Interface (TILE) 10-K2019 FY Annual report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_______________

 

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting 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)

 

 

Number of shares outstanding of each of the registrant’s classes of Common Stock, as of February 18, 2020:

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2020 Annual Meeting of Shareholders are incorporated by reference into Part III.

TABLE OF CONTENTS

 

PART I

 

Interface is a global flooring company specializing in carpet tile and resilient flooring, including luxury vinyl tile (“LVT”) and rubber flooring. We help our customers create high-performance interior spaces that support well-being, productivity, and creativity, as well as the sustainability of the planet.

 

The nora acquisition is expected to advance the Company’s growth strategy in expanding market segments, particularly in the healthcare, life sciences and education market segments. Similar to Interface, nora operates on an international footprint and the Company expects the acquisition will also allow for geographic sales synergies as well. The results of operations for this acquisition have been consolidated with those of the Company from the acquisition date forward. 

 

Capitalizing on our acquisition of nora, as well as our leadership in modular carpet for the corporate office market segment, we are executing a market diversification strategy to increase our presence and market penetration for modular carpet in non-corporate office market segments, such as government, education, healthcare, hospitality and retail space. As a result of our efforts, our mix of corporate office versus non-corporate office modular carpet and LVT sales in the Americas was 47% and 53%, respectively, for 2019. Company-wide, our mix of corporate office versus non-corporate office modular carpet and LVT sales was 61% and 39%, respectively, in 2019.  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 a market leader in the corporate office segment to support and facilitate our penetration into these segments around the world. Rubber flooring also is an attractive product for non-corporate applications and the acquisition of nora will continue to allow for growth of non-corporate office markets.

 

Our principal geographic markets are the Americas, Europe and Asia-Pacific, where the percentages of our total net sales were approximately 57%, 29% and 14%, respectively, for fiscal year 2019.

Our principal competitive strengths include:

 

 

 

 

 

 

About half of our modular carpet products worldwide are made-to-order sales, which are not custom products, but are instead standard styles which can be produced once ordered. Our made-to-order capabilities not only enhance our marketing and sales, they significantly improve our inventory turns. Our customized products, which are both custom colors of established styles, as well as limited amounts of true custom carpet designs or configurations, are less than 10% of our global sales. The remainder of our modular carpet sales are serviced from off-the-shelf inventory. The salient terms of our contracts for made-to-order and custom modular carpet tile do not differ materially from those for off-the-shelf inventory.

 

Our global manufacturing capabilities in modular carpet production are an important component of our strength in these areas, 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.

 

 

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, LVT products and rubber flooring 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:

 

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

 

 

 

 

 

 

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:

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.

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 and other market segments have increased and currency fluctuations have impacted us; our second and third quarter sales have sometimes been the highest.

 

 

Modular Carpet

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.

 

 

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.

 

 

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. 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.

 

Rubber Flooring

 

 

 

Marketing and Sales

 

 

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.

 

Manufacturing

 

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

 

Having several 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. For our rubber production we have one manufacturing facility, but we have regional warehouses to achieve advantageous delivery times and optimal freight costs.

 

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. For rubber flooring, the key polymer raw materials are available from multiple sources and we can source both synthetic and natural rubber depending on product specification and material availability.

 

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. Nora’s manufacturing facility, which is located in Weinheim, Germany, is ISO14001 certified as well and sells the majority of its products with the Blauer Engel label. Blauer Engel is the leading German institute that recognizes products that have environmentally friendly aspects.

 

Our significant international operations are subject to various political, economic and other uncertainties, including risks of restrictive taxation policies, foreign exchange risk, 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. In some markets, we also purchase raw materials in one currency (such as the U.S. dollar or Euro) and sell our products in a local currency which can affect our margins due to foreign currency transaction risk. 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, from time to time we engage in hedging programs intended to 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, pricing and sustainability. In the corporate office market segment, modular carpet competes with various floorcoverings including broadloom carpet, polished concrete and LVT. 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), sustainability and convenience of our modular carpet are our principal competitive advantages.

 

 

 

 

We maintain an active research, development and design staff of approximately 90 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.

 

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.

 

 

 

 

 

Our backlog of unshipped orders was approximately $177.8 million at February 9, 2020, compared with approximately $190.4 million at February 10, 2019. 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 9, 2020 are expected to be shipped during the succeeding six to nine months.

 

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.

At December 29, 2019, we employed a total of 4,110 employees worldwide. Of such total, 1,682 were clerical, staff, sales, supervisory and management personnel and 2,428 were manufacturing personnel. We also utilized the services of 225 temporary personnel as of December 29, 2019.

Some of our employees in Australia, the United Kingdom and China 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. The majority of our employees in Germany are members of a Works Council as well. Our management believes that its relations with the Works Councils, the unions and all of our employees are good.

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, Germany and Australia are certified under ISO Standard No. 14001.

Our executive officers, their ages as of December 29, 2019, and their principal positions with us are set forth below. Executive officers serve at the pleasure of the Board of Directors.

 

 

 

 

 

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

 

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”.

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.

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 and resilient flooring 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.

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 other 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 flooring 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.

We have substantial international operations. In 2019, 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 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 2019 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.

In 2016, voters in the U.K. approved an exit from the European Union via a referendum (commonly referred to as “Brexit”). In 2017, the U.K. notified the European Union of its intention to withdraw pursuant to Article 50 of the Lisbon Treaty, and the U.K. exited the European Union on January 31, 2020. A complex and uncertain process of negotiation is taking place to determine trade agreements as well as other aspects of the U.K.’s relationship with the European Union. The uncertainty leading up to and following Brexit has had, and the implementation of Brexit may continue to have, a negative impact on our business and demand for our products in Europe, and particularly in the U.K. The long-term nature of the U.K.’s relationship with the European Union is unclear and there is considerable uncertainty as to when any agreement or long-term relationship strategy, including trade deals, will be agreed to and implemented by the U.K. and the European Union. Brexit could adversely affect European or worldwide political, regulatory, economic or market conditions and could contribute to instability in political institutions and regulatory agencies. Brexit could also have the effect of disrupting the free movement of goods, services, and people between the U.K., the European Union and elsewhere. In addition, Brexit 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 flooring products in the U.K. and in Europe if the U.K. exit leads to economic difficulties in Europe.

