Q2 2019 Earnings Call

Greetings and welcome to Armstrong flooring second quarter 2019 earnings call. At this time all participants are in listen only mode. A question and answer session will follow the presentation.

Anyone should require operator assistance during the conference. Please press star zero on your telephone keypad, the sort of Wonder This conference is being recorded.

I'd now like to turn the conference over to Doug Baker, Chief Financial Officer. Thank you. Please go ahead.

Thank you for joining us today for Armstrong flooring second quarter 2019 earnings Conference call I am joined by our Chairman and interim CEO , Larry Mcwilliams, our chief product officer, and SVP of global operations Dominic Rice.

Our SVP of North American sales when play already.

We trust you have seen our press release. This morning. Additionally, a copy of the slide presentation to accompany this call is available on the investors section of our website at Www Dot Armstrong flooring Dot com.

I refer you to slide two of 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 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 statements 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 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 with that I will now turn the call over to Larry.

Thank you Doug good morning, everyone and thank you for participating on our second quarter 2019 earnings call.

On the call today, I will be discussing our operating highlights and business activity.

Doug will then cover additional details regarding our financial results before I offer some closing remarks and open the call for questions.

During the past several months I, along with Armstrong team have been working hard to address the continuing trend of challenging industry dynamics and soft market conditions.

We have a number of initiatives underway to improve our execution and financial performance.

We are focused on innovation and serving our valued customers to drive profitable growth in every facet of our operations.

During the second quarter, our customers continue to reduce inventory from elevated levels in previous quarters.

This de stocking activity represented the tail end of demand pull forward into 2018.

Ahead of the initial wave of tariffs on Chinese imports implemented late last year.

We believe we ended the quarter with channel inventory at more sustainable levels that said the de stocking activity combined with softer end market demand adversely impacted second quarter sales, particularly at our residential categories.

In this environment the team did a good job of delivering stronger adjusted EBITDA margin and free cash flow in the second quarter.

However, our year to date performance does not mirror, albeit an internal efforts that are being made to grow our business and get the portfolio in the right places we look forward.

We're driving innovation to bring new products to market.

We are working closely with customers to implement price actions in response to input cost pressures.

We are achieving productivity gains in our facilities and realizing cost savings and overhead to right size our operations.

These actions together with our strategic priorities support our confidence in the potential of our business to generate more favorable results.

In L.D.T., we continue to rapidly shift our portfolio emphasis to Ritchie core products, such as our central product line.

As we stay at the forefront of the innovation curve.

Our award winning Diamond 10 technology continues to appeal to a wide range of customers and we are working rapidly to apply it to you on to even more product lines within our portfolio.

In D.C.T., we recently added Diamond 10 technology to our non PBC product, providing enhanced durability and ease of installation. In addition to its strong sustained sustainability attributes.

As we continue to introduce a steady stream of products. We are tightly coordinated our marketing efforts with distributors to more effectively grow our market presence, especially in commercial.

We are committed to improving our performance in all product categories through innovation and cost efficiencies, we have a strong balance sheet to invest in our business as we take advantage of that Nick has significant opportunities ahead.

We look forward to our internal efforts, becoming more evident in our results as we continue to execute on our objectives.

Before I pass the call to Doug I would like to mention that I'm working with the board to fill the permanent CEO role.

We're making good progress and we will keep you updated as appropriate.

And you get from I am committed to working with the talented teams across our business along with our customers and suppliers to facilitate a seamless transition.

I'll now turn the call over to Doug to walk through the details of our financial performance.

Thank you Larry.

I'll begin with a review of our second quarter results on slide five.

For the second quarter 2019, net sales were down 11.7% to $178 million as compared to $201 million in the prior year quarter, including an unfavorable impact of 110 basis points from changes in currency exchange rates.

The decrease in net sales was largely due to lower volumes and unfavorable mix in almost all product categories.

Volumes were affected by distributor Destocking and soft end market conditions similar to last quarter.

The factors were more pronounced on the residential side of our business, including residential LPT.

The effect on commercial sales was less severe partly attributable to the emphasis of our strategy on that end market.

Selling prices were up modestly year over year in response to inflationary pressures from tariffs.

