of productivity, which may adversely affect our results.

 

The company will be moving its corporate headquarters in 2018. The transition and relocation of the company’s headquarters could be disruptive and could create a distraction to management in running day-to-day operations which could adversely affect the business.

 

We are also making significant investments and modifications to our manufacturing facilities in LaGrange Georgia. At times this process can be disruptive, and there is no guarantee that these efforts will yield the financial returns and improvements in the business that we hope to achieve from them. In addition, while these changes are intended to yield stronger financial results, they could potentially adversely affect financial results due to project delays, business disruption as new facilities and equipment come online, and general disruption as we make changes and modifications to our manufacturing facilities and processes.

 

Our business operations could suffer significant losses from natural disasters, catastrophes, fire or other unexpected events.

 

While we manufacture our products in several facilities and maintain insurance covering our facilities, including business interruption insurance, our manufacturing facilities could be materially damaged by natural disasters, such as floods, tornadoes, hurricanes and earthquakes, or by fire or other unexpected events such as adverse weather conditions or other disruptions to our facilities, supply chain or our customers’ facilities. For example, in July 2012, a fire occurred at our manufacturing facility in Picton, Australia, causing extensive damage and rendering the facility inoperable. In January 2014, we commenced operations at a new manufacturing facility in Minto, Australia. We could incur uninsured losses and liabilities arising from such events, including damage to our reputation, and/or suffer material losses in operational capacity, which could have a material adverse impact on our business, financial condition and results of operations.

 

Disruptions to or failures of our information technology systems could adversely effect on our business.

 

We rely heavily on information technology systems—both software and computer hardware—to operate our business. We rely on these systems to, among other things:

 

 

facilitate and plan the purchase, management and distribution of, and payment for, inventory and raw materials;

 

Control our production processes;

 

manage and monitor our distribution network and logistics;

 

receive, process and ship orders;

 

manage billing, collections and payables;

 

manage financial reporting; and

 

manage payroll and human resources information.

 

 

Our IT systems may be disrupted or fail for a number of reasons, including:

 

natural disasters, like fires;

 

power loss;

 

software “bugs”, hardware defects or human error; or

 

hacking, computer viruses, malware, ransomware or other cyber attacks.

 

Any of these events which deny us use of vital IT systems may seriously disrupt our normal business operations. These disruptions may lead to production or shipping stoppages, which may in turn lead to material revenue loss and reputational harm. There is no guarantee that our backup systems or disaster recovery procedures will be adequate to mitigate losses due to IT system disruptions in a timely fashion, and we may incur significant expense in correcting IT system emergencies.

 

To the extent our IT systems store sensitive data, including about our employees, security breaches may expose us to other serious liabilities and reputational harm if such data is misappropriated. In addition, as cybercriminals continue to become more sophisticated, the costs to defend and insure against cyberattacks can be expected to rise.

 

Our Rights Agreement could discourage tender offers or other transactions for our stock that could result in shareholders receiving a premium over the market price for our stock.

 

Our Board of Directors has adopted a Rights Agreement pursuant to which holders of our common stock will be entitled to purchase from us a fraction of a share of our Series B Participating Cumulative Preferred Stock if a third party acquires beneficial ownership of 15% or more of our common stock without our consent. In addition, the holders of our common stock will be entitled to purchase the stock of an Acquiring Person (as defined in the Rights Agreement) at a discount upon the occurrence of triggering events. These provisions of the Rights Agreement could have the effect of discouraging tender offers or other transactions that could result in shareholders receiving a premium over the market price for our common stock.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2. PROPERTIES 

 

We maintain our corporate headquarters in Atlanta, Georgia in approximately 20,000 square feet of leased space. The following table lists our principal manufacturing facilities and other material physical locations (some locations are comprised of multiple buildings), all of which we own except as otherwise noted:

 

 

Location

 

Floor

Space

(Sq. Ft.)

 

Bangkok, Thailand

    275,946  

Craigavon, N. Ireland(1)

    80,986  

LaGrange, Georgia

    539,545  

LaGrange, Georgia(1)

    322,096  

Union City, Georgia(1)

    370,000  

Valley, Alabama(1)

    338,086  

Minto, Australia

    259,356  
Scherpenzeel, the Netherlands     360,800  

West Point, Georgia

    299,600  

Taicang, China(1)

    142,500  

__________

(1)

Leased.

 

We maintain sales or marketing offices in over 70 locations in over 30 countries and a number of other distribution facilities in several countries.  Most of our sales and marketing locations and many of our distribution facilities are leased.

 

We believe that our manufacturing and distribution facilities and our marketing offices are sufficient for our present operations. We will continue, however, to consider the desirability of establishing additional facilities and offices in other locations around the world as part of our business strategy to meet expanding global market demands. Substantially all of our owned properties in the United States are subject to mortgages, which secure borrowings under our Syndicated Credit Facility.

 

 

ITEM 3. LEGAL PROCEEDINGS

 

We are subject to various legal proceedings in the ordinary course of business, none of which we believe are required to be disclosed under this Item 3.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

PART II

 

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Our Common Stock is traded on the Nasdaq Global Select Market under the symbol TILE. As of February 18, 2018, we had 624 holders of record of our Common Stock. We estimate that there are in excess of 10,000 beneficial holders of our Common Stock. The following table sets forth, for the periods indicated, the high and low sale prices of the Company’s Common Stock on the Nasdaq Global Select Market as well as dividends paid during such periods.

 

   

High

   

Low

   

Dividends Per Share

 

2018

                       

First Quarter (through February 16, 2018)

  $ 26.25     $ 22.10     $ 0.00  
                         

2017

                       

Fourth Quarter

  $ 25.70     $ 21.21     $ 0.065  

Third Quarter

    22.60       18.30       0.065  

Second Quarter

    21.05       18.15       0.06  

First Quarter

    19.93       17.18       0.06  
                         

2016

                       

Fourth Quarter

  $ 19.10     $ 14.59     $ 0.06  

Third Quarter

    18.45       15.02       0.06  

Second Quarter

    18.71       14.56       0.05  

First Quarter

    18.99       13.70       0.05  

 

On February 21, 2018, our Board also declared a regular quarterly cash dividend of $0.065 per share, payable March 23, 2018 to shareholders of record as of March 9, 2018. Future declaration and payment of dividends is at the discretion of our Board, and depends upon, among other things, our investment policy and opportunities, results of operations, financial condition, cash requirements, future prospects, and other factors that may be considered relevant by our Board at the time of its determination. Such other factors include limitations contained in the agreement for our Syndicated Credit Facility, which specifies conditions as to when any dividend payments may be made. As such, we may discontinue our dividend payments in the future if our Board determines that a cessation of dividend payments is proper in light of the factors indicated above.

 

 

Stock Performance 

 

The following graph and table compare, for the five-year period ended December 31, 2017, the Company’s total returns to shareholders (stock price plus dividends, divided by beginning stock price) with that of (i) all companies listed on the Nasdaq Composite Index, and (ii) a self-determined peer group comprised primarily of companies in the commercial interiors industry, assuming an initial investment of $100 in each on December 30, 2012 (the last day of the fiscal year 2012).

 

 

 

 

 

12/30/12

12/29/13

12/28/14

1/3/16

1/1/17

12/31/17

 

Interface, Inc.

$100

$137

$107

$124

$122

$167

 

NASDAQ Composite Index

$100

$142

$166

$175

$191

$248

 

Self-Determined Peer Group (14 Stocks)

$100

$150

$166

$178

$205

$229

 

Notes to Performance Graph

 

 

(1)

The lines represent annual index levels derived from compound daily returns that include all dividends.

 

(2)

The indices are re-weighted daily, using the market capitalization on the previous trading day.

 

(3)

If the annual interval, based on the fiscal year-end, is not a trading day, the preceding trading day is used.

 

(4)

The index level was set to $100 as of December 30, 2012 (the last day of fiscal year 2012).

 

(5)

The Company’s fiscal year ends on the Sunday nearest December 31.

 

(6)

The following companies are included in the Self-Determined Peer Group depicted above: Acuity Brands, Inc.; Albany International Corp.; Apogee Enterprises, Inc.; Armstrong World Industries, Inc.; BE Aerospace, Inc.; The Dixie Group, Inc.; Herman Miller, Inc.; HNI Corporation; Kimball International, Inc.; Knoll, Inc.; Mohawk Industries, Inc.; Steelcase, Inc.; Unifi, Inc.; and USG Corp.

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

See Item 12 of Part III of this Annual Report on Form 10-K.

 

 

Issuer Purchases of Equity Securities

 

The following table contains information with respect to purchases made by or on behalf of the Company, or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of our common stock during our fourth quarter ended December 31, 2017:

 

Period(1)

 

Total

Number

of Shares Purchased

   

Average

Price

Paid

Per Share

   

Total Number

of Shares Purchased

as Part of Publicly

Announced Plans or Programs(2)

   

Approximate Dollar

Value of Shares that

May Yet Be

Purchased Under the

Plans or Programs(2)

 
                                 

October 2 - 31, 2017

    0     $ 0.00       0     $ 50,077,293  

November 1 – 30, 2017 (3)

    436,399       23.28       435,399       39,940,933  

December 1 – 31, 2017

    15,201       23.99       15,201       39,576,216  

Total

    451,600     $ 23.30       450,600     $ 39,576,216  

 

(1) The monthly periods identified above correspond to the Company’s fiscal fourth quarter of 2017, which commenced October 2, 2017 and ended December 31, 2017.

(2) In April 2017, the Company announced a new share purchase program authorizing the repurchase of up to $100 million of common stock. This program has no specific expiration date.

(3) Includes 1,000 shares acquired by the Company from an employee at a price of $22.75 per share to satisfy income tax withholding obligations in connection with the vesting of a previous grant of an equity award.

 

 

ITEM 6. SELECTED FINANCIAL DATA

 

We derived the summary consolidated financial data presented below from our audited consolidated financial statements and the notes thereto for the years indicated. You should read the summary financial data presented below together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited consolidated financial statements and notes thereto included within this document. Amounts for all periods presented have been adjusted for discontinued operations.

 

   

2017

   

2016

   

2015

   

2014

   

2013

 
                                         

Net sales

  $ 996,443     $ 958,617     $ 1,001,863     $ 1,003,903     $ 959,989  

Cost of sales

    610,422       589,973       618,974       663,876       618,880  

Operating income(1)

    109,844       84,937       113,593       70,295       95,630  

Net income(2)

    53,246       54,162       72,418       24,808       48,255  

Income from continuing operations per common share attributable to Interface, Inc.

                                       

Basic

  $ 0.86     $ 0.83     $ 1.10     $ 0.37     $ 0.73  

Diluted

  $ 0.86     $ 0.83     $ 1.10     $ 0.37     $ 0.73  

Average Shares Outstanding

                                       

Basic

    61,996       65,098       66,027       66,389       66,194  

Diluted

    62,040       65,136       66,075       66,448       66,297  

Cash dividends per common share

  $ 0.25     $ 0.22     $ 0.18     $ 0.14     $ 0.11  

Property additions

    30,474       28,071       27,188       38,922       91,851  

Depreciation and amortization(3)

    37,508       36,505       44,751       34,675       32,605  

Working capital

  $ 254,221     $ 311,799     $ 245,391     $ 240,881     $ 257,918  

Total assets

    800,600       835,439       756,549       774,914       796,335  

Total long-term debt

    229,928       270,347       213,531       263,338       273,826  

Shareholders’ equity

    330,091       340,729       342,366       306,639       340,787  

Current ratio(4)

    2.4       3.0       2.6       2.7       3.0  

__________   

 

(1)

The following charges and items are included in our operating income.  In 2017, we recorded restructuring and asset impairment charges of $7.3 million. In 2016, we recorded restructuring and asset impairment charges of $19.8 million. In 2014, we recorded restructuring and asset impairment charges of $12.4 million. In 2013, we recorded a gain of approximately $7.0 million related to the final settlement of our insurance claim relating to the Australia fire.

   

(2)

Included in 2017 net income are provisional tax charges of $15.2 million due to the recently enacted U.S. Tax Cuts and Jobs Act. Please see Item 8, Note 13 “Taxes on Income” for further discussion of these charges.  Included in 2014 net income is $9.2 million of pre-tax expenses related to the premium paid to redeem senior note debt as well as $2.8 million related to the unamortized debt cost that related to these notes at redemption.  Included in the 2013 net income are $1.7 million of expenses related to the retirement of debt, and a one-time tax dispute resolution benefit of $1.9 million.

   

(3)

Includes stock compensation amortization

   

(4)

Current ratio is the ratio of current assets to current liabilities.

 

 

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

General

 

Our revenues are derived from sales of floorcovering products, primarily modular carpet and luxury vinyl tile (“LVT”). Our business, as well as the commercial interiors industry in general, is cyclical in nature and is impacted by economic conditions and trends that affect the markets for commercial and institutional business space. The commercial interiors industry, including the market for floorcovering products, is largely driven by reinvestment by corporations into their existing businesses in the form of new fixtures and furnishings for their workplaces. In significant part, the timing and amount of such reinvestments are impacted by the profitability of those corporations. As a result, macroeconomic factors such as employment rates, office vacancy rates, capital spending, productivity and efficiency gains that impact corporate profitability in general, also affect our business.

 

Most of our sales are to customers in the corporate office market segment, but we also focus our marketing and sales efforts on non-corporate office segments to reduce somewhat our exposure to economic cycles that affect the corporate office market segment more adversely, as well as to capture additional market share. Our mix of corporate office versus non-corporate office modular carpet sales in the Americas was 44% and 56%, respectively, for 2017. Company-wide, our mix of corporate office versus non-corporate office sales was 59% and 41%, respectively, in 2017.