In December 2019, a novel strain of coronavirus began to impact the population of China, and it began to spread globally. In late January 2020, in an effort to contain the spread of the virus, maintain the wellbeing of our employees and in accordance with governmental requirements, we temporarily closed our manufacturing facility in China through February 9, 2020. While the closure and limitations on movement in the region are expected to be temporary, the duration of the production and supply chain disruption, and related financial impact, cannot be estimated at this time. Should the production facility closure reoccur, or such disruption continue for an extended period of time, the impact on our supply chain in China and globally could have a material adverse effect on our results of operations and cash flows. 

Petroleum-based products comprise the predominant portion of the cost of raw materials that we use in manufacturing carpet. Synthetic rubber uses petroleum based products as feedstock as well. 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.

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, pandemics, fire, earthquake, energy shortages, flooding or other natural disasters. The primary manufacturing facility of our sole supplier of LVT is located in South Korea, which recently reported an outbreak of the novel coronavirus described above. 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 recently completed the acquisition of nora, a manufacturer and multinational marketer of resilient rubber floor coverings.  The success of the acquisition will depend substantially on our ability to realize the expected synergies and other benefits from combining the Company’s legacy business and nora.  Our ability to realize these anticipated benefits and cost savings is subject to various risks and uncertainties, including the risks that:

 

If we are not able to successfully combine the businesses within the anticipated time frame, or at all, the expected synergies and other benefits of the transaction may not be realized fully or at all, or may take longer to realize than expected, the combined businesses may not perform as expected and the results of our operations or value of our common stock may be adversely affected.

 

It is also possible that the integration process could result in the loss of key employees or customers of the Company or nora, the disruption of the companies’ ongoing businesses or in unexpected integration issues, higher than expected integration costs and an overall integration process that takes longer than originally anticipated.

 

We will be required to devote significant management attention and resources to integrating the Company’s legacy operations and nora. It is possible that the integration process could result in:

 

 

Any of these consequences could adversely affect each company’s ability to maintain relationships with customers, suppliers, employees and other constituencies or their ability to achieve the anticipated benefits of the transaction, or could reduce each company’s earnings or otherwise adversely affect the business and financial results of the combined company and the value of our common stock.

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

It is important for you to consider that we have a significant amount of indebtedness. 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 2023. We cannot assure you that we will be able to renegotiate, refinance or otherwise obtain the necessary funds to satisfy these obligations. 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.

 

On July 27, 2017, the U.K. Financial Conduct Authority (the “FCA”), which regulates the London interbank offered rate (“LIBOR”), announced that the FCA will no longer persuade or compel banks to submit rates for the calculation of LIBOR after 2021. This announcement indicates that the continuation of LIBOR on the current basis is not guaranteed after 2021, and LIBOR may be discontinued or modified by 2021. The Federal Reserve Bank of New York began publishing the Secured Overnight Financing Rate (“SOFR”) in April 2018 as an alternative for LIBOR. SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities. A transition away from the widespread use of LIBOR to SOFR or another benchmark rate may occur over the course of the next few years. We have exposure to LIBOR-based financial instruments, namely our floating rate Syndicated Credit Facility. This facility allows for the use of an alternative benchmark rate if LIBOR is no longer available. At this time, we cannot predict the overall effect of the modification or discontinuation of LIBOR or the establishment of alternative benchmark rates.

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.

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.

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.

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, pandemics or other public health crises (such as the recent outbreak of the novel coronavirus described above), or other disruptions to our facilities, supply chain or our customers’ facilities. 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.

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:

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

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 or other individuals, 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.

None.

We maintain our corporate headquarters in Atlanta, Georgia in approximately 42,000 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:

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.

From time to time, we are a party to legal proceedings, whether arising in the ordinary course of business or otherwise. The disclosure set forth in Note 17 to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K is incorporated by reference herein.

 

Not applicable.

PART II

Our Common Stock is traded on the Nasdaq Global Select Market under the symbol TILE. As of February 18, 2020, we had 635 holders of record of our Common Stock. We estimate that there are in excess of 10,000 beneficial holders of our Common Stock.

 

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.

The following graph and table compare, for the five-year period ended December 29, 2019, 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) our self-determined peer group, assuming an initial investment of $100 in each on December 28, 2014 (the last day of the fiscal year 2014). In determining its peer group companies, the Company considered various factors, including the potential peer’s industry, business model, size and complexity.  The Company chose a peer group that it believes provides a robust sample size with minimal revenue dispersion, with companies in similar industries or lines of business or subject to similar economic and business cycles, including companies with a significant international presence that are also focused on sustainability.

 

 

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

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 29, 2019:

 

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.

 

Our revenues are derived from sales of floorcovering products, primarily modular carpet, luxury vinyl tile (“LVT”) and starting in August 2018, rubber flooring products. 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. In the Americas, our mix of corporate office versus non-corporate office modular carpet and LVT sales was 47% and 53%, respectively, for 2019. Company-wide, our mix of corporate office versus non-corporate office modular carpet and LVT sales was 61% and 39%, respectively, in 2019.

 

On August 7, 2018, the Company completed the acquisition of nora for a purchase price of €385.1 million, or $447.2 million at the exchange rate as of the transaction date, including acquired cash of €40.0 million ($46.5 million) for a net purchase price of €345.1 million ($400.7 million). Nora is an industry leader in the rubber flooring market, and this acquisition is expected to advance the Company’s growth strategy in expanding market segments, particularly in the healthcare, life sciences and education market segments. Similar to Interface, nora operates on an international footprint and the Company expects the acquisition will also allow for geographic sales synergies as well. During fiscal 2019, the Company continued to expand into these market segments as the sales of rubber flooring products were primarily in the healthcare, education and transportation market segments.

 

During 2019, we had net sales of $1,343.0 million, up 13.9% compared to $1,179.6 million in 2018. Operating income for 2019 was $130.9 million compared to $76.4 million in 2018. Net income for 2019 was $79.2 million, or $1.34 per share, compared to $50.3 million, or $0.84 per share, in 2018. The 2019 period included the results of the acquired nora business for the full fiscal year, $5.9 million of purchase accounting amortization in connection with the nora acquisition, and $12.9 million of restructuring and other charges. The 2018 period included the results on the nora acquisition from August 7, 2018 to the end of the 2018 fiscal year.

