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spk05: Greetings. Welcome to Armstrong Flooring Incorporated third quarter 2020 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Greg Wainer, interim chief financial officer. You may begin.
spk03: Thank you for joining us today for Armstrong Flooring's third quarter 2020 earnings conference call. I am joined by our president and CEO, Michelle Vermette. In addition to the earnings press release issued today, a copy of the slide presentation to accompany this call is available on the investors section of our website at www.armstrongflooring.com. During this call, we will be making forward-looking statements that involve risks and uncertainties. Actual outcomes may differ materially from those expected or implied. For a more detailed discussion of the risks and uncertainties that may affect Armstrong flooring, please review our SEC filings. Forward-looking statements speak only as of the date they were made, and we undertake no obligation to update any forward-looking statement beyond what is required by applicable security law. In addition, our discussion of operating performance will include non-GAAP financial measures within the meaning of SEC Regulation G. A reconciliation of these measures to the most directly comparable GAAP measures is included in the press release. I'll now turn the call over to Michelle, beginning on slide three.
spk04: Thank you, Greg. and good morning to everyone on the line. Our team remains focused on executing our multi-year transformation to modernize our operations and become a leaner, faster-growing, and more profitable company. During the quarter, we made great progress across many initiatives. Our results were largely in line with our expectation, in which we produced sequential top-line improvement compared to the second quarter of 2020. primarily from stronger trends in residential end markets that have outpaced a slow recovery in commercial activity within the U.S. In addition, results from our international operations have improved sequentially, primarily in China. We were pleased that our residential business grew in the third quarter, led by strong demand at home centers, and supported by the actions we have taken in our go-to-market approach and refined customer-centric operating model. Additionally, record low interest rates and de-urbanization trends have fueled growth in new residential construction, an area where we are working to deepen our presence through increased targeting of single and multifamily builders. Home centers have generally continued to operate at a robust pace, offsetting lower activity at some independent customer retail locations. As evidenced by recent data from the Architectural Billing Index, commercial activity is choppy in nearly every sector in geography. On the commercial retail side, some customers' projects have been postponed as they reassess demand or floor plans. This dynamic is also evident at larger institutions. For example, in the education sector, many operators are focused solely on reinventing their own operating model to adapt to evolving policy, with less time to spend on planning remodeling projects. We are noticing the same trend with hospitals, who are cautious on starting major renovation projects as they do not want to have any capacity limitations whatsoever in this environment. These are just a few examples of what has been an overall softer commercial demand environment as the pandemic has progressed. Looking ahead, we expect residential activity to continue its recovery at a strong pace, while commercial demand will likely be pushed out. I will also note that we experienced benefits from several commercial rollouts in the fourth quarter of last year, which will not reoccur in the fourth quarter of 2020. Furthermore, inconsistent state and local government orders related to COVID-19 have resulted in and will continue to have varying impacts on Armstrong Flooring and some of our customers. Despite these complex market dynamics, I'm extremely proud of our team's progress and efforts to execute the projects as part of our business transformation. With greater access to capital, following our debt recapitalization in June, we've been able to ramp up more of our planned SG&A investments. We are focusing on the factors that are in our control, and the disciplined execution of our strategy is already leading to some benefits that have set the foundation for our long-term transformation. Armstrong Flooring is listening more intently to its customers and becoming more competitive both in product quality, service, and the overall presentation of our products in the marketplace. The positive feedback from customers is translating into a stronger desire to work with us. This is opening new doors for our company on many fronts. I will build on this as we turn to slide four to discuss more details on our business transformation. As a reminder, our strategy encompasses three critical objectives that include expanding customer reach, simplifying products offering, and operations. and strengthening our core capabilities. We're expanding our reach with customers in the third quarter. We add resources to our commercial