 

During 2017, we had net sales of $996.4 million, up 3.9% compared to $958.6 million in 2016. Operating income for 2017 was $109.8 million as compared to $84.9 million in 2016. Net income for 2017 was $53.2 million, or $0.86 per share, compared with $54.2 million, or $0.83 per share, in 2016. Included in our results for 2017 were $7.3 million of restructuring and asset impairment charges as well as $15.2 million of tax charges related to the recently enacted U.S. Tax Cuts and Jobs Act. Please see Item 8, Note 13 “Taxes on Income” for further discussion of these tax charges.

 

During 2016, we had net sales of $958.6 million, down 4.3% compared to $1.0 billion in 2015. Operating income for 2016 was $84.9 million as compared to $113.6 million for 2015. Net income for 2016 was $54.2 million, or $0.83 per share, compared with $72.4 million, or $1.10 per share, in 2015. Included in our results for 2016 was a restructuring and asset impairment charge of $19.8 million, as discussed below.

 

2016 Restructuring Plan

 

In the fourth quarter of 2016, we committed to a new restructuring plan in our continuing efforts to improve efficiencies and decrease costs across our worldwide operations, and more closely align our operating structure with our business strategy. The plan involved (i) a substantial restructuring of the FLOR business model that included closure of its headquarters office and most retail FLOR stores, (ii) a reduction of approximately 70 FLOR employees and a number of employees in the commercial carpet tile business, primarily in the Americas and Europe regions, and (iii) the write-down of certain underutilized and impaired assets that included information technology assets, intellectual property assets, and obsolete manufacturing, office and retail store equipment.

 

As a result of this plan, we incurred a pre-tax restructuring and asset impairment charge in the fourth quarter of 2016 of $19.8 million. In connection with this plan, in the first quarter of 2017, the Company recorded an additional charge of $7.3 million, primarily related to exit costs associated with the closure of most FLOR retail stores in the first quarter of 2017. The charge in the fourth quarter of 2016 was comprised of $10.1 million of severance charges, $8.0 million of asset impairment charges and lease exit costs of $1.7 million. The charge in the first quarter of 2017 was comprised of lease exit costs of $3.4 million, asset impairment charges of $3.3 million and severance charges of $0.6 million.

 

  Approximately $16 million of the charges were expected to result in cash expenditures, primarily for severance payments (approximately $11 million) and lease exit costs (approximately $5 million). This restructuring plan was substantially completed in 2017.

 

 

Analysis of Results of Operations 

 

The following discussion and analyses reflect the factors and trends discussed in the preceding sections.

 

Our net sales that were denominated in currencies other than the U.S. dollar were approximately 46% in 2017, and 48% in 2016 and 2015. Because we have such substantial international operations, we are impacted, from time to time, by international developments that affect foreign currency transactions. In 2017, the strengthening of the euro, Australian dollar and Canadian dollar had a small positive impact on our net sales and operating income. During 2016, our sales and operating income were negatively impacted by the strengthening of the U.S. dollar and euro against the British Pound Sterling, with smaller impacts due to weakening of the Australian dollar and Canadian dollar against the U.S. dollar. In 2015, the strengthening of the U.S. dollar led to a significant impact on our consolidated operations. In particular, the euro, Australian dollar and Canadian dollar were translated at lower rates compared to prior years. The following table presents the amounts (in U.S. dollars) by which the exchange rates for converting euros, Australian dollars and Canadian dollars into U.S. dollars have affected our net sales and operating income during the past three years:

 

   

2017

   

2016

   

2015

 
   

(in millions)

 
                         

Impact of changes in foreign currency on net sales

  $ 5.5     $ (10.9 )   $ (79.5 )

Impact of changes in foreign currency on operating income

    1.0       (1.0 )     (9.8 )

 

The following table presents, as a percentage of net sales, certain items included in our Consolidated Statements of Operations during the past three years:

 

   

Fiscal Year

 
   

2017

   

2016

   

2015

 

Net sales

    100.0 %     100.0 %     100.0 %

Cost of sales

    61.3       61.5       61.8  

Gross profit on sales

    38.7       38.5       38.2  

Selling, general and administrative expenses

    27.0       27.5       26.9  

Restructuring and asset impairment charges

    0.7       2.1       0.0  

Operating income

    11.0       8.9       11.3  

Interest/Other expense

    0.9       0.6       0.7  

Income before income tax expense

    10.1       8.3       10.6  

Income tax expense

    4.7       2.6       3.3  

Net income

    5.3       5.7       7.2  

 

Net Sales

 

Below we provide information regarding our net sales and analyze those results for each of the last three fiscal years. Fiscal year 2015 was a 53-week period. Fiscal years 2017 and 2016 were 52-week periods.

 

   

Fiscal Year

   

Percentage Change

 
   

2017

   

2016

   

2015

   

2017 compared

   

2016 compared

 
   

(in thousands)

   

with 2016

   

with 2015

 
                                         

Net Sales

    996,443     $ 958,617       1,001,863       3.9 %     (4.3 %)

 

Net sales for 2017 compared with 2016

 

For 2017, our net sales increased $37.8 million (3.9%) as compared to 2016. Fluctuations in currency exchange rates had a positive impact on the comparison of approximately $5.5 million, meaning that if currency levels had remained constant year over year our 2017 sales would have been lower by this amount. On a geographic basis, we experienced sales growth across all our regions. Sales in the Americas were up 3.5%, sales in Europe were up 2.0% in U.S. dollars (1.5% increase in local currencies), and sales in Asia-Pacific were up 8.7%.

 

In the Americas, our weighted average selling price per square yard for our modular carpet decreased 1% in 2017 as compared to 2016. The sales increase in the Americas was due primarily to the introduction of our LVT products in early 2017, as our modular carpet sales in the Americas declined versus 2016.  This decline in modular carpet sales was due entirely to the closure of our FLOR specialty retail stores in the first quarter of 2017, as our commercial modular business was up approximately 1% in 2017 as compared to 2016.   The corporate office market segment increased 2% for the year.  Other market segments showing growth were the government (up 19%), retail (up 5%) and education (up 4%) market segments.  The increase in the government market segment was seen across most government customers, with sales to state and municipal governments representing the most significant increase.   The increase in retail was due to the performance of our Interface SERVICES™ business, which has a larger percentage of its sales to the retail segment.  These increases were offset by declines in the hospitality (down 7%) and healthcare (down 6%) market segments.

 

 

In Europe, our weighted average selling price per square meter increased 3% in 2017 compared with 2016.  Sales in the region were up in both U.S. dollars (2%) and local currency (1.5%).  Within the region, the weakening of the British Pound versus the euro had a negative impact on sales, however this was offset by the strengthening of the euro versus the U.S. dollar during 2017 as compared to 2016. The United Kingdom, which has historically been our third largest market, experienced a sales increase in local currency of 3% for the year, but a decline of 2% when translated into U.S. dollars.   We also experienced growth in Germany in 2017, but this was partially offset by other declines in central Europe.  The increase in sales was entirely within the corporate office market segment (up 3%) as no other market segment had a significant increase in sales.  The corporate office market comprises the majority of sales in the Europe region.  This increase was partially offset by declines in the retail (down 17%), education (down 12%), and residential (down 52%) market segments.

 

In Asia-Pacific, our weighted average selling price increased 5.6% for the year, with the appreciation of the Australian dollar having a positive impact on this increase.  Within the region, Asia sales increased 5% while Australia sales increased 12% as translated into U.S. dollars.  As noted, the appreciation of the Australian dollar had a positive impact on the sales increase, as in local currency sales in Australia increased 9%.  The increase in sales for the region was primarily due to the strength of the corporate office market (which comprises the bulk of the region’s sales and was up 8%).  Other non-office market segments showing growth for the year were education (up 16%) and healthcare (up 36%).  The increase in the education segment was due to our success in the Australian education market, a result of increased government education spending in the market, as well as growth of student accommodation projects at the university level.  These increases were only slightly offset by declines in the retail, government and residential market segments.

 

Net sales for 2016 compared with 2015

 

For 2016, our net sales declined $43.3 million (4.3%) as compared to 2015. Fluctuations in currency exchange rates had a negative impact on the comparison of approximately $10.9 million, meaning that if currency levels had remained constant year over year, our 2016 sales would have been higher by this amount. On a geographic basis, we experienced sales declines in the Americas (down 4.2%) and Europe (down 8.1%), partially offset by an increase of 2% in Asia-Pacific.

 

In the Americas, our weighted average selling price per square yard increased approximately 1% in 2016 compared with 2015. The sales decline in the Americas was experienced across the majority of our customer segments, with the most significant decline occurring in the corporate office segment (down 5%), which is the largest single customer segment in the Americas. We saw lower levels of customer orders during the first three quarters of the year, although this trend somewhat reversed during the fourth quarter, as sales in the corporate segment were effectively flat for the quarter. We also experienced a decline in the residential market segment of 15%, due largely to the performance of our FLOR consumer business. Other declines were seen in the government (down 19%) and retail (down 5%) market segments. The decline in government segment sales in the region was primarily a result of reduced order activity in light of the election cycle. The hospitality market segment in the region increased 11% versus 2015, as we continued to convert customers to modular carpet.

 

In Europe, our weighted average selling price per square meter declined approximately 3% in 2016 compared with 2015. The largest single factor impacting our performance in this region was the turmoil surrounding the decision of the United Kingdom to exit the European Union. This had a significant negative impact on our sales performance in the United Kingdom, which has historically been our third largest market. Not only were sales impacted by the uncertainty around the exit vote, the significant decline in the British Pound led to a translation effect on sales in the U.K. as reported in U.S. dollars. In local currency, the sales decline in the U.K. was 13%, but when translated into U.S. dollars the decline was over 25%. This decrease was partially offset by double digit increases in other countries, notably Germany, Spain and Italy. On a market segment basis, the decline was most significant in the corporate office market (down 6%), which represents the majority of sales within Europe. With the exception of the hospitality (up 19%) and healthcare (up 17%) market segments, all other non-office market segments in the region were down year over year, with the most significant declines occurring in the education (down 29%) and government (down 13%) market segments.

 

In the Asia-Pacific region, our weighted average selling price per square meter declined approximately 1% in 2016 compared with 2015. The 2% sales increase in the region was evenly split between Australia and Asia, with both geographic markets seeing a 2% increase in revenue. In local currency, the increase in Australia was approximately 3%. The increase in sales in the Asia-Pacific region was experienced in the corporate office market segment (up 5%), which represents the majority of sales within the region. This increase was a result of large development projects that led to increases in the first half of the year, particularly in Australia. The only other market segment in the region that experienced an increase of significance was the hospitality segment (up 24%), due to investment in additional selling resources in the region which led to greater market share. Within the region, the sales increases in corporate and hospitality segments were offset by declines in the retail (down 31%) and education (down 11%) market segments.

 

 

Cost and Expenses

 

The following table presents our overall cost of sales and selling, general and administrative expenses during the past three years:

 

Cost and Expenses

 

Fiscal Year

   

Percentage Change

 
   

2017

   

2016

   

2015

   

2017 compared

with 2016

   

2016 compared

with 2015

 
   

(in thousands)

                 

Cost of Sales

  $ 610,422     $ 589,973     $ 618,974       3.5 %     (4.7 %)

Selling, General and Administrative Expenses

    268,878       263,919       269,296       1.9 %     (2.0 %)

Total

  $ 879,300     $ 853,892     $ 888,270       3.0 %     (3.9 %)

 

For 2017, our costs of sales increased $20.4 million (3.5%) compared with 2016.  Fluctuations in currency exchange rates did not have a significant impact (less than 1%) on the comparison.  In absolute dollars, the increase in costs of sales was a result of the higher sales for 2017 as compared to 2016.  As noted above, sales increased 3.9% in 2017.  As a percentage of sales, our costs of sales improved to 61.3% in 2017 versus 61.5% in 2016.  This improvement was a result of (1) productivity initiatives, including our investment in our manufacturing facilities in LaGrange Georgia, (2) lower cost of sales as a percentage of sales due to the introduction of our LVT product offerings, which commanded margins in 2017 that were accretive to our modular carpet products, and (3) non-recurring charges in 2016 related to the transition to a centralized warehouse and distribution center in our Americas business.  These benefits were partially offset by (1) higher raw materials costs due to input cost inflation, particularly in our European business, and (2) negative gross margin impacts due to the exit of our FLOR specialty retail business.  Our FLOR business delivers higher gross margins than our commercial business, and with the closure of the specialty retail stores the decline in sales had a negative impact on our cost of sales as a percentage of sales.

 

For 2016, our cost of sales decreased $29.0 million (4.7%) compared with 2015. Fluctuations in currency exchange rates did not have a significant impact (less than 1%) on the comparison. In absolute dollars, the decrease in cost of sales was due to lower sales and production versus the prior year, as production for 2016 was down 11% in Americas, 3% in Europe and 3% in Asia-Pacific versus 2015. As a percentage of sales, our cost of sales declined to 61.5% in 2016 versus 61.8% in 2015. The most significant reason for this decline was lower raw materials costs during the year as a result of lower feedstock prices for our raw materials, primarily yarn. These lower prices produced a benefit in cost of sales of approximately $12 million, meaning that our raw materials costs for 2016 were lower by this amount. We also experienced more favorable production and utilization efficiencies in 2016 versus 2015. Our cost of sales was, however, negatively impacted by approximately $5 million in the second half of 2016, as there were additional costs within our Americas business as a result of the transition to a new centralized warehouse and distribution center operated by a third party for the region.