 

During 2018, we had net sales of $1,179.6 million, up 18.4% compared to $996.4 million in 2017. Operating income for 2018 was $76.4 million as compared to $111.6 million in 2017. Net income for 2018 was $50.3 million, or $0.84 per share, compared with $53.2 million, or $0.86 per share, in 2017. The 2018 period included the results of the acquired nora business from August 7 through the end of the year, including nora net sales of $112.6 million during that stub period. These results included amortization related to the fair value of inventory acquired of $26.7 million, and amortization of acquired intangible assets of $5.4 million. 2018 also includes $9.5 million related to nora transaction expenses. Also included in our results for 2018 were $20.5 million of restructuring and asset impairment charges as well as $6.7 million of tax benefits related to the finalization of our analysis of the U.S. Tax Cuts and Jobs Act enacted in 2017. Please see Item 8, Note 16 “Income Taxes” for further discussion of these tax benefits.

 

On December 23, 2019, the Company committed to a new restructuring plan that continues to focus on efforts to improve efficiencies and decrease costs across its worldwide operations, and more closely align its operating structure with its business strategy. The plan involves a reduction of approximately 105 employees and early termination of two office leases. As a result of this plan, the Company recorded a pre-tax restructuring charge in the fourth quarter of 2019 of approximately $9.0 million. The charge is comprised of severance expenses ($8.8 million) and lease exit costs ($0.2 million). The restructuring plan is expected to result in future cash expenditures of approximately $9.0 million for payment of the employee severance and lease exit costs, as described above. The Company expects to complete the restructuring plan in fiscal year 2020, and expects the plan to yield annualized savings of approximately $6.0 million. A portion of the annualized savings is expected to be realized on the income statement in fiscal year 2020, with the remaining portion of the annualized savings expected to be realized in fiscal year 2021.

On December 29, 2018, the Company committed to a new restructuring plan in its continuing efforts to improve efficiencies and decrease costs across its worldwide operations, and more closely align its operating structure with its business strategy. The plan involved (i) a restructuring of its sales and administrative operations in the United Kingdom, (ii) a reduction of approximately 200 employees, primarily in the Europe and Asia-Pacific geographic regions, and (iii) the write-down of certain underutilized and impaired assets that included information technology assets and obsolete manufacturing equipment. As a result of this plan, the Company recorded a pre-tax restructuring and asset impairment charge in the fourth quarter of 2018 of approximately $20.5 million. The charge was comprised of severance expenses (approximately $10.8 million), impairment of assets (approximately $8.6 million) and other items (approximately $1.1 million). The charge was expected to result in future cash expenditures of $12 million, primarily for severance payments (approximately $10.8 million). The restructuring plan was substantially complete at the end of fiscal 2019. The Company redeployed the savings toward the funding of sales and strategic growth initiatives in 2019, yielding negligible net savings on the Company’s income statement. In connection with the 2018 restructuring plan, the Company recorded $0.7 million of additional lease exit costs in the third quarter of 2019, and in the fourth quarter of 2019 the Company adjusted its expected severance expenses and recognized a decrease in restructuring costs of $1.7 million.

In the first quarter of 2017, the Company recorded a restructuring charge of $7.3 million, which was related to a previous restructuring plan announced in 2016, primarily related to exit costs associated with the closure of various FLOR retail stores. The 2017 charge was comprised of lease exit costs of $3.4 million, asset impairment charges of $3.3 million and severance charges of $0.6 million. The restructuring plan was substantially completed in 2017.

 

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

Net sales denominated in currencies other than the U.S. dollar were approximately 49% in 2019, 49% in 2018, and 46% in 2017. Because we have such substantial international operations, we are impacted, from time to time, by international developments that affect foreign currency transactions. In 2019, the weakening of the Euro, British pound, Australian dollar, Canadian dollar and Chinese renminbi against the U.S. dollar had a negative impact on our net sales and operating income. In 2018, the strengthening of the Euro and British pound against the U.S. dollar had a positive impact on our net sales and operating income. In 2017, the strengthening of the Euro, Australian dollar and Canadian dollar had a positive impact on our net sales and operating income.

The following table presents the amounts (in U.S. dollars) by which the exchange rates for translating Euros, British pounds, Australian dollars and Canadian dollars into U.S. dollars have affected our net sales and operating income during the past three years:

 

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

Net Sales

 

Below we provide information regarding our net sales and analyze those results for each of the last three fiscal years. Fiscal years 2019, 2018, and 2017 were 52-week periods.

For 2019, our net sales increased $163.5 million (13.9%) as compared to 2018. As discussed above, the 2019 period included revenue from the nora acquisition for the full fiscal year. The 2018 period included nora revenue only from the acquisition date on August 7, 2018 to the end of the 2018 fiscal year of $112.6 million during that stub period. The increase in net sales was primarily volume related and not materially impacted by changing prices. Fluctuations in currency exchange rates had a negative impact on our year-over-year sales comparison of approximately $26.2 million, meaning that if currency levels had remained constant year over year our 2019 sales would have been higher by this amount. On a geographic basis, including the impact of the nora acquisition, we experienced sales growth across all our regions. Sales in the Americas were up 11.0%, sales in Europe were up 23.0% as reported in U.S. dollars, and sales in Asia-Pacific were up 8.5%.

 

The sales increase of 11.0% in the Americas in 2019 was due primarily to the impact of the nora acquisition and growth from our luxury vinyl tile (“LVT”) products. The legacy Americas carpet and LVT business grew approximately 3.6% for the year.  This increase in the legacy business was due to increased sales in the corporate office market segment (up 8.6%) as well as increases in the healthcare (up 18.2%) and education (up 7.6%) market segments.  These legacy sales increases were partially offset by a decline in the retail market segment (down 24.6%).

 

In Europe, sales in the region were up in both U.S. dollars (23.0%) and local currency (29.1%). This increase was due primarily to the impact of the nora acquisition and growth from our LVT products offset by weakening of the Euro and British pound against the U.S. dollar. The legacy European carpet and LVT business declined 2.7% on a U.S. dollar basis, but grew 2.6% in local currency.  The sales growth in local currency in the legacy European business was most pronounced in the corporate office segment (up 6.9%). The decline in legacy sales on a U.S. dollars basis was primarily due to the weakening of the Euro and British pound against the U.S. dollar.

