Edited Transcript of AFI earnings conference call or presentation 3-Mar-20 3:00pm GMT

Looking at our full year results on Page 6, we experienced unfavorable volumes and product mix throughout 2019. Roughly half of the decline in sales was attributable to increased channel stocking in 2018 as a result of anticipated tariff increases. This was further compounded by distributor challenges and share loss, particularly in residential. Full year adjusted EBITDA was impacted by lower net sales and higher input cost inflation pressure related to tariffs. These costs were partly offset by improved productivity and SG&A benefits. As a reminder, SG&A benefited from additional income associated with our transition service agreement from the sale of our Wood business as well as lower expense for incentive compensation.

Turning to free cash flow and liquidity on Slide 7. During 2019, we invested $29 million in CapEx and operating cash flow was modestly negative. While we effectively drove down working capital according to plan as we move through the year, the unusually steep first quarter outflow was difficult to fully overcome. As a reminder, the timing of operating cash outflows over the past 2 years resulted in relatively strong free cash flow in 2018 compared to an outflow of free cash in 2019. In addition, we incurred roughly $13 million related to executive transitions and other nonrecurring cash costs. We ended the year with a strong balance sheet to support our strategy. In addition, in the fourth quarter, we completed the replacement of our prior credit facility with a new $100 million asset-based facility. This new credit structure provides us with better flexibility to invest in initiatives and growth opportunities that make sense for our business and align with our multiyear strategic road map. During the fourth quarter, we began to execute our plan to expand, simplify and strengthen our business to generate stronger performance and augment the trajectory of our long-term profitability.

I will now turn the call over to Michel to walk through our strategic business update and provide context behind the decisive actions that we are taking to help our company achieve its full potential in coming years.

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Michel S. Vermette, Armstrong Flooring, Inc. – President, CEO & Director [3]

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Thank you, Doug, and good morning, everyone. Over the past 6 months, we have thoroughly reviewed our business and strategic direction. The plan we will detail today reflects both the areas of strength in the business that we believe we can build upon as well our diagnosis of the root causes of some of the most critical issues the business has faced that our plans seek to remedy.

We have already begun to execute on the multiyear plan announced today, this includes expanding our customer reach and modernizing our processes as well as optimizing our product portfolio and production footprint to better serve our end markets. And to do so more profitably, some examples of actions we already taken are: we announced that the National Floor Covering Association members and commercial national accounts will be serviced directly in Q2. We are investing in underserved sales segments. We had 2 people calling on hundreds of large builders and contractors. We had one person calling on commercial national accounts. We had one person dedicated to calling 13,000 independent retailers. We are in process of augmenting these resources and we expect to have quick payback on these SG&A investments. We have discontinued 20% of our SKUs since October 1. We are consolidating our commercial VCT from 3 to 2 plants and our felt sheet from 2 to 1 plant. We initiated a monetization process for noncore assets such as South Gate. We kicked off major productivity and quality improvements effort in our plans. We launched a review of our corporate headquarters and believe we can cut lease expense by over 60%. We have attracted a very good talent to augment our dedicated team in sales, product management, design and finance. We’ll expand on these points today and provide additional color on our multiyear road map.

As we do it, it’s important to keep in mind several factors. First, we’re not starting from scratch. We are already gaining momentum from our early actions. The tremendous value behind the Armstrong Flooring brand allows us to reopen doors with customers that are not easily accessible to most. In addition, we have the people, products, footprint and relationships in place for initial execution. Second, there are a lot of obvious actions for us to take to change the direction. But to be clear, some will provide benefits sooner and others will come over several years. And finally, we do not believe our stock price reflects our plan and commitment to unlock the company’s full potential as the leading Resilient flooring company. We understand that to earn the evaluation we deserve, we need to demonstrate a healthier mix of top line growth, gross profit and EBITDA margin improvement and improved cash conversion. Not only do I have full confidence in our ability to do so, we have aligned our incentive plans with sales, gross profit and stock price to help keep everyone focused to deliver on our objectives.

Slide 9 provides a high-level view of our company and represents our starting point. Having operated in the global flooring industry for over 2 decades, I am convinced there is tremendous value behind the Armstrong Flooring brand. As a Resilient-only company, we’re positioned in the fastest-growing flooring categories, led by our largest category, LVT. We have a diversified manufacturing footprint, complemented by established sourcing relationships. Our mix of business today reflects our strong presence in residential renovation and overall commercial, with additional potential in residential new construction and underpenetrated commercial verticals like hospitality and corporate. We will discuss our growth pillars in all these areas and how we see our company evolving in the next several years.

