Armstrong Flooring, Inc.

Greetings and welcome to Armstrong Flooring Fourth Quarter 2020 Earnings Conference Call. At this time, all participants are on 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. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Amy Trojanowski.

You may begin.

Thank you for joining us today for Armstrong Flooring's fourth quarter and full year 2020 earnings conference call. I'm joined today 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 investor section of our website at 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 are made, and we undertake no obligation to update any forward-looking statement beyond what is required by applicable securities 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 and the slide presentation posted on our website. I'll now turn the call over to Michelle, beginning on slide three.

Thank you, Amy, and good morning to everyone on the line. I will begin with a brief overview of our business highlights Then Amy will discuss our financials in more detail before I close with a review of our business transformation progress and our outlook for 2021. 2020 was a transformative year for Armstrong Flooring, and I could not be prouder of our team for their resiliency and dedication to staying safe and delivering exceptional service to our customers. In March 2020, we announced our multi-year plan to transform and modernize our business Since that time, we have pursued Project Group under three critical objectives. One, expanding customer reach. Two, simplifying our portfolio and organization. And three, strengthening our capabilities. Shortly after introducing our plan, the COVID-19 pandemic created an unprecedented environment for the global economy as many governments, communities, and companies implement strict controls to minimize the spread of the virus. During that time, we shifted our immediate focus to prioritizing safety, financial flexibility, and operational efficiencies. With our debt recapitalization in place by mid-year, we then had the financing and the financial flexibility to progress further with our planned business investments. Against that backdrop, macro trends have further supported our strategic initiatives, and we see that continuing in 2021. Residential housing construction remains positive for our customers, with this end market continuing to grow in importance. Across the industry, seasonally adjusted single-family housing starts are up 28% as of December. Other indices, such as the Harvard's leading indicator of remodeling activity, are predicting a 3.8% increase in 2021, similar to trends in the fourth quarter of 2020. While the commercial end market remains murky for 2021, we anticipate that the worst may be behind us. The architectural billing index, ABI, while still below 50, has been improving after bottoming in April 2020, providing a better indicator for the commercial end market as we look forward. In the short period of time since we announced the transformation, We have made significant progress in overhauling our product portfolio, reengaging with customers, introducing innovative products, and rebalancing our residential and commercial footprint. In short, we have done exactly what we said we were going to do, despite the pandemic impacts on our business throughout the year. We are dedicated to becoming a leaner, faster growing, and more profitable company. and the fourth quarter provided further evidence of our progress. As it relates to our financial performance, fourth quarter results were in line with our expectations. We improved our top line year over year as we capitalized on the strong recovery in residential end markets in North America. More importantly, we increased our investments in internal efforts to ramp up our transformative initiatives. Specifically, in the fourth quarter alone, we introduced new and innovative products to expand our addressable market. We improved the utilization of our plants with increased productivity and yield. We also added capability to our Kankakee facility to facilitate the transition of our tile consolidation. We implemented our simplified price increase, which became effective in January 2021, to combat tariffs and raw material-related impacts. And finally, we launched a new and modern corporate rebranding, including a new website that is driving higher level of customer engagement. In regard to end market activity, stronger trends in residential end markets have continued to outpace a slow recovery in commercial activity within the U.S. We were pleased that our residential business grew in the fourth quarter. as the actions we have taken to improve our marketing and sales efforts were supported by continued strong residential demand. Low interest rates and de-urbanization trends continue to fuel the growth in the housing starts, and we expect this trend to continue in the coming quarters. On the commercial side, we have business in healthcare, education, and retail and markets. In this environment, the retail businesses that are doing well do not want to lose momentum by disrupting their stores for a renovation project. And many of the businesses that aren't doing well have limited resources for capital investment. So to that point, we expect retail to remain challenged into 2021. On the healthcare side, remodel in existing facilities has slowed significantly while the new construction environment is holding up, but activity remains slower than normal. Renovation projects can only be delayed so long before obsolescence and maintenance becomes an issue. If you take that factor into account, this creates pent-up demand for renovations over the long term. Our team is focused on executing to grow sales in 2021, and we believe we will continue to capitalize on strong demand tailwinds, most particularly in residential and markets. These market indicators have been considered as we introduce our 2021 top-line growth expectations. I will provide further detail on our progress under each of the three key areas of expand, simplify, and strengthen later in the call. However, the important takeaway here is that we are making great progress against our goals. Overall, we are confident that we are making the right long-term decisions to position our business for future success. Success begins with service. And another important point is that we have created a step change in the way we service our customers in 2020 versus 2019. Armstrong Flooring's products are finally getting widely recognized again. We received many awards in 2020 for the recognition of our innovation, as well as our environmental stewardship in the industry, reflecting the strength of our brand. An example. Green Builder Media ranked Armstrong Flooring as number one in sustainability among 10 leading companies included in the flooring category. We received the 8X Platinum Award for our American Personality 12 product. Good Design, one of the oldest and most prestigious design awards programs, recently recognized our rigid core essentials, unbound, MenPure, and Regim Nation Restore products in their floor and wall covering category. Of the 11 products in this category, Armstrong Flooring received four recognitions. We were named the winner of the Environmental Excellence Award sponsored by Keep Oklahoma Beautiful as a result of our environmental stewardship to reduce process waste at our Stillwater plant. We are grateful for this recognition that would not have been possible without our talented design and operation teams who are working hard to help Armstrong Flooring reach its full potential. I will discuss additional progress updates on our transformation later in the call, but before that, I will now turn the call to Amy to provide detail on our financial performance and liquidity.