 

For 2017, our SG&A expenses increased $5.0 million (1.9%) versus 2016. Currency fluctuations had only a slight (less than 1%) unfavorable impact on SG&A expenses. The increase in SG&A expenses during the year was due to (1) higher incentive-based compensation (approximately $6 million) and performance-based stock compensation (approximately $1.5 million) as performance targets were met to a higher degree in 2017 as comparted to 2016, and (2) higher administrative expenses of $5 million as we centralize certain support functions. These increases were partially offset by (1) lower marketing expenses of $3.9 million, a result of our restructuring efforts as well as global consolidation of costs for marketing expenditures leading to lower levels of total spend, and (2) lower selling costs of $4.2 million due primarily to exiting our FLOR specialty retail business in 2017. Despite the higher SG&A expense in absolute dollars, due to the increase in sales noted above, SG&A expenses declined as a percentage of sales in 2017 to 27.0% versus 27.5% in 2016.

 

For 2016, our SG&A expenses decreased $5.4 million (2.0%) versus 2015. Currency fluctuations had only a slight (less than 1%) favorable impact on SG&A expenses. On an absolute dollar basis, the decrease was almost entirely related to lower administrative expenses of $9.4 million resulting from lower incentive-based compensation, including share-based compensation, due to performance targets not being met in 2016 to the same degree as in 2015. These declines were primarily at the corporate and Americas level. Other declines were lower selling expenses of $1.2 million due to reduced commissions on lower sales volumes. These decreases were partially offset by higher marketing expenses in 2016 of approximately $5.2 million, as we continued to expand our marketing efforts related to the early rollout of our modular resilient flooring (“MRF”) products as well as other initiatives to drive product adoption. These marketing increases were most significant in the Americas region (up $1.7 million) due to the MRF rollout and in the Asia-Pacific region (up $1.9 million), primarily in Asia related to additional customer events, product rollout support and increased marketing management. Despite the overall decline in SG&A expenses in absolute dollars, due to the lower sales in 2016 versus 2015 our SG&A expenses increased as a percentage of sales to 27.5% in 2016 versus 26.9% in 2015, as the decline in SG&A expenses was less than the decline in net sales.

 

 

Interest Expense

 

For 2017, our interest expense increased $1.0 million to $7.1 million, versus $6.1 million in 2016. This increase was a result of (1) higher average interest rates under our Syndicated Credit Facility during 2017 (the average interest rate for 2016 was 2.5% as compared to 2.9% for 2017), and (2) in 2017 we fixed the variable interest rate on $100 million of our term loan borrowings under the Syndicated Credit Facility by entering into an interest rate swap transaction. The effect of this interest rate swap was to increase the interest rate on the $100 million notional amount of the swap above the variable rate in effect for our other term loan borrowings under the Syndicated Credit Facility.

 

For 2016, our interest expense decreased $0.3 million to $6.1 million, versus $6.4 million in 2015. This decrease was due to lower average outstanding debt balances in 2016 versus 2015. During 2016, we repaid a net amount of $6.2 million under our Syndicated Credit Facility, and this lower level of debt led to lower interest expense during 2016. We did incur additional Syndicated Credit Facility borrowings of approximately $63.5 million in December of 2016, but this debt was outstanding for only the final month of 2016 and did not have a significant impact on interest expense (less than $0.1 million).

 

Tax

 

On December 22, 2017, the U.S. Tax Cuts and Jobs Act (the “Tax Act”) was enacted into law. Among the significant changes resulting from the law, the Tax Act reduces the U.S. federal income tax rate from 35% to 21% effective January 1, 2018 and creates a modified territorial tax system with a one-time mandatory “transition tax” on previously unrepatriated foreign earnings.

 

Due to the tax legislation, the Company has recorded a provisional tax expense of $3.5 million related to the remeasurement of its net deferred tax assets. The Company also recorded a provisional tax expense of $11.7 million related to the one-time transition toll tax. These amounts are considered provisional because they use reasonable estimates of which tax returns have not been filed and because estimated amounts may be impacted by future regulatory and accounting guidance if and when issued. The Company will adjust these provisional amounts as further information becomes available and as we refine our calculations. Please see Item 8, Note 13 entitled “Taxes on Income” for further information on the financial statement impact of the Tax Act.

 

Our effective tax rate in 2017 was 47.0%, compared with an effective tax rate of 31.6% in 2016. The increase in our effective tax rate in 2017 compared to 2016 was primarily due to a $15.2 million tax charge for the impacts of the Tax Act as discussed above and an increase in U.S. earnings resulting in more U.S. state tax expense.

 

Our effective tax rate in 2016 was 31.6%, compared with an effective tax rate of 31.5% in 2015. The 2016 effective tax rate was favorably impacted by a higher portion of income earned in foreign jurisdictions which are taxed at lower tax rates than the U.S federal tax rate. The favorable impact to the 2016 effective tax rate was offset by a decrease in the release of valuation allowances related to state net operating loss carryforwards utilized in 2016 compared to 2015. For additional information on taxes and a reconciliation of effective tax rates to statutory tax rates, see the Note 13 entitled “Taxes on Income” in Item 8 of this Report.

 

Liquidity and Capital Resources

 

General

 

In our business, we require cash and other liquid assets primarily to purchase raw materials and to pay other manufacturing costs, in addition to funding normal course SG&A expenses, anticipated capital expenditures, interest expense and potential special projects. We generate our cash and other liquidity requirements primarily from our operations and from borrowings or letters of credit under our Syndicated Credit Facility discussed below.

 

Historically, we use more cash in the first half of the fiscal year, as we pay insurance premiums, taxes and incentive compensation and build up inventory in preparation for the holiday/vacation season of our international operations.

 

 

In December 2016, one of the Company’s foreign subsidiaries borrowed 61 million euros (approximately $63.5 million) under the Syndicated Credit Facility. The funds were distributed to its U.S. parent company to fund then-current and projected U.S. cash needs. A significant portion of these borrowings were repaid in the first quarter of 2017.

 

At December 31, 2017, we had $87.0 million in cash. Approximately $14.1 million of this cash was located in the U.S., and the remaining $72.9 million was located outside of the U.S. The cash located outside of the U.S. is indefinitely reinvested in the respective jurisdictions (except as identified below). We believe that our strategic plans and business needs, particularly for working capital needs and capital expenditure requirements in Europe, Asia, Canada, and Australia, support our assertion that a portion of our cash in foreign locations will be reinvested and remittance will be postponed indefinitely.  Of the $72.9 million of cash in foreign jurisdictions, approximately $43.0 million represents earnings which we have determined are not permanently reinvested, and as such we have provided for foreign withholding and U.S. state income taxes on these amounts in accordance with applicable accounting standards.

 

As of December 31, 2017, we had $229.9 million of borrowings and $6.0 million in letters of credit outstanding under our Syndicated Credit Facility. Of those borrowings outstanding, $170.0 million were Term Loan A borrowings and $59.9 million were revolving loan borrowings. As of December 31, 2017, we could have incurred $184.1 million of additional revolving loan borrowings under our Syndicated Credit Facility. In addition, we could have incurred the equivalent of $9.8 million of borrowings under our other credit facilities in place at other non-U.S. subsidiaries.

 

We have approximately $95.0 million in contractual cash obligations due by the end of fiscal year 2018, which includes, among other things, pension cash contributions, interest payments on our debt and lease commitments. Based on current interest rate and debt levels, we expect our aggregate interest expense for 2018 to be between $8 million and $11 million. We estimate aggregate capital expenditures in 2018 to be between $50 million and $60 million, although we are not committed to these amounts.

 

It is important for you to consider that we have a significant amount of indebtedness. Our Syndicated Credit Facility matures in August of 2022. We cannot assure you that we will be able to renegotiate or refinance any of our debt on commercially reasonable terms, or at all. If we are unable to refinance our debt or obtain new financing, we would have to consider other options, such as selling assets to meet our debt service obligations and other liquidity needs, or using cash, if available, that would have been used for other business purposes.

 

It is also important for you to consider that borrowings under our Syndicated Credit Facility comprise the substantial majority of our indebtedness, and that these borrowings are based on variable interest rates (as described below) that expose the Company to the risk that short-term interest may increase. We have, however, entered into an interest rate swap transaction to fix the variable interest rate with respect to $100 million of the term loan borrowings under the Syndicated Credit Facility. For information regarding the current variable interest rates of these borrowings, the potential impact on our interest expense from hypothetical increases in short term interest rates, and the interest rate swap transaction, please see the discussion in Item 7A of this Report.

 

Syndicated Credit Facility 

 

We have a syndicated credit facility (the “Syndicated Credit Facility” or “Facility”, most recently amended and restated in August 2017) pursuant to which the lenders provide to us and certain of our subsidiaries a multicurrency revolving credit facility and provide to us a term loan.  The key features of the Facility are as follows:

 

 

The Facility matures in August of 2022.

 

The Facility includes a multicurrency revolving loan facility made available to the Company and our principal subsidiaries in Europe and Australia not to exceed $250 million in the aggregate at any one time outstanding. A sublimit of $40 million exists for the issuance of letters of credit under the Facility.

 

The Facility includes a Term Loan A borrowing that had an original principal amount of $177.5 million.

 

The Facility provides for required amortization payments of the Term Loan A borrowing, as well as mandatory prepayments of the Term Loan A borrowing (and any term loans made available pursuant to any future multicurrency loan facility increase) from certain asset sales, casualty events and debt issuances, subject to certain qualifications and exceptions as provided for therein.

 

Advances under the Facility are secured by a first-priority lien on substantially all of Interface, Inc.’s assets and the assets of each of our material domestic subsidiaries, which have guaranteed the Facility.

 

The Facility contains financial covenants (specifically, a consolidated net leverage ratio and a consolidated interest coverage ratio) that must be met as of the end of each fiscal quarter.

 

We have the option to increase the borrowing availability under the Facility, either for revolving loans or term loans, by up to $150 million, subject to the receipt of lender commitments for the increase and the satisfaction of certain other conditions.

 

 

Interest Rates and Fees. Interest on base rate loans is charged at varying rates computed by applying a margin ranging from 0.25% to 1.50% over the applicable base interest rate (which is defined as the greatest of the prime rate, a specified federal funds rate plus 0.50%, or a specified Eurocurrency rate), depending on our consolidated net leverage ratio as of the most recently completed fiscal quarter. Interest on Eurocurrency-based loans and fees for letters of credit are charged at varying rates computed by applying a margin ranging from 1.25% to 2.50% over the applicable Eurocurrency rate, depending on our consolidated net leverage ratio as of the most recently completed fiscal quarter. In addition, we pay a commitment fee ranging from 0.20% to 0.35% per annum (depending on our consolidated net leverage ratio as of the most recently completed fiscal quarter) on the unused portion of the Facility.

 

Amortization Prepayments. We are required to make quarterly amortization payments of $3.75 million of the Term Loan A borrowing.

 

Covenants. The Facility contains standard and customary covenants for agreements of this type, including various reporting, affirmative and negative covenants. Among other things, these covenants limit our ability to:

 

 

create or incur liens on assets;

 

make acquisitions of or investments in businesses (in excess of certain specified amounts);

 

incur indebtedness or contingent obligations;

 

sell or dispose of assets (in excess of certain specified amounts);

 

pay dividends or repurchase our stock (in excess of certain specified amounts);

 

repay other indebtedness prior to maturity unless we meet certain conditions; and

 

enter into sale and leaseback transactions.

 

The Facility also requires us to remain in compliance with the following financial covenants as of the end of each fiscal quarter, based on our consolidated results for the year then ended:

 

 

Consolidated Net Leverage Ratio: Must be no greater than 3.75:1.00.

 

Consolidated Interest Coverage Ratio: Must be no less than 2.25:1.00.

 

Events of Default. If we breach or fail to perform any of the affirmative or negative covenants under the Facility, or if other specified events occur (such as a bankruptcy or similar event or a change of control of Interface, Inc. or certain subsidiaries, or if we breach or fail to perform any covenant or agreement contained in any instrument relating to any of our other indebtedness exceeding $20 million), after giving effect to any applicable notice and right to cure provisions, an event of default will exist. If an event of default exists and is continuing, the lenders’ Administrative Agent may, and upon the written request of a specified percentage of the lender group shall:

 

 

declare all commitments of the lenders under the facility terminated;

 

declare all amounts outstanding or accrued thereunder immediately due and payable; and

 

exercise other rights and remedies available to them under the agreement and applicable law.

 

Collateral. Pursuant to an Amended and Restated Security and Pledge Agreement, the Facility is secured by substantially all of the assets of Interface, Inc. and our domestic subsidiaries (subject to exceptions for certain immaterial subsidiaries), including all of the stock of our domestic subsidiaries and up to 65% of the stock of our first-tier material foreign subsidiaries. If an event of default occurs under the Facility, the lenders’ Administrative Agent may, upon the request of a specified percentage of lenders, exercise remedies with respect to the collateral, including, in some instances, foreclosing mortgages on real estate assets, taking possession of or selling personal property assets, collecting accounts receivables, or exercising proxies to take control of the pledged stock of domestic and first-tier material foreign subsidiaries.

 

As of December 31, 2017, we had $170.0 million of Term Loan A borrowings and $59.9 million of revolving loan borrowings outstanding under the Facility, and had $6.0 million in letters of credit outstanding under the Facility.

