Q3 2019 Earnings Call
Greetings and welcome to the Armstrong flooring Inc. third quarter 2019 earnings call. At this time all participants are in listen only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during their program. Please press star zero on your telephone keypad.
As a reminder, this conference is being recorded it is now my pleasure to introduce your host Doug <unk> Senior Vice President and Chief Financial Officer. Thank you Mr. bring them you may begin.
Thank you for joining us today for Armstrong flooring third quarter 2019 earnings conference call.
I'm joined by our new President and CEO , Michelle formats, We trust you've seen our press release. This morning. Additionally, a copy of the flight presentation to accompany this call is available on the Investor section of our web site at Armstrong flooring Dot com.
I refer you to flight to that presentation and advise you that during this call we will be making forward looking statements that involve risks and uncertainties actual outcomes may differ materially from those expected when applied 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.
They are made and we undertake no obligation to update any forward looking statements beyond what is required by applicable securities laws.
In addition, our discussion of operating performance will include non-GAAP financial measures within many of FCC regulation G. A reconciliation of these measures to the most directly comparable GAAP measures is included in the press release and in the appendix of this presentation.
That I will now turn the call over to Michelle Thank.
Thank you Doug.
Good morning, everyone and thank you for participating in North third quarter 2019 earnings call.
I will discuss our business activity when Doug will then cover additional details regarding our financial results before we open the call for questions.
I had to be at Armstrong flooring since joining the company at September I spend time connecting with customers visiting so he's reviewing our product portfolio and having an open dialogue with many members of our team.
Having operated in the global flooring industry for two decades, I can confidently say that there's tremendous value behind the Armstrong flooring Brian .
The company has a strong history of innovation and great potential.
I'm pleased by the many uncapped ideas. The team has to help the company achieved that potential as the leading resilient flooring company.
We are aware that our recent performance does not reflect the significant upside potential for business.
We are moving quickly and we're conducting a comprehensive review of our business and strategy. So we can change the disappointing trend of our results.
We're deep in our review and expect to provide a more comprehensive plan in coming months.
See opportunities in many places some will take time, others, we have already begun to implement and will improve our competitiveness and maximize our penetration with all customers moving forward.
This includes steps to expand our customers reach and serve them in the way the desire.
We also need to optimize our product portfolio. So we can be cost competitive and have the most in demand resilient products in the industry.
Finally, we're looking to modernize our processes, so we couldn't be more efficient and easier to do business with.
Look at our broader market opportunity when the best categories with the highest growth in Florida.
We should be growing.
There are verticals, such as hospitality office single family builders in multifamily, where there's significant room to grow.
Well in the process of recruiting additional representatives to call on commercial National account home centers in multifamily customers.
We are exploring all options to maximize our reach within customers through the most cost effective condemnation distributors and direct sales.
Within the distribution channel will be working closely with them to ensure all end customers are receiving exceptional service about Armstrong flooring when their trust.
Given our innovation and brand presence, there's much more than we can do to foster a reputation the value chain.
Look at our product portfolio or award winning Diamond technology continues to appeal, so wide range of customers and we are expanding it onto.
Sourced products.
The benefits to our commercial end users in particular are meaningful and deliver extra margin to us, but we have not done a good job promoting.
Across all categories, we have too many underperforming that's good news and need to sharpen our focus on products that are growing or have higher contribution margins to realize better returns on are cutting edge designs.
Accordingly, we are conducting line reviews with our product managers to assess strategic direction and stocking profile. So we can focus on resources on growth in value add categories, such as Richard core commercial sheet and not PBC options I.
An example of this is our investment in our new innovative restore sheet product that reduces healthcare workers fatigue and has a better long term performance in rubber alternatives.
In addition, we're working on some exciting options for non PBC products, which is becoming increasingly important to commercial customers.
Even within the brought Lv tea category, we're taking a hard look at what product lines make the most sets for our business and aligning our product offering with customer demand.
In addition, we made the decision to liquidate the remaining linoleum in laminate inventories and some older less profitable product lines. So we can use our warehousing to improve our Lv T. service.
Our goal was to have the right products available for each customer.
In regards to our production, we're focused on optimizing our manufacturing footprint, where there may be excess capacity and evaluating ways to drive monetization to improve efficiency.
In line with that we recently reduced shifts at two of our domestic plants to consolidate production and improve our cost profile.
We have also initiate a strategic assessment of our Southgate land portfolio in California, as a demographics for that region have change.
In terms of modernizing processes. The team has already started a review of needed changes to improve our productivity accelerator decision, making and increase our responsiveness to customer needs.
We have standardized procedures to align our business structure increased transparency and empower frontline employees.