Our second quarter 2019, adjusted EBITDA was $20 million as compared to $20.7 million in the second quarter of 2018.

This decline in adjusted EBITDA was primarily due to lower net sales.

This was partially offset by lower SGN, a spending and improved productivity.

The lower reported SGN. They spend included the 2.5 million dollar benefit related to an early sub lease termination fee.

Hi, the owners of our former wood business as a percent of sales adjusted EBITDA was 100 point basis points higher year over year.

Im a distributor channel we believe customers have largely worked gallon unusually high levels of inventory purchased ahead of tariffs on Chinese imports last year.

That said the general uncertainty around the ultimate outcome of U.S. trying to trade negotiations has continued to influence normal seasonal buying patterns.

Our several rounds of price increases since October 2018 have allowed us to partly blunt the impact of inflation due to tariffs.

In May we announced additional price actions on select products in response to the U.S. decision to raise tariffs on Chinese flooring imports from 10% to 25%.

We have worked closely with our customers to minimize the impact to their supply chains from recent price increases, while providing us an opportunity to help offset these cost increases.

During the second quarter, we generated operating cash flow of approximately $29 million.

Consistent with our expectation the main driver of operating cash flow in the second quarter was a reduction in working capital as we drove down a significant working capital build in the first quarter.

For the quarter, we invested $7 million in Capex, which remain below our run rate depreciation.

During the quarter, we were pleased to return excess capital to our shareholders through the repurchase of 4.5 million shares for a net purchase price of approximately $50 million.

This repurchase activity fully utilize the remaining unused portion of our share repurchase authorization.

We ended the quarter with a strong balance sheet, providing us the flexibility to invest in initiatives and growth avenues that makes sense for our business.

Our capital allocation objectives remain unchanged with our focus on maintaining the business funding internal growth initiatives and pursuing M&A opportunities that support our growth strategy.

Moving to our full year outlook, we have moderated our adjusted EBITDA expectations for the full year, which we now expect to be in the range of 46 million to $54 million.

Well, we believe elevated inventory levels in the channel have been largely worked down on favorable market conditions are likely to pressure results into year end.

As a reminder for quarterly balancing into year end. Our prior year comparison is relatively tougher in the third quarter given the significant pre buy activity in September 2018.

While our full year outlook has been tempered, we anticipate that pricing actions productivity gains and cost savings will allow us to achieve our full year objectives.

We remain committed to growing our adjusted EBITDA margin to 10%. However, based on our revised 2019 expectations and in light of persistent market challenges at this time, we believe it will take longer to achieve than initially expected as such a 10% margin level is a more attainable target as we look beyond 2020.

On the piano, our effective tax rate could change significantly quarter to quarter. We continue to expect our tax rate to be approximately 25% in 2019.

In regard to cash flow, we continue to expect capital expenditures of approximately $30 million for the year maintenance Capex. It should continue to approximate 2% to 3% of sales with the balance of the spending budgeted for high return investments.

We expect to build cash as we progress through the balance of the year.

With that I will now hand, the call back to Larry for closing comments. Thanks, Doug as we have discussed today. Our team has been focused on executing our key initiatives.

We are working to improve our growth trajectory and augment our margin profile. We have a strong portfolio of award winning products and our team is committed to expanding its leadership positions in the resilient flooring industry.

We are working closely with our customers to maintain strong relationships at exceptional levels of service.

We aim to accelerate positive momentum in our business over the long term as we build upon our strong brand and market leadership to drive returns for our shareholders. Operator, we're now ready to take questions.

Thank you feel like that's question at this time. Please press star one on your telephone keypad, a confirmation tone indicate that your line is in the question queue and you May Press Star two lightroom move your questions from the queue.

For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.

Got a star one question at this time.

Our first question comes from the line of our <unk> Gee that research.

Good morning.

Hey, Elvira.

I wanted to start with just the revenue outlook and if you could talk about the first half.

What you think growth rates, how much they were impacted by this inventory build it seems to be reducing and what are your expectations for the second half and if you could just provide color by by sub segment Lv TV C T and resilient sheet.

Sure Yeah. So as I commented earlier, we did see continued inventory destocking.

For the first half it was roughly half of the sales change was due to the de stocking activity.