 

We are presently in compliance with all covenants under the Syndicated Credit Facility and anticipate that we will remain in compliance with the covenants for the foreseeable future.

 

In the third quarter of 2017, we entered into an interest rate swap transaction that fixed the variable interest rate with respect to $100 million of the term loan borrowings under the Syndicated Credit Facility. For additional information, please see Item 7A and Note 8 entitled “Borrowings” in Item 8 of this Report.

 

 

Analysis of Cash Flows

 

We ended 2017 with $87.0 million in cash, a decrease of $78.6 million during the year.  The most significant decrease in cash was due to our share repurchase program which used $91.6 million of cash to repurchase and retire 4.6 million shares of our outstanding common stock, pursuant to our established share repurchase plans.  We also used $72.0 million of cash to repay outstanding borrowings under our Syndicated Credit Facility (including $15.0 million of required amortization payments under our term loan), as well as $15.5 million for the payment of dividends.    We borrowed $25.0 million during 2017 under our Syndicated Credit Facility.  Outside of these financing activities, we also used cash of $30.5 million for capital expenditures during 2017.  These uses of cash were partially offset by cash flow from operations of $103.4 million.  The significant components of cash flow from operations were (1) net income of $53.2 million, and (2) a $12.0 million increase in accruals and accounts payable.  Cash flow from operations was partially offset by (1) an increase of accounts receivable of $10.3 million, and (2) an increase in inventory of $13.6 million.  Included in cash flow from operations is a $15.2 million add-back to net income related to the non-cash charge recorded in 2017 in connection with the Tax Act.  A portion of this impact (an estimated $9.8 million) will result in cash expenditures over the next eight years as is allowed by the Tax Act.  However, this estimated amount could change as the Company completes its analysis of the Tax Act over the course of 2018.

 

We exited 2016 with $165.7 million in cash, an increase of $90.0 million during the year.  The most significant increase in cash was a result of borrowings under our Syndicated Credit Facility, the largest portion of which was borrowings of $63.5 million in the December 2016 borrowing transaction discussed above.  We also borrowed an additional $23.9 million under our Syndicated Credit Facility during 2016.  Outside of these borrowings, our cash flow from operating activities of $98.1 million was the most significant factor in our cash generation.  The significant components of this cash flow from operations were (1) net income of $54.2 million, (2) a $12.2 million increase in accounts payable and accruals, and (3) a $2.7 million decrease in inventory.  These increases were partially offset by a $7.7 million increase in prepaid expenses and other assets.  Other primary uses of cash during 2016 were (1) capital expenditures of $28.1 million, (2) $18.5 million used to repurchase and retire 1.2 million shares of our outstanding common stock pursuant to our established share repurchase plan, (3) $17.6 million of repayments under our Syndicated Credit Facility, (4) $14.3 million for the payment of dividends, and (5) $12.5 million for repayment of term loan borrowings under our Syndicated Credit Facility as required by the applicable amortization schedule.

 

We exited 2015 with $75.7 million in cash, an increase of $20.8 million during the year.  The increase in cash was primarily due to improved cash flow from operating activities of $126.5 million in 2015, compared with $46.4 million in 2014.  The factors driving the increase in cash flow from operating activities were (1) higher net income in 2015 due to improved operational performance, (2) a $16.2 million reduction in cash paid for interest, (3) an $18.7 million reduction in accounts receivable, and (4) a $15.5 million increase in accounts payable and accrued expenses.  The increase in cash from operating activities was partially offset by an increase in inventories of $26.5 million and an increase in prepaid expenses and other assets of $8.3 million.  Our other primary uses of cash during 2015 were (1) $45.3 million of repayments of revolving loan borrowings under our Syndicated Credit Facility, (2) $27.2 million of capital expenditures, primary related to our manufacturing locations, (3) $13.3 million used to repurchase and retire 650,000 shares of our outstanding common stock, pursuant to our established share repurchase plan, (4) $11.9 million for the payment of dividends, and (5) $2.5 million for repayment of term loan borrowings under our Syndicated Credit Facility as required by the applicable amortization schedule.

 

We believe that our liquidity position will provide sufficient funds to meet our current commitments and other cash requirements for the foreseeable future.

 

 

Funding Obligations 

 

We have various contractual obligations that we must fund as part of our normal operations. The following table discloses aggregate information about our contractual obligations and the periods in which payments are due. The amounts and time periods are measured from December 31, 2017.

 

           

Payments Due by Period

 
   

Total Payments Due

   

Less than

1 year

   

1-3 years

   

3-5 years

   

More than

5 years

 
   

(in thousands)

 

Long-Term Debt Obligations

  $ 229,928     $ 15,000     $ 30,000     $ 184,928     $ 0  

Operating Lease Obligations(1)

    62,439       16,719       21,789       8,431       15,500  

Expected Interest Payments(2)

    28,842       7,013       12,589       9,240       0  

Unconditional Purchase Obligations(3)

    49,383       45,091       3,709       583       0  

Pension Cash Obligations(4)

    123,169       11,145       23,044       24,329       64,651  

Total Contractual Cash Obligations(5) (6)

  $ 493,761     $ 94,968     $ 91,131     $ 227,511     $ 80,151  

______________________  

 

 

(1)

Our capital lease obligations are insignificant.

 

 

(2)

Expected interest payments to be made in future periods reflect anticipated interest payments related to the $170.0 million of Term Loan A borrowings outstanding and the $59.9 million of revolving loan borrowings outstanding under our Syndicated Credit Facility as of December 31, 2017. We have also assumed in the presentation above that these borrowings will remain outstanding until maturity with the exception of the required amortization payments for our Term Loan A borrowings.

 

 

(3)

Unconditional purchase obligations do not include unconditional purchase obligations that are included as liabilities in our Consolidated Balance Sheet. Our capital expenditure commitments are not significant.

 

 

(4)

We have two foreign defined benefit plans and a domestic salary continuation plan. We have presented above the estimated cash obligations that will be paid under these plans over the next ten years. Such amounts are based on several estimates and assumptions and could differ materially should the underlying estimates and assumptions change. Our domestic salary continuation plan is an unfunded plan, and we do not currently have any commitments to make contributions to this plan. However, we do use insurance instruments to hedge our exposure under the salary continuation plan. Contributions to our other employee benefit plans are at our discretion.

 

 

(5)

The above table does not reflect unrecognized tax benefits of $29.2 million, the timing of which payments are uncertain. See Note 13 entitled “Taxes on Income” in Item 8 of this Report for further information.

 

 

(6)

The above table does not reflect any provisional payments under the U.S. Tax Cuts and Jobs Act enacted December 2017. At this time, the Company estimates it will be required to pay $9.8 million for transition toll taxes over a maximum of eight years. The Company is still analyzing the impact of the U.S. Tax Cuts and Jobs Act and will determine during 2018 the ultimate amount and timing of these payments. The $9.8 million amount is currently included as an accrued liability in our consolidated financial statements. As these amounts and timing are still under review and may increase or decrease during 2018, the Company has not included them in the above table. See Note 13 entitled “Taxes on Income” in Item 8 of this Report for further information.

 

Critical Accounting Policies

 

The policies discussed below are considered by management to be critical to an understanding of our consolidated financial statements because their application places the most significant demands on management’s judgment, with financial reporting results relying on estimations about the effects of matters that are inherently uncertain. Specific risks for these critical accounting policies are described in the following paragraphs. For all of these policies, management cautions that future events may not develop as forecasted, and the best estimates routinely require adjustment.

 

Revenue Recognition. The vast majority of our revenue is recognized at the date of shipment when the following criteria are met: persuasive evidence of an agreement exists, price to the buyer is fixed and determinable, and collectability is reasonably assured. Delivery is not considered to have occurred until the customer takes title and assumes the risks and rewards of ownership, which is generally on the date of shipment. Provisions for discounts, sales returns and allowances are estimated using historical experience, current economic trends, and the Company’s quality performance. The related provision is recorded as a reduction of sales and cost of sales in the same period that the revenue is recognized. Accordingly, our estimates and assumptions regarding revenue recognition primarily relate to sales returns and allowances, which historically have been in the range of 2.5-3.0% of gross sales. Over the last several years, we have not experienced any significant fluctuation in sales returns and allowances, our estimates and assumptions related thereto have not changed significantly, and we believe our estimates and assumptions to be reasonably accurate. Management also believes this past experience can be relied upon for such estimates and assumptions in future periods, as our business model and customer mix have not changed significantly.

 

 

A small percentage (approximately 5%) of our revenue relates to flooring installation projects, which generally involve short time periods (typically less than two weeks) and therefore present little risk of material difference due to changes in experience.

 

Shipping and handling fees billed to customers are classified in net sales in the consolidated statements of operations. Shipping and handling costs incurred are classified in cost of sales in the consolidated statements of operations.

 

Impairment of Long-Lived Assets. Long-lived assets are reviewed for impairment at the asset group level whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If the sum of the expected future undiscounted cash flow is less than the carrying amount of the asset, an impairment is indicated. A loss is then recognized for the difference, if any, between the fair value of the asset (as estimated by management using its best judgment) and the carrying value of the asset. If actual market value is less favorable than that estimated by management, additional write-downs may be required.

 

Deferred Income Tax Assets and Liabilities. The carrying values of deferred income tax assets and liabilities reflect the application of our income tax accounting policies in accordance with applicable accounting standards and are based on management’s assumptions and estimates regarding future operating results and levels of taxable income, as well as management’s judgment regarding the interpretation of the provisions of applicable accounting standards. The carrying values of liabilities for income taxes currently payable are based on management’s interpretations of applicable tax laws and incorporate management’s assumptions and judgments regarding the use of tax planning strategies in various taxing jurisdictions. The use of different estimates, assumptions and judgments in connection with accounting for income taxes may result in materially different carrying values of income tax assets and liabilities and results of operations.

 

We evaluate the recoverability of these deferred tax assets by assessing the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. These sources of income inherently rely heavily on estimates. We use our historical experience and our short and long-term business forecasts to provide insight. Further, our global business portfolio gives us the opportunity to employ various prudent and feasible tax planning strategies to facilitate the recoverability of future deductions. To the extent we do not consider it more likely than not that a deferred tax asset will be recovered, a valuation allowance is established. As of December 31, 2017, and January 1, 2017, we had state net operating loss carryforwards of $108.6 million and $108.9 million, respectively. As of January 1, 2017, we had $3.8 million of foreign net operating loss carryforwards. Certain of these state net operating loss carryforwards are reserved with a valuation allowance because, based on the available evidence, we believe it is more likely than not that we would not be able to utilize those deferred tax assets in the future. The remaining year-end 2017 amounts are expected to be fully recoverable within the applicable statutory expiration periods. If the actual amounts of taxable income differ from our estimates, the amount of our valuation allowance could be materially impacted

 

Goodwill. Pursuant to applicable accounting standards, we test goodwill for impairment at least annually using a two step approach. In the first step of this approach, we prepare valuations of reporting units, using both a market comparable approach and an income approach, and those valuations are compared with the respective book values of the reporting units to determine whether any goodwill impairment exists. In preparing the valuations, past, present and expected future performance is considered. If impairment is indicated in this first step of the test, a step two valuation approach is performed. The step two valuation approach compares the implied fair value of goodwill to the book value of goodwill. The implied fair value of goodwill is determined by allocating the estimated fair value of the reporting unit to the assets and liabilities of the reporting unit, including both recognized and unrecognized intangible assets, in the same manner as goodwill is determined in a business combination under applicable accounting standards. After completion of this step two test, a loss is recognized for the difference, if any, between the fair value of the goodwill associated with the reporting unit and the book value of that goodwill. If the actual fair value of the goodwill is determined to be less than that estimated, an additional write-down may be required.

 

During the fourth quarters of 2017, 2016 and 2015, we performed the annual goodwill impairment test. We perform this test at the reporting unit level. For our reporting units which carried a goodwill balance as of December 31, 2017, no impairment of goodwill was indicated. As of December 31, 2017, if our estimates of the fair value of our reporting units were 10% lower, we believe no additional goodwill impairment would have existed.

 

Inventories. We determine the value of inventories using the lower of cost or net realizable value. We write down inventories for the difference between the carrying value of the inventories and their net realizable value. If actual market conditions are less favorable than those projected by management, additional write-downs may be required.

 

We estimate our reserves for inventory obsolescence by continuously examining our inventories to determine if there are indicators that carrying values exceed net realizable values. Experience has shown that significant indicators that could require the need for additional inventory write-downs are the age of the inventory, the length of its product life cycles, anticipated demand for our products and current economic conditions. While we believe that adequate write-downs for inventory obsolescence have been made in the consolidated financial statements, consumer tastes and preferences will continue to change and we could experience additional inventory write-downs in the future. Our inventory reserve on December 31, 2017 and January 1, 2017, was $20.4 million and $17.6 million, respectively. To the extent that actual obsolescence of our inventory differs from our estimate by 10%, our 2017 net income would be higher or lower by approximately $1.5 million, on an after-tax basis.