Moving to Slide 10. As an initial step, we have begun to implement our new operating model to get the company focused on expanding our customer reach and serving them in the way they desire. This aligned with our investment in sales, products, processes to get in front of customers. For many years, the company has been internally in short-term focused in nearly all aspects, leading to strained customer relationships and market share loss. That internal focus has restrained new product innovation and launches, especially in LVT. We have missed the industry shift to unbranded or private label opportunities that have effectively eroded our share. Our short-term focus caused us to miss major waves of innovation in LVT by introducing limited offering in rigid core and loosely and supporting them with very little working capital. In terms of operation, we still have significant complexities in our processes that are fit for a much larger company versus a company our size. Our go-to-market approach has put a lot of responsibility in our distributors and has given them roles that we are better suited for such as branding, marketing and also connectivity with large counts. Overall, we have been very cost-focused at the expense of missing profitable opportunities. That’s partly attributable to our slow decision-making, where the approach has been very cautious versus taking required actions.

With all these factors in mind, we have developed our new operating model centered on our customers and how we can contribute to their success. Fortunately, we already have most of the capabilities to add value to our customers as an innovation leader but we have to embrace a mindset of being the first in the market and the cultural willingness to embrace change. We will continue building on our brand and our innovation will augment our position in the market as the Resilient authority. We will use our innovation in all channels, including in private label programs. We are simplifying our processes to fit the size of our company to become more agile, reliable and competitive. We are realigning our go-to-market model to operate in every channel to better reach underserved areas such as builder, multifamily and some key national and global accounts. We’re approaching market opportunities from a mindset of profitable growth and generating returns. We are flattening our organization to streamline decision-making so that we can execute with speed. Our addressable market is expanding quickly and under our new operating model, we will position ourselves to lead the category.

With the backdrop of Slide 11, there are 5 key points we want you to take away from today. We have a large addressable market opportunity in both commercial and residential. We are well positioned in geographic markets and product categories. We have a clear understanding of our U.S. performance issues. We have a focused strategy to transform and modernize our business and we will become more agile, faster-growing and more profitable company.

On Slide 12, looking at North America, which is our largest market, the Resilient category has grown at a double-digit pace since 2015, led by LVT. In commercial, we operate in a $7 billion market. Our core products, including LVT, VCT and vinyl sheet directly touched $1.6 billion of that. LVT, in particular, is taking share from all categories and providing a strong alternative to carpet, rubber, linoleum and ceramic so the size of the Resilient commercial market is expanding rapidly. The North American residential market is about twice the size of commercial at roughly $13 billion. We directly operate in LVT, bundle sheet and vinyl tile, representing just over $3 billion of the market. Similar to commercial, LVT offers a highly competitive alternative to carpet with laminate and ceramic, expanding the Resilient market in residential as well. Our brand, Diamond 10 and other innovations, along with our domestic manufacturing, for faster service, provide a solid bedrock to build upon. We also have a robust non PVC offering that we’re beginning to promote in more places, which is especially important to our commercial end users. And beyond North America, we have a global footprint to serve customers very well across Asia and Australia, which we have seen some of our strongest performing markets in recent years. Our execution has been inconsistent in the past but the foundation is still strong and the opportunity is meaningful.

Moving to our positioning on Slide 14. Looking at our products, we’re going to focus on rebuilding the categories where we operate currently. We believe that being the expert in Resilient in every aspect is a significant advantage and allows us to dedicate our efforts to the fastest-growing flooring segment. We are clearly focused on growing our mix of LVT, but overall, we are in the right categories for a purely Resilient company, with all the related ancillary products to support total solutions for clients. We are well positioned within our markets and product categories. Our focus is to excel in the geographic markets across North America, Asia, Australia, where we operate today by expanding our channels. Penetrating deeper and investing in relationship, there is significant untapped potential in the market that we already operate in. So that’s our focus for the next 3 years. We’re working to improve our product line and we are attracting great talent as we build out our sales team. At the same time, as I mentioned earlier, we need to be flexible with certain customers to include the right private label programs so we can maximize our appeal in the marketplace and adapt our offering to partners that have their own branding strategy.