Very similar in Q1 and in Q2.

Within the within the categories. It was more pronounced in the residential categories as opposed to the commercial categories. Both.

The de stocking as well the the softer end market.

Drug on his call.

What are the expectations for the second half baked baked into your guide.

Sure yes so.

We did indicate that it will be a relatively tougher comparison in Q3, just given that there was a large inventory build last year.

Around the tariffs that we don't expect to repeat this year.

And then Q4, we had a little bit of an inventory draw down.

Kind of coming off the Q3 peak, but but not too heavy.

With regards to your fixed cost footprint today, how would you categorize it is that fully rationalized or do you see opportunities there and are there any updated guy updated commentary around reconfiguring existing capacity.

Yeah. So.

We're constantly evaluating our footprint for opportunities as volumes continue to decline.

We will certainly take action when its appropriate we basically look at it on a cash basis. So at the point, where the plant is going to stop generating positive cash flow. That's the that's the time that we would take action.

On it.

Based on our.

What we see out in the marketplace more broadly with the sourcing opportunities that are available in China.

We think there is there are good opportunities to source LBC products and rigid products from suppliers overseas and so that will be our focus more on the sourcing element rather than the domestic manufacturing ability.

Just given that evolving R&D curve and the expansion of the supply chain, that's moving beyond China at this point.

Got it and the 4.7 million in strategic projects. That's part of the adjusted EBITDA can you maybe talk about what you're doing what the payback period is and then from a price cost perspective have you been able to offset.

The first 10% round already today or are you still lagging a little bit that original 10% of tariffs.

Yeah. So we took some actions as you know back in last year, we were able to get a partial offset on those we were also able to get some supplier to supplier concessions.

Which helped offset as well.

The second round, that's gone into place we've announced price increases. It's it's been kind of a mixed bag. What the competitive response has been on that and so we continue to work to price our products appropriately and work with our suppliers to offset the cost impact.

Your question on the strategic projects and cost reduction initiatives.

A fairly large piece of that 4.7 million is the severance related to the separation of our former CEO .

All right. Thank you.

[noise] [noise]. Our next questions are from the line of Michael <unk> with Nomura.

Hi, good morning.

I first wanted to ask about the the 10% margin goal that you said was pushed out beyond 2020, I'm still curious to your line of sight in terms of getting there. It does still seem like a stretch and are there any mean, you know flooring product categories that you might need to exit in order to reach that 10% goal.

Yeah. That's a good question, Mike I think as we look at that you know, we still feel that that's an appropriate target for us to get to the timing of it is a little more uncertain at this point.

Looking at our product portfolio. There are certainly some products that are you know.

Above that but we feel comfortable with and will continue to expand.

Other product categories or a little more challenged but it's possible that we may.

Overtime exit some of those are or reduce the that their relative weighting in the portfolio.

But I don't think its a precondition that we.

Get us in any of the existing products to get to that 10%.

Okay can you I'm also give us an update on the lockout at the Lancaster facility, what product line that is and and is it a interrupting production or or having a profit impact at all for you.

Hey, Mike Dominic Rice, Jay Thanks for the question so.

Link this to flow plan, we produce both Oh, we tee in residential sheet vinyl we continue to operate the plant with both salaried staff and temporary labor and so we.

We have not seen and doesn't anticipate.

Any interruption to out the service to our customers with those products.

Okay, Great and just finally can I ask in terms of the you know post the Dutch tender offer you know how are you feeling in terms of comfort with your with your leverage and are there any large capital opportunities that may be in front of you now in terms of.

You know either larger productivity or restructuring initiatives or any other growth investments.

Thank you.

I think we're still comfortable with the leverage that we've got you know where were at now we've thought about that.

28 million of net debt.

So we're still pretty comfortable on the leverage ratio.

If there are projects that come up that are that are meaningful we'll certainly discuss those we do.

Feel like we've got adequate diet Drypowder excuse me adequate drypowder to address any opportunities to invest that come up.

Thanks.

Our next question from the line of Justin Steris Selman.

Hi, Good morning, guys. Thank you.

Appreciate the color on the revenue growth, but in terms of the EBITDA margins implied in the back half I guess, maybe you can help us unpack that a little bit.