 

 

Pension Benefits. Net pension expense recorded is based on, among other things, assumptions about the discount rate, estimated return on plan assets and salary increases. While management believes these assumptions are reasonable, changes in these and other factors and differences between actual and assumed changes in the present value of liabilities or assets of our plans above certain thresholds could cause net annual expense to increase or decrease materially from year to year. The actuarial assumptions used in our salary continuation plan and our foreign defined benefit plans reporting are reviewed periodically and compared with external benchmarks to ensure that they appropriately account for our future pension benefit obligation. The expected long-term rate of return on plan assets assumption is based on weighted average expected returns for each asset class. Expected returns reflect a combination of historical performance analysis and the forward-looking views of the financial markets, and include input from actuaries, investment service firms and investment managers. The table below represents the changes to the projected benefit obligation as a result of changes in discount rate assumptions:

 

Foreign Defined Benefit Plans

 

Increase (Decrease) in

Projected Benefit Obligation

 
   

(in millions)

 

1% increase in actuarial assumption for discount rate

  $ (60.1 )

1% decrease in actuarial assumption for discount rate

  $ 61.5  

 

Domestic Salary Continuation Plan

 

Increase (Decrease) in

Projected Benefit Obligation

 
   

(in millions)

 

1% increase in actuarial assumption for discount rate

  $ (3.3 )

1% decrease in actuarial assumption for discount rate

  $ 4.0  

 

Environmental Remediation. We provide for environmental remediation costs and penalties when the responsibility to remediate is probable and the amount of associated costs is reasonably determinable. Remediation liabilities are accrued based on estimates of known environmental exposures and are discounted in certain instances. We regularly monitor the progress of environmental remediation. Should studies indicate that the cost of remediation is to be more than previously estimated, an additional accrual would be recorded in the period in which such determination is made. As of December 31, 2017, no significant amounts were provided for remediation liabilities.

 

Allowances for Doubtful Accounts. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. Estimating this amount requires us to analyze the financial strengths of our customers. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. By its nature, such an estimate is highly subjective, and it is possible that the amount of accounts receivable that we are unable to collect may be different than the amount initially estimated. Our allowance for doubtful accounts on December 31, 2017 and January 1, 2017, was $3.5 million and $3.8 million, respectively. To the extent the actual collectability of our accounts receivable differs from our estimates by 10%, our 2017 net income would be higher or lower by approximately $0.3 million, on an after-tax basis, depending on whether the actual collectability was better or worse, respectively, than the estimated allowance.

 

Product Warranties. We typically provide limited warranties with respect to certain attributes of our carpet products (for example, warranties regarding excessive surface wear, edge ravel and static electricity) for periods ranging from ten to twenty years, depending on the particular carpet product and the environment in which the product is to be installed. Similar limited warranties are provided on certain attributes of our LVT products, typically for a period of 15 years. We typically warrant that any services performed will be free from defects in workmanship for a period of one year following completion. In the event of a breach of warranty, the remedy typically is limited to repair of the problem or replacement of the affected product. We record a provision related to warranty costs based on historical experience and periodically adjust these provisions to reflect changes in actual experience. Our warranty and sales allowance reserve on December 31, 2017 and January 1, 2017, was $4.1 million and $5.5 million, respectively. Actual warranty expense incurred could vary significantly from amounts that we estimate. To the extent the actual warranty expense differs from our estimates by 10%, our 2017 net income would be higher or lower by approximately $0.3 million, on an after-tax basis, depending on whether the actual expense is lower or higher, respectively, than the estimated provision.

 

Off-Balance Sheet Arrangements

 

We are not a party to any material off-balance sheet arrangements.

 

 

Recent Accounting Pronouncements 

 

Please see Item 8, Note 2 entitled “Recent Accounting Pronouncements” for discussion of these items.

 

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Market Risk

 

As a result of the scope of our global operations, we are exposed to an element of market risk from changes in interest rates and foreign currency exchange rates. Our results of operations and financial condition could be impacted by this risk. We manage our exposure to market risk through our regular operating and financial activities and, to the extent we deem appropriate, through the use of derivative financial instruments.

 

We employ derivative financial instruments as risk management tools and not for speculative or trading purposes. We monitor the use of derivative financial instruments through objective measurable systems, well-defined market and credit risk limits, and timely reports to senior management according to prescribed guidelines. We have established strict counter-party credit guidelines and enter into transactions only with financial institutions with a rating of investment grade or better. As a result, we consider the risk of counter-party default to be minimal.

 

Interest Rate Market Risk Exposure

 

Changes in interest rates affect the interest paid on certain of our debt. To mitigate the impact of fluctuations in interest rates, our management monitors interest rates and has developed and implemented a policy to maintain the percentage of fixed and variable rate debt within certain parameters, subject to approval by our Board of Directors. In 2017, the Company entered into an interest rate swap transaction with regard to a portion of its term loan debt. The Company’s interest rate swap is designated and qualifies as a cash flow hedge of forecasted interest payments. The Company reports the effective portion of the fair value gain or loss on the swap as a component of other comprehensive income (or other comprehensive loss). Gains or losses (if any) on any ineffective portion of derivative instruments in cash flow hedging relationships are recorded in the period in which they occur as a component of other expense (or other income) in the Consolidated Condensed Statement of Operations. There were no such gains or losses in 2017. The aggregate notional amount of the swap as of December 31, 2017 was $100 million.

 

Foreign Currency Exchange Market Risk Exposure

 

A significant portion of our operations consists of manufacturing and sales activities in foreign jurisdictions. We manufacture our products in the United States, Northern Ireland, the Netherlands, China, Thailand and Australia, and sell our products in more than 100 countries. As a result, our financial results have been, and could be, significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which we distribute our products. Our operating results are exposed to changes in exchange rates between the U.S. dollar and many other currencies, including the euro, British pound sterling, Canadian dollar, Australian dollar, Thai baht and Japanese yen. When the U.S. dollar strengthens against a foreign currency, the value of anticipated sales in those currencies decreases, and vice versa. Additionally, to the extent our foreign operations with functional currencies other than the U.S. dollar transact business in countries other than the United States, exchange rate changes between two foreign currencies could ultimately impact us. Finally, because we report in U.S. dollars on a consolidated basis, foreign currency exchange fluctuations could have a translation impact on our financial position.

 

At December 31, 2017, we recognized a $31.6 million increase in our foreign currency translation adjustment account compared with January 1, 2017, because of the weakening of the U.S. dollar against certain foreign currencies during 2017, particularly the euro and the Australian dollar.

 

Sensitivity Analysis

 

For purposes of specific risk analysis, we use sensitivity analysis to measure the impact that market risk may have on the fair values of our market-sensitive instruments.

 

To perform sensitivity analysis, we assess the risk of loss in fair values associated with the impact of hypothetical changes in interest rates and foreign currency exchange rates on market-sensitive instruments. The market value of instruments affected by interest rate and foreign currency exchange rate risk is computed based on the present value of future cash flows as impacted by the changes in the rates attributable to the market risk being measured. The discount rates used for the present value computations were selected based on market interest and foreign currency exchange rates in effect at December 31, 2017. The values that result from these computations are then compared with the market values of the financial instruments. The differences are the hypothetical gains or losses associated with each type of risk.

 

 

Interest Rate Risk 

 

Our weighted average interest rate for our outstanding borrowings in 2017 and 2016 was 3.0% and 2.1%, respectively.

 

As discussed above, our Syndicated Credit Facility is comprised of a combination of term loan and revolving loan borrowings. The following table summarizes our market risks associated with our debt obligations as of December 31, 2017. For debt obligations, the table presents principal cash flows and related weighted average interest rates by year of maturity. Variable interest rates presented for variable-rate debt represent the weighted average interest rate on our Syndicated Credit Facility borrowings as of December 31, 2017.

 

   

2018

   

2019

   

2020

   

2021

   

Thereafter

   

Total

   

Fair Value

 
   

(in thousands)

 

Rate-Sensitive Liabilities

                                                       

Long-term Debt:

                                                       

Variable Rate

  $ 15,000     $ 15,000     $ 15,000     $ 15,000     $ 169,928     $ 229,928     $ 229,928  

Variable Interest Rate

    3.0 %     3.0 %     3.0 %     3.0 %     3.0 %                

 

An increase in our effective interest rate of 1% would increase annual interest expense by approximately $2.3 million. We will continue to review our exposure to interest rate fluctuations and evaluate whether we should continue to manage such exposures through our current and any future interest rate swap transactions.

 

Foreign Currency Exchange Rate Risk

 

As of December 31, 2017, a 10% decrease or increase in the levels of foreign currency exchange rates against the U.S. dollar, with all other variables held constant, would result in a decrease in the fair value of our short-term financial instruments (primarily cash, accounts receivable and accounts payable) of $10.1 million or an increase in the fair value of our financial instruments of $12.3 million, respectively. As the impact of offsetting changes in the fair market value of our net foreign investments is not included in the sensitivity model, these results are not indicative of our actual exposure to foreign currency exchange risk.

 

 

 

ITEM 8.      FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

INTERFACE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

 

   

FISCAL YEAR

 
   

2017

   

2016

   

2015

 
   

(in thousands, except per share data)

 

Net sales

  $ 996,443     $ 958,617     $ 1,001,863  

Cost of sales

    610,422       589,973       618,974  

Gross profit on sales

    386,021       368,644       382,889  
                         

Selling, general and administrative expenses

    268,878       263,919       269,296  

Restructuring and asset impairment charges

    7,299       19,788       0  
                         

Operating income

    109,844       84,937       113,593  
                         

Interest expense

    7,128       6,130       6,401  

Other expense (income)

    2,177       (329 )     1,426  
                         

Income before income tax expense

    100,539       79,136       105,766  

Income tax expense

    47,293       24,974       33,348  
                         

Net income

  $ 53,246     $ 54,162     $ 72,418  
                         

Net income per share – basic

  $ 0.86     $ 0.83     $ 1.10  
                         

Net income per share – diluted

  $ 0.86     $ 0.83     $ 1.10  
                         

Basic weighted average common shares outstanding

    61,996       65,098       66,027  

Diluted weighted average common shares outstanding

    62,040       65,136       66,075  

 

See accompanying notes to consolidated financial statements.

 

 

 

INTERFACE, INC. AND SUBSIDIARIES 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

   

FISCAL YEAR

 
   

2017

   

2016

   

2015

 
   

(in thousands)

 

Net income

  $ 53,246     $ 54,162     $ 72,418  

Other comprehensive income (loss), after tax

                       

Foreign currency translation adjustment

    31,579       (19,011 )     (32,575 )

Cash flow hedge change in net unrealized gains (losses)

    904       0       0  

Pension liability adjustment

    (1,692 )     (11,572 )     6,072  
                         

Comprehensive income

  $ 84,037     $ 23,579     $ 45,915  

 

See accompanying notes to consolidated financial statements.

 

 

 

INTERFACE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

   

END OF FISCAL YEAR

 
   

2017

   

2016

 
   

(in thousands)

 

ASSETS

               

Current

               

Cash and cash equivalents

  $ 87,037     $ 165,672  

Accounts receivable, net

    142,808       126,004  

Inventories, net

    177,935       156,083  

Prepaid expenses and other current assets

    23,087       23,123  

Total current assets

    430,867       470,882  

Property and equipment, net

    212,645       204,508  

Deferred tax asset

    18,003       33,117  

Goodwill, net

    68,754       61,218  

Other assets

    70,331       65,714  
                 
Total assets   $ 800,600     $ 835,439  
                 

LIABILITIES AND SHAREHOLDERS’ EQUITY

               

Current liabilities

               

Accounts payable

  $ 50,672     $ 45,380  

Accrued expenses

    110,974       98,703  

Current portion of long-term debt

    15,000       15,000  

Total current liabilities

    176,646       159,083  

Long term debt

    214,928       255,347  

Deferred income taxes

    6,935       4,728  

Other

    72,000       75,552  
                 

Total liabilities

    470,509       494,710  
                 

Commitments and contingencies

               
                 

Shareholders’ equity

               

Preferred stock

    0       0  

Common stock

    5,981       6,424  

Additional paid-in capital

    271,271       359,451  

Retained earnings

    187,432       140,238  

Accumulated other comprehensive loss – foreign currency translation

    (78,943 )     (110,522 )

Accumulated other comprehensive income – cash flow hedge

    904       0  

Accumulated other comprehensive loss – pension liability

    (56,554 )     (54,862 )
                 

Total shareholders’ equity

    330,091       340,729  
                 

Total liabilities and shareholders’ equity

  $ 800,600     $ 835,439  

 

See accompanying notes to consolidated financial statements.

 

 

 

INTERFACE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

   

FISCAL YEAR

 
   

2017

   

2016

   

2015

 

 

         

(in thousands)

         
OPERATING ACTIVITIES:                        

Net income

  $ 53,246     $ 54,162     $ 72,418  

Adjustments to reconcile income to cash provided by operating activities

                       

Depreciation and amortization

    30,261       30,632       30,803  

Stock compensation amortization expense

    7,247       5,873       13,948  

Enactment of U.S. Tax Cuts and Jobs Act expenses

    15,174       0       0  

Bad debt expense

    219       145       763  

Deferred income taxes and other

    8,154       468       9,052  

Working capital changes:

                       

Accounts receivable

    (10,313 )     (372 )     18,738  

Inventories

    (13,629 )     2,686       (26,452 )

Prepaid expenses and other current assets

    1,019       (7,720 )     (8,332 )

Accounts payable and accrued expenses

    11,975       12,184       15,512  

Cash provided by operating activities

    103,353       98,058       126,450  
                         

INVESTING ACTIVITIES:

                       

Capital expenditures

    (30,474 )     (28,071 )     (27,188 )

Other

    (614 )     1,642       731  

Cash used in investing activities

    (31,088 )     (26,429 )     (26,457 )
                         

FINANCING ACTIVITIES:

                       

Credit facility borrowing

    25,000       87,400       0  

Credit facility repayments

    (57,014 )     (17,575 )     (45,267 )

Term loan repayments

    (15,000 )     (12,500 )     (2,500 )

Repurchase of common stock

    (91,576 )     (18,496 )     (13,306 )

Dividends paid

    (15,487 )     (14,285 )     (11,885 )

Tax Withholding Payments for Share-Based Compensation

    (1,479 )     (4,895 )     (1,015 )

Debt issuance costs

    (1,427 )     0       0  

Proceeds from issuance of common stock

    0       0       359  

Cash provided by (used in) financing activities

    (156,983 )     19,649       (73,614 )
                         

Net cash provided by (used in) operating, investing and financing activities

    (84,718 )     91,278       26,379  

Effect of exchange rate changes on cash

    6,083       (1,302 )     (5,579 )
                         

CASH AND CASH EQUIVALENTS:

                       

Net increase (decrease)

    (78,635 )     89,976       20,800  

Balance, beginning of year

    165,672       75,696       54,896  
                         

Balance, end of year

  $ 87,037     $ 165,672     $ 75,696  

 

See accompanying notes to consolidated financial statements.