national account sales team and our residential sales team, with an increased focus on targeting home center business. In addition, we continue growing in the number of our sample displays and other sales initiatives with the National Flooring Alliance. To quantify that, at the end of September, we already have increased our displays over 85% compared to the end of the first quarter. On top of these sales efforts, we are pleased to have recently announced the appointment of our new head of hospitality sales. This is a completely untapped vertical for AFI that we're pursuing from a long-term perspective in an area where we do not have a material presence historically. And most importantly, we already produced the rest and refuge line of flooring that will be provided to that vertical. As more hospitality providers see early signs of demand, we expect them to start modernizing their properties so they can be more competitive when demand returns to more normal levels. Expanding our presence into more verticals is a significant area of future upside. These collective actions represent major steps forward in our go-to-market capabilities that we expect to better utilize our capacity as time progresses. In regards to simplifying our business, we have undertaken several initiatives to simplify our product portfolio, optimize inventory, and improve operational efficiency. Last quarter we discussed the relocation of our corporate headquarters. which will become effective in the summer of 2021, with estimated annual lease savings of approximately 60%. In the third quarter, we start upgrading our plant lines in Kankakee, Illinois, to improve the throughput and scale to service new products from that line going forward. This is in part to manage a transition of production from our Southgate facility as we look to monetize that asset. In addition, we continue to reduce our mix of underperforming SKUs, and we have put several initiatives in place to optimize our inventory levels. We have also implemented various initiatives to remove certain bottlenecks out of our manufacturing processes, which are already leading to improved productivity across some of our plant lines. These simplification exercises are leading to strengthened service capabilities with customers. which is the third pillar of our business transformation. With improved organization and movement of our inventory comes greater opportunities to better service our customers. On this front, we have recently introduced a new Quickship program, which has allowed us to take advantage of some quick service opportunities for our distributor partners. Project timelines continue to contract, particularly on the commercial side. making agility and speed for manufacturers increasingly important. A quick ship program is one more way we will be able to accommodate these accelerated timelines. Innovation remains an important part of our goal to strengthen our capabilities with customers. We continue to invest in innovative product offerings with the intention to manufacture more of our LVT in our facilities in the U.S. As we listen more intently to customers, our service is getting better, and feedback from customers is improving. We're increasingly being perceived by the marketplace as a more customer-centric company, which is also helping us attract great new talent. We recently appointed our first VP of Logistics, who will help us enhance our interactions with customers by aligning our capabilities with their expectations. Working through a business transformation during a global pandemic is not an easy task, but we are pleased with our progress considering the circumstances of these unique times. We're focusing on the factors we control, and we will continue to manage through any changes in demand or in the marketplace. With all that said, I would like to reiterate the important point we have stated in prior calls. Our operating results in the short term will continue to be pressured by incremental expenses necessary to execute our business transformation initiatives. We are making significant progress in executing our strategy in this complex environment, but we are still in the early stages. Having now been CEO of Armstrong Forum for just over a year, I'm more confident than ever in the immense upside potential of our company. Earlier this week, we announced an important update to our leadership team with the hiring of Amy Trojanowski, the position of Chief Financial Officer. We're pleased to welcome Amy's well-rounded financial expertise and her fresh perspective to our executive team. As we continue to execute on our business transformation, her proven record of building world-class finance organization makes her a great fit for Armstrong Flooring. I look forward to working closely with Amy as we further advance her company's transformation. Before I turn the call over to Greg, I would like to thank him for his service and dedication to help us build value during his tenure with us as interim CFO. I equally appreciate his assistance with advising Amy in a consulting capacity to ensure a smooth transition. I will now turn the call to Greg to provide additional updates on our financial performance and liquidity.