In Q4 will start design processes and systems, we need to reduce complexity and support our strategy.
We have already initiated a redesign of our pricing system to simplify our execution in a proof customer satisfaction.
Furthermore, I made a change in my leadership team to streamline communication and decision making.
Additionally, on the lining our leadership in incentive structure to be more customer shrunk centric.
And proactively to capture business improvements.
As a tangible example, we're implementing system changes across our plant network that will allow us to improve our operations. The more consistently in officially you scrap driving down our operating costs.
I recently walk the floor of one of our facilities and the production crews were pleased by the prospect of spending less time chasing materials and more time on productive efforts, just as quality and service.
Overall these are just several areas, where we can improve in reignite profitable growth in coming years.
We're committed to improving our performance through more modern efficient platform that more effectively reaches an expense base a productive customers.
I look forward to working with the talented teams across our business along with our customers and suppliers to get our business back on solid footing I'll now turn the call over to Doug to walk through detailed or a financial performance.
Thank you Michelle I'll begin with a review of our third quarter results on slide four for the third quarter of 2019, net sales were down 20.7% to $166 million as compared to $209 million in the prior year quarter, including an unfavorable impact of 90 basis points from changes in currency exchange rate.
This disappointing sales performance was largely due to lower volumes and unfavorable mix.
We believe the volumes were affected by several factors, including an unfavorable comparison against third quarter 2018, a period that saw significant customer purchases in the distribution channel in anticipation of U.S. tariffs combined with additional de stocking this year I.
Additionally performance of several of our key distributors with wet much weaker than the market.
We also experienced share loss in some categories, particularly in residential where we need to better serve our customers needs.
Mix was adversely impacted by lower relative leaky sales as a result, a distributor loaded activity in the prior year quarter.
Over the past year, we have implemented several rounds of price increases the partly offset the impact of tariffs.
While we largely held firm on price in the third quarter. We believe intense competition resulted in modest overall price pressure on result.
Many small to midsize competitors have not an active price increases in response to caris.
We continue to work closely with our distributors to effectively implement price increases, but remain committed to pricing in line with market conditions.
Our third quarter 2019, adjusted EBITDA was $9 million as compared to $24 million in the prior year quarter.
This decline in adjusted EBITDA was primarily due to lower net sales increased input cost inflation pressure, including US tariffs. This was partially offset by improved productivity and lower eschewing spending.
Adjustments to EBITDA in the third quarter 2019 totaled 23.3 million Michelle discussed several actions we've taken during the quarter in connection with our efforts to shift our focus from less profitable products and improve our operating efficiency. This includes write down of certain finished goods inventory to rationalize obsolete products such as our discontinued linoleum at.
Laminate product lines, we also disposed of merchandising displays and samples that are no longer required following a shift in our marketing strategy.
Separately during the quarter, we overhauled our procedures across plants to standardize how we handle raw materials and scrap.
We also incurred other business transformation costs to modernize additional processes and systems.
Finally, we had executive transition costs largely associated with what realignments within our senior leadership team.
During the third quarter, we generated operating cash flow of approximately $32 million.
This was inline with our plan to drive down working capital as we move through the year.
For the quarter, we invested $7 million in Capex, which remain below our run rate depreciation.
We ended the quarter with a strong cash position and modest levels of debt. We are in process of replacing our existing credit facility with a new asset based facility.
Expect to have the new credit structure in place by year end, providing us with even more flexibility to invest in initiatives and growth avenues that makes sense for our business.
In the interim our credit facility has been reduced from 150 million to $100 million to better align with our anticipated asset based facility size and provide some modest savings on fuel on unused funds.
Moving to our full year outlook, we are taking many steps to improve our business for the long term, but the persistent topline challenges of impacted our year to date results and will continue into the fourth quarter.
The fourth quarter, we anticipate that lower net sales and investments for future improvements were more than offset the benefits of productivity gains.
Factoring in results for the third quarter, we're moderating our adjusted EBITDA outlook for the full year, which we now expect to be in the range of 20 million to $25 million.
We will also incur 1 million to $3 million of onetime cash charges in connection with our manufacturing changes and small residual management transition costs.
On the PML, our effective tax rate could change significantly quarter to quarter, but we do not expect to pay in cash taxes for the full year 2019.
In regards to cash flow, we continue to expect capital expenditures of approximately $30 million for the year make Nick maintenance Capex should continue to approximate 2% to 3% of sales with the balance of the spending budgeted for high return investments.
We expect to end the year with a strong and flexible balance sheet to execute on our unchanged capital allocation objectives.