The EBITDA or maybe.

Looking at it differently. They asked you to any level. It at 27 million on an adjusted basis, how should we think about that.

On a quarterly run rate basis into the back half.

HM.

Yeah, so or or or or as ginny in this quarter was a little.

A little lower than the normal because of that two and half million dollar these breakage fee.

But other than that it was a it's a relatively good baseline yet we've still got some.

Income related to the T.S.A. of the wood business in there, but we've also got some expense running through it as well.

So so I don't it for the full year, I guess, what what kind of.

Yesterday March and you're looking at for the full year as you think about your guidance.

Yeah, So we but.

Baked in our SGN exhibition expectations into that guidance.

Based on the you know the Q1 into Q2 that you've seen kind of adjusting for some of those.

Onetimers or or unusual items.

It would be fairly typical for what we'd expect in the back half.

Okay and then the other the other element to this is on the gross margin side of things.

If you think about your raw materials I know, there's a lot of like moving parts with tariffs and.

And and underlying demand trends, but as you think about your mapping out how should we think about raw materials being a tailwind in the back half do you think you can hold on to those and how much tailwind do you expect in the back half from raw materials.

Yeah, So I'll kind of set aside that the tariff piece, because that's kind of its own own animal.

Raw materials have been fairly flattish for us.

Dave they're gallon from the peaks that they hit in 2018, so we should get some tailwinds from those.

Transportation Likewise, we had some improvement in Q2, so we're not facing the same pressures that we were previously.

Okay. So some tailwinds there potentially and then the other element that I'd like I'd be curious to get your thoughts on what the tariffs now, particularly largely imported Lv T product.

How do you think about the momentum of demand now that you. Yes, you may have some of the economics of Lv team, maybe not as friendly relative to where they were before the terror stepping up how do you think about your overall portfolio as you think about Lv T portion of your business and the non Lv T. portion of your business into the back half and into next year.

Yeah, well, we still really like the portfolio that we've got in Lv tea and we're constantly looking at new ways that we can expand the.

Portfolio and Larry mentioned in his remarks by the introduction of elements, which will be a I think a great excuse me essentials, which will be a great oh product in the marketplace.

You know that the dynamics out in the industry right now until the T. There is a lot of noise because of the terrorists.

But we think you know the fundamentals are still there it's a great product and we expect that people will continue to adopt that.

With that though the cost impacts from the terrorists if that is something that that ends up or slowing down the growth rates of LT key.

Given that we do have a large domestic ah portfolio of other products that that's not necessarily a bad thing for us.

Hey, I guess from your from your perspective are you injecting any of that kind of dynamism in your guidance or is that as you know in terms of the revenue growth implied in your guidance.

You know I guess think stripping out the inventory element and what do you think underlying demand looks like for your flooring products into the back half.

Yeah, we've kept a fairly consistent you from a kind of looking at that what last year was just on a little lower base is how we do that.

And last question for me is just in terms of the last two questions I have two more questions or cash conversion side. Do you think you can generate positive free cash flow for the full year 19 based on the way things are falling or or do you think it might be a tough putt from here.

Yeah. So what we've said is that you know we feel we feel strongly that we will continue to generate cash in the remaining quarters of the year.

But as you know we had a kind of a large headwind in Q1.

Okay and then last question for me in terms of filling the permanent CEO role in terms of those those discussions do you have any good candidates and are those candidates from within the industry.

Yeah. This is Larry we are.

At very active in the process, we're well through the process now.

We're seeing some very very good candidates I will comment on their backgrounds, but I'm very pleased with where we are in a getting a new CEO in place.

Excellent. Thank you very much for your time gentlemen.

Our next question comes from the line of John Baugh with Stifel.

[noise] good morning, and thanks for taking my questions.

I was wondering on a flexible LDP would [laughter], you're making in their Lang Lancaster plant its demand for that still growing and what's the status.

Oh, the sort of.

Line utilization on flexible LPT.

Yeah, John Thanks for the question its Dominic you certainly and primarily on the residential side. Richard is is more of a growth kind of greys influx, but flexible only to remain so particularly in some segments.

