INTERFACE INC - Quarter Report: 2018 September (Form 10-Q)

 

 

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q 

 

☑	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For Quarterly Period Ended September 30, 2018

 

Commission File Number 001-33994

 

INTERFACE, INC.

(Exact name of registrant as specified in its charter)

 

GEORGIA		58-1451243
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

 

 

1280 WEST PEACHTREE STREET, ATLANTA, GEORGIA 30309

(Address of principal executive offices and zip code)

 

(770) 437-6800

(Registrant’s telephone number, including area code)

 

 

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

 

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

 

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

 

Large accelerated filer ☑

Accelerated filer ☐

Non-accelerated filer ☐   Emerging Growth Company ☐

Smaller reporting company ☐

 

 

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes ☐    No ☑

 

Shares outstanding of each of the registrant’s classes of common stock at November 1, 2018:

 

	Class		Number of Shares
	Common Stock, $.10 par value per share		59,520,468

 

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INTERFACE, INC.

 

INDEX

 

			PAGE
PART I.	FINANCIAL INFORMATION
	Item 1.	Financial Statements	3
		Consolidated Condensed Balance Sheets – September 30, 2018 and December 31, 2017	3
		Consolidated Condensed Statements of Operations – Three Months and Nine Months Ended September 30, 2018 and October 1, 2017	4
		Consolidated Statements of Comprehensive Income – Three Months and Nine Months Ended September 30, 2018 and October 1, 2017	5
		Consolidated Condensed Statements of Cash Flows – Nine Months Ended September 30, 2018 and October 1, 2017	6
		Notes to Consolidated Condensed Financial Statements	7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	23
	Item 4.	Controls and Procedures	24
PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings	25
	Item 1A.	Risk Factors	25
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	25
	Item 3.	Defaults Upon Senior Securities	25
	Item 4.	Mine Safety Disclosures	25
	Item 5.	Other Information	25
	Item 6.	Exhibits	26

 

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		SEPTEMBER 30, 2018				DECEMBER 31, 2017
		(UNAUDITED)
ASSETS
Current Assets:
Cash and cash equivalents		$	107,331			$	87,037
Accounts receivable, net			177,766				142,808
Inventories, net			278,815				177,935
Prepaid expenses and other current assets			36,314				23,087
Total current assets			600,226				430,867
Property and equipment, net			292,606				212,645
Deferred tax asset			23,324				18,003
Goodwill and intangible assets, net			353,810				68,754
Other assets			72,994				70,331
Total assets		$	1,342,960			$	800,600
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	69,353			$	50,672
Accrued expenses			137,862				110,974
Current portion of long-term debt			31,315				15,000
Total current liabilities			238,530				176,646
Long-term debt			617,565				214,928
Deferred income taxes			27,475				6,935
Other			106,410				72,000
Total liabilities			989,980				470,509
Commitments and Contingencies
Shareholders’ equity
Preferred stock			0				0
Common stock			5,951				5,981
Additional paid-in capital			265,300				271,271
Retained Earnings			219,689				187,432
Accumulated other comprehensive loss – foreign currency translation			(85,922	)			(78,943	)
Accumulated other comprehensive income – cash flow hedges			3,469				904
Accumulated other comprehensive loss – pension liability			(55,507	)			(56,554	)
Total shareholders’ equity			352,980				330,091
Total liabilities and shareholders’ equity		$	1,342,960			$	800,600

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		THREE MONTHS ENDED								NINE MONTHS ENDED
		SEPTEMBER 30, 2018				OCTOBER 1, 2017				SEPTEMBER 30, 2018				OCTOBER 1, 2017
NET SALES		$	318,325			$	257,431			$	842,514			$	730,233
Cost of Sales			218,380				158,887				539,839				445,990
GROSS PROFIT ON SALES			99,945				98,544				302,675				284,243
Selling, General and Administrative Expenses			84,160				67,233				230,199				196,333
Restructuring and Asset Impairment Charges			0				0				0				7,299
OPERATING INCOME			15,785				31,311				72,476				80,611
Interest Expense			4,852				1,851				9,207				5,150
Other Expense			1,570				1,051				5,350				3,143
INCOME BEFORE INCOME TAX EXPENSE			9,363				28,409				57,919				72,318
Income Tax Expense			1,191				8,970				14,061				23,394
NET INCOME		$	8,172			$	19,439			$	43,858			$	48,924
Earnings Per Share – Basic		$	0.14			$	0.32			$	0.74			$	0.78
Earnings Per Share – Diluted		$	0.14			$	0.32			$	0.74			$	0.78
Common Shares Outstanding – Basic			59,496				61,018				59,553				62,630
Common Shares Outstanding – Diluted			59,536				61,060				59,594				62,672