We are focused on modernizing the business and funding growth initiatives, while preserving balance sheet strength.
Before I turn the call back to Michel I'd like to mentioned that in 2019, we benefited from roughly $15 million that favorable impacts to test DNA such as income from our transition service agreements with the purchaser of our wood flooring business rental income lower incentive compensation and deferrals of IP upgrades among other items.
We anticipate that these SGN a benefits will represent headwinds of a similar amount in 2020.
We acknowledged that it will take time to improve results, but we started taking decisive actions and are committed to continue to do so to achieve the company's full potential with that I will now hand, the call back to Michel for closing comments.
Thank you Doug as I mentioned earlier, we're updating our strategy and crafting a comprehensive path to improve our operating performance and results, which we expect to share in the coming months, while we have a long road ahead to get our business back on track, we're setting the foundation to target numerous areas of improvement in the short and long term to better capitalize on.
The strong market opportunity in the resilient flooring industry.
I look forward to working closely with a dedicated team to strengthen our growth Craig trajectory and augment the margin profile of our award winning portfolio.
We are all committed to realizing the significant value underpinning Armstrong flooring, Brian to generate meaningful returns for shareholders operators were ready to take questions.
Thank you we will now be conducting a question and answer session. If you'd like to ask your question you May Press star one on your telephone keypad.
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Our first question comes from the line of Michael Wood with Nomura Instinet. Please proceed with your question.
Hi, good morning.
Hey, Mike.
You talked about some.
Actions, you're taking you know overdue shifts and some optimization actions I I'm curious why there are some more dramatic plant closures.
Well clearly there's some businesses that are in secular decline not likely to get better and.
Curious why are you know how you're evaluating.
Some of those businesses, which I imagine are running at fairly low levels of capacity utilization.
Hey, Michael This is Michelle so we're going through this category by category as you know not every product can be made in every plant in.
Directly so we're going through that process one by one.
Basically took actions what things that made sense to move immediately in we're evaluating every component of each facility in that regard there were some capabilities that make sense to keep in.
In these facilities, so we will be looking at those.
But I think everything's on the table and we're looking at that across the portfolio.
Okay and on.
Guidance can you just bridge for us what specifically caused a reduction since twoq.
Sure Yes, Mike This is Doug the biggest piece has been the continued declines that we've had in sales.
And I would point to the.
Further reductions in inventory in the channel.
Some of our distributors, we mentioned have shown weaker performance.
And now what we expected.
And then we've also had some some share loss in some categories, which have combined to make tougher sales environment than what we anticipated.
Okay and on the distributor performance that you called out.
It is this share loss.
Distributors are experiencing in the market is that our that you're losing share with them and I.
I guess.
Now that we're kind of getting beyond the changes you made in terms that advertising structure have you evaluated whether or not that was a good decision at this point.
Michael This and Michelle.
Let's face it not every distributors made equal so theres different performance in for different distributors. So some are performing better some performing worse.
But that's obvious based on our results that what we're doing right now is not the way we need to operate for the long term. So we need to combination. So we will be looking at every aspect to make sure we reach or customers, we need to get closer to our and customer.
And so we're looking at that and we'll have the right conversation with our distributors and also make sure we have the right access and serve the customers the way they need to be.
So those there's definitely opportunities there to augment our reach.
Hey, thanks to the comment.
Our next question comes from the line of Alvaro Lacayo with GE Research. Please proceed with your question.
Good morning. This is al ROA. Thank you for taking my questions.
I wanted to start with cash flow in working capital and just your expectations for the fourth quarter and just because over the years over the last several quarters has been a lot of volatility there, but would you expect working capital to continue to.
Be reduced.
Sequentially from the third quarter or what kind of an impact or where are you. We are you're going to see in the fourth quarter from a cash perspective from working capital.
Yes. So we've made some good progress this year in and bringing down inventory levels in improving our working capital.
As we go into the fourth quarter will continue to look at opportunities to reduce inventory to rationalize skews to do the things that they get our business in track understanding that in some cases, we may need to.
Build inventory positions to better serve customers are to meet their needs.
So I would expect that will follow.
Q4, specifically will probably all a fairly normal.
Improvement in working capital is as we move through the month.
Can you just describe what normal is just because there has been so many moving pieces.
And if you could just you know is working capital expected to be down in the fourth quarter versus the third quarter. If you just yes or no you have any view into that.
It should be down in the fourth quarter.
Okay. Thank you and then with.
With regard to the guidance I mean, the last time you gave guidance you were five weeks into the corridor I realize things, obviously didn't work out as expected, but the magnitude is fairly large so I want to go into how you what kind of what kind of us.