 

 

 

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES


Nature of Operations

 

The Company is a recognized leader in the worldwide commercial interiors market, offering modular carpet and luxury vinyl tile (“LVT”). The Company manufactures modular carpet focusing on the high quality, designer-oriented sector of the market, sources LVT from a third party and focuses on the same sector of the market, and provides specialized carpet replacement, installation and maintenance services. Additionally, the Company offers Intersept, a proprietary antimicrobial used in a number of interior finishes.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company and its subsidiaries. All of our subsidiaries are wholly-owned, and we are not a party to any joint venture, partnership or other variable interest entity that would potentially qualify for consolidation. All material intercompany accounts and transactions are eliminated. Investments in which the Company does not have the ability to exercise significant influence are carried at fair value. The Company monitors investments for other than temporary declines in value and makes reductions in carrying values when appropriate. As of December 31, 2017 and January 1, 2017, the Company did not hold significant investments of this nature.


Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Examples include provisions for returns, bad debts, product claims reserves, rebates, inventory obsolescence and the length of product life cycles, accruals associated with restructuring activities, income tax exposures and valuation allowances, environmental liabilities, and the carrying value of goodwill and property and equipment. Actual results could vary from these estimates.

 

Revenue Recognition

 

Revenue is recognized when the following criteria are met: persuasive evidence of an agreement exists, delivery has occurred or services have been rendered, price to the buyer is fixed and determinable, and collectability is reasonably assured. Delivery is not considered to have occurred until the customer takes title and assumes the risks and rewards of ownership, which is generally on the date of shipment. Provisions for discounts, sales returns and allowances are estimated using historical experience, current economic trends, and the Company’s quality performance. The related provision is recorded as a reduction of sales and cost of sales in the same period that the revenue is recognized. Material differences may result in the amount and timing of net sales for any period if management makes different judgments or uses different estimates.

 

Shipping and handling fees billed to customers are classified in net sales in the consolidated statements of operations. Shipping and handling costs incurred are classified in cost of sales in the consolidated statements of operations.

 

Research and Development

 

Research and development costs are expensed as incurred and are included in the selling, general and administrative expense caption in the consolidated statements of operations. Research and development expense was $14.0 million, $14.3 million, and $14.5 million for the years 2017, 2016 and 2015, respectively.

 

 

Cash, Cash Equivalents and Short-Term Investments

 

Highly liquid investments with insignificant interest rate risk and with original maturities of three months or less are classified as cash and cash equivalents. Investments with maturities greater than three months and less than one year are classified as short-term investments. The Company did not hold any significant amounts of cash equivalents and short-term investments at December 31, 2017 and January 1, 2017.

 

Cash payments for interest amounted to approximately $6.3 million, $5.5 million, and $4.8 million for the years 2017, 2016, and 2015, respectively. Income tax payments amounted to approximately $19.1 million, $12.8 million and $7.2 million for the years 2017, 2016 and 2015, respectively. During the years 2017, 2016 and 2015, the Company received income tax refunds of $0.1 million, $0.2 million and $3.1 million, respectively.

 

Inventories

 

Inventories are carried at the lower of cost (standards approximating the first-in, first-out method) or market. Costs included in inventories are based on invoiced costs and/or production costs, as applicable. Included in production costs are material, direct labor and allocated overhead. The Company writes down inventories for the difference between the carrying value of the inventories and their estimated net realizable value. If actual market conditions are less favorable than those projected by management, additional write-downs may be required.

 

Management estimates its reserves for inventory obsolescence by continuously examining its inventories to determine if there are indicators that carrying values exceed net realizable values. Experience has shown that significant indicators that could require the need for additional inventory write-downs are the age of the inventory, the length of its product life cycles, anticipated demand for the Company’s products, and current economic conditions. While management believes that adequate write-downs for inventory obsolescence have been made in the consolidated financial statements, consumer tastes and preferences will continue to change and the Company could experience additional inventory write-downs in the future.

 

Rebates

 

The Company has agreements to receive cash consideration from certain of its vendors, including rebates and cooperative marketing reimbursements. The amounts received from its vendors are generally presumed to be a reduction of the prices the Company pays for their products and, therefore, such amounts are reflected as either a reduction of cost of sales in the accompanying consolidated statements of operations, or, if the product inventory is still on hand at the reporting date, it is reflected as a reduction of “Inventories” on the accompanying consolidated balance sheets. Vendor rebates are typically dependent upon reaching minimum purchase thresholds. The Company evaluates the likelihood of reaching purchase thresholds using past experience and current year forecasts. When rebates can be reasonably estimated and receipt becomes probable, the Company records a portion of the rebate as the Company makes progress towards the purchase threshold.

 

When the Company receives direct reimbursements for costs incurred in marketing the vendor’s product or service, the amount received is recorded as an offset to selling, general and administrative expenses in the accompanying consolidated statements of operations.

 

Assets and Liabilities of Businesses Held for Sale

 

The Company considers businesses to be held for sale when the Board or management, having the relevant authority to do so, approves and commits to a formal plan to actively market a business for sale and the sale is considered probable. Upon designation as held for sale, the carrying value of the assets of the business are recorded at the lower of their carrying value or their estimated fair value, less costs to sell. The Company ceases to record depreciation expense at that time.

 

 

Property and Equipment and Long-Lived Assets

 

Property and equipment are carried at cost. Depreciation is computed using the straight-line method over the following estimated useful lives: buildings and improvements ten to forty years; and furniture and equipment – three to twelve years. Interest costs for the construction/development of certain long-term assets are capitalized and amortized over the related assets’ estimated useful lives. The Company capitalized net interest costs on qualifying expenditures of approximately $0.6 million, $0.5 million, and $0.3 million for the fiscal years 2017, 2016 and 2015, respectively. Depreciation expense amounted to approximately $29.5 million, $30.1 million, and $30.4 million for the years 2017, 2016, and 2015 respectively.

 

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the sum of the expected future undiscounted cash flow is less than the carrying amount of the asset, a loss is recognized for the difference between the fair value and carrying value of the asset. Repair and maintenance costs are charged to operating expense as incurred.

 

Goodwill and Other Intangible Assets

 

Goodwill is the excess of the purchase price over the fair value of net assets acquired in business combinations accounted for as acquisitions. Accumulated amortization amounted to approximately $77.3 million at both December 31, 2017 and January 1, 2017, and cumulative impairment losses recognized were $212.6 million as of both December 31, 2017 and January 1, 2017.

 

As of December 31, 2017, and January 1, 2017, the net carrying amount of goodwill was $68.8 million and $61.2 million, respectively. Other intangible assets were $0.6 million and $1.0 million as of December 31, 2017 and January 1, 2017, respectively. Amortization expense related to intangible assets during the years 2017, 2016 and 2015 was $0.7 million, $0.5 million and $0.3 million, respectively

 

The Company capitalizes patent defense costs when it determines that a successful defense is probable. Any patent defense costs are amortized over the remaining useful life of the patent. During 2016, the Company determined that approximately $3.4 million of patent defense costs related to our TacTiles® carpet tile installation system should be impaired as a successful defense was deemed no longer probable. This impairment is included in “Restructuring and Asset Impairment Charges” in our consolidated statement of operations.

 

During the fourth quarters of 2017, 2016 and 2015, as of the last day of the third quarter of each year, the Company performed the annual goodwill impairment test required by applicable accounting standards. The Company performs this test at the reporting unit level, which is one level below the segment level for the Modular Carpet segment. In effecting the impairment testing, the Company prepared valuations of reporting units on both a market comparable methodology and an income methodology in accordance with the applicable standards, and those valuations were compared with the respective book values of the reporting units to determine whether any goodwill impairment existed. In preparing the valuations, past, present and future expectations of performance were considered. The annual testing indicated no potential of goodwill impairment in any of the years presented.

 

Each of the Company’s reporting units maintained fair values in excess of their respective carrying values as of the measurement date, and therefore no impairment was indicated during the impairment testing. As of December 31, 2017, if the Company’s estimates of the fair values of its reporting units which carry a goodwill balance were 10% lower, the Company still believes no goodwill impairment would have existed.

 

The changes in the carrying amounts of goodwill for the year ended December 31, 2017 are as follows:

 

BALANCE

JANUARY 1,

2017

   

ACQUISITIONS

   

IMPAIRMENT

   

FOREIGN

CURRENCY

TRANSLATION

   

BALANCE

DECEMBER 31,

2017

 

(in thousands)

 
$ 61,218     $ 0     $ 0       7,536     $ 68,754  

 

 

Product Warranties

 

The Company typically provides limited warranties with respect to certain attributes of its carpet products (for example, warranties regarding excessive surface wear, edge ravel and static electricity) for periods ranging from ten to twenty years, depending on the particular carpet product and the environment in which it is to be installed. Similar limited warranties are provided on certain attributes of its LVT products, typically for a period of 15 years. The Company typically warrants that services performed will be free from defects in workmanship for a period of one year following completion. In the event of a breach of warranty, the remedy typically is limited to repair of the problem or replacement of the affected product.

 

The Company records a provision related to warranty costs based on historical experience and periodically adjusts these provisions to reflect changes in actual experience. Warranty and sales allowance reserves amounted to $4.1 million and $5.5 million as of December 31, 2017 and January 1, 2017, respectively, and are included in “Accrued Expenses” in the accompanying consolidated balance sheets.

 

Taxes on Income

 

The Company accounts for income taxes under an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. In estimating future tax consequences, the Company generally considers all expected future events other than enactments of changes in tax laws or rates. The effect on deferred tax assets and liabilities of a change in tax rates will be recognized as income or expense in the period that includes the enactment date.

 

The Company records a valuation allowance to reduce its deferred tax assets when it is more likely than not that some portion or all of the deferred tax assets will expire before realization of the benefit or that future deductibility is not probable. The ultimate realization of the deferred tax assets depends on the ability to generate sufficient taxable income of the appropriate character in the future. This requires us to use estimates and make assumptions regarding significant future events such as the taxability of entities operating in the various taxing jurisdictions. 

 

The Company does not record taxes collected from customers and remitted to governmental authorities on a gross basis.

 

For uncertain tax positions, the Company applies the provisions of relevant authoritative guidance, which requires application of a “more likely than not” threshold to the recognition and derecognition of tax positions. The Company’s ongoing assessments of the more likely than not outcomes of tax authority examinations and related tax positions require significant judgment and can increase or decrease the Company’s effective tax rate as well as impact operating results. For further information, see Note 13 entitled “Taxes on Income.”

 

Fair Values of Financial Instruments

 

Fair values of cash and cash equivalents and short-term debt approximate cost due to the short period of time to maturity. Fair values of debt are based on quoted market prices or pricing models using current market rates.

 

Translation of Foreign Currencies

 

The financial position and results of operations of the Company’s foreign subsidiaries are measured generally using local currencies as the functional currency. Assets and liabilities of these subsidiaries are translated into U.S. dollars at the exchange rate in effect at each year-end. Income and expense items are translated at average exchange rates for the year. The resulting translation adjustments are recorded in the foreign currency translation adjustment account. In the event of a divestiture of a foreign subsidiary, the related foreign currency translation results are reversed from equity to income. Foreign currency exchange gains and losses are included in net income (loss). Foreign exchange translation gains (losses) were $31.6 million, ($19.0) million, and ($32.6) million for the years 2017, 2016 and 2015, respectively.

 

Income (Loss) Per Share

 

Basic income (loss) per share is computed based on the average number of common shares outstanding. Diluted income (loss) per share reflects the increase in average common shares outstanding that would result from the assumed exercise of outstanding stock options, calculated using the treasury stock method.

 

 

Stock-Based Compensation

 

The Company has stock-based employee compensation plans, which are described more fully in Note 10 entitled “Shareholders’ Equity”.

 

The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model. However, there were no stock options granted in 2017, 2016 or 2015.

 

The Company recognizes expense related to its restricted stock and performance share grants based on the grant date fair value of the shares awarded, as determined by its market price at date of grant.

 

Derivative Financial Instruments

 

Accounting standards require a company to recognize all derivatives on the balance sheet at fair value. Derivatives that do not meet the criteria of an accounting hedge must be adjusted to fair value through income. If the derivative is a fair value hedge, changes in the fair value of the hedged assets, liabilities or firm commitments are recognized through earnings. If the derivative is a cash flow hedge, the effective portion of changes in the fair value of the derivative are recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value is immediately recognized in earnings. In 2017, the Company entered in to an interest rate swap instrument that it has designated as a derivative instrument. See further discussion of this instrument below in Note 8 entitled “Borrowings”.