On Slide 15, even with the growth of private label programs, our brand remains strong and desirable. We are encouraged by the continued recognition of Armstrong Flooring in the industry with a strong record of product and brand awards, backed by strong product performance and quality. As we consider the required actions to get our company back on sound footing, our strong industry reputation provides a solid launching pad to reopen doors and participate in new opportunities.

I discussed earlier, the limitations of our short-term cost-focused operating model. On Slide 17, I’ll explain how those factors have directly contributed to our performance issues in the U.S. as reflected in our financial results in recent years. These company-specific performance challenges are also reflected in the current depressed valuation multiple, well below our peers. From all angles, it is clear that our previous strategy was not sustainable. The drivers of top and bottom line underperformance can be grouped into 4 key areas: regression in multiple channels; a slow turning product portfolio; underutilized assets; and complex infrastructure. Prior decisions to pull back sales and marketing efforts through the transfer of branding decisions to distributors, particularly in residential, have deteriorated our position in the market.

These actions have placed responsibility in distributors where they are not correctly equipped to represent us. This has put us further from the people that install the floors as well as the people that own the spaces and make final purchase decisions. In other cases, we have built relationships with end users but forcing them to go through distribution was not aligned with their needs as customer. The products that we have developed have largely been well received by the market but we have, unfortunately, been too slow to market and did not refresh them frequently enough. As an example, we have been, in many months, behind adopting new LVT technologies like WPC, loose lay and now Rigid Core. This is reflected in our sales performance, given that only 10% of our sales are coming from products we have launched in the past 24 months. That ratio based on cycle times and fashion in the flooring industry should be closer to twice that level, so there is significant opportunity for us to improve our launch process and to be more fashionable and relevant.

In our manufacturing, we have multiple production lines that are underutilized. We’ve already taken some steps to address this, but our overall manufacturing footprint needs to be rebalanced to better reflect the trends of our product categories. We will discuss this further and address some of these actions momentarily. When you look at our processes and infrastructure, it is clear that we are too complex. As an example, the fact that we still have multiple custom IT systems layered on top of SAP, some of which are over 20 years old. When we talk about modernization, as a clear example where self-help initiatives will last to process data uniformly, eliminate nonvalue-added activities, make decisions faster and implement actions efficiently to be more agile and responsive with customers. All in, we see significant opportunities to accelerate growth and improve profitability as we address these performance issues, which will improve our returns.

Moving to Slide 19, we have put in place the strategic framework to transform and modernize our business. We have 3 critical focus areas. First and foremost, we’re being closer to our customers to expand our business. Second, we have started simplifying our product offering in our organization so we can become more competitive. And finally, we’re putting in place or strengthening the many niche capabilities to compete at a higher level and make ourselves more appealing. Our new customer-oriented operating model will allow us to more effectively accomplish all 3 objectives.

On Slide 20, our expansion strategy is to gain share where we operate and significantly expand our presence in underserved markets. To reach more customers, we’re adding direct sales representation to connect with large independent retailers, e-commercial contractors and national accounts on large flooring contracts. National and large regional customers expect to work directly with manufacturers on any sizable project. We have already begun to work directly to service some of these customers, such as the National Floor Covering Association membership and large customer — commercial end users, and they are excited to partner with us. Along those same lines, the builder and multifamily channels have changed significantly, with a group of large contractors performing an increasing amount of the installation services. Therefore, many builders have similar expectations of interacting directly with the manufacturer, as they operate in national or super-regional level.

We’re ramping up our selling efforts to restore that direct connectivity in order to meet their needs and deliver on the larger scale. In big box and national accounts, these channels are getting more and more sophisticated with their supply chain. We need to be part of the discussion as they develop their long-term road maps so we can contribute to their success. We also need to work with our distribution network to ensure the selling variance is uniform across the country with the highest names our customers expect. Well-coordinated activities between AFI and our distributor network will create best-in-class customer experience and cost efficiency that will be hard for our competitors to replicate. Another expansion consideration is that there are some verticals that we do not touch directly such as hospitality, corporate or government due to the product offering, sourcing or marketing. All those verticals represent untapped upside potential for us.