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		THREE MONTHS ENDED								NINE MONTHS ENDED
		SEPTEMBER 30, 2018				OCTOBER 1, 2017				SEPTEMBER 30, 2018				OCTOBER 1, 2017
Net Income		$	8,172			$	19,439			$	43,858			$	48,924
Other Comprehensive Income / (Loss), Foreign Currency Translation Adjustment			4,964				9,848				(6,979	)			30,678
Other Comprehensive Income, Cash Flow Hedges			286				0				2,565				0
Other Comprehensive Income / (Loss), Pension Liability Adjustment			(196	)			(1,994	)			1,047				(4,974	)
Comprehensive Income		$	13,226			$	27,293			$	40,491			$	74,628

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		NINE MONTHS ENDED
		SEPTEMBER 30, 2018				OCTOBER 1, 2017
OPERATING ACTIVITIES:
Net Income		$	43,858			$	48,924
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization			27,067				22,203
Stock compensation amortization expense			9,181				4,479
Deferred income taxes and other			(10,705	)			5,926
Amortization of acquired intangible assets			2,414				0
Amortization of acquired inventory step-up			17,849				0
Working capital changes:
Accounts receivable			(5,540	)			(1,397	)
Inventories			(27,037	)			(22,377	)
Prepaid expenses and current assets			(9,398	)			(653	)
Accounts payable and accrued expenses			10,987				10,804
CASH PROVIDED BY OPERATING ACTIVITIES:			58,676				67,909
INVESTING ACTIVITIES:
Capital expenditures			(28,853	)			(22,809	)
Cash paid for business, net of cash acquired			(400,697	)			0
Other			531				(421	)
CASH USED IN INVESTING ACTIVITIES:			(429,019	)			(23,230	)
FINANCING ACTIVITIES:
Repayments of long-term debt			(51,403	)			(62,085	)
Borrowing of long-term debt			479,837				20,000
Tax withholding payments for share-based compensation			(1,056	)			(1,477	)
Proceeds from issuance of common stock			207				0
Debt Issuance Costs			(8,757	)			(1,418	)
Dividends paid			(11,602	)			(11,571	)
Repurchase of common stock			(14,485	)			(81,061	)
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES:			392,741				(137,612	)
Net cash provided by / (used) in operating, investing and financing activities			22,398				(92,933	)
Effect of exchange rate changes on cash			(2,104	)			5,369
CASH AND CASH EQUIVALENTS:
Net change during the period			20,294				(87,564	)
Balance at beginning of period			87,037				165,672
Balance at end of period		$	107,331			$	78,108

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NOTE 1 – CONDENSED FOOTNOTES

 

As contemplated by the Securities and Exchange Commission (the “Commission”) instructions to Form 10-Q, the following footnotes have been condensed and, therefore, do not contain all disclosures required in connection with annual financial statements. Reference should be made to the Company’s year-end consolidated financial statements and notes thereto contained in its Annual Report on Form 10-K for the fiscal year ended December 31, 2017, as filed with the Commission.

 

The financial information included in this report has been prepared by the Company, without audit. In the opinion of management, the financial information included in this report contains all adjustments (all of which are normal and recurring) necessary for a fair presentation of the results for the interim periods. Nevertheless, the results shown for interim periods are not necessarily indicative of results to be expected for the full year. The December 31, 2017, consolidated condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States.

 

Certain prior period amounts have been reclassified to conform to the current period presentation. There was no change to consolidated assets, liabilities, cash flows or net income as a result of these reclassifications.

 

NOTE 2 – REVENUE RECOGNITION

 

Effective January 1, 2018, the Company adopted a new accounting standard with regard to revenue from customers. 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.