 

Pension Benefits

 

Net pension expense recorded is based on, among other things, assumptions about the discount rate, estimated return on plan assets and salary increases. While the Company believes these assumptions are reasonable, changes in these and other factors and differences between actual and assumed changes in the present value of liabilities or assets of the Company’s plans above certain thresholds could cause net annual expense to increase or decrease materially from year to year. The actuarial assumptions used in the Company’s salary continuation plan and foreign defined benefit plans reporting are reviewed periodically and compared with external benchmarks to ensure that they appropriately account for our future pension benefit obligation. The expected long-term rate of return on plan assets assumption is based on weighted average expected returns for each asset class. Expected returns reflect a combination of historical performance analysis and the forward-looking views of the financial markets, and include input from actuaries, investment service firms and investment managers.

 

Environmental Remediation

 

The Company provides for remediation costs and penalties when the responsibility to remediate is probable and the amount of associated costs is reasonably determinable. Remediation liabilities are accrued based on estimates of known environmental exposures and are discounted in certain instances. The Company regularly monitors the progress of environmental remediation. Should studies indicate that the cost of remediation is to be more than previously estimated, an additional accrual would be recorded in the period in which such determination is made. As of December 31, 2017, and January 1, 2017, no significant amounts were provided for remediation liabilities.

 

Allowances for Doubtful Accounts

 

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. Estimating this amount requires the Company to analyze the financial strengths of its customers. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. By its nature, such an estimate is highly subjective, and it is possible that the amount of accounts receivable that the Company is unable to collect may be different than the amount initially estimated.

 

 

Reclassifications

 

Certain prior period amounts have been reclassified to conform to current year financial statement presentation. These reclassifications had no effect on reported income, comprehensive income, cash flows, or shareholders’ equity as previously reported. Total assets as previously reported was impacted by the adoption of an accounting standard addressing the treatment of deferred taxes as discussed below.

 

Fiscal Year

 

The Company’s fiscal year is the 52 or 53 week period ending on the Sunday nearest December 31. All references herein to “2017,” “2016,” and “2015,” mean the fiscal years ended December 31, 2017, January 1, 2017, and January 3, 2016 respectively. Fiscal year 2015 was comprised of 53 weeks, while fiscal years 2017 and 2016 were each comprised of 52 weeks.

 

 

NOTE 2 RECENT ACCOUNTING PRONOUNCEMENTS

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standard regarding recognition of revenue from contracts with customers that will supersede the existing revenue recognition under U.S. GAAP. In summary, the core principle of this standard, along with various subsequent amendments, is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additionally, the new standard requires enhanced disclosures about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts, including revenue recognition policies to identify performance obligations, assets recognized from costs incurred to obtain and fulfill a contract, and significant judgments in measurements and recognition. The standard, as amended, will be effective for annual periods beginning after December 15, 2017, including interim periods within that reporting period. Nearly 95% of the Company’s current revenue is produced from the sale of carpet, hard surface flooring and related products (TacTiles installation system, etc.) and the revenue from sales of these products is recognized upon shipment, or in certain cases upon delivery to the customer.  There does not exist any performance or any other obligation after the sale of these products outside of the product warranty, which has not historically been of significance compared to total product sales.  There is a small portion of the Company’s revenues (approximately 5%) that is for the sale and installation of carpet and related products.  Of these projects, the overwhelming majority are completed in less than two weeks and therefore the Company does not expect a significant shift in the timing of revenue recognition for these sales either.  Upon adoption of this standard, the company will change the accounting for these projects to recognize the major components of revenue over time.  However, it is not expected that this change will have a significant impact upon our results of operations given the generally short period of time of these projects. As of the end of 2017, the amount of revenue that would have been recognized under the new standard versus previous guidance was not significant.  The standard offers practical expedients to help with adoption. The Company will apply the portfolio approach expedient, which is applicable as its sales contracts share similar characteristics. The Company will apply the practical expedient regarding the accounting for costs to obtain contracts, as its costs for such contracts are primarily sales commissions which are recognized within a year of the sale of product.  The Company will use the modified retrospective method of adoption, but as noted the impact as of year-end was insignificant.  Given the nature of the Company’s sales, it currently believes that revenue recognition under the new standard will be mostly consistent under both the current and new standards, with performance obligations being satisfied under the majority of contracts with customers upon shipment or delivery of product.  Given the nature of the Company’s revenue there is not expected to be significant changes to the Company’s information systems as a result of this adoption.

 

In November 2015, the FASB issued an accounting standard which requires deferred tax assets and liabilities, as well as any related valuation allowance, be classified as noncurrent on the balance sheet. As a result, each jurisdiction will only have one net noncurrent deferred tax asset or liability. This standard does not change the existing requirement that only permits offsetting within a jurisdiction. The amendments in the standard may be applied either prospectively or retrospectively to all prior periods presented. The new guidance is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods, with early adoption permitted. The Company adopted this standard in the first quarter of 2017 and applied this standard retrospectively by recording a reduction of current assets of $10.0 million and a corresponding increase in long term assets of $5.9 million as well as a reduction of long term liabilities of $4.1 million.

 

 

In March 2016, the FASB issued an accounting standard update to simplify several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and the classification on the statement of cash flows. In addition, an entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest, which is the current U.S. GAAP practice, or account for forfeitures when they occur.  This update is effective for fiscal periods beginning after December 15, 2016, including interim periods within that reporting period. The element of the new standard having the most impact on the Company’s financial statements is income tax consequences. Excess tax benefits and tax deficiencies on stock-based compensation awards are now included in the tax provision within the consolidated statement of operations as discrete items in the reporting period in which they occur, rather than the previous accounting of recording them in additional paid-in capital on the consolidated balance sheet. The adoption of this standard resulted in an increase in deferred tax assets of approximately $9.4 million, with a corresponding increase to equity accounts, in 2017.  See further discussion of this amount in Note 13 “Taxes on Income.”  There was an impact of this standard on the consolidated statement of cash flows upon adoption, as under the standard when an employer withholds shares for tax withholding purposes those related tax payments are treated as financing activities, not as operating activities.  Upon adoption in the first quarter of 2017, this resulted in a reclassification of $4.6 million of such tax payments in 2016 from operating activities to financing activities, and $1.0 million of such tax payments in 2015 from operating activities to financing activities.   The Company has elected to continue its current policy of estimating forfeitures of stock-based compensation awards at the time of grant and revising in subsequent periods to reflect actual forfeitures, which is allowable under the new standard.

 

In February 2016, the FASB issued a new accounting standard regarding leases. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.  The Company is currently evaluating the impact of our pending adoption of the new standard on our consolidated financial statements, but the standard will result in the Company recording both assets and liabilities for leases currently classified as operating leases.

 

In January 2017, the FASB issued a new accounting standard that provides for the elimination of Step 2 from the goodwill impairment test. Under the new guidance, impairment charges are recognized to the extent the carrying amount of a reporting unit exceeds its fair value with certain limitations. The new guidance is effective for any annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted. The Company does not anticipate that the adoption of the new guidance will have a material effect on its consolidated financial statements.

 

In March 2017, the FASB issued a new accounting standard regarding the treatment of net periodic benefit costs. This standard will require segregation of these net benefit costs between operating and non-operating expenses. Currently, the Company reports the net benefit costs associated with its defined benefit plans as a component of operating income. The new standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. When the new standard is implemented, only the service cost component of defined benefit plan costs will be reported within operating income, while all other components of net benefit cost will be presented within the “Other Expense (income)” line item on the consolidated statements of operations. The standard requires retrospective application, and as such upon adoption this standard will result in offsetting changes in operating income and “Other Expense (income)” on the consolidated statements of operations for all periods presented, with no impact on net income. Upon adoption in 2018 the Company will reclassify $1.9 million and $2.2 million for 2017 and 2016, respectively, from operating expenses to other expense.

 

In February 2018, the FASB issued a new accounting standard to address a narrow-scope financial reporting issue that arose as a consequence of the Tax Act. Existing guidance requires that deferred tax liabilities and assets be adjusted for a change in tax laws or rates with the effect included in income from continuing operations in the reporting period that includes the enactment date. That guidance is applicable even in situations in which the related income tax effects of items in accumulated other comprehensive income were originally recognized in other comprehensive income (rather than in net income), such as amounts related to benefit plans and hedging activity. As a result, the tax effects of items within accumulated other comprehensive income do not reflect the appropriate tax rate (the difference is referred to as stranded tax effects). The new guidance allows for a reclassification of these amounts to retained earnings thereby eliminating these stranded tax effects. The new guidance is effective for interim and annual periods beginning after December 15, 2018. The Company is currently evaluating the impact of adoption of this standard on its consolidated financial statements.

 

 

NOTE 3 RECEIVABLES

 

The Company has adopted credit policies and standards intended to reduce the inherent risk associated with potential increases in its concentration of credit risk due to increasing trade receivables from sales to owners and users of commercial office facilities and with specifiers such as architects, engineers and contracting firms. Management believes that credit risks are further moderated by the diversity of its end customers and geographic sales areas. The Company performs ongoing credit evaluations of its customers’ financial condition and requires collateral as deemed necessary. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. If the financial condition of its customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. As of December 31, 2017, and January 1, 2017, the allowance for bad debts amounted to $3.5 million and $3.8 million, respectively, for all accounts receivable of the Company. Reserves for warranty and returns allowances amounted to $4.1 million and $5.5 million as of December 31, 2017 and January 1, 2017, respectively.

 

 

NOTE 4 FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The Company does not have significant assets and liabilities measured at fair value on a recurring basis under applicable accounting standards as of the end of 2017. The Company does have approximately $23.7 million of Company-owned life insurance which is measured on readily determinable cash surrender value on a recurring basis. Due to the short maturity of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, their carrying values approximate fair value. As of December 31, 2017, the carrying value of the Company’s borrowings under its Syndicated Credit Facility approximates fair value as the Facility bears interest rates that are similar to existing market rates. The Company does hedge its interest rate exposure on $100 million of borrowings on the Syndicated Credit Facility and this cash flow hedge is measured at fair value. See discussion of this instrument below in Note 8 entitled “Borrowings”.

 

 

 

NOTE 5 INVENTORIES

 

Inventories are summarized as follows:

 

   

END OF FISCAL YEAR

 
   

2017

   

2016

 
   

(in thousands)

 

Finished goods

  $ 115,512     $ 104,742  

Work-in-process

    13,022       8,711  

Raw materials

    49,401       42,630  
                 
Inventory, Net   $ 177,935     $ 156,083  

 

Reserves for inventory obsolescence amounted to $20.4 million and $17.6 million as of December 31, 2017 and January 1, 2017, respectively, and have been netted against amounts presented above.

 

 

NOTE 6 PROPERTY AND EQUIPMENT

 

Property and equipment consisted of the following:

 

   

END OF FISCAL YEAR

 
   

2017

   

2016

 
   

(in thousands)

 

Land

  $ 17,743     $ 16,063  

Buildings

    130,919       121,216  

Equipment

    371,300       350,539  
                 
      519,962       487,818  

Accumulated depreciation

    (307,317 )     (283,310 )
                 
Property and Equipment   $ 212,645     $ 204,508  

 

The estimated cost to complete construction-in-progress at December 31, 2017, was approximately $61.5 million.

 

 

NOTE 7 ACCRUED EXPENSES

 

Accrued expenses are summarized as follows:

 

   

END OF FISCAL YEAR

 
   

2017

   

2016

 
   

(in thousands)

 

Compensation

  $ 71,760     $ 58,927  

Interest

    362       114  

Restructuring

    2,568       10,291  

Taxes

    19,948       11,467  

Accrued purchases

    4,569       3,101  

Warranty and sales allowances

    4,111       5,529  

Other

    7,656       9,274  
                 
Accrued Expenses   $ 110,974     $ 98,703  

 

Other non-current liabilities include pension liability of $43.3 million and $47.3 million as of December 31, 2017 and January 1, 2017, respectively (see the discussion below in Note 15 entitled “Employee Benefit Plans”).

 

 

 

NOTE 8 BORROWINGS

 

Syndicated Credit Facility

 

Pursuant to an Amended and Restated Facility Agreement entered into on August 8, 2017, the Company has a syndicated credit facility (the “Facility”) pursuant to which the lenders provide to the Company and certain of its subsidiaries a multicurrency revolving credit facility and provide to the Company a term loan. The key features of the Facility are as follows:

 

 

The Facility matures on August 8, 2022.

 

The Facility includes a multicurrency revolving loan facility made available to the Company and its principal subsidiaries in Europe and Australia not to exceed $250 million in the aggregate at any one time outstanding. A sublimit of $40 million exists for the issuance of letters of credit under the Facility.

 

The Facility includes a Term Loan A borrowing principal that had an original principal amount of $177.5 million.

 

The Facility provides for required amortization payments of the Term Loan A borrowing, as well as mandatory prepayments of the Term Loan A borrowing (and any term loans made available pursuant to any future multicurrency loan facility increase) from certain asset sales, casualty events and debt issuances, subject to certain qualifications and exceptions as provided for therein.

 

Advances under the Facility are secured by a first-priority lien on substantially all of the Company’s assets and the assets of each of its material domestic subsidiaries, which have guaranteed the Facility.

 

The Facility contains financial covenants (specifically, a consolidated net leverage ratio and a consolidated interest coverage ratio) that must be met as of the end of each fiscal quarter.