Overall, due to our cost focus in recent years, we have dramatically underinvested in our marketing capabilities, digital tools, merchandising and brand awareness across the industry. Fortunately, we’re still the #1 recognized brand in flooring, and the demand creation opportunities within our addressable markets are meaningful. It is our responsibility to energize the marketplace to make sure that the appeal of our brand goes to every demographic over the long term.

On Slide 21, the simplification and optimization of our business is a critical step for us to execute better throughout our organization. In regards to our product portfolio, we have the advantage of being an LVT, which is taking share from most other flooring categories. We also have 1/3 of our business in stable categories such as commercial sheet and residential tile, where we have opportunities to take share. In our mature categories such as VCT and residential sheet, the goal is to optimize our product and footprint to ensure that we can have a source of sustainable cash in order to fund our growth categories. We are in the right categories but we need to improve our weighting towards the faster-growing categories. This means we need to increase our SKU mix towards LVT and reduce the offering in our VCT and residential sheet products, which collectively represent almost half of our SKUS. This is important because this portfolio weighting has heavily influenced our working capital commitments and our allocation of our sales and marketing spend, which has not reflected the direction of the market. Going forward, our marketing, supply chain and design innovation will be weighted heavily towards the growing categories, and we will make sure that our marketing investments and capital investments are also in the same attractive categories. We expect our weighting to shift to LVT over the next 24 months as we eliminate costly and slow turning products. As mentioned earlier, we are off to a good start with 20% of our SKUs discontinued.

On Slide 22, our portfolio rebalancing is in line with the broader objective to refocus our resources to simplify processes and optimize operations. Our system needs significant work to integrate and make ourselves more agile. We believe that as we modernize ourselves over time, we can redeploy SG&A dollars into more productive selling efforts and brand building. Furthermore, at a customer level, there is significant opportunity for us to improve the ease of doing business with Armstrong Flooring. This not only through our go-to-market enhancements but also eliminating back and forth between departments, providing customers with a simplified pricing structure and digitizing the customer experience where possible to get our company up to industry standards, practices.

There’s also additional overhead that can be addressed, such as our headquarters, where we can reduce our lease costs and use those savings to invest in the business or just make ourselves more profitable. There are also opportunities in our manufacturing footprint. It’s important to note that each of our 6 domestic plants produce a different range of products and certain capabilities that some plants still makes sense within our broader facility network. We’re going through the process one by one, evaluating every component of each plant, searching for the best use case or value for — to the company.

In line with that, as announced in November, we consolidated all of our felt sheet production to 1 facility to improve our cost profile. As previously disclosed, we are addressing — monetizing our South Gate facility land portfolio in California as the demographics of that region have become more favorable in recent years. In addition to these actions, we’re consolidating our commercial VCT from 3 plants to 2 plants in Mississippi and Illinois. All options remain on the table to optimize the footprint in the long term, so we can make ourselves more efficient.

On Slide 23, our third pillar is to strengthen the core of our organization. This slide is a direct reflection of the migration of our company from an internally focused model to the customer-centric model. The essential takeaway is that we are revamping and modernizing all processes, work stream, product designs, productivity and culture to raise the bar and ability to service customers. These investments will allow us to redeploy funding to our customer-facing areas and drive further growth.

On Slide 24, we have an exciting pipeline of innovative products that we need to bring to market faster. As mentioned, we are focused on leading the industry being nimble and getting paid for the products that customers want. We’re innovating where we believe we can create value for our customers while generating strong returns. In addition to aesthetics appeal, features such as acoustic and air quality are attracting attention in every flooring category. Non-PVC alternatives are gaining traction. We’re listening to the customers and we’re working to meet their evolving flooring needs. This is a critical step to rebalancing our product portfolio for growth. Recent examples include Rejuvenations Restore, which has been well received in the health care industry for its sound and wellness benefits and we look forward to more launches in coming quarters.

On Slide 25, I’d like to talk to you how we align organization to successfully follow the road map. We have a lot of exciting opportunities and it’s critical that we put in place the right incentive structure to reinforce the changes necessary to drive shareholder value. Our annual incentive programs will now be tied to delivery of sales and gross profit, which is where the biggest challenge has been in recent years. We will also require minimum adjusted EBITDA to ensure that we execute investment prudently. Profitable growth will be foundation of our earnings, which would improve our valuation and, accordingly, long-term incentive targets, which now include substantial share price improvements to restore the company to a more appropriate level. These are the right measures to put in place to ensure that our management team is focused on creating long-term shareholder value.