 

In Asia-Pacific, sales increased 8.5% primarily due to the impact of the nora acquisition and growth in our LVT products. This sales increase was partially offset by the weakening of the Australian dollar and lower sales in Australia.  The legacy Asia-Pacific carpet and LVT business declined 3.9% on a U.S. dollar basis, but increased 0.1% in local currency.  The sales decline in the legacy Asia-Pacific business was primarily in the corporate (down 5.7%) and government (down 17.9%) market segments, partially offset by increases in the retail market segment (up 12.0%).

 

For 2018, our net sales increased $183.1 million (18.4%) compared to 2017. As discussed above, the 2018 period included revenue of $112.6 million from the nora acquisition that was not present in 2017. Fluctuations in currency exchange rates had a positive impact on our year-over-year sales comparison of approximately $8.4 million, meaning that if currency levels had remained constant year over year our 2018 sales would have been lower by this amount. On a geographic basis, including the impact of nora, we experienced sales growth across all of our regions. Sales in the Americas were up 16.0%, sales in Europe were up 29.7% as reported in U.S. dollars, and sales in Asia-Pacific were up 9.7%.

 

 

In Europe, sales in the region were up in both U.S. dollars (29.7%) and local currency (25.0%). This sales increase was due primarily to the impact of the nora acquisition, growth in our LVT products and the strengthening of the Euro and British pound against the U.S. dollar. The legacy Interface European carpet and LVT business grew 9% on a U.S. dollar basis, and 5% in local currency.  The sales growth in the legacy Interface European business was most pronounced in the corporate office (up 9%), retail (up 11%), healthcare (up 15%), and hospitality (up 34%) market segments.

 

In Asia-Pacific, sales increased 9.7% primarily due to the impact of the nora acquisition and growth in our LVT products. This sales increase was partially offset by the weakening of the Australian dollar and lower sales in Australia. The legacy Interface Asia-Pacific carpet and LVT business grew 1% on a U.S. dollar basis and 2% in local currency.  Within the region on a legacy Interface basis, Asia sales increased 8% while Australia sales decreased 5% as translated into U.S. dollars. The sales growth in the legacy Asia-Pacific business was primarily in the hospitality (up 5%) and healthcare (up 6%) market segments, partially offset by decreases in government (down 32%) and retail (down 3%) market segments.

 

Cost and Expenses

 

The following table presents our overall cost of sales and selling, general and administrative (“SG&A”) expenses during the past three years:

For 2019, our costs of sales increased $62.4 million (8.3%) compared to 2018. Included in 2019 are costs of sales for the acquired nora business for the full year, which includes purchase accounting amortization of $5.9 million related to acquired intangible assets. Fluctuations in currency exchange rates had a 1.8% positive impact on the year-over-year comparison. In absolute dollars, the increase in costs of sales was a result of higher sales for 2019 as compared to 2018, as well as the full year impact of the acquired nora business. As a percentage of sales, our costs of sales decreased to 60.9% in 2019 versus 64.0% in 2018. This decrease was primarily due to productivity initiatives and the nora non-recurring inventory step-up amortization which occurred in 2018, but did not recur in 2019.

For 2018, our costs of sales increased $144.8 million (23.7%) compared with 2017. Included in the 2018 period are cost of sales of $96.6 million for the acquired nora business, which includes amortization related to acquired inventory and intangible assets of $32.1 million. Fluctuations in currency exchange rates did not have a significant impact (less than 1%) on the year-over-year comparison. In absolute dollars, the increase in costs of sales was a result of higher sales for 2018 as compared to 2017. As a percentage of sales, our costs of sales increased to 64.0% in 2018 versus 61.3% in 2017. This increase was a result of (1) higher costs of sales related to the acquired nora business, including purchase accounting amortization of $32.1 million for acquired inventory and intangible assets, (2) delayed productivity initiatives due to increased sales and production volumes, as well as (3) a change in the sales mix weighted more heavily toward the Interface Services business, which typically generates a lower gross margin compared to the rest of our operations.

For 2019, our SG&A expenses increased $54.2 million (16.5%) versus 2018. Included in the 2019 period were a full year of SG&A expenses for the acquired nora business versus only a stub period of approximately five months in 2018. Fluctuations in currency rates had a 1.5% favorable impact on SG&A expenses. The increase in SG&A expenses during the year was primarily due to (1) higher selling expenses for the full year impact in 2019 of the acquired nora business, (2) higher year-over-year legal expenses of $3.5 million related to the SEC matter discussed in Note 17 – “Commitments and Contingencies”, and (3) higher selling expenses related to bringing the Company’s global sales organization together for a meeting to accelerate the nora integration, advance our selling system transformation, and engage the sales force in the Company’s sustainability mission. These increases were partially offset by lower stock compensation expense of $5.8 million compared to prior year. As a percentage of sales, SG&A expenses increased to 28.4% in 2019 versus 27.8% in 2018.

For 2018, our SG&A expenses increased $60.3 million (22.6%) versus 2017. SG&A expenses for the acquired nora business were $34.9 million from August 7 through the end of the 2018 year. 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) transaction costs in connection with the nora acquisition of $5.3 million, (2) higher performance-based stock compensation of approximately $7.0 million as performance targets were met to a higher degree in 2018 as compared to 2017, (3) higher selling expenses of $24.0 million related to the acquired nora business, (4) higher selling expense of $7.5 million due to higher sales volumes in the legacy Interface business, and (5) higher administrative expenses of $15.8 million primarily due to the acquired nora business as noted above. As a percentage of sales, SG&A expenses increased to 27.8% in 2018 versus 26.8% in 2017.

Interest Expense

 

For 2019, our interest expense increased $10.2 million to $25.6 million, versus $15.4 million in 2018. This increase was a result of higher outstanding borrowings incurred in August 2018 to complete the nora acquisition offset slightly by lower average interest rates on our borrowings (our average borrowing rate for 2019 was 3.27% as compared to 3.50% for 2018). Our interest rate swaps, entered into in 2017 and 2019, had approximately $0.2 million impact on interest expense for 2019.

 

For 2018, our interest expense increased $8.3 million to $15.4 million, versus $7.1 million in 2017. This increase was a result of (1) additional debt incurred to complete the nora acquisition and (2) higher average interest rates on our borrowings (our average borrowing rate for 2018 was 3.5% as compared to 2.9% for 2017). Our interest rate swap entered into in 2017 did not have any significant impact on interest expense for 2018.