Some changes do you make when you provide forward guidance.
Given that you had been through the second quarter, you were five weeks through the third quarter and you're cutting guidance by a significant amount, but maybe just walk us through what your assumptions were.
Going in and what happened and the remaining of the quarter given you've already seen what was going on the first five weeks.
Yes.
As we.
And finally, we gave the guidance are.
The sales that we've seen so far.
Were in line with with our expectations there were a little bit soft, but we really saw some degradation later in the quarter.
Which has caused us to reevaluate where we're at in terms of sales in the outlook.
I think what we've seen is that there were larger distributor movements on inventory. So we were expecting that it was a tough comp with the.
I had activity that happened last year, but we weren't necessarily expecting a kind of sequential reduction in inventory in the distribution channel and we did see that in the third quarter.
In addition, the performance of our distributors.
We believe that they were.
They were doing fairly well in the first part of the year and as.
As we've had for their conversations and and then we'll work it's clear that there's some.
Some challenges with some of our distributors that have caused us to revisit our outlook.
So during the first five weeks of the third quarter, they were not reducing inventory or what changed just because you would think five weeks then you'd have some color into those trends.
Yeah, we saw more of the movements as we got into September .
Alright, thank you.
Our next question comes from the line of Justin Spear with Zelman and Associates. Please proceed with your question.
Hi, Good morning, guys. Thank you and Michelle banks for the color I know you're coming into a pretty obviously, a pretty turbulent environment in flooring in general.
And just appreciate your perspective.
Number one I just wanted to talk through LPG not non LDP.
Volume trends or revenue trends in the quarter.
A lot of moving parts, but if you give us maybe characterize.
If it's below or above fleet in terms of the percentage down 20% organic.
I'll be team was above or below that you're not LPG volumes for the quarter.
Yes, so I'll take that one Justin this is Doug the volumes in LDP were were below the overall companies and again, a big part of that was.
Inventory build last year compared to the reduction this year.
But even so we believe that LDP sales adjusting for that were were soft.
In terms of the.
The inventories with a channel as it stands today I guess, maybe characterize what your visibility is how good it is and what your stance is.
As it stands today.
Based on your guidance I'm guessing, it's still big fill elevated but.
In terms of what you're seeing how long declined with the system.
At this point the inventories are actually low there the lowest point they've been in about three years in the channel. So we feel like it's that the channel is where it needs to be and maybe even a little bit under.
So as you think about no and I wanted to unpack your statement there at the end of the prepared remarks on the $15 million of benefits as DNA in 2019.
And that does all will become I guess headwinds in 2020, when one of those benefits or were those benefits spread across the first three quarters or is that the first half a year all four quarters, how should we think about the within your guidance for the fourth quarter. The actual SJ spend for the fourth quarter.
We saw some of those benefits in the first half. So you think of the rental income we talked about last quarter that was all in the first and second quarter. Some of them. The income that we've received have been more evenly spread.
And then the adjustments on the incentive comp those tend to be more back half loaded based on the timing of when you make that changes to be a cool.
Okay, and so you're not Michel if you're thinking about just walking through it saying.
Areas of opportunity.
On the margin front on the efficiency front on the process for how much in terms of savings.
Oh potential do you see high level as you think about process improvements on an annualized basis.
Well, we are in deep review that but I'll just give you like the two adjustments we did to a point handsets, a little about $4 million improvement so theres improvements in many areas.
So we're building that listen we'll share that lists or though the that plan in the coming months, but we believe there is significant opportunities across the business and one thing I would add also as we are.
M. conversation with our customers and discussing how we want to service them, they're very open two different models a lot of people want to help us and support us. So we're actually funding opportunities in the marketplace as we speak.
To help reversed the trend, let's face it our biggest priorities reversing the sales trend and that's our first.
For most focus as we speak so.
And we're seeing people want to support us in that regard so that that's definitely a positive.
In terms of the distributor partners that maybe I don't know if they're distressed or just underperforming in terms of the receivables, but you have out to those particular customers are those and you think in good standing or do you think you maybe you need a risk adjust for potential risks true true outstanding receivables.
Well the good thing is many of these receivables are paid very quickly and.
So they have incentive to take early payment discount so they're very efficient and their nature. So we feel pretty good about that process, so and as we.
Work through our strategy and sit down with them actually having seen now with them tomorrow. So we will go through but I think we feel pretty good where we're at right now.
Okay last question for me is tied.
Twofold question, but.
We know that and cost inputs should be a good guy for for you for it for your manufactured.
Components of your business manufactured components of your business that you do in house are performing house, but.