Thank you, Michelle, and good morning to everyone on the line. I'm honored to be a part of the Armstrong Flooring team and excited to see our company enter 2021 on much stronger footing in our goals to achieve greater success. I'll now provide a review of our fourth quarter and full year financial performance. Turning to our fourth quarter results on slide five, we were pleased to produce fourth quarter results that were in line with our expectations. On a year-on-year basis, revenues increased 1.8% to $143.9 million, compared to $141.3 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. In the quarter, our residential revenues were up over 2019, while commercial revenue declined over the same period. Volumes were a greater driver of residential revenue growth in the fourth quarter of 2020, and we should see the benefits from late 2020 pricing actions into 2021. Fourth quarter 2020 adjusted EBITDA was a loss of $14.5 million. We realized higher tariffs and an unfavorable mix of raw materials versus the prior year quarter. Adjusted EBITDA had approximately $4 million of incremental SG&A, resulting primarily from transition service agreement income in the prior year quarter, which did not recur, in addition to planned growth investments to support our business transformation. Also worth noting is that we experienced benefits from several commercial rollouts in the fourth quarter of last year which did not recur in the fourth quarter of 2020. Looking at our full year results on slide six, net sales declined 6.6% to 584.8 million as compared to 626.3 million in the prior year. The decrease in net sales was primarily due to the effects of COVID-19 on our business, particularly in the second and third quarter of 2020. For the full year, residential sales were up, representing 40% of our total revenues, reflecting a shift from our historical 35% trend. Commercial sales declined year over year, representing a total of 60% of our overall revenues. Full year 2020 adjusted EBITDA was a loss of $6.3 million as compared to EBITDA income of $24.4 million in the prior year. The decrease in adjusted EBITDA was primarily due to lower net sales and increased investments to support our transformation initiatives. In addition, we entered 2020 with SG&A headwind totaling around $20 million, resulting from benefits incurred in 2019 related to our transition service agreements with the buyer of our wood flooring business. That headwind ended in the fourth quarter of 2020. Turning now to free cash flow and liquidity on slide seven. During 2020, we invested 21 million in CapEx with spending related to manufacturing consolidation, maintenance and safety, and other key initiatives to support our long-term growth. We also incurred approximately 17 million in incremental costs associated with our business transformation projects in 2020. In turn, our operating cash flow was modestly negative for the year and in line with our expectations. Cash flow will continue to reflect incremental capex and investments necessary to execute our strategy into 2021. Additionally, as we mentioned on our last earnings call, our inventory levels have increased in the short term to support our Quick Ship initiative, as well as the transfer of production from our Southgate facility to our Kankakee, Illinois facility. We continue to prioritize the monetization of non-core assets, namely our Southgate facility and land portfolio. As we indicated last quarter, given our intention to sell Southgate, we reclassified that property as an asset held for sale on our balance sheet. Under the terms of our credit agreements during the fourth quarter, $30 million of availability was withheld under our credit facilities. This withholding will continue until we sell the Southgate site. At December 31st, 2020, we had total liquidity of approximately $53 million, including cash of approximately $14 million plus availability under our credit facilities. The sequential reduction in our available liquidity represents the $30 million withheld for Southgate, as well as working capital, other capital investments, and the previously mentioned inventory build to implement the changes as part of our manufacturing consolidation initiatives. We have no significant debt maturities until the year 2023. Moving into 2021, we will continue to execute our plan to expand, simplify, and strengthen our business to generate stronger performance and augment the trajectory of our long-term profitability. We believe that we have ample financial resources to effectively execute our near-term and long-term objectives. I will now turn the call back to Michelle to discuss our business transformation progress and 2021 outlook.