 

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 reduced the U.S. federal income tax rate from 35% to 21% effective January 1, 2018 and created a modified territorial tax system with a one-time mandatory “transition toll tax” on previously unrepatriated foreign earnings.

 

As of December 31, 2017, the Company recorded a provisional tax expense of $3.5 million related to the remeasurement of its net deferred tax asset and a provisional tax expense of $11.7 million related to the one-time transition toll tax. As of December 30, 2018, the Company completed the accounting of remeasuring its net deferred tax asset which resulted in a $1.7 million decrease to the previously recorded provisional amount and completed its assessment of the one-time transition toll tax which resulted in a $5.0 million decrease to the previously recorded provisional amount. See Note 16 – “Income Taxes” to the consolidated financial statements in Item 8 for further information on the financial statement impact of the Tax Act.

 

Our effective tax rate in 2019 was 22.2%, compared with an effective tax rate of 8.6% in 2018. The increase in our effective tax rate in 2019 compared to 2018 was primarily due to the nonrecurring $6.7 million tax benefit realized in 2018 related to the impacts of the Tax Act as discussed above. In addition, there was a net increase in our effective tax rate in 2019 due to less U.S. federal and foreign tax credits which was partially offset by a reduction in non-deductible expenses, favorable change in unrecognized tax benefits and a higher portion of income earned in foreign jurisdictions not subject to U.S. state income taxes.

 

Our effective tax rate in 2018 was 8.6%, compared with an effective tax rate of 47.0% in 2017. The decrease in our effective tax rate in 2018 compared to 2017 was primarily due to a $6.7 million tax benefit related to the impacts of the Tax Act as discussed above, the reduction in the U.S. federal income tax rate from 35% to 21%, and an increase in U.S. federal and foreign tax credits.

 

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.

 

On August 7, 2018, our Syndicated Credit Facility was amended and restated in connection with our acquisition of nora. Please see Note 9 – “Long-Term Debt” and Note 19 – “Acquisition of Nora” in Item 8 for additional information.

 

At December 29, 2019, we had $81.3 million in cash. Approximately $2.9 million of this cash was located in the U.S., and the remaining $78.4 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, 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 $78.4 million of cash in foreign jurisdictions, approximately $3.6 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 29, 2019, we had $602.5 million of borrowings and $2.2 million in letters of credit outstanding under our amended and restated Syndicated Credit Facility. Of those borrowings outstanding, $581.6 million were term loan borrowings and $20.9 million were revolving loan borrowings. As of December 29, 2019, we had additional borrowing capacity of $276.9 million under our amended and restated Syndicated Credit Facility and $9.5 million of borrowings under our other credit facilities in place at other non-U.S. subsidiaries.

 

We have approximately $162.8 million in contractual cash obligations due by the end of fiscal year 2020, which includes, among other things, pension cash contributions, interest payments on our debt and lease commitments. Based on current interest rates and debt levels, we expect our aggregate interest expense for 2020 to be between $24 million and $25 million. We estimate aggregate capital expenditures in 2020 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 amended and restated Syndicated Credit Facility matures in August of 2023. 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 interest rate swap transactions to fix the variable interest rate with respect to $250 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 

On August 7, 2018, we amended and restated our Syndicated Credit Facility (the “Facility”) in connection with the nora Holding GmbH (“nora”) acquisition. The purpose of the amended and restated Facility was to fund the nora purchase price and related fees and expenses of the acquisition, and to increase the credit available to us and our subsidiaries following the closing of the nora acquisition in view of the larger enterprise. At December 29, 2019, the amended and restated Facility provided to us and certain of our subsidiaries a multicurrency revolving loan facility up to $300 million, as well as other U.S. denominated and multicurrency term loans.

 

On December 18, 2019, the Company amended its Facility, with certain of its wholly-owned foreign subsidiaries as co-borrowers. The primary purpose of this amendment was to allow the Company to make various intercompany transactions.

 

Interest on base rate loans is charged at varying rates computed by applying a margin ranging from 0.25% to 1.25%, depending on the Company’s consolidated net leverage ratio as of the most recently completed fiscal quarter.  Interest on LIBOR-based loans and fees for letters of credit are charged at varying rates computed by applying a margin over the applicable LIBOR rate, depending on the Company’s consolidated net leverage ratio as of the most recently completed fiscal quarter. Interest on multi-currency-based loans and fees for letters of credit are charged at varying rates computed by applying a margin ranging from 1.25% to 2.25% 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.

 

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:

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:

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:

 

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 29, 2019, we had outstanding $581.6 million of term loan borrowing and $20.9 million of revolving loan borrowings under the Facility, and had $2.2 million in letters of credit outstanding under the Facility. As of December 29, 2019, the weighted average interest rate on borrowings outstanding under the Facility was 3.27%.

Under the amended and restated Facility, we are required to make quarterly amortization payments of the Term Loan A borrowings, which commenced in the fourth quarter of 2018. The amortization payments are due on the last day of the calendar quarter.

 

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

 

In the third quarter of 2017 and first quarter of 2019, we entered into interest rate swap transactions that fixed the variable interest rate with respect to $100 million and $150 million, respectively, of the term loan borrowings under the Syndicated Credit Facility. For additional information, please see Item 7A and Note 9 entitled “Long-Term Debt” in Item 8 of this Report.

 

Analysis of Cash Flows

 

We ended 2019 with $81.3 million in cash, an increase of $0.3 million during the year. The most significant uses of cash in 2019 were (1) repayments on our Syndicated Credit Facility of $111.7 million offset by borrowings of $90 million, (2) capital expenditures of $74.6 million, (3) $25.2 million to repurchase 1.6 million shares of the Company’s outstanding common stock, and (3) dividend payments of $15.4 million These uses were offset by cash flow from operations of $141.8 million, primarily generated from (1) net income of $79.2 million, (2) $19.4 million for increases in accounts payable and accrued expenses, and (3) $2.6 million due to a decrease in inventories. These sources of cash were reduced by working capital uses of (1) $9.7 million due to increases in prepaid expenses and (2) $0.9 million due to increases in accounts receivable.