spk03: Thank you, Michelle. One of my key initiatives as interim CFO was to help hire an exceptional operator for the permanent CFO position. I could not be more excited with Amy, and I look forward to assisting her during this transition period. Now, I'll provide a review of our third quarter financial results on slide six. As Michelle mentioned, our results were in line with our expectations, including a sequential increase in sales. On a year-on-year basis, revenues were $156.6 million compared to $165.6 million in the prior year quarter. Increased activity at home centers and other residential channels helped to partially offset COVID-19 related business disruptions. mainly the postponement of certain commercial projects, and slower activity at many of our independent customer retail locations. Adjusted EBITDA was $2.8 million in the third quarter of 2020. Favorable product mix amounted to a roughly $3 million EBITDA benefit, which offset half of the $6 million impact from lower volume. Adjusted EBITDA was approximately $6 million of incremental SG&A, resulting primarily from transition service agreement income in the prior year quarter, which did not reoccur, as well as planned growth investments to support our business transformation. Improvements in manufacturing productivity and lower input costs contributed positive impacts of approximately $2 million and $1 million, respectively. As a reminder, We entered 2020 with SG&A headwinds totaling $20 million as a result of benefits incurred in 2019 from income related to the transition service agreements with the buyers of our wood flooring business, with approximately $4 million of that in the third quarter of 2019. We expect a similar SG&A impact of approximately $4 million in the fourth quarter of 2020. Looking at our cash flow on slide seven, during the third quarter of 2020, we spent $4 million in capbacks with spending related to manufacturing consolidation, maintenance and safety, and other key initiatives to support long-term growth as part of our business transformation. Operating cash usage was $9 million during the third quarter of 2020. As we mentioned last quarter, we don't expect the remainder of the year to follow normal cash flow patterns, and we have implemented numerous measures to preserve cash as necessary. Cash flow will continue to reflect incremental CapEx to execute our business transformation. Additionally, we expect inventory levels to increase in the short term to support our new Quick Shift initiatives as well as the transfer of production from our Southgate facility. At September 30th, 2020, we had total liquidity of approximately $110 million, including cash of $22 million plus availability under our credit facilities. We have no significant debt maturities until the year 2023. Prior to the onset of the pandemic, we began to assess monetization of non-core assets, namely our Southgate facility and land portfolio. As we indicated in our press release today, given our intention to sell Southgate, we have reclassified that property as an asset held for sale on our balance sheet. Under the terms of our credit agreements, $30 million of availability will be withheld under the credit facilities. The withholding will begin upon the filing of our third quarter Form 10-Q and continue until we close on the sales south gate. Factoring in the $30 million to be withheld, our available liquidity will be approximately $80 million. We believe that we have ample financial resources to effectively execute our near and long-term objectives. Looking ahead, we will remain focused on additional actions to optimize our liquidity and cash as necessary. I will now turn the call back to Michelle for closing remarks.
spk04: Thank you, Greg. In conclusion, I'm extremely proud of the Armstrong Flooring Team for their unwavering commitment to transform a business while providing the best possible service to our customers. Positive feedback from customers in regard to our service enhancement leaves us confident that we are on the right path to improve our market positioning and set the stage to ignite growth in the coming years. Through our customer-centric operating model, we will continue to approach opportunities with a returns-oriented mindset. while keeping our focus on the three core areas that include expanding our reach within our addressable flooring market, simplifying our processes, and strengthening our competitive positioning for long-term success. We look forward to updating you in the coming quarters as we make further progress on our business transformation. Thank you again for joining us today.
spk06: Operator, please open the lines for questions.
spk05: And at this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. The confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.
spk06: One moment, please, while we poll for questions. And our first question is from Brian
spk05: from Thompson Research Group. Please proceed with your question.
spk01: Hey, good morning. Thank you for taking my questions. I wanted to start and see if you could talk about the cadence of sales throughout the quarter. And I guess really going back, thinking, you know, April was down 20% and Q2 was down, I believe, 18%. So some better trends there, but not super meaningfully. But then it seems like things really picked up at the end of Q2 and into Q3. So I guess just how did sales trend throughout Q3 and maybe into October, if you have any insight?
spk04: Well, I think the positive, and thank you for joining the call. Appreciate you being here. So I won't give comments per month, but I think overall we're definitely the trends in Q3. We're more bullish than Q2, and we expect that to continue, in particular on the residential side. The home center, new construction, and I would say even in remodels. Commercial remains a challenge, as we saw with the ABI and the number of projects being listed. So we expect continued improvement in residential overall and with some challenges in commercial. But I think the trend is positive overall, and we expect continuous improvement in that area.
spk01: Okay, and maybe we could segment out the big box and home centers and just focusing on them for a minute. Some of our contacts had mentioned that their sales into the big box stores were up even more than what the big box stores were reporting overall, so really robust sales there. Your commentary seemed consistent with that theme, but I wanted to see if there was anything more to add on that. And if you think those trends will continue into Q4 or if that might return to a more normal cadence going into the end of the year?