Tariffs money that water because of the source nature of a portion of your business, particularly LTT can you maybe help us characterize how cost inputs graduate and your model if at all and too in terms of tariffs, let's assume tariffs stay in motion or perhaps maybe we say tariffs are removed altogether lets say we've come to.
So I'm kind of good terms is that good or bad for your business just trying to get a sense for how terrorists manifest themselves on your cost structure, how you plan around both cost inputs and tariffs.
The tariffs have really been a headwind for this year, we've been able to offset some of that through negotiating better terms with our suppliers as well as an acting price increases out in the marketplace.
But net net there has been a slight headwind there.
I think more broadly speaking, we do produce a significant portion of our of our product in the U.S. and so that part is really insulated from tariffs.
Think as we look at our manufacturing footprint and ways that we can.
Take advantage of that as the tariff dynamic involved, but I think thats an opportunity for us.
Sorry, so in terms of the.
Tariffs or mix, maybe for your business, but has been a headwind.
Inventories are in better shape now.
And now you've got cost inputs that are probably favorable to you in terms of though kind of separately the cost of plus raw materials.
How is that how does that factor another quarter and what are the expectations going forward with oil prices where they are.
Sequentially, our raw material prices have been fairly stable. We do we are starting a little bit of that have a benefit relative to last year when they were increasing throughout the year.
Our.
The feedstock that that gets into a lot of our product is actually propane rather than oil. So it looks similar to oil, but not exactly the same.
Thank you guys appreciate it.
Thank you.
Our next question comes from a line of John Baugh Stifel. Please proceed with your question.
Oh, Thank you and good morning.
I guess my first question is.
Have you lost any distributors or hand, or lost any shelf space with distributors over say the past year or as their business just down with you.
John This Michel I think they.
They have introduced other products within their piece, we have not lacing distributors, but distributors have had other products as and their offering.
And Michelle what would be I mean, there's probably a different situation on the beach distributor, but if you tried to.
Ring fence.
The reason why they went somewhere else it would be.
Well I can't.
I won't speculate John I mean, so I'll sit down with then we'll have the conversation and I've talked a few of them I need to talk some more of them.
But let's face it does not have been a.
An incumbent my job its own should help that discussion going so.
We'll have that discussion with them and we're what's happening with that so good at what.
What percentage of of your revenue.
Up is currently sourced versus manufactured and what might that looked like a year from now I would assume there's immense pressure with your revenue down on the fixed manufacturing footprint.
Hey look at sourcing more in making less if that's an error correctly. Thank you.
Yes, so were about 35% sourced and 65% manufactured.
It really is.
Product line by product line. So you look at something like DCT and the change that we made on the production line. There we're not going to change how much DCT. We're manufacturing, we're just able to consolidate some of the operations.
So the plan changes that we've talked about don't necessarily have an impact on.
Getting on that sourced versus.
Manufactured mix and the one thing John just looking at where we participate in how we are set up to compete in individual channels. We believe there's significant.
Opportunities to do more so we're actually incurring.
Some representatives. So we can participate you know we talked about some the changes in business, we definitely have pulled back from representations certain areas and we need to add back representation. So we have the right conversation get closer to our customers. So I think both I think there's opportunities both on the manufactured side.
And on the source side.
Yes, just based on the reach at I received from multiple customers and relationships I have.
I think the having more feet on the street will help us significantly in that area.
And can you remind me Michel how much how much right now on a run rate is commercial versus residential I believe you got a lot of commercial.
I think were 60 40, Doug is that right, so 60% commercial 40% residential.
Okay.
And then lastly, there was an LTAC comment in there.
Your intelligence is better than mine is it your sense that LPP, whether its flexible originator or WPC or whatever it is and maybe you could parse it.
Is slowing in terms of rate of growth I assume it is only because it's got much lot larger and the law of numbers, but is it decelerated a lot in your view or what what could you sort of.
Describe as the internal <unk> play between I don't know laminate and L., the T. and maybe even engineered wood flooring and I know you're not in that anymore, but you were.
Well I think just based on the feedback I mean from just.
As soon as a customer recently I think Lv TV is definitely growing.
To your point, maybe slightly off from what it has been in recent years, but it's definitely very strong still so.
Overall.
The outlook, it's definitely taken a significant piece of the growth in the marketplace.
Overall, so it's it's a place to be so.
Okay, great. Good luck. Thank you.
Thank you.
There are no further questions any queue I'd like to hand, the call back to management for closing comments.
Well. Thank you everyone for joining us today, we appreciate your interest in Armstrong flooring, and we look forward to update you with the next chapter Armstrong flooring on future calls.
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation you may disconnect. Your lines at this time and have a wonderful day.