 

We ended 2018 with $81.0 million in cash, a decrease of $6.0 million during the year. During 2018, we borrowed $462.8 million of new term loan debt to finance the acquisition of nora. The cash purchase price for nora, net of cash acquired, was $400.7 million. Other than the nora purchase transaction, the most significant uses of cash in 2018 were (1) repayments on our Syndicated Credit Facility of $64.5 million, (2) capital expenditures of $54.9 million, (3) dividend payments of $15.5 million and (4) $14.5 million of cash used to repurchase our common stock. These uses were offset by cash flow generated by operations of $91.8 million. Our cash flow from operations was primarily generated by net income of $50.3 million. This net income was offset by working capital uses, primarily $18.8 million for an increase in inventory and $15.5 million due to increases in prepaid and other current assets. The Company generated cash of $9.9 million for increases in accounts payable and accrued expenses. In addition to working capital generation of cash, the Company also borrowed $17 million under its Syndicated Credit Facility during 2018.

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.

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 29, 2019.

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.

 

 

 

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 29, 2019, and December 30, 2018, we had state net operating loss carryforwards of $87.6 million and $96.1 million, respectively. 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 2019 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.

 

 

During the fourth quarters of 2019, 2018 and 2017, 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 29, 2019, no impairment of goodwill was indicated. As of December 29, 2019, if our estimates of the fair value of our reporting units were 10% lower, we believe no additional goodwill impairment would have existed. However, the Company has experienced significant competitive pressure in fiscal 2019 along with volatility in the company stock price. As such, it is reasonably possible that such circumstances along with a recent acquisition may together warrant the need to write down the value of goodwill in the near term.

 

 

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 29, 2019 and December 30, 2018, was $28.3 million and $28.1 million, respectively. To the extent that actual obsolescence of our inventory differs from our estimate by 10%, our 2019 net income would be higher or lower by approximately $2.2 million, on an after-tax basis.

 

 

 

The most significant of the fair value estimates is related to intangible assets not subject to amortization and intangible assets subject to amortization. We acquired $103.3 million of intangible assets in connection with the nora acquisition.This amount of intangible assets was determined based primarily on nora’s projected cash flows. The projected cash flows include various assumptions, including the timing of projects embedded in backlog, success in securing future business, profitability of the business, and the appropriate risk-adjusted discount rate used to discount the projected cash flows. At December 29, 2019 intangible assets, net of amortization, were approximately $89.1 million. The final residual value assigned to goodwill related to the nora acquisition was $201.9 million, at the acquisition date exchange rate. We completed our final valuation of the assets acquired and liabilities assumed at the acquisition date in the second quarter of 2019.

 

 

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

 

 

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

 

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 and 2019, the Company entered into interest rate swap transactions with regard to a portion of its term loan debt. The Company’s interest rate swaps are designated and qualify as cash flow hedges of forecasted interest payments. The Company reports the effective portion of the fair value gain or loss on the swaps as a component of other comprehensive income (or other comprehensive loss). The aggregate notional amount of the swaps as of December 29, 2019 was $250 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, Germany, 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 29, 2019, we recognized an $11.7 million decrease in our foreign currency translation adjustment account compared with December 30, 2018, because of the weakening of the Euro, British pound and Australian dollar against the U.S. dollar in 2019.

 

 

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 29, 2019. 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 2019 and 2018 was 3.27% and 3.50%, 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 29, 2019. 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 29, 2019.

 

An increase in our effective interest rate of 1% would increase annual interest expense by approximately $3.3 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.

 

As of December 29, 2019, a 100 bps decrease or increase in interest rates would result in a decrease or increase in the fair value of our interest rate swaps of approximately $7.3 million.

 

Foreign Currency Exchange Rate Risk

 

As of December 29, 2019, 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 $12.4 million or an increase in the fair value of our financial instruments of $15.1 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.

 

See accompanying notes to consolidated financial statements.

 

INTERFACE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to consolidated financial statements.

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.

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.

Effective January 1, 2018, the Company adopted a new accounting standard with regard to revenue from customers.  The core principle of this standard is that an entity should recognize revenue to depict the transfer of 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. To achieve this core principle, the guidance provides that an entity should apply the following steps: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, the entity satisfies a performance obligation. The Company elected the modified retrospective approach for adoption of this new standard, as is allowed by the standard. The Company did not have any significant impact from this standard as of the date of the adoption.

Contracts with customers typically take the form of invoices for purchase of materials from the Company. Customer payment terms vary by region and are typically less than 60 days. The performance obligation is the delivery of these materials to the customer’s control. During 2019 and 2018, approximately 98% and 97% of the Company’s total revenue, respectively, was produced from the sale of carpet, resilient flooring, rubber flooring, and related products (TacTiles installation materials, etc.) and the revenue from sales of these products is recognized upon shipment, or in certain cases, upon delivery to the customer.  The transaction price for these sales is readily identifiable. The remaining revenue for 2019 and 2018 of 2% and 3%, respectively, was generated from the installation of carpet and other flooring-related material.

 

The remaining revenue generated by the Company is for contracts to sell and install carpet and related products at customer locations. For projects underway, the Company recognized installation revenue over time as the customer simultaneously received and consumed the benefit of the services. The installation of the carpet and related products is a separate performance obligation from the sale of carpet. The majority of these projects are completed within 5 days of the start of installation. The transaction price for these sale and installation contracts is readily determinable between flooring material and installation services and is specifically identified in the contract with the customer.

 

The Company has utilized the portfolio approach to its contracts with customers, as its contracts with customers have similar characteristics and it is reasonable to expect that the effects from applying this approach are not materially different from applying the accounting standard to individual contracts.

 The Company does not have any other significant revenue streams outside of these sales of flooring material, and the sale and installation of flooring material, as described above. 

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

 

As noted above, the Company primarily generates revenue through the sale of flooring material to end users either upon shipment or upon arrival of the product at its destination. In these instances, there typically is no other obligation to the customers other than the delivery of flooring material with the exception of warranty. The Company does offer a warranty to its customers which guarantees certain on-floor performance characteristics and warrants against manufacturing defects. The warranty is not a service warranty, and there is no ability to separate the warranty obligation from the sale of the flooring or purchase them separately.  The Company’s incidence of warranty claims is extremely low, with less than 0.5% of revenue in claims on an annual basis for the last three fiscal years.  Given the nature of the warranty as well as the financial impact, the Company has determined that there is no need to identify this warranty as a separate performance obligation and the Company will continue to account for warranty on an accrual basis. 