And now I’ll turn the call over to Doug to review our near-term financial summary and detail our path to become a leaner, faster-growing and more profitable company.

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Douglas B. Bingham, Armstrong Flooring, Inc. – Senior VP, CFO & Treasurer [4]

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Thank you, Michel. I’ll begin with the revenue drivers to support our road map on Slide 27. And as we look to reengage with our customers to drive top line growth, there are several factors that we have taken into account. First, we have established relationships in key commercial verticals, where we will continue to invest. In addition, we will partner with major customers such as the builder multifamily channel to deliver the consistent services they need to run their businesses. Finally, all of these customers already know and trust Armstrong Flooring, so it is important that we stay current in our product offering and time to market. It all comes down to providing the best products and services that our customers want and we believe this will enable us to grow sales.

Looking at Slide 28, our incremental direct sales model will come with higher margins but there are other initiatives we will execute on to improve our gross profit. First, as Michel mentioned earlier, we have taken action at 2 plants to consolidate production and increase our utilization. We also began a strategic assessment of our South Gate facility to explore monetizing that asset. In addition, as we discussed on our last earnings call, we are working to update our pricing approach. This is a sensitive topic for competitive reasons but at a high level, we are reducing complexity for both our customers and ourselves. We are simplifying our product offering in declining categories, particularly residential sheet and VCT, which will allow us to run our plants more efficiently and raise customer satisfaction. Finally, we are developing new logistics capabilities to better serve our customers. In many cases, our current logistics approach is based on capabilities that are outdated and the technological developments in that space provide us with the opportunity to simultaneously improve our service levels, reliability, feed and grow margins. When we benchmark ourselves with the competition, we believe that AFI has a long way from the gross margin that a business with our brand recognition and commercial mix should have. Our improvement plan focuses on realizing that significant potential.

Turning to SG&A on Slide 29, to facilitate the various improvements we have discussed, we are looking to make several key investments. First, we need to put the right sales team in place that can serve our existing customers as well as direct accounts that we don’t currently do business with. We also need to invest wisely in marketing our brand, especially with younger generations, where there is a significant market opportunity. Our business transformation will be helped by 2 important factors. First, we are looking to reduce the lease expense for our corporate headquarters. Second, we have aligned our incentive structure to focus on profitable growth, so that we can set the foundation for enhanced margins.

Furthermore, as we mentioned previously, many of our processes and systems are old and inefficient, which not only increases costs but also adds complexity. One implication is that our control environment is very complex. And as you will see in our 10-K filing, we identified and reported a material weakness in internal controls related to information technology general controls around a specific type of customer rebate program that we use. I can tell you that there have been no misstatements identified in the financial statements as a result of these internal control deficiencies. Remediation efforts have begun but the material weakness will not be considered remediated until the applicable controls operate for a sufficient period of time and we conclude through testing that the controls are operating effectively. We expect the remediation to be completed by the end of fiscal 2020. As we modernize our systems and processes, we expect this will further improve our control environment and allow us to capture operating efficiencies, helping us to more effectively manage costs.

In regard to working capital and CapEx on Slide 30, there are a few key areas we are focused on. First, as we discussed earlier on the call, we are looking to reduce inventory in declining categories and build inventory in growing categories. We also expect to increase our receivables as we sell more product directly to retailers and contractors, in some cases, with longer terms than our current average. We are also looking to initiate targeted capital investments in areas such as recycling capabilities to meet customer needs and reduce cost as well as back-end systems to enable greater operating efficiencies.

We expect to facilitate these key investments in 2 ways. First, we are looking to monetize noncore assets such as the South Gate facility we mentioned earlier. Also, we have closed on a new $100 million ABL facility, which will provide us with improved operating flexibility to invest where we need to in order to grow our business.

Looking at our financial path forward on Slide 31, the challenges we are facing have been building over time and we know that it will require a lot of hard work to improve our results. We have already begun to take action in some areas, like improving the reach and capabilities of our sales team. The reaction of large residential and commercial customers have been very positive. Accordingly, in 2020, we expect to see improvements in our top line for both volume and price mix as well as improvements in gross profit margin. These improvements will be offset in 2020 by the investments required to create a long-term growth engine. In addition, certain 2019 SG&A benefits that we discussed on our previous call will not repeat in 2020. Therefore, we expect a significant percentage decline in our adjusted EBITDA dollars and margin in 2020 compared to 2019.