spk04: Well, the feedback we're getting from the home centers is they remain bullish on their outlook. And let's face it, they have a competitive advantage in this setting with their operations, their ability to go through. We expect continued good results in the home centers in that area, and we expect that to be a bright spot, definitely for the business. So I think there will be continued momentum there as people want to remodel their home and attend to projects that they've been waiting for. But, yeah, we're bullish on the home center channel for sure.
spk01: Okay, that's good to hear. And I think we can switch to maybe the independent retail segment next. Some of your comments said slower activity. I would have thought maybe we would have seen a little stronger demand once this reopened. I guess, could you talk about more about that slower activity and if that was due to maybe COVID restrictions and maybe still some shutdowns on the actual independent retailers or if that was more of a lack of demand from buyers walking into those retail stores?
spk04: I think it's very regional specific. As you know, there's very different safety protocols in different parts of the country. So definitely where states that are more open are definitely having good results. Actually, some retailers are commenting that their business with the pickup in Q3, they expect actually some of them to be up for the year. So I think it's geography-based, but from a national perspective, when you have some big states like New York, California, and others that represent a large demand of the remodel piece in particular that have restrictions, that definitely impacts the national average overall. So I think the independent retail is better in Q3 than Q2, and depending on what happens with this market, stimulus and the new activity and, you know, depending what government position will be on COVID-19 in the coming quarters, I'm sure that will impact. But overall, I think the trend should be bullish in there, just maybe take a little longer based on the different state restrictions for retailers.
spk01: Okay, but you are seeing some pockets of strong demand, but when you, like you said, when you go to the national level and you have some of those larger restrictions, it does drag down the overall.
spk04: That's right. That's kind of to put in context. That's well said.
spk01: All right. Understood. At least we're seeing some regional strength. And then I guess still on the kind of the resi R&R and the specialty independent retailers, I think on one of the previous calls, it was mentioned that the true test for activity in that segment might really be in this October-November timeframe, kind of once those backlogs from before start to roll off. Are there any early indications on that thought now that we're kind of almost through October, and if there's any update to that thought?
spk04: I'm bullish on the independent retailer as they improve and stabilize. I think, Pete, to your point, right now everybody's trying to work through their backlog. It's hard to get qualified labor. Labor is probably the biggest limitation in the industry, talking to residential remodel contractors. So they're working hard to execute. And also with builder being so strong in certain areas, everybody's competing for some of the same resources depending on the marketplace. So I think residential, I said, both in new construction or remodel should be a bright spot for the rest of this year and next year.
spk01: Got it. I do have a few more questions, but I'll jump back in the queue for anyone else on the call.
spk06: All right. Appreciate that. Thank you. And our next question is from Keith Hughes from Truist.
spk05: Please proceed with your question.
spk00: Thank you. A question on product availability. Have you had issues or have any of your distributors have issues with just not having the right products due to the surge of demand we've seen in residential? Any demand push to the fourth quarter? Any sort of comments on what you're seeing there would be helpful.
spk04: We've been pretty lucky, Keith, and thank you for joining. We have put a lot of effort improving our service and our metrics. So we actually had our best service in Q3 than probably had some time, and that's the effort of us modernizing our processes and being in touch with our customers. So we've had actually pretty limited disruptions. There's some transportation challenges right now. Trucking is a little more difficult to get the base as demand picking up across the country. But for product availability, we are definitely moving the ball in the right way. And I'm pretty bullish that that's how we're also changing our relationship with our customers. So we've done a really nice job there with the team to stay ahead of our customers and making product available. And we've also increased our U.S. offerings. So it probably allows us to be more nimble and more responsive than some others that depend on long supply chains.
spk00: Second question, within your residential product offering, I'm going to assume LVT is your best growth product. But have you seen in the last six months as all the changes have gone LVT with the tariff coming in, the hot and cold demand we've seen for consumers, Has it changed the trajectory of LVT growth at all?