 

For the Company’s installation business, the sales of carpet and other flooring materials and installation services are separate deliverables which under the revenue recognition requirements should be characterized as separate performance obligations.  Prior to the adoption of the new accounting standard, the Company historically had not separated these obligations and had accounted for these installation projects on a completed contract basis.  The nature of the installation projects is such that the vast majority – an amount in excess of 90% of these installation projects – are completed in less than 5 days.  The Company’s largest installation customers are retail and corporate customers, and these are on a project-by-project basis and are short-term installations.  The Company has evaluated these projects at the end of the reporting period and recorded revenue in accordance with the accounting standards for projects which were underway as of the end of 2019.  

The Company pays sales commissions to many of its sales personnel based upon their selling activity. These are direct costs associated with obtaining the contracts and are expensed as the revenue is earned. As these commissions become payable upon shipment (or in certain cases delivery) of product, the commission is earned as the revenue is recognized. There are no other material costs the Company incurs as part of obtaining the sales contract.

 

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 costs are expensed as incurred and are included in selling, general and administrative expenses and cost of sales in the consolidated statements of operations. Research and development expense was $17.8 million, $16.4 million, and $14.0 million for the years 2019, 2018 and 2017, respectively.

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. Significant concentrations of credit risk may arise from the Company’s cash maintained at various banks, as from time to time cash balances may exceed the FDIC limits. The Company did 0t hold any significant amounts of cash equivalents and short-term investments at December 29, 2019 and December 30, 2018.

Cash payments for interest amounted to approximately $22.7 million, $13.8 million, and $6.3 million for the years 2019, 2018, and 2017, respectively. 2019 includes cash payments for interest related to the Company’s finance lease liabilities. Income tax payments amounted to approximately $34.8 million, $29.5 million and $19.1 million for the years 2019, 2018 and 2017, respectively. During the years 2019, 2018 and 2017, the Company received income tax refunds of $1.9 million, $0.8 million and $0.1 million, respectively.

Inventories are carried at the lower of cost (standards approximating the first-in, first-out method) or net realizable value. 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.

 

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.

 

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 $2.1 million, $0.7 million, and $0.6 million for the fiscal years 2019, 2018 and 2017, respectively. Depreciation expense amounted to approximately $41.5 million, $37.6 million, and $29.5 million for the years 2019, 2018, and 2017 respectively. Depreciation expense recorded to costs of sales in the consolidated statements of operations was $26.3 million, $21.8 million, and $14.8 million for the years 2019, 2018, and 2017, respectively. Depreciation expense recorded in SG&A expenses in the consolidated statements of operations was $15.2 million, $15.8 million, and $14.7 million, for the years 2019, 2018, and 2017, 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.

In connection with the nora acquisition on August 7, 2018, the Company recognized goodwill of $201.9 million and acquired intangible assets of $103.3 million. Goodwill includes all purchase price accounting adjustments of approximately $18.6 million related to additional liabilities that existed at the acquisition date. Goodwill and intangible assets were assigned pro-rata to the Company’s 3 operating segments. NaN of the goodwill is expected to be deductible for income tax purposes.

 

As of December 29, 2019, and December 30, 2018, the net carrying amount of goodwill was $257.4 million and $245.8 million, respectively. Other intangible assets were $89.1 million and $97.7 million as of December 29, 2019 and December 30, 2018, respectively. Amortization expense related to intangible assets during the years 2019, 2018 and 2017 was $5.9 million, $5.4 million and $0.7 million, respectively and are recorded in cost of sales in the consolidated statements of operations.

  

During the fourth quarters of 2019, 2018 and 2017, as of the last day of the third quarter of each year, the Company performed the annual goodwill impairment test. The Company performs this test at the reporting unit level, which is one level below the segment level for the Flooring segment. In performing the impairment testing, the Company prepared valuations of reporting units on both a market comparable methodology and an income methodology, and those valuations were compared with the respective carrying 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 as a result of the impairment testing. As of December 29, 2019, 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. However, the Company has experienced significant competitive pressure in fiscal 2019 along with volatility in the company stock price. As such, it is reasonably possible that such circumstances along with a recent acquisition may together warrant the need to write down the value of goodwill in the near term.

The changes in the carrying amounts of goodwill for the years ended December 29, 2019 and December 30, 2018 are as follows (in thousands):

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 rubber and LVT products, typically for a period of 5 to 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 $3.9 million and $3.5 million as of December 29, 2019 and December 30, 2018, respectively, and are included in “Accrued Expenses” in the accompanying consolidated balance sheets.

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. 

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 16 entitled “Income Taxes.”

 

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 and classified as level 2 within the fair value hierarchy.

The financial position and results of operations of the Company’s foreign subsidiaries are measured 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 exchange translation gains (losses) were ($11.7) million, ($22.5) million, and $31.6 million for the years 2019, 2018 and 2017, respectively.

Basic earnings per share is computed based on the average number of common shares outstanding. Diluted earnings 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.

The Company has stock-based employee compensation plans, which are described more fully in Note 13 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 0 stock options granted in 2019, 2018 or 2017.

 

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.

 

Derivatives are recognized on the balance sheet at fair value. For derivatives that meet the criteria as designated cash flow hedges, 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. Derivative liabilities are recorded in accrued expenses and derivative assets are recorded in other current assets in the consolidated balance sheet.

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.

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.

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.

The Company’s fiscal year is the 52 or 53 week period ending on the Sunday nearest December 31. All references herein to “2019,” “2018,” and “2017,” mean the fiscal years ended December 29, 2019, December 30, 2018, and December 31, 2017, respectively. Fiscal years 2019, 2018 and 2017 were each comprised of 52 weeks.

 

 

 

Effective January 1, 2018, the Company adopted a new accounting standard regarding revenue recognition from contracts with customers. The Company elected the modified retrospective approach for adoption of this new standard. The Company did not have any significant impact from this standard as of the date of the adoption.

Revenue from sales of carpet, modular resilient flooring, rubber flooring, and other flooring-related material was approximately 98% of total revenue for 2019. The remaining 2% of revenue was generated from the installation of carpet and other flooring-related material.

 

For 2019, revenue from the Company’s customers is broken down by geography as follows:

 

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 29, 2019 and December 30, 2018, the allowance for bad debts amounted to $3.8 million and $3.5 million, respectively, for all accounts receivable of the Company. Reserves for warranty and returns allowances amounted to $3.9 million and $3.5 million as of December 29, 2019 and December 30, 2018, respectively.