As we continue to make meaningful progress on our initiatives, the benefits will grow and we expect our EBITDA dollars to be higher in 2021 than 2019, driven by top line growth and productivity generated by our actions. We also expect that our EBITDA margin will improve in 2021 compared to 2019 and each year thereafter as accretive initiatives and investments drive meaningful benefits to results. Given our current low valuation, it will be important that we improve the fundamental health and trajectory of the company. And this will be reflected in top line and gross profit improvements. We will be judicious in our pace of investments and pay particular attention to cash usage. We expect to consume cash over the next 2 years. However, we believe that we can monetize noncore assets to help fund our growth initiatives. As we move into 2022 and beyond, we expect to once again generate positive free cash flow as we restore EBITDA to healthy levels.

I’ll highlight some factors to keep in mind for the first quarter. The 2019 SG&A benefits that I referenced earlier, totaled around $20 million, with roughly 2/3 of that in the first half of 2019 and 1/3 in the second half of 2019. Separately, we directly serve the China market and also have portions of our supply chain in Asia. The coronavirus epidemic is truly tragic and we are doing all we can to keep our regional employees safe. Based on what we know so far in the first quarter of 2020, we expect to see a $6 million to $8 million unfavorable impact to sales and a $2 million to $3 million adverse EBITDA impact due to lower sales in China. Beyond the first quarter, we are likely to experience some supply chain disruptions for our U.S. operations, with some but not all of our suppliers, having started production again. Transportation is improving and our own plant is running but not yet at full capacity since all our employees have not yet returned. We are working to find alternative products in the U.S. market, which should help to offset part of the impact. That said, the full coronavirus impact to our 2020 performance will depend on the magnitude and duration of this epidemic, which remains unclear.

Like any business transformation, we expect that there will be challenges along the way. And it is important for us to stay focused on creating long-term shareholder value rather than managing to the quarter. Accordingly, beginning in 2020, we will no longer provide annual guide ranges as we have in the past. Instead, we will provide an update on the key metrics that are important to delivering our strategic plan. In closing, we believe the steps we are taking should create enhancements that will allow us to drive value for our shareholders in coming years.

With that, I’ll now turn the call back over to Michel for closing remarks on Slide 32.

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Michel S. Vermette, Armstrong Flooring, Inc. – President, CEO & Director [5]

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Thank you, Doug. We have provided you with a clear road map for our company in coming years. It begins with repositioning our culture for constant improvement and empowerment. To reiterate the core enhancement of our new operating model, we are putting the customer first by aligning our services to meet their needs in the ways they want. We are realigning our go-to-market model to operate in every channel, to better reach underserved areas such as builder, multifamily and some key national and global accounts. Becoming an industry leader in product innovation to differentiate the Armstrong Flooring brand while carefully evaluating our participation in unbranded or private label opportunities. Simplifying our processes to fit the size of our company to become more competitive and efficient. Implementing system changes across our plant network that allow us to improve our operations, drive down costs and reignite organic growth. And finally, in investing thoughtfully with a return-focused mindset supported by an improved incentive structure.

We are confident these actions will bring stronger performance to our organization in the coming years and should allow to generate greater value for our shareholders in the future. In conclusion, and to reinforce the key points we want you to take away from today’s call, we believe we are laying a sturdy foundation to build on our growth pillars of expanding, simplifying and strengthening our business in the years ahead. We have a large and addressable market opportunity in the commercial and residential flooring spaces, combined with solid positioning in attractive geographies and product categories and a market-leading brand. I’m confident that our company will become leaner, more agile and more profitable through our multiyear road map to transform and modernize the way we do business. With the full support of the Board, our team is highly aligned with our long-term plan and incentives to get it done. Thank you, again, for joining us today, and we look forward to updating you on our progress during our next quarterly call.

Operator, please open the lines for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Michael Wood with Nomura Instinet.