 

The Company has the option to increase the borrowing availability under the Facility, either for revolving loans or term loans, by up to $150 million, subject to the receipt of lender commitments for the increase and the satisfaction of certain other conditions.

 

Interest Rates and Fees. Interest on base rate loans is charged at varying rates computed by applying a margin ranging from 0.25% to 1.50% over the applicable base interest rate (which is defined as the greatest of the prime rate, a specified federal funds rate plus 0.50%, or a specified Eurocurrency rate), depending on the Company’s consolidated net leverage ratio as of the most recently completed fiscal quarter. Interest on Eurocurrency-based loans and fees for letters of credit are charged at varying rates computed by applying a margin ranging from 1.25% to 2.50% over the applicable Eurocurrency rate, depending on the Company’s consolidated net leverage ratio as of the most recently completed fiscal quarter. In addition, the Company pays a commitment fee ranging from 0.20% to 0.35% per annum (depending on the Company’s consolidated net leverage ratio as of the most recently completed fiscal quarter) on the unused portion of the Facility.

 

Amortization Payments. The Company is required to make quarterly amortization payments of $3.75 million of the Term Loan A borrowing.

 

Covenants. The Facility contains standard and customary covenants for agreements of this type, including various reporting, affirmative and negative covenants. Among other things, these covenants limit the Company’s and its subsidiaries’ ability to:

 

 

create or incur liens on assets;

 

make acquisitions of or investments in businesses (in excess of certain specified amounts);

 

incur indebtedness or contingent obligations;

 

sell or dispose of assets (in excess of certain specified amounts);

 

pay dividends or repurchase the Company’s stock (in excess of certain specified amounts);

 

repay other indebtedness prior to maturity unless the Company meets certain conditions; and

 

enter into sale and leaseback transactions.

 

The Facility also requires the Company to remain in compliance with the following financial covenants as of the end of each fiscal quarter, based on the Company’s consolidated results for the year then ended:

 

 

Consolidated Net Leverage Ratio: Must be no greater than 3.75:1.00.

 

Consolidated Interest Coverage Ratio: Must be no less than 2.25:1.00.

 

 

Events of Default. If the Company breaches or fails to perform any of the affirmative or negative covenants under the Facility, or if other specified events occur (such as a bankruptcy or similar event or a change of control of Interface, Inc. or certain subsidiaries, or if the Company breaches or fails to perform any covenant or agreement contained in any instrument relating to any of the Company’s other indebtedness exceeding $20 million), after giving effect to any applicable notice and right to cure provisions, an event of default will exist. If an event of default exists and is continuing, the lenders’ Administrative Agent may, and upon the written request of a specified percentage of the lender group shall:

 

 

declare all commitments of the lenders under the facility terminated;

 

declare all amounts outstanding or accrued thereunder immediately due and payable; and

 

exercise other rights and remedies available to them under the agreement and applicable law.

 

Collateral. Pursuant to an Amended and Restated Security and Pledge Agreement executed on the same date, the Facility is secured by substantially all of the assets of the Company and its domestic subsidiaries (subject to exceptions for certain immaterial subsidiaries), including all of the stock of the Company’s domestic subsidiaries and up to 65% of the stock of its first-tier material foreign subsidiaries. If an event of default occurs under the Facility, the lenders’ Administrative Agent may, upon the request of a specified percentage of lenders, exercise remedies with respect to the collateral, including, in some instances, foreclosing mortgages on real estate assets, taking possession of or selling personal property assets, collecting accounts receivables, or exercising proxies to take control of the pledged stock of domestic and first-tier material foreign subsidiaries.

 

In December 2016, one of the Company’s foreign subsidiaries borrowed 61 million euros (approximately $63.5 million) under the Syndicated Credit Facility. The funds were distributed to its U.S. parent company to fund then-current and projected U.S. cash needs. A significant portion of these borrowings were repaid in 2017.

 

As of December 31, 2017, the Company had outstanding $170.0 million of Term Loan A borrowing and $59.9 million of revolving loan borrowings outstanding under the Facility, and had $6.0 million in letters of credit outstanding under the Facility. As of December 31, 2017, the weighted average interest rate on borrowings outstanding under the Facility was 3.0%.

 

The Company is currently in compliance with all covenants under the Facility and anticipates that it will remain in compliance with the covenants for the foreseeable future.

 

Interest Rate Risk Management

 

Shortly after entering into the Amended and Restated Facility Agreement, the Company entered into an interest rate swap transaction to fix the variable interest rate on a portion of its term loan borrowings in order to manage a portion of its exposure to interest rate fluctuations. The Company’s objective and strategy with respect to this interest rate swap is to protect the Company against adverse fluctuations in interest rates by reducing its exposure to variability to cash flows relating to interest payments on a portion of its outstanding debt. The Company is meeting its objective by hedging the risk of changes in its cash flows (interest payments) attributable to changes in LIBOR, the designated benchmark interest rate being hedged (the “hedged risk”), on an amount of the Company’s debt principal equal to the outstanding swap notional amount.

 

Cash Flow Interest Rate Swap

 

The Company’s interest rate swap is designated and qualifies as a cash flow hedge of forecasted interest payments. The Company reports the effective portion of the fair value gain or loss on the swap as a component of other comprehensive income (or other comprehensive loss). Gains or losses (if any) on any ineffective portion of derivative instruments in cash flow hedging relationships are recorded in the period in which they occur as a component of other expense (or other income) in the consolidated condensed statement of operations. There were no such gains or losses in 2017. The aggregate notional amount of the swap as of December 31, 2017 was $100 million.

 

As of December 31, 2017, the fair value of the cash flow interest rate swap asset was $0.9 million and was recorded in other assets and accumulated other comprehensive income.

 

Other Lines of Credit

 

Subsidiaries of the Company have an aggregate of the equivalent of $9.8 million of other lines of credit available at interest rates ranging from 2.5% to 6.5%. As of December 31, 2017, and January 1, 2017, there were no borrowings outstanding under these lines of credit.

 

 

Borrowing Costs

 

Deferred borrowing costs, which include underwriting, legal and other direct costs related to the issuance of debt, net of accumulated amortization, were $2.3 million and $1.4 million, as of December 31, 2017 and January 1, 2017, respectively.  These amounts are included in other long term assets in the Company’s consolidated balance sheets. The Company amortizes these costs over the life of the related debt.  Expenses related to such costs for the years 2017, 2016, and 2015 amounted to $0.5 million for each of those years.

 

Future Maturities

 

The aggregate maturities of borrowings for each of the five fiscal years subsequent to 2017 are as follows:

 

FISCAL YEAR

 

AMOUNT

 
   

(in thousands)

 

2018

  $ 15,000  

2019

    15,000  

2020

    15,000  

2021

    15,000  

2022

    169,928  

Thereafter

    0  
Total Debt   $ 229,928  

 

 

NOTE 9 PREFERRED STOCK

 

The Company is authorized to designate and issue up to 5,000,000 shares of $1.00 par value preferred stock in one or more series and to determine the rights and preferences of each series, to the extent permitted by the Articles of Incorporation, and to fix the terms of such preferred stock without any vote or action by the shareholders. The issuance of any series of preferred stock may have an adverse effect on the rights of holders of common stock and could decrease the amount of earnings and assets available for distribution to holders of common stock. In addition, any issuance of preferred stock could have the effect of delaying, deferring or preventing a change in control of the Company. As of December 31, 2017, and January 1, 2017, there were no shares of preferred stock issued.

 

Preferred Share Purchase Rights 

 

The Company has previously issued one purchase right (a “Right”) in respect of each outstanding share of Common Stock pursuant to a Rights Agreement it entered into in March 2008. Each Right entitles the registered holder of the Common Stock to purchase from the Company one one-hundredth of a share (a “Unit”) of Series B Participating Cumulative Preferred Stock (the “Series B Preferred Stock”).

 

The Rights may have certain anti-takeover effects. The Rights will cause substantial dilution to a person or group that acquires (without the consent of the Company’s Board of Directors) 15% or more of the outstanding shares of Common Stock or if other specified events occur without the Rights having been redeemed or in the event of an exchange of the Rights for Common Stock as permitted under the Shareholder Rights Plan.

 

The dividend and liquidation rights of the Series B Preferred Stock are designed so that the value of one Unit of Series B Preferred Stock issuable upon exercise of each Right will approximate the same economic value as one share of Common Stock, including voting rights. The exercise price per Right is $90, subject to adjustment. Shares of Series B Preferred Stock will entitle the holder to a minimum preferential dividend of $1.00 per share, but will entitle the holder to an aggregate dividend payment of 100 times the dividend declared on each share of Common Stock. In the event of liquidation, each share of Series B Preferred Stock will be entitled to a minimum preferential liquidation payment of $1.00, plus accrued and unpaid dividends and distributions thereon, but will be entitled to an aggregate payment of 100 times the payment made per share of Common Stock. In the event of any merger, consolidation or other transaction in which Common Stock is exchanged for or changed into other stock or securities, cash or other property, each share of Series B Preferred Stock will be entitled to receive 100 times the amount received per share of Common Stock. Series B Preferred Stock is not convertible into Common Stock.

 

Each share of Series B Preferred Stock will be entitled to 100 votes on all matters submitted to a vote of the shareholders of the Company, and shares of Series B Preferred Stock will generally vote together as one class with the Common Stock and any other voting capital stock of the Company on all matters submitted to a vote of the Company’s shareholders.

 

 

Further, whenever dividends on the Series B Preferred Stock are in arrears in an amount equal to six quarterly payments, the Series B Preferred Stock, together with any other shares of preferred stock then entitled to elect directors, shall have the right, as a single class, to elect one director until the default has been cured.

 

Prior to entering into the March 2008 Rights Agreement, which expires on March 16, 2018, the Company maintained a substantially similar Rights Agreement that was entered into in 1998.

 

 

NOTE 10 SHAREHOLDERS’ EQUITY

 

Prior to March 5, 2012, the Company had two classes of common stock – Class A Common Stock and Class B Common Stock. On March 5, 2012, the number of issued and outstanding shares of Class B Common Stock constituted less than 10% of the aggregate number of issued and outstanding shares of the Company’s Class A Common Stock and Class B Common Stock, as the cumulative result of varied transactions that caused the conversion of shares of Class B Common Stock into shares of Class A Common Stock. Accordingly, the Class A Common Stock and Class B Common Stock are now, irrevocably from March 5, 2012, a single class of Common Stock in all respects. Following the March 5, 2012 event, the Company is authorized to issue 120 million shares of $0.10 par value Common Stock.

 

The Company’s Common Stock is traded on the Nasdaq Global Select Market under the symbol TILE.

 

The Company paid cash dividends totaling $0.25 per share in 2017, $0.22 per share in 2016, and $0.18 per share in 2015, to each share of Common Stock. The future declaration and payment of dividends is at the discretion of the Company’s Board, and depends upon, among other things, the Company’s investment policy and opportunities, results of operations, financial condition, cash requirements, future prospects, and other factors that may be considered relevant at the time of the Board’s determination. Such other factors include limitations contained in the agreement for its syndicated credit facility, which specifies conditions as to when any dividend payments may be made. As such, the Company may discontinue its dividend payments in the future if its Board determines that a cessation of dividend payments is proper in light of the factors indicated above.

 

On October 7, 2014, the Company announced a program to repurchase up to 500,000 shares of common stock per fiscal year, commencing with the 2014 fiscal year. On November 19, 2015, the Board of Directors amended the program to provide that the 500,000 shares of common stock previously approved for repurchases for the 2016 fiscal year may be repurchased by the Company, in management’s discretion, during the period commencing on November 19, 2015 and ending at the conclusion of fiscal year 2016. In the second quarter of 2016, the Company amended the share purchase program to authorize the repurchase of up to $50 million of common stock. This amended program had no specific expiration date. During the first three months of 2017, the Company completed the $50 million repurchase program. In the second quarter of 2017, the Company adopted a new share repurchase program in which the Company is authorized to repurchase up to $100 million of its outstanding shares of common stock. The program has no specific expiration date.

 

Pursuant to the above-described programs, the Company has repurchased shares in the past three years as follows. During 2015, the Company repurchased and retired 650,000 shares of common stock at an average purchase price of $20.47 per share. During 2016, the Company repurchased and retired 1,177,600 shares of common stock at a weighted average purchase price of $15.68 per share. During 2017, the Company repurchased and retired a combined total of 4,628,300 shares under these plans, at an average purchase price of $19.76 per share. As of December 31, 2017, the Company had approximately $39.5 million of availability remaining to purchase shares under the repurchase program put in place in 2017.

 

All treasury stock is accounted for using the cost method.

 

 

The following tables depict the activity in the accounts which make up shareholders equity for the years 2015-2017.

 

   

SHARES

   

AMOUNT

   

ADDITIONAL PAID-IN

CAPITAL

   

RETAINED EARNINGS

(DEFICIT)

   

PENSION LIABILITY

   

FOREIGN

CURRENCY TRANSLATION

ADJUSTMENT

 
   

(in thousands)

 

Balance, at December 28, 2014

    65,968     $ 6,597     $ 368,603     $ 39,737     $ (49,362 )   $ (58,936 )

Net income

    0       0       0       72,418       0       0  

Stock issuances under employee option plans

    39       4       355       0       0       0  

Other issuances of common stock

    597       59       9,746       0       0       0  

Unamortized stock compensation expense related to restricted stock awards

    0       0       (9,806 )     0       0       0  

Cash dividends paid

    0       0       0       (11,885 )     0       0  

Forfeitures and compensation expense related to stock awards

    (253 )     (25 )     14,670       0       0