Thank you, Amy. I will now provide some additional details on our transformation progress. These collective strategic initiatives should translate to improved earnings, cash flows, and overall returns. we'll start with expanding our customer reach on slide 10. In the fourth quarter, we continue to directly service the National Flooring Alliance, where we have nearly double our sales displays since Q1. Other key national accounts and home centers remain a significant area of long-term focus for us. Prudent investments in sales and marketing are crucial to the long-term success of our customer-centric operating model and in the second half of the year, we added resources to our sales team to expand our reach in both existing and untapped verticals. The pandemic initially delayed our ramp-up on the go-to-market side by several months, most particularly as it relates to access to our customers. However, our team was able to get creative to offset that impact, and we were able to make significant strides as the year progressed. On the product side, We believe we will continue to outperform in LVT because of the actions we are taking to improve product mix, utilize QuickShift, and capture additional share in areas where we have not participated in the past, such as hospitality. In the fourth quarter, we hired our head of hospitality, who has wrapped up quickly to target that segment proactively for the first time in our history. Reorganizing and augmenting our supply chain resources to reduce costs and increase efficiencies also allowed us to enhance our customer reach in 2020. Last quarter, we discussed our Made in America QuickShip program, which continues to receive positive customer feedback. The QuickShip program has enhanced our relationship with distributors' partners by providing them with a more efficient means to execute on tight project timelines. To date, the program has contributed to an increase in capacity utilization at our Lancaster facility by 33%, an encouraging result. Turning to the simplification of our portfolio in organization on slide 11, the key takeaway on the simplification is that we have optimized the production output and rationalized the capacity of our plants this year versus last year. Our consolidation and streamlining actions have provided Armstrong Flooring with a better manufacturing footprint that is operating more efficiently. These efforts included the recent consolidation of our residential felt sheet and VCT manufacturing lines. We also completed the manufacturing closure of our Southgate facility with final production on February 12th. Consolidation and streamlining of our plants has produced positive absorption impacts. Our lines are experiencing improved productivity and we're running less unplanned overtime. Into 2021, we will continue to optimize shifts with demand as we will realize further efficiencies. We reduced our SKU count of underperforming products by 31% in 2020. We have simplified our product pricing approach as well. In December, we enacted price increases of 5% to 9% on our products that became effective on January 15th to help offset some of the impacts to our business from inflation and tariffs. And in the first quarter, we plan to launch an alternate LVT product refresh and a new sheet product refresh, both of which will be manufactured in the US. Overall, during 2020, we dramatically simplified our product portfolio reduce administrative overhead, optimize inventory, and improve our operational efficiency, but there is still more work to be done. Looking at the strengthening of our capabilities on slide 12, the various work streams we have implemented to date have helped strengthen our overall capabilities for our customers, We are revamping and modernizing all processes, workstreams, product designs, productivity, and our culture to raise the bar on our ability to service customer. As a result, it's much easier to do business with Armstrong Flooring than it used to be. And we anticipate continuing enhancements. Our service is improving, and feedback received from our customers to date has validated our approach. In regards to our financial capabilities, our debt recapitalization was completed in mid-year, strengthening our balance sheet, enabling us to make the needed investments to transform the business. During the fourth quarter, we launched our new corporate branding, which will be incorporated into retail programs across our footprint. Initial receptions of both our new branding and corporate websites have been outstanding. We're grateful for those who help bring this refreshing and modernized new look to Armstrong Flooring. Another example where we have strengthened capabilities is that with the closure of our Southgate facility, we have transferred Southgate's production capabilities to our plant at Kankakee to absorb the demand while maintaining a distribution presence with our new Southern California Distribution Center to support our West Coast customers. It is evident that the actions we have taken to simplify our operations in product portfolio have also strengthened our service capabilities. We are now better able to focus on in-demand products that are important to our customers, where in the past we spent too much time pushing outdated, lower margin products. As an example of this, we have augmented our LVT capacity at our Stillwater facility to produce multiple in-demand product lines. We have also modernized our Jackson plant to streamline production capabilities. On the administrative side, our headquarters relocation project is moving along and is on track to be completed by the second quarter. As a reminder, we expect this move will provide us with cost savings on our corporate headquarters lease of approximately 60% annually. I will now discuss our outlook for 2021 on slide 13. In 2021, we expect to improve our top line driven by strong residential activity, particularly in LVT product categories and partially offset by declines in VCT categories. Commercial demand will likely continue to be pushed out. Our recently announced price increase and expansion into additional market segments will also support our growth prospects. In addition, we will continue to focus on improving our growth profit over the long term. But to do this, we have to invest in SG&A and reinvest in the business, albeit cautiously and with a return-oriented mindset. We expect improvement to adjusted beta in 2021 to be supported by top-line growth as well as benefit from our transformation. We expect growth to be weighed towards the back half of the year as the market environment improves. It's important to note that 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. We're also carefully monitoring potential raw material inflation impacts and rising transportation costs. As we have stated on prior calls, our operating results in the short term will continue to be limited by go-to-market investment necessary to execute our business transformation. Results will improve as we grow into these investments. In conclusion, we believe Lantern 2021 as a better company in all aspects. And I'm grateful for the focus and dedicated efforts of the Armstrong flooring team to work through a complex environment in 2020. We have created a culture of continuous improvement with a long-term decision-making mindset. As you saw and heard today, we have made significant progress on our strategic plan, but there's still much work to be done. That said, we remain confident that we have the right leadership team and plan in place to return to long-term growth and profitability. We look forward to updating you in the coming quarters as we make further progress. Thank you again for joining us today. Operator, please open the lines for questions.

Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 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. One moment, please, while we poll for questions. Our first question comes from Keith Hughes with Truist Securities. Please proceed with your question.

Thank you. I have a couple questions. Number one, you've highlighted a lot of change going on in the business, some costs coming out, some investment coming back in. Without the assist of volume gains or N21, What would that cost work do to this negative six EBITDA that you just reported? Would it improve on that, or are you going to need volume to make that move up?

Keith, well, thank you for joining us. One, we do expect volume to be better, first and foremost. Just with the efforts maturing both on the residential side that we have done. And to your point, costs, we just stopped manufacturing in the Southgate facility recently. So that base of costs will be coming out at the end of March. So that is not there. So the staffing will be eliminated. So that will be definitely a reduction in our cost base that will be helpful across the platform. So those initiatives will be paying off also. So we'll continue working through it. Also, the headquarters, as I mentioned in the second half, will be significantly reduced. That expense will benefit us going forward. There'll be other costs that we will be spending to participate in other verticals. There'll be some give and take, but we definitely expect both top line and adjusted EBITDA to continue improving as we go forward.

Okay. You talked about growth and you talked about that in the slide with residential strength. Where are you now in commercial in terms of the sequential pace of business? Has there been any signs of life in the end user markets of a pickup in the last three, four months?

Well, it's been better. There's been consistent improvement quarter to quarter. So we are hopeful that we, as the year improves next year, that we eventually get to positive also. We're not positive yet, but it's getting closer to that in the fourth quarter. So I'm definitely bullish on what the team's doing. We also got a lot of self-help with our QuickShip program. It's an area we were not participating on the transactional side. So there's definitely some parts and pieces that we're not playing in. And also you think of hospitality. We just had no presence at all. So it's a combination of market getting better and a lot of self-help in that area. And also, we've done a lot of work on our product portfolio. We introduced some really good products, such as MenPure and some Revamp NCD10 LVT and improved our LVT offering in the middle of the year last year. And as you know, commercial takes a little bit of time to specify and get the business out there. So as those things mature, and we get the benefit of the work of the sales team and those specifications, we expect definitely that to benefit ourselves as those efforts mature in 2021.