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Michael Robert Wood, Nomura Securities Co. Ltd., Research Division – Research Analyst [2]

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Thanks for outlining the strategic plan. On that topic, can you talk about the CapEx and SG investment that’s needed as well as just management capacity in general? It sounds like you’re doing a lot and I’ve seen companies in the past move too quickly and suffering some short-term disruption. So just if you can talk about how you’re going to manage all these changes to ensure the relationships remain steady.

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Michel S. Vermette, Armstrong Flooring, Inc. – President, CEO & Director [3]

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So Mike, thank you for the question. This is Michel. I’ll take the management bandwidth one. I think we have a key set of priorities listed, to your point. I think we’re going through a process of triage, what makes sense and what does not make sense and we’re going off priorities. Obviously, engaging with customers is right on top of that. And I think that’s to correct our top line growth and our gross margin growth. So those are, first and foremost, I would say there’s a lot of — we’re doing a lot of things, but also — and everything also ties together to support the go-to-market. So we’re hopeful and we like also the early feedback we’re getting on those activities. But we’re very conscious of that and watching that carefully to make sure we put our energies on the areas that have the most impact, so — and we’ll adjust accordingly. So we’re very much on top of that all the way through. And we brought in some new talent also that helps us execute in these areas. So we’re complementing the team with the right skill set to execute these activities.

So I’ll turn it over to Doug for the SG&A and capital component.

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Douglas B. Bingham, Armstrong Flooring, Inc. – Senior VP, CFO & Treasurer [4]

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Yes, Mike, as we think about where we’re going to invest, clearly, the top line has been the challenge historically and that’s what we want to focus on in driving some improvement there in the gross profit, which is why the SG&A increases that we’ve been talking about have really been focused in the go-to-market space, places where we can get a quick payback. We’re cognizant of the constraints that we have, both for time and money on these investments, and so we’re being judicious in the way that we pace them. The same goes for CapEx. Michel and I look at each capital project as it comes up and make that decision of, “Is this something that is going to have a quick payback for us? Or is this something that we need to delay until a future date?”

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Michael Robert Wood, Nomura Securities Co. Ltd., Research Division – Research Analyst [5]

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Okay. And as you’ve reached out, like you talked about in prior calls to distributors to help shape your plan, can you just share with us some of the top feedback that you received in terms of what they were asking for to help stabilize or improve wallet distribution?

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Michel S. Vermette, Armstrong Flooring, Inc. – President, CEO & Director [6]

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We’ve had very candid conversation with our distributors. I must say, I’m very happy with their support of some of the decisions. They do realize in some areas, we — they were not participating and we were not participating in our prior go-to-market strategy. So they’ve been — as we’ve been very open with them, they’ve been very supportive in this area.

Also, I’m happy to say that as we’re introducing new products, they have been supportive and making commitments to stock in this area. So I think — and the other piece is we made some key investments in people, in products that they recognize and know, and they’re encouraged by what we’re doing product-wise. I think, let’s face it, for them and us, overall, having a great product line helps cures a lot of challenges. So they’re very happy in the direction we’re taking on the product side, in particular.

But we keep evolving. We keep discussing with them things we can help each other. And I think we’re both mutually really important to each other, so we need to be accretive and supportive of that and I look forward to what we can accomplish this year and the years to come.

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Michael Robert Wood, Nomura Securities Co. Ltd., Research Division – Research Analyst [7]

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Great. Just if I can sneak one more in, when — I know it’s early but when your strategy is complete, do you have any sense, at this point, in terms of what you’d be targeting for a longer-term EBIT margin goal?

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Michel S. Vermette, Armstrong Flooring, Inc. – President, CEO & Director [8]

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I think there’s been this question on the company of when we reach a 10%-plus EBITDA, and I think I mentioned earlier in the previous call, I’m totally convinced that can be done. That better. We have some issues we need to fix now. We’re addressing those. But there’s nothing limiting us from doing that. But unfortunately, that hasn’t been the path of the company in the past. And we’re addressing that, and that can definitely be done or better.

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Operator [9]

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Our next question is from Justin Speer with Zelman & Associates.

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Justin A. Speer, Zelman & Associates LLC – MD of Research [10]

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I just wanted to make sure I understood the answer to the previous question. In terms of the SG&A investment growth versus 2019 required in your strategic plan for 2020, can you give us some kind of a baseline to think about for the initiatives? Because recognizing that I know there’s a lot of moving parts, but the headcount initiatives that you have, what kind of SG&A investment growth are you expecting year-over-year?