 

Revenue Recognized from Contracts with Customers

 

100% of the Company’s revenue is due to contracts with its customers. These contracts typically take the form of invoices for purchase of materials from the Company. The performance obligation is the delivery of these materials to customer control. Nearly 97% of the Company’s current revenue is produced from the sale of carpet, resilient 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 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.

 

Impairment Losses

 

The Company does not recognize any impairment losses related to its revenue contracts due primarily to the short-term and straightforward nature of these contracts.

 

 

Disaggregation of Revenue

 

For the first nine months ended September 30, 2018, revenue from the Company’s customers is broken down by geography as follows:

 

 

Revenue from sales of carpet, modular resilient flooring, rubber flooring, and other flooring-related material was approximately 97% of total revenue for the nine months ended September 30, 2018. The remaining 3% of revenue was generated from the installation of carpet and other flooring-related material.

 

Performance Obligations

 

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 carpet or purchase them separately. The Company’s incidence of warranty claims is extremely low, with approximately 0.2% 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. The Company historically has not separated these obligations and has 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 impact of bifurcating the carpet sale from the installation sale is not considered to be material to the total Company. The Company has, however, 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 the third quarter of 2018.   

 

Costs to Obtain Contracts

 

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. Under the accounting standard, these costs should be 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. Due to this fact pattern, there is no change to the Company’s accounting for these selling commissions. There are no other material costs the Company incurs as part of obtaining the sales contract.

 

NOTE 3– INVENTORIES

 

Inventories are summarized as follows:

 

 

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NOTE 4 – EARNINGS PER SHARE

 

The Company computes basic earnings per share (“EPS”) by dividing net income by the weighted average common shares outstanding, including participating securities outstanding, during the period as discussed below.  Diluted EPS reflects the potential dilution beyond shares for basic EPS that could occur if securities or other contracts to issue common stock were exercised, converted into common stock or resulted in the issuance of common stock that would have shared in the Company’s earnings.

 

The Company includes all unvested stock awards which contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, in the number of shares outstanding in our basic and diluted EPS calculations when the inclusion of these shares would be dilutive. Unvested share-based awards of restricted stock are paid dividends equally with all other shares of common stock. As a result, the Company includes all outstanding restricted stock awards in the calculation of basic and diluted EPS. Distributed earnings include common stock dividends and dividends earned on unvested share-based payment awards. Undistributed earnings represent earnings that were available for distribution but were not distributed. The following tables show distributed and undistributed earnings:

 

 

The following tables present net income that was attributable to participating securities:

 

 

The weighted average shares outstanding for basic and diluted EPS were as follows:

 

 

For all periods presented, there were no options or participating securities excluded from the computation of diluted EPS.

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NOTE 5 – LONG-TERM DEBT

 

Syndicated Credit Facility

 

On August 7, 2018, the Company amended and restated its 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 the Company and its subsidiaries following the closing of the nora acquisition in view of the larger enterprise. At September 30, 2018, the amended and restated Facility provided to the Company and certain of its subsidiaries a multicurrency revolving loan and U.S. denominated and multicurrency term loans. Interest on base rate loans was charged at varying rates computed by applying a margin 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 were 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. In addition, the Company paid a commitment fee 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.

 

In connection with the amended and restated Facility as discussed above, the Company recorded $8.8 million of debt issuance costs associated with the new term loans that are reflected as a reduction of long-term debt in accordance with applicable accounting standards.  As these fees are expensed over the life of the outstanding borrowing the debt balance will increase by the same amount as the fees that are expensed.

 

As of September 30, 2018, the Company had outstanding $625.2 million of term loan borrowing and $32.1 million of revolving loan borrowings under the Facility, and had $3.6 million in letters of credit outstanding under the Facility. As of September 30, 2018, the weighted average interest rate on borrowings outstanding under the Facility was 3.70%.

 

Under the amended and restated Facility, the Company is required to make quarterly amortization payments of the term loan borrowings, which commence in the fourth quarter of 2018. The amortization payments are due on the last day of the calendar quarter. There was no required quarterly amortization payment for the third quarter of 2018.

 

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.

 

Other Lines of Credit

 

Subsidiaries of the Company have an aggregate of the equivalent of $9.6 million of other lines of credit available at interest rates ranging from 2.5% to 6.5%. As of September 30, 2018, there were no borrowings outstanding under these lines of credit. 

 

NOTE 6 – DERIVATIVE INSTUMENTS

 

 Interest Rate Risk Management

 

In the third quarter of 2017, the Company entered into an interest rate swap transaction 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 amount.

 

Cash Flow Interest Rate Swap

 

The Company’s interest rate swap is designated and qualifies as a cash flow hedge of forecasted interest payments. The Company reports the effective portion of the fair value gain or loss on the swap as a component of other comprehensive income (or other comprehensive loss). Gains or losses (if any) on any ineffective portion of derivative instruments in cash flow hedging relationships are recorded in the period in which they occur as a component of other expense (or other income) in the Consolidated Condensed Statement of Operations and as a component of operating activities in the Consolidated Condensed Statement of Cash Flows.  The aggregate notional amount of the swap as of September 30, 2018 was $100 million.

 

 

Forward Contracts

 

The recently acquired nora operations 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). A portion of these forward contracts expire each month, with the final contract expiring in September of 2019.  These contracts cover approximately 70% of the expected intercompany sales activity between the nora European manufacturing facility and the U.S. subsidiary and at this time the Company believes these are probable transactions given historical performance as well as budget projections.  The current notional value of these forward currency contracts and the future intercompany sales these instruments hedge is approximately $52 million.

 

 

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

 

 

The table below sets forth the fair value of derivative instruments as of December 31, 2017 (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 the three and nine months ended September 30, 2018.  There was no significant impact from the reclassification of hedged items from accumulated other comprehensive income during the three and nine months ended September 30, 2018. The amount of hedged items expected to be reclassified from accumulated other comprehensive income in the next 12 months is not significant.

   

The following tables summarize the pre-tax 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 during the three and nine months ended September 30, 2018 (in thousands):

  

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NOTE 7 – STOCK-BASED COMPENSATION

 

Stock Option Awards

 

In accordance with accounting standards, the Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. That cost will be recognized over the period in which the employee is required to provide the services – the requisite service period (usually the vesting period) – in exchange for the award.

 

All outstanding stock options vested prior to the end of 2013, and therefore there was no stock option compensation expense in the first nine months of 2018 or 2017.

 

As of September 30, 2018, there were 62,500 stock options outstanding and exercisable, at an average exercise price of $7.88 per share. There were no stock options granted in 2018 or 2017. There were 20,000 stock options exercised in the first nine months of 2018 and no forfeitures during those nine months. There were no exercises or forfeitures of stock options in the first nine months of 2017. The aggregate intrinsic value of the outstanding and exercisable stock options was $1.0 million as of September 30, 2018.

 

Restricted Stock Awards

 

During the nine months ended September 30, 2018 and October 1, 2017, the Company awarded restricted stock to certain employees. Awards of restricted stock (or a portion thereof) vest with respect to each recipient over a one to three-year period from the date of grant, provided the individual remains in the employment or service of the Company as of the vesting date. Additionally, certain awards (or a portion thereof) could vest earlier in the event of a change in control of the Company, or upon involuntary termination without cause.

 

Compensation expense related to restricted stock grants was $2.9 million and $2.0 million for the nine months ended September 30, 2018 and October 1, 2017, respectively. Accounting standards allow that the Company estimate forfeitures for restricted stock and reduce compensation expense accordingly. The Company has reduced its expense by the assumed forfeiture rate and will evaluate experience against this forfeiture rate going forward.

 

The following table summarizes restricted stock outstanding as of September 30, 2018, as well as activity during the nine months then ended:

 

 

As of September 30, 2018, the unrecognized total compensation cost related to unvested restricted stock was $5.6 million. That cost is expected to be recognized by the end of 2021.

 

 

Performance Share Awards

 

During the nine months ended September 30, 2018 and October 1, 2017, the Company issued awards of performance shares to certain employees. These awards vest based on the achievement of certain performance-based goals over a performance period of one to three years, subject to the employee’s continued employment through the last date of the performance period, and will be settled in shares of our common stock or in cash at the Company’s election. The number of shares that may be issued in settlement of the performance shares to the award recipients may be greater (up to 200%) or lesser than the nominal award amount depending on actual performance achieved as compared to the performance targets set forth in the awards.

 

 

The following table summarizes the performance shares outstanding as of September 30, 2018, as well as the activity during the nine months then ended:

 

 

Compensation expense related to performance shares was $6.3 million and $2.4 million for the nine months ended September 30, 2018, and October 1, 2017, respectively. Unrecognized compensation expense related to these performance shares was approximately $5.9 million as of September 30, 2018. That cost is expected to be recognized by the end of 2021.

 

The tax benefits recognized with regard to restricted stock and performance shares were approximately $1.8 million for the nine months ended September 30, 2018.

 

NOTE 8 – EMPLOYEE BENEFIT PLANS

 

The following tables provide the components of net periodic benefit cost for the three-month and nine-month periods ended September 30, 2018, and October 1, 2017, respectively:

 

 

 

 

 

 

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NOTE 9 – ACQUISITION OF NORA

 

    On June 14, 2018, the Company entered into a share purchase and transfer agreement to acquire the issued and outstanding shares of nora, nora’s outstanding third-party debt, and receivables related to nora’s shareholder loans. Nora is the holding company for a Germany-based manufacturer and multinational marketer of resilient floor coverings, including rubber flooring. In connection with the signing of the nora share purchase and transfer agreement, the Company entered into a derivative instrument to address the foreign currency risk associated with a portion of the nora purchase price. This option instrument did not qualify for hedge accounting, and the mark-to-market expense of $2.8 million to record the instrument at fair value at the end of the second quarter of 2018 was recorded in other expense in our consolidated condensed statement of operations during the second quarter. The option instrument had a notional value of €315 million (or approximately $364 million as of the end of the second quarter of 2018) and an initial maturity of 120 days. Upon completion of the nora acquisition as discussed below, the option instrument was terminated and the Company recognized a loss of approximately $1.4 million upon termination, which was recorded in other expense in our Consolidated Condensed Statement of Operations during the third quarter of 2018.

 

   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 growing 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 transaction will be accounted for as a business combination using the acquisition method of accounting, which requires, among other things, that assets acquired and liabilities assumed be recorded at their fair market values as of the acquisition date. The results of operations for this acquisition have been consolidated with those of the Company from the acquisition date forward.  Tangible assets and liabilities of nora systems GmbH were valued as of the acquisition date using a market analysis, and intangible assets were valued using a discounted cash flow analysis.

 

       The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the acquisition date. The amounts represent a provisional measurement of the fair values, and is therefore subject to change:

 

 

        Acquired intangibles assets of $103.3 million include $60.8 million of trademarks and tradenames that are not subject to amortization and will instead be subject to annual impairment testing, or more frequent testing should there be a significant change in business conditions. The remaining intangible assets include developed technology of $39.1 million that will be amortized on a straight-line basis over the estimated useful life of 7 years and backlog of $3.4 million that will be amortized on a straight-line basis over the estimated useful life of six months. The inventory amount above includes a step-up of inventory to fair value of approximately $26.6 million which will be recognized in earnings over the expected turns of the inventory. This step-up of inventory to fair value will be fully amortized by the end of 2018.

 

 

       As of September 30, 2018, the balances, net of accumulated amortization where applicable, of the acquired intangible assets from the nora acquisition were (in thousands):

 

 

       As of September 30, 2018, the recognized goodwill of $183.3 million and acquired intangible assets, net of amortization of $100.2 million, were assigned pro-rata to the Company’s three operating segments. None of the goodwill is expected to be deductible for income tax purposes.

 

The fair value of acquired accounts receivable was $30.1 million with the gross value being $31.9 million. The Company expects $1.8 million to be uncollectible.

 

       The Company recognized $8.2 million of transaction costs related to the nora acquisition for the nine months ended September 30, 2018. Approximately $4.0 million of these expenses are included in selling, general and administrative expenses in the consolidated condensed statement of operations and $4.2 million are included in other expenses related to the derivative instrument the Company used to address the foreign currency risk associated with a portion of the nora purchase price. The Company also recognized $8.8 million of debt issuance costs in connection with the amended and restated credit facility, which were recorded as a reduction of long-term debt in the consolidated condensed balance sheet.

 

     The amounts of revenue and net loss of nora included in the Company’s consolidated condensed statements of operations from the acquisition date to September 30, 2018 are as follows (in thousands):

 

 

       The following represents the pro forma consolidated condensed statement of operations as if nora had been included in the consolidated results of the Company as of January 1, 2017. These are estimated for pro forma purposes only and do not necessarily reflect the results had nora been included as of the beginning of 2018 and 2017.

 

 

       Pro forma net income for the nine months ended September 30, 2018, excludes any transaction related costs as these are non-recurring costs for the combined Company.

 

NOTE 10 – SEGMENT INFORMATION

 

Based on applicable accounting standards, the Company has determined that it has three operating segments – namely, the Americas, Europe and Asia-Pacific geographic regions. Pursuant to accounting standards, the Company has aggregated the three operating segments into one reporting segment because they have similar economic characteristics, and the operating segments are similar in all of the following areas: (a) the nature of the products and services; (b) the nature of the production processes; (c) the type or class of customer for their products and services; (d) the methods used to distribute their products or provide their services; and (e) the nature of the regulatory environment. Nora results are included in the 2018 figures as of the date of acquisition through the end of the third quarter of 2018, and are included in our operating segments based on the geographic split of the operations.

 

 

While the Company operates as one reporting segment for the reasons discussed, included below is selected information on our operating segments.

 

 

A reconciliation of the Company’s total operating segment depreciation and amortization, and assets, to the corresponding consolidated amounts follows:

 

 

 

 

 

 

 

 

NOTE 11 – SUPPLEMENTAL CASH FLOW INFORMATION

 

Cash payments for interest amounted to $7.4 million and $4.6 million for the nine months ended September 30, 2018 and October 1, 2017, respectively. Income tax payments amounted to $21.2 million and $14.8 million for the nine months ended September 30, 2018 and October 1, 2017, respectively.

 

NOTE 12 – RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

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

 

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

 

In August 2017, the FASB issued a new accounting standard to improve the accounting for hedging activities. This standard will eliminate the requirement to separately measure and report hedge ineffectiveness and requires companies to recognize all elements of hedge accounting that impact earnings in the same line item in the statement of income where the hedged item is reported. The amendments ease the requirements for effectiveness testing and permit an entity to perform qualitative hedge effectiveness assessments. The new guidance is effective for interim and annual periods beginning after December 15, 2018. Early adoption is permitted. The Company has elected to early adopt this standard in the third quarter of 2018 and there was no material effect on its consolidated financial statements.

 

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

 

In June 2018, the FASB issued a new accounting standard to address non-employee share-based payments. This standard will require that the accounting treatment for non-employee share-based payments for goods or services be consistent with current GAAP for employee share-based payments, including measurement of awards at grant-date fair value and the application of probability to evaluate performance conditions. This standard will also eliminate the current GAAP requirement to reassess the classification of non-employee share-based payments awards upon vesting. The new guidance is effective for interim and annual periods beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact of adoption of this standard, but does not anticipate that the adoption will have a material effect on its consolidated financial statements.

 

 

In August 2018, the FASB issued a new accounting standard that modifies disclosure requirements related to fair value measurements. This standard eliminates the current requirement to disclose the amount or reason for transfers between level 1 and level 2 of the fair value hierarchy and the requirement to disclose the valuation methodology for level 3 fair value measurements. The standard includes additional disclosure requirements for level 3 fair value measurements, including the requirement to disclose the changes in unrealized gains and losses in other comprehensive income during the period and permits the disclosure of other relevant quantitative information for certain unobservable inputs. The new guidance is effective for interim and annual periods beginning after December 15, 2019. Early adoption is permitted. The Company does not anticipate that the adoption of the new standard will have a material effect on its consolidated financial statements.

 

In August 2018, the FASB issued a new accounting standard that changes the disclosure requirements for defined benefit retirement plans. This standard eliminates the current requirement to disclose amounts in accumulated other comprehensive income that are expected to be recognized in net periodic benefit expense in the next fiscal year. The standard requires additional disclosures for an entity to explain the reasons for significant gains and losses related to changes in the benefit obligation for the period and clarifies current guidance for disclosures where projected benefit obligations or accumulated benefit obligations exceed the fair value of plan assets. The new guidance is effective for annual periods ending after December 15, 2020. Early adoption is permitted. The Company does not anticipate that the adoption of the new standard will have a material effect on its consolidated financial statements.

 

In August 2018, the FASB issued a new accounting standard to align the requirements for capitalizing implementation costs incurred in a hosting arrangement service contract with the guidance to capitalize implementation costs of internal use software. This standard requires that the costs for implementation activities during the application development phase be capitalized in a hosting arrangement service contract, and costs during the preliminary and post implementation phase are expensed. The new guidance is effective for interim and annual periods beginning after December 15, 2019. Early adoption is permitted. The Company is currently evaluating the impact of adoption of this standard, but does not anticipate that the adoption will have a material effect on its consolidated financial statements.

 

NOTE 13– INCOME TAXES

 

On December 22, 2017, the U.S. Tax Cuts and Jobs Act (the “Tax Act”) was enacted into law. The Company is continuing to evaluate the Tax Act and its requirements, as well as its application to our business and its impact on our effective tax rate.

 

The Company is applying the guidance to address the accounting for income taxes under accounting standards in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act.  Accounting standards provide a reasonable “measurement period” not to exceed twelve months from the date of enactment to complete the accounting of these provisional estimates.  As disclosed in the Company’s Annual report on Form 10-K for the fiscal year ended December 31, 2017, two material provisional estimates that impacted the Company were the U.S. statutory rate reduction and the one-time transition tax. These amounts were considered provisional because they used reasonable estimates for taxes with respect to which tax returns had not been filed and because estimated amounts may be impacted by future regulatory and accounting guidance if and when issued. 

 

For the nine months ended September 30, 2018, there were no significant changes to the Company’s provisional estimates of the income tax effects reflected in 2017 for the changes in tax law and tax rate from the enactment of the Tax Act. The impact of tax law changes on the Company’s financial statements could differ from its reasonable estimates due to further analysis of the new law, regulatory guidance, technical corrections, legislation, or guidance under U.S. generally accepted accounting principles. If significant changes occur, the Company will provide updated information in connection with future regulatory filings or the Company will adjust these provisional amounts as further information becomes available and as we refine our calculations.

 

During the nine months ended September 30, 2018, the Company’s effective tax rate was favorably impacted by the reduction in the U.S. statutory tax rate due to the enactment of the Tax Act. This favorable impact was partially offset by certain base broadening provisions of the Tax Act. For the nine months ended September 30, 2018, our effective tax rate was 24%, as compared to 32% for the first nine month of 2017.

 

 

Accounting standards require that all tax positions be analyzed using a two-step approach. The first step requires an entity to determine if a tax position is more-likely-than-not to be sustained upon examination. In the second step, the tax benefit is measured as the largest amount of benefit, determined on a cumulative probability basis, that is more-likely-than-not to be realized upon ultimate settlement. In the first nine months of 2018, the Company decreased its liability for unrecognized tax benefits by $1.0 million. As of September 30, 2018, the Company had accrued approximately $28.2 million for unrecognized tax benefits. In accordance with applicable accounting standards, the Company’s deferred tax asset as of September 30, 2018 reflects a reduction for $3.3 million of these unrecognized tax benefits.

 

NOTE 14 – ITEMS RECLASSIFIED FROM OTHER COMPREHENSIVE INCOME

 

During the first nine months of 2018, the Company did not reclassify any significant amounts out of accumulated other comprehensive income. The reclassifications that occurred in that period were primarily comprised of $1.2 million related to the Company’s defined benefit retirement plan and salary continuation plan. These reclassifications were included in the other expense line item of the Company’s consolidated condensed statement of operations.

 

NOTE 15– REPURCHASE OF COMMON STOCK

 

In 2017, the Company adopted a new share repurchase program in which the Company is authorized to repurchase up to $100 million of its outstanding shares of common stock. The program has no specific expiration date.

 

During the first nine months of 2018, the Company repurchased and retired 615,000 shares of common stock at a weighted average price of $23.54 per share pursuant to this share repurchase program.

 

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