And your LVT growth, I know you're anticipating in 21. Are you at the point, are you growing in excess of the market, particularly given your commercial exposure? Are you growing in excess of the market at this point?

Well, I haven't seen any exact market data so far, so I don't know. But our trend is improving, so our LVT growth is positive, and we expect to continue improving on it.

Okay. And this final question, what is your outlook for your sheet vinyl markets in 21, both heterogeneous and homogenous?

You know, hopefully, you know, as the health care market stabilizes, we expect, you know, the new construction has been pretty good, but renovation has been put on hold. So we expect that to come back somewhat. A lot of people have been holding up on projects, but hopefully this vaccine will kick in. And as things improve in the second half, it will be better. Yeah.

Yeah, so I expect a little bit more robust. Okay, all right, thank you very much. All right, thank you, Keith. Our next question comes from Julio Romero with Sidoti & Company.

Please proceed with your question.

Hey, good morning, Michelle and Amy. You talked about your business transformation and your customer-centric initiatives. What are you hearing from your customers in terms of evolving residential needs as folks repurpose homes for work from home, school from home, et cetera? And how does that impact, I guess, Armstrong?

Well, I think definitely everybody is definitely bullish on residential for 2021. And I think everybody's seen, I would say, in the last six months the change. And I would say not only In the poem for renovation, everybody's seen, mentioned a little bit in their opening comments that people are moving outside of some of the larger cities into larger spaces, and everybody wants more room and is looking at their lifestyle. Everybody, companies are much more open to remote work, and that's a benefit in many companies and entrepreneurs and retailers as people reinvent their ways their homes to match the lifestyle. There's still a lot of remote learning, a lot of remote work. Myself and Amy are definitely in that boat personally, how we work through it. And I think it's created a lot of different projects for everyone. And I think the trend will continue for some time. I think a lot of people are reassessing their life and what's important to them. And I think we'll see that trend benefit for at least another two or three years as that comes about. And I think it creates a lot of good opportunities for our customers, both on the builder side, I say new construction, and I would say on the remodel side for very much the retailers out there. So definitely that will be a robust market for years to come, I think.

Got it. And Can you talk to your goal to penetrate new commercial verticals such as corporate, office, government, and how you see those potentially offsetting the headwinds you expect in retail?

Well, I think to your point, I think there's been a series of verticals where we have not participated, such as hospitalities and corporate has been very moderate for us. And I think in some, even some other verticals, we may not have been as equipped as we needed to. to compete. We're adding some commercial sales rep for specifications in certain segments also. So I think there's a lot of opportunities where we can do more. Our brand is very well respected and opens a lot of doors in many areas. So we've also added a national account team that we have high expectations with, and they were off to a great start of open up some key national accounts. And the good thing is many major businesses want cleaner areas, easier to maintain, and so they can show how it is safe to come into their business. And our national account teams are really making a, open up some new doors that maybe weren't there before. So we're really lucky that they are having some nice momentum with commercial national accounts. Uh, where, uh, that people are consuming resilient, maybe where there was carpet before, and now they're willing to put resilient and that's a big win for us. So, uh, have high expectation there. You know, we're more and more engaged with our customers now. And I think that that goes a long, long way. So I'm bullish with the commercial team will accomplish very bullish, what the residential team can do. Uh, and you know, getting this company back on track starts with growing sales again, and that's first and foremost.

Got it. This last one for me is if you can talk to kind of cash flow outlook and are you still aiming to get back to free cash flow positive in 22?

I think definitely with this pandemic, we're looking at everything. It's definitely top of mind. That's where we need to get to. The one thing we are looking at everything that we're doing to make sure we're doing it. We're looking to monetize assets. We're looking to at our inventories, and I want to also give the benefit of Amy being here. She just got here and looking at this and penciling this out for us. So I think we're going to make the most of 2021, and then we're going to assess 22, but definitely the sooner we get there, the better, right? So I think that's definitely top of mind for all of us. So we're definitely focused on it.

Great. Thanks for taking the questions, and best of luck in 2021. Thank you, appreciate it.

We have reached the end of the question and answer session. I would now like to turn the call back over to Michelle Vermette, CEO, for closing comments.

Well, thank you everyone for joining us today. We appreciate your interest in Armstrong Flooring, and we look forward to updating you on future calls. Thank you.

This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.