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Douglas B. Bingham, Armstrong Flooring, Inc. – Senior VP, CFO & Treasurer [11]

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We’re not providing specific details on the magnitude. What I will tell you is that the SG&A investments that we make will be self-funding this year. So as we add additional sales folks or other roles like that, we expect that we’ll have gross margin improvement to offset the cost.

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Justin A. Speer, Zelman & Associates LLC – MD of Research [12]

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Okay. And then in terms of the drive towards LVT and your mix of business, just what will be required from a sourcing standpoint to drive towards that improved mix there, recognizing that you do produce flexible LVT internally?

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Michel S. Vermette, Armstrong Flooring, Inc. – President, CEO & Director [13]

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We do. So we produce flex, and that’s definitely with the current circumstances in the marketplace. That’s a big plus. We also have key relationships outside of China that we’re leveraging to bring product in also. So I think it’s going to be a combination of rigid and loose line to go through. So we have the opportunity to do some of that here soon. So we’re working through that. And I think that’s making sure we’re using our assets for the most profitable type products.

And I think the other thing we’re doing, we’re also investing in working capital. When we started this process, we adjusted some inventory levels of areas we were not participating in the way we should. And so we have made some net working capital investment starting in the fourth quarter, and that will help us for the rest of this year also. So we started adjusting that mix in the fourth quarter, which will benefit us for 2020.

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Justin A. Speer, Zelman & Associates LLC – MD of Research [14]

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Okay, okay. And then in terms of, I guess, in terms of the cash generation expectations, and I know you’re looking for outlays in the next couple of years possibly. But what are the leverage requirements of your refinance credit facility? Just give us a sense for any risks there that we need to be aware of?

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Douglas B. Bingham, Armstrong Flooring, Inc. – Senior VP, CFO & Treasurer [15]

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The ABL structure is really tied more to availability — remaining availability on the facility. So it’s a $100 million facility. And as is standard with a lot of these asset-based loans, if you get to the point where you’ve used all but 15% or somewhere in that range, that’s where it becomes problematic.

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Justin A. Speer, Zelman & Associates LLC – MD of Research [16]

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Right. And then last question for me, just the near- and intermediate-term impact to your portfolio from the removal of Click LVT tariffs. And separately, maybe help us understand what went to your math on the coronavirus impact?

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Douglas B. Bingham, Armstrong Flooring, Inc. – Senior VP, CFO & Treasurer [17]

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Sure. So the impact of the exclusion on the Click products, it’s got kind of a 2-pronged effect. One is that we’ve been able to recognize lower import costs but then we’ve also turned around to our customers and provided that benefit back to them. So we’re still working through the exact details, and this program is scheduled according to the administration to end in August. So we’ll kind of have to see how that dynamic plays out.

So on the coronavirus, what we’ve seen is that our China operations were down for an extended period, given government restrictions on travel, our plant is now up and running, not at full capacity, but up and running. And so the overall Chinese economy, there’s not a lot of construction activity going on right now, obviously. And so that’s where we’ve seen the main impact. As I mentioned earlier, we do expect that there will be some impact to sourcing product into the U.S. from China. We’re still working with our suppliers to understand where they’re at and their ramp-ups and when we can start getting product. And in the meantime, we’re looking at domestic alternatives that we can sell in the marketplace to help our customers meet the needs and deadlines that they have.

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Michel S. Vermette, Armstrong Flooring, Inc. – President, CEO & Director [18]

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And I would add that transportation is a key issue. We’ve been fortunate that our team have secured sailings, and we are getting product from both our vendors and our facility, so that’s definitely a positive. The team has done a great job dealing with that challenge. So we’re staying on top of it daily and focused on it. And — but the team has responded very, very well under difficult circumstances.

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Operator [19]

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(Operator Instructions) We have no further questions at this time. I would like to turn the conference back over to Michel for closing remarks.

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Michel S. Vermette, Armstrong Flooring, Inc. – President, CEO & Director [20]

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Thank you, everyone, for joining us today. We appreciate your interest in Armstrong Flooring, and we look forward to updating you in the next chapter of Armstrong Flooring on future calls. Thank you very much.

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Operator [21]

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Thank you. This does conclude today’s conference. You may disconnect your lines at this time, and thank you for your participation.