Accounting standards establish a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure estimated fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under applicable accounting standards are described below:

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

As of December 29, 2019 and December 30, 2018, the Company had approximately $23.3 million and $24.3 million, respectively, of Company-owned life insurance, which is measured on a readily determinable cash surrender value on a recurring basis. This Company-owned life insurance is classified as a Level 2 asset within the fair value hierarchy. 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 29, 2019, 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 fair value of the Company’s derivative instruments is determined using discounted cash flow valuation models. The significant inputs used in these models are readily available in public markets, or can be derived from other observable market transactions, and therefore are classified as Level 2 within the fair value hierarchy.

 

Inventories are summarized as follows:

 

Reserves for inventory obsolescence amounted to $28.3 million and $28.1 million as of December 29, 2019 and December 30, 2018, respectively, and have been netted against amounts presented above.

Property, plant and equipment consisted of the following:

The estimated cost to complete construction-in-progress at December 29, 2019, was approximately $57.2 million.

 

Accrued expenses are summarized as follows:

 

 

On August 7, 2018, the Company amended and restated its Syndicated Credit Facility (the “Facility”) in connection with the nora acquisition. The purpose of the amended and restated Facility was to fund the nora purchase price and related fees and expenses of the acquisition, and to increase the credit available to the Company and its subsidiaries following the closing of the nora acquisition in view of the larger enterprise. At December 29, 2019, the amended and restated Facility provided to the Company and certain of its subsidiaries a multicurrency revolving loan facility up to $300.0 million, as well as other U.S. denominated and multicurrency term loans.

 

Interest on base rate loans is charged at varying rates computed by applying a margin ranging from 0.25% to 1.25%, depending on the Company’s consolidated net leverage ratio as of the most recently completed fiscal quarter. Interest on LIBOR-based loans and fees for letters of credit are charged at varying rates computed by applying a margin over the applicable LIBOR rate, depending on the Company’s consolidated net leverage ratio as of the most recently completed fiscal quarter. Interest on multi-currency-based loans and fees for letters of credit are charged at varying rates computed by applying a margin ranging from 1.25% to 2.25% 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.

 

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:

 

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:

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:

Pursuant to an Amended and Restated Security and Pledge Agreement, 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.

 

As of December 29, 2019, the Company had outstanding $581.6 million of term loan borrowing and $20.9 million of revolving loan borrowings under the Facility, and had $2.2 million in letters of credit outstanding under the Facility. As of December 29, 2019, the weighted average interest rate on borrowings outstanding under the Facility was 3.27%.

 

Under the amended and restated Facility, the Company is required to make quarterly amortization payments of the term loan borrowings, which commenced in the fourth quarter of 2018. The amortization payments are due on the last day of the calendar quarter.

 

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.

In the third quarter of 2017 and the first quarter of 2019, the Company entered into interest rate swap transactions 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 these interest rate swaps 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 amounts.

Subsidiaries of the Company have an aggregate of the equivalent of $9.5 million of other lines of credit available at interest rates ranging from 2.0% to 6.0%. As of December 29, 2019 and December 30, 2018, there were 0 borrowings outstanding under these lines of credit.

In connection with the amended and restated Facility on August 7, 2018, as discussed above, the Company recorded $8.8 million of debt issuance costs associated with the new term loans, which are reflected as a reduction of long-term debt in accordance with applicable accounting standards.  These fees are amortized straight-line, which approximates the effective interest method, over the life of the outstanding borrowing, the debt balance will increase by the same amount as the fees that are amortized. As of December 29, 2019, the unamortized debt costs recorded as a reduction of long-term debt was $6.3 million.

 

Other deferred borrowing costs, which include underwriting, legal and other direct costs related to the issuance of revolving debt, net of accumulated amortization, were $1.3 million and $1.8 million, as of December 29, 2019 and December 30, 2018, 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 2019, 2018, and 2017 amounted to $0.4 million, $0.5 million, and $0.5 million, respectively for each of those years.

The aggregate maturities of borrowings for each of the five fiscal years subsequent to 2019 are as follows:

 

Total long-term debt in the consolidated balance sheet includes a reduction for unamortized debt issuance costs of $6.3 million which are excluded from the maturities table above.

 

 

In the third quarter of 2017 and the first quarter of 2019, the Company entered into interest rate swap transactions in notional amounts of $100 million and $150 million, respectively, to fix the variable interest rate on a portion of its term loan borrowing 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 amounts.

 

 

Both of the interest rate swaps described above are designated and qualify as cash flow hedges of forecasted interest payments. The Company reports the changes in fair value of the swaps as a component of other comprehensive income (or other comprehensive loss). The aggregate notional amount of the swaps as of December 29, 2019 was $250 million.

 

 

Our nora operations, from time to time, are party to currency forward contracts designed to hedge the cash flow risk of intercompany sales from the manufacturing facility in Europe to the Americas.  The Company’s objective and strategy with respect to these currency forward contracts is to protect the Company against adverse fluctuations in currency rates by reducing its exposure to variability in cash flows related to receipt of payment on intercompany sales.  The Company is meeting its objective by hedging the risk of changes in its cash flows (intercompany payments for inventory) attributable to changes in the U.S. dollar/Euro exchange rate (the “hedged risk”). Changes in fair value attributable to components other than exchange rates will be excluded from the assessment of effectiveness and amortized to earnings on a straight-line basis.  Changes in fair value related to the effective portion of these contracts will be reflected as a component of other comprehensive income (or other comprehensive loss). As of December 29, 2019, all foreign currency forward contracts have expired.

The table below sets forth the fair value of derivative instruments as of December 29, 2019 (in thousands):

                                                                

The table below sets forth the fair value of derivative instruments as of December 30, 2018 (in thousands):

 

There was no significant impact to earnings from the changes in fair value of derivatives designated as cash flow hedges or from amounts excluded from the assessment of hedge effectiveness during 2019. We expect that approximately $1.6 million related to cash flow hedges will be reclassified from accumulated other comprehensive income as an increase to interest expense in the next 12 months.

The following table summarizes the impact that changes in the fair value of derivatives designated as cash flow hedges and included in the assessment of hedge effectiveness had on accumulated other comprehensive income, net of tax (in thousands):

The following table summarizes the gains and losses reclassified from accumulated other comprehensive income into earnings during 2019 (in thousands):