A a preferred product of choice. So then notably in commercial or commercial remains primarily a flexible over 80.

And a significant part of our Lancaster plant is devoted to servicing the commercial segment with a flexible <unk>.

So it was it was flexible caught up in all this de stocking and whatnot because more that's made I believe in the U.S. and certainly rigid.

Hi, Yes, there was a the but the stocking up and the de stocking activity was across the board L.P.T. portfolios.

Both rigid and flexible.

Okay, and any comment or John I used to kind of call. It legacy products, but obviously I'm not on the L. VP.

Brazilian tie all sheet final and VCT any comments there because I wouldn't think those products would be is.

Greatly impacted by the rich its core Chinese imports, but I may be wrong on that.

Yeah. So we haven't really seen a market change in kind of the market dynamics for those those legacy products.

I think they all continued to be impacted by by Lv T in one form or another.

Did the rigid impact as Dominic mentioned is probably more pronounced on the residential products like residential sheet.

But you know certainly LTT flexible warm impacts <unk> as well.

[laughter] and do like it's true your comments around the sourcing more not producing much is that your.

Efforts to try to convert.

Some ah think goals.

Neared word plants to make Richard Correale, we'd see that that's essentially.

What a couple abandon process or.

You're not going to I assume try to make S.P.C. here in the U.S.

Yeah as it stands now as we've looked at it. The you know look we'll continue to look for opportunities to use our existing assets, but the.

Development in the in the overseas markets around S.P.C. continues to evolve.

And produce some pretty phenomenal products.

And as far as you know the tariff concern has has evolved what we're seeing is a lot of Chinese manufacturers are starting production in countries like Vietnam and other areas that would not be impacted by the carriers.

[noise] and currently on that topic, Oh, what amount if any are you sourcing oh LPT from outside of China. Currently or is this all kind of [laughter] and development and discussion more than actual those points.

Yeah, I'd say, it's more in development discussion there is some minimal amounts, but it's it's primarily in China at this point.

Okay, and finally, we've heard that.

Yeah, a little price increase announced.

But the big players yourselves included Shaw and Mohawk bond.

Lv Ts [laughter] I think the word you used is sort of a on certain or.

We have to see how it all shakes out primarily because there were still inventory brought in particularly from many smaller players.

Oh that was perhaps delaying the implementation of that price increase is that.

I don't have that kind of right in where do you think we are time to time wise and are running through that lower cost or pre tariff inventory in the United States.

Yeah, I think he's got the right perspective, there you know that.

The channel from Us and from others, you know everybody was buying a lot of material ahead of the tariff.

I think at this point, we indicated that from from what we see in our own space. You know the inventory is getting to better levels and maybe still a few pockets that are a little bit height, but you know given that the tariffs just increased in about two months ago, I think there's probably still a little bit of time before all that pre tariff inventory is out of the system.

Great. Thanks for answering my questions and good luck.

Thank you.

I have follow up questions from the line of Oh, Okay, well Gee that research.

Thanks for taking my follow up I just had a question on V C T and in the past you've talked about.

Kind of a a low single digit volume decline offset by solid pricing wanted to get your thoughts on whether anything has changed from that kind of a level of demand and then secondly, the two and a half million that you received a relative to the what divestiture is that part of my adjusted EBITDA I just wanted to be clear on that.

Yes, the the two and half million that is part of our adjusted EBITDA.

The.

Your other question.

Sorry, Albro I've forgotten your other question.

Just three C.T. a in the past we've discussed it as being you know given that you're you're by far the largest player you had it was a category with low single digit volume declines, but a lot of it offset by good pricing and I wanted to get an update on the dynamics if that still holds or if there has been a change.

Hey approached on Medicaid. Thanks for the question no. We continue to see that to be a fairly consistent dynamic.

With BCG.

Thank you.

Okay. Thank you we have now reached the end of our question and answer session I would like to turn the floor back to Larry Mcwilliams for closing comments.

[noise] [noise].

Thanks, everyone for joining us today, we appreciate your interest in Armstrong flooring, and we look forward to updating you on future calls.

Thank you ladies and gentlemen. This concludes today's teleconference. You may disconnect. Your lines at this time and thank you for your participation.

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