spk04: Well, I believe LVT will still be a growth category for this. We were fortunate to grow our LVT in Q3, which is definitely a positive, and I expect that to continue to get better in Q4. I think for the next three years, Keith, I think we can see definitely high single-digit, low double-digit growth in LVT for the next two, three years. You just see it taking share from the other categories. You see builder offerings changing, and LVT just has a competitive advantage due to maintenance and sound now. So it's still taking share from the other categories, and I expect that to be a bright spot for us and in the industry.
spk00: That would be a deceleration in the last several years, but I guess a lot of numbers are coming into play to a certain extent here.
spk04: That's the math, but still, as you know, 10% to 12% of that category of a bigger base is still large numbers and opportunities for all of us.
spk00: Good point. I guess final question. The TSA you refer to, how long will that be in the numbers?
spk06: Greg, you want to take that one?
spk04: Maybe he's going through. You'll see another $4 million, I believe, Keith, in the fourth quarter, and then it's really tailed off. So that will be the last quarter that we'll have to compare to that. Okay.
spk06: All right. Thank you. Thank you, Keith.
spk05: And our next question is from Ken Zimmer with KeyBank Capital Markets. Please proceed with your question.
spk02: Good morning, gentlemen. Good morning. Morning. I just, I want to take a step back if we could, given, you know, obviously COVID is impacting the business, but there are structural issues. And I just want to get kind of an update on the reference point. You know, starting with, you know, how the industry, the tariff factor, I believe about 30% of your business is LVT, kind of split commercial res. Can you just talk about how you know, tariffs, what impact it is having in the U.S. market by category and, you know, how much of that market is actually being impacted that's being imported versus your domestic capacity, just so I can understand, you know, how pricing is affecting things.
spk04: So on overall spread for the industry, I believe the latest number I saw was about 85% is sourced and 15% is made in the U.S., even though there's Capacity being added, it's definitely not keeping up with the growth that we talked earlier there. So source is still the largest part by far. But I would say the sources of supply are expanding. So to your point, China supply chains have been impacted by tariffs, but ourselves and many others have basically diversified the supply chain in other countries such as Vietnam, Korea, and others. And so there's more supply from other locations, and I would say many of the North American providers are now sourcing a large part, if not all, from these other countries to avoid any unknowns to tariffs. So definitely there's been some pricing actions to recognize those impacts. So it has impacted certain product lines, different manufacturers differently depending where they are in that change in the supply chain, and probably dampened some demand in the short term. But I think there's a reset there, and as we all diversify that supply chain, that will only be better. And that's also why we augmented our U.S. offering to be more competitive and not have to deal with that complexity for everybody.
spk02: Appreciate that. Would you say because of the emphasis of sourcing from China where the tariffs are being impacted, has that taken away some of the pricing power? What had been, I assume, a tailwind for price asks has diminished? Or how is the industry responding to that in terms of the end market?
spk04: Well, as you know, the market is competitive, right? So there's definitely been a lot of I think you've got to keep the different products competitive with each other, and when you're getting multiple sources of supply, you have to be relevant to the marketplace. So I think pricing is going to remain competitive, and I think the sources of supply are going to be less relevant. There's just some price points for key products that you just have to meet if you're going to compete. And I would say it's fairly stable right now. And we just got to stay relevant and bring up the right innovation to make it there. The other thing that's good about LVT, you see longer, wider, you see some trends also, beefier products that are actually helping the price point that were not as prevalent maybe 24 months ago. And so that's also offsetting some of the overall categories. So there's just some better-looking, higher-end products that are out there versus just the two and a half mil, two and a half, 12 mil product or six mil product.
spk02: Understood. Thank you. If I could switch gears a little bit just for, you know, business transformation obviously can be very powerful for a company. As you, given your time so far at the company, when you think about what the future will look like and you talk about SKU rationalization, which has got to be a big part of, you know, margin expansion in a, you know, in the categories that aren't growing. How do you approach that? I mean, there's many different ways, right? Rationalization could be 80-20. You reduce your fixed cost basis. You reduce your channel concentration. How does it work? I think about 75% of your sales are to distribution in the U.S., but how do you maximize, you know, what's your approach essentially to get these SKU costs down dramatically? yet have them more effective in the end market, just given you've been there for a year. I appreciate it. Thank you for your time.
spk04: I appreciate it. Very good question. So we go product by category. We start by simplification. So the company has a broad portfolio for many years. Some of that was dated and some we need to revamp. So To give you an idea, so far we discontinued about a third of the SKUs we had the same time last year. Some categories, the mature categories such as VCT and residential sheet vinyl have had a lot more than others. We've actually invested in LVT and you see that our gross margin is trending up year over year and improving in that regard. And we have reset our footprint. We consolidated our residential sheet activities into for felt into Lancaster. We consolidate our VCT operation from Southgate to both Jackson and Kankakee. And we'll do now the same thing for peel and stick. So we reset the footprint to get higher utilization, more simplified runs, higher margin product, to your point, to go through. So it's really done in a very surgical way category, category. Some of this, we're just getting the early benefits as of now to go through. And also, I would say the feedback of the different products has been very, very good across the business. So it's a journey to turn around the whole portfolio. But, you know, just like I look at our overall business for the quarter, you know, every product category is up other than our VCT category that is dealing with challenges both in mass retailers that don't want to disrupt or hospitals or education that I mentioned. So it's definitely we're doing this and still growing the business in the other categories as we're changing our offering. So I think that's only going to get better in the near future.
spk06: Thank you very much. Appreciate it.
spk05: And our next question is from Brian Beros with Thompson Research Group. Please proceed with your question.
spk01: Hey, can we just touch on the commercial market a little bit? It sounds like health care and education have kind of hit a wall now based on your comments after previously being bright spots. I guess any more color there and then any comments on other end markets in commercial and whether things maybe are expected to bounce back in the first half of 2021 or maybe it's still too uncertain to call. Any thoughts on those?
spk04: Well, as you saw in the ABIs, a lot of people are looking at projects, but a lot of people are postponing. So you think of commercial, the areas, some of the areas where we have significant presence, such as retail or education or hospital, right? They're probably retailers that are open, don't want to disrupt their operation. We still have the same specs. They're just making sure that they can operate freely. They don't want a disruption of contractors or work. That demand is still there. It will pick back up when there is better outlook on the pandemic. No one thought this pandemic would be this lengthy when we went down that road or got impacted in that March-April timeframe. And you look at schools, I mean, they're reinventing their whole model with technology and processes and many of them don't have students in their buildings, so their priorities are somewhere else, right? And, naturally, hospitals, they want to keep their capacity open for any changes. So there's realities out there. As we know, hospitality, we really don't have any presence, but have worked in that market for many years. Many operators are impacted, and their demand is significantly down in the whole tourism industry. And corporate, many corporate offices, in particular in major cities, are still very limited in capacity. So everybody's kind of thinking through that. I think the commercial market will be the more challenging market for the coming 12 months, and we've adjusted to that. But within that, for a company like ours, there's a lot of opportunities across that. But I think for the industry, I think that's probably the biggest question for the 2021 demand.
spk01: And then last one for me, kind of related to Keith's question about product availability. I heard some other flooring manufacturers have kind of had to play catch up once things are reopened in terms of restocking the retailer inventory. And to do that across multiple SKUs required shorter, more frequent production runs, but that comes at the detriment of margins. Did that come into play at all for AFI in the quarter?
spk04: I would say we probably took some actions to increase our inventory in the right areas early based on feedback we got from customers. There's always opportunities there, and that's also based on the feedback we're getting in the industry. That's why we introduced our QuickShift program, and that's been a nice success in that regard to get more demand. So to your point, the supply chains are more challenging and the patterns are a little bit different, but we were fortunate to have been focusing on service since I started. And we took some bets and we're happy that we were able to service our customers at a high level and we'll continue to do so. Thank you. Thank you. Thank you for joining the call.
spk05: And we have reached the end of the question and answer session, and I'll now turn the call over to Michelle Vermette for closing remarks.
spk04: Well, thank you very much. I appreciate everybody joining the call and look forward to talking to you next quarter as we continue progressing and improving our operations. So, thank you very much.
spk05: And this concludes today's conference, and you may disconnect your lines at this time